<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON SEPTEMBER 28, 1994
SECURITIES ACT FILE NO. 33-40332
INVESTMENT COMPANY ACT FILE NO. 811-6304
- - - --------------------------------------------------------------------------------
- - - --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
FORM N-1A
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 [X]
PRE-EFFECTIVE AMENDMENT NO. [_]
[X]
POST-EFFECTIVE AMENDMENT NO. 4
AND/OR
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 [X]
[X]
AMENDMENT NO. 6
(CHECK APPROPRIATE BOX OR BOXES)
---------------
MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
800 SCUDDERS MILL ROAD PLAINSBORO, 08536
NEW JERSEY (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE
OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (609) 282-2800
ARTHUR ZEIKEL
MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC.
800 SCUDDERS MILL ROAD, PLAINSBORO, NEW JERSEY
MAILING ADDRESS: P.O. BOX 9011, PRINCETON, NEW JERSEY 08543-9011
(NAME AND ADDRESS OF AGENT FOR SERVICE)
---------------
COPIES TO:
COUNSEL FOR THE FUND: PHILIP L. KIRSTEIN, ESQ.
BROWN & WOOD MERRILL LYNCH ASSET MANAGEMENT
ONE WORLD TRADE CENTER
NEW YORK, NEW YORK 10048-0557 P.O. BOX 9011
PRINCETON, NEW JERSEY 08543-9011
ATTENTION: THOMAS R. SMITH, JR.
IT IS PROPOSED THAT THIS FILING WILL BECOME EFFECTIVE (CHECK APPROPRIATE BOX):
[X] immediately upon filing pursuant to paragraph (b)
[_] on (date) pursuant to paragraph (b)
[_] 60 days after filing pursuant to paragraph (a)
[_] on (date) pursuant to paragraph (a) of rule 485.
---------------
THE REGISTRANT HAS REGISTERED AN INDEFINITE NUMBER OF ITS SHARES UNDER THE
SECURITIES ACT OF 1933 PURSUANT TO RULE 24F-2 UNDER THE INVESTMENT COMPANY ACT
OF 1940. THE NOTICE REQUIRED BY SUCH RULE FOR THE REGISTRANT'S MOST RECENT
FISCAL YEAR WAS FILED ON JULY 22, 1994.
CALCULATION OF REGISTRATION FEE UNDER THE SECURITIES ACT OF 1933
- - - --------------------------------------------------------------------------------
- - - --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PROPOSED PROPOSED
AMOUNT OF MAXIMUM MAXIMUM
TITLE OF SECURITIES SHARES BEING OFFERING PRICE AGGREGATE AMOUNT OF
BEING REGISTERED REGISTERED PER UNIT OFFERING PRICE* REGISTRATION FEE
- - - -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Shares of Common Stock (par value
$0.10 per share)................. 41,420,452 $9.75 $289,995 $100
</TABLE>
- - - --------------------------------------------------------------------------------
- - - --------------------------------------------------------------------------------
*(1) The calculation of the maximum aggregate offering price is made pursuant
to Rule 24e-2 under the Investment Company Act of 1940.
(2) The total amount of securities redeemed or repurchased during Registrant's
previous fiscal year was 41,390,709 shares.
(3) None of the shares described in (2) above have been used for reduction
pursuant to Rule 24e-2(a) or Rule 24f-2(c) under the Investment Company Act
of 1940 in previous filings during Registrant's current fiscal year.
(4) 41,390,709 of the shares redeemed during Registrant's previous fiscal year
are being used for the reduction of the registration fee in this amendment to
the Registration Statement.
- - - --------------------------------------------------------------------------------
- - - --------------------------------------------------------------------------------
<PAGE>
MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC.
REGISTRATION STATEMENT ON FORM N-1A
CROSS REFERENCE SHEET
<TABLE>
<CAPTION>
N-
1A ITEM NO. LOCATION
----------- --------
<C> <S> <C>
PART A
Item 1. Cover Page................. Cover Page
Item 2. Synopsis................... Prospectus Summary and Fee Table
Item 3. Condensed Financial
Information............... Not Applicable
Item 4. General Description of
Registrant................ Investment Objective and Policies;
Additional Information
Item 5. Management of the Fund..... Fee Table; Management of the Fund;
Inside Back Cover Page
Item 6. Capital Stock and Other
Securities................ Cover Page; Additional Information
Item 7. Purchase of Securities
Being Offered............. Cover Page; Fee Table; Alternative
Sales Arrangements; Purchase of
Shares; Shareholder Services;
Additional Information; Inside Back
Cover Page
Item 8. Redemption or Repurchase... Fee Table; Alternative Sales
Arrangements; Purchase of Shares;
Redemption of Shares
Item 9. Pending Legal Proceedings.. Not Applicable
PART B
Item 10. Cover Page................. Cover Page
Item 11. Table of Contents.......... Back Cover Page
Item 12. General Information and
History................... Not Applicable
Item 13. Investment Objectives and
Policies.................. Investment Objectives and Policies
Item 14. Management of the Fund..... Management of the Fund
Item 15. Control Persons and
Principal Holders of
Securities................ Management of the Fund
Item 16. Investment Advisory and
Other Services............ Management of the Fund; Purchase of
Shares; General Information
Item 17. Brokerage Allocation and
Other Practices........... Portfolio Transactions and
Brokerage; Financial Statements
Item 18. Capital Stock and Other
Securities................ General Information
Item 19. Purchase, Redemption and
Pricing of Securities
Being Offered............. Purchase of Shares; Redemption of
Shares; Determination of Net Asset
Value; Shareholder Services
Item 20. Tax Status................. Distributions and Taxes
Item 21. Underwriters............... Purchase of Shares
Item 22. Calculation of Performance
Data...................... Performance Data
Item 23. Financial Statements....... Financial Statements
</TABLE>
PART C
Information required to be included in Part C is set forth under the
appropriate Item, so numbered, in Part C to this Registration Statement.
<PAGE>
PROSPECTUS
September 28, 1994
MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC.
P.O. BOX 9011, PRINCETON, NEW JERSEY 08543-9011 . PHONE NO. (609) 282-2800
----------------
Merrill Lynch Adjustable Rate Securities Fund, Inc. (the "Fund") is a mutual
fund seeking high current income consistent with a policy of limiting the
degree of fluctuation in net asset value of Fund shares resulting from
movements in interest rates. The Fund seeks to achieve this objective by
investing primarily in a portfolio of adjustable rate securities, consisting
principally of mortgage-backed and asset-backed securities. The Fund does not,
however, attempt to maintain a constant net asset value per share. The Fund
may engage in various portfolio strategies to enhance income and to hedge its
portfolio against investment and interest rate risks, including the use of
interest rate transactions, options on portfolio securities, financial futures
contracts and options on such futures. There can be no assurance that the
investment objective of the Fund will be realized.
The Fund offers two classes of shares which may be purchased at a price
equal to the next determined net asset value per share, plus a sales charge
which, at the election of the purchaser, may be imposed (i) at the time of
purchase (the "Class A shares"), or (ii) on a deferred basis (the "Class B
shares"). The original charges to which the Class B shares are subject shall
consist of a contingent deferred sales charge which may be imposed on
redemptions made within three years of purchase and an ongoing account
maintenance and distribution fee. These alternatives permit an investor to
choose the method of purchasing shares that the investor believes is most
beneficial given the amount of the purchase, the length of time the investor
expects to hold the shares and other circumstances. Class A shares pay an
ongoing account maintenance fee at the annual rate of 0.25% of the Fund's
average daily net assets attributable to Class A shares; Class B shares pay an
ongoing account maintenance fee and an ongoing distribution fee at annual
rates of 0.25% and 0.50%, respectively, of the Fund's average daily net assets
attributable to the Class B shares. Investors should understand that the
purpose and function of the deferred sales charge and account maintenance fee
with respect to the Class B shares are the same as those of the initial sales
charge and account maintenance fee with respect to the Class A shares.
Investors should also understand that over time the deferred sales charges
related to Class B shares may exceed the initial sales charge and account
maintenance fee with respect to Class A shares. See "Alternative Sales
Arrangements" on page 5. On or about October 21, 1994, the Fund intends to
commence offering additional classes of shares having different sales charges
and distribution arrangements than those offered by this Prospectus. Also, the
Fund's exchange privilege will be modified on or about October 24, 1994. See
"Shareholder Services--Exchange Privilege" below.
Each Class A share and Class B share represents an identical interest in the
investment portfolio of the Fund and has the same rights, except that Class B
shares bear the expenses of the account maintenance and distribution fees and
certain other costs resulting from the deferred sales charge arrangement,
which will cause Class B shares to have a higher expense ratio and to pay
lower dividends than Class A shares, which also bear the expense of an account
maintenance fee. The two classes also have different exchange privileges.
Shares may be purchased directly from Merrill Lynch Funds Distributor, Inc.
(the "Distributor"), P.O. Box 9011, Princeton, New Jersey 08543-9011 [(609)
282-2800], or from securities dealers which have entered into selected dealer
agreements with the Distributor, including Merrill Lynch, Pierce, Fenner &
Smith Incorporated ("Merrill Lynch"). The minimum initial purchase is $1,000
and the minimum subsequent purchase is $50, except that for retirement plans
the minimum initial purchase is $100 and the minimum subsequent purchase is
$1. Merrill Lynch may charge its customers a processing fee (presently $4.85)
for confirming purchases and repurchases. Purchases and redemptions directly
through the Fund's Transfer Agent are not subject to the processing fee. See
"Purchase of Shares" and "Redemption of Shares."
----------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PRO-SPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
----------------
This Prospectus is a concise statement of information about the Fund that is
relevant to making an investment in the Fund. This Prospectus should be
retained for future reference. A statement containing additional information
about the Fund dated September 28, 1994 (the "Statement of Additional
Information"), has been filed with the Securities and Exchange Commission and
is available, without charge, by calling or by writing the Fund at the above
telephone number or address. The Statement of Additional Information is hereby
incorporated by reference into this Prospectus.
----------------
MERRILL LYNCH ASSET MANAGEMENT--MANAGER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC.--DISTRIBUTOR
<PAGE>
PROSPECTUS SUMMARY AND FEE TABLE
The following summary is qualified in its entirety by reference to the more
detailed information included elsewhere in this Prospectus and in the Statement
of Additional Information.
THE FUND
Merrill Lynch Adjustable Rate Securities Fund, Inc. (the "Fund") is a
diversified management investment company.
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to seek high current income
consistent with a policy of limiting the degree of fluctuation in the net asset
value of Fund shares from movements in interest rates. The Fund will seek to
achieve its objective by investing at least 65% of its total assets in
adjustable rate securities ("Adjustable Rate Securities"). Adjustable Rate
Securities bear interest at rates that adjust at periodic intervals in
conjunction with changes in market levels of interest rates. The Adjustable
Rate Securities in which the Fund will invest will consist principally of
mortgage-backed and asset-backed securities. Such securities will be issued or
guaranteed by agencies or instrumentalities of the United States or be rated AA
by Standard & Poor's Corporation ("Standard & Poor's") or Aa by Moody's
Investors Service, Inc. ("Moody's"). The Fund may engage in various portfolio
strategies to enhance income and to hedge its portfolio against investment and
interest rate risks, including the use of interest rate transactions, options
on portfolio securities, financial futures contracts and options on such
futures. There can be no assurance that the investment objective of the Fund
will be realized.
The Fund may invest up to 35% of its total assets in other types of mortgage
and asset related securities, and derivative securities relating thereto,
including fixed rate mortgage and asset related securities and stripped
securities. Such securities must be issued or guaranteed by agencies or
instrumentalities of the United States or be rated "investment grade" by
Standard & Poor's (currently AAA, AA, A and BBB) or Moody's (currently Aaa, Aa,
A and Baa). No more than 10% of the Fund's total assets will be invested in
securities rated in the lowest category of investment grade. The Fund may also
invest in debentures issued by the Federal National Mortgage Association. The
Fund also, under normal circumstances, may invest up to 35% of its total assets
in money market securities rated in the highest rating category by Standard &
Poor's or Moody's and, for temporary or defensive purposes, may invest up to
100% of its assets in such money market securities. See "Investment Objective
and Policies."
SPECIAL CONSIDERATIONS AND RISK FACTORS
The types of securities in which the Fund invests have certain unique
attributes that warrant special consideration or that present risks that may
not exist in other types of mutual fund investments. Some of these
considerations and risks pertain to the characteristics of mortgage-backed
securities ("MBSs") or asset-backed securities ("ABSs") generally, while others
are peculiar to Adjustable Rate Securities. One of the principal risks
regarding MBSs and, to a lesser extent, ABSs is the risk of prepayments.
Prepayment rates are affected by changes in prevailing interest rates and
numerous economic, geographic, social and other factors. The special
considerations and risks inherent in investments in MBSs and ABSs are discussed
under "Investment Objective and Policies--Special Considerations and Risk
Factors."
2
<PAGE>
THE MANAGER
The Fund's investment adviser is Merrill Lynch Asset Management, L.P. (the
"Manager" or "MLAM"). The Manager is owned and controlled by Merrill Lynch &
Co., Inc., a financial services holding company and the parent of Merrill
Lynch. The Manager, or an affiliate of the Manager, Fund Asset Management, L.P.
("FAM"), acts as the investment adviser for more than 100 other registered
investment companies. MLAM and FAM also offer portfolio management and
portfolio analysis services to individuals and institutions. As of August 31,
1994, the Manager and FAM had a total of approximately $165.7 billion in
investment company and other portfolio assets under management, including
accounts of certain affiliates of MLAM. See "Management of the Fund--Management
and Advisory Arrangements."
PURCHASE AND REDEMPTION OF SHARES
Shares of the Fund may be purchased at a price equal to the next determined
net asset value per share, plus a sales charge which, at the election of the
purchaser, may be imposed either (i) at the time of the purchase (the "Class A
shares"), or (ii) on a deferred basis (the "Class B shares"). Class A shares
pay an ongoing account maintenance fee and Class B shares pay an ongoing
account maintenance fee and an ongoing distribution fee. See "Alternative Sales
Arrangements" and "Purchase of Shares."
Shareholders may redeem their shares at any time at the next determined net
asset value. The Class B shares may be subject to a contingent deferred sales
charge if redeemed within three years of purchase. See "Redemption of Shares."
DIVIDENDS AND DISTRIBUTIONS
It is the Fund's intention to distribute all its net investment income.
Dividends from such net investment income will be declared daily prior to the
determination of net asset value on that day and paid monthly. All net realized
long-term and short-term capital gains, if any, will be distributed to the
Fund's shareholders at least annually. See "Additional Information--Dividends
and Distributions."
DETERMINATION OF NET ASSET VALUE
The net asset value of the Fund is determined by the Manager once daily at
4:15 P.M. following the normal close of trading on the New York Stock Exchange
on each day during which the New York Stock Exchange is open for trading. See
"Additional Information--Determination of Net Asset Value."
3
<PAGE>
FEE TABLE
A general comparison of the sales arrangements and other nonrecurring and
recurring expenses applicable to Class A and Class B shares follows:
<TABLE>
<CAPTION>
CLASS A SHARES CLASS B SHARES
INITIAL SALES DEFERRED SALES
CHARGE ALTERNATIVE CHARGE ALTERNATIVE
------------------ -------------------
<S> <C> <C>
SHAREHOLDER TRANSACTION EXPENSES:
Maximum Sales Charge Imposed on Pur-
chases (as a percentage of offering
price)................................ 3.00%(a) None
Sales Charge Imposed on Dividend Rein-
vestments............................. None None
Deferred Sales Charge (as a percentage
of original purchase price or redemp-
tion proceeds, whichever is lower).... None 3.00%
during
the first
year,
decreasing
1.0%
annually
to 0.00%
after the
third
year(b)
Exchange Fee........................... None None
ANNUAL FUND OPERATING EXPENSES (AS A
PERCENTAGE OF AVERAGE NET ASSETS):
Management Fees(c)..................... 0.50% 0.50%
Rule 12b-1 Fees(d)..................... 0.25% 0.75%
Other Expenses
Custodial Fees......................... 0.01% 0.01%
Shareholder Servicing Costs(e)......... 0.08% 0.08%
Other.................................. 0.12% 0.12%
----- -----
Total Other Expenses................. 0.21% 0.21%
----- -----
Total Fund Operating Expenses........... 0.96% 1.46%
===== =====
</TABLE>
- - - --------
(a) Reduced for purchases of $100,000 and over, decreasing to 0.50% for
purchases of $5,000,000 and over. Certain purchases of $5,000,000 or more
in a single transaction will, in lieu of a front-end sales load, be
subject to a contingent deferred sales charge of 0.25% of the dollar
amount of the purchase if the shares are redeemed within one year after
purchase. See "Purchase of Shares--Initial Sales Charge Alternative--Class
A Shares"--page 27.
(b) See "Purchase of Shares--Deferred Sales Charge Alternative--Class B
Shares"--page 29.
(c) See "Management of the Fund--Management and Advisory Arrangements"--page
23.
(d) See "Purchase of Shares--Alternative Sales Arrangements--Distribution
Plans"--page 26.
(e) See "Management of the Fund--Transfer Agency Services"--page 24.
EXAMPLE:
<TABLE>
<CAPTION>
CUMULATIVE EXPENSES PAID
FOR THE PERIOD OF:
-------------------------------
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
An investor would pay the following expenses
on a $1,000 investment including, for Class A
shares, the maximum $30 front-end sales
charge and assuming (1) an operating expense
ratio of 0.96% for Class A shares and 1.46%
for Class B shares, (2) a 5% annual return
throughout the periods and (3) redemption at
the end of the period:
Class A...................................... $39.50 $59.67 $81.50 $144.27
Class B...................................... $44.86 $56.17 $79.74 $174.63
An investor would pay the following expenses
on the same $1,000 investment assuming no re-
demption at the end of the period:
Class A...................................... $39.50 $59.67 $81.50 $144.27
Class B...................................... $14.86 $46.17 $79.74 $174.63
</TABLE>
The foregoing Fee Table is intended to assist investors in understanding the
costs and expenses that a shareholder in the Fund will bear directly or
indirectly. The Example set forth above assumes reinvestment of all dividends
and distributions and utilizes a 5% annual rate of return as mandated by
Securities and Exchange Commission regulations. THE EXAMPLE SHOULD NOT BE
CONSIDERED A REPRESENTATION OF PAST OR FUTURE EXPENSES OR ANNUAL RATE OF
RETURN, AND ACTUAL EXPENSES OR ANNUAL RATE OF RETURN MAY BE MORE OR LESS THAN
THOSE ASSUMED FOR PURPOSES OF THE EXAMPLE. Class B shareholders who hold their
shares for an extended period of time may pay more in Rule 12b-1 distribution
fees than the economic equivalent of the maximum front-end sales charges
permitted under the Rules of Fair Practice of the National Association of
Securities Dealers, Inc. Merrill Lynch may charge its customers a processing
fee (presently $4.85) for confirming purchases and redemptions. Purchases and
redemptions directly through the Fund's Transfer Agent are not subject to the
processing fee. See "Purchase of Shares" and "Redemption of Shares."
4
<PAGE>
ALTERNATIVE SALES ARRANGEMENTS
Shares of the Fund may be purchased at a price equal to the next determined
net asset value per share, plus a sales charge which, at the election of the
purchaser, may be imposed either (i) at the time of the purchase (the "initial
sales charge alternative"), or (ii) on a deferred basis (the "deferred sales
charge alternative").
Class A Shares. An investor who elects the initial sales charge alternative
acquires Class A shares. Class A shares incur a sales charge when they are
purchased and are subject to an ongoing account maintenance fee of 0.25% of the
Fund's average net assets attributable to the Class A shares. Although Class A
shares incur a sales charge when they are purchased, they enjoy the benefit of
not being subject to the ongoing distribution fee to which Class B shares are
subject or any sales charge when they are redeemed. Certain purchases of Class
A shares qualify for reduced initial sales charges. See "Purchase of Shares--
Initial Sales Charge Alternative--Class A Shares."
Class B Shares. An investor who elects the deferred sales charge alternative
acquires Class B shares. Class B shares do not incur a sales charge when they
are purchased, but they are subject to ongoing account maintenance and
distribution fees of 0.25% and 0.50%, respectively, of the Fund's average net
assets attributable to the Class B shares and a sales charge if they are
redeemed within three years of purchase. Class B shares enjoy the benefit of
permitting all of the investor's dollars to work from the time the investment
is made. The ongoing distribution fee paid by Class B shares will cause such
shares to have a higher expense ratio and to pay lower dividends than Class A
shares. Both Class A shares and Class B shares pay an ongoing account
maintenance fee. Payment of the distribution fee is subject to certain limits
as set forth under "Purchase of Shares--Deferred Sales Charge Alternative--
Class B Shares."
As an illustration, investors who qualify for significantly reduced sales
charges might elect the initial sales charge alternative because similar sales
charge reductions are not available for purchases under the deferred sales
charge alternative. Shares acquired under the initial sales charge alternative
would be subject to an ongoing account maintenance fee that is lower than the
sum of the ongoing account maintenance fee and distribution fee on Class B
shares. However, because initial sales charges are deducted at the time of
purchase, such investors would not have all their funds invested initially.
Investors not qualifying for reduced initial sales charges who expect to
maintain their investment for an extended period of time might also elect the
initial sales charge alternative because over time the accumulated continuing
account maintenance and distribution fees on Class B shares may exceed the
initial sales charge and ongoing account maintenance fee on Class A shares.
Again, however, such investors must weigh this consideration against the fact
that not all their funds will be invested initially. Furthermore, the ongoing
account maintenance and distribution fees will be offset to the extent any
return is realized on the additional funds initially invested under the
deferred alternative. However, there can be no assurance as to the return, if
any, which will be realized on such additional funds. Certain other investors
might determine it to be more advantageous to have all their funds invested
initially, although remaining subject to continued account maintenance and
distribution fees and, for a three-year period of time, a contingent deferred
sales charge.
The distribution expenses incurred by the Distributor and dealers (primarily
Merrill Lynch) in connection with the sale of the shares will be paid, in the
case of the Class A shares, from the proceeds of the initial sales charge and
ongoing account maintenance fee and, in the case of the Class B shares, from
the proceeds of the ongoing account maintenance and distribution fees and the
contingent deferred sales charge incurred upon redemption within three years of
purchase. Sales personnel may receive different compensation for selling Class
A or Class B shares. Investors should understand that the purpose and function
of the deferred sales charges and ongoing account maintenance fee with respect
to the Class B shares are the same as those of the initial sales charge and
account maintenance fee with respect to the Class A shares.
5
<PAGE>
Dividends paid by the Fund with respect to Class A and Class B shares, to the
extent any dividends are paid, will be calculated in the same manner at the
same time on the same day and will be in the same amount, except that account
maintenance and distribution fees and any incremental transfer agency costs
relating to Class B shares will be borne exclusively by that Class and the
account maintenance fee relating to Class A shares will be borne exclusively by
that Class. See "Additional Information--Determination of Net Asset Value."
Class A and Class B shareholders of the Fund each have an exchange privilege
for Class A and Class B shares, respectively, of certain other mutual funds
sponsored by Merrill Lynch. Class A and Class B shareholders of the Fund also
may exchange their shares for shares of certain money market funds sponsored by
Merrill Lynch. See "Shareholder Services--Exchange Privilege."
The Directors of the Fund have determined that currently no conflict of
interest exists between the Class A and Class B shares. On an ongoing basis,
the Directors of the Fund, pursuant to their fiduciary duties under the
Investment Company Act of 1940 (the "1940 Act") and state laws, will seek to
assure that no such conflict arises.
THE ALTERNATIVE SALES ARRANGEMENTS PERMIT AN INVESTOR TO CHOOSE THE METHOD
OF PURCHASING SHARES THAT IS MOST BENEFICIAL GIVEN THE AMOUNT OF THE
PURCHASE, THE LENGTH OF TIME THE INVESTOR EXPECTS TO HOLD THE SHARES AND
OTHER CIRCUMSTANCES. INVESTORS SHOULD DETERMINE WHETHER UNDER THEIR
PARTICULAR CIRCUMSTANCES IT IS MORE ADVANTAGEOUS TO INCUR AN INITIAL SALES
CHARGE AND AN ONGOING ACCOUNT MAINTENANCE FEE, OR TO HAVE THE ENTIRE
INITIAL PURCHASE PRICE INVESTED IN THE FUND WITH THE INVESTMENT THEREAFTER
BEING SUBJECT TO ONGOING ACCOUNT MAINTENANCE AND DISTRIBUTION FEES. TO
ASSIST INVESTORS IN MAKING THIS DETERMINATION, THE FEE TABLE ON PAGE 4
SETS FORTH THE CHARGES APPLICABLE TO EACH CLASS OF SHARES AND A DISCUSSION
OF RELEVANT FACTORS IN MAKING SUCH DETERMINATION IS SET FORTH UNDER
"PURCHASE OF SHARES--ALTERNATIVE SALES ARRANGEMENTS" ON PAGE 25.
6
<PAGE>
FINANCIAL HIGHLIGHTS
The financial information in the table below has been audited in conjunction
with the annual audit of the financial statements of the Fund by Deloitte &
Touche LLP, independent auditors. Financial statements and the independent
auditor's report thereon for the fiscal year ended May 31, 1994 are included in
the Statement of Additional Information. Further information about the
performance of the Fund is contained in the Fund's most recent annual report to
shareholders which may be obtained, without charge, by calling or by writing
the Fund at the telephone number or address on the front cover of this
Prospectus.
The following per share data and ratios have been derived from the
information provided in the financial statements.
<TABLE>
<CAPTION>
CLASS A CLASS B
--------------------------- -----------------------------
FOR THE FOR THE
PERIOD FOR THE YEAR PERIOD
FOR THE YEAR AUGUST 2, ENDED AUGUST 2,
ENDED MAY 31, 1991+ TO MAY 31, 1991+ TO
---------------- MAY 31, ------------------ MAY 31,
Increase (Decrease) in 1994 1993 1992 1994 1993 1992
Net Asset Value: ------- ------- --------- -------- -------- ---------
<S> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING PER-
FORMANCE:
Net asset value, begin-
ning of period......... $ 9.76 $ 9.92 $ 10.00 $ 9.76 $ 9.92 $ 10.00
------- ------- ------- -------- -------- --------
Investment income--net.. .37 .45 .56 .32 .40 .52
Realized and unrealized
loss on investments--
net.................... (.24) (.16) (.08) (.24) (.16) (.08)
------- ------- ------- -------- -------- --------
Total from investment
operations............. .13 .29 .48 .08 .24 .44
------- ------- ------- -------- -------- --------
Less dividends:
Investment income--net. (.36) (.45) (.56) (.31) (.40) (.52)
------- ------- ------- -------- -------- --------
Net asset value, end of
period................. $ 9.53 $ 9.76 $ 9.92 $ 9.53 $ 9.76 $ 9.92
======= ======= ======= ======== ======== ========
TOTAL INVESTMENT RE-
TURN:**
Based on net asset value
per share.............. 1.28% 2.99% 4.75%++ 0.77% 2.48% 4.33%++
======= ======= ======= ======== ======== ========
RATIOS TO AVERAGE NET
ASSETS:
Expenses, net of reim-
bursement and excluding
account maintenance and
distribution fees...... .71% .66% .62%* .71% .65% .61%*
======= ======= ======= ======== ======== ========
Expenses, net of reim-
bursement.............. .96% .91% .87%* 1.46% 1.40% 1.36%*
======= ======= ======= ======== ======== ========
Expenses................ .96% .91% .96%* 1.46% 1.40% 1.47%*
======= ======= ======= ======== ======== ========
Investment income--net.. 3.69% 4.79% 6.54%* 3.20% 4.15% 6.07%*
======= ======= ======= ======== ======== ========
SUPPLEMENTAL DATA:
Net assets, end of
period (in thousands).. $23,043 $51,398 $80,411 $374,376 $689,593 $887,110
======= ======= ======= ======== ======== ========
Portfolio turnover...... 60.38% 104.71% 94.72% 60.38% 104.71% 94.72%
======= ======= ======= ======== ======== ========
</TABLE>
- - - --------
* Annualized.
** Total investment returns exclude the effects of sales loads; total
investment returns would be lower if sales loads were included.
+ Commencement of Operations.
++ Aggregate total investment return.
7
<PAGE>
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to seek high current income
consistent with a policy of limiting the degree of fluctuation in the net asset
value of Fund shares from movements in interest rates. The Fund will seek to
achieve its objective by investing at least 65% of its total assets in
adjustable rate securities ("Adjustable Rate Securities"). Adjustable Rate
Securities bear interest at rates that adjust at periodic intervals in
conjunction with changes in market levels of interest rates. The Adjustable
Rate Securities in which the Fund will invest will consist principally of
mortgage-backed and asset-backed securities. Such securities will be issued or
guaranteed by agencies or instrumentalities of the United States or be rated AA
by Standard & Poor's Corporation ("Standard & Poor's") or Aa by Moody's
Investors Service, Inc. ("Moody's"). The investment objective and policies set
forth in the first two sentences of this paragraph are fundamental policies and
may not be changed without shareholder approval.
The Fund may invest up to 35% of its total assets in other types of mortgage
and asset related securities, and derivative securities relating thereto,
including fixed rate mortgage and asset related securities and stripped
securities. Such securities must be issued or guaranteed by agencies or
instrumentalities of the United States or be rated "investment grade" by
Standard & Poor's or Moody's. Securities rated investment grade are obligations
rated at the time of purchase within the four highest quality ratings as
determined by either Standard & Poor's (currently AAA, AA, A and BBB) or
Moody's (currently Aaa, Aa, A and Baa). No more than 10% of the Fund's total
assets will be invested in securities rated in the lowest category of
investment grade. The Fund may also invest in debentures issued by the Federal
National Mortgage Association. The Fund also, under normal circumstances, may
invest up to 35% of its total assets in money market securities rated in the
highest rating category by Standard & Poor's or Moody's and, for temporary or
defensive purposes, may invest up to 100% of its assets in such money market
securities.
The Fund will invest at least 65% of its total assets in Adjustable Rate
Securities. The distinguishing feature of Adjustable Rate Securities is that
interest payments made thereon will vary in relation to a specified index,
typically at a spread over such index. Merrill Lynch Asset Management, L.P.,
the Fund's manager (the "Manager"), believes that because of the
characteristics of Adjustable Rate Securities, a portfolio of such securities
is likely to generate current income in excess of a portfolio of money market
securities but with less volatility in market value (and consequently, the
Fund's net asset value) than fixed rate mortgage-backed or asset-backed
securities and other fixed rate debt obligations of comparable maturity. At the
same time, however, the Fund's net asset value will be more volatile than that
of a portfolio of money market securities. Additionally, if interest rates
decrease, the Fund may experience a lower total return than a fund investing in
fixed-rate long-term debt, such as U.S. Treasury bonds.
The Adjustable Rate Securities in which the Fund will invest will consist
principally of mortgage-backed securities (herein sometimes referred to as
"MBSs") and asset-backed securities (herein sometimes referred to as "ABSs").
MBSs are securities that directly or indirectly represent an interest in, or
are backed by and payable from, mortgage loans secured by real property. ABSs
generally consist of structures similar to MBSs, except that the underlying
asset pools are comprised of credit card, automobile or other types of
receivables, or of commercial loans (receivables and commercial loans are
together referred to herein as "financial assets"). MBSs and ABSs are issued in
structured financings wherein the sponsor securitizes the underlying mortgage
loans or financial assets in order to liquify the underlying assets or to
achieve certain other financial goals. The special considerations and risks
inherent in investments in MBSs and ABSs are discussed more fully below. See
"Investment Objective and Policies--Special Considerations and Risk Factors."
8
<PAGE>
The Adjustable Rate Securities in which the Fund may invest may also include
debentures of the Federal National Mortgage Association which bear interest at
an adjustable rate. See "Investment Objective and Policies--Description of
Other Securities" for a description of such debentures.
TYPES OF ISSUERS/QUALITY STANDARDS
The Fund intends to invest primarily in mortgage-backed and asset-backed
securities. The MBSs in which the Fund may invest will primarily be either
guaranteed by the Government National Mortgage Association ("GNMA"), or issued
by the Federal National Mortgage Association ("FNMA") or the Federal Home Loan
Mortgage Corporation ("FHLMC"). Certain of the ABSs in which the Fund will
invest will be guaranteed by the Small Business Administration ("SBA").
Certain of the MBSs and ABSs in which the Fund may invest will be issued by
private issuers. Privately issued MBSs and ABSs may take a form similar to
pass-through MBSs issued by agencies or instrumentalities of the United States,
described below, or may be structured in a manner similar to other types of
ABSs or MBSs, also described below. Private issuers include originators of or
investors in mortgage loans and receivables such as savings and loan
associations, savings banks, commercial banks, investment banks, finance
companies and special purpose finance subsidiaries of any of the above. With
respect to the Adjustable Rate Securities comprising at least 65% of the Fund's
total assets, securities issued by private issuers must be rated at least AA by
Standard & Poor's or Aa by Moody's or, if unrated, be of comparable quality as
determined by the Manager. The rating may be based, in part, on certain types
of credit enhancements issued in respect of those securities. Such credit
enhancements may include insurance policies, bank letters of credit, guarantees
by third parties or protections afforded by the structure of a particular
transaction (e.g., the use of reserve funds, over-collateralization or the
issuance of subordinated securities as protection for more senior securities
being purchased by the Fund). In purchasing securities for the Fund, the
Manager will take into account not only the creditworthiness of the issuer of
the securities, but also the creditworthiness of the provider of any external
credit enhancement of the securities.
Up to 35% of the Fund's total assets may be invested in securities rated in
rating categories below AA by Standard & Poor's or Aa by Moody's. Any such
rated securities will be rated investment grade by Standard & Poor's or
Moody's. Securities rated investment grade are obligations rated at the time of
purchase within the four highest quality ratings as determined by either
Standard & Poor's (currently AAA, AA, A and BBB) or Moody's (currently Aaa, Aa,
A and Baa). The Fund may also invest in unrated securities which possess
characteristics which are, in the opinion of the Manager, similar to those of
securities rated at least BBB or Baa. Securities rated BBB by Standard & Poor's
or Baa by Moody's and comparable unrated securities may be subject to greater
market price fluctuations and are considered more speculative than more highly
rated securities with respect to the capacity to pay interest and repay
principal in accordance with the terms of the security. In purchasing such
securities, the Fund will rely on the Manager's judgment, analysis and
experience in evaluating the creditworthiness of the issuer of such securities.
The Manager will take into consideration, among other things, the underwriting
standards of the originator of the underlying loans, applicable loan-to-value
ratios, regional pressures affecting the housing market, the type of property
underlying the loans, and the general sensitivity of the securities to economic
conditions and trends. Similarly, if an issue of securities rated at the time
of purchase in one of the two highest rating categories by Standard & Poor's or
Moody's ceases to be rated, or its rating is reduced, the Manager will consider
such factors as price, credit risk, market conditions and interest rates to
determine whether to continue to hold the securities in the Fund's portfolio.
No more than 10% of the Fund's total assets will be invested in securities
rated in the lowest category of investment grade or in comparable unrated
securities. A description of applicable ratings is contained in the Appendix to
the Statement of Additional Information.
9
<PAGE>
GNMA, FNMA and FHLMC are agencies or instrumentalities of the United States,
and MBSs issued or guaranteed by them are generally considered to be of higher
quality than privately issued securities rated AA or Aa. GNMA MBSs are
guaranteed by GNMA and consist of pass-through interests in pools of mortgage
loans guaranteed or insured by agencies or instrumentalities of the United
States. FNMA and FHLMC MBSs are issued by FNMA and FHLMC, respectively, and
most often represent pass-through interests in pools of similarly insured or
guaranteed mortgage loans or pools of conventional mortgage loans or
participations therein. GNMA, FNMA and FHLMC "pass-through" MBSs are so-named
because they represent undivided interests in the underlying mortgage pools and
a pro rata share of both regular interest and principal payments (net of fees
assessed by GNMA, FNMA and FHLMC and any applicable loan servicing fees), as
well as unscheduled early prepayments on the underlying mortgage pool, are
passed through monthly to the holder of the MBSs (i.e., the Fund). As described
more fully below, FNMA and FHLMC also may issue types of mortgage-backed
securities other than pass-through MBSs.
Timely payment of principal and interest on GNMA MBSs is guaranteed by GNMA,
a wholly owned corporate instrumentality of the United States within the
Department of Housing and Urban Development, which guarantee is backed by the
full faith and credit of the United States. FNMA, a federally chartered and
privately owned corporation organized and existing under the Federal National
Mortgage Association Charter Act, guarantees timely payment of principal and
interest on FNMA MBSs. FHLMC, a corporate instrumentality of the United States,
guarantees (i) the timely payment of interest on all FHLMC MBSs, (ii) the
ultimate collection of principal with respect to some FHLMC MBSs, and (iii) the
timely payment of principal with respect to other FHLMC MBSs. Neither the
obligations of FNMA nor those of FHLMC are backed by the full faith and credit
of the United States. Nevertheless, because of the relationship of each such
entity to the United States, it is widely believed that MBSs issued by such
entities are high quality securities with minimal credit risk.
The SBA is an independent agency of the United States, and ABSs guaranteed by
the SBA carry a guarantee of both principal and interest. The guarantee given
by the SBA is backed by the full faith and credit of the United States.
Set forth below is a description of the mortgage and asset related securities
in which the Fund may invest. The Fund may invest in other similar types of
mortgage and asset related securities, including those which may be developed
in the future, without shareholder approval.
DESCRIPTION OF ADJUSTABLE RATE SECURITIES
As stated above, the Fund will invest primarily in Adjustable Rate
Securities. The interest paid on Adjustable Rate Securities and, therefore, the
current income earned by the Fund by investing in such securities, will be a
function primarily of the indexes upon which adjustments are based and the
applicable spread relating to such securities. Examples of indexes which may be
used are (i) one, three and five year U.S. Treasury securities adjusted to a
constant maturity index, (ii) U.S. Treasury bills of three or six months, (iii)
the daily Bank Prime Loan Rate made available by the Federal Reserve Board,
(iv) the cost of funds of member institutions for the Federal Home Loan Bank of
San Francisco ("COFI"), and (v) the offered quotations to leading banks in the
London interbank market for Eurodollar deposits of a specified duration
("LIBOR").
The interest rates paid on Adjustable Rate Securities are generally
readjusted periodically to an increment over the chosen interest rate index.
Such readjustments occur at intervals ranging from one to
10
<PAGE>
thirty-six months. The degree of volatility in the market value of the Fund's
portfolio and of the net asset value of Fund shares will be a function
primarily of the length of the adjustment period and the degree of volatility
in the applicable indexes. It will also be a function of the maximum increase
or decrease of the interest rate adjustment on any one adjustment date, in any
one year and over the life of the securities. These maximum increases and
decreases are typically referred to as "caps" and "floors," respectively. The
Fund does not seek to maintain an overall average cap or floor, although the
Manager will consider caps or floors in selecting Adjustable Rate Securities
for the Fund.
While the Fund does not attempt to maintain a constant net asset value per
share, during periods in which short-term interest rates move within the caps
and floors of the Fund's portfolio the fluctuation in the market value of the
Adjustable Rate Securities portfolio is expected to be relatively limited,
since the interest
rate on the portfolio will adjust to market rates within a short period of
time. In periods of substantial short-term volatility in short-term interest
rates, the value of the portfolio may fluctuate more substantially since the
caps and floors of the Adjustable Rate Securities in the portfolio may not
permit the interest rate to adjust to the full extent of the movements in
short-term rates during any one adjustment period. In the event of dramatic
increases in interest rates, the lifetime caps on the Adjustable Rate
Securities may prevent such securities from adjusting to prevailing rates over
the term of the loan. In this circumstance, the market value of the Adjustable
Rate Securities may be substantially reduced with a corresponding decline in
the Fund's net asset value.
Mortgaged-Backed Securities. The Fund will invest in pass-through mortgage-
backed securities which are collateralized by a pool of adjustable rate
mortgages ("ARMs") on single-family or multi-family residences. ARMs typically
provide for a fixed initial interest rate for either the first three, six, 12,
13 or 36 scheduled monthly payments. Thereafter, the payment of interest on the
remaining principal amount of the ARM is at a rate which is adjusted on a
periodic basis at a spread over the average market rate of interest over the
adjustment period, a specified short-term debt instrument or cost of funds
rate. Thus, interest payments on ARMs (and, consequently, on adjustable rate
MBSs) will increase or decrease with fluctuations in the specified index,
subject to any applicable caps and floors. Principal payments on the loan are
generally amortized over the stated term of the ARM and there is no penalty for
prepayment of principal.
In addition, the Fund will invest in collateralized mortgage obligations
("CMOs") paying adjustable rates of interest. CMOs are debt obligations
collateralized by mortgage loans or mortgage pass-through securities.
Typically, CMOs are collateralized by pass-through MBSs guaranteed by GNMA, or
issued by FNMA or FHLMC. They may, however, also be collateralized by whole
loans or by pass-through MBSs of private issuers. The collateral for CMOs is
hereinafter referred to as "CMO Collateral." The term CMO as used herein also
includes multi-class pass-through securities, which are equity interests in a
trust composed of CMO Collateral. CMOs may be issued by agencies or
instrumentalities of the United States, including FNMA and FHLMC, or by the
types of private issuers described above. The issuer of a series of CMOs may
elect to be treated as a Real Estate Mortgage Investment Conduit ("REMIC").
The funds for payment on the CMOs are derived from payments of principal and
interest on the underlying CMO Collateral, and, to the extent provided in a
particular transaction, any reinvestment income therefrom. In the case of
adjustable rate CMOs, payments are made generally in the manner described above
with respect to Adjustable Rate Securities generally. The interest on some
CMOs, however, may vary inversely with the rate of a specified index. Thus, for
example, the return to the Fund on a CMO that varies inversely with LIBOR will
increase as the LIBOR rate decreases, and vice versa. Since the interest paid
on
11
<PAGE>
inverse floating rate CMOs is generally set at some multiple of an index such
as LIBOR, an increase in the index rate will typically result in an even
greater decrease in the interest paid on the CMOs. See "Indexed and Inverse
Securities" below.
Most CMOs are structured with multiple classes. Each class is issued at a
fixed or, as in the case of adjustable rate CMOs, a floating coupon rate, and
has a specified maturity or final distribution date. The interest rate paid on
CMOs with a floating coupon rate may adjust regardless of whether the mortgage
loans or underlying CMO Collateral pay a fixed or a floating rate. Principal
prepayments on the CMO Collateral may cause the CMOs to be retired
substantially earlier than their stated maturities or final distribution dates.
Interest is paid or accrues on all classes of the CMOs on a monthly, quarterly
or semiannual basis. The principal of and interest on the CMO Collateral may be
allocated among the several classes of a CMO in many ways. In one structure,
payments of principal, including any principal prepayments, on the CMO
Collateral are applied to the classes of the CMO in the order of their
respective stated maturities or final distribution dates, so that no payment of
principal will be made on any class of CMOs until all other classes having an
earlier stated maturity or final distribution date have been paid in full. In
other structures, certain CMO classes may pay concurrently or one or more
classes may have a priority with respect to payments on the underlying CMO
Collateral up to a specified amount.
Asset-Backed Securities. The Fund will invest in various types of Adjustable
Rate Securities in the form of ABSs. The securitization techniques used in the
context of ABSs are similar to those used for MBSs. Thus, through the use of
trusts and special purpose corporations, various types of receivables,
primarily home equity loans and automobile and credit card receivables, are
securitized in pass-through structures similar to the mortgage pass-through
structures described above or in a pay-through structure similar to the CMO
structure. ABSs are typically bought or sold from or to the same entities that
act as primary dealers in U.S. Government securities.
The Fund's investments in Adjustable Rate Securities consisting of ABSs may
include pass-through securities collateralized by SBA guaranteed loans whose
interest rates adjust in much the same fashion as described above with respect
to ARMs. Such loans generally include commercial loans such as working capital
loans and equipment loans. The underlying loans are originally made by private
lenders and are guaranteed in part by the SBA. It is the guaranteed portion of
such loans that constitute the underlying financial assets in these ABSs.
In general, the collateral supporting ABSs is of shorter maturity than
mortgage loans and may be less likely to experience substantial prepayments. As
with MBSs, ABSs are often backed by a pool of assets representing the
obligations of a number of different parties. Currently, pass-through
securities collateralized by SBA guaranteed loans and home equity loans are the
most prevelant ABSs which are Adjustable Rate Securities. The market for ABSs
is currently smaller and less developed than that for MBSs, and consequently,
it is anticipated that the majority of Adjustable Rate Securities held by the
Fund will be MBSs.
ABSs are relatively new and untested instruments and may be subject to
greater risk of default during periods of economic downturn than other
securities, including MBSs, satisfying the quality standards of the Fund,
resulting in possible losses to the Fund. Also, the secondary market for ABSs
may not be as liquid as the market for other securities, including MBSs, which
may result in the Fund experiencing difficulty in valuing such securities.
Investments in ABSs that cannot be disposed of promptly within seven days and
in the usual course of business without taking a reduced price will be
considered illiquid and limited to an amount which, together with other
illiquid investments, does not exceed 10% of the value of the Fund's net
assets.
12
<PAGE>
Indexed and Inverse Securities. As described above, the Fund may invest in
Adjustable Rate Securities whose potential investment return is based on the
change in particular measurements of value or rate (an "index"). As an
illustration, the Fund may invest in an Adjustable Rate Security that pays
interest and returns principal based on the change in an index of interest
rates such as LIBOR. Interest and principal payable on a security may also be
based on relative changes among particular indices. In addition, the Fund may
invest in Adjustable Rate Securities whose potential investment return is
inversely based on the change in particular indices. For example, the Fund may
invest in securities that pay a higher rate of interest and principal when a
particular index decreases and pay a lower rate of interest and principal when
the value of the index increases. To the extent that the Fund invests in such
types of securities, it will be subject to the risks associated with changes in
the particular indices, which may include reduced or eliminated interest
payments and losses of invested principal.
Certain indexed securities, including certain inverse securities, may have
the effect of providing a degree of investment leverage, because they may
increase or decrease in value at a rate that is a multiple of the changes in
applicable indices. As a result, the market value of such securities will
generally be more volatile than the market values of fixed-rate securities. The
Fund believes that indexed securities, including inverse securities, represent
flexible portfolio management instruments that may allow the Fund to seek
potential investment rewards, hedge other portfolio positions, or vary the
degree of portfolio leverage relatively efficiently under different market
conditions.
DESCRIPTION OF OTHER SECURITIES
The Fund may invest up to 35% of its total assets in mortgage or asset
related securities other than Adjustable Rate Securities, either alone or in
combination with money market securities. Other securities in which the Fund
may invest consist principally of fixed rate MBSs and ABSs, stripped
securities, and fixed rate debt securities of FNMA which are not MBSs.
Fixed rate MBSs in which the Fund may invest consist primarily of fixed rate
pass-through securities and fixed rate CMOs. As in the case of Adjustable Rate
Securities, these fixed rate securities may be issued either by agencies or
instrumentalities of the United States or by the types of private issuers
described above. Similarly, the basic structures with respect to fixed rate
MBSs are the same as those described above with respect to Adjustable Rate
Securities. The principal difference between fixed rate securities and
Adjustable Rate Securities is that the interest rate on the former type of
securities is set at a predetermined amount and does not vary according to
changes in any index. As in the case of Adjustable Rate Securities, fixed rate
ABSs reflect basically the same structures as fixed rate MBSs.
Stripped mortgage-backed securities ("SMBSs") are derivative multiclass
mortgage-backed securities. Such securities are typically issued by the same
types of issuers as are MBSs generally. The structure of SMBSs, however, is
different. SMBS arrangements commonly involve two classes of securities that
receive different proportions of the interest and principal distributions on a
pool of mortgage assets. A common variety of SMBS is where one class (the
principal-only or PO class) receives some of the interest and most of the
principal from the underlying assets, while the other class (the interest-only
or IO class) receives most of the interest and the remainder of the principal.
In the most extreme case, the IO class receives all of the interest, while the
PO class receives all of the principal. While the Fund may purchase securities
of a PO class, it is more likely to purchase the securities of an IO class. The
yield to maturity of an IO class is extremely sensitive to the rate of
principal payments (including prepayments) on the related underlying assets,
and a rate of principal payments in excess of that considered in pricing the
securities will have a material
13
<PAGE>
adverse effect on an IO security's yield to maturity. If the underlying
mortgage assets experience greater than anticipated payments of principal, the
Fund may fail to recoup fully its initial investment in IOs. In addition, there
are certain types of IOs which represent the interest portion of a particular
class as opposed to the interest portion of the entire pool. The sensitivity of
this type of IO to interest rate fluctuations may be increased because of the
characteristics of the principal portion to which they relate. As a result of
the above factors, the Fund generally will purchase IOs only as a component of
so-called "synthetic" securities. This means that purchases of IOs will be
matched with certain purchases of other securities such as inverse floating
rate CMOs or fixed rate securities; as interest rates fall, presenting a
greater risk of unanticipated prepayments of principal, the negative effect on
the Fund because of its holdings of IOs should be diminished somewhat because
of the increased yield on the inverse floating rate CMOs or the increased
appreciation on the fixed rate securities. IOs and POs are considered by the
staff of the Securities and Exchange Commission to be illiquid securities and,
consequently, the Fund will not invest in IOs or POs in an amount which, taken
together with the Fund's other investments in illiquid securities, exceeds 10%
of the Fund's net assets.
The Fund may also purchase debentures issued by FNMA. FNMA debentures are
unsecured general obligations of FNMA. FNMA's obligations have traditionally
been treated as "U.S. Agency" debt in the marketplace and are eligible for
investment by many supervised financial institutions without regard to legal
limits generally imposed on investment securities. However, the debentures
(together with interest thereon) are not guaranteed by the United States and do
not constitute a debt or obligation of the United States or of any agency or
instrumentality thereof other than FNMA. The debentures generally are issued in
book-entry form and are offered through a nationwide group of securities
dealers and dealer banks. FNMA does not generally sell its debentures directly
to investors. The debentures typically bear interest at fixed rates per annum,
payable semiannually in arrears and computed on the basis of a 360-day year of
twelve 30-day months.
DESCRIPTION OF MONEY MARKET SECURITIES
The money market securities in which the Fund may invest consist of United
States Government securities, United States Government agency or
instrumentality securities, domestic bank or savings institution certificates
of deposit and bankers' acceptances, short-term debt securities such as
commercial paper and other corporate debt, and repurchase agreements. These
investments must have a maturity not in excess of one year from the date of
purchase.
The Fund has established the following standards with respect to money market
securities in which the Fund invests. Commercial paper investments at the time
of purchase must be rated "A-1" by Standard & Poor's or "Prime-1" by Moody's
or, if not rated, be issued by companies having such a rating with respect to
comparable short-term debt securities. Investments in corporate bonds and
debentures (which must have maturities at the date of purchase of one year or
less) will be limited to securities of issuers which, at the time of purchase,
have a rating with respect to comparable short-term debt of A-1 by Standard &
Poor's or Prime-1 by Moody's. The Fund may not invest in any security issued by
a commercial bank or a savings institution unless the bank or institution is
organized and operating in the United States, has total assets of at least one
billion dollars and is a member of the Federal Deposit Insurance Corporation.
SPECIAL CONSIDERATIONS AND RISK FACTORS
The types of securities in which the Fund invests have certain unique
attributes that warrant special consideration or that present risks that may
not exist in other types of mutual fund investments. Some of these
considerations and risks pertain to the characteristics of MBSs or ABSs
generally, while others are
14
<PAGE>
peculiar to Adjustable Rate Securities. One of the principal risks regarding
MBSs and, to a lesser extent, ABSs is the risk of prepayments. From time to
time, prepayment rates on MBSs have been high. The rate of principal
prepayments on MBSs will depend on the rates of principal payments on the
related mortgages. In general, when prevailing mortgage interest rates decline
significantly below the interest rates on the mortgages, the prepayment rate on
the mortgages is likely to increase, although a number of other factors may
also influence the prepayment rate, such as the acceleration of mortgage
payments due to transfers of mortgaged properties, liquidations due to default
and refinancings of existing loans. No assurance can be given as to the rate
and timing of principal prepayments on mortgage loans underlying MBSs. High
prepayment rates may have an adverse effect on the value of MBS securities and
in particular SMBSs, such as IOs.
Payments of principal of and interest on MBSs and ABSs are made more
frequently than are payments on conventional debt securities. In addition,
holders of MBSs and of certain ABSs (such as ABSs backed by home equity loans)
may receive unscheduled payments of principal at any time representing
prepayments on the underlying mortgage loans or financial assets. Such
prepayments may usually be made by the related obligor without penalty.
Prepayment rates are affected by changes in prevailing interest rates and
numerous other economic, geographic, social and other factors. (ABSs backed by
other than home equity loans do not generally prepay in response to changes in
interest rates, but may be subject to prepayments in response to other
factors.) Changes in the rate of prepayments will generally affect the yield to
maturity of the security. Moreover, when the holder of the security attempts to
reinvest prepayments or even the scheduled payments of principal and interest,
it may receive a rate of interest which is higher or lower than the rate on the
MBS or ABS originally held. Another consideration is that to the extent that
MBSs or ABSs are purchased at a premium, mortgage foreclosures and principal
prepayments may result in loss to the extent of premium paid. On the other
hand, where such securities are bought at a discount, both scheduled payments
of principal and unscheduled prepayments will increase current and total
returns and will accelerate the recognition of income which, when distributed
to shareholders, will be taxable as ordinary income. The Manager will consider
remaining maturities or estimated average lives of MBSs and ABSs in selecting
them for the Fund. Finally, ABSs may present certain risks not present in MBSs.
While ABSs are a growing sector of the financial markets, they are relatively
new instruments and may be subject to a greater risk of default during periods
of economic downturn than are MBSs. Additionally, assets underlying ABSs such
as credit-card receivables are generally unsecured, and debtors are entitled to
the protection of various state and Federal consumer protection laws. Some of
those laws give a right of set-off, which may reduce the balance owed. Also,
the market for ABSs may not be as liquid as that for MBSs.
Adjustable Rate Securities have several characteristics that should be
considered before investing in the Fund. As indicated above, the interest rate
reset features of Adjustable Rate Securities held by the Fund will reduce the
effect on the net asset value of Fund shares caused by changes in market
interest rates. See "Investment Objective and Policies--Description of
Adjustable Rate Securities." However, the market value of Adjustable Rate
Securities and, therefore, the Fund's net asset value, may vary to the extent
that the current interest rate on such securities differs from market interest
rates during periods between the interest reset dates. These variations in
value occur inversely to changes in the market interest rates. Thus, if market
interest rates rise above the current rates on the securities, the value of the
securities will decrease; conversely, if market interest rates fall below the
current rate on the securities, the value of the securities will rise. If
investors in the Fund sold their shares during periods of rising rates before
an adjustment occurred, such investors may suffer some loss. The longer the
adjustment intervals on Adjustable Rate Securities held by the Fund, the
greater the potential for fluctuations in the Fund's net asset value.
Investors in the Fund will receive increased income as a result of upward
adjustments of the interest rates on Adjustable Rate Securities held by the
Fund in response to market interest rates. However, the Fund
15
<PAGE>
and its shareholders will not benefit from increases in market interest rates
once such rates rise to the point where they cause the rates on such Adjustable
Rate Securities to reach their maximum adjustment date, annual or lifetime
caps. In addition, because of their interest rate adjustment feature,
Adjustable Rate Securities are not an effective means of "locking-in"
attractive interest rates for periods in excess of the adjustment period. Also
a consideration, in the case of privately issued MBSs where the underlying
mortgage assets carry no agency or instrumentality guarantee, is that the
mortgagors on the loans underlying Adjustable Rate Securities are often
qualified for such loans on the basis of the original payment amounts. The
mortgagors' income may not be sufficient to enable them to continue making
their loan payments as such payments increase, resulting in a greater
likelihood of default. The Fund seeks to guard against this risk, however,
through the Fund's quality standards, discussed above.
Conversely, any benefits to the Fund and its shareholders from an increase in
the Fund's net asset value caused by falling market interest rates is reduced
by the potential for increased prepayments and a decline in the interest rates
paid on Adjustable Rate Securities held by the Fund. When market rates decline
significantly, the prepayment rate on Adjustable Rate Securities is likely to
increase as borrowers refinance with fixed rate mortgage loans, thereby
decreasing the capital appreciation potential of Adjustable Rate Securities. In
this regard, the Fund is not designed for investors seeking capital
appreciation.
As described above under "Description of Adjustable Rate Securities--Indexed
and Inverse Securities," the Fund may invest in Adjustable Rate Securities
whose potential investment return is inversely based on the change in
particular indices. Such securities may have the effect of providing a degree
of investment leverage because they may increase or decrease in value at a rate
that is a multiple of the changes in applicable indices. As a result, the
market values of such securities will generally be more volatile than the
market values of fixed-rate securities.
Under normal circumstances, it is anticipated that the Fund's annual
portfolio turnover rate will be less than 200%. High portfolio turnover
involves correspondingly greater transaction costs in the form of dealer
spreads and brokerage commissions, which are borne directly by the Fund.
PORTFOLIO STRATEGIES INVOLVING INTEREST RATE TRANSACTIONS, OPTIONS AND FUTURES
The Fund may engage in various portfolio strategies to seek to increase its
return through the use of options on portfolio securities and to hedge its
portfolio against movements in interest rates. The Fund has authority to engage
in interest rate transactions in order to hedge against interest rate
movements, purchase call and put options on securities, write (i.e., sell)
covered call and put options on its portfolio securities, and engage in hedging
transactions in financial futures, and related options on such futures. Each of
these portfolio strategies is described below.
Although certain risks are involved in interest rate, options and futures
transactions, the Manager believes that, because the Fund will (i) write only
covered options on portfolio securities, and (ii) engage in other transactions
only for hedging purposes, these portfolio strategies will not subject the Fund
to the risks frequently associated with the speculative use of such
transactions. While the Fund's use of hedging strategies is intended to reduce
the volatility of the net asset value of Fund shares, the Fund's net asset
value will fluctuate. There can be no assurance that the Fund's hedging
transactions will be effective. Furthermore, the Fund will only engage in
hedging activities from time to time and may not necessarily be engaging in
hedging activities when movements in interest rates occur. Reference is made to
the Statement of Additional Information for further information concerning
these strategies.
Interest Rate Hedging Transactions. In order to hedge the value of the Fund's
portfolio against interest rate fluctuations, the Fund may enter into various
hedging transactions, such as interest rate swaps and the
16
<PAGE>
purchase or sale of interest rate caps and floors. The Fund expects to enter
into these transactions primarily to preserve a return or spread on a
particular investment or portion of its portfolio or to protect against any
increase in the price of securities the Fund anticipates purchasing at a later
date. The Fund intends to use these transactions as a hedge and not as a
speculative investment.
The purchase of an interest rate cap entitles the purchaser, to the extent
that a specified index exceeds a predetermined interest rate, to receive
payments of interest on a notional principal amount from the party selling such
interest rate cap. The purchase of an interest rate floor entitles the
purchaser, to the extent that a specified index falls below a predetermined
interest rate, to receive payments of interest on a notional principal amount
from the party selling such interest rate floor.
In an interest rate swap the Fund exchanges with another party their
respective commitments to pay or receive interest, e.g., an exchange of
floating rate payments for fixed rate payments. The net amount of the excess,
if any, of the Fund's obligations over its entitlement with respect to each
interest rate swap will be accrued on a daily basis and an amount of cash, cash
equivalents or high grade liquid debt securities having an aggregate net asset
value at least equal to the accrued excess will be maintained in a segregated
account by the Fund's custodian.
The Fund will not enter into any interest rate swap, cap or floor transaction
unless the unsecured senior debt or the claims-paying ability of the other
party thereto is rated in one of the highest two rating categories of at least
one nationally recognized statistical rating organization at the time of
entering into such transaction or whose creditworthiness is believed by the
Manager to be equivalent to such rating. If there is a default by the other
party to such a transaction, the Fund will have contractual remedies pursuant
to the agreements related to the transaction. The Manager believes that the
swap market is relatively liquid. Caps and floors, however, are less liquid
than swaps. The Fund will not enter into a cap or floor transaction in an
amount which, together with other illiquid investments of the Fund, exceeds 10%
of the Fund's net assets.
Call Options on Portfolio Securities. The Fund may purchase call options on
any of the types of securities in which it may invest. A purchased call option
gives the Fund the right to buy, and obligates the seller to sell, the
underlying security at the exercise price at any time during the option period.
The Fund also is authorized to write (i.e., sell) covered call options on the
securities in which it may invest and to enter into closing purchase
transactions with respect to certain of such options. A covered call option is
an option where the Fund, in return for a premium, gives another party a right
to buy specified securities owned by the Fund at a specified future date and
price set at the time of the contract. The principal reason for writing call
options is to attempt to realize, through the receipt of premiums, a greater
return than would be realized on the securities alone. By writing covered call
options, the Fund gives up the opportunity, while the option is in effect, to
profit from any price increase in the underlying security above the option
exercise price. In addition, the Fund's ability to sell the underlying security
will be limited while the option is in effect unless the Fund effects a closing
purchase transaction. A closing purchase transaction cancels out the Fund's
position as the writer of an option by means of an offsetting purchase of an
identical option prior to the expiration of the option it has written. Covered
call options also serve as a partial hedge against the price of the underlying
security declining.
Put Options on Portfolio Securities. The Fund is authorized to purchase put
options to hedge against a decline in the value of its securities. By buying a
put option the Fund has a right to sell the underlying security at the exercise
price, thus limiting the Fund's risk of loss through a decline in the market
value of the security until the put option expires. The amount of any
appreciation in the value of the underlying security will be partially offset
by the amount of the premium paid for the put option and any related
transaction costs. Prior
17
<PAGE>
to its expiration, a put option may be sold in a closing sale transaction and
profit or loss from the sale will depend on whether the amount received is
more or less than the premium paid for the put option plus the related
transaction costs. A closing sale transaction cancels out the Fund's position
as the purchaser of an option by means of an offsetting sale of an identical
option prior to the expiration of the option it has purchased. The Fund also
has authority to write (i.e., sell) put options on the types of securities
which may be held by the Fund, provided that such put options are covered,
meaning that such options are secured by segregated, high quality liquid debt
securities. The Fund will receive a premium for writing a put option, which
increases the Fund's return. In selling puts, there is a risk that the Fund
may be required to buy the underlying security at a disadvantageous price.
Financial Futures and Options Thereon. The Fund is authorized to engage in
transactions in financial futures contracts ("futures contracts"), and related
options on such futures contracts as a hedge against adverse changes in the
market value of its portfolio securities and interest rates. A futures
contract is an agreement between two parties which obligates the purchaser of
the futures contract to buy and the seller of a futures contract to sell a
security for a set price on a future date or, in the case of an index futures
contract, to make and accept a cash settlement based upon the difference in
value of the index between the time the contract was entered into and the time
of its settlement. Transactions by the Fund in futures contracts and financial
futures are subject to limitations as described below under "Restrictions on
the Use of Futures Transactions."
The Fund may sell financial futures contracts in anticipation of an increase
in the general level of interest rates. Generally, as interest rates rise, the
market values of securities which may be held by the Fund will fall, thus
reducing the net asset value of the Fund. However, as interest rates rise, the
value of the Fund's short position in the futures contract will also tend to
increase, thus offsetting all or a portion of the depreciation in the market
value of the Fund's investments which are being hedged. While the Fund will
incur commission expenses in selling and closing out futures positions, these
commissions are generally less than the transaction expenses which the Fund
would have incurred had the Fund sold portfolio securities in order to reduce
its exposure to increases in interest rates. The Fund also may purchase
financial futures contracts in anticipation of a decline in interest rates
when it is not fully invested in a particular market in which it intends to
make investments to gain market exposure that may in part or entirely offset
an increase in the cost of securities it intends to purchase. It is
anticipated that, in a substantial majority of these transactions, the Fund
will purchase securities upon termination of the futures contract.
The Fund also has authority to purchase and write call and put options on
futures contracts in connection with its hedging activities. Generally, these
strategies are utilized under the same market and market sector conditions
(i.e., conditions relating to specific types of investments) in which the Fund
enters into futures transactions. The Fund may purchase put options or write
call options on futures contracts rather than selling the underlying futures
contract in anticipation of a decrease in the market value of a security or an
increase in interest rates. Similarly, the Fund may purchase call options, or
write put options on futures contracts, as a substitute for the purchase of
such futures to hedge against the increased cost resulting from an increase in
the market value or a decline in interest rates of securities which the Fund
intends to purchase.
The Fund may engage in options and futures transactions on exchanges and
options in the over-the-counter markets ("OTC options"). In general, exchange-
traded contracts are third-party contracts (i.e., performance of the parties'
obligations is guaranteed by an exchange or clearing corporation) with
standardized strike prices and expiration dates. OTC options transactions are
two-party contracts with price and terms negotiated by the buyer and seller.
See "Restrictions on OTC Options" below for information as to restrictions on
the use of OTC options.
18
<PAGE>
Restrictions on the Use of Futures Transactions. Regulations of the Commodity
Futures Trading Commission ("CFTC") applicable to the Fund provide that the
futures trading activities described herein will not result in the Fund being
deemed a "commodity pool," as defined under such regulations if the Fund
adheres to certain restrictions. In particular, the Fund may purchase and sell
futures contracts and options thereon (i) for bona fide hedging purposes, and
(ii) for non-hedging purposes, if the aggregate initial margin and premiums
required to establish positions in such contracts and options does not exceed
5% of the liquidation value of the Fund's portfolio, after taking into account
unrealized profits and unrealized losses on any such contracts and options.
When the Fund purchases a futures contract or writes a put option or
purchases a call option thereon, an amount of cash and cash equivalents will be
deposited in a segregated account with the Fund's custodian so that the amount
so segregated, plus the amount of variation margin held in the account of its
broker, equals the market value of the futures contract, thereby ensuring that
the use of such futures is unleveraged.
An order has been obtained from the Securities and Exchange Commission (the
"Commission") which exempts the Fund from certain provisions of the Investment
Company Act of 1940 in connection with transactions involving futures contracts
and options thereon.
Restrictions on OTC Options. The Fund will engage in OTC options only with
member banks of the Federal Reserve System and primary dealers in U.S.
Government securities or with affiliates of such banks or dealers which have
capital of at least $50 million or whose obligations are guaranteed by an
entity having capital of at least $50 million.
The staff of the Commission has taken the position that purchased OTC options
and the assets used as cover for written OTC options are illiquid securities.
Therefore, except to the extent set forth in the Statement of Additional
Information, the Fund has adopted an investment policy pursuant to which it
will not purchase or sell OTC options (including OTC options on futures
contracts) if, as a result of such transaction, the sum of the market value of
OTC options currently outstanding which are held by the Fund, the market value
of the underlying securities covered by OTC options currently outstanding which
were sold by the Fund and margin deposits on the Fund's existing OTC options on
futures contracts exceed 10% of the net assets of the Fund, taken at market
value, together with all other assets of the Fund which are illiquid or are not
otherwise readily marketable.
Risk Factors in Interest Rate Transactions and Options and Futures
Transactions. The use of interest rate transactions is a highly specialized
activity which involves investment techniques and risks different from those
associated with ordinary portfolio securities transactions. Interest rate
transactions involve the risk of an imperfect correlation between the index
used in the hedging transaction and that pertaining to the securities which are
the subject of such transaction. If the Manager is incorrect in its forecasts
of market values, interest rates and other applicable factors, the investment
performance of the Fund would diminish compared with what it would have been if
these investment techniques were not used. In addition, interest rate
transactions that may be entered into by the Fund do not involve the delivery
of securities or other underlying assets or principal. Accordingly, the risk of
loss with respect to interest rate swaps is limited to the net amount of
interest payments that the Fund is contractually obligated to make. If the MBS
or other security underlying an interest rate swap is prepaid and the Fund
continues to be obligated to make payments to the other party to the swap, the
Fund would have to make such payments from another source. If the other party
to an interest rate swap defaults, the Fund's risk of loss consists of the net
amount of interest payments that the Fund contractually is entitled to receive.
In the case of a purchase by the Fund of an interest rate cap or floor, the
amount of loss is limited to the fee paid.
19
<PAGE>
Utilization of options and futures transactions to hedge the portfolio
involves the risk of imperfect correlation in movements in the price of
options and futures and movements in the prices of the securities which are
the subject of the hedge. If the price of the options or futures moves more or
less than the price of the subject of the hedge, the Fund will experience a
gain or loss which will not be completely offset by movements in the price of
the subject of the hedge. This risk particularly applies to the Fund's use of
futures and options thereon since it will generally use such instruments as a
so-called "cross-hedge," which means that the security that is the subject of
the futures contract is different from the security being hedged by the
contract. The Fund will not purchase puts, calls, straddles, spreads or any
combination thereof if by reason thereof the premiums paid for the aggregate
investments in such classes of securities exceed 5% of the Fund's total assets
at the time of purchase.
The Fund intends to enter into options and futures transactions, on an
exchange or in the over-the-counter market, only if there appears to be a
liquid secondary market for such options or futures. However, there can be no
assurance that a liquid secondary market will exist at any specific time.
Thus, it may not be possible to close an options or futures position. The
inability to close options and futures positions also could have an adverse
impact on the Fund's ability to effectively hedge its portfolio. There is also
the risk of loss by the Fund of margin deposits or collateral in the event of
bankruptcy of a broker with whom the Fund has an open position in an option, a
futures contract or an option related to a futures contract.
OTHER INVESTMENT POLICIES AND PRACTICES
Repurchase Agreements and Purchase and Sale Contracts. The Fund may invest
in securities pursuant to repurchase agreements and purchase and sale
contracts. Repurchase agreements and purchase and sale contracts may be
entered into only with a member bank of the Federal Reserve System or primary
dealer in U.S. Government securities or an affiliate thereof. Under such
agreements, the bank or primary dealer or an affiliate thereof agrees, upon
entering into the contract, to repurchase the security at a mutually agreed
upon time and price, thereby determining the yield during the term of the
agreement. This results in a fixed rate of return insulated from market
fluctuations during such period. The Fund may not invest in repurchase
agreements maturing in more than seven days if, as a result, more than 10% of
the Fund's net assets would be invested in illiquid securities, including such
repurchase agreements. In the event of default by the seller under a
repurchase agreement, the Fund may suffer time delays and incur costs or
possible losses in connection with the disposal of the collateral.
Lending of Portfolio Securities. The Fund may from time to time lend
securities from its portfolio with a value not exceeding 33 1/3% of its total
assets, to banks, brokers and other financial institutions and receive
collateral in cash or securities issued or guaranteed by the United States
Government which will be maintained at all times in an amount equal to at
least 100% of the current market value of the loaned securities. During the
period of this loan, the Fund receives the income on the loaned securities and
either receives the income on the collateral or other compensation (i.e.,
negotiated loan premium or fee) for entering into the loan and thereby
increases its yield. In the event that the borrower defaults on its obligation
to return borrowed securities, because of insolvency or otherwise, the Fund
could experience delays and costs in gaining access to the collateral and
could suffer a loss to the extent that the value of the collateral falls below
the market value of the borrowed securities.
Reverse Repurchase Agreements. The Fund may enter into reverse repurchase
agreements with the same parties with whom it may enter into repurchase
agreements. Under a reverse repurchase agreement, the Fund sells securities
and agrees to repurchase them at a mutually agreed date and price. At the time
the Fund enters
20
<PAGE>
into a reverse repurchase agreement, it will establish and maintain a
segregated account with its approved custodian containing cash, cash
equivalents or liquid high grade debt securities having a value not less than
the repurchase price (including accrued interest). Reverse repurchase
agreements involve the risk that the market value of the securities retained
in lieu of sale by the Fund may decline below the price of the securities the
Fund has sold but is obligated to repurchase. In the event the buyer of
securities under a reverse repurchase agreement files for bankruptcy or
becomes insolvent, such buyer or its trustee or receiver may receive an
extension of time to determine whether to enforce the Fund's obligations to
repurchase the securities and the Fund's use of the proceeds of the reverse
repurchase agreement may effectively be restricted pending such decision.
When-Issued Securities, Delayed Delivery Transactions and Dollar Rolls. The
Fund may purchase or sell securities on a delayed delivery basis or a when-
issued basis at fixed purchase terms. These transactions arise when securities
are purchased or sold by the Fund with payment and delivery taking place in
the future. The purchase will be recorded on the date the Fund enters into the
commitment and the value of the obligation will thereafter be reflected in the
calculation of the Fund's net asset value. The value of the obligation on the
delivery date may be more or less than its purchase price. A separate account
of the Fund will be established with its custodian consisting of cash, cash
equivalents or high grade liquid debt securities having a market value at all
times at least equal to the amount of the forward commitment.
The Fund also may enter into "dollar rolls." A dollar roll is where the Fund
sells mortgage-backed securities for delivery in the current month and
simultaneously contracts to repurchase substantially similar (same type,
coupon and maturity) securities on a specified future date. During the roll
period, the Fund forgoes principal and interest paid on the mortgage-backed
securities. The Fund is compensated by the difference between the current
sales price and the lower forward price for the future purchase (often
referred to as the "drop") as well as by the interest earned on the cash
proceeds of the initial sale. A "covered roll" is a specific type of dollar
roll for which there is a segregated account with liquid high grade debt
securities. Money market securities held by the Fund in such an account will
not be subject to the general limitation that, other than for temporary or
defensive purposes, the Fund will invest no more than 35% of its total assets
in money market securities. Dollar rolls in which the Fund may invest will be
limited to covered rolls.
INVESTMENT RESTRICTIONS
The Fund has adopted a number of restrictions and policies relating to the
investment of its assets and its activities, which are fundamental policies
and may not be changed without the approval of the holders of a majority of
the Fund's outstanding voting securities, as defined in the 1940 Act. Among
the more significant restrictions, the Fund may not:
--with respect to at least 75% of its total assets, invest in the
securities of any one issuer if, immediately after and as a result of such
investment, the value of the holdings of the Fund in the securities of such
issuer exceeds 5% of the Fund's total assets, taken at market value, except
that such restriction shall not apply to securities issued or guaranteed by
the United States Government or any of its agencies or instrumentalities;
--borrow amounts in excess of 33 1/3% of its total assets taken at market
value (including the amount borrowed), and then only from banks as a
temporary measure for the purpose of meeting redemption requests,
distribution requirements under the Internal Revenue Code of 1986, as
amended, settlement of securities transactions, or for extraordinary or
emergency purposes; provided, however, that for purposes of this
restriction, transactions involving "cover" or for which segregated
accounts have been established as described under "Portfolio Strategies
Involving Interest Rate Transactions,
21
<PAGE>
Options and Futures" and "Other Investment Policies and Practices" shall
not be considered a borrowing; or
--invest more than 25% of its total assets (taken at market value at the
time of each investment) in the securities of issuers in any particular
industry; provided that, for these purposes, neither investments in
mortgage-backed securities nor investments in asset-backed securities are
deemed to be investments in a single industry.
Other fundamental policies include policies which limit investments in
securities which cannot be readily resold because of legal or contractual
restrictions or which are not otherwise readily marketable, if, regarding all
such securities, more than 10% of the Fund's net assets, taken at market value,
would be invested in such securities. While the Fund will not purchase illiquid
securities in an amount exceeding 10% of its net assets, the Fund may purchase,
without regard to that limitation, securities that are not registered under the
Securities Act of 1933 (the "Securities Act"), but that can be offered and sold
to "qualified institutional buyers" under Rule 144A under the Securities Act,
provided that the Fund's Board of Directors continuously determines, based on
the trading markets for the specific Rule 144A security, that it is liquid. The
Board of Directors may adopt guidelines and delegate to the Manager the daily
function of determining and monitoring liquidity of restricted securities. The
Board of Directors, however, will retain sufficient oversight and be ultimately
responsible for the determinations.
The Board of Directors carefully monitors the Fund's investments in
securities purchased pursuant to Rule 144A, focusing on such factors, among
others, as valuation, liquidity and availability of information. The Fund's
investments in securities purchased pursuant to Rule 144A could have the effect
of increasing the level of illiquidity in the Fund to the extent that qualified
institutional buyers become for a time uninterested in purchasing these
restricted securities.
MANAGEMENT OF THE FUND
DIRECTORS
The Board of Directors of the Fund consists of six individuals, five of whom
are not "interested persons" of the Fund as defined in the 1940 Act. The
Directors are responsible for the overall supervision of the operations of the
Fund and perform the various duties imposed on the directors of investment
companies by the 1940 Act.
The Directors are:
Arthur Zeikel*--President and Chief Investment Officer of Merrill Lynch
Asset Management, L.P. ("MLAM" or the "Manager"); President and Chief
Investment Officer of Fund Asset Management, L.P. ("FAM"); President and
Director of Princeton Services, Inc. ("Princeton Services"); Executive Vice
President of Merrill Lynch & Co., Inc. ("ML&Co."); Executive Vice President
of Merrill Lynch, Pierce, Fenner & Smith Incorporated ("Merrill Lynch");
and Director of Merrill Lynch Funds Distributor, Inc. ("MLFD").
Joe Grills--Member of the Committee of Investment of Employee Benefit
Assets of the Financial Executives Institute ("CIEBA"); Member of CIEBA's
Executive Committee; Member of the Investment Advisory Committee of the
State of New York Common Retirement Fund; Director, Duke Management Company
and Winthrop Financial Associates (real estate management).
22
<PAGE>
Walter Mintz--Special Limited Partner of Cumberland Associates
(investment partnership) since 1982.
Melvin R. Seiden--President of Silbanc Properties, Ltd. (real estate,
investment and consulting).
Stephen B. Swensrud--Principal of Fernwood Associates (financial
consultants); Director, Hitchiner Manufacturing Company.
Harry Woolf--Member of the editorial board of Interdisciplinary Science
Reviews; Director, Alex. Brown Mutual Funds, Advanced Technology
Laboratories, Family Health International and SpaceLabs Medical (medical
equipment manufacturing and marketing).
- - - --------
* Interested person, as defined by the 1940 Act, of the Fund.
MANAGEMENT AND ADVISORY ARRANGEMENTS
The Fund's investment manager is Merrill Lynch Asset Management, L.P. (the
"Manager" or "MLAM"). The Manager is owned and controlled by ML&Co., a
financial services holding company and the parent of Merrill Lynch. The
Manager, or an affiliate of the Manager, Fund Asset Management, L.P. ("FAM"),
acts as the investment adviser for more than 100 other registered investment
companies. MLAM and FAM also offer portfolio management and portfolio analysis
services to individuals and institutions. As of August 31, 1994, the Manager
and FAM had a total of approximately $165.7 billion in investment company and
other portfolio assets under management, including accounts of certain
affiliates of MLAM.
Subject to the direction of the Directors, the Manager is responsible for the
actual management of the Fund's portfolio and constantly reviews the Fund's
holdings in light of its own research analysis and that from other relevant
sources. The responsibilities for making decisions to buy, sell or hold a
particular security rest with the Manager. The Manager performs certain of the
other administrative services and provides all the office space, facilities,
equipment and necessary personnel for management of the Fund.
Pursuant to the management agreement between the Manager and the Fund (the
"Management Agreement"), the Manager receives from the Fund a monthly fee based
upon the average daily net assets of the Fund at an annual rate of 0.50%. For
the fiscal year ended May 31, 1994, the fee payable by the Fund to the Manager
was $2,710,336 (based on average net assets of approximately $542.1 million).
The Management Agreement obligates the Fund to pay certain expenses incurred in
the Fund's operations, including, among other things, the management fee, legal
and audit fees, unaffiliated Directors' fees and expenses, registration fees,
custodian and transfer agency fees, accounting and pricing costs, and certain
of the costs of printing proxies, shareholder reports, prospectuses and
statements of additional information. Accounting services are provided to the
Fund by the Manager and the Fund reimburses the Manager for its costs in
connection with such services on a semi-annual basis. For the fiscal year ended
May 31, 1994, the amount of such reimbursement was $226,047. For the fiscal
year ended May 31, 1994, the ratio of total expenses to average net assets was
.96% for the Class A shares and 1.46% for the Class B shares. For the fiscal
year ended May 31, 1994, the ratio of expenses net of reimbursement and
excluding account maintenance and distribution fees for both Class A and Class
B shares was .71%.
23
<PAGE>
Gregory Mark Maunz, Vice President of the Fund, is primarily responsible for
the day-to-day management of the Fund's portfolio. Mr. Maunz has been Vice
President of the Manager since 1985 and a Portfolio Manager for the Manager
since 1984.
TRANSFER AGENCY SERVICES
Financial Data Services, Inc. (the "Transfer Agent"), which is a wholly-owned
subsidiary of Merrill Lynch & Co., Inc., acts as the Fund's transfer agent
pursuant to a transfer agency, dividend disbursing agency and shareholder
servicing agency agreement (the "Transfer Agency Agreement"). Pursuant to the
Transfer Agency Agreement, the Transfer Agent is responsible for the issuance,
transfer and redemption of shares and the opening and maintenance of
shareholder accounts. Pursuant to the Transfer Agency Agreement, the Fund pays
the Transfer Agent an annual fee of $11.00 per Class A shareholder account and
$14.00 per Class B shareholder account and the Transfer Agent is entitled to
reimbursement for out-of-pocket expenses incurred by it under the Transfer
Agency Agreement. For the fiscal year ended May 31, 1994, the Fund paid
$480,353 to the Transfer Agent pursuant to the Transfer Agency Agreement.
PURCHASE OF SHARES
Merrill Lynch Funds Distributor, Inc. (the "Distributor"), a subsidiary of
the Manager and an affiliate of Merrill Lynch, acts as the distributor of
shares of the Fund.
Shares of the Fund are offered continuously for sale by the Distributor and
other eligible securities dealers (including Merrill Lynch). During the
continuous offering, shares of the Fund may be purchased from securities
dealers or by mailing a purchase order directly to the Transfer Agent. The
minimum initial purchase during the continuous offering is $1,000, and the
minimum subsequent purchase in the continuous offering is $50, except that for
retirement plans, the minimum initial purchase is $100 and the minimum
subsequent purchase is $1.00.
The Fund is offering its shares at a public offering price equal to the next
determined net asset value per share plus sales charges which, at the option of
the purchaser, may be imposed either at the time of purchase (the "initial
sales charge alternative") or on a deferred basis (the "deferred sales charge
alternative"), as described below. The applicable offering price for purchase
orders is based upon the net asset value of the Fund next determined after
receipt of the purchase orders by the Distributor. As to purchase orders
received by securities dealers prior to the close of normal trading on the New
York Stock Exchange on each day during which the New York Stock Exchange is
open for trading, which includes orders received after the determination of net
asset value on the previous day, the applicable offering price will be based on
the net asset value determined on the day the order is placed with the
Distributor, provided the order is received by the Distributor prior to 4:30
P.M., New York time, on that day. If the purchase orders are not received by
the Distributor prior to 4:30 P.M., New York time, such orders shall be deemed
received on the next business day. Any order may be rejected by the Distributor
or the Fund. The Fund or the Distributor may suspend the continuous offering of
the Fund's shares to the general public at any time in response to conditions
in the securities markets or otherwise and may thereafter resume such offering
from time to time. Neither the Distributor nor the dealers are permitted to
withhold placing orders to benefit themselves by a price change. Merrill Lynch
may charge its customers a processing fee (presently $4.85) to confirm a sale
of shares to such customers. Purchases directly through the Fund's transfer
agent are not subject to the processing fee.
The Fund issues two classes of shares: Class A shares are sold to investors
choosing the initial sales charge alternative and Class B shares are sold to
investors choosing the deferred sales charge alternative. The
24
<PAGE>
two classes of shares each represent an interest in the same portfolio of
investments of the Fund, have the same rights and are identical in all
respects, except that (i) Class B shares bear the expenses of the deferred
sales arrangements, any expenses (including incremental transfer agency costs)
resulting from such sales arrangements and the expenses paid by the account
maintenance fee, (ii) Class A shares bear the expenses of the account
maintenance fee, and (iii) each Class has exclusive voting rights with respect
to the Rule 12b-1 distribution plan pursuant to which the account maintenance
and distribution fees, in the case of the Class B shares, and the account
maintenance fee, in the case of the Class A shares, are paid. The two classes
also have different exchange privileges. See "Shareholder Services--Exchange
Privilege." The net income attributable to Class B shares and the dividends
payable on Class B shares will be reduced by the amount by which the sum of the
account maintenance and distribution fees and incremental expenses associated
with such account maintenance and distribution fees exceeds the account
maintenance fee attributable to the Class A shares; likewise, the net asset
value of the Class B shares will be reduced by such amount to the extent the
Fund has undistributed net income. Sales personnel may receive different
compensation for selling Class A or Class B shares. Investors are advised that
only Class A shares may be available for purchase through securities dealers,
other than Merrill Lynch, which are eligible to sell shares.
ALTERNATIVE SALES ARRANGEMENTS
The alternative sales arrangements of the Fund permit investors to choose the
method of purchasing shares that the investor views as most beneficial given
the amount of their purchase, the length of time the investor expects to hold
his shares and other relevant circumstances. Investors should determine whether
under their particular circumstances it is more advantageous to incur an
initial sales charge and ongoing account maintenance fee, as discussed below,
or to have the entire initial purchase price invested in the Fund with the
investment thereafter being subject to ongoing account maintenance and
distribution fees.
As an illustration, investors who qualify for significantly reduced sales
charges, as described below, might elect the initial sales charge alternative
because similar sales charge reductions are not available for purchases under
the deferred sales charge alternative. Moreover, shares acquired under the
initial sales charge alternative would not be subject to both an ongoing
account maintenance fee and distribution fee as described below, although the
shares are subject to the lower account maintenance fee, as discussed below.
However, because initial sales charges are deducted at the time of purchase,
such investors would not have all their funds invested initially.
Investors not qualifying for reduced initial sales charges who expect to
maintain their investment for an extended period of time might also elect the
initial sales charge alternative because over time the accumulated continuing
distribution fees may exceed the initial sales charge and ongoing account
maintenance fees. Again, however, such investors must weigh this consideration
against the fact that not all their funds will be invested initially.
Furthermore, the ongoing distribution fees will be offset to the extent any
return is realized on the additional funds initially invested under the
deferred alternative. Another factor that may be applicable under certain
circumstances is that the payment of the Class B distribution fee and
contingent deferred sales charge is subject to certain limits as set forth
below under "Purchase of Shares--Deferred Sales Charge Alternative--Class B
Shares."
Certain other investors might determine it to be more advantageous to have
all their funds invested initially, although remaining subject to continuing
account maintenance and distribution fees and, for a three-year period of time,
a contingent deferred sales charge as described below. For example, an investor
subject to the 3.0% initial sales charge will have to hold its investment for
more than six years for the ongoing 0.25%
25
<PAGE>
account maintenance fee and the 0.50% distribution fee of Class B shares to
exceed the initial sales charge plus the accumulated account maintenance fee of
Class A shares. This example does not take into account the time value of money
which further reduces the impact of the ongoing 0.25% account maintenance fee
and the 0.50% distribution fee of Class B shares on the investment,
fluctuations in net asset value, the effect of the return on the investment
over this period of time, or the effect of any limits that may be imposed upon
the payment of the distribution fee and the contingent deferred sales charge.
Distribution Plans. Pursuant to separate distribution plans adopted by the
Fund pursuant to Rule 12b-1 under the 1940 Act (the "Distribution Plans"), the
Fund pays the Distributor (a) an ongoing account maintenance fee relating to
Class A shares, accrued daily and paid monthly, at the annual rate of 0.25% of
the average daily net assets of the Fund attributable to Class A shares in
order to compensate the Distributor and Merrill Lynch (pursuant to a sub-
agreement) in connection with account maintenance activities, and (b) an
ongoing account maintenance fee and a distribution fee relating to Class B
shares, accrued daily and paid monthly, at the annual rate of 0.25% and 0.50%,
respectively, of the average daily net assets of the Fund attributable to Class
B shares. Pursuant to a sub-agreement with the Distributor, Merrill Lynch also
provides account maintenance and distribution services to the Fund. The ongoing
account maintenance fees relating to the Class A shares and the Class B shares
compensate the Distributor and Merrill Lynch for providing account maintenance
services to shareholders of each Class. The ongoing distribution fee
compensates the Distributor and Merrill Lynch for providing shareholder and
distribution services and bearing certain distribution-related expenses of the
Fund, including payments to financial consultants for selling shares of the
Fund. See "Additional Information--Organization of the Fund."
Prior to July 7, 1993, the Fund paid the Distributor an ongoing distribution
fee, accrued daily and paid monthly, at the annual rate of 0.75% of average
daily net assets of the Class B shares of the Fund under a distribution plan
previously adopted by the Fund (the "Prior Plan") to compensate the Distributor
and Merrill Lynch for providing account maintenance and distribution-related
activities and services to Class B shareholders.The fee rate and the services
provided under the Prior Plan are identical to the aggregate fee rate payable
and the services provided under the Distribution Plan, the difference being
that the account maintenance and distribution services have been unbundled. For
the fiscal year ended May 31, 1994, the Fund paid the Distributor $3,808,315
pursuant to the Prior Plan and the Distribution Plan (based on average net
assets subject to the Prior Plan and the Distribution Plan of $507.8 million),
all of which was paid to Merrill Lynch for providing account maintenance and
distribution-related activities and services in connection with Class B shares.
At July 31, 1994, the net assets of the Fund subject to the Distribution Plan
aggregated approximately $367.0 million. At this asset level, the annual fee
payable pursuant to the Distribution Plan would aggregate approximately $2.8
million. Both the Distribution Plan and the Prior Plan were designed to permit
an investor to purchase Class B shares through dealers without the assessment
of a front-end sales charge and at the same time permit the dealer to
compensate its financial consultants in connection with the sale of the Class B
shares. In this regard, the purpose and function of the ongoing account
maintenance and distribution fees under either the Distribution Plan or the
Prior Plan and the contingent deferred sales charge are the same as those of
the initial sales charge with respect to the Class A shares of the Fund in that
the deferred sales charges and the distribution fees provide for the financing
of the distribution of the Fund's Class B shares.
The payments under the Class B Distribution Plan, as was the case with the
Prior Plan, are based on a percentage of average daily net assets attributable
to Class B shares regardless of the amount of expenses incurred and,
accordingly, distribution-related revenues may be more or less than
distribution-related
26
<PAGE>
expenses. Information with respect to the distribution-related revenues and
expenses is presented to the Directors for their consideration in connection
with their deliberations as to the continuance of the Class B Distribution
Plan. This information is presented annually as of December 31 of each year on
a "fully allocated accrual" basis and quarterly on a "direct expense and
revenue/cash" basis. On the fully allocated accrual basis, revenues consist of
the account maintenance fees, distribution fees, the contingent deferred sales
charges and certain other related revenues, and expenses consist of financial
consultant compensation, branch office and regional operation center selling
and transaction processing expenses, advertising, sales promotion and
marketing expenses, corporate overhead and interest expense. On the direct
expense and revenue/cash basis, revenues consist of the account maintenance
fees, distribution fees and contingent deferred sales charges and the expenses
consist of financial consultant compensation. At December 31, 1993, the fully
allocated accrual expenses incurred by the Distributor and Merrill Lynch for
the period since the commencement of the offering of Class B shares exceeded
fully allocated accrual revenues for such period by approximately $4,722,000
(1.02% of Class B net assets at that date). As of December 31, 1993, direct
cash revenues for the period since commencement of the offering of Class B
shares exceeded direct cash expenses by $9,309,111 (2.02% of Class B net
assets at that date). As of May 31, 1994, direct cash revenues for the period
since commencement of the offering of Class B shares exceeded direct cash
expenses by $10,970,382 (2.93% of Class B net assets at that date).
The Fund has no obligation with respect to distribution and account
maintenance-related expenses incurred by the Distributor and Merrill Lynch in
connection with the Class B and Class A shares, respectively, and there is no
assurance that the Directors of the Fund will approve the continuance of the
Distribution Plans from year to year. However, the Distributor intends to seek
annual continuation of the Distribution Plans. In their review of the
Distribution Plans, the Directors will be asked to take into consideration
expenses incurred in connection with the distribution of each Class of shares
separately. The distribution and account maintenance fees and the contingent
deferred sales charges of a particular Class will not be used to subsidize the
sale of shares of the other Class.
INITIAL SALES CHARGE ALTERNATIVE--CLASS A SHARES
The public offering price of Class A shares for purchasers choosing the
initial sales charge alternative is the next determined net asset value plus
varying sales charges (i.e., sales loads), as set forth below.
<TABLE>
<CAPTION>
DISCOUNT TO
SALES CHARGE SELECTED
SALES AS DEALERS AS
CHARGE AS PERCENTAGE* OF PERCENTAGE OF
PERCENTAGE OF THE NET AMOUNT THE OFFERING
AMOUNT OF PURCHASE OFFERING PRICE INVESTED PRICE
------------------ -------------- -------------- -------------
<S> <C> <C> <C>
Less than $100,000................. 3.00% 3.09% 2.75%
$100,000 but less than $500,000.... 2.50 2.56 2.25
$500,000 but less than $1,000,000.. 2.00 2.04 1.75
$1,000,000 but less than
$3,000,000........................ 1.50 1.52 1.25
$3,000,000 but less than
$5,000,000........................ 1.00 1.01 0.75
$5,000,000 and over................ 0.50 0.50 0.40
</TABLE>
- - - --------
* Rounded to the nearest one-hundredth percent.
Initial sales charges will be waived for shareholders purchasing $5 million
or more in a single transaction (other than an employer sponsored retirement
or savings plan, such as a tax qualified retirement plan under Section 401 of
the Internal Revenue Code of 1986, as amended (the "Code"), a deferred
compensation plan under Section 403(b) and Section 457 of the Code, other
deferred compensation arrangements, Voluntary Employee Benefits Association
("VEBA") plans and non-qualified After Tax Savings and Investment
27
<PAGE>
programs maintained on the Merrill Lynch Group Employee Services system herein
referred to as "Employer Sponsored Retirement or Savings Plans"), or a purchase
by a TMASM Managed Trust, of Class A shares of the Fund. In addition, purchases
of Class A shares of the Fund made in connection with a single investment of $1
million or more under the Merrill Lynch Mutual Fund Adviser Program will not be
subject to an initial sales charge. Such purchases will be subject to a
contingent deferred sales charge of 0.25% of the dollar amount of the purchase
if the shares are redeemed within one year after purchase.
The Distributor may reallow discounts to selected dealers and retain the
balance over such discounts. At times the Distributor may reallow the entire
sales charge to such dealers. Since securities dealers selling Class A shares
of the Fund will receive a concession equal to most of the sales charge, they
may be deemed to be underwriters under the Securities Act. During the fiscal
year ended May 31, 1994, the Fund sold 1,365,792 Class A shares for aggregate
net proceeds to the Fund of $13,269,165. The gross sales charges for the sale
of Class A shares for that period were $61,480, of which $49,708 was received
by Merrill Lynch and $11,772 was received by the Distributor.
Reduced Initial Sales Charges. Sales charges are reduced under a Right of
Accumulation and a Letter of Intention. Class A shares of the Fund are offered
at net asset value to Directors of the Fund, to directors of Merrill Lynch &
Co., Inc., to participants in certain benefits plans, to directors or trustees
of certain other Merrill Lynch-sponsored investment companies, to an investor
who has a business relationship with a financial consultant who joined Merrill
Lynch from another investment firm within six months prior to the date of
purchase if certain conditions set forth in the Statement of Additional
Information are met and to employees of Merrill Lynch & Co., Inc. and its
subsidiaries (the term "subsidiaries", when used herein with respect to Merrill
Lynch & Co., Inc., includes MLAM, FAM and certain other entities directly or
indirectly wholly-owned and controlled by Merrill Lynch & Co., Inc.). Class A
shares may be offered at net asset value in connection with the acquisition of
assets of other investment companies. No initial sales charges are imposed on
Class A shares issued as a result of the automatic reinvestment of dividends or
capital gains distributions. Class A shares of the Fund are also offered at net
asset value, without sales charge, to an investor who has a business
relationship with a Merrill Lynch financial consultant and who has invested in
a mutual fund sponsored by a non-Merrill Lynch company for which Merrill Lynch
has served as a selected dealer and where Merrill Lynch has either received or
given notice that such arrangement will be terminated, if the following
conditions are satisfied: first, the investor must purchase Class A shares of
the Fund with proceeds from a redemption of shares of such other mutual fund
and such fund imposed a sales charge either at the time of purchase or on a
deferred basis; second, such purchase of Class A shares must be made within 90
days after such notice of termination. Class A shares of the Fund are also
offered at net asset value to shareholders of certain closed-end funds advised
by MLAM or FAM who wish to reinvest the net proceeds from a sale of their
closed-end fund shares of common stock in shares of the Fund, provided certain
conditions are met. For example, Class A shares of the Fund and certain other
mutual funds advised by the Manager or FAM are offered at net asset value to
shareholders of Merrill Lynch Senior Floating Rate Fund, Inc. (formerly known
as Merrill Lynch Prime Fund, Inc.) who wish to reinvest the net proceeds from a
sale of certain of their shares of common stock of Merrill Lynch Senior
Floating Rate Fund, Inc. in shares of such Funds. Class A shares are offered at
net asset value to (i) certain retirement plans, including eligible 401(k)
plans, provided such plans meet the required minimum number of eligible
employees or required amount of assets advised by the Manager or any of its
affiliates and (ii) certain Employer Sponsored Retirement or Savings Plans,
provided such plans meet the required minimum number of eligible employees or
required amount of assets advised by the Manager or any of its affiliates.
28
<PAGE>
Additional information concerning these reduced initial sales charges is set
forth in the Statement of Additional Information.
DEFERRED SALES CHARGE ALTERNATIVE--CLASS B SHARES
Investors choosing the deferred sales charge alternative purchase Class B
shares at net asset value per share without the imposition of a sales charge at
the time of purchase. The Class B shares are being sold without an initial
sales charge so that the Fund will receive the full amount of the investor's
purchase payment. Merrill Lynch compensates its financial consultants for
selling Class B shares at the time of purchase from its own funds. The proceeds
of the contingent deferred sales charge and the ongoing distribution fee
discussed below are used to defray Merrill Lynch's expenses, including
compensating its financial consultants. The proceeds from the ongoing account
maintenance fee are used to compensate Merrill Lynch for providing continuing
account maintenance activities.
Proceeds from the contingent deferred sales charge are paid to the
Distributor and are used in whole or in part by the Distributor to defray the
expenses of dealers (including Merrill Lynch) related to providing
distribution-related services to the Fund in connection with the sale of the
Class B shares, such as the payment of compensation to financial consultants
for selling Class B shares. Payments by the Fund to the Distributor of the
distribution fee under the Distribution Plan relating to Class B shares may be
used in whole or in part by the Distributor for this purpose. The combination
of the contingent deferred sales charge and the ongoing distribution fee
facilitates the ability of the Fund to sell the Class B shares without a sales
charge being deducted at the time of purchase. Class B shareholders of the Fund
exercising the exchange privilege described under "Shareholder Services--
Exchange Privilege" will continue to be subject to the Fund's contingent
deferred sales charge schedule if such schedule is higher than the deferred
sales charge schedule relating to the Class B shares acquired as a result of
the exchange. For the fiscal year ended May 31, 1994, the Distributor received
contingent deferred sales charges of $2,010,325 with respect to the redemption
of Class B shares, all of which was paid to Merrill Lynch.
Contingent Deferred Sales Charge. Class B shares which are redeemed within
three years of purchase may be subject to a contingent deferred sales charge at
the rates set forth below charged as a percentage of the dollar amount subject
thereto. The charge will be assessed on an amount equal to the lesser of the
current market value or the costs of the shares being redeemed. Accordingly, no
sales charge will be imposed on increases in net asset value above the initial
purchase price. In addition, no charge will be assessed on shares derived from
reinvestment of dividends or capital gains distributions.
The following table sets forth the rates of the contingent deferred sales
charge:
<TABLE>
<CAPTION>
CONTINGENT DEFERRED
SALES CHARGE AS A
PERCENTAGE OF
YEAR SINCE PURCHASE DOLLAR AMOUNT
PAYMENT MADE SUBJECT TO CHARGE
------------------- -------------------
<S> <C>
0-1.................................................... 3.0%
1-2.................................................... 2.0%
2-3.................................................... 1.0%
3 and thereafter....................................... None
</TABLE>
In determining whether a contingent deferred sales charge is applicable to a
redemption, the calculation will be determined in the manner that results in
the lowest possible rate being charged. Therefore, it will be
29
<PAGE>
assumed that the redemption is first of shares held for over three years or
shares acquired pursuant to reinvestment of dividends or distributions and then
of shares held longest during the three-year period. The charge will not be
applied to dollar amounts representing an increase in the net asset value since
the time of purchase. A transfer of shares from a shareholder's account to
another account will be assumed to be made in the same order as a redemption.
To provide an example, assume an investor purchased 100 shares at $10 per
share (at a cost of $1,000) and in the third year after purchase, the net asset
value per share is $12 and, during such time, the investor has acquired 10
additional shares through dividend reinvestment. If at such time the investor
makes his first redemption of 50 shares (proceeds of $600), 10 shares will not
be subject to the charge because of dividend reinvestment. With respect to the
remaining 40 shares, the charge is applied only to the original cost of $10 per
share and not to the increase in net asset value of $2 per share. Therefore,
$400 of the $600 redemption proceeds will be charged at a rate of 1.0% (the
applicable rate in the third year after purchase).
The contingent deferred sales charge is waived on redemptions of shares in
connection with certain post-retirement withdrawals from IRA or other
retirement plans or following the death or disability (as defined in the
Internal Revenue Code) of a shareholder.
The contingent deferred sales charge is waived on redemption of shares by
certain eligible 401(a) and eligible 401(k) plans. The contingent deferred
sales charge is also waived for any Class B shares which are purchased by an
eligible 401(k) or eligible 401(a) plan and are rolled over into a Merrill
Lynch or Merrill Lynch Trust Company custodied Individual Retirement Account
and held in such account at the time of redemption. Additional information
concerning the waiver of the contingent deferred sales charge is set forth in
the Statement of Additional Information.
Limitations on the Payment of Deferred Sales Charges. The maximum sales
charge rule in the Rules of Fair Practice of the National Association of
Securities Dealers, Inc. ("NASD") imposes a limitation on certain asset-based
sales charges such as the Fund's distribution fee and the contingent deferred
sales charge but not the account maintenance fees. As applicable to the Fund,
the maximum sales charge rule limits the aggregate of distribution fee payments
and contingent deferred sales charges payable by the Fund to (1) 6 1/4% of
eligible gross sales of Class B shares (defined to exclude shares issued
pursuant to dividend reinvestments and exchanges) plus (2) interest on the
unpaid balance at the prime rate plus 1% (the unpaid balance being the maximum
amount payable minus amounts received from the payment of the distribution fee
and the contingent deferred sales charge). The Distributor has voluntarily
agreed to waive interest charges on the unpaid balance in excess of 0.50% of
eligible gross sales. Consequently the maximum amount payable to the
Distributor (referred to as the "voluntary maximum") is 6.75% of eligible gross
sales. The Distributor retains the right to stop waiving interest charges at
any time. To the extent payments would exceed the voluntary maximum, the Fund
will not make further payments of the distribution fee and any contingent
deferred sales charges will be paid to the Fund rather than to the Distributor;
however, the Fund will continue to make payments of the account maintenance
fees. In certain circumstances the amount payable pursuant to the voluntary
maximum may exceed the amount payable under the NASD formula. In such
circumstances payment in excess of the amount payable under the NASD formula
will not be made.
30
<PAGE>
The following table sets forth comparative information as of May 31, 1994,
with respect to the Class B shares of the Fund indicating the maximum
allowable payments that can be made under the NASD maximum sales charge rule
and the Distributor's voluntary maximum for the fiscal year ended May 31,
1994.
<TABLE>
<CAPTION>
DATA CALCULATED AS OF MAY 31, 1994
- - - -------------------------------------------------------------------------------------------------------
ANNUAL
ALLOWABLE ALLOWABLE AMOUNTS DISTRIBUTION
ELIGIBLE AGGREGATE INTEREST ON MAXIMUM PREVIOUSLY AGGREGATE FEE AT CURRENT
GROSS SALES UNPAID AMOUNT PAID TO UNPAID NET ASSET
SALES(1) CHARGES BALANCE(2) PAYABLE DISTRIBUTOR(3) BALANCE LEVEL(4)
-------- --------- ----------- ------- -------------- --------- --------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Under NASD Rule......... $983,259 $61,454 $10,646 $72,100 $16,649 $55,460 $1,872
Under Distributor's
Voluntary Waiver....... $983,259 $61,454 $ 4,916 $66,370 $16,649 $49,730 $1,872
</TABLE>
- - - --------
(1) Purchase price of all eligible Class B shares sold since August 2, 1991
(commencement of operations) other than shares acquired through dividend
reinvestment and the exchange privilege.
(2) Interest is computed on a monthly basis based upon the average prime rate,
as reported in The Wall Street Journal, plus 1%, as permitted under the NASD
Rule.
(3) Consists of contingent deferred sales charge payments, distribution fee
payments and accruals. Of the distribution fee payments made prior to July
7, 1993, under the Prior Plan at the 0.75% rate, 0.50% of average daily net
assets has been treated as a distribution fee and 0.25% of average daily net
assets has been deemed to have been a service fee and not subject to the
NASD maximum sales charge rule.
(4) Provided to illustrate the extent to which the current level of
distribution fee payments (not including any contingent deferred sales
charge payments) is amortizing the unpaid balance. No assurance can be given
that payments of the distribution fee will reach either the voluntary
maximum or the NASD maximum.
REDEMPTION OF SHARES
The Fund is required to redeem for cash all full and fractional shares of
the Fund upon receipt of a written request in proper form. The redemption
price is the net asset value per share next determined after the initial
receipt of proper notice of redemption. Except for any contingent deferred
sales charge which may be applicable to Class B shares, there will be no
charge for redemption if the redemption request is sent directly to the
Transfer Agent. Shareholders liquidating their holdings will receive upon
redemption all dividends reinvested through the date of redemption. The value
of shares at the time of redemption may be more or less than the shareholder's
cost, depending on the market value of the securities held by the Fund at such
time.
REDEMPTION
A shareholder wishing to redeem shares may do so by tendering the shares
directly to the Fund's Transfer Agent, Financial Data Services, Inc., Attn:
TAMFO, P.O. Box 45289, Jacksonville, Florida 32223-5289. Proper notice of
redemption in the case of shares deposited with the Transfer Agent may be
accomplished by a written letter requesting redemption. Proper notice of
redemption in the case of shares for which certificates have been issued may
be accomplished by a written letter as noted above accompanied by certificates
for the shares to be redeemed. Redemption requests delivered other than by
mail should be delivered to Financial Data Services, Inc., Transfer Agency
Mutual Fund Operations, 4800 Deer Lake Drive East, Jacksonville, Florida
32246-6484. Redemption requests should not be sent to the Fund. A redemption
31
<PAGE>
request requires the signature(s) of all persons in whose name(s) the shares
are registered, signed exactly as his (their) name(s) appear(s) on the Transfer
Agent's register or on the certificate, as the case may be. The signature(s) on
the redemption request must be guaranteed by a national bank or other bank
which is a member of the Federal Reserve System (not a savings bank) or by a
member firm of any national or regional securities exchange. Notarized
signatures are not sufficient. In certain instances, the Transfer Agent may
require additional documents such as, but not limited to, trust instruments,
death certificates, appointments as executor or administrator, or certificates
of corporate authority. For shareholders redeeming directly with the Transfer
Agent, payments will be mailed within seven days of receipt of a proper notice
of redemption.
At various times the Fund may be requested to redeem shares for which it has
not yet received good payment (e.g. cash, Federal funds or certified check
drawn on a United States bank). The Fund may delay or cause to be delayed the
mailing of a redemption check until such time as it has assured itself that
good payment has been collected for the purchase of such Fund shares, which may
take up to 10 days.
REPURCHASE
The Fund will also repurchase shares through a shareholder's listed
securities dealer. The Fund will normally accept orders to repurchase shares by
wire or telephone from dealers for their customers at the net asset value next
computed after receipt of the order by the dealer, provided that the request
for repurchase is received by the dealer prior to the normal close of business
on the New York Stock Exchange on the day received and is received by the Fund
from such dealer not later than 4:30 P.M., New York time, on the same day.
Dealers have the responsibility of submitting such repurchase requests to the
Fund not later than 4:30 P.M., New York time, in order to obtain that day's
closing price.
The repurchase arrangements are for the convenience of shareholders and do
not involve a charge by the Fund (other than any applicable contingent deferred
sales charge in the case of Class B shares); securities firms which do not have
selected dealer agreements with the Distributor, however, may impose a
transaction charge on the shareholder for transmitting the notice of repurchase
to the Fund. Merrill Lynch may charge its customers a processing fee (presently
$4.85) to confirm a repurchase of shares. Redemptions directly through the
Fund's Transfer Agent are not subject to the procesing fee. The Fund reserves
the right to reject any order for repurchase, which right of rejection might
adversely affect shareholders seeking redemption through the repurchase
procedure. However, a shareholder whose order for repurchase is rejected by the
Fund may redeem shares as set forth above.
REINSTATEMENT PRIVILEGE--CLASS A SHARES
Shareholders who have redeemed their Class A shares have a one-time privilege
to reinstate their accounts by purchasing Class A shares of the Fund at net
asset value without a sales charge up to the dollar amount redeemed. The
reinstatement privilege may be exercised by sending a notice of exercise along
with a check for the amount to be reinstated to the Transfer Agent within 30
days after the date the request for redemption was accepted by the Transfer
Agent or the Distributor. The reinstatement will be made at the net asset value
per share next determined after the notice of reinstatement is received and
cannot exceed the amount of the redemption proceeds. The reinstatement
privilege is a one-time privilege and may be exercised by the Class A
shareholder only the first time such shareholder makes a redemption.
32
<PAGE>
SHAREHOLDER SERVICES
The Fund offers a number of shareholder services and investment plans
described below which are designed to facilitate investment in shares of the
Fund. Full details as to each of such services, copies of the various plans
described below and instructions as to how to participate in the various
services or plans, or to change options with respect thereto, can be obtained
from the Fund by calling the telephone number on the cover page hereof or from
the Distributor or Merrill Lynch. Included in such services are the following:
Investment Account. Each shareholder whose account is maintained at the
Transfer Agent has an Investment Account and will receive, at least quarterly,
statements from the Transfer Agent. These statements will serve as transaction
confirmations for automatic investment purchases and the reinvestment of
ordinary income dividends and long-term capital gain distributions. The
statements will also show any other activity in the account since the preceding
statement. Shareholders will receive separate transaction confirmations for
each purchase or sale transaction other than automatic investment purchases and
the reinvestments of ordinary income dividends and long-term capital gain
distributions. Shareholders may make additions to their Investment Account at
any time by mailing a check directly to the Transfer Agent. Shareholders may
also maintain their accounts through Merrill Lynch. Upon the transfer of shares
out of a Merrill Lynch brokerage account, an Investment Account in the
transferring shareholder's name will be opened automatically, without charge,
at the Transfer Agent. Shareholders considering transferring their Class A
shares from Merrill Lynch to another brokerage firm or financial institution
should be aware that, if the firm to which the Class A shares are to be
transferred will not take delivery of shares of the Fund, a shareholder either
must redeem the Class A shares so that the cash proceeds can be transferred to
the account at the new firm or such shareholder must continue to maintain an
Investment Account at the Transfer Agent for those Class A shares. Shareholders
interested in transferring their Class B shares from Merrill Lynch and who do
not wish to have an Investment Account maintained for such shares at the
Transfer Agent may request their new brokerage firm to maintain such shares in
an account registered in the name of the brokerage firm for the benefit of the
shareholder. If the new brokerage firm is willing to accommodate the
shareholder in this manner, the shareholder must request that he be issued
certificates for his shares, and then must turn the certificates over to the
new firm for re-registration as described in the preceding sentence.
Shareholders considering transferring a tax deferred retirement account such as
an individual retirement account from Merrill Lynch to another brokerage firm
or financial institution should be aware that, if the firm to which the
retirement account is to be transferred will not take delivery of shares of the
Fund, a shareholder must either redeem the shares (paying any applicable
contingent deferred sales charge) so that the cash proceeds can be transferred
to the account at the new firm, or such shareholder must continue to maintain a
retirement account at Merrill Lynch for those shares.
Exchange Privilege. Class A and Class B shareholders of the Fund currently
each have an exchange privilege with certain other mutual funds advised by MLAM
or FAM. There is currently no limitation on the number of times a shareholder
may exercise the exchange privilege. The exchange privilege may be modified or
terminated in accordance with the rules of the Securities and Exchange
Commission and it is presently anticipated that the Fund's existing exchange
privilege will be modified on or about October 24, 1994, as explained below.
Present Exchange Privilege--Currently, Class A shareholders of the Fund may
exchange their shares ("outstanding Class A shares") for Class A shares of
another fund ("new Class A shares") on the basis of relative net asset value
per Class A share, plus an amount equal to the difference, if any, between the
sales charge previously paid on the outstanding Class A shares and the sales
charge payable at the time of the exchange on the new Class A shares. The
Fund's exchange privilege is presently modified with respect to
33
<PAGE>
purchases of Class A shares under the Merrill Lynch Mutual Fund Adviser
program. First, the initial allocation of assets is made under the program.
Then, any subsequent exchange under the program of Class A shares of a fund for
Class A shares of the Fund will be made solely on the basis of the relative net
asset values of the shares being exchanged. Therefore, there will not be a
charge for any difference between the sales charge previously paid on the
shares of the other fund and the sales charge payable on the shares of the Fund
being acquired in the exchange under this program.
Currently, Class B shareholders of the Fund may exchange their shares
("outstanding Class B shares") for Class B shares of another fund ("new Class B
shares") on the basis of relative net asset value per share, without the
payment of any contingent deferred sales charge that might otherwise be due
upon redemption of the outstanding Class B shares. Class B shareholders of the
Fund exercising the exchange privilege will be subject to the higher of the
Fund's contingent deferred sales charge or the deferred sales charge schedule
relating to the new Class B shares. In addition, Class B shares of the Fund
acquired through use of the exchange privilege will be subject to the higher of
the Fund's contingent deferred sales charge schedule or the deferred sales
charge schedule relating to the Class B shares of the fund from which the
exchange has been made. For purposes of computing the contingent deferred sales
charge that may be payable upon a disposition of the new Class B shares, the
holding period for outstanding Class B shares is "tacked" to the holding period
of the new Class B shares. Class A and Class B shareholders of the Fund may
also exchange their shares for shares of certain money market funds, but in the
case of an exchange from Class B shares the period of time that shares are held
in a money market fund will not count toward satisfaction of the holding period
requirement for purposes of reducing the contingent deferred sales charge.
Exercise of the exchange privilege is treated as a sale for Federal income tax
purposes.
Impending Changes--On or about October 24, 1994, the Fund's existing exchange
privilege will be modified as described below if shareholders approve at an
upcoming meeting certain matters related to the implementation of the Merrill
Lynch Select PricingSM System pursuant to which each of the funds participating
in the current Dual Distribution System, including the Fund, will offer four
classes of shares, Classes A, B, C and D, each with a different combination of
sales charges, ongoing fees and other features, instead of the two classes of
shares presently offered. Under the Select Pricing System, shares of Class A
and Class D will be offered to investors choosing the initial sales charge
alternatives, and shares of Class B and Class C will be offered to investors
choosing the deferred sales charge alternatives.
The existing Class A shares of certain funds participating in the current
exchange privilege, including the Fund's, are subject to an account maintenance
fee and are the equivalent of the new Class D shares. Upon implementation of
the Select Pricing System, such Class A shares automatically will be
redesignated Class D shares. Such shares will not be exchangeable for Class A
shares of other funds beginning on or about October 24, 1994, but will be
exchangeable for Class D shares offered by all funds which operate pursuant to
the Select Pricing System. The following eight other funds currently offer
Class A shares to be redesignated Class D shares: Merrill Lynch Americas Income
Fund, Inc., Merrill Lynch Dragon Fund, Inc, Merrill Lynch Federal Securities
Trust, Merrill Lynch Fundamental Growth Fund, Inc., Merrill Lynch Global
SmallCap Fund, Inc., Merrill Lynch International Equity Fund, Merrill Lynch
Latin America Fund, Inc. and Merrill Lynch Short-Term Global Income Fund, Inc.
After the implementation date, Class A shares will only be offered to a
limited group of investors including participants in certain retirement plans
and investment programs (such participants are referred to herein as "Qualified
Purchasers") and existing Class A shareholders ("Existing Class A
shareholders") will not include holders of the Fund's Class A shares prior to
implementation of the Select Pricing System. Investors who are not Qualified
Purchasers who hold Class A shares of a specific fund in an account will be
34
<PAGE>
entitled to purchase additional Class A shares of that fund for that account
only. Class A shareholders of one fund who are not Qualified Purchasers and who
wish to exchange their Class A shares for shares of a second fund will receive
Class A shares of that second fund only if such shareholder already owned in
the same account Class A shares of the second fund on the date of the exchange.
Otherwise, shareholders who are not Qualified Purchasers will receive in
exchange for their Class A shares the shares of a new Class D which will be
subject to an account maintenance fee at a maximum annual rate of 0.25% of the
fund's average daily net assets attributable to such new class of shares. An
investor will have the right to exchange Class D shares for Class A shares of
any other fund held in the investor's account, provided that Class A shares of
the fund to be acquired in the exchange are held in the account at the time of
the exchange. Otherwise, Class D shares will only be exchangeable for Class D
shares of another fund.
Class B and Class C shares will be exchangeable only with shares of the same
class. Accordingly, the Class B shareholders' exchange privilege will remain
unchanged. The existing Class B shares of Merrill Lynch Fundamental Growth
Fund, Inc. are presently the equivalent of the new Class C shares and, upon
implementation of the Select Pricing System, automatically will be redesignated
Class C shares. Such shares will not be exchangeable for Class B shares
beginning on or about October 24, 1994, but will be exchangeable instead for
Class C shares to be created in the other funds.
For further information, see "Shareholder Services--Exchange Privilege" in
the Statement of Additional Information.
Automatic Reinvestment of Dividends and Capital Gains Distributions. All
dividends and capital gains distributions are reinvested automatically in full
and fractional shares of the Fund, without sales charges, at the net asset
value per share next determined on the payable date of such dividends or
distributions. A shareholder may, at any time, by written notification or
telephone call (1-800-MER-FUND) to the Transfer Agent, elect to have subsequent
dividends or both dividends and capital gains distributions, paid in cash,
rather than reinvested, in which event payment will be mailed monthly. No
contingent deferred sales charge will be imposed on redemption of shares issued
as a result of the automatic reinvestment of dividends or capital gains
distributions.
Systematic Withdrawal and Automatic Investment Plans. A Class A shareholder
may elect to receive systematic withdrawal payments from his Investment Account
in the form of payments by check or through automatic payment by direct deposit
to his bank account on either a monthly or quarterly basis. Regular additions
of both Class A and Class B shares may be made to an investor's Investment
Account by prearranged charges of $50 or more to his regular bank account.
Investors who maintain CMA(R) accounts may arrange to have periodic investments
made in the Fund in their CMA(R) account or in certain related accounts in
amounts of $100 or more through the CMA Automated Investment Program. The
Automated Investment Program is not available to shareholders whose shares are
held in a brokerage account with Merrill Lynch (other than a CMA account) or to
shareholders participating in retirement plans.
Retirement Plans. Class A shares are offered at net asset value to qualified
retirement plans within the meaning of Section 401(a) of the Internal Revenue
Code of 1986, as amended (the "Code"), and deferred compensation plans within
the meaning of Sections 403(b) and 457 of the Code ("Retirement Plans"),
provided the plan has $5 million or more in existing plan assets initially
invested in portfolios, mutual funds or trusts advised either directly or
through the Manager or its affiliate, FAM. Class A shares may also be offered
at net asset value to Retirement Plans, provided the plan has accumulated $5
million or more in existing plan assets invested in mutual funds advised by the
Manager or FAM charging a front-end sales charge or contingent
35
<PAGE>
deferred sales charge. Assets of Retirement Plans with the same sponsor or an
affiliated sponsor may be aggregated. Retirement Plans that are also qualified
under Section 401(k) of the Code with a salary reduction feature offering a
menu of investment to plan participants ("Eligible 401(k) Plans") are also
offered Class A shares at net asset value, provided such plan initially has
1,000 or more employees eligible to participate in the plan. Employees
eligible to participate in Retirement Plans of the same sponsoring employer or
its affiliates may be aggregated. Retirement Plans meeting any of the
foregoing requirements and which are provided specialized services (e.g.,
plans whose participants may direct on a daily basis their plan allocations
among a wide range of investments including individual corporate equities and
other securities in addition to mutual fund shares) by the Merrill Lynch
Blueprint Program, are offered Class A shares at a price equal to net asset
value per share plus a reduced sales charge of 0.50%. Any Retirement Plan
which does not meet the above described qualifications to purchase Class A
shares at net asset value has the option of purchasing Class A shares at the
sales charge schedule disclosed in the Prospectus, or if the Retirement Plan
meets the specified requirements, then it may purchase Class B shares with a
waiver of the contingent deferred sales charge upon redemption. The minimum
initial and subsequent purchase requirements are waived in connection with all
the above referenced Retirement Plans.
TAXES
The Fund intends to continue to qualify for the special tax treatment
afforded regulated investment companies ("RICs") under the Internal Revenue
Code of 1986, as amended (the "Code"). If it so qualifies, the Fund (but not
its shareholders) will not be subject to Federal income tax on the part of its
net ordinary income and net realized capital gains which it distributes to
Class A and Class B shareholders (together, the "shareholders"). The Fund
intends to distribute substantially all of such income.
Dividends paid by the Fund from its ordinary income and distributions of the
Fund's net realized short-term capital gains (together referred to hereafter
as "ordinary income dividends") are taxable to a shareholder as ordinary
income. Distributions made from the Fund's net realized long-term capital
gains (including long-term gains from certain transactions in futures and
options) ("capital gain dividends") are taxable to a shareholder as long-term
capital gains, regardless of the length of time the shareholder has owned Fund
shares. Any loss upon the sale or exchange of Fund shares held for six months
or less, however, will be treated as long-term capital loss to the extent of
any capital gain dividends received by the shareholder. Distributions in
excess of the Fund's earnings and profits will first reduce the adjusted tax
basis of a holder's shares and, after such adjusted tax basis is reduced to
zero, will constitute capital gains to such holder (assuming the shares are
held as a capital asset).
Dividends are taxable to shareholders even though they are reinvested in
additional shares of the Fund. Not later than 60 days after the close of its
taxable year, the Fund will provide its shareholders with a written notice
designating the amounts of any ordinary income dividends or capital gain
dividends. Distributions by the Fund, whether from ordinary income or capital
gains, will not be eligible for the dividends-received deduction allowed to
corporations under the Code. If the Fund pays a dividend in January which was
declared in the previous October, November or December to shareholders of
record on a specified date in one of such months, then such dividend will be
treated for tax purposes as being paid by the Fund and received by its
shareholders on December 31 of the year in which such dividend was declared.
Ordinary income dividends paid by the Fund to shareholders who are
nonresident aliens or foreign entities will be subject to a 30% United States
withholding tax under existing provisions of the Code applicable to foreign
individuals and entities unless a reduced rate of withholding or a withholding
exemption is provided under applicable treaty law. Nonresident shareholders
are urged to consult their own tax advisers concerning the applicability of
the United States withholding tax.
36
<PAGE>
Dividends and interest received by the Fund may give rise to withholding and
other taxes imposed by foreign countries. Tax conventions between certain
countries and the United States may reduce or eliminate such taxes.
Under certain provisions of the Code, some shareholders may be subject to a
31% withholding tax on ordinary income dividends, capital gain dividends and
redemption payments ("backup withholding"). Generally, shareholders subject to
backup withholding will be those for whom no certified taxpayer identification
number is on file with the Fund or who, to the Fund's knowledge, have furnished
an incorrect number. When establishing an account, an investor must certify
under penalty of perjury that such number is correct and that the investor is
not otherwise subject to backup withholding.
If a shareholder exercises an exchange privilege within 90 days of acquiring
the shares, then the loss the shareholder can recognize on the exchange will be
reduced (or the gain increased) to the extent the sales charge paid to the Fund
reduces any sales charge the shareholder would have owed upon the purchase of
the new shares in the absence of the exchange privilege. Instead, such sales
charge will be treated as an amount paid for the new shares.
A loss realized on a sale or exchange of shares of the Fund will be
disallowed if other Fund shares are acquired (whether through the automatic
reinvestment of dividends or otherwise) within a 61-day period beginning 30
days before and ending 30 days after the date that the shares are disposed of.
In such a case, the basis of the shares acquired will be adjusted to reflect
the disallowed loss.
The Fund may make investments that produce taxable income that is not matched
by a corresponding receipt of cash or an offsetting loss deduction. Such
investments would include dollar rolls and obligations that have original issue
discount (such as SMBSs), accrete discount or are subordinated in the mortgage-
backed securities structure. Such taxable income would be treated as income
earned by the Fund and would be subject to the distribution requirements of the
Code. Because such income may not be matched by a corresponding receipt of cash
by the Fund or an offsetting loss deduction, the Fund may be required to borrow
money or dispose of other securities to be able to make distributions to
shareholders. The Fund intends to make sufficient and timely distributions to
shareholders so as to qualify for RIC status at all times.
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code and Treasury regulations presently in effect. For the
complete provisions, reference should be made to the pertinent Code sections
and the Treasury regulations promulgated thereunder. The Code and the Treasury
regulations are subject to change by legislative, judicial or administrative
action either prospectively or retroactively.
Ordinary income and capital gain dividends may also be subject to state and
local taxes.
Certain states exempt from state income taxation dividends paid by RICs which
are derived from interest on U.S. Government obligations. State law varies as
to whether dividend income attributable to U.S. Government obligations is
exempt from state income tax. In general, state law does not consider income
derived from MBSs to be income attributable to U.S. Government obligations.
Shareholders are urged to consult their own tax advisers regarding specific
questions as to Federal, foreign, state or local taxes. Foreign investors
should consider applicable foreign taxes in their evaluation of an investment
in the Fund.
37
<PAGE>
PERFORMANCE DATA
From time to time the Fund may include its average annual total return and
yield for various specified time periods in advertisements or information
furnished to present or prospective shareholders. Average annual total return
and yield are computed separately for Class A and Class B shares in accordance
with formulas specified by the Securities and Exchange Commission.
Average annual total return quotations for the specified period will be
computed by finding the average annual compounded rates of return (based on net
investment income and any realized and unrealized capital gains or losses on
portfolio investments over such periods) that would equate the initial amount
invested to the redeemable value of such investment at the end of each period.
Average annual total return will be computed assuming all dividends and
distributions are reinvested and taking into account all applicable recurring
and nonrecurring expenses, including the maximum sales charge in the case of
Class A shares and the contingent deferred sales charge that would be
applicable to a complete redemption of the investment at the end of the
specified period in the case of Class B shares. Dividends paid by the Fund with
respect to Class A and Class B shares to the extent any dividends are paid,
will be calculated in the same manner at the same time on the same day and will
be in the same amount, except that account maintenance and distribution fees
and any incremental transfer agency costs relating to Class B shares will be
borne exclusively by Class B shares and the account maintenance fee relating to
Class A shares will be borne exclusively by Class A shares. The Fund will
include performance data for both Class A and Class B shares of the Fund in any
advertisement or information including performance data of the Fund.
The Fund also may quote total return and aggregate total return performance
data for various specified time periods. Such data will be calculated
substantially as described above, except that (1) the rates of return
calculated will not be average annual rates, but rather, actual annual,
annualized or aggregate rates of return and (2) the maximum applicable sales
charges will not be included with respect to annual or annualized rates of
return calculations. Aside from the effect on the performance data calculations
of including or excluding the maximum applicable sales charges, actual annual
or annualized total return data generally will be lower than average annual
total return data since the average annual rates of return reflect compounding;
aggregate total return data generally will be higher than average annual total
return data since the aggregate rates of return reflect compounding over a
longer period of time. In advertisements distributed to investors whose
purchases are subject to reduced sales load in the case of Class A shares or
waiver of the contingent deferred sales charge in the case of Class B shares
(such as investors in certain retirement plans), the performance data may take
into account the reduced, and not the maximum, sales charges or may not take
into account the contingent deferred sales charge and therefore may reflect
greater total return since, due to the reduced sales charges or waiver of the
contingent deferred sales charge, a lower amount of expenses is deducted. See
"Purchase of Shares." The Fund's total return may be expressed either as a
percentage or as a dollar amount in order to illustrate such total return on a
hypothetical $1,000 investment in the Fund at the beginning of each specified
period.
Yield quotations will be computed based on a 30-day period by dividing (a)
net income based on the yield of each security earned during the period by (b)
the average daily number of shares outstanding during that period that were
entitled to receive dividends multiplied by (c) the maximum offering price per
share on the last day of the period.
Total return and yield figures are based on the Fund's historical performance
and are not intended to indicate future performance. The Fund's total return
and yield will vary depending on market conditions,
38
<PAGE>
the securities comprising the Fund's portfolio, the Fund's operating expenses
and the amount of realized and unrealized net capital gains or losses during
the period. The value of an investment in the Fund will fluctuate and an
investor's shares, when redeemed, may be worth more or less than their original
cost.
On occasion, the Fund may compare its performance to performance data
published by Lipper Analytical Services, Inc., CDA Investment Technology, Inc.,
Morningstar Publications, Inc., Money Magazine, U.S. News and World Report,
Business Week, Forbes, Fortune, or other industry publications. In addition,
from time to time the Fund may include the Fund's risk-adjusted performance
ratings assigned by Morningstar Publications, Inc. in advertising or
supplemental sales literature. As with other performance data, performance
comparisons should not be considered representative of the Fund's relative
performance for any future period.
PORTFOLIO TRANSACTIONS
The Fund has no obligation to deal with any dealer or group of dealers in the
execution of transactions in portfolio securities of the Fund. The securities
in which the Fund invests are normally purchased directly from the issuer or
from an underwriter or dealer in such securities. Where possible, the Fund
deals directly with the dealers who make a market in the securities involved
except in those circumstances where better prices and execution are available
elsewhere. It is the policy of the Fund to obtain the best net results in
conducting portfolio transactions, taking into account such factors as price
(including the applicable dealer spread), the size, type and difficulty of the
transactions involved, the firm's general execution and operations facilities,
and the firm's risk in positioning the securities involved and the provision of
supplemental investment research by the firm. While reasonably competitive
spreads or commissions are sought, the Fund will not necessarily be paying the
lowest spread or commission available. The portfolio securities of the Fund
generally are traded on a net basis and normally do not involve either
brokerage commissions or transfer taxes. The cost of portfolio securities
transactions of the Fund primarily consists of dealer or underwriter spreads.
Under the 1940 Act, persons affiliated with the Fund, including Merrill Lynch,
are prohibited from dealing with the Fund as a principal in the purchase and
sale of securities unless such trading is permitted by an exemptive order
issued by the Securities and Exchange Commission. In addition, the Fund may not
purchase securities for the Fund from any underwriting syndicate of which
Merrill Lynch is a member except pursuant to procedures approved by the
Directors of the Fund which comply with rules adopted by the Securities and
Exchange Commission. Affiliated persons of the Fund may serve as its broker in
over-the-counter transactions conducted for the Fund on an agency basis only.
PORTFOLIO TURNOVER
Generally, the Fund does not purchase securities for short-term trading
profits. However, the Fund may dispose of securities without regard to the time
they have been held when such actions, for defensive or other reasons, appear
advisable to the Manager. While it is not possible to predict turnover rates
with any certainty, at present it is anticipated that the Fund's annual
portfolio turnover rate, under normal circumstances, will be less than 200%.
For the fiscal year ended May 31, 1994, the Fund's portfolio turnover rate was
60.38%. (The portfolio turnover rate is calculated by dividing the lesser of
purchases or sales of portfolio securities for the particular fiscal year by
the monthly average of the value of the portfolio securities owned by the Fund
during the particular fiscal year.) High portfolio turnover involves
correspondingly greater transaction costs in the form of dealer spreads and
brokerage commissions, which are borne directly by the Fund.
39
<PAGE>
ADDITIONAL INFORMATION
DIVIDENDS AND DISTRIBUTIONS
All or a portion of the Fund's net investment income will be declared as
dividends daily prior to the determination of net asset value on that day and
paid monthly. The Fund may at times pay out less than the entire amount of net
investment income earned in any particular period and may at times pay out such
accumulated undistributed income in addition to net investment income earned in
any particular period in order to permit the Fund to maintain a more stable
level of distributions. As a result, the distribution paid by the Fund for any
particular period may be more or less than the amount of net investment income
earned by the Fund during such period. However, it is the Fund's intention to
distribute during any fiscal year all its net investment income. Shares will
accrue dividends as long as they are issued and outstanding. Shares are issued
and outstanding as of the settlement date of a purchase order to the settlement
date of a redemption order. All net realized long-term and short-term capital
gains, if any, will be distributed to the Fund's shareholders at least
annually.
The per share dividends and distributions on Class B shares will be lower
than the per share dividends and distributions on Class A shares as a result of
the effect of the account maintenance, distribution and higher transfer agency
fees applicable with respect to the Class B shares, as compared with the
account maintenance fee applicable to the Class A shares. See "Additional
Information--Determination of Net Asset Value." Dividends and distributions may
be reinvested automatically in shares of the Fund at net asset value.
Shareholders may elect in writing to receive any such dividends or
distributions, or both, in cash. Dividends and distributions are taxable to
shareholders as discussed under "Taxes" whether they are reinvested in shares
of the Fund or received in cash.
DETERMINATION OF NET ASSET VALUE
The net asset value of the Fund is determined by the Manager once daily at
4:15 P.M. following the normal close of trading on the New York Stock Exchange
on each day during which the New York Stock Exchange is open for trading. The
net asset value per share is computed by dividing the value of the securities
held by the Fund plus any cash or other assets (including interest and
dividends accrued but not yet received) minus all liabilities (including
accrued expenses) by the total number of shares outstanding at such time,
rounded to the nearest cent. Expenses, including the fees payable to the
Manager and the Distributor, are accrued daily. The Fund employs Merrill Lynch
Securities Pricing Service ("MLSPS"), an affiliate of the Manager, to provide
mortgage-backed securities prices for the Fund. Such arrangements went into
effect following the close of the Fund's most recent fiscal year end and
therefore no payments were made to MLSPS during such fiscal year.
The net asset value per share of the Class A and Class B shares are expected
to be equivalent. Under certain circumstances, however, the per share net asset
value of the Class B shares generally will be lower than the per share net
asset value of the Class A shares reflecting the daily expense accruals of the
higher distribution and transfer agency fees applicable with respect to the
Class B shares, as compared with the account maintenance fee applicable to the
Class A shares. It is expected, however, that the per share net asset value of
the two classes will tend to converge immediately after the payment of
dividends or distributions, which will differ by approximately the amount of
the expense accrual differential between the classes.
ORGANIZATION OF THE FUND
The Fund was incorporated under Maryland law on April 19, 1991. It has an
authorized capital of 300,000,000 shares of common stock, par value $0.10 per
share, divided into two classes, designated Class A
40
<PAGE>
and Class B Common Stock. Class A Common Stock consists of 100,000,000 shares.
Class B Common Stock consists of 200,000,000 shares. Both Class A and Class B
Common Stock represent an interest in the same assets of the Fund and are
identical in all respects except that the expenses of the account maintenance
fee related to the Class A shares are borne solely by the Class A shares and
the expenses of the account maintenance and distribution fees related to the
Class B shares are borne solely by the Class B shares and Class A and Class B
shares have exclusive voting rights with respect to matters relating to such
account maintenance and distribution expenditures. See "Purchase of Shares."
The Fund has received an order from the Securities and Exchange Commission (the
"Commission") permitting the issuance and sale of multiple classes of common
stock. The Directors of the Fund may classify and reclassify the shares of the
Fund into additional classes of common stock at a future date. See "Shareholder
Services--Exchange Privilege."
Shareholders are entitled to one vote for each share held and fractional
votes for fractional shares held and will vote on the election of Directors and
any other matter submitted to a shareholder vote. The Fund does not intend to
hold meetings of shareholders in any year in which the 1940 Act does not
require shareholders to act upon any of the following matters: (i) election of
directors; (ii) approval of an investment advisory agreement; (iii) approval of
a distribution agreement; and (iv) ratification of selection of independent
accountants. Also, the by-laws of the Fund require that a special meeting of
stockholders be held upon the written request of shareholders of the Fund as
required by Maryland corporate law. Voting rights for Directors are not
cumulative. Shares issued are fully paid and non-assessable and have no
preemptive or conversion rights. Each share of Class A and Class B Common Stock
is entitled to participate equally in dividends and distributions declared by
the Fund and in the net assets of the Fund upon liquidation or dissolution
after satisfaction of outstanding liabilities, except that, as noted above,
expenses related to the distribution of the shares of a class will be borne
solely by such class.
SHAREHOLDER INQUIRIES
Shareholder inquiries may be addressed to the Fund at the address or
telephone number set forth on the cover page of this Prospectus.
SHAREHOLDER REPORTS
Only one copy of each shareholder report and certain shareholder
communications will be mailed to each identified shareholder regardless of the
number of accounts such shareholder has. If a shareholder wishes to receive
separate copies of each report and communication for each of the shareholder's
related accounts the shareholder should notify in writing:
Financial Data Services, Inc.
Attn.: TAMFO
P.O. Box 45289
Jacksonville, FL 32223-5289
The written notification should include the shareholder's name, address, tax
identification number and Merrill Lynch, Pierce, Fenner & Smith Incorporated
and/or mutual fund account numbers. If you have any questions regarding this
please call your Merrill Lynch financial consultant or Financial Data Services,
Inc. at 800-637-3863.
41
<PAGE>
[THIS PAGE INTENTIONALLY LEFT BLANK]
42
<PAGE>
MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC.--AUTHORIZATION FORM
- - - --------------------------------------------------------------------------------
- - - --------------------------------------------------------------------------------
1. SHARE PURCHASE APPLICATION
I, being of legal age, wish to purchase . . . . . . Class A shares or
. . . . . . Class B shares (choose one) of Merrill Lynch Adjustable Rate
Securities Fund, Inc. and establish an Investment Account as described in the
Prospectus.
Basis for establishing an Investment Account:
A. I enclose a check for $. . . . . . . payable to Financial Data
Services, Inc., as an initial investment (minimum $1,000). (Subsequent
investments $50 or more). I understand that this purchase will be executed
at the applicable offering price next to be determined after this
Application is received by you.
B. I already own shares of the following Merrill Lynch mutual funds that
would qualify for the right of accumulation as outlined in the Statement of
Additional Information:
<TABLE>
<S> <C>
1. ............................................. 4. .............................................
2. ............................................. 5. .............................................
3. ............................................. 6. .............................................
</TABLE>
(Please list all Funds. Use a separate sheet of paper if necessary.)
Until you are notified by me in writing, the following options with
respect to dividends and distributions are elected:
Distribution
Options Elect [_] reinvest dividends Elect [_] reinvest capital gains
One [_] pay dividends in cash One [_] pay capital gains in cash
If no election is made, dividends and capital gains will be reinvested
automatically at net asset value without a sales charge.
---------------
(Please Print)
Name ........................................ [_][_][_][_][_][_][_][_]
First Name Initial Last Name
Social Security
Name of Co-Owner (if any) ................... No. or Taxpayer
First Name Initial Last Name Identification
No.
Address .....................................
......., 19..
............................................. Date
(Zip Code)
Occupation................ Name and Address of Employer.......................
...................................................
...................................................
Under penalty of perjury, I certify (1) that the number set forth above is my
correct Social Security No. or Taxpayer Identification No. and (2) that I am
not subject to backup withholding (as discussed under "Taxes" in the
Prospectus) either because I have not been notified that I am subject thereto
as result of a failure to report all interest or dividends or the Internal
Revenue Service ("IRS") has notified me that I am no longer subject thereto.
INSTRUCTION: YOU MUST STRIKE OUT THE LANGUAGE IN (2) ABOVE IF YOU HAVE BEEN
NOTIFIED THAT YOU ARE SUBJECT TO BACKUP WITHHOLDING DUE TO UNDER-REPORTING AND
IF YOU HAVE NOT RECEIVED A NOTICE FROM THE IRS THAT BACKUP WITHHOLDING HAS BEEN
TERMINATED.
SIGNATURE OF OWNER ........... SIGNATURE OF CO-OWNER (IF ANY) ............
In the case of co-owners, a joint tenancy with right of survivorship will be
presumed unless otherwise specified.
- - - --------------------------------------------------------------------------------
2. LETTER OF INTENTION--CLASS A SHARES ONLY (SEE TERMS AND CONDITIONS IN THE
STATEMENT OF ADDITIONAL INFORMATION)
. . . . . . . . . . . . . . . . . . . . . . . . . . .,
19. . . . .
Date of initial
purchase
Gentlemen:
Although I am not obligated to do so, I intend to purchase shares of Merrill
Lynch Adjustable Rate Securities Fund, Inc. or any other investment company
with an initial sales charge or deferred sales charge for which Merrill Lynch
Funds Distributor, Inc. acts as a distributor over the next 13-month period
which will equal or exceed:
[_] $100,000 [_] $500,000 [_] $1,000,000 _[_] $3,000,000___[_] $5,000,000
Each purchase will be made at the then reduced offering price applicable to
the amount checked above, as described in the Fund's prospectus.
I agree to the terms and conditions of the Letter of Intention. I hereby
irrevocably constitute and appoint Merrill Lynch Funds Distributor, Inc., my
attorney, with full power of substitution, to surrender for redemption any or
all shares of Merrill Lynch Adjustable Rate Securities Fund, Inc. held as
security.
<TABLE>
<S> <C>
By ............................................. ................................................
Signature (If registered in joint names, both
Signature of Owner must sign)
</TABLE>
In making purchases under this letter, the following are the related accounts
on which reduced offering prices are to apply:
<TABLE>
<S> <C>
(1) Name ....................................... (2) Name .......................................
</TABLE>
43
<PAGE>
MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC.--AUTHORIZATION FORM
- - - -------------------------------------------------------------------------------
3. SYSTEMATIC WITHDRAWAL PLAN--CLASS A SHARES ONLY (SEE TERMS AND CONDITIONS
IN THE STATEMENT OF ADDITIONAL INFORMATION)
Minimum Requirements: $10,000 for monthly disbursements, $5,000 for
quarterly, of shares in Merrill Lynch Adjustable Rate Securities Fund, Inc. at
cost or current offering price.
Begin systematic withdrawal on .........................., 19....
(date)
Withdrawals to be made either (check one) [_] Monthly
[_] Quarterly*
*Quarterly withdrawals are made on the 24th day of March,
June, September and December.
Specify withdrawal amount (check one): [_] $... or [_]...% of the current
value of Class A shares in the account.
Specify withdrawal method: [_] check or [_] direct deposit to bank account
(check one and complete part (a) or (b) below):
(b) I HEREBY AUTHORIZE PAYMENT BY
(a) I HEREBY AUTHORIZE PAYMENT BY DIRECT DEPOSIT TO BANK ACCOUNT AND (IF
CHECK NECESSARY) DEBIT ENTRIES AND
Draw checks payable (check one) ADJUSTMENTS FOR ANY CREDIT ENTRIES
[_] as indicated in item 1. MADE IN ERROR TO MY ACCOUNT.
[_] to the order of ................ Specify type of account (check one):
[_] checking [_] savings
I agree that this authorization will
Mail to (check one) remain in effect until I provide
[_] the address indicated in item written notification to Financial Data
1. Services, Inc. amending or terminating
[_] Name (Please Print)............. this service.
Address............................... Name on your Account...................
Signature of Owner.................... Bank...................................
Signature of Co-Owner (if any)........ Bank #........... Account #............
Bank Address...........................
Signature of Depositor...... Date......
Signature of Depositor (if joint
account)...............................
Note: If Automatic Direct Deposit is
elected, your blank, unsigned check
marked "VOID" or a deposit slip from
your savings account shall accompany
this Application.
- - - -------------------------------------------------------------------------------
4. APPLICATION FOR AUTOMATIC INVESTMENT PLAN
I hereby request that Financial Data Services, Inc. draw a check or an
automated clearing house ("ACH") debit on my checking account as described
below each month to purchase . . . . Class A shares or . . . . Class B shares
(choose one) of Merrill Lynch Adjustable Rate Securities Fund, Inc. subject to
the terms set forth below.
AUTHORIZATION TO HONOR CHECKS OR ACH
DEBITS DRAWN BY FINANCIAL DATA
FINANCIAL DATA SERVICES, INC. SERVICES, INC.
You are hereby authorized to draw
checks or an ACH debit each month on To ...............................Bank
my bank account for investment in (Investor's Bank)
Merrill Lynch Adjustable Rate Bank Address .........................
Securities Fund, Inc. as indicated
below:
Amount of each check or ACH
debit $ ........................ City ..... State ...... Zip Code.....
Account No. ....................
As a convenience to me, I hereby
Please date and invest checks or request and authorize you to pay and
draw ACH debits on the 20th day charge to my account checks or ACH
of each month beginning ..... debits drawn on my account by and
(Month) payable to Financial Data Services,
or as soon thereafter as Inc., Attn: TAMFO, Jacksonville,
possible. Florida 32223-5289. I agree that your
rights in respect of each such check
I agree that you are preparing or debit shall be the same as if it
these checks or drawing these debits were a check drawn on you and signed
voluntarily at my request and that personally by me. This authority is
you shall not be liable for any loss to remain in effect until revoked
arising from any delay in preparing personally by me in writing. Until
or failure to prepare any such check you receive such notice, you shall be
or debit. If I change banks or desire fully protected in honoring any such
to terminate or suspend this program, check or debit. I further agree that
I agree to notify you promptly in if any such check or debit be
writing. dishonored, whether with or without
I further agree that if a check or cause and whether intentionally or
debit is not honored upon inadvertently, you shall be under no
presentation, Financial Data liability.
Services, Inc. is authorized to
discontinue immediately the Automatic
Investment Plan and to liquidate
sufficient shares held in my account
to offset the purchase made with the
returned check or dishonored debit.
......... ........................
Date Signature of Depositor
......... ........................
Bank Signature of Depositor
Account (If joint account, both
....... ..................... Number must sign)
Date Signature of
Depositor
.....................
Signature of NOTE: IF AUTOMATIC INVESTMENT PLAN IS
Depositor ELECTED, YOUR BLANK, UNSIGNED CHECK
(If joint account, MARKED "VOID" SHOULD ACCOMPANY THIS
both must sign) APPLICATION.
- - - -------------------------------------------------------------------------------
5. FOR DEALER ONLY We hereby authorize Merrill
Branch Office, Address, Stamp Lynch Funds Distributor, Inc. to
act as our agent in connection
- - - - - with transactions under this
authorization form and agree to
notify the Distributor of any
purchases made under a Letter of
Intention or Systematic Withdrawal
Plan. We guarantee the
shareholder's signature.
- - - - -
This form when completed should be
mailed to:
Merrill Lynch Adjustable Rate ...................................
Securities Fund, Inc. Dealer Name and Address
c/o Financial Data Services, Inc. By ................................
Attn: TAMFO Authorized Signature of Dealer
P.O. Box 45289
Jacksonville, Florida 32223-5289
[_][_][_] [_][_][_][_] ..........
Branch-Code F/C No. F/C Last
Name
[_][_][_] [_][_][_][_]
Dealer's Customer F/C No.
44
<PAGE>
[THIS PAGE INTENTIONALLY LEFT BLANK]
45
<PAGE>
[THIS PAGE INTENTIONALLY LEFT BLANK]
46
<PAGE>
Manager
Merrill Lynch Asset Management
Administrative Offices:
800 Scudders Mill Road
Plainsboro, New Jersey
Mailing Address:
P.O. Box 9011
Princeton, New Jersey 08543-9011
Distributor
Merrill Lynch Funds Distributor, Inc.
Administrative Offices:
800 Scudders Mill Road
Plainsboro, New Jersey
Mailing Address:
P.O. Box 9011
Princeton, New Jersey 08543-9011
Custodian
The Bank of New York
90 Washington Street 12th Floor
New York, New York 10286
Transfer Agent
Financial Data Services, Inc.
Administrative Offices:
Transfer Agency Mutual Fund Operations
4800 Deer Lake Drive East
Jacksonville, Florida 32246-6484
Mailing Address: Attn: TAMFO
P.O. Box 45289
Jacksonville, Florida 32223-5289
Independent Auditors
Deloitte & Touche LLP
117 Campus Drive
Princeton, New Jersey 08540
Counsel
Brown & Wood
One World Trade Center
New York, New York 10048-0557
<PAGE>
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRE-
SENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, IN CONNECTION WITH
THE OFFER CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER IN-
FORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE FUND, THE MANAGER OR DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE
AN OFFERING IN ANY STATE IN WHICH SUCH OFFERING MAY NOT LAWFULLY BE MADE.
------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary and Fee Table.......................................... 2
Alternative Sales Arrangements............................................ 5
Financial Highlights...................................................... 7
Investment Objective and Policies......................................... 8
Types of Issuers/Quality Standards....................................... 9
Description of Adjustable Rate Securities................................ 10
Description of Other Securities.......................................... 13
Description of Money Market Securities................................... 14
Special Considerations and Risk Factors.................................. 14
Portfolio Strategies Involving Interest Rate Transactions, Options and
Futures................................................................. 16
Other Investment Policies and Practices.................................. 20
Investment Restrictions.................................................. 21
Management of the Fund.................................................... 22
Directors................................................................ 22
Management and Advisory Arrangements..................................... 23
Transfer Agency Services................................................. 24
Purchase of Shares........................................................ 24
Alternative Sales Arrangements........................................... 25
Initial Sales Charge Alternative--Class A Shares......................... 27
Deferred Sales Charge Alternative--Class B Shares........................ 29
Redemption of Shares...................................................... 31
Redemption............................................................... 31
Repurchase............................................................... 32
Reinstatement Privilege--Class A Shares.................................. 32
Shareholder Services...................................................... 33
Taxes..................................................................... 36
Performance Data.......................................................... 38
Portfolio Transactions.................................................... 39
Portfolio Turnover....................................................... 39
Additional Information.................................................... 40
Dividends and Distributions.............................................. 40
Determination of Net Asset Value......................................... 40
Organization of the Fund................................................. 40
Shareholder Inquiries.................................................... 41
Shareholder Reports...................................................... 41
Authorization Form........................................................ 43
</TABLE>
Code #13937--0994
Prospectus
(ART)
- - - ----------------------------------
MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC.
September 28, 1994
Distributor: Merrill Lynch Funds Distributor, Inc.
This prospectus should be retained for future reference.
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
- - - -----------------------------------
MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC.
P.O. BOX 9011, PRINCETON, NEW JERSEY 08543-9011 . PHONE NO. (609) 282-2800
----------------
The investment objective of Merrill Lynch Adjustable Rate Securities Fund,
Inc. (the "Fund") is to seek high current income consistent with a policy of
limiting the degree of fluctuation in the net asset value of Fund shares from
movements in interest rates. The Fund does not attempt to maintain a constant
net asset value per share. The Fund seeks to achieve this objective by
investing at least 65% of its total assets in adjustable rate securities,
consisting principally of mortgage-backed and asset-backed securities. The Fund
may employ a variety of portfolio strategies to enhance income and to hedge
against changes in interest rates. There can be no assurance that the
investment objective of the Fund will be realized.
The Fund offers two classes of shares which may be purchased at a price equal
to the next determined net asset value per share, plus in both cases a sales
charge which, at the election of the purchaser, may be imposed (i) at the time
of purchase (the "Class A shares"), or (ii) on a deferred basis (the "Class B
shares"). These alternatives permit an investor to choose the method of
purchasing shares that is most beneficial given the amount of the purchase, the
length of time the investor expects to hold the shares and other circumstances.
Investors should understand that the purpose and function of the deferred sales
charges and ongoing account maintenance fee with respect to the Class B shares
are the same as those of the initial sales charge and ongoing account
maintenance fee with respect to the Class A shares. Each Class A and Class B
share represents identical interests in the investment portfolio of the Fund
and has the same rights, except that Class B shares bear the expenses of the
account maintenance fee and distribution fee and certain other costs resulting
from the deferred sales charge arrangement and Class A shares bear the expenses
of the account maintenance fee. The two classes also have different exchange
privileges.
----------------
This Statement of Additional Information of the Fund is not a prospectus and
should be read in conjunction with the Prospectus of the Fund, dated September
28, 1994 (the "Prospectus"), which has been filed with the Securities and
Exchange Commission and can be obtained, without charge, by calling or by
writing the Fund at the above telephone number or address. This Statement of
Additional Information has been incorporated by reference into the Prospectus.
----------------
MERRILL LYNCH ASSET MANAGEMENT--MANAGER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC.--DISTRIBUTOR
The date of this Statement of Additional Information is September 28, 1994
<PAGE>
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to seek high current income
consistent with a policy of limiting the degree of fluctuation in the net asset
value of Fund shares from movements in interest rates. The Fund will seek to
achieve its objective by investing at least 65% of its total assets in
adjustable rate securities ("Adjustable Rate Securities"), consisting
principally of mortgage-backed and asset-backed securities. Adjustable Rate
Securities bear interest at rates that adjust at periodic intervals in
conjunction with changes in market levels of interest. Such securities will be
issued or guaranteed by agencies or instrumentalities of the United States or
rated AA by Standard & Poor's Corporation ("Standard & Poor's") or Aa by
Moody's Investors Service ("Moody's"). Reference is made to "Investment
Objective and Policies" in the Prospectus for a discussion of the investment
objective and policies of the Fund.
The Fund may invest up to 35% of its total assets in other types of mortgage
and asset related securities, and derivative securities relating thereto,
including fixed rate mortgage and asset related securities and stripped
securities. The Fund also may invest in fixed rate securities issued by the
Federal National Mortgage Association. The above securities must be issued or
guaranteed by agencies or instrumentalities of the United States or be rated
"investment grade" by Standard & Poor's or by Moody's. Securities rated
investment grade are obligations rated at the time of purchase within the four
highest quality ratings as determined by either Standard & Poor's (currently
AAA, AA, A and BBB) or Moody's (currently Aaa, Aa, A and Baa). No more than 10%
of the Fund's total assets will be invested in securities rated in the lowest
category of investment grade. The Fund also may invest up to 35% of its total
assets in money market securities rated in the highest rating category by
Standard & Poor's or Moody's and, for temporary or defensive purposes, may
invest up to 100% of its assets in such securities.
The collateral backing mortgage-backed securities ("MBSs") and asset-backed
securities ("ABSs") is usually held by an independent bailee, custodian or
trustee on behalf of the holders of the related MBSs or ABSs. In such
instances, the holder of the related MBSs or ABSs (i.e., the Fund) will have
either an ownership interest or security interest in the underlying collateral
and can exercise its rights thereto through such bailee, custodian or trustee.
The Fund's investments in MBSs, ABSs and other securities are described in
detail in the Prospectus. Included below is certain additional information
related to such investments.
PRIVATELY ISSUED MORTGAGE-BACKED AND ASSET-BACKED SECURITIES--CREDIT
ENHANCEMENTS
As discussed more fully in the Prospectus, the Fund will, with respect to at
least that portion of its total assets (at least 65%) invested primarily in
Adjustable Rate Securities, limit its investments in privately issued MBSs and
ABSs to those MBSs and ABSs rated at least AA by Standard & Poor's or Aa by
Moody's or, if unrated, which are of comparable quality as determined by
Merrill Lynch Asset Management, L.P. (the "Manager"). As further indicated in
the Prospectus, such a rating may be based, in part, on certain credit
enhancements. These credit enhancements may offer two types of protection: (i)
liquidity protection, and (ii) protection against losses resulting from
ultimate default by an obligor and the underlying assets. Liquidity protection
refers to the provision of advances, generally by the entity administering the
pool of assets, to ensure that the receipt of payments on the underlying pool
occurs in a timely fashion. Protection against losses resulting from ultimate
default ensures ultimate payment of the obligations on at least a portion of
the assets in the pool. Such protection may be provided through guarantees,
insurance policies or letters of credit obtained by the issuer or sponsor from
third parties, through various means of structuring the transaction or through
a combination of such approaches. The Fund will not pay any additional fees for
such credit support, although the existence of credit support may increase the
price of a security.
2
<PAGE>
Credit enhancements can come from external providers such as banks or
financial insurance companies. Alternatively, they may come from the structure
of a transaction itself. Examples of credit support arising out of the
structure of the transaction include "senior-subordinated securities" (multiple
class securities with one or more classes subordinate to other classes as to
the payment of principal thereof and interest thereon, with the result that
defaults on the underlying assets are borne first by the holders of the
subordinated class), creation of "reserve funds" (where cash or investments,
sometimes funded from a portion of the payments on the underlying assets, are
held in reserve against future losses) and "overcollateralization" (where the
scheduled payments on, or the principal amount of, the underlying assets
exceeds that required to make payment of the securities and pay any servicing
or other fees). The degree of credit support provided for each issue is
generally based on historical information respecting the level of credit risk
associated with the underlying assets. Delinquencies or losses in excess of
those anticipated could adversely affect the return on an investment in such
issue. In addition, the Fund may purchase subordinated securities which, as
noted above, may serve as a form of credit support for senior securities
purchased by other investors.
UNITED STATES GOVERNMENT AGENCIES OR INSTRUMENTALITIES
As indicated in the Prospectus, at the present time, the majority of MBSs in
which the Fund may invest are either guaranteed by the Government National
Mortgage Association ("GNMA"), or issued by the Federal National Mortgage
Association ("FNMA") or the Federal Home Loan Mortgage Corporation ("FHLMC").
In addition, the Fund may invest in ABSs guaranteed by the U.S. Small Business
Administration. See "Investment Objective and Policies" in the Prospectus. Set
forth below is a more detailed description of those agencies and
instrumentalities, together with a description of the types of assets typically
comprising the pools underlying the securities of those entities.
Governmental National Mortgage Association. GNMA is a wholly-owned corporate
instrumentality of the United States within the Department of Housing and Urban
Development. The National Housing Act of 1934, as amended (the "Housing Act"),
authorizes GNMA to guarantee the timely payment of the principal of and
interest on securities that are based on and backed by a pool of specified
mortgage loans. To qualify such securities for a GNMA guarantee, the underlying
mortgages must be insured by the Federal Housing Administration under the
Housing Act, or Title V of the Housing Act of 1949 ("FHA Loans"), or be
guaranteed by the Veterans' Administration under the Servicemen's Readjustment
Act of 1944, as amended ("VA Loans"), or be pools of other eligible mortgage
loans. The Housing Act provides that the full faith and credit of the United
States Government is pledged to the payment of all amounts that may be required
to be paid under any guarantee. In order to meet its obligations under such
guarantee, GNMA is authorized to borrow from the United States Treasury with no
limitations as to amount.
GNMA pass-through MBSs may represent a pro rata interest in one or more pools
of the following types of mortgage loans: (i) fixed rate level payment mortgage
loans; (ii) fixed rate graduated payment mortgage loans; (iii) fixed rate
growing equity mortgage loans; (iv) fixed rate mortgage loans secured by
manufactured (mobile) homes; (v) mortgage loans on multifamily residential
properties under construction; (vi) mortgage loans on completed multifamily
projects; (vii) fixed rate mortgage loans as to which escrowed funds are used
to reduce the borrower's monthly payments during the early years of the
mortgage loans ("buydown" mortgage loans); (viii) mortgage loans that provide
for adjustments in payments based on periodic changes in interest rates or in
other payment terms of the mortgage loans; and (ix) mortgage-backed serial
notes.
Federal National Mortgage Association. FNMA is a federally chartered and
privately owned corporation established under the Federal National Mortgage
Association Charter Act. FNMA was originally organized in 1938 as a United
States Government agency to add greater liquidity to the mortgage market. FNMA
was transformed into a private sector corporation by legislation enacted in
1968. FNMA
3
<PAGE>
provides funds to the mortgage market primarily by purchasing home mortgage
loans from local lenders, thereby providing them with funds for additional
lending. FNMA acquires funds to purchase such loans from investors that may not
ordinarily invest in mortgage loans directly, thereby expanding the total
amount of funds available for housing.
Each FNMA pass-through MBS represents a pro rata interest in one or more
pools of FHA Loans, VA Loans or conventional mortgage loans (i.e., mortgage
loans that are not insured or guaranteed by any governmental agency). The loans
contained in those pools consist of: (i) fixed rate level payment mortgage
loans; (ii) fixed rate growing equity mortgage loans; (iii) fixed rate
graduated payment mortgage loans; (iv) variable rate mortgage loans; (v) other
adjustable rate mortgage loans; and (vi) fixed rate mortgage loans secured by
multifamily projects.
Federal Home Loan Mortgage Corporation. FHLMC is a corporate instrumentality
of the United States established by the Emergency Home Finance Act of 1970, as
amended (the "FHLMC Act"). FHLMC was organized primarily for the purpose of
increasing the availability of mortgage credit to finance needed housing. The
operations of FHLMC currently consist primarily of the purchase of first lien,
conventional, residential mortgage loans and participation interests in such
mortgage loans and the resale of the mortgage loans so purchased in the form of
mortgage-backed securities.
The mortgage loans underlying the FHLMC MBSs typically consist of fixed rate
or adjustable rate mortgage loans with original terms to maturity of between
ten and thirty years, substantially all of which are secured by first liens on
one- to four-family residential properties or multifamily projects. Each
mortgage loan must meet the applicable standards set forth in the FHLMC Act.
Mortgage loans underlying FHLMC MBSs may include whole loans, participation
interests in whole loans and undivided interests in whole loans and
participations in another FHLMC MBS.
U.S. Small Business Administration. The U.S. Small Business Administration
(the "SBA") is an independent agency of the United States established by the
Small Business Act of 1953. The SBA was organized primarily to assist
independently owned and operated businesses that are not dominant in their
respective markets. The SBA provides financial assistance, management
counseling and training for small businesses, as well as acting generally as an
advocate of small businesses.
The SBA guarantees the payment of principal and interest on portions of loans
made by private lenders to certain small businesses. The loans are generally
commercial loans such as working capital loans and equipment loans. The SBA is
authorized to issue from time to time, through its fiscal and transfer agent,
SBA-guaranteed participation certificates evidencing fractional undivided
interests in pools of these SBA-guaranteed portions of loans made by private
lenders. The SBA's guarantee of such certificates, and its guarantee of a
portion of the underlying loan, are backed by the full faith and credit of the
United States.
ADJUSTABLE RATE SECURITIES--INDEXES
As indicated above and described more fully in the Prospectus, at least 65%
of the Fund's total assets will be comprised of its investments in Adjustable
Rate Securities. The key determinant of the interest rates paid on such
securities is the interest rate index chosen (and the spread relating to such
securities). Certain of such indexes are tied to interest rates paid on
specified securities, such as one, three or five year U.S. Treasury securities,
while other indexes are more general. A prominent example of the latter type of
index is the cost of funds for member institutions (i.e., savings and loan
associations and savings banks) for the Federal Home Loan Bank (the "FHLB") of
San Francisco (the "COFI"). There are a number of factors that may affect the
COFI and cause it to behave differently from indexes tied to specific types of
securities. The COFI is
4
<PAGE>
dependent upon, among other things, the origination dates and maturities of the
member institution liabilities. Consequently, the COFI may not reflect the
average prevailing market interest rates on new liabilities of similar
maturities. There can be no assurance that the COFI will necessarily move in
the same direction as prevailing interest rates since as longer term deposits
or borrowings mature and are renewed at market interest rates the COFI will
rise or fall depending upon the differential between the prior and the new
rates on such deposits and borrowings. In addition, associations in the thrift
industry in recent years have caused and may continue to cause the cost of
funds of thrift institutions to change for reasons unrelated to changes in
general interest rate levels. Furthermore, any movement in the COFI as compared
to other indexes based upon specific interest rates may be affected by changes
instituted by the FHLB of San Francisco in the method used to calculate the
COFI. To the extent that COFI may reflect interest changes on a more delayed
basis than other indexes, in a period of rising interest rates any increase may
produce a higher yield to holder later than would be produced by such other
indices and in a period of declining interest rates the COFI may remain higher
than other market interest rates which may result in a higher level of
principal prepayments on mortgage loans which adjust in accordance with COFI
than mortgage or other loans which adjust in accordance with other indices. In
addition, to the extent that COFI may lag behind other indexes in a period of
rising interest rates securities based on COFI may have a lower market value
than would result from use of such other indexes, and in a period of declining
interest rates securities based on COFI may reflect a higher market value than
would securities based on other indexes.
ADDITIONAL COLLATERALIZED MORTGAGE OBLIGATION STRUCTURES
The Fund may invest to a significant extent in collateralized mortgage
obligations ("CMOs"). There are many types of CMO structures. Two such
structures are parallel pay CMOs and Planned Amortization Class CMOs ("PAC
Bonds"). Parallel pay CMOs are structured to provide payments of principal on
each payment date to more than one class. These simultaneous payments are taken
into account in calculating the stated maturity date or final distribution date
of each class, which, as with other CMO structures, must be retired by its
stated maturity date or final distribution date but may be retired earlier. PAC
Bonds generally require payments of a specified amount of principal on each
payment date so long as payments on the underlying pool of mortgage loans
remain within a certain range. PAC Bonds are always parallel pay CMOs with the
required principal payment on such securities having the highest priority after
interest has been paid to all classes.
PORTFOLIO STRATEGIES INVOLVING INTEREST RATE TRANSACTIONS, OPTIONS AND FUTURES
Reference is made to the discussion under the caption "Investment Objective
and Policies--Portfolio Strategies Involving Interest Rate Transactions,
Options and Futures" in the Prospectus for information with respect to various
portfolio strategies involving such portfolio strategies. The Fund may seek to
increase its return through the use of covered options on portfolio securities
and to hedge its portfolio against movements in the interest rates by means of
other portfolio strategies. The Fund has authority to write (i.e., sell)
covered call and put options on its portfolio securities, purchase and sell
call and put options on securities and engage in transactions in interest rate
swaps, caps and floors, financial futures contracts, and related options on
such futures. Each of such portfolio strategies is described in the Prospectus.
Although certain risks are involved in such transactions (as discussed in the
Prospectus and below), the Manager believes that, because the Fund will (i)
write only covered options and (ii) engage in other transactions only for
hedging purposes, the portfolio strategies of the Fund will not subject the
Fund to the risks frequently associated with the speculative use of such
transactions. While the Fund's use of hedging strategies is intended to reduce
the volatility of the net asset value of Fund shares, the Fund's net asset
value will fluctuate. There can be no assurance that the Fund's hedging
transactions will be effective. The following is further information relating
to certain portfolio strategies the Fund may utilize.
5
<PAGE>
Interest Rate Hedging Transactions and Risk Factors in Such Transactions. The
Fund may hedge all or a portion of its portfolio investments against
fluctuations in interest rates by entering into interest rate transactions. The
Fund bears the risk of an imperfect correlation between the index used in the
hedging transaction and that pertaining to the securities which are the subject
of the hedging transaction.
The Fund expects to enter into interest rate transactions primarily to hedge
its portfolio of Adjustable Rate Securities against fluctuations in interest
rates. Typically, the parties with which the Fund will enter into interest rate
transactions will be broker-dealers and other financial institutions. Certain
Federal income tax requirements may, however, limit the Fund's ability to
engage in certain interest rate transactions. Gains from transactions in
interest rate swaps distributed to shareholders will be taxable as ordinary
income or, in certain circumstances, as long-term capital gains to
shareholders. See "Dividends, Distributions and Taxes."
The purchase of an interest rate cap entitles the purchaser, to the extent
that a specified index exceeds a predetermined rate to receive payments of
interest on a notional principal amount from the party selling such interest
rate cap. The purchase of an interest rate cap therefore hedges against an
increase in interest rates above the cap on an Adjustable Rate Security held by
the Fund. Thus, for example, in the case of such a security indexed to COFI, if
COFI increases above the rate paid on the security, the counter-party will pay
the differential to the Fund. The opposite is true in the case of an interest
rate floor; it hedges against a decrease in the index rate below any floor on
the Adjustable Rate Security.
Interest rate swap transactions involve the exchange by the Fund with another
party of their respective commitments to pay or receive interest, such as an
exchange of fixed rate payments for floating rate payments. For example, if the
Fund holds an MBS with an interest rate that is reset only once each year, it
may swap the right to receive interest at this fixed rate for the right to
receive interest at a rate that is reset every week. This would enable the Fund
to offset a decline in the value of the MBS due to rising interest rates, but
would also limit its ability to benefit from falling interest rates.
Conversely, if the Fund holds an MBS with an interest rate that is reset every
week and it would like to lock in what it believes to be a high interest rate
for one year, it may swap the right to receive interest at this variable weekly
rate for the right to receive interest at a rate that is fixed for one year.
Such a swap would protect the Fund from a reduction in yield due to falling
interest rates, but would preclude it from taking full advantage of rising
interest rates.
The Fund usually will enter into interest rate swap transactions on a net
basis, i.e., the two payment streams are netted out, with the Fund receiving or
paying, as the case may be, only the net amount of the two payments. Inasmuch
as these transactions are entered into for good faith hedging purposes, the
Manager believes that such obligations do not constitute senior securities and,
accordingly, will not treat them as being subject to its borrowing
restrictions. The net amount of the excess, if any, of the Fund's obligations
over its entitlements with respect to each interest rate swap will be accrued
on a daily basis, and an amount of cash or high grade liquid debt securities
having an aggregate net asset value at least equal to the accrued excess will
be maintained in a segregated account by the Fund's custodian. If the interest
rate swap transaction is entered into on other than a net basis, the full
amount of the Fund's obligations will be accrued on a daily basis, and the full
amount of the Fund's obligations will be maintained in a segregated account by
the Fund's custodian. The Fund will not enter into any interest rate swap
transaction unless the credit quality of the unsecured senior debt or the
claims-paying ability of the other party thereto is rated in one of the highest
two rating categories by at least one nationally recognized statistical rating
organization or is believed by the Manager to be equivalent to such rating. If
there is a default by the other party to such a transaction, the Fund will have
contractual remedies pursuant to the agreements related to the transaction. The
swap market has grown substantially in recent years with a large number of
banks and investment banking firms acting
6
<PAGE>
both as principals and as agents utilizing standardized swap documentation. As
a result, the swap market has become relatively liquid in comparison with other
similar instruments traded in the interbank market.
The use of interest rate swaps is a highly specialized activity which
involves investment techniques and risks different from those associated with
ordinary portfolio securities transactions. If the Manager is incorrect in its
forecasts of market values, interest rates and other applicable factors, the
investment performance of the Fund would diminish compared with what it would
have been if these investment techniques were not used.
Interest rate swap transactions do not involve the delivery of securities or
other underlying assets or principal. Accordingly, the risk of loss with
respect to interest rate swaps is limited to the net amount of interest
payments that the Fund is contractually obligated to make. If the MBS or other
security underlying an interest rate swap is prepaid and the Fund continues to
be obligated to make payments to the other party to the swap, the Fund would
have to make such payments from another source. If the other party to an
interest rate swap defaults, the Fund's risk of loss consists of the net amount
of interest payments that the Fund contractually is entitled to receive. Since
interest rate transactions are individually negotiated, the Manager expects to
achieve an acceptable degree of correlation between the Fund's rights to
receive interest on MBSs and its rights and obligations to receive and pay
interest pursuant to interest rate swaps.
Writing Covered Options. The Fund is authorized to write, i.e., sell, covered
call options on the securities in which it may invest and to enter into closing
purchase transactions with respect to certain of such options. A covered call
option is an option where the Fund, in return for a premium, gives another
party a right to buy specified securities owned by the Fund at a specified
future date and price set at the time of the contract. The principal reason for
writing call options is to attempt to realize, through the receipt of premiums,
a greater return than would be realized on the securities alone. By writing
covered call options, the Fund gives up the opportunity, while the option is in
effect, to profit from any price increase in the underlying security above the
option exercise price. In addition, the Fund's ability to sell the underlying
security will be limited while the option is in effect unless the Fund effects
a closing purchase transaction. A closing purchase transaction cancels out the
Fund's position as the writer of an option by means of an offsetting purchase
of an identical option prior to the expiration of the option it has written.
Covered call options serve as a partial hedge against the price of the
underlying security declining.
The writer of a covered call option has no control over when he may be
required to sell his securities since he may be assigned an exercise notice at
any time prior to the termination of his obligation as a writer. If an option
expires unexercised, the writer realizes a gain in the amount of the premium.
Such a gain, of course, may be offset by a decline in the market value of the
underlying security during the option period. If a call option is exercised,
the writer realizes a gain or loss from the sale of the underlying security.
The Fund also may write put options which give the holder of the option the
right to sell the underlying security to the Fund at the stated exercise price.
The Fund will receive a premium for writing a put option which increases the
Fund's return. The Fund writes only covered put options which means that so
long as the Fund is obligated as the writer of the option it will, through its
custodian, have deposited and maintained cash, cash equivalents, U.S.
Government securities or other high grade liquid debt with the Fund's custodian
with a value equal to or greater than the exercise price of the underlying
securities. By writing a put, the Fund will be obligated to purchase the
underlying security at a price that may be higher than the market value of that
security at the time of exercise for as long as the option is outstanding. The
Fund may engage in closing transactions in order to terminate put options that
it has written.
7
<PAGE>
Options referred to herein and in the Fund's Prospectus may be options issued
by The Options Clearing Corporation (the "Clearing Corporation") which are
currently traded on the Chicago Board Options Exchange, American Stock
Exchange, Philadelphia Stock Exchange, Pacific Stock Exchange, New York Stock
Exchange or Midwest Stock Exchange. An option position may be closed out only
on an exchange which provides a secondary market for an option of the same
series. If a secondary market does not exist, it might not be possible to
effect closing transactions in particular options, with the result, in the case
of a covered call option, that the Fund will not be able to sell the underlying
security until the option expires or it delivers the underlying security upon
exercise. Reasons for the absence of a liquid secondary market on an exchange
include the following: (i) there may be insufficient trading interest in
certain options; (ii) restrictions may be imposed by an exchange on opening
transactions or closing transactions or both; (iii) trading halts, suspensions
or other restrictions may be imposed with respect to particular classes or
series of options or underlying securities; (iv) unusual or unforeseen
circumstances may interrupt normal operations on an exchange; (v) the
facilities of an exchange or the Clearing Corporation may not at all times be
adequate to handle current trading volume; or (vi) 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), in which event the secondary market on that exchange (or in that
class or series of options) would cease to exist, although outstanding options
on that exchange that had been issued by the Clearing Corporation as a result
of trades on that exchange would continue to be exercisable in accordance with
their terms.
The Fund may also enter into over-the-counter option transactions ("OTC
options"), which are two-party contracts with price and terms negotiated
between the buyer and seller. The staff of the Securities and Exchange
Commission has taken the position that OTC options and the assets used as cover
for written OTC options are illiquid securities. However, if the OTC option is
sold by the Fund to a primary U.S. Government securities dealer recognized by
the Federal Reserve Bank of New York and the Fund has the unconditional
contractual right to repurchase such OTC option from the dealer at a
predetermined price, then the Fund will treat as illiquid such amount of the
underlying securities as is equal to the repurchase price less the amount by
which the option is "in-the-money" (i.e., current market value of the
underlying security minus the option's strike price). The repurchase price with
the primary dealers is typically a formula price which is generally based on a
multiple of the premium received for the option, plus the amount by which the
option is "in-the-money". This policy is not a fundamental policy of the Fund
and may be amended by the Directors of the Fund without the approval of the
Fund's shareholders. However, the Fund will not change or modify this policy
prior to the change or modification by the Commission staff of its positions.
Purchasing Options. The Fund may purchase put options to hedge against a
decline in the market value of its equity holdings. By buying a put, the Fund
has a right to sell the underlying security at the exercise price, thus
limiting the Fund's risk of loss through a decline in the market value of the
security until the put option expires. The amount of any appreciation in the
value of the underlying security will be offset partially by the amount of the
premium paid for the put option and any related transaction costs. Prior to its
expiration, a put option may be sold in a closing sale transaction and profit
or loss from the sale will depend on whether the amount received is more or
less than the premium paid for the put option plus the related transaction
cost. A closing sale transaction cancels out the Funds' position as the
purchaser of an option by means of an offsetting sale of an identical option
prior to the expiration of the option it has purchased. In certain
circumstances, the Fund may purchase call options on securities held in its
portfolio on which it has written call options or which it intends to purchase.
The Fund may purchase either options traded on an exchange or OTC options.
8
<PAGE>
Futures and Financial Futures. As described in the Prospectus, the Fund is
authorized to engage in transactions in financial futures, and related options
on such futures. Set forth below is further information concerning futures
transactions.
A futures contract is an agreement between two parties to buy and sell a
security or, in the case of an index-based futures contract, to make and accept
a cash settlement for a set price on a future date. A majority of transactions
in futures contracts, however, do not result in the actual delivery of the
underlying instrument or cash settlement, but are settled through liquidation,
i.e., by entering into an offsetting transaction. Futures contracts have been
designed by boards of trade which have been designated "contracts markets" by
the Commodity Futures Trading Commission ("CFTC").
The purchase or sale of a futures contract differs from the purchase or sale
of a security in that no price or premium is paid or received. Instead, an
amount of cash or securities acceptable to the broker and the relevant contract
market, which varies, but is generally about 5% of the contract amount, must be
deposited with the broker. This amount is known as "initial margin" and
represents a "good faith" deposit assuring the performance of both the
purchaser and seller under the futures contract. Subsequent payments to and
from the broker, called "variation margin", are required to be made on a daily
basis as the price of the futures contracts fluctuates making the long and
short positions in the futures contracts more or less valuable, a process known
as "mark to market." At any time prior to the settlement date of the futures
contract, the position may be closed out by taking an opposite position which
will operate to terminate the position in the futures contract. A final
determination of variation margin is then made, additional cash is required to
be paid to or released by the broker and the purchaser realizes a loss or gain.
In addition, a nominal commission is paid on each completed sale transaction.
The Fund has received an order from the Securities and Exchange Commission
exempting it from the provisions of Section 17(f) and Section 18(f) of the
Investment Company Act of 1940 (the "1940 Act") in connection with its strategy
of investing in futures contracts. Section 17(f) relates to the custody of
securities and other assets of an investment company and may be deemed to
prohibit certain arrangements between the Fund and commodities brokers with
respect to initial and variation margin. Section 18(f) of the 1940 Act
prohibits an open-end investment company such as the Fund from issuing a
"senior security" other than a borrowing from a bank. The staff of the
Securities and Exchange Commission has in the past indicated that a futures
contract may be a "senior security" under the 1940 Act.
Risk Factors in Options and Futures Transactions. Utilization of options and
futures transactions to hedge the portfolio involves the risk of imperfect
correlation in movements in the prices of options and futures contracts and
movements in the prices of the securities which are the subject of the hedge.
If the price of the options and futures contract moves more or less than the
price of the securities, the Fund will experience a gain or loss which will not
be completely offset by movements in the price of the securities which are the
subject of the hedge. The successful use of options and futures also depends on
the Investment Adviser's ability to predict correctly price movements in the
market involved in a particular options or futures transaction.
Prior to exercise or expiration, an exchange-traded option position can only
be terminated by entering into a closing purchase or sale transaction. This
requires a secondary market on an exchange for call or put options of the same
series. The Fund will enter into an option or futures transaction on an
exchange only if there appears to be a liquid secondary market for such options
or futures. However, there can be no assurance that a liquid secondary market
will exist for any particular call or put option or futures contract at any
specific time. Thus, it may not be possible to close an option or futures
position. In the case of a futures position or an option on a futures position
written by the Fund, in the event of adverse price movements, the Fund would
9
<PAGE>
continue to be required to make daily cash payments of variation margin. In
such situations, if the Fund has insufficient cash, it may have to sell
portfolio securities to meet daily variation margin requirements at a time when
it may be disadvantageous to do so. In addition, the Fund may be required to
take or make delivery of the currency underlying futures contracts it holds.
The inability to close options and futures positions also could have an adverse
impact on the Fund's ability to hedge effectively its portfolio. There is also
the risk of loss by the Fund of margin deposits in the event of bankruptcy of a
broker with whom the Fund has an open position in a futures contract or related
option. The risk of loss from investing in futures transactions is
theoretically unlimited.
The exchanges on which the Fund intends to conduct options transactions have
generally established limitations governing the maximum number of call or put
options on the same underlying currency (whether or not covered) which may be
written by a single investor, whether acting alone or in concert with others
(regardless of whether such options are written on the same or different
exchanges or are held or written on one or more accounts or through one or more
brokers). "Trading limits" are imposed on the maximum number of contracts which
any person may trade on a particular trading day. An exchange may order the
liquidation of positions found to be in violation of these limits and it may
impose other sanctions or restrictions. The Manager does not believe that these
trading and position limits will have any adverse impact on the portfolio
strategies for hedging the Fund's portfolio.
OTHER INVESTMENT POLICIES AND PRACTICES
Repurchase Agreements and Purchase and Sale Contracts. The Fund may invest in
securities pursuant to repurchase agreements and purchase and sale contracts.
Repurchase agreements and purchase and sale contracts may be entered into only
with a member bank of the Federal Reserve System or primary dealer in U.S.
Government securities or an affiliate thereof. Under such agreements, the bank
or primary dealer or affiliate agrees, upon entering into the contract, to
repurchase the security at a mutually agreed upon time and price, thereby
determining the yield during the term of the agreement. This results in a fixed
rate of return insulated from market fluctuations during such period. In the
case of repurchase agreements, the prices at which the trades are conducted do
not reflect accrued interest on the underlying obligations; whereas, in the
case of purchase and sale contracts, the prices take into account accrued
interest. Such agreements usually cover short periods, such as under one week.
Repurchase agreements may be construed to be collateralized loans by the
purchaser to the seller secured by the securities transferred to the purchaser.
In the case of a repurchase agreement, the Fund will require the seller to
provide additional collateral if the market value of the securities falls below
the repurchase price at any time during the term of the repurchase agreement;
the Fund does not have the right to seek additional collateral in the case of
purchase and sale contracts. In the event of default by the seller under a
repurchase agreement construed to be a collateralized loan, the underlying
securities are not owned by the Fund but only constitute collateral for the
seller's obligation to pay the repurchase price. Therefore, the Fund may suffer
time delays and incur costs or possible losses in connection with the
disposition of the collateral. A purchase and sale contract differs from a
repurchase agreement in that the contract arrangements stipulate that the
securities are owned by the Fund. In the event of a default under such a
repurchase agreement or a purchase and sale contract, instead of the
contractual fixed rate of return, the rate of return to the Fund shall be
dependent upon intervening fluctuations of the market value of such security
and the accrued interest on the security. In such event, the Fund would have
rights against the seller for breach of contract with respect to any losses
arising from market fluctuations following the failure of the seller to
perform.
Lending of Portfolio Securities. Subject to investment restriction (8) below,
the Fund may lend securities from its portfolio to approved borrowers and
receive collateral in cash or securities issued or
10
<PAGE>
guaranteed by the United States Government which are maintained at all times in
an amount equal to at least 100% of the current market value of the loaned
securities. The purpose of such loans is to permit the borrower to use such
securities for delivery to purchasers when such borrower has sold short. If
cash collateral is received by the Fund, it is invested in short-term money
market securities, and a portion of the yield received in respect of such
investment is retained by the Fund. Alternatively, if securities are delivered
to the Fund as collateral, the Fund and the borrower negotiate a rate for the
loaned premium to be received by the Fund for lending its portfolio securities.
In either event, the total yield on the Fund's portfolio is increased by loans
of its portfolio securities. The Fund will have the right to regain record
ownership of loaned securities to exercise beneficial rights such as voting
rights, subscription rights and rights to dividends, interest or other
distributions. Such loans are terminable at any time. The Fund may pay
reasonable finder's, administrative and custodial fees in connection with such
loans.
INVESTMENT RESTRICTIONS
The Fund has adopted the following restrictions and policies relating to the
investment of its assets and its activities, which are fundamental policies and
may not be changed without the approval of the holders of a majority of the
Fund's outstanding voting securities (which for this purpose and under the 1940
Act means the lesser of (i) 67% of the shares represented at a meeting at which
more than 50% of the outstanding shares are represented or (ii) more than 50%
of the outstanding shares). The Fund may not:
(1) With respect to at least 75% of its total assets, invest in the
securities of any one issuer if, immediately after and as a result of such
investment, the value of the holdings of the Fund in the securities of such
issuer exceeds 5% of the Fund's total assets, taken at market value, except
that such restriction shall not apply to securities issued or guaranteed by
the United States Government or any of its agencies or instrumentalities.
(2) Make investments for the purpose of exercising control or management.
(3) Purchase the securities of other investment companies except in
connection with a merger, consolidation, acquisition or reorganization, and
provided further that the Fund may purchase, to the extent permitted by the
1940 Act, the securities of another investment company having substantially
the same investment objective and policies as the Fund.
(4) Purchase or sell real estate (including interests in real estate
limited partnerships); provided that the Fund may invest in mortgage-backed
securities as described in the Prospectus and Statement of Additional
Information, and including any securities secured by real estate or
interests therein.
(5) Purchase any securities on margin, except that the Fund may obtain
such short-term credit as may be necessary for the clearance of purchases
and sales of portfolio securities. (The deposit or payment by the Fund of
initial or variation margin in connection with options, futures or related
options transactions, if applicable, is not considered the purchase of a
security on margin.)
(6) Make short sales of securities or maintain a short position in
securities.
(7) Make loans to other persons (except as provided in (8) below);
provided that for purposes of this restriction the acquisition of mortgage-
backed and asset-backed securities, FNMA debentures, money market
securities, purchase and sale contracts and repurchase agreements shall not
be deemed to be the making of a loan.
(8) Lend its portfolio securities in excess of 33 1/3% of its total
assets, taken at market value; provided that such loans shall be made in
accordance with the guidelines set forth in the Prospectus and Statement of
Additional Information.
11
<PAGE>
(9) Issue senior securities, borrow money or pledge its assets in excess
of 33 1/3% of its total assets taken at value (including the amount
borrowed) and then only from banks as a temporary measure for the purpose
of meeting redemption requests, distribution requirements under the
Internal Revenue Code of 1986, as amended, or settlement of investment
transactions, or for extraordinary or emergency purposes; provided,
however, that for purposes of this restriction, transactions involving
"cover" or for which segregated accounts have been established as described
in the Prospectus and herein under "Investment Objective and Policies--
Portfolio Strategies Involving Interest Rate Transactions, Options and
Futures" and "Investment Objective and Policies--Other Investment Policies
and Practices" shall not be considered a borrowing. Usually only
"leveraged" investment companies may borrow in excess of 5% of their
assets; however, the Fund will not borrow to increase income but intends
only to borrow to meet redemption requests, to meet such distribution
requirements, to settle investment transactions which may otherwise require
untimely dispositions of Fund securities or for extraordinary or emergency
purposes. Interest paid on such borrowings will reduce net income. (See
restriction (10) below regarding the exclusion from this restriction of
arrangements with respect to interest rate transactions, options, futures
contracts and options on futures contracts.)
(10) Mortgage, pledge, hypothecate or in any manner transfer as security
for indebtedness any securities owned or held by the Fund except as may be
necessary in connection with borrowings mentioned in (9) above, and then
such mortgaging, pledging or hypothecating may not exceed 10% of its total
assets, taken at market value. (For the purpose of this restriction and
restriction (9) above, collateral arrangements with respect to interest
rate transactions or the writing of options, futures contracts, options on
futures contracts, and collateral arrangements with respect to initial and
variation margin are not deemed to be a pledge of assets, and neither such
arrangements nor the entering into of interest rate transactions nor the
purchase and sale of options, futures or related options are deemed to be
the issuance of a senior security.)
(11) Invest in securities which cannot be readily resold because of legal
or contractual restrictions or which are not otherwise readily marketable,
including repurchase agreements maturing in more than seven days, if,
regarding all such securities, more than 10% of its net assets, taken at
market value, would be invested in such securities. While the Fund will not
purchase illiquid securities in an amount exceeding 10% of its net assets,
the Fund may purchase, without regard to that limitation, securities that
are not registered under the Securities Act of 1933 (the "Securities Act"),
but that can be offered and sold to "qualified institutional buyers" under
Rule 144A under the Securities Act, provided that the Fund's Board of
Directors continuously determines, based on the trading markets for the
specific Rule 144A security, that it is liquid.
(12) Act as an underwriter of securities, except to the extent that the
Fund may technically be deemed an underwriter in selling portfolio
securities described in (11) above.
(13) Purchase or sell interests in oil, gas or other mineral exploration
or development programs.
(14) Invest more than 25% of its total assets (taken at market value at
the time of each investment) in the securities of issuers in any particular
industry (provided that for these purposes, the Fund's investments in
mortgage-backed and asset-backed securities shall not be considered
investments in the securities of issuers in a particular industry).
Additional investment restrictions adopted by the Fund, which may be changed
by the Directors, provide that the Fund may not:
(i) Invest in securities or companies having a record, together with
predecessors, of less than three years of continuous operation, if more
than 5% of its total assets would be invested in such securities
12
<PAGE>
(except that the Fund will not be subject to this restriction with respect
to investments in mortgage-backed or asset-backed securities).
(ii) Write, purchase or sell puts or calls or combinations thereof,
except to the extent described in the Fund's Prospectus and in this
Statement of Additional Information, as amended from time to time.
(iii) Purchase or retain the securities of any issuer, if those
individual Directors, officers and directors of the Fund, the Manager or
any subsidiary thereof each owning beneficially more than 1/2 of 1% of the
securities of such issuer own in the aggregate more than 5% of the
securities of such issuer.
(iv) Purchase or sell OTC options and securities underlying such options
if, as a result of such a transaction, such options, to the extent the
Commission staff views such options as illiquid, together with all other
illiquid securities or securities which are not readily marketable, exceed
10% of the net assets of the Fund, taken at market value.
(v) Invest in residual interests in collateralized mortgage obligation
structures or residual interests in real estate mortgage investment
conduits.
The Fund will not change or modify the policy described in clause (iv) above
prior to the change or modification by the Commission staff of its position
regarding OTC options.
Portfolio securities of the Fund generally may not be purchased from, sold or
loaned to the Manager or its affiliates or any of their directors, officers or
employees, acting as principal.
Because of the affiliation of Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("Merrill Lynch") with the Fund, the Fund is prohibited from
engaging in certain transactions involving such firm, or its affiliates except
for brokerage transactions permitted under the 1940 Act involving only usual
and customary commissions or transactions pursuant to an exemptive order under
the 1940 Act. See "Portfolio Transactions and Brokerage." Without such an
exemptive order, the Fund is prohibited from engaging in portfolio transactions
with Merrill Lynch or its affiliates acting as principal and from purchasing
securities in public offerings which are not registered under the Securities
Act or are not municipal securities as defined in the Securities Exchange Act
of 1934, in which such firms or any of its affiliates participate as an
underwriter or dealer.
MANAGEMENT OF THE FUND
DIRECTORS AND OFFICERS
The Directors and executive officers of the Fund and their principal
occupations for at least the last five years are set forth below. Unless
otherwise noted, the address of each executive officer and Director is P.O. Box
9011, Princeton, New Jersey 08543-9011.
Arthur Zeikel--President (1)(2)--President of Merrill Lynch Asset Management,
L.P. ("MLAM" or the "Manager") or its predecessors since 1977 and Chief
Investment Officer since 1976; President and Chief Investment Officer of Fund
Asset Management, L.P. ("FAM") or its predecessors since 1977; President and
Director of Princeton Services, Inc. ("Princeton Services") since 1993;
Executive Vice President of Merrill Lynch & Co., Inc. ("ML&Co.") since 1990;
Executive Vice President of Merrill Lynch since 1990 and Senior Vice President
thereof from 1985 to 1990; and Director of Merrill Lynch Funds Distributor,
Inc. (the "Distributor").
13
<PAGE>
Joe Grills--Director (2)--183 Soundview Lane, New Canaan, Connecticut 06840.
Member of the Committee of Investment of Employee Benefit Assets of the
Financial Executives Institute ("CIEBA") since 1986; member of CIEBA's
Executive Committee since 1988 and its Chairman from 1991 to 1992; Assistant
Treasurer of International Business Machines Incorporated ("IBM") and Chief
Investment Officer of IBM Retirement Funds from 1986 until 1993; Member of the
Investment Advisory Committee of the State of New York Common Retirement Fund;
Director, Duke Management Company and Winthrop Financial Associates (real
estate management).
Walter Mintz--Director (2)--1114 Avenue of the Americas, New York, New York
10036. Special Limited Partner of Cumberland Associates (investment
partnership) since 1982.
Melvin R. Seiden--Director (2)--780 Third Avenue, Suite 2502, New York, New
York 10017. President of Silbanc Properties, Ltd. (real estate, investment and
consulting) since 1987; Chairman and President of Seiden & de Cuevas, Inc.
(private investment firm) from 1964 to 1987.
Stephen B. Swensrud--Director (2)--24 Federal Street, Boston, Massachusetts
02110. Principal of Fernwood Associates (financial consultants); Director,
Hitchiner Manufacturing Company.
Harry Woolf--Director (2)--The Institute for Advanced Study, Olden Lane,
Princeton, New Jersey 08540. Member of the editorial board of Interdisciplinary
Science Reviews; Director, Alex. Brown Mutual Funds, Advanced Technology
Laboratories, Family Health International and SpaceLabs Medical (medical
equipment manufacturing and marketing).
Terry K. Glenn--Executive Vice President (1)(2)--Executive Vice President of
the Manager and FAM or their predecessors since 1983; Executive Vice President
and Director of Princeton Services since 1993; President of the Distributor
since 1986 and Director since 1991; President of Princeton Administrators, L.P.
since 1988.
Gerald M. Richard--Treasurer (1)(2)--Senior Vice President and Treasurer of
the Manager and FAM or their predecessors since 1984; Senior Vice President and
Treasurer of Princeton Services since 1993; Treasurer of the Distributor since
1984 and Vice President since 1981.
Jeffrey B. Hewson--Vice President (1)(2)--Vice President of the Manager or
its predecessors since 1989 and Portfolio Manager of the Manager or its
predecessors since 1985; Senior Consultant, Price Waterhouse 1981 to 1985.
Gregory Mark Maunz--Vice President (1)(2)--Vice President of the Manager or
its predecessors since 1985 and Portfolio Manager of the Manager or its
predecessors since 1984.
Theodore J. Magnani--Vice President (1)--Vice President of the Manager or its
predecessors since 1992.
Donald C. Burke--Vice President (1)(2)--Vice President and Director of
Taxation of the Manager or its predecessors since 1990; employee of Deloitte &
Touche llp from 1982 to 1990.
Michael J. Hennewinkel--Secretary (1)(2)--Vice President of the Manager or
its predecessors since 1985 and attorney associated with the Manager and FAM or
their predecessors since 1982.
- - - --------
(1) Interested person, as defined in the 1940 Act, of the Fund.
(2) Such Director or officer is a director, trustee or officer of certain other
investment companies for which the Manager or an affiliate, FAM, acts as
investment adviser or manager.
14
<PAGE>
At August 31, 1994, the officers and Directors of the Fund as a group (13
persons) owned an aggregate of less than 1% of the outstanding shares of common
stock of Merrill Lynch & Co., Inc.
Until calendar year 1994, the Fund paid each Director not affiliated with the
Manager (each a "non-affiliated Director") a fee of $5,000 per year plus $500
per meeting attended, together with such Director's actual out-of-pocket
expenses relating to attendance at meetings. The Fund also compensated members
of its Audit Committee, which consists of all of the nonaffiliated Directors.
As of calendar year 1994, the Fund has paid each nonaffiliated Director a fee
of $5,000 per year plus $250 for each board meeting attended and each Audit and
Nominating Committee member an additional $1,000 per year plus $500 for each
Committee meeting attended. For the fiscal year ended May 31, 1994, fees and
expenses paid to nonaffiliated Directors aggregated $40,587.
MANAGEMENT AND ADVISORY ARRANGEMENTS
Reference is made to "Management of the Fund--Management and Advisory
Arrangements" in the Prospectus for certain information concerning the
management and advisory arrangements of the Fund.
Securities may be held by, or be appropriate investments for, other funds or
investment advisory clients for which the Manager or its affiliates act as an
adviser. Because of different objectives or other factors, a particular
security may be bought for one or more clients when one or more clients are
selling the same security. If purchases or sales of securities by the Manager
for the Fund or other funds for which it acts as investment adviser or for its
advisory clients arise for consideration at or about the same time,
transactions in such securities will be made, insofar as feasible, for the
respective funds and clients in a manner deemed equitable to all. To the extent
that transactions on behalf of more than one client of the Manager or its
affiliates during the same period may increase the demand for securities being
purchased or the supply of securities being sold, there may be an adverse
effect on price.
The Fund has entered into a management agreement with the Manager (the
"Management Agreement"). The Manager receives for its services to the Fund
monthly compensation at the annual rate of 0.50% of the average daily net
assets of the Fund. For the fiscal year ended May 31, 1994, the total
management fees paid to the Manager aggregated $2,710,336. For the fiscal year
ended May 31, 1993, the total management fees paid to the Manager aggregated
$4,759,742. For the period August 2, 1991 (commencement of operations) to May
31, 1992, the total management fees payable to the Manager aggregated
$3,052,541. During such period, the Manager elected to waive a portion of its
fee in the amount of $680,946.
California imposes limitations on the expenses of the Fund. These expense
limitations require that the Manager reimburse the Fund in any amount necessary
to prevent the aggregate ordinary operating expenses (excluding taxes,
brokerage fees and commissions, distribution fees and extraordinary charges
such as litigation costs) from exceeding in any fiscal year 2.5% of the Fund's
first $30 million of average daily net assets, 2.0% of the next $70 million of
average daily net assets and 1.5% of the remaining average daily net assets.
Such reimbursement, if any, will be subtracted from the monthly advisory fee.
No fee payment will be made to the Manager during any fiscal year which will
cause such expenses to exceed the most restrictive expense limitation at the
time of such payment. For the fiscal years ended May 31, 1994 and 1993 and the
period August 2, 1991 (commencement of operations) to May 31, 1992, no
reimbursement was required pursuant to such expense limitations.
The Management Agreement obligates the Manager to provide investment advisory
services and to pay all compensation of and furnish office space for officers
and employees of the Fund connected with investment
15
<PAGE>
and economic research, trading and investment management of the Fund, as well
as the fees of all Directors of the Fund who are affiliated persons of the
Manager or any of its subsidiaries. The Fund pays all other expenses incurred
in the operation of the Fund, including, among other things, taxes, expenses
for legal and auditing services, costs of printing proxies, stock certificates,
shareholder reports and prospectuses and statements of additional information
(except to the extent paid by the Distributor), charges of the custodian, any
subcustodian and transfer agent, expenses of redemption of shares, Securities
and Exchange Commission fees, expenses of registering the shares under Federal,
state or foreign laws, fees and expenses of nonaffiliated Directors, accounting
and pricing costs (including the daily calculation of net asset value,
insurance, interest, brokerage costs, litigation and other extraordinary or
non-recurring expenses, and other expenses properly payable by the Fund). The
Distributor will pay the promotional expenses of the Fund in connection with
the offering of shares of the Fund. Certain expenses will be financed by the
Fund pursuant to a distribution plan in compliance with Rule 12b-1 under the
1940 Act. See "Purchase of Shares--Deferred Sales Charge Alternative--Class B
Shares--Distribution Plan."
Merrill Lynch & Co., Inc., Merrill Lynch Investment Management, Inc. and
Princeton Services, Inc. are "controlling persons" of the Manager as defined
under the Investment Company Act because of their ownership of its voting
securities or their power to exercise a controlling influence over its
management or policies.
Duration and Termination. Unless earlier terminated as described below, the
Management Agreement will remain in effect from year to year if approved
annually (a) by the Directors or by a majority of the outstanding shares of the
Fund and (b) by a majority of the Directors who are not parties to such
contract or interested persons (as defined in the 1940 Act) of any such party.
Such contracts are not assignable and may be terminated without penalty on 60
days' written notice at the option of either party thereto or by the vote of
the shareholders of the Fund.
PURCHASE OF SHARES
Reference is made to "Purchase of Shares" in the Prospectus for certain
information as to the purchase of Fund shares.
ALTERNATIVE SALES ARRANGEMENTS
The Fund issues two classes of shares: Class A shares are sold to investors
choosing the initial sales charge alternative and Class B shares are sold to
investors choosing the deferred sales charge alternative. The two classes of
shares each represent interests in the same portfolio of investment of the
Fund, have the same rights and are identical in all respects, except that (i)
Class B shares bear the expenses of the deferred sales charge arrangements, any
expenses (including incremental transfer agency costs) resulting from such
sales arrangements and the expenses paid by the account maintenance fee, (ii)
Class A shares bear the expenses of the account maintenance fee, and (iii) each
Class has exclusive voting rights with respect to the Rule 12b-1 distribution
plan pursuant to which the account maintenance and distribution fees, in the
case of the Class B shares, and the account maintenance fee, in the case of the
Class A shares, is paid. The two classes also have different exchange
privileges. See "Shareholder Services--Exchange Privilege."
The Fund has entered into separate distribution agreements with the
Distributor in connection with the continuous offering of Class A and Class B
shares of the Fund (the "Distribution Agreements"). The
16
<PAGE>
Distribution Agreements obligate the Distributor to pay certain expenses in
connection with the offering of the Class A and Class B shares of the Fund.
After the prospectuses, statements of additional information and periodic
reports have been prepared, set in type and mailed to shareholders, the
Distributor pays for the printing and distribution of copies thereof used in
connection with the offering to dealers and investors. The Distributor also
pays for other supplementary sales literature and advertising costs. The
Distribution Agreements are subject to the same renewal requirements and
termination provisions as the Management Agreement described above.
Distribution Plans. Reference is made to "Purchase of Shares--Distribution
Plans" in the Prospectus for certain information with respect to the
Distribution Plans of the Fund.
The payment of the account maintenance fee and distribution fee with respect
to Class B, and the account maintenance fee with respect to Class A shares, is
subject to the provisions of Rule 12b-1 under the 1940 Act. See "General
Information--Description of Shares." Among other things, each Distribution Plan
provides that the Distributor shall provide and the Directors shall review
quarterly reports of the disbursement of the distribution and account
maintenance fees paid to the Distributor. In their consideration of the
Distribution Plans, the Directors must consider all factors they deem relevant,
including information as to the benefits of the Distribution Plans to the Fund
and its shareholders. Each Distribution Plan further provides that, so long as
the Distribution Plan remains in effect, the selection and nomination of
Directors who are not "interested persons" of the Fund, as defined in the 1940
Act (the "Independent Directors"), shall be committed to the discretion of the
Independent Directors then in office. In approving each Distribution Plan in
accordance with Rule 12b-1, the Independent Directors concluded that there is
reasonable likelihood that the Distribution Plan will benefit the Fund and its
respective shareholders. Each Distribution Plan can be terminated at any time,
without penalty, by the vote of a majority of the Independent Directors or by
the vote of the holders of a majority of the outstanding Class A or Class B
voting securities of the Fund voting separately by Class. Each Distribution
Plan cannot be amended to increase materially the amount to be spent by the
Fund without approval by the related class of shareholders, and all material
amendments are required to be approved by the vote of Directors, including a
majority of the Independent Directors who have no direct or indirect financial
interest in the Distribution Plan, cast in person at a meeting called for that
purpose. Rule 12b-1 further requires that the Fund preserve copies of the
Distribution Plans and any reports made pursuant to such plans for a period of
not less than six years from the date of the Distribution Plans or such report,
the first two years in an easily accessible place.
INITIAL SALES CHARGE ALTERNATIVE--CLASS A SHARES
For the period August 2, 1991 (commencement of operations) to May 31, 1992,
the Fund sold 9,932,771 Class A shares, for aggregate net proceeds to the Fund
of $99,100,022. The gross sales charges for the sale of Class A shares of the
Fund were $1,381,880, of which $80,666 and $1,301,214 were received by the
Distributor and Merrill Lynch, respectively. During the fiscal year ended May
31, 1993, the Fund sold 5,909,926 Class A shares for aggregate net proceeds to
the Fund of $58,465,229. The gross sales charge for the sale of Class A shares
for that period was $153,817, of which $133,086 was received by Merrill Lynch
and $20,731 was received by the Distributor. During the fiscal year ended May
31, 1994, the Fund sold 1,365,792 Class A shares for aggregate net proceeds to
the Fund of $13,269,165. The gross sales charge for the sale of Class A shares
for that period was $61,480, of which $49,708 was received by Merrill Lynch and
$11,772 was received by the Distributor.
17
<PAGE>
The term "purchase," as used in the Prospectus and this Statement of
Additional Information in connection with an investment in Class A shares of
the Fund, refers to a single purchase by an individual or to concurrent
purchases, which in the aggregate are at least equal to the prescribed amounts,
by an individual, his spouse and their children under the age of 21 years
purchasing shares for his or their own account and to single purchases by a
trustee or other fiduciary purchasing shares for a single trust estate or
single fiduciary account although more than one beneficiary is involved. The
term "purchase" also includes purchases by any "company," as that term is
defined in the 1940 Act, but does not include purchases by any such company
which has not been in existence for at least six months or which has no purpose
other than the purchase of shares of the Fund or shares of other registered
investment companies at a discount; provided, however, that it shall not
include purchases by any group of individuals whose sole organizational nexus
is that the participants therein are credit cardholders of a company,
policyholders of an insurance company, customers of either a bank or broker-
dealer or clients of an investment adviser.
Closed-End Fund Investment Option. Class A shares of the Fund and certain
other mutual funds advised by MLAM or FAM (the "Eligible Class A Shares") are
offered at net asset value to shareholders of certain closed-end funds advised
by MLAM or FAM who wish to reinvest the net proceeds from a sale of their
closed-end fund shares of common stock in Eligible Class A Shares, if the
conditions set forth below are satisfied. First, the sale of the closed-end
fund shares must be made through Merrill Lynch and the net proceeds therefrom
must be immediately reinvested in Eligible Class A shares. Second, the closed-
end fund shares must have been either acquired in the initial public offering
or be shares representing dividends from shares of common stock acquired in
such offering. Third, the closed-end fund shares must have been continuously
maintained in a Merrill Lynch securities account. Fourth, there must be a
minimum purchase of $250 to be eligible for the investment option. Class A
shares of the Fund are offered at net asset value to shareholders of Merrill
Lynch Prime Fund, Inc. ("Prime Fund") who wish to reinvest the net proceeds
from a sale of certain of their shares of common stock of Prime Fund in shares
of the Fund. In order to exercise this investment option, Prime Fund
shareholders must sell their Prime Fund shares to the Prime Fund in connection
with a tender offer conducted by the Prime Fund and reinvest the proceeds
immediately in the Fund. This investment option is available only with respect
to the proceeds of Prime Fund shares as to which no Early Withdrawal Charge (as
defined in the Prime Fund prospectus) is applicable. Purchase orders from Prime
Fund shareholders wishing to exercise this investment option will be accepted
only on the day that the related Prime Fund tender offer terminates and will be
effected at the net asset value of the Fund at such day.
REDUCED INITIAL SALES CHARGES--CLASS A SHARES
Rights of Accumulation. Reduced sales charges are applicable through a right
of accumulation under which eligible investors are permitted to purchase Class
A shares of the Fund at the offering price applicable to the total of (a) the
public offering price of the Class A shares then being purchased plus (b) an
amount equal to the then current net asset value or cost, whichever is higher,
of the purchaser's combined holdings of the Class A shares and Class B shares
of the Fund and of any other investment company with an initial sales charge or
a deferred sales charge for which the Distributor acts as the distributor. For
any such right of accumulation to be made available the Distributor must be
provided at the time of purchase, by the purchaser or the purchaser's
securities dealer, with sufficient information to permit confirmation of
qualification. Acceptance of the purchase order is subject to such
confirmation. The right of accumulation may be amended or terminated at any
time. Shares held in the name of a nominee or custodian under pension, profit-
sharing,
18
<PAGE>
or other employee benefit plans may not be combined with other shares to
qualify for the right of accumulation.
Letter of Intention. Reduced sales charges are applicable to purchases
aggregating $100,000 or more of the Class A shares of the Fund or any other
investment company with an initial sales charge or a deferred sales charge for
which the Distributor acts as the distributor made within a thirteen-month
period starting with the first purchase pursuant to the Letter of Intention in
the form provided in the Prospectus. The Letter of Intention is available only
to investors whose accounts are maintained at the Fund's Transfer Agent. The
Letter of Intention is not available to employee benefit plans for which
Merrill Lynch provides plan participant record-keeping services. The Letter of
Intention is not a binding obligation to purchase any amount of Class A shares,
however, its execution will result in the purchaser paying a lower sales charge
at the appropriate quantity purchase level. A purchase not originally made
pursuant to a Letter of Intention may be included under a subsequent Letter of
Intention executed within 90 days of such purchase if the Distributor is
informed in writing of this intent within such 90-day period. The value of
Class A shares of the Fund and of other investment companies with an initial
sales charge or a deferred sales charge for which the Distributor acts as the
distributor presently held, at cost or maximum offering price (whichever is
higher), on the date of the first purchase under the Letter of Intention, may
be included as a credit toward the completion of such Letter, but the reduced
sales charge applicable to the amount covered by such Letter will be applied
only to new purchases. If the total amount of shares does not equal the amount
stated in the Letter of Intention (minimum of $100,000), the investor will be
notified and must pay, within 20 days of the expiration of such Letter, the
difference between the sales charge on the Class A shares purchased at the
reduced rate and the sales charge applicable to the shares actually purchased
through the Letter. Class A shares equal to five percent of the intended amount
will be held in escrow during the thirteen-month period (while remaining
registered in the name of the purchaser) for this purpose. The first purchase
under the Letter of Intention must be at least five percent of the dollar
amount of such Letter. If a purchase during the term of such Letter would
otherwise be subject to a further reduced sales charge based on the right of
accumulation, the purchaser will be entitled on that purchase and subsequent
purchases to that further reduced percentage sales charge but there will be no
retroactive reduction of the sales charges on any previous purchase. The value
of any shares redeemed or otherwise disposed of by the purchaser prior to
termination or completion of the Letter of Intention will be deducted from the
total purchases made under such Letter. An exchange from Merrill Lynch Ready
Assets Trust, Merrill Lynch Retirement Reserves Money Fund, Merrill Lynch U.S.
Treasury Money Fund or Merrill Lynch U.S.A. Government Reserves into the Fund
that creates a sales charge will count toward completing a new or existing
Letter of Intention from the Fund.
Employer Sponsored Retirement or Savings Plans. Class A shares are offered at
net asset value to employer sponsored retirement or savings plans, such as tax
qualified retirement plans within the meaning of Section 401(a) of the Internal
Revenue Code of 1986, as amended (the "Code"), deferred compensation plans
within the meaning of Sections 403(b) and 457 of the Code, other deferred
compensation arrangements, VEBA plans, and non-qualified After-Tax Savings and
Investment programs maintained on the Merrill Lynch Group Employee Services
system (herein referred to as "Employer Sponsored Retirement or Savings
Plan(s)"), provided the Employer Sponsored Retirement or Savings Plan has $5
million or more in existing plan assets initially invested in portfolios,
mutual funds or trusts advised by the Fund's investment adviser either directly
or through an affiliate. Class A shares are also offered at net asset value to
Employer Sponsored Retirement or Savings Plans, provided the plan has
accumulated $5 million or more in existing plan assets invested in mutual funds
advised by the Fund's investment adviser charging a front-end sales charge or
contingent deferred sales charge. In either case, assets of Employer Sponsored
Retirement or Savings Plans
19
<PAGE>
sponsored by the same sponsor or an affiliated sponsor may be aggregated. The
Class A share reduced load breakpoints also apply to these aggregated assets.
Employer Sponsored Retirement or Savings Plans are also offered Class A shares
at net asset value, provided such plan initially has 1,000 or more employees
eligible to participate in the plan. Employees eligible to participate in
Employer Sponsored Retirement or Savings Plans of the same sponsoring employer
or its affiliates may be aggregated. Any Employer Sponsored Retirement or
Savings Plan which does not meet the above-described qualifications to purchase
Class A shares at net asset value has the option of purchasing Class A shares
at the sales charge schedule disclosed in the Prospectus, or if the Employer
Sponsored Retirement or Savings Plan is a tax qualified retirement plan and
meets the specified requirements (see Redemption of Shares--Contingent Deferred
Sales Charge--Class B Shares), then it may purchase Class B shares with a
waiver of the contingent deferred sales charge upon redemption. The minimum
initial and subsequent purchase requirements are waived in connection with all
the above-referenced Employer Sponsored Retirement or Savings Plans.
Purchase Privileges of Certain Persons. Directors of the Fund, directors and
trustees of certain other Merrill Lynch-sponsored investment companies,
directors of Merrill Lynch & Co., Inc., employees of Merrill Lynch & Co., Inc.
and its subsidiaries, and any trust, pension, profit-sharing or other benefit
plan for such persons, may purchase Class A shares of the Fund at net asset
value.
Directors and trustees of certain other Merrill Lynch-sponsored mutual funds,
and any trust, pension, profit-sharing or other benefit plan for such directors
or trustees, may purchase Class A shares of the Fund at net asset value;
provided that (a) any such director or trustee has acted in such capacity for
at least 90 days prior to the purchase of Fund Class A shares, (b) the purchase
is made only through the distributor and does not involve the retail sales
force of Merrill Lynch in any way, (c) no solicitation of directors or trustees
is made, and (d) on making any purchase, a director or trustee submits to the
Distributor written assurance that the purchase is made for investment purposes
and that the Class A shares will not be resold except through redemption or
repurchase by or on behalf of the Fund.
Class A shares of the Fund are also offered at net asset value, without sales
charge, to an investor who has a business relationship with a Merrill Lynch
financial consultant and who has invested in a mutual fund sponsored by a non-
Merrill Lynch company for which Merrill Lynch has served as a selected dealer
and where Merrill Lynch has either received or given notice that such
arrangement will be terminated, if the following conditions are satisfied:
first, the investor must purchase Class A shares of the Fund with proceeds from
a redemption of shares of such other mutual fund and such fund imposed a sales
charge either at the time of purchase or on a deferred basis; second, such
purchase of Class A shares must be made within 90 days after such notice of
termination.
In addition, the Fund offers its Class A shares for sale at net asset value,
without sales charge, to employees of Merrill Lynch & Co., Inc. and its
subsidiaries pursuant to a cash purchase or payroll deduction plan of Merrill
Lynch. Under such program, the Fund realizes economies of scale and reduction
of sales related expenses by virtue of employee familiarity with the Fund.
Acquisition of Certain Investment Companies. The public offering price of
Class A shares may be reduced to the net asset value per Class A share in
connection with the acquisition of the assets of or merger or consolidation
with a personal holding company or a public or private investment company. The
value of the assets or company acquired in a tax-free transaction may be
adjusted in appropriate cases to reduce possible adverse tax consequences to
the Fund which might result from an acquisition of assets having net unrealized
appreciation which is disproportionately higher at the time of acquisition than
the realized or unrealized appreciation of the Fund.
20
<PAGE>
REDEMPTION OF SHARES
Reference is made to "Redemption of Shares" in the Prospectus for certain
information as to the redemption and purchase of Fund shares.
The right to redeem shares or to receive payment with respect to any such
redemption may be suspended for more than seven days only for periods during
which trading on the New York Stock Exchange is restricted as determined by the
Securities and Exchange Commission or such Exchange is closed (other than
customary weekend and holiday closings), for any period during which an
emergency exists, as defined by the Securities and Exchange Commission, as a
result of which disposal of portfolio securities or determination of the net
asset value of the Fund is not reasonably practicable, and for such other
periods as the Securities and Exchange Commission may by order permit for the
protection of shareholders of the Fund.
The value of shares at the time of redemption may be more or less than the
shareholder's cost, depending on the market value of the securities held by the
Fund at such time.
CONTINGENT DEFERRED SALES CHARGE--CLASS B SHARES
As discussed in the Prospectus under "Purchase of Shares--Alternative Sale
Arrangements--Deferred Sales Charge Alternative--Class B Shares", while Class B
shares redeemed within three years of purchase are subject to a contingent
deferred sales charge under most circumstances, the charge is waived on
redemptions of Class B shares following the death or disability of a Class B
shareholder. Redemptions for which the waiver applies are any partial or
complete redemption following the death or disability (as defined in the
Internal Revenue Code) of a Class B shareholder (including one who owns the
Class B shares as joint tenant with his or her spouse), provided the redemption
is requested within one year of the death or initial determination of
disability. For the period August 2, 1991 (commencement of operations) to May
31, 1992 and the fiscal years ended May 31, 1993 and May 31, 1994, the
Distributor received contingent deferred sales charges of $911,653, $3,964,093
and $2,010,325, respectively, all of which was paid to Merrill Lynch.
Retirement Plans. Any Retirement Plan which does not meet the qualifications
to purchase Class A shares at net asset value has the option of purchasing
Class A shares at the sales charge schedule disclosed in the Prospectus, or if
the Retirement Plan meets the following requirements, then it may purchase
Class B shares with a waiver of the contingent deferred sales charge upon
redemption. The contingent deferred sales charge is waived for any Eligible
401(k) Plan redeeming Class B shares. The contingent deferred sales charge is
also waived for redemptions from 401(a) plans qualified under the Code,
provided, however, such plan has the same or an affiliated sponsoring employer
as an Eligible 401(k) Plan purchasing Class B shares of a mutual fund advised
by the Manager or FAM ("Eligible 401(a) Plan"). The contingent deferred sales
charge is waived for any Class B shares which are purchased by an Eligible
401(k) Plan or Eligible 401(a) Plan and are rolled over into a Merrill Lynch or
Merrill Lynch Trust Company custodied Individual Retirement Account and held in
such account at the time of redemption. The contingent deferred sales charge is
also waived for any Class B shares which are purchased by a Merrill Lynch
rollover IRA that was funded by a rollover from a terminated 401(k) plan
managed by the MLAM Private Portfolio Group and held in such account at the
time of redemption. The minimum initial and subsequent purchase requirements
are waived in connection with all the above referenced Retirement Plans.
"Eligible 401(k) Plan" is defined as a retirement plan qualified under Section
401(k) of the Code with a salary reduction feature offering a menu of
investments to plan participants.
21
<PAGE>
PORTFOLIO TRANSACTIONS
Subject to policies established by the Directors, the Manager is responsible
for the execution of the Fund's portfolio transactions. The Fund has no
obligation to deal with any dealer or broker or group of brokers in the
execution of transactions in portfolio securities. Orders for transactions in
portfolio securities are placed for the Fund with a number of brokers and
dealers, including Merrill Lynch. In placing orders, it is the policy of the
Fund to obtain the most favorable net results, taking into account various
factors, including price (including applicable dealer spread or brokerage
commissions), size of the transaction and difficulty of execution. Where
practicable, the Manager surveys a number of brokers and dealers in connection
with proposed portfolio transactions and selects the broker or dealer which
offers the Fund best price and execution or other services which are of benefit
to the Fund. Securities firms also may receive brokerage commissions on
transactions including covered call options written by the Fund and the sale of
underlying securities upon the exercise of such options. In addition,
consistent with the Rules of Fair Practice of the National Association of
Securities Dealers, Inc. and policies established by the Fund's Directors, the
Manager may consider sales of shares of the Fund as a factor in the selection
of brokers or dealers to execute portfolio transactions for the Fund.
The Fund does not use any particular broker or dealer, and brokers who
provide supplemental investment research to the Manager may receive orders for
transactions by the Fund. Such supplemental research services ordinarily
consist of assessments and analyses of the business or prospects of a company,
industry or economic sector. Information so received will be in addition to and
not in lieu of the services required to be performed by the Manager under the
Management Agreement. The expenses of the Manager will not necessarily be
reduced as a result of the receipt of such supplemental information, and the
Manager may use such information in servicing its other accounts.
The Fund invests in securities traded primarily in the over-the-counter
market. Transactions in the over-the-counter market are generally principal
transactions with dealers and the costs of such transactions involve dealer
spreads rather than brokerage commissions. With respect to over-the-counter
transactions, where possible, the Fund deals directly with the dealers who make
a market in the securities involved, except in those circumstances in which
better prices and execution are available elsewhere. Under the 1940 Act,
persons affiliated with the Fund are prohibited from dealing with the Fund as
principal in purchase and sale of securities. Since transactions in the over-
the-counter market usually involve transactions with dealers acting as
principal for their own accounts, affiliated persons of the Fund, including
Merrill Lynch, will not serve as the Fund's dealer in such transactions.
However, affiliated persons of the Fund may serve as its broker in over-the-
counter transactions conducted on an agency basis. The Fund may not purchase
securities from any underwriting syndicate of which Merrill Lynch is a member,
except pursuant to procedures adopted by the Directors of the Fund which comply
with rules adopted by the Securities and Exchange Commission.
The Directors of the Fund have considered the possibility of recapturing for
the benefit of the Fund brokerage commissions, dealer spreads and other
expenses of possible portfolio transactions, such as underwriting commissions,
by conducting such portfolio transactions through affiliated entities,
including Merrill Lynch. For example, brokerage commissions received by Merrill
Lynch could be offset against the management fee paid by the Fund to the
Manager. After considering all factors deemed relevant, the Directors made a
determination not to seek such recapture. The Directors will reconsider this
matter from time to time.
22
<PAGE>
Section 11(a) of the Securities Exchange Act of 1934, as amended, generally
prohibits members of the U.S. national securities exchanges from executing
exchange transactions for their affiliates and institutional accounts which
they manage unless the member (i) has obtained prior express authorization from
the account to effect such transactions, (ii) at least annually furnishes the
account with a statement disclosing the aggregate compensation received by the
member in effecting such transactions, and (iii) complies with any rules the
Commission has prescribed with respect to the requirements of clauses (i) and
(ii). To the extent Section 11(a) would apply to Merrill Lynch acting as a
broker for the Fund in any of its portfolio transactions executed on any such
securities exchange of which it is a member, appropriate consents have been
obtained from the Fund, and annual statements as to aggregate compensation will
be provided to the Fund.
PORTFOLIO TURNOVER
Generally, the Fund does not purchase securities for short-term trading
profits. However, the Fund may dispose of securities without regard to the time
they have been held when such actions, for defensive or other reasons, appear
advisable to the Investment Adviser. While it is not possible to predict
turnover rates with any certainty, at present it is anticipated that the Fund's
annual portfolio turnover rate, under normal circumstances, will be less than
200%. (The portfolio turnover rate is calculated by dividing the lesser of
purchases or sales of portfolio securities for the particular fiscal year by
the monthly average of the value of the portfolio securities owned by the Fund
during the particular fiscal year). High portfolio turnover involves
correspondingly greater transaction costs in the form of dealer spreads and
brokerage commissions, which are borne directly by the Fund.
DETERMINATION OF NET ASSET VALUE
Reference is made to "Additional Information--Determination of Net Asset
Value" in the Prospectus concerning the determination of net asset value.
The net asset value of the shares of the Fund is determined by the Manager
once daily, Monday through Friday, at 4:15 P.M. New York time, on each day
during which the New York Stock Exchange is open for trading. The New York
Stock Exchange is not open on New Year's Day, Presidents' Day, Good Friday,
Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day.
Net asset value per share is computed by dividing the sum of the value of the
securities held by the Fund plus any cash or other assets minus all liabilities
by the total number of shares outstanding at such time, rounded to the nearest
cent. Expenses, including the fees payable to the Manager and Distributor, are
accrued daily. The net asset value per share of the Class A and Class B shares
are expected to be equivalent. Under certain circumstances, however, the per
share net asset value of the Class B shares may be lower than the per share net
asset value of the Class A shares reflecting the higher daily expense accruals
of the distribution and transfer agency fees applicable with respect to the
Class B shares. Even under those circumstances, the per share net asset value
of the two classes eventually will tend to converge immediately after the
payment of dividends, which will differ by approximately the amount of the
expense accrual differential between the classes.
23
<PAGE>
The Board of Directors will take steps to ensure that such value reflects the
fair value of those securities and the Board will continuously monitor the
accuracy of such pricing information. Portfolio securities of the Fund which
are traded in the market are valued at the last available bid price in the
market or on the basis of yield equivalents as obtained from one or more
dealers that make markets in such securities traded in the market. Options on
mortgage-backed securities and other securities of the Fund which are traded on
exchanges, are valued at their last bid price in the case of options purchased
by the Fund and their last asked price in the case of options written by the
Fund. An option traded on the market is valued at its last bid price or asked
price as obtained from at least two independent entities (one of which is not a
party to the option). Interest rate futures contracts and options thereon,
which are traded on exchanges, are valued at their last sale price as of the
close of such exchanges.
Where there is no market quotation on securities or options, fair market
value will be determined in good faith by or under the direction of the Fund's
Directors. Such valuations and procedures will be reviewed periodically by the
Directors.
Generally, trading in mortgage-backed or other securities issued or
guaranteed by United States Government agencies or instrumentalities is
substantially completed each day at various times prior to 4:15 P.M., New York
time. The values of such securities used in computing the net asset value of
the Fund's shares are determined as of such times. Occasionally, events
affecting the values of such securities may occur between the times at which
they are determined and the time the Fund determines its net asset value which
will not be reflected in the computation of the Fund's net asset value. If
events materially affecting the value of such securities occur during such
period, then these securities will be valued at their fair value as determined
in good faith by the Directors.
SHAREHOLDER SERVICES
The Fund offers a number of shareholder services described below which are
designed to facilitate investment in its shares. Certain of such services are
not available to investors who place orders for the Fund shares through
Blueprint. Full details as to each such service and copies of the various plans
described below can be obtained from the Fund, the Distributor or Merrill
Lynch.
INVESTMENT ACCOUNT
Each shareholder whose account is maintained at the transfer agent has an
Investment Account and will receive statements, at least quarterly, from the
transfer agent. These statements will serve as transaction confirmations for
automatic investment purchases and the reinvestment of ordinary income
dividends and long-term capital gain distributions. The statements will also
show any other activity in the account since the preceding statement.
Shareholders will receive separate transaction confirmations for each purchase
or sale transaction other than automatic investment purchases and the
reinvestment of ordinary income dividends and long-term capital gain
distributions.
Share certificates are issued only for full shares and only upon the specific
request of the shareholder. Issuance of certificates representing all or only
part of the full shares in an Investment Account may be requested by a
shareholder directly from the Transfer Agent. Shareholders considering
transferring their Class A shares from Merrill Lynch to another brokerage firm
or financial institution should be aware that, if
24
<PAGE>
the firm to which the Class A shares are to be transferred will not take
delivery of shares of the Fund, a shareholder either must redeem the Class A
shares so that the cash proceeds can be transferred to the account at the new
firm or such shareholder must continue to maintain an Investment Account at the
Transfer Agent for those Class A shares. Shareholders interested in
transferring their Class B shares from Merrill Lynch and who do not wish to
have an Investment Account maintained for such shares at the Transfer Agent may
request their new brokerage firm to maintain such shares in an account
registered in the name of the brokerage firm for the benefit of the
shareholder. If the new brokerage firm is willing to accommodate the
shareholder in this manner, the shareholder must request that he be issued
certificates for his shares, and then must turn the certificates over to the
new firm for re-registration as described in the preceding sentence.
AUTOMATIC INVESTMENT PLAN
A shareholder may make additions to an Investment Account at any time by
purchasing Class A or Class B shares at the applicable public offering price
either through the shareholder's securities dealer, or by mail directly to the
Transfer Agent, acting as agent for such securities dealer. Voluntary
accumulation can also be made through a service known as the Automatic
Investment Plan whereby the Fund is authorized through pre-authorized checks of
$50 or more to charge the regular bank account of the shareholder on a regular
basis to provide systematic additions to the Investment Account of such
shareholder. Investors whose shares of the Fund are held within a CMA account
may arrange to have periodic investments made in the Fund, in their CMA
accounts or in certain related accounts in the amount of $100 or more through
the CMA Automatic Investment Program. The Automatic Investment Program is not
available to shareholders whose shares are held in a brokerage account with
Merrill Lynch other than a CMA(R) account.
AUTOMATIC REINVESTMENT OF DIVIDENDS AND CAPITAL GAINS DISTRIBUTIONS
Unless specific instructions are given as to the method of payment of
dividends and capital gains distributions, dividends and distributions will be
reinvested automatically in additional shares of the Fund. Such reinvestment
will be at the net asset value of shares of the Fund, without sales charge, as
of the close of business on the payable date of the dividend or distribution.
Shareholders may elect in writing to receive either their dividends or capital
gains distributions, or both, in cash, in which event payment will be mailed on
or about the payment date.
Shareholders may, at any time, notify the Transfer Agent in writing or by
telephone (1-(800)-MER-FUND) that they no longer wish to have their dividend
and/or capital gains distributions reinvested in shares of the Fund or vice
versa and, commencing ten days after the receipt by the Transfer Agent of such
notice, those instructions will be effected.
SYSTEMATIC WITHDRAWAL PLANS--CLASS A SHARES
A Class A shareholder may elect to make systematic withdrawals from an
Investment Account on either a monthly or quarterly basis as provided below.
Quarterly withdrawals are available for shareholders who have acquired Class A
shares of the Fund having a value, based on cost or the current offering price,
of $5,000 or more, and monthly withdrawals for shareholders with Class A shares
with such a value of $10,000 or more.
At the time of each withdrawal payment, sufficient Class A shares are
redeemed from those on deposit in the shareholder's account to provide the
withdrawal payment specified by the shareholder. The shareholder
25
<PAGE>
may specify either a dollar amount or a percentage of the value of his Class A
shares. Redemptions will be made at net asset value as determined at the close
of business on the New York Stock Exchange on the 24th day of each month or the
24th day of the last month of each quarter, whichever is applicable. If the
Exchange is not open for business on such date, the Class A shares will be
redeemed at the close of business on the following business day. The check for
the withdrawal payment will be mailed, or the direct deposit for the withdrawal
payment will be made, on the next business day following redemption. When a
shareholder is making systematic withdrawals, dividends and distributions on
all Class A shares in the Investment Account are reinvested automatically in
Fund Class A shares. A shareholder's Systematic Withdrawal Plan may be
terminated at any time, without charge or penalty, by the shareholder, the
Fund, the Transfer Agent or the Distributor. Withdrawal payments should not be
considered as dividends, yield or income. Each withdrawal is a taxable event.
If periodic withdrawals continuously exceed reinvested dividends, the
shareholder's original investment may be reduced correspondingly. Purchases of
additional Class A shares concurrent with withdrawals are ordinarily
disadvantageous to the shareholder because of sales charges and tax
liabilities. The Fund will not knowingly accept purchase orders for Class A
shares of the Fund from investors who maintain a systematic withdrawal plan
unless such purchase is equal to at least one year's scheduled withdrawals or
$1,200, whichever is greater. Periodic investments may not be made into an
Investment Account in which the shareholder has elected to make systematic
withdrawals.
RETIREMENT PLANS
Self-directed individual retirement accounts and other retirement plans are
available from Merrill Lynch. Under these plans, investments may be made in the
Fund and in certain of the other mutual funds sponsored by Merrill Lynch as
well as in other securities. Merrill Lynch charges an annual custodial fee for
each account. Information with respect to these plans is available on request
from Merrill Lynch. The minimum initial purchase to establish any such plan is
$100 and the minimum subsequent purchase is $1.
Capital gains and income received in each of the plans referred to above are
exempt from Federal taxation until distributed from the plans. Investors
considering participations in any such plan should review specific tax laws
relating thereto and should consult their attorneys or tax advisers with
respect to the establishment and maintenance of any such plan.
EXCHANGE PRIVILEGE
On or about October 24, 1994, the exchange privilege described below will be
modified as explained in the Prospectus under "Shareholder Services--Exchange
Privilege".
Class A and Class B shareholders of the Fund may exchange their Class A or
Class B shares for shares of the same class of the funds that issue Class A and
Class B shares listed below. In addition, Class A shareholders of the Company
may exchange their Class A shares of the Fund for the shares of the "Class A
money market funds", and Class B shareholders of the Fund may exchange their
shares for shares of the "Class B money market funds", on the basis described
below. Shares with a net asset value of at least $100 are required to qualify
for the exchange privilege, and any shares utilized in an exchange must have
been held by the shareholder for at least 15 days. Certain funds into which
exchanges may be made may impose a redemption fee (not in excess of 2.00% of
the amount redeemed) on shares purchased through the exchange privilege when
such shares are subsequently redeemed, including redemption through subsequent
exchanges. Such redemption fee would be in addition to any contingent deferred
sales charge otherwise applicable to a
26
<PAGE>
redemption of Class B shares. It is contemplated that the exchange privilege
may be applicable to other new mutual funds whose shares may be distributed by
the Distributor.
Under the exchange privilege, each of the funds with Class A shares
outstanding offers to exchange its Class A shares ("new Class A shares") for
Class A shares ("outstanding Class A shares") of any of the other funds, on the
basis of relative net asset value per Class A share, plus an amount equal to
the difference, if any, between the sales charge previously paid on the
outstanding Class A shares and the sales charge payable at the time of the
exchange on the new Class A shares. With respect to outstanding Class A shares
as to which previous exchanges have taken place, the "sales charge previously
paid" shall include the aggregate of the sales charges paid with respect to
such Class A shares in the initial purchase and any subsequent exchange. Class
A shares issued pursuant to dividend reinvestment are sold on a no-load basis
in each of the funds offering Class A shares. For purposes of the exchange
privilege, dividend reinvestment Class A shares shall be deemed to have been
sold with a sales charge equal to the sales charge previously paid on the Class
A shares on which the dividend was paid. Based on this formula, Class A shares
of the Fund generally may be exchanged into the Class A shares of the other
funds or into shares of a money market fund advised by the Manager or its
affiliates with a reduced or without a sales charge.
In addition, each of the funds with Class B shares outstanding offers to
exchange its Class B shares ("new Class B shares") for Class B shares
("outstanding Class B shares") of any of the other funds on the basis of
relative net asset value per Class B share, without the payment of any
contingent deferred sales charge that might otherwise be due on redemption of
the outstanding shares. Class B shareholders of the Fund exercising the
exchange privilege will continue to be subject to the Fund's contingent
deferred sales charge schedule if such schedule is higher than the deferred
sales charge schedule relating to the new Class B shares acquired through use
of the exchange privilege. In addition, Class B shares of the Fund acquired
through the use of the exchange privilege will be subject to the Fund's
contingent deferred sales charge schedule if such schedule is higher than the
deferred sales charge schedule relating to the Class B shares of the fund from
which the exchange has been made. For purposes of computing the sales charge
that may be payable on a disposition of the new Class B shares, the holding
period for the outstanding Class B shares is "tacked" to the holding period of
the new Class B shares. For example, an investor may exchange Class B shares of
the Fund for those of Merrill Lynch Special Value Fund, Inc. ("Special Value
Fund") after having held the Fund's Class B shares for two and a half years.
The 2% sales charge that generally would apply to a redemption would not apply
to the exchange. Three years later the investor may decide to redeem the Class
B shares of Special Value Fund and receive cash. There will be no contingent
deferred sales charge due on this redemption, since by "tacking" the two and a
half year holding period of the Fund's Class B shares to the three years
holding period for the Special Value Fund Class B shares the investor will be
deemed to have held the new Class B shares for more than five years.
Shareholders also may exchange Class A shares and Class B shares from any of
the funds into shares of the Class A money market funds and Class B money
market funds, respectively, but the period of time that Class B shares are held
in a Class B money market fund will not count towards satisfaction of the
holding period requirement for purposes of reducing the contingent deferred
sales charge. However, shares of a Class B money market fund which were
acquired as a result of an exchange for Class B shares of a fund, may, in turn,
be exchanged back into Class B shares of any fund offering such shares, in
which event the holding period for Class B shares of the Fund will be
aggregated with previous holding periods for purposes of reducing the
contingent deferred sales charge. Thus, for example, an investor may exchange
Class B shares of the Fund for shares of Merrill Lynch Institutional Fund after
having held the Class B shares for two and a
27
<PAGE>
half years and three years later decide to redeem the shares of Merrill Lynch
Institutional Fund for cash. At the time of this redemption, the 2% contingent
deferred sales charge that would have been due had the Class B shares of the
Fund been redeemed for cash rather than exchanged for shares of Merrill Lynch
Institutional Fund will be payable. If, instead of such redemption the
shareholder exchanged such shares for Class B shares of a fund which the
shareholder continues to hold for an additional two and a half years, any
subsequent redemption will not incur a contingent deferred sales charge.
Merrill Lynch Mutual Fund Adviser Program. Class A shareholders of the Fund
that participate in the Merrill Lynch Mutual Fund Adviser Program may exchange
Class A shares of the Fund for Class A shares of the funds listed below at net
asset value. Once the initial allocation of assets is made under the program,
any subsequent exchange under the program of Class A shares of a fund for Class
A shares of the Fund will be made on the basis of the relative net asset values
of the shares being exchanged with no additional charges for any difference
between the sales charge previously paid on Fund shares exchanged and the sales
charge payable on Fund shares acquired in the exchange.
The investment objectives of the other funds into which exchanges can be made
are as follows:
Merrill Lynch Americas Income Fund,
Inc. ...............................
A high level of current income,
consistent with prudent investment
risk, by investing primarily in debt
securities denominated in a currency
of a country located in the Western
Hemisphere (i.e., North and South
America and the surrounding waters).
Merrill Lynch Arizona Limited
Maturity Municipal Bond Fund...
A portfolio of Merrill Lynch Multi-
State Limited Maturity Municipal Se-
ries Trust, a series fund, whose ob-
jective is to provide as high a level
of income exempt from Federal and Ari-
zona income taxes as is consistent
with prudent investment management
through investment in a portfolio pri-
marily of intermediate-term investment
grade Arizona Municipal Bonds.
Merrill Lynch Arizona Municipal Bond
Fund................................
A portfolio of Merrill Lynch Multi-
State Municipal Series Trust, a series
fund, whose objective is as high a
level of income exempt from Federal
and Arizona income taxes as is
consistent with prudent investment
management.
Merrill Lynch Arkansas Municipal
Bond Fund......................
A portfolio of Merrill Lynch Multi-
State Municipal Series Trust, a series
fund, whose objective is to provide as
high a level of income exempt from
Federal and Arkansas income taxes as
is consistent with prudent investment
management.
28
<PAGE>
Merrill Lynch Asset Growth Fund, High total investment return, con-
Inc. .......................... sistent with prudent risk, from in-
vestment in United States and for-
eign equity, debt and money market
securities the combination of which
will be varied both with respect to
types of securities and markets in
response to changing market and
economic trends.
Merrill Lynch Asset Income Fund, A high level of current income
Inc. .......................... through investment primarily in
United States fixed income securi-
ties.
Merrill Lynch Balanced Fund for
Investment and Retirement...........
As high a level of total investment
return as is consistent with rea-
sonable risk by investing in common
stock and other types of securi-
ties, including fixed income secu-
rities and convertible securities.
Merrill Lynch Basic Value Fund, Capital appreciation and, secondari-
Inc. ............................... ly, income through investment in
securities, primarily equities,
that are undervalued and therefore
represent basic investment value.
Merrill Lynch California Insured
Municipal Bond Fund............
A portfolio of Merrill Lynch Cali-
fornia Municipal Series Trust, a
series fund, whose objective is as
high a level of income exempt from
Federal and California income taxes
as is consistent with prudent in-
vestment management through invest-
ment in a portfolio primarily of
insured California Municipal Bonds.
Merrill Lynch California Limited
Maturity Municipal Bond Fund...
A portfolio of Merrill Lynch Multi-
State Limited Maturity Municipal
Series Trust, a series fund, whose
objective is as high a level of in-
come exempt from Federal and Cali-
fornia income taxes as is consis-
tent with prudent investment man-
agement through investment in a
portfolio primarily of intermedi-
ate-term investment grade Califor-
nia Municipal Bonds.
Merrill Lynch California Municipal
Bond Fund...........................
A portfolio of Merrill Lynch Cali-
fornia Municipal Series Trust, a
series fund, whose objective is as
high a level of income exempt from
Federal and California income taxes
as is consistent with prudent in-
vestment management.
29
<PAGE>
Merrill Lynch Capital Fund, Inc. .... The highest total investment return
consistent with prudent risk
through a fully managed investment
policy utilizing equity, debt and
convertible securities.
Merrill Lynch Colorado Municipal
Bond Fund......................
A portfolio of Merrill Lynch Multi-
State Municipal Series Trust, a se-
ries fund, whose objective is as
high a level of income exempt from
Federal and Colorado income taxes
as is consistent with prudent in-
vestment management.
Merrill Lynch Connecticut Municipal
Bond Fund......................
A portfolio of Merrill Lynch Multi-
State Municipal Series Trust, a se-
ries fund, whose objective is as
high a level of income exempt from
Federal and Connecticut income
taxes as is consistent with prudent
investment management.
Merrill Lynch Corporate Bond Fund,
Inc. ...............................
Current income from three separate
diversified portfolios of fixed in-
come securities.
Merrill Lynch Developing Capital
Markets Fund, Inc. .................
Long-term appreciation through in-
vestment in securities, principally
equities, of issuers in countries
having smaller capital markets.
Merrill Lynch Dragon Fund, Inc. .....
Capital appreciation primarily
through investment primarily in eq-
uity and debt securities of issuers
domiciled in developing countries
located in Asia and the Pacific Ba-
sin, other than Japan, Australia
and New Zealand.
Merrill Lynch EuroFund. ............. Capital appreciation primarily
through investment in equity secu-
rities of corporations domiciled in
Europe.
Merrill Lynch Federal Securities High current return through invest-
Trust .............................. ments in U.S. Government and Gov-
ernment agency securities, includ-
ing GNMA mortgage-backed certifi-
cates and other mortgage-backed
Government securities.
Merrill Lynch Florida Limited
Maturity Municipal Bond Fund...
A portfolio of Merrill Lynch Multi-
State Limited Maturity Municipal
Series Trust, a series fund, whose
objective is as high a level of in-
come exempt from Federal income
taxes as is consistent with prudent
investment management while serving
to offer shareholders the opportu-
nity to own securities exempt from
Florida intangible personal prop-
erty taxes through investment in a
portfolio primarily of intermedi-
ate-term investment grade Florida
Municipal Bonds.
30
<PAGE>
Merrill Lynch Florida Municipal Bond
Fund..................................
A portfolio of Merrill Lynch Multi-
State Municipal Series Trust, a se-
ries fund, whose objective is as
high a level of income exempt from
Federal income taxes as is consis-
tent with prudent investment manage-
ment while seeking to offer share-
holders the opportunity to own secu-
rities exempt from Florida intangi-
ble personal property taxes.
Merrill Lynch Fund for Tomorrow,
Inc. ................................. Long-term growth through investment
in a portfolio of good quality secu-
rities, primarily common stock, po-
tentially positioned to benefit from
demographic and cultural changes as
they affect consumer markets.
Merrill Lynch Fundamental Growth Fund,
Inc. .................................
Long-term growth of capital through
investment in a diversified portfo-
lio of equity securities placing
particular emphasis on companies
that have exhibited an above-average
growth rate in earnings.
Merrill Lynch Global Allocation Fund,
Inc. .................................
High total return, consistent with
prudent risk, through a fully man-
aged investment policy utilizing
United States and foreign equity,
debt and money market securities,
the combination of which will be
varied from time to time both with
respect to the types of securities
and markets in response to changing
market and economic trends.
Merrill Lynch Global Bond Fund for
Investment and Retirement ............
High total investment return from in-
vestment in a global portfolio of
debt instruments denominated in var-
ious currencies and multinational
currency units.
Merrill Lynch Global Convertible Fund,
Inc. .................................
High total return from investment
primarily in an internationally di-
versified portfolio of convertible
debt securities, convertible pre-
ferred stock and "synthetic" con-
vertible securities consisting of a
combination of debt securities or
preferred stock and warrants or op-
tions.
Merrill Lynch Global Holdings
(residents of Arizona must meet
investor suitability standards)..
The highest total investment return
consistent with prudent risk through
worldwide investment in an interna-
tionally diversified portfolio of
securities.
31
<PAGE>
Merrill Lynch Global Resources Trust ... Long-term growth and protection of
capital from investment in securi-
ties of domestic and foreign compa-
nies that possess substantial natu-
ral resource assets.
Merrill Lynch Global SmallCap Fund, Long-term growth of capital by in-
Inc............................... vesting primarily in equity securi-
ties of companies with relatively
small market capitalizations lo-
cated in various foreign countries
and in the United States.
Merrill Lynch Global Utility Fund, Capital appreciation and current in-
Inc. .................................. come through investment of at least
65% of its total assets in equity
and debt securities issued by do-
mestic and foreign companies which
are primarily engaged in the owner-
ship or operation of facilities
used to generate, transmit or dis-
tribute electricity, telecommunica-
tions, gas or water.
Merrill Lynch Government Fund .......... A portfolio of Merrill Lynch Funds
for Institutions Series, a series
fund, whose objective is to provide
current income consistent with li-
quidity and security of principal
from investment in securities is-
sued or guaranteed by the U.S. Gov-
ernment, its agencies and instru-
mentalities and in repurchase
agreements secured by such obliga-
tions.
Merrill Lynch Growth Fund for
Investment and Retirement .............
Growth of capital and, secondarily,
income from investment in a diver-
sified portfolio of equity securi-
ties placing principal emphasis on
those securities which management
of the fund believes to be under-
valued.
Merrill Lynch Healthcare Fund, Inc.
(residents of Wisconsin must meet
investor suitability standards) .......
Capital appreciation through
worldwide investment in equity
securities of companies that derive
or are expected to derive a
substantial portion of their sales
from products and services in
healthcare.
Merrill Lynch Institutional Fund ....... A portfolio of Merrill Lynch Funds
for Institutions Series, a series
fund, whose objective is to provide
maximum current income consistent
with liquidity and the maintenance
of a high-quality portfolio of
money market securities.
32
<PAGE>
Merrill Lynch Institutional Tax-Exempt
Fund ..................................
A portfolio of Merrill Lynch Funds
for Institutions Series, a series
fund, whose objective is to provide
maximum current income exempt from
Federal income taxes, preservation
of capital and liquidity available
from investing in a diversified
portfolio of short-term, high
quality municipal bonds.
Merrill Lynch International Equity Capital appreciation and,
Fund .................................. secondarily, income by investing in
a diversified portfolio of equity
securities of issuers located in
countries other than the United
States.
Merrill Lynch Latin America Fund,
Inc. ................................... Capital appreciation by investing
primarily in Latin American equity
and debt securities.
Merrill Lynch Maryland Municipal Bond
Fund..............................
A portfolio of Merrill Lynch Multi-
State Municipal Series Trust, a se-
ries fund, whose objective is as
high a level of income exempt from
Federal and Maryland income taxes
as is consistent with prudent in-
vestment management.
Merrill Lynch Massachusetts Limited
Maturity Municipal Bond Fund......
A portfolio of Merrill Lynch Multi-
State Limited Maturity Municipal
Series Trust, a series fund, whose
objective is as high a level of in-
come exempt from Federal and Massa-
chusetts income taxes as is consis-
tent with prudent investment man-
agement through investment in a
portfolio primarily of intermedi-
ate-term investment grade Massachu-
setts Municipal Bonds.
Merrill Lynch Massachusetts Municipal
Bond Fund .............................
A portfolio of Merrill Lynch Multi-
State Municipal Series Trust, a se-
ries fund, whose objective is as
high a level of income exempt from
Federal and Massachusetts income
taxes as is consistent with prudent
investment management.
Merrill Lynch Michigan Limited Maturity
Municipal Bond Fund...............
A portfolio of Merrill Lynch Multi-
State Limited Maturity Municipal
Series Trust, a series fund, whose
objective is as high a level of in-
come exempt from Federal and Michi-
gan income taxes as is consistent
with prudent investment management
through investment in a portfolio
primarily of intermediate-term in-
vestment grade Michigan Municipal
Bonds.
33
<PAGE>
Merrill Lynch Michigan Municipal Bond
Fund ..................................
A portfolio of Merrill Lynch Multi-
State Municipal Series Trust, a se-
ries fund, whose objective is as
high a level of income exempt from
Federal and Michigan income taxes
as is consistent with prudent in-
vestment management.
Merrill Lynch Minnesota Municipal Bond
Fund ..................................
A portfolio of Merrill Lynch Multi-
State Municipal Series Trust, a se-
ries fund, whose objective is as
high a level of income exempt from
Federal and Minnesota income taxes
as is consistent with prudent in-
vestment management.
Merrill Lynch Municipal Bond Fund, Tax-exempt income from three sepa-
Inc. .................................. rate diversified portfolios of mu-
nicipal bonds.
Merrill Lynch Municipal Intermediate
Term Fund ........................
Currently the only portfolio of Mer-
rill Lynch Municipal Series Trust,
a series fund, whose objective is
as high a level of income exempt
from Federal income taxes as possi-
ble by investing in investment
grade obligations with a dollar
weighted average maturity of five
to twelve years.
Merrill Lynch New Jersey Limited
Maturity Municipal Bond Fund......
A portfolio of Merrill Lynch Multi-
State Limited Maturity Municipal
Series Trust, a series fund, whose
objective is as high a level of in-
come exempt from Federal and New
Jersey income taxes as is consis-
tent with prudent investment man-
agement through a portfolio primar-
ily of intermediate-term investment
grade New Jersey Municipal Bonds.
Merrill Lynch New Jersey Municipal Bond
Fund ..................................
A portfolio of Merrill Lynch Multi-
State Municipal Series Trust, a se-
ries fund, whose objective is as
high a level of income exempt from
Federal and New Jersey income taxes
as is consistent with prudent in-
vestment management.
Merrill Lynch New Mexico Municipal
Bond Fund.........................
A portfolio of Merrill Lynch Multi-
State Municipal Series Trust, a se-
ries fund, whose objective is as
high a level of income exempt from
Federal and New Mexico income taxes
as is consistent with prudent in-
vestment management.
34
<PAGE>
Merrill Lynch New York Limited
Maturity Municipal Bond Fund.....
A portfolio of Merrill Lynch Multi-
State Limited Maturity Municipal
Series Trust, a series fund, whose
objective is as high a level of in-
come exempt from Federal, New York
State and New York City income
taxes as is consistent with prudent
investment management through in-
vestment in a portfolio primarily
of intermediate-term investment
grade New York Municipal Bonds.
Merrill Lynch New York Municipal Bond
Fund .................................
A portfolio of Merrill Lynch Multi-
State Municipal Series Trust, a se-
ries fund, whose objective is as
high a level of income exempt from
Federal, New York State and New
York City income taxes as is con-
sistent with prudent investment
management.
Merrill Lynch North CarolinaMunicipal
Bond Fund ............................
A portfolio of Merrill Lynch Multi-
State Municipal Series Trust, a se-
ries fund, whose objective is as
high a level of income exempt from
Federal and North Carolina income
taxes as is consistent with prudent
investment management.
Merrill Lynch Ohio Municipal Bond
Fund ................................. A portfolio of Merrill Lynch Multi-
State Municipal Series Trust, a se-
ries fund, whose objective is as
high a level of income exempt from
Federal and Ohio income taxes as is
consistent with prudent investment
management.
Merrill Lynch Oregon Municipal Bond
Fund .................................
A portfolio of Merrill Lynch Multi-
State Municipal Series Trust, a se-
ries fund, whose objective is as
high a level of income exempt from
Federal and Oregon income taxes as
is consistent with prudent invest-
ment management.
Merrill Lynch Pacific Fund, Inc. ......
Capital appreciation primarily by
investing in equity securities of
corporations domiciled in Far East-
ern and Western Pacific countries,
including Japan, Australia, Hong
Kong and Singapore.
35
<PAGE>
Merrill Lynch Pennsylvania Limited
Maturity Municipal Bond Fund......
A portfolio of Merrill Lynch Multi-
State Limited Maturity Municipal
Series Trust, a series fund, whose
objective is to provide as high a
level of income exempt from Federal
and Pennsylvania income taxes as is
consistent with prudent investment
management through investment in a
portfolio of intermediate-term in-
vestment grade Pennsylvania Munici-
pal Bonds.
Merrill Lynch PennsylvaniaMunicipal
Bond Fund .............................
A portfolio of Merrill Lynch Multi-
State Municipal Series Trust, a se-
ries fund, whose objective is as
high a level of income exempt from
Federal and Pennsylvania income
taxes as is consistent with prudent
investment management.
Merrill Lynch Phoenix Fund, Inc. ....... Long-term growth of capital by in-
vesting in equity and fixed income
securities, including tax-exempt
securities, of issuers in weak fi-
nancial condition or experiencing
poor operating results believed to
be undervalued relative to the cur-
rent or prospective condition of
such issuer.
Merrill Lynch Ready Assets Trust ....... Preservation of capital, liquidity
and the highest possible current
income consistent with the forego-
ing objectives from the short-term
money market securities in which
the Trust invests.
Merrill Lynch Retirement ReservesMoney
Fund (available only if the exchange
occurs within certain retirement
plans) ................................
Currently the only portfolio of Mer-
rill Lynch Retirement Series Trust,
a series fund, whose objectives are
current income, preservation of
capital and liquidity available
from investing in a diversified
portfolio of short-term money mar-
ket securities.
Merrill Lynch Short-Term Global Income
Fund, Inc. ............................
As high a level of current income as
is consistent with prudent invest-
ment management from a global port-
folio of high quality debt securi-
ties denominated in various curren-
cies and multi-national currency
units and having remaining maturi-
ties not exceeding three years.
36
<PAGE>
Merrill Lynch Special Value Fund, Long-term growth of capital from in-
Inc. .................................. vestments in securities, primarily
common stock, of relatively small
companies believed to have special
investment value and emerging
growth companies regardless of
size.
Merrill Lynch Strategic Dividend Fund .. Long-term total return from invest-
ment in dividend paying common
stocks which yield more than Stan-
dard & Poor's 500 Composite Stock
Price Index.
Merrill Lynch Technology Fund, Inc. .... Capital appreciation through
worldwide investment in equity
securities of companies that derive
or are expected to derive a
substantial portion of their sales
from products and services in
technology.
Merrill Lynch Texas Municipal Bond
Fund................................... A portfolio of Merrill Lynch Multi-
State Municipal Series Trust, a se-
ries fund, whose objective is to
provide investors with as high a
level of income exempt from Federal
income taxes as is consistent with
prudent investment management by
investing primarily in a portfolio
of long-term, investment grade ob-
ligations issued by the State of
Texas, its political subdivisions,
agencies and instrumentalities.
Merrill Lynch Treasury Fund ............ A portfolio of Merrill Lynch Funds
for Institutions Series, a series
fund, whose objective is to provide
current income consistent with li-
quidity and security of principal
from investment in direct obliga-
tions of the U.S. Treasury and up
to 10% of its total assets in re-
purchase agreements secured by such
obligations.
Merrill Lynch U.S.A. Government Preservation of capital, current in-
Reserves............................... come and liquidity available from
investing in direct obligations of
the U.S. Government and repurchase
agreements relating to such securi-
ties.
Merrill Lynch U.S. Treasury Money Preservation of capital, liquidity
Fund .................................. and current income through invest-
ment exclusively in a diversified
portfolio of short-term marketable
securities which are direct obliga-
tions of the U.S. Treasury.
37
<PAGE>
Merrill Lynch Utility Income Fund, High current income through invest-
Inc. ............................. ment in equity and debt securities
issued by companies which are pri-
marily engaged in the ownership or
operation of facilities used to
generate, transmit or distribute
electricity, telecommunications,
gas or water.
Merrill Lynch World Income Fund, Inc. .. High current income by investing in
a global portfolio of fixed income
securities denominated in various
currencies, including multinational
currencies.
Before effecting an exchange, shareholders of the Fund should obtain a
currently effective prospectus of the fund into which the exchange is to be
made. Exercise of the exchange privilege is treated as a sale for Federal
income tax purposes and, depending on the circumstances, a short- or long-term
capital gain or loss may be realized. In addition, a shareholder exchanging
shares of any of the funds may be subject to a backup withholding tax unless
such shareholder certifies under penalty of perjury that the taxpayer
identification number on file with any such fund is correct and that such
shareholder is not otherwise subject to backup withholding. See "Dividends,
Distributions and Taxes" below.
To exercise the exchange privilege, shareholders should contact their Merrill
Lynch financial consultant, who will advise the Fund of the exchange, or, if
the exchange does not involve a money market fund, the shareholder may write to
the Transfer Agent requesting that the exchange be effected. Such letter must
be signed exactly as the account is registered with signatures guaranteed by an
"eligible guarantor institution" (including, for example, Merrill Lynch branch
offices and certain other financial institutions) as such is defined in Rule
17Ad-15 under the Securities Exchange Act of 1934, as amended, the existence
and validity of which may be verified by the transfer agent through the use of
industry publications. Shareholders of the Fund, and shareholders of the other
funds described above with shares for which certificates have not been issued,
may exercise the exchange privilege by wire through their securities dealers.
The Fund reserves the right to require a properly completed Exchange
Application. This exchange privilege may be modified or terminated in
accordance with the rules of the Securities and Exchange Commission. The Fund
reserves the right to limit the number of times an investor may exercise the
exchange privilege. Certain funds may suspend the continuous offering of their
shares to the general public at any time and may thereafter resume such
offering from time to time. The exchange privilege is available only in states
where the exchange legally may be made.
DIVIDENDS, DISTRIBUTIONS AND TAXES
DIVIDENDS AND DISTRIBUTIONS
All or a portion of the Fund's net investment income will be declared as
dividends daily prior to the determination of net asset value on that day and
paid monthly. The Fund may at times pay out less than the entire amount of net
investment income earned in any particular period and may at times pay out such
accumulated undistributed income in addition to net investment income earned in
any particular period in order to permit the Fund to maintain a more stable
level of distributions. As a result, the distribution paid by the Fund for any
particular period may be more or less than the amount of net investment income
earned by
38
<PAGE>
the Fund during such period. However, it is the Fund's intention to distribute
during any fiscal year all its net investment income. Shares will accrue
dividends as long as they are issued and outstanding. Shares are issued and
outstanding as of the settlement date of a purchase order to the settlement
date of a redemption order. All net realized long-term and short-term capital
gains, if any, will be distributed to the Fund's shareholders at least
annually.
See "Shareholder Services--Automatic Reinvestment of Dividends and Capital
Gains Distributions" for information concerning the manner in which dividends
and distributions may be automatically reinvested in shares of the Fund.
Shareholders may elect in writing to receive any such dividends or
distributions, or both, in cash. Dividends and distributions are taxable to
shareholders as discussed below whether they are reinvested in shares of the
Fund or received in cash.
TAXES
The Fund intends to continue to qualify for the special tax treatment
afforded regulated investment companies ("RICs") under the Internal Revenue
Code of 1986, as amended (the "Code"). If it so qualifies, the Fund (but not
its shareholders) will not be subject to Federal income tax on the part of its
net ordinary income and net realized capital gains which it distributes to
Class A and Class B shareholders (together, the "shareholders"). The Fund
intends to distribute substantially all of such income.
Dividends paid by the Fund from its ordinary income and distributions of the
Fund's net realized short-term capital gains (together referred to hereafter as
"ordinary income dividends") are taxable to a shareholder as ordinary income.
Distributions made from the Fund's net realized long-term capital gains
(including long-term gains from certain transactions in futures and options)
("capital gain dividends") are taxable to a shareholder as long-term capital
gains, regardless of the length of time the shareholder has owned Fund shares.
Any loss upon the sale or exchange of Fund shares held for six months or less,
however, will be treated as long-term capital loss to the extent of any capital
gain dividends received by the shareholder. Distributions in excess of the
Fund's earnings and profits will first reduce the adjusted tax basis of a
holder's shares and, after such adjusted tax basis is reduced to zero, will
constitute capital gains to such holder (assuming the shares are held as a
capital asset).
Dividends are taxable to shareholders even though they are reinvested in
additional shares of the Fund. Not later than 60 days after the close of its
taxable year, the Fund will provide its shareholders with a written notice
designating the amounts of any ordinary income dividends or capital gain
dividends. Distributions by the Fund, whether from ordinary income or capital
gains, will not be eligible for the dividends-received deduction allowed to
corporations under the Code. If the Fund pays a dividend in January which was
declared in the previous October, November or December to shareholders of
record on a specified date in one of such months, then such dividend will be
treated for tax purposes as being paid by the Fund and received by its
shareholders on December 31 of the year in which such dividend was declared.
Ordinary income dividends paid by the Fund to shareholders who are
nonresident aliens or foreign entities will be subject to a 30% United States
withholding tax under existing provisions of the Code applicable to foreign
individuals and entities unless a reduced rate of withholding or a withholding
exemption is provided under applicable treaty law. Nonresident shareholders are
urged to consult their own tax advisers concerning the applicability of the
United States withholding tax.
39
<PAGE>
Dividends and interest received by the Fund may give rise to withholding and
other taxes imposed by foreign countries. Tax conventions between certain
countries and the United States may reduce or eliminate such taxes.
Under certain provisions of the Code, some shareholders may be subject to a
31% withholding tax on ordinary income dividends, capital gain dividends and
redemption payments ("backup withholding"). Generally, shareholders subject to
backup withholding will be those for whom no certified taxpayer identification
number is on file with the Fund or who, to the Fund's knowledge, have furnished
an incorrect number. When establishing an account, an investor must certify
under penalty of perjury that such number is correct and that the investor is
not otherwise subject to backup withholding.
If a shareholder exercises an exchange privilege within 90 days of acquiring
the shares, then the loss the shareholder can recognize on the exchange will be
reduced (or the gain increased) to the extent the sales charge paid to the Fund
reduces any sales charge the shareholder would have owed upon the purchase of
the new shares in the absence of the exchange privilege. Instead, such sales
charge will be treated as an amount paid for the new shares.
A loss realized on a sale or exchange of shares of the Fund will be
disallowed if other Fund shares are acquired (whether through the automatic
reinvestment of dividends or otherwise) within a 61-day period beginning 30
days before and ending 30 days after the date that the shares are disposed of.
In such a case, the basis of the shares acquired will be adjusted to reflect
the disallowed loss.
The Code requires a RIC to pay a nondeductible 4% excise tax to the extent
the RIC does not distribute, during each calendar year, 98% of its ordinary
income, determined on a calendar year basis, and 98% of its capital gains,
determined, in general, on an October 31 year end, plus certain undistributed
amounts from previous years. While the Fund intends to distribute its income
and capital gains in the manner necessary to avoid imposition of the 4% excise
tax, there can be no assurance that sufficient amounts of the Fund's taxable
income and capital gains will be distributed to avoid entirely the imposition
of the tax. In such event, the Fund will be liable for the tax only on the
amount by which it does not meet the foregoing distribution requirements.
TAX TREATMENT OF INTEREST RATE TRANSACTIONS, OPTIONS AND FUTURES
The Fund may engage in interest rate transactions, write (i.e., sell) covered
call and covered put options on its portfolio securities, purchase call and put
options on securities, and engage in transactions in financial futures and
related options on such futures. Such options and futures contracts that are
"Section 1256 contracts" will be "marked to market" for Federal income tax
purposes at the end of each taxable year, i.e., each such option or futures
contract will be treated as sold for its fair market value on the last day of
the taxable year and any gain or loss from transactions in Section 1256
contracts will be 60% long-term and 40% short-term capital gain or loss. The
mark to market rules outlined above, however, will not apply to certain
transactions entered into by the Fund solely to reduce the risk of changes in
price or interest or currency exchange rates with respect to its investments.
Code Section 1092, which applies to certain "straddles", may affect the
taxation of the Fund's transactions in options and futures contracts. Under
Section 1092, the Fund may be required to postpone recognition for tax purposes
of losses incurred in certain closing transactions in options and futures
contracts.
40
<PAGE>
One of the requirements for qualification as a RIC is that less than 30% of
the Fund's gross income be derived from gains from the sale or other
disposition of securities held for less than three months. Accordingly, the
Fund may be restricted in effecting closing transactions within three months
after entering into an option or futures contract.
The Fund may make investments that produce taxable income that is not matched
by a corresponding receipt of cash or an offsetting loss deduction. Such
investments would include dollar rolls and obligations that have original issue
discount (such as SMBSs), accrete discount or are subordinated in the mortgage-
backed securities structure. Such taxable income would be treated as income
earned by the Fund and would be subject to the distribution requirements of the
Code. Because such income may not be matched by a corresponding receipt of cash
by the Fund or an offsetting loss deduction, the Fund may be required to borrow
money or dispose of other securities to be able to make distributions to
shareholders. The Fund intends to make sufficient and timely distributions to
shareholders so as to qualify for RIC status at all times and to avoid
imposition of the excise tax.
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code and Treasury regulations presently in effect. For the
complete provisions, reference should be made to the pertinent Code sections
and the Treasury regulations promulgated thereunder. The Code and the Treasury
regulations are subject to change by legislative, judicial or administrative
action either prospectively or retroactively.
Ordinary income and capital gain dividends may also be subject to state and
local taxes.
Certain states exempt from state income taxation dividends paid by RICs which
are derived from interest on U.S. Government obligations. State law varies as
to whether dividend income attributable to U.S. Government obligations is
exempt from state income tax. In general, state law does not consider income
derived from MBSs to be income attributable to U.S. Government obligations.
Shareholders are urged to consult their own tax advisers regarding specific
questions as to Federal, state, local or foreign taxes. Foreign investors
should consider applicable foreign taxes in their evaluation of an investment
in the Fund.
PERFORMANCE DATA
From time to time the Fund may include its average annual total return and
other total return data, as well as yield, in advertisements or information
furnished to present or prospective shareholders. Total return is based on the
Fund's historical performance and is not intended to indicate future
performance. Average annual total return and yield are determined separately
for Class A and Class B shares in accordance with formulas specified by the
Securities and Exchange Commission.
Average annual total return quotations for the specified periods are computed
by finding the average annual compounded rates of return (based on net
investment income and any realized and unrealized capital gains or losses on
portfolio investments over such periods) that would equate the initial amount
invested to the redeemable value of such investment at the end of each period.
Average annual total return is computed assuming all dividends and
distributions are reinvested and taking into account all applicable recurring
and nonrecurring expenses, including the maximum sales charge in the case of
Class A shares and the contingent
41
<PAGE>
deferred sales charge that would be applicable to a complete redemption of the
investment at the end of the specified period in the case of Class B shares.
The Fund also may quote annual, average and annualized total return and
aggregate total return performance data, both as a percentage and as a dollar
amount based on a hypothetical $1,000 investment, for various periods other
than those noted below. Such data will be computed as described above, except
that (1) as required by the period of the quotations, actual annual, annualized
or aggregate data, rather than average annual data, may be quoted and (2) the
maximum applicable sales charges will not be included. Actual annual or
annualized total return data generally will be lower than average annual total
return data since the average rates of return reflect compounding of return;
aggregate total return data generally will be higher than average annual total
return data since the aggregate rates of return reflect compounding over a
longer period of time.
<TABLE>
<CAPTION>
CLASS A SHARES CLASS B SHARES
----------------------------------- -----------------------------------
REDEEMABLE REDEEMABLE
VALUE OF A VALUE OF A
EXPRESSED AS A HYPOTHETICAL EXPRESSED AS A HYPOTHETICAL
PERCENTAGE BASED $1,000 INVESTMENT PERCENTAGE BASED $1,000 INVESTMENT
ON A HYPOTHETICAL AT THE END OF THE ON A HYPOTHETICAL AT THE END OF THE
$1,000 INVESTMENT PERIOD $1,000 INVESTMENT PERIOD
----------------- ----------------- ----------------- -----------------
AVERAGE ANNUAL TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGES)
<S> <C> <C> <C> <C>
PERIOD
- - - ------
One Year Ended May 31,
1994................... (1.76%) $ 982.40 (2.16%) $ 978.40
Inception (August 2,
1991) to May 31, 1994.. 2.08% $1,059.90 2.35% $1,067.80
ANNUAL TOTAL RETURN
(EXCLUDING MAXIMUM APPLICABLE SALES CHARGES)
YEAR ENDED MAY 31,
- - - ------------------
1994.................... 1.28% $1,012.80 0.77% $1,007.70
1993.................... 2.99% $1,029.90 2.48% $1,024.80
Inception (August 2,
1991) to May 31, 1992.. 4.75% $1,047.50 4.33% $1,043.30
AGGREGATE TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGES)
Inception (August 2,
1991) to May 31, 1994.. 5.99% $1,059.90 6.78% $1,067.80
</TABLE>
GENERAL INFORMATION
DESCRIPTION OF SHARES
The Fund was incorporated under Maryland law on April 19, 1991. It has an
authorized capital of 300,000,000 shares of Common Stock, par value $0.10 per
share, divided into two classes, designated Class A and Class B Common Stock.
Class A Common Stock consists of 100,000,000 shares. Class B Common Stock
consists of 200,000,000 shares. Both Class A and Class B Common Stock represent
an interest in the same assets of the Fund and are identical in all respects
except that the expenses of the account maintenance fee related to the Class A
shares are borne solely by the Class A shares, and the expenses of the account
maintenance fee and distribution fee related to the Class B shares are borne
solely by the Class B shares, and
42
<PAGE>
the Class A and Class B shares have exclusive voting rights with respect to
matters relating to such account maintenance and/or distribution expenditures.
The Fund has received an order from the Securities and Exchange Commission (the
"Commission") permitting the issuance and sale of multiple classes of Common
Stock. The Board of Directors of the Fund may classify and reclassify the
shares of the Fund into additional classes of Common Stock at a future date.
Shareholders are entitled to one vote for each full share held and fractional
votes for fractional shares held and will vote on the election of Directors and
any other matter submitted to a shareholder vote. The Fund does not intend to
hold meetings of shareholders in any year in which the Investment Company Act
of 1940 does not require shareholders to act upon any of the following matters:
(i) election of Directors; (ii) approval of an investment advisory agreement;
(iii) approval of a distribution agreement; and (iv) ratification of selection
of independent accountants. Generally, under Maryland law, a meeting of
shareholders may be called for any purpose on the written request of the
holders of at least 25% of the outstanding shares of the Fund. Voting rights
for Directors are not cumulative. Shares issued are fully paid and non-
assessable and have no preemptive or conversion rights. Redemption rights are
discussed elsewhere herein and in the Prospectus. Each share of Class A or
Class B Common Stock is entitled to participate equally in dividends and
distributions declared by the Fund and in the net assets of the Fund upon
liquidation or dissolution after satisfaction of outstanding liabilities,
except that, as noted above, expenses related to the account maintenance and/or
distribution of the shares of a class will be borne solely by such class. Stock
certificates will be issued by the Transfer Agent only on specific request.
Certificates for fractional shares are not issued in any case.
The Manager provided the initial capital for the Fund by purchasing 10,000
shares for $100,000. Such shares will be acquired for investment and can only
be disposed by redemption. The organizational expenses of the Fund were paid by
the Fund and amortized over a period not exceeding five years. The proceeds
realized by the Manager (or any subsequent holder) upon redemption of any of
such shares will be reduced by the proportionate amount of the unamortized
organizational expenses which the number of shares redeemed bears to the number
of shares initially purchased.
INDEPENDENT AUDITORS
Deloitte & Touche LLP, 117 Campus Drive, Princeton, New Jersey 08540, have
been selected as the independent auditors of the Fund. The selection of
independent auditors is subject to ratification by the shareholders of the
Fund. The independent auditors are responsible for auditing the annual
financial statements of the Fund.
CUSTODIAN
The Bank of New York, 90 Washington Street, 12th Floor, New York, New York
10286, acts as the custodian of the Fund's assets. The Custodian is responsible
for safeguarding and controlling the Fund's cash and securities, handling the
receipt and delivery of securities and collecting interest and dividends on the
Fund's investment.
TRANSFER AGENT
Financial Data Services, Inc., Transfer Agency Mutual Fund Operations, 4800
Deer Lake Drive East, Jacksonville, Florida 32246-6484, acts as the Fund's
transfer agent. The Transfer Agent is responsible for the issuance, transfer
and redemption of shares and the opening, maintenance and servicing of
shareholder accounts. See "Management of the Fund--Transfer Agency Services" in
the Prospectus.
43
<PAGE>
LEGAL COUNSEL
Brown & Wood, One World Trade Center, New York, New York 10048-0557, is
counsel for the Fund.
REPORTS TO SHAREHOLDERS
The fiscal year of the Fund ends on May 31 of each year. The Fund sends to
its shareholders at least semi-annually reports showing the Fund's portfolio
and other information. An annual report, containing financial statements
audited by Independent Auditors, is sent to shareholders each year. After the
end of each year, shareholders will receive Federal income tax information
regarding dividends and capital gains distributions.
ADDITIONAL INFORMATION
The Prospectus and this Statement of Additional Information do not contain
all the information set forth in the Registration Statement and the exhibits
relating thereto, which the Fund has filed with the Securities and Exchange
Commission, Washington, D.C., under the Securities Act and the 1940 Act, to
which reference is hereby made.
Under a separate agreement Merrill Lynch has granted the Fund the right to
use the "Merrill Lynch" name and has reserved the right to withdraw its consent
to the use of such name by the Fund at any time or to grant the use of such
name to any other company, and the Fund has granted Merrill Lynch, under
certain conditions, the use of any other name it might assume in the future,
with respect to any corporation organized by Merrill Lynch.
44
<PAGE>
APPENDIX
DESCRIPTION OF COMMERCIAL PAPER
AND CORPORATE BOND RATINGS
COMMERCIAL PAPER
Commercial paper with the greatest capacity for timely payment is rated A by
Standard & Poor's Corporation ("S&P"). Issues within this category are further
redefined with designations 1, 2 and 3 to indicate the relative degree of
safety; A-1, the highest of the three, indicates the degree of safety is very
strong.
Moody's Investors Service, Inc. ("Moody's") employs the designations of
Prime-1, Prime-2 and Prime-3 to indicate the relative repayment ability of
rated issuers. Prime-1 issues have a superior capacity for repayment.
CORPORATE BONDS
Bonds rated AAA have the highest rating assigned by S&P to a debt obligation.
Capacity to pay interest and repay principal is extremely strong. Bonds rated
AA have a very strong capacity to pay interest and repay principal and differ
from the highest rated issues only in small degree. Debt rated A has a strong
capacity to pay interest and repay principal although it is somewhat more
susceptible to the adverse effects of changes in circumstances and economic
conditions than debt in higher-rated categories. Debt rated BBB is regarded as
having an adequate capacity to pay interest and repay principal. Whereas it
normally exhibits adequate protection parameters, adverse economic conditions
or changing circumstances are more likely to lead to a weakened capacity to pay
interest and repay principal for debt in this category than for debt in higher-
rated categories.
Bonds rated Aaa by Moody's are judged to be of the best quality. They carry
the smallest degree of investment risk and are generally referred to as "gilt
edge." Interest payments are protected by a large or by an exceptionally stable
margin and principal is secure. While the various protective elements are
likely to change, such changes as can be visualized are most unlikely to impair
the fundamentally strong position of such issues. Bonds rated Aa are judged to
be of high quality by all standards. They are rated lower than the best bonds
because margins of protection may not be as large or fluctuation of protective
elements may be of greater amplitude or there may be other elements present
which make the long-term risks appear somewhat larger than in Aaa securities.
Bonds which are rated A possess many favorable investment attributes and are to
be considered as upper medium grade obligations. Factors giving security to
principal and interest are considered adequate, but elements may be present
which suggest a susceptibility to impairment sometime in the future. 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. Moody's applies numerical modifiers 1, 2
and 3 in each generic rating classification from Aa through B in its corporate
bond rating system. The modifier 1 indicates that the security ranks in the
higher end of its generic rating category; the modifier 2 indicates a mid-range
ranking; and the modifier 3 indicates that the issue ranks in the lower end of
its generic rating category.
45
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders,
Merrill Lynch Adjustable Rate Securities Fund, Inc.:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of Merrill Lynch Adjustable Rate Securities Fund,
Inc. as of May 31, 1994, the related statements of operations for the year then
ended, and changes in net assets for each of the years in the two-year period
then ended, and financial highlights for each of the years in the two-year
period then ended and the period August 2, 1991 (commencement of operations) to
May 31, 1992. These financial statements and financial highlights are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements and financial highlights based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned at May 31,
1994 by correspondence with the custodian. An audit also includes assessing the
accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of Merrill Lynch
Adjustable Rate Securities Fund, Inc. as of May 31, 1994, the results of its
operations, the changes in its net assets and financial highlights for each of
the respective stated periods in conformity with generally accepted accounting
principles.
Deloitte & Touche LLP
Princeton, New Jersey
June 30, 1994
46
<PAGE>
[THIS PAGE IS INTENTIONALLY LEFT BLANK.]
47
<PAGE>
<TABLE>
SCHEDULE OF INVESTMENTS
<CAPTION>
Face Value Percent of
Index Amount Issue Cost (Note 1a) Net Assets
<S> <S> <C> <S> <C> <C> <C>
Adjustable Constant Maturity $ 5,464,276 Bear Stearns Secured Investors, Inc. II,
Mortgage- Treasury Indexed Pass-Through 91-1-A, 7.90% due 11/25/2021 $ 5,567,262 $ 5,445,479 1.37%
Backed Obligations Federal Home Loan Mortgage Corporation:
Obliga- 12,235,245 5.537% due 8/01/2031 12,648,185 12,502,891 3.15
tions** 101,234 7.265% due 8/01/2020 103,575 100,474 0.03
3,207,604 7.732% due 5/01/2015 3,261,732 3,318,868 0.83
Federal National Mortgage Association:
2,505,006 5.31% due 11/01/2013 2,577,025 2,569,197 0.65
1,871,109 6.25% due 9/01/2015 1,924,903 1,907,946 0.48
703,611 6.628% due 10/01/2013 723,840 719,222 0.18
7,461,212 6.792% due 12/01/2021 7,615,099 7,619,763 1.92
26,351,591 Prudential Home Mortgage Securities
Company, Inc., REMIC (a) 92-35-A1, 5.947%
due 10/01/2022 27,010,381 26,475,127 6.66
Resolution Trust Corporation, REMIC (a):
10,000,000 92-4-B2, 5.729% due 7/25/2028 10,102,247 10,000,000 2.52
2,892,605 91-M7-A3, 6.365% due 1/25/2021 2,901,645 2,892,605 0.73
14,365,846 91-M6-A3, 6.385% due 6/25/2021 14,755,546 14,442,164 3.63
39,063,765 91-M2-A1, 6.76% due 9/25/2020 39,078,985 39,234,669 9.87
21,287,353 91-M2-A3, 6.828% due 9/25/2020 21,340,570 21,619,968 5.44
5,579,206 92-6-B4, 7.367% due 11/25/2025 5,716,682 5,561,743 1.40
14,125,630 Sears Mortgage Securities Corporation,
REMIC (a) 92-11-A1, 5.524% due
4/25/2022 14,267,924 14,010,859 3.53
Cost of Funds 10,162,396 DLJ Mortgage Acceptance Corp., REMIC (a)
Indexed 91-6-A1, 7.828% due 9/01/2021 10,397,401 10,241,789 2.58
Obligations Federal National Mortgage Association:
27,930,903 4.96% due 5/01/2018 28,694,603 27,599,224 6.94
1,411,511 5.625% due 7/01/2017 1,466,979 1,407,983 0.35
11,494,480 5.625% due 10/01/2028 11,946,177 11,458,560 2.88
11,184,110 5.625% due 2/01/2029 11,623,611 11,103,724 2.79
2,148,064 Kidder Peabody Acceptance Corporation I,
REMIC (a) 88-04-A, 6.669% due 1/01/2019 2,225,932 2,126,584 0.53
Resolution Trust Corporation, REMIC (a):
9,037,206 91-M6-A2, 5.487% due 6/25/2021 9,202,421 8,828,175 2.22
17,638,005 91-M2-A2, 7.552% due 9/25/2020 17,708,248 17,671,076 4.45
2,888,813 Ryland--First Nationwide Trust, REMIC (a)
88-1-A, 5.773% due 10/25/2018 2,982,699 2,863,536 0.72
London Interbank 13,402,100 Federal Home Loan Mortgage Corporation,
Offered Rate REMIC (a) 92-1363-C, 47.00% (c) due
Indexed Obligations 8/15/2022 (d) 1,596,897 958,250 0.24
5,913,846 Federal Home Loan Mortgage Corporation,
3.766% due 2/01/2024 6,067,450 5,751,216 1.45
5,400,244 Fund America Investors Corporation II,
Pass-Through (a) 93-K-F, 6.187%
due 1/25/2023 5,400,244 5,400,244 1.36
Resolution Trust Corporation, REMIC (a):
4,242,827 91-M4-B, 5.937% due 2/25/2020 4,240,175 4,221,613 1.06
6,509,430 91-M7-B, 5.937% due 1/25/2021 6,509,430 6,631,481 1.67
15,000,000 92-C1-B, 5.937% due 8/25/2023 14,446,875 15,225,000 3.83
</TABLE>
48
<PAGE>
<TABLE>
<S> <S> <C> <S> <C> <C> <C>
27,000,000 Saxon Mortgage Securities Corporation,
REMIC (a) 92-3-B, 5.551% due 10/01/2021 27,620,000 27,472,500 6.91
Total Investments in Adjustable Rate
Mortgage-Backed Obligations 331,724,743 327,381,930 82.37
Fixed Rate 35,377,546 Capstead Mortgage Securities Corporation
Mortgage- II, REMIC (a) 93-I-A3, 12.01% (c) due
Backed 9/25/2023 (d) 505,632 420,108 0.11
Obligations** 1,003,045 Citicorp Mortgage Securities Inc., REMIC
(a) 92-12-A3, 8.00% due 3/25/2021 1,020,660 989,253 0.25
3,266,961 Collateralized Mortgage Securities Corp.,
REMIC (a) 90-5-L, 11.981% (b) due
9/20/2020 761,229 506,379 0.13
101,156,947 DLJ Mortgage Acceptance Corp., REMIC (a)
92-6-A1, 14.753% (c) due 7/25/2022 (d) 1,705,161 1,244,230 0.31
Federal National Mortgage Association,
REMIC (a):
4,496,068 91-G-46-K, 9.00% (b) due 12/25/2009 1,659,427 1,157,738 0.29
453,540 90-142-K, 10.99% (b) due 7/25/2014 140,966 19,956 0.00
4,105,287 Federal National Mortgage Association,
Trust 32-2, 8.46% (c) due 4/01/2018 (d) 3,457,655 1,275,205 0.32
8,513,834 Kidder Peabody Acceptance Corporation,
REMIC (a) 93-M1-A2, 7.15% due 4/25/2025 8,477,003 8,146,675 2.05
Prudential Home Mortgage Securities
Company, Inc., REMIC (a):
23,112,384 93-44-A2, 6.75% due 8/25/2023 23,542,600 23,061,826 5.80
42,338 92-1-A9, 13.00% (c) due 2/25/2022 80,259 24,556 0.01
29,947,399 Residential Funding Mortgage Securities I,
Inc., REMIC (a) 92-S3-A9, 14.00% (c)
due 1/01/2007 (d) 2,198,796 89,842 0.02
8,926,386 Resolution Trust Corporation, REMIC (a)
92-CHF-B, 7.15% due 12/25/2020 9,036,623 8,937,544 2.25
Sears Mortgage Securities Corp., REMIC
(a):
67,318,483 92-12-A3, 18.00% (c) due 7/25/2023 (d) 851,848 883,555 0.22
513,729 91-K-A4, 18.00% (b) due 9/25/2021 753,622 780,868 0.20
Total Investments in Fixed Rate
Mortgage-Backed Obligations 54,191,481 47,537,735 11.96
Total Investments in Mortgage-Backed
Obligations 385,916,224 374,919,665 94.33
</TABLE>
49
<PAGE>
<TABLE>
SCHEDULE OF INVESTMENTS
<CAPTION>
Face Value Percent of
Index Amount Issue Cost (Note 1a) Net Assets
<S> <S> <C> <S> <C> <C> <C>
Short-Term Repurchase $ 15,800,000 Nikko Securities International, Inc.,
Securities Agreements*** purchased on 5/31/1994 to yield 4.30%
to 6/01/1994 $ 15,800,000 $ 15,800,000 3.98%
US Government 10,000,000 Federal Home Loan Mortgage Association,
& Agency 4.17% due 6/27/1994 9,969,883 9,969,883 2.51
Obligations****
Total Investments in Short-Term Securities 25,769,883 25,769,883 6.49
Total Investments $411,686,107 400,689,548 100.82
============
Liabilities in Excess of Other Assets (3,270,253) (0.82)
------------ -------
Net Assets $397,419,295 100.00%
============ =======
<FN>
*Adjustable Rate Obligations have coupon rates which reset
periodically.
**Mortgage-Backed Obligations are subject to principal paydowns as
a result of prepayments or refinancings of the underlying mortgage
instruments. As a result, the average life may be substantially less
than the original maturity.
***Repurchase Agreements are fully collateralized by US Government
& Agency Obligations.
****US Government & Agency Obligations are traded on a discount basis;
the interest rate shown is the discount rate paid at the time of purchase
by the Fund.
(a) Real Estate Mortgage Investment Conduits (REMIC).
(b) Represents the approximate yield to maturity. These securities have
a high coupon interest rate and were purchased at a substantial
premium to their original face amounts. Monthly premium amortization,
due to prepayments, reduces considerably the net interest income
earned on these securities.
(c) Represents the approximate yield to maturity.
(d) Represents the interest only portion of a mortgage-backed obligation.
See Notes to Financial Statements.
</TABLE>
50
<PAGE>
<TABLE>
STATEMENT OF ASSETS AND LIABILITIES
<CAPTION>
As of May 31, 1994
<S> <S> <C> <C>
Assets: Investments, at value (identified cost--$411,686,107) (Notes 1a & 1b) $400,689,548
Cash 145,408
Receivables:
Interest $ 2,144,671
Principal paydowns 702,780
Capital shares sold 296,728 3,144,179
------------
Deferred organization expenses (Note 1g) 51,197
Prepaid registration fees and other assets (Note 1g) 74,675
------------
Total assets 404,105,007
------------
Liabilities: Payables:
Capital shares redeemed 5,508,500
Dividends to shareholders (Note 1h) 521,552
Distributor (Note 2) 243,640
Investment adviser (Note 2) 169,204 6,442,896
------------
Accrued expenses and other liabilities 242,816
------------
Total liabilities 6,685,712
------------
Net Assets: Net assets $397,419,295
============
Net Assets Class A Common Stock, $0.10 par value, 100,000,000 shares authorized $241,816
Consist of: Class B Common Stock, $0.10 par value, 200,000,000 shares authorized 3,926,889
Paid-in capital in excess of par 427,747,212
Undistributed investment income--net 362,953
Accumulated realized capital losses--net (Note 5) (23,863,016)
Unrealized depreciation on investments--net (10,996,559)
------------
Net assets $397,419,295
============
Net Asset Class A--Based on net assets of $23,043,432 and 2,418,159 shares outstanding $ 9.53
Value: ============
Class B--Based on net assets of $374,375,863 and 39,268,886 shares outstanding $ 9.53
============
See Notes to Financial Statements.
</TABLE>
51
<PAGE>
<TABLE>
STATEMENT OF OPERATIONS
<CAPTION>
For the Year Ended May 31, 1994
<S> <S> <C>
Investment Interest and discount earned, net of premium amortization $ 25,076,112
Income Other 217,119
(Note 1f): ------------
Total income 25,293,231
------------
Expenses: Distribution fees--Class B (Note 2) 3,808,315
Investment advisory fees (Note 2) 2,710,336
Transfer agent fees--Class B (Note 2) 451,897
Accounting services (Note 2) 226,047
Printing and shareholder reports 145,025
Professional fees 87,612
Maintenance fees--Class A (Note 2) 85,730
Custodian fees 64,345
Registration fees (Note 1g) 51,643
Directors' fees and expenses 40,587
Transfer agent fees--Class A (Note 2) 28,456
Amortization of organization expenses (Note 1g) 23,565
Other 41,965
------------
Total expenses 7,765,523
------------
Investment income--net 17,527,708
------------
Realized & Realized loss on investments--net (19,663,874)
Unrealized Change in unrealized depreciation on investments--net 8,608,834
Gain (Loss) ------------
on Invest- Net Increase in Net Assets Resulting from Operations $ 6,472,668
ments--Net ============
(Notes 1f & 3):
See Notes to Financial Statements.
</TABLE>
52
<PAGE>
<TABLE>
STATEMENTS OF CHANGES IN NET ASSETS
<CAPTION>
For the Year Ended May 31,
Increase (Decrease) in Net Assets: 1994 1993
<S> <S> <C> <C>
Operations: Investment income--net $ 17,527,708 $ 39,959,417
Realized loss on investments--net (19,663,874) (3,230,836)
Change in unrealized depreciation on investments--net 8,608,834 (13,586,313)
------------ ------------
Net increase in net assets resulting from operations 6,472,668 23,142,268
------------ ------------
Dividends to Investment income--net:
Shareholders Class A (1,245,307) (3,578,083)
(Note 1h): Class B (15,919,448) (36,381,334)
------------ ------------
Net decrease in net assets resulting from dividends to shareholders (17,164,755) (39,959,417)
------------ ------------
Capital Net decrease in net assets derived from capital share transactions (332,880,261) (209,712,303)
Share ------------ ------------
Transactions
(Note 4):
Net Assets: Total decrease in net assets (343,572,348) (226,529,452)
Beginning of year 740,991,643 967,521,095
------------ ------------
End of year* $397,419,295 $740,991,643
============ ============
*Undistributed investment income--net $ 362,953 $ --
============ ============
See Notes to Financial Statements.
</TABLE>
53
<PAGE>
<TABLE>
FINANCIAL HIGHLIGHTS
<CAPTION>
The following per share data and Class A Class B
ratios have been derived from For the For the
information provided in the finan- Period Period
cial statements. August 2, August 2,
1991++ to 1991++ to
Increase (Decrease) in For the Year Ended May 31, May 31, For the Year Ended May 31, May 31,
Net Asset Value: 1994 1993 1992 1994 1993 1992
<S> <S> <C> <C> <C> <C> <C> <C>
Per Share Net asset value, beginning of
Operating period $ 9.76 $ 9.92 $ 10.00 $ 9.76 $ 9.92 $ 10.00
Performance: --------- --------- -------- -------- -------- ---------
Investment income--net .37 .45 .56 .32 .40 .52
Realized and unrealized loss on
investments--net (.24) (.16) (.08) (.24) (.16) (.08)
--------- --------- -------- -------- -------- ---------
Total from investment
operations .13 .29 .48 .08 .24 .44
--------- --------- -------- -------- -------- ---------
Less dividends:
Investment income--net (.36) (.45) (.56) (.31) (.40) (.52)
--------- --------- -------- -------- -------- ---------
Net asset value, end of
period $ 9.53 $ 9.76 $ 9.92 $ 9.53 $ 9.76 $ 9.92
========= ========= ======== ======== ======== =========
Total Based on net asset value
Investment per share 1.28% 2.99% 4.75%++++ 0.77% 2.48% 4.33%++++
Return:** ========= ========= ======== ======== ======== =========
Ratios to Expenses, net of reimbursement
Average Net and excluding maintenance and
Assets: distribution fees .71% .66% .62%* .71% .65% .61%*
========= ========= ======== ======== ======== =========
Expenses, net of reimbursement .96% .91% .87%* 1.46% 1.40% 1.36%*
========= ========= ======== ======== ======== =========
Expenses .96% .91% .96%* 1.46% 1.40% 1.47%*
========= ========= ======== ======== ======== =========
Investment income--net 3.69% 4.79% 6.54%* 3.20% 4.15% 6.07%*
========= ========= ======== ======== ======== =========
Supplemental Net assets, end of period
Data: (in thousands) $ 23,043 $ 51,398 $ 80,411 $374,376 $689,593 $ 887,110
========= ========= ======== ======== ======== =========
Portfolio turnover 60.38% 104.71% 94.72% 60.38% 104.71% 94.72%
========= ========= ======== ======== ======== =========
<FN>
*Annualized.
**Total investment returns exclude the effects of sales loads.
++Commencement of Operations.
++++Aggregate total investment return.
See Notes to Financial Statements.
</TABLE>
54
<PAGE>
NOTES TO FINANCIAL STATEMENTS
1. Significant Accounting Policies:
Merrill Lynch Adjustable Rate Securities Fund, Inc. (the "Fund") is
registered under the Investment Company Act of 1940 as a diversi-
fied, open-end management investment company. The Fund offers both
Class A and Class B Shares. Class A Shares are sold with a front-
end sales charge. Class B Shares may be subject to a contingent
deferred sales charge. Both classes of shares have identical voting,
dividend, liquidation and other rights and the same terms and con-
ditions, except that Class A Shares bear the expenses of the on-
going account maintenance fee and have exclusive voting rights with
respect to such maintenance fee expenditures and Class B Shares bear
certain expenses related to the distribution of such shares and have
exclusive voting rights with respect to matters relating to such
distribution expenditures. The following is a summary of significant
accounting policies followed by the Fund.
(a) Valuation of investments--Portfolio securities which are traded
in the market are valued at the last available bid price in the market
or on the basis of yield equivalents as obtained from one or more deal-
ers that make markets in such securities. Options on mortgage-backed
securities and other securities of the Fund which are traded on
exchanges are valued at their last bid price in the case of options
purchased by the Fund and their last asked price in the case of
options written by the Fund. Options traded on the market are valued
at their last bid price or asked price as obtained from at least
two independent entities (one of which is not a party to the option).
Interest rate futures contracts and options thereon, which are traded
on exchanges, are valued at their last sale price as of the close of
such exchanges. Securities for which market quotations are not readily
available are valued at their fair value as determined in good faith
by or under the direction of the Board of Directors of the Fund.
(b) Repurchase agreements--The Fund invests in US Government secur-
ities pursuant to repurchase agreements with a member bank of the Fed-
eral Reserve System or a primary dealer in US Government securities.
Under such agreements, the bank or primary dealer agrees to repurchase
the security at a mutually agreed upon time and price. The Fund takes
possession of the underlying securities, marks to market such secur-
ities and, if necessary, receives additions to such securities daily
to ensure that the contract is fully collateralized.
(c) Options--When the Fund sells an option, an amount equal to the
premium received by the Fund is reflected as an asset and an equiva-
lent liability. The amount of the liability is subsequently marked to
market to reflect the current market value of the option written.
When a security is purchased or sold through an exercise of an option,
the related premium paid (or received) is added to (or deducted
from) the basis of the security acquired or deducted from (or added
to) the proceeds of the security sold. When an option expires (or the
Fund enters into a closing transaction), the Fund realizes a gain or
loss on the option to the extent of the premiums received or paid
(or gain or loss to the extent that the cost of the closing trans-
action is less than or greater than the premiums paid or received).
Written and purchased options are non-income producing
investments.
(d) Futures contracts--The Fund may purchase or sell interest rate
futures contracts and related options on such futures contracts. Upon
entering into a contract, the Fund deposits and maintains as col-
lateral such initial margin as required by the exchange on which the
transaction is effected. Pursuant to the contract, the Fund agrees to
receive from or pay to the broker an amount of cash equal to the daily
fluctuation in value of the contract. Such receipts or payments are
known as variation margins and are recorded by the Fund as unrealized
gains or losses. When the contract is closed, the Fund records a real-
ized gain or loss equal to the difference between the value of the
contract at the time it was opened and the value at the time it was
closed.
(e) Income taxes--It is the Fund's policy to comply with the require-
ments of the Internal Revenue Code applicable to regulated invest-
ment companies and to distribute substantially all of its taxable
income to its shareholders. Therefore, no Federal income tax pro-
vision is required.
(f) Security transactions and investment income--Security trans-
actions are recorded on the dates the transactions are entered into
(the trade dates). Interest income (including amortization of dis-
count and premiums) is recognized on the accrual basis. Realized
gains and losses on security transactions are determined on the
identified cost basis.
(g) Deferred organization expenses and prepaid registration fees--
Deferred organization expenses are charged to expense on a straight-
line basis over a five-year period. Prepaid registration fees are
charged to expense as the related shares are issued.
(h) Dividends and distributions--All or a portion of the Fund's net
investment income is declared daily and paid monthly. Distributions
paid by the Fund are recorded on the ex-dividend dates.
(i) Dollar rolls--The Fund sells mortgage-backed securities for
delivery in the current month and simultaneously contracts to
repurchase substantially similar (same type, coupon and maturity)
securities on a specific future date.
55
<PAGE>
NOTES TO FINANCIAL STATEMENTS (concluded)
2. Investment Advisory Agreement and Transactions
with Affiliates:
The Fund has entered into an Investment Advisory Agreement with
Merrill Lynch Asset Management, L.P. ("MLAM"). Effective January 1,
1994, the investment advisory business of MLAM was reorganized
from a corporation to a limited partnership. Both prior to and after
the reorganization, ultimate control of MLAM was vested with
Merrill Lynch & Co., Inc. ("ML & Co."). The general partner of
MLAM is Princeton Services, Inc., an indirect wholly-owned
subsidiary of ML & Co. The limited partners are ML & Co. and
Merrill Lynch Investment Management, Inc. ("MLIM"), which is also
an indirect wholly-owned subsidiary of ML & Co. The Fund has
entered into a Distribution Agreement and a Distribution Plan with
Merrill Lynch Funds Distributor, Inc. ("MLFD" or "Distributor"),
a wholly-owned subsidiary of MLIM.
MLAM is responsible for the management of the Fund's portfolio
and provides the necessary personnel, facilities, equipment and
certain other services necessary to the operations of the Fund. For
such services, the Fund pays a monthly fee of 0.50%, on an annual
basis, of the average daily value of the Fund's net assets. For the
year ended May 31, 1994, MLAM earned fees of $2,710,336. The Invest-
ment Advisory Agreement obligates MLAM to reimburse the Fund to the
extent the Fund's expenses (excluding interest, taxes, distribution
fees, brokerage fees and commissions, and extraordinary items)
exceed 2.5% of the Fund's first $30 million of average daily net
assets, 2.0% of the Fund's next $70 million of average daily net
assets, and 1.5% of the average daily net assets in excess thereof.
No fee payment will be made to MLAM during any fiscal year which
will cause such expenses to exceed the most restrictive expense
limitation at the time of such payment.
The Fund has adopted separate Plans of Distribution (the "Distri-
bution Plans") for Class A and Class B Shares in accordance with
Rule 12b-1 under the Investment Company Act of 1940, pursuant to
which MLFD receives from the Fund at the end of each month (a)
an account maintenance fee, at an annual rate of 0.25% of the
average daily net assets of the Fund's Class A Shares, in order to
compensate the Distributor in connection with account mainte-
nance activities, and (b) an account maintenance fee and a distribu-
tion fee relating to Class B Shares, accrued daily and paid monthly,
at the annual rate of 0.25% and 0.50%, respectively, of the average
daily net assets of the Fund attributable to Class B Shares. In order
to compensate the Distributor for the services it provides and the
expenses borne by the Distributor under the Distribution Agree-
ment. As authorized by the Distribution Plans, the Distributor has
3. Investments:
Purchases and sales of investments, excluding short-term securities,
for the year ended May 31, 1994 were $328,517,202 and $715,564,238,
respectively.
Net realized and unrealized losses as of May 31, 1994 were as follows:
Realized Unrealized
Losses Losses
Long-term investments $(19,663,837) $(10,996,559)
Short-term investments (37) --
------------ ------------
Total $(19,663,874) $(10,996,559)
============ ============
As of May 31, 1994, net unrealized depreciation for Federal income
tax purposes aggregated $12,835,753, of which $1,456,009 related
to appreciated securities and $14,291,762 related to depreciated
securities. The aggregate cost of investments at May 31, 1994 for
Federal income tax purposes was $413,525,301.
4. Capital Share Transactions:
Net decrease in net assets derived from capital share transactions
was $332,880,261 and $209,712,303 for the years ended May 31, 1994
and May 31, 1993, respectively.
Transactions in capital shares for Class A and Class B Shares were
as follows:
Class A Shares for the Year Dollar
Ended May 31, 1994 Shares Amount
Shares sold 1,365,792 $ 13,269,165
Shares issued to shareholders
in reinvestment of dividends
to shareholders 75,693 735,836
------------ -------------
Total issued 1,441,485 14,005,001
Shares redeemed (4,289,994) (41,714,877)
------------ -------------
Net decrease (2,848,509) $ (27,709,876)
============ =============
Class A Shares for the Year Dollar
Ended May 31, 1993 Shares Amount
Shares sold 5,909,926 $ 58,465,229
Shares issued to shareholders
in reinvestment of dividends
to shareholders 210,719 2,068,479
------------ -------------
Total issued 6,120,645 60,533,708
Shares redeemed (8,960,468) (87,979,025)
------------ -------------
Net decrease (2,839,823) $ (27,445,317)
============ =============
Class B Shares for the Year Dollar
Ended May 31, 1994 Shares Amount
Shares sold 4,768,628 $ 46,269,096
56
<PAGE>
entered into an agreement with Merrill Lynch, Pierce, Fenner &
Smith Inc. ("MLPF&S"), which provides for the compensation of
MLPF&S in connection with account maintenance activities for
Class A Shares and for providing distribution-related services to the
Fund for Class B Shares. For the year ended May 31, 1994, MLFD
earned $85,730 and $3,808,315 for Class A and Class B Shares,
respectively, under the Distribution Plans, all of which was paid to
MLPF&S pursuant to the agreement. For the year ended May 31,
1994, MLFD earned underwriting discounts of $11,772, and MLPF&S
earned dealer concessions of $49,708 on the sale of the Fund's
Class A Shares. MLPF&S also received contingent deferred sales
charges of $2,010,325 relating to Class B Share transactions during
the year.
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of
ML & Co., is the Fund's transfer agent.
Accounting services are provided to the Fund by MLAM at cost.
Certain officers and/or directors of the Fund are officers and/or
directors of MLIM, MLPF&S, FDS, MLFD, and/or ML & Co.
Shares issued to shareholders
in reinvestment of dividends
to shareholders 966,330 9,395,018
------------ -------------
Total issued 5,734,958 55,664,114
Shares redeemed (37,100,715) (360,834,499)
------------ -------------
Net decrease (31,365,757) $(305,170,385)
============ =============
Class B Shares for the Year Dollar
Ended May 31, 1993 Shares Amount
Shares sold 28,963,546 $ 285,135,805
Shares issued to shareholders
in reinvestment of dividends
to shareholders 2,110,164 20,705,785
------------ -------------
Total issued 31,073,710 305,841,590
Shares redeemed (49,873,230) (488,108,576)
------------ -------------
Net decrease (18,799,520) $(182,266,986)
============ =============
5. Capital Loss Carryforward:
At May 31, 1994, the Fund had a net capital loss carryforward of
approximately $21,580,000, all of which expires in 2002. This amount
will be available to offset like amounts of any future taxable gains.
57
<PAGE>
[THIS PAGE INTENTIONALLY LEFT BLANK]
58
<PAGE>
[THIS PAGE INTENTIONALLY LEFT BLANK]
59
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objective and Policies........................................... 2
Management of the Fund...................................................... 13
Purchase of Shares.......................................................... 16
Redemption of Shares........................................................ 21
Portfolio Transactions...................................................... 22
Determination of Net Asset Value............................................ 23
Shareholder Services........................................................ 24
Dividends, Distributions and Taxes.......................................... 38
Performance Data............................................................ 41
General Information......................................................... 42
Description of Shares...................................................... 42
Independent Auditors....................................................... 43
Custodian.................................................................. 43
Transfer Agent............................................................. 43
Legal Counsel.............................................................. 44
Reports to Shareholders.................................................... 44
Additional Information..................................................... 44
Appendix: Description of Commercial Paper and Corporate Bond Ratings........ 45
Independent Auditors' Report................................................ 46
Financial Statements........................................................ 48
</TABLE>
Code #13938-0994
Statement of
Additional Information
[ART TO COME]
- - - ----------------------------------
MERRILL LYNCH
ADJUSTABLE RATE
SECURITIES FUND, INC.
September 28, 1994
Distributor:
Merrill Lynch Funds
Distributor, Inc.
<PAGE>
PART C. OTHER INFORMATION
ITEM 24. FINANCIAL STATEMENTS AND EXHIBITS.
(A) FINANCIAL STATEMENTS
Contained in Part A:
Financial Highlights for the years ended May 31, 1993 and 1994 and for
the period August 2, 1991 (commencement of operations) through May 31, 1992
Contained in Part B:
Schedule of Investments as of May 31, 1994
Statement of Assets and Liabilities as of May 31, 1994
Statement of Operations for the year ended May 31, 1994
Statement of Changes in Net Assets for the years ended May 31, 1994
and 1993.
Financial Highlights for the years ended May 31, 1993 and 1994 and for
the period August 2, 1991 (commencement of operations) to May 31,
1992
(C) EXHIBITS:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
-------
<C> <S>
1(a) --Articles of Incorporation of Registrant.(a)
(b) --Articles of Amendment of Registrant.(b)
(c) --Articles Supplementary of Registrant.(c)
2 --By-Laws of Registrant.(d)
3 --None.
4(a) --Specimen certificate for Class A shares of common stock of
Registrant.(b)
(b) --Specimen certificate for Class B shares of common stock of
Registrant.(b)
(c) --Portions of the Articles of Incorporation and the By-Laws of the
Registrant defining the rights of holders of shares of the
Registrant.(f)
5 --Form of proposed Management Agreement between Registrant and Merrill
Lynch Asset Management, Inc.(b)
6(a) --Class A Distribution Agreement between Registrant and Merrill Lynch
Funds Distributor, Inc.(b)
(b) --Class B Distribution Agreement between Registrant and Merrill Lynch
Funds Distributor, Inc.(b)
7 --None.
8 --Custody Agreement between Registrant and The Bank of New York.(b)
9 --Transfer Agency, Dividend Disbursing Agency and Shareholder
Servicing Agency Agreement between Registrant and Financial Data
Services, Inc.(b)
10 --Opinion of Brown & Wood, counsel to Registrant.
11 --Consent of Deloitte & Touche LLP, independent auditors for
Registrant.
12 --None.
13 --Form of certificate of Merrill Lynch Asset Management, Inc.(d)
14 --None.
15(a) --Class A Shares Distribution Plan of Registrant.(b)
(b) --Amended and Restated Class B Shares Distribution Plan of Registrant.
16(a) --Schedule for computation of each performance quotation provided in
the Registration Statement in response to item 22 relating to Class A
shares.(e)
(b) --Schedule for computation of each performance quotation provided in
the Registration Statement in response to item 22 relating to Class B
shares.(e)
17(a) --Financial Data Schedule for Class A Shares.
(b) --Financial Data Schedule for Class B Shares.
</TABLE>
- - - --------
(a) Filed on May 2, 1991 in connection with the Registrant's Registration
Statement on Form N-1A under the Securities Act of 1933.
(b) Filed on June 7, 1991 in connection with Pre-Effective Amendment No. 1 to
the Registrant's Registration Statement on Form N-1A under the Securities Act
of 1933.
(c) Filed on September 28, 1992 in connection with Post-Effective Amendment No.
2 to the Registrant's Registration Statement on Form N-1A under the
Securities Act of 1933.
C-1
<PAGE>
(d) Filed on June 14, 1991 in connection with Pre-Effective Amendment No. 2 to
the Registrant's Registration Statement on Form N-1A under the Securities Act
of 1933.
(e) Filed on March 5, 1992 in connection with Post-Effective Amendment No. 1 to
the Registrant's Registration Statement on Form N-1A under the Securities Act
of 1933.
(f) Reference is made to Article V, Article VI (Section 3), Article VII,
Article VIII and Article X of the Registrant's Articles of Incorporation,
previously filed as Exhibit (1), to the Registration Statement; and to
Article II, Article III (sections 1, 3, 5, 6, and 17), Article VI, Article
VII, Article XIII and Article XIV of the Registrant's By-Laws previously
filed as Exhibit (2) to the Registration Statement.
ITEM 25. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH REGISTRANT.
Registrant is not controlled by or under common control with any person.
ITEM 26. NUMBER OF HOLDERS OF SECURITIES.
<TABLE>
<CAPTION>
NUMBER OF RECORD
HOLDERS AT
TITLE OF CLASS JULY 30, 1994
-------------- ----------------
<S> <C>
Class A shares of Common
Stock, par value $0.10
per share.............. 26
Class B shares of Common
Stock, par value $0.10
per share.............. 663
</TABLE>
ITEM 27. INDEMNIFICATION.
Reference is made to Article VI of Registrant's Articles of Incorporation,
Article VI of Registrant's By-Laws, Section 2-418 of the Maryland General
Corporation Law and Section 9 of the Class A and Class B Distribution
Agreements.
Insofar as the conditional advancing of indemnification moneys for actions
based on the Investment Company Act of 1940 may be concerned, such payments
will be made only on the following conditions: (i) the advances must be limited
to amounts used, or to be used, for the preparation or presentation of a
defense to the action, including costs connected with the preparation of a
settlement; (ii) advances may be made only on receipt of a written promise by,
or on behalf of, the recipient to repay that amount of the advance which
exceeds the amount to which it is ultimately determined that he is entitled to
receive from the Registrant by reason of indemnification; and (iii)(a) such
promise must be secured by a surety bond, other suitable insurance or an
equivalent form of security which assures that any repayments may be obtained
by the Registrant without delay or litigation, which bond, insurance or other
form of security must be provided by the recipient or the advance ultimately
will be found entitled to indemnification.
In Section 9 of the Class A and Class B Distribution Agreements relating to
the securities being offered hereby, the Registrant agrees to indemnify the
Distributor and each person, if any, who controls the Distributor within the
meaning of the Securities Act of 1933, as amended (the "Act"), against certain
types of civil liabilities arising in connection with the Registration
Statement or Prospectus and Statement of Additional Information.
Insofar as indemnification for liabilities arising under the Act may be
permitted to Directors, officers and controlling persons of the Registrant and
the principal underwriter pursuant to the foregoing provisions or otherwise,
the Registrant has been advised that in the opinion of the Securities and
Exchange Commission such indemnification is against public policy as expressed
in the Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
Registrant of expenses incurred or paid by a Director, officer or controlling
person of the Registrant and the principal underwriter in connection with the
successful defense of any action, suit or proceeding) is asserted by such
Director, officer or controlling person or the principal underwriter in
connection with the shares being registered, the 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 Act and will
be governed by the final adjudication of such issue.
C-2
<PAGE>
ITEM 28. BUSINESS AND OTHER CONNECTIONS OF MANAGER.
Merrill Lynch Asset Management, L.P. ("MLAM" or the "Manager") acts as
investment adviser for the following investment companies: Convertible
Holdings, Inc., Merrill Lynch Adjustable Rate Securities Fund, Inc., Merrill
Lynch Americas Income Fund, Inc., Merrill Lynch Asset Growth Fund, Inc.,
Merrill Lynch Asset Income Fund, Inc., Merrill Lynch Balanced Fund for
Investment and Retirement, Merrill Lynch Capital Fund, Inc., Merrill Lynch
Developing Capital Markets Fund, Inc., Merrill Lynch Dragon Fund, Inc., Merrill
Lynch EuroFund, Merrill Lynch Fundamental Growth Fund, Inc., Merrill Lynch Fund
for Tomorrow, Inc., Merrill Lynch Global Bond Fund for Investment and
Retirement, Merrill Lynch Global Allocation Fund, Inc., Merrill Lynch Global
Convertible Fund, Inc., Merrill Lynch Global Holdings, Inc., Merrill Lynch
Global Resources Trust, Merrill Lynch Global Utility Fund, Inc., Merrill Lynch
Global SmallCap Fund, Inc., Merrill Lynch Growth Fund for Investment and
Retirement, Merrill Lynch Healthcare Fund, Inc., Merrill Lynch High Income
Municipal Bond Fund, Inc., Merrill Lynch Institutional Intermediate Fund,
Merrill Lynch International Equity Fund, Merrill Lynch Latin America Fund,
Inc., Merrill Lynch Municipal Series Trust, Merrill Lynch Pacific Fund, Inc.,
Merrill Lynch Ready Assets Trust, Merrill Lynch Retirement Series Trust,
Merrill Lynch Senior Floating Rate Fund, Inc., Merrill Lynch Series Fund, Inc.,
Merrill Lynch Short-Term Global Income Fund, Inc., Merrill Lynch Strategic
Dividend Fund, Merrill Lynch Technology Fund, Inc., Merrill Lynch U.S. Treasury
Money Fund, Merrill Lynch U.S.A. Government Reserves, Merrill Lynch Utility
Income Fund, Inc. and Merrill Lynch Variable Series Funds, Inc. Fund Asset
Management, L.P. ("FAM"), an affiliate of the Manager, acts as the investment
adviser for the following registered investment companies: Apex Municipal Fund,
Inc., CBA Money Fund, CMA Government Securities Fund, CMA Money Fund, CMA
Multi-State Municipal Series Trust, CMA Tax-Exempt Fund, CMA Treasury Fund, The
Corporate Fund Accumulation Program, Inc., Corporate High Yield Fund, Inc.,
Corporate High Yield Fund II, Inc., Emerging Tigers Fund, Inc., Financial
Institutions Series Trust, Income Opportunities Fund 1999, Inc., Income
Opportunities Fund 2000, Inc., Merrill Lynch Basic Value Fund, Inc., Merrill
Lynch California Municipal Series Trust, Merrill Lynch Corporate Bond Fund,
Inc., Merrill Lynch Federal Securities Trust, Merrill Lynch Funds for
Institutions Series, Merrill Lynch Multi-State Municipal Series Trust, Merrill
Lynch Multi-State Limited Maturity Municipal Series Trust, Merrill Lynch
Municipal Bond Fund, Inc., Merrill Lynch Phoenix Fund, Inc., Merrill Lynch
Special Value Fund, Inc., Merrill Lynch World Income Fund, Inc., MuniAssets
Fund, Inc., MuniBond Income Fund, Inc., The Municipal Fund Accumulation
Program, Inc., MuniEnhanced Fund, Inc., MuniInsured Fund, Inc., MuniVest Fund,
Inc., MuniVest Fund II, Inc., MuniVest California Insured Fund, Inc., MuniVest
Florida Fund, MuniVest Michigan Insured Fund, Inc., MuniVest New Jersey Fund,
Inc., MuniVest New York Insured Fund, Inc., MuniVest Pennsylvania Insured Fund,
MuniYield Arizona Fund, Inc., MuniYield Arizona Fund II, Inc., MuniYield
California Fund, Inc., MuniYield California Insured Fund, Inc., MuniYield
California Insured Fund II, Inc., MuniYield Florida Fund, MuniYield Florida
Insured Fund, Inc., MuniYield Fund, Inc., MuniYield Insured Fund, Inc.,
MuniYield Insured Fund II, Inc., MuniYield Michigan Fund, Inc., MuniYield
Michigan Insured Fund, Inc., MuniYield New Jersey Fund, Inc., MuniYield New
Jersey Insured Fund, Inc., MuniYield New York Insured Fund, Inc., MuniYield New
York Insured Fund II, Inc., MuniYield New York Insured Fund III, Inc.,
MuniYield Pennsylvania Fund, MuniYield Quality Fund, Inc., MuniYield Quality
Fund II, Inc., Senior High Income Portfolio, Inc., Senior High Income Portfolio
II, Inc., Senior Strategic Income Fund, Inc., Taurus MuniCalifornia Holdings,
Inc., Taurus MuniNew York Holdings, Inc., and Worldwide DollarVest Fund, Inc.
The address of each of these investment companies is P.O. Box 9011, Princeton,
New Jersey 08543-9011, except that the address of Merrill Lynch Funds for
Institutions Series and Merrill Lynch Institutional Intermediate Fund is One
Financial Center, 15th Floor, Boston, Massachusetts 02111-2646. The address of
the Manager and FAM is also P.O. Box 9011, Princeton, New Jersey 08543-9011.
The address of Merrill Lynch, Pierce, Fenner & Smith Incorporated ("Merrill
Lynch") and Merrill Lynch & Co., Inc. ("ML & Co.") is World Financial Center,
North Tower, 250 Vesey Street, New York, New York 10281. The address of
Financial Data Services is 4800 Deer Lake Drive East, Jacksonville, Florida
32246-6484.
C-3
<PAGE>
Set forth below is a list of each executive officer and partner of the
Manager indicating each business, profession, vocation or employment of a
substantial nature in which each such person or entity has been engaged since
November 1, 1992 for his or its own account or in the capacity of director,
officer, partner or trustee. In addition, Mr. Zeikel is President and Mr.
Richard is Treasurer of all or substantially all of the investment companies
described in the preceding paragraph and Messrs. Durnin, Glenn, Giordano,
Harvey, Kirstein and Monagle and Ms. Griffin are directors or officers of one
or more of such companies.
<TABLE>
<CAPTION>
OTHER SUBSTANTIAL BUSINESS,
NAME POSITION WITH MANAGER PROFESSION, VOCATION OR EMPLOYMENT
---- --------------------- ----------------------------------
<S> <C> <C>
ML&Co. ................. Limited Partner Financial Services Holding Company
Merrill Lynch
Investment
Management Inc. ....... Limited Partner Investment Advisory Services; Limited Partner
of FAM
Princeton Services, Inc.
("Princeton Services"). General Partner General Partner of FAM
Arthur Zeikel........... President and Chief President and Chief Investment Officer of
Investment Officer FAM; President and Director of Princeton
Services; Director of Merrill Lynch Funds
Distributor, Inc. ("MLFD"), Executive Vice
President of ML & Co., Inc. and Executive
Vice President of Merrill Lynch
Terry K. Glenn.......... Executive Vice Executive Vice President of FAM; Executive
President Vice President and Director of Princeton
Services; President and Director of MLFD;
Director of Financial Data Services, Inc.
("FDS"); President of Princeton
Administrators
Bernard J. Durnin....... Senior Vice Senior Vice President of FAM; Senior Vice
President President of Princeton Services
Vincent R. Giordano..... Senior Vice Senior Vice President of FAM; Senior Vice
President President of Princeton Services
Elizabeth Griffin....... Senior Vice Senior Vice President of FAM; Senior Vice
President President of Princeton Services
Norman R. Harvey........ Senior Vice Senior Vice President of FAM; Senior Vice
President President of Princeton Services
N. John Hewitt.......... Senior Vice Senior Vice President of FAM; Senior Vice
President President of Princeton Services
Philip L. Kirstein...... Senior Vice Senior Vice President, General Counsel and
President, General Secretary of FAM; Senior Vice President,
Counsel and Director and Secretary of Princeton
Secretary Services; Director of MLFD
Ronald M. Kloss......... Senior Vice Senior Vice President and Controller of FAM;
President and Senior Vice President and Controller of
Controller Princeton Services
Stephen M.M. Miller..... Senior Vice Executive Vice President of Princeton
President Administrators; Senior Vice President of
Princeton Services
Joseph T. Monagle, Jr. . Senior Vice Senior Vice President of FAM; Senior Vice
President President of Princeton Services
Gerald M. Richard....... Senior Vice Senior Vice President and Treasurer of FAM;
President and Senior Vice President and Treasurer of
Treasurer Princeton Services; Vice President and
Treasurer of MLFD
Richard L. Rufener...... Senior Vice Senior Vice President of FAM; Vice President
President of MLFD; Senior Vice President of Princeton
Services
Ronald L. Welburn....... Senior Vice Senior Vice President of FAM; Senior Vice
President President of Princeton Services
Anthony Wiseman......... Senior Vice Senior Vice President of FAM; Senior Vice
President President of Princeton Services
</TABLE>
C-4
<PAGE>
ITEM 29. PRINCIPAL UNDERWRITERS.
(a) MLFD acts as the principal underwriter for the Registrant and for each of
the open-end investment companies referred to in the first paragraph of Item 28
except Apex Municipal Fund, Inc., CBA Money Fund, CMA Government Securities
Fund, CMA Money Fund, CMA Multi-State Municipal Series Trust, CMA Tax-Exempt
Fund, CMA Treasury Fund, Convertible Holdings, Inc., The Corporate Fund
Accumulation Program, Inc., Corporate High Yield Fund, Inc., Corporate High
Yield Fund II, Inc., Income Opportunities Fund 1999, Inc., Income Opportunities
Fund 2000, Inc., MuniAssets Fund, Inc., MuniBond Income Fund, Inc., The
Municipal Fund Accumulation Program, Inc., MuniEnhanced Fund, Inc., MuniInsured
Fund, Inc., MuniVest Fund, Inc., MuniVest Fund II, Inc., MuniVest California
Insured Fund, Inc., MuniVest Florida Fund, MuniVest Michigan Insured Fund,
Inc., MuniVest New Jersey Fund, Inc., MuniVest New York Insured Fund, Inc.,
MuniVest Pennsylvania Fund, MuniYield Arizona Fund, MuniYield Arizona Fund II,
Inc., MuniYield California Fund, Inc., MuniYield California Insured Fund, Inc.,
MuniYield Florida Fund, MuniYield Florida Insured Fund, MuniYield Fund, Inc.,
MuniYield Insured Fund, Inc., MuniYield Insured Fund II, Inc., MuniYield
Michigan Fund, Inc., MuniYield Michigan Insured Fund, Inc., MuniYield New
Jersey Fund, Inc., MuniYield New Jersey Insured Fund, Inc., MuniYield New York
Insured Fund, Inc., MuniYield New York Insured Fund II, Inc., MuniYield New
York Insured Fund III, Inc., MuniYield Pennsylvania Fund, MuniYield Quality
Fund, Inc., MuniYield Quality Fund II, Inc., Senior High Income Portfolio,
Inc., Senior High Income Portfolio II, Inc., Taurus MuniCalifornia Holdings,
Inc., Taurus MuniNewYork Holdings, Inc. and Worldwide DollarVest Fund, Inc.
(b) Set forth below is information concerning each director and officer of
MLFD. The principal business address of each such person is P.O. Box 9011,
Princeton, New Jersey 08543-9011, except that the address of Messrs. Crook,
Aldrich, Breen, Graczyk, Fatseas, and Wasel is One Financial Center, Boston,
Massachusetts 02111-2665.
<TABLE>
<CAPTION>
(2) (3)
(1) POSITIONS AND OFFICES POSITIONS AND OFFICES
NAME WITH MLFD WITH REGISTRANT
---- --------------------- ---------------------
<S> <C> <C>
Terry K. Glenn.......... President and Director Executive Vice President
Arthur Zeikel........... Director President and Director
Philip L. Kirstein...... Director None
William E. Aldrich...... Senior Vice President None
Robert W. Crook......... Senior Vice President None
Kevin P. Boman.......... Vice President None
Michael J. Brady........ Vice President None
William M. Breen........ Vice President None
Sharon Creveling........ Vice President and Assistant Treasurer None
Mark A. DeSario......... Vice President None
James T. Fatseas........ Vice President None
Stanley Graczyk......... Vice President None
Michelle T. Lau......... Vice President None
Gerald M. Richard....... Vice President and Treasurer Treasurer
Richard L. Rufener...... Vice President None
Salvatore Venezia....... Vice President None
William Wasel........... Vice President None
Lisa Gobora............. Assistant Vice President None
Susan Kibler............ Assistant Vice President None
Richard Romm............ Assistant Vice President None
Robert Harris........... Secretary None
</TABLE>
(c) Not applicable.
C-5
<PAGE>
ITEM 30. LOCATION OF ACCOUNTS AND RECORDS.
All accounts, books and other documents required to be maintained by Section
31(a) of the Investment Company Act of 1940 and the rules thereunder will be
maintained at the offices of the Registrant and Financial Data Services, Inc.
ITEM 31. MANAGEMENT SERVICES.
Other than as set forth under the caption "Management of the Trust--
Management and Advisory Arrangements" in the Prospectus constituting Part A of
the Registration Statement and under "Management of the Fund--Management and
Advisory Arrangements" in the Statement of Additional Information constituting
Part B of the Registration Statement, Registrant is not a party to any
management-related service contract.
ITEM 32. UNDERTAKINGS.
(a) Not applicable.
(b) Not applicable.
(c) Registrant undertakes to furnish each person to whom a prospectus is
delivered with a copy of the Registrant's latest annual report to shareholders,
upon request and without charge.
C-6
<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933 AND THE INVESTMENT
COMPANY ACT OF 1940, THE REGISTRANT CERTIFIES THAT IT MEETS ALL OF THE
REQUIREMENTS FOR EFFECTIVENESS OF THIS REGISTRATION STATEMENT PURSUANT TO RULE
485(B) UNDER THE SECURITIES ACT OF 1933 AND HAS DULY CAUSED THIS REGISTRATION
STATEMENT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY
AUTHORIZED, IN THE TOWNSHIP OF PLAINSBORO, AND STATE OF NEW JERSEY, ON THE 27TH
DAY OF SEPTEMBER, 1994.
Merrill Lynch Adjustable Rate Securities
Fund, Inc.
(Registrant)
/s/ Arthur Zeikel
By__________________________________
(ARTHUR ZEIKEL, PRESIDENT)
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS REGISTRATION
STATEMENT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS IN THE CAPACITIES AND
ON THE DATES INDICATED.
SIGNATURE TITLE DATE
President and
/s/ Arthur Zeikel Director (Principal September 27,
- - - ------------------------------------- Executive Officer) 1994
(ARTHUR ZEIKEL)
Treasurer (Principal
/s/ Gerald M. Richard Financial and September 27,
- - - ------------------------------------- Accounting Officer) 1994
(GERALD M. RICHARD)
Director
- - - -------------------------------------
(JOE GRILLS)
Walter Mintz* Director
- - - -------------------------------------
(WALTER MINTZ)
Melvin R. Seiden* Director
- - - -------------------------------------
(MELVIN R. SEIDEN)
Stephen B. Swensrud* Director
- - - -------------------------------------
(STEPHEN B. SWENSRUD)
Harry Woolf* Director
- - - -------------------------------------
(HARRY WOOLF)
/s/ Arthur Zeikel September 27,
*By _________________________________ 1994
(ARTHUR ZEIKEL, ATTORNEY-IN-FACT)
C-7
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
PAGE
EXHIBIT NUMBER DESCRIPTION NUMBER
-------------- ----------- ------
<C> <S> <C>
10 --Opinion of Brown & Wood, counsel to Registrant.
11 --Consent of independent auditors for Registrant.
27(a) --Financial Data Schedule for Class A Shares.
27(b) --Financial Data Schedule for Class B Shares.
</TABLE>
<PAGE>
APPENDIX FOR GRAPHIC AND IMAGE MATERIAL
Pursuant to Rule 304 of Regulation S-T, the following table presents fair
and accurate narrative descriptions of graphic and image material omitted from
this EDGAR Submission file due to ASCII-incompatibility and cross-references
this material to the location of each occurrence in the text.
DESCRIPTION OF OMITTED LOCATION OF GRAPHIC
GRAPHIC OR IMAGE OR IMAGE IN TEXT
- - - ---------------------- -------------------
Compass plate, circular Back cover of Prospectus and
graph paper and Merrill Lynch back cover of Statement of
logo including stylized market Additional Information
bull
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 6
<SERIES>
<NUMBER> 1
<NAME> CLASS A
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> MAY-31-1994
<PERIOD-START> JUN-01-1993
<PERIOD-END> MAY-31-1994
<INVESTMENTS-AT-COST> 411686107
<INVESTMENTS-AT-VALUE> 400689548
<RECEIVABLES> 3144179
<ASSETS-OTHER> 271280
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 404105007
<PAYABLE-FOR-SECURITIES> 0
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 6685712
<TOTAL-LIABILITIES> 6685712
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 431915917
<SHARES-COMMON-STOCK> 2418159
<SHARES-COMMON-PRIOR> 5266667
<ACCUMULATED-NII-CURRENT> 362953
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> (23863016)
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> (10996559)
<NET-ASSETS> 23043432
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 25076112
<OTHER-INCOME> 217119
<EXPENSES-NET> 7765523
<NET-INVESTMENT-INCOME> 17527708
<REALIZED-GAINS-CURRENT> (19663874)
<APPREC-INCREASE-CURRENT> 8608834
<NET-CHANGE-FROM-OPS> 6472668
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> 1245307
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 1365792
<NUMBER-OF-SHARES-REDEEMED> 4289994
<SHARES-REINVESTED> 75693
<NET-CHANGE-IN-ASSETS> (343572348)
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> (4192679)
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 2710336
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 7765523
<AVERAGE-NET-ASSETS> 34291858
<PER-SHARE-NAV-BEGIN> 9.76
<PER-SHARE-NII> .37
<PER-SHARE-GAIN-APPREC> (.24)
<PER-SHARE-DIVIDEND> .36
<PER-SHARE-DISTRIBUTIONS> .0
<RETURNS-OF-CAPITAL> .0
<PER-SHARE-NAV-END> 9.53
<EXPENSE-RATIO> .96
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 6
<SERIES>
<NUMBER> 2
<NAME> CLASS B
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> MAY-31-1994
<PERIOD-START> JUN-01-1993
<PERIOD-END> MAY-31-1994
<INVESTMENTS-AT-COST> 411686107
<INVESTMENTS-AT-VALUE> 400689548
<RECEIVABLES> 3144179
<ASSETS-OTHER> 271280
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 404105007
<PAYABLE-FOR-SECURITIES> 0
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 6685712
<TOTAL-LIABILITIES> 6685712
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 431915917
<SHARES-COMMON-STOCK> 39268886
<SHARES-COMMON-PRIOR> 70634642
<ACCUMULATED-NII-CURRENT> 362953
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> (23863016)
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> (10996559)
<NET-ASSETS> 374375863
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 25076112
<OTHER-INCOME> 217119
<EXPENSES-NET> 7765523
<NET-INVESTMENT-INCOME> 17527708
<REALIZED-GAINS-CURRENT> (19663874)
<APPREC-INCREASE-CURRENT> 8608834
<NET-CHANGE-FROM-OPS> 6472668
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> 15919448
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 4768628
<NUMBER-OF-SHARES-REDEEMED> 37100715
<SHARES-REINVESTED> 966330
<NET-CHANGE-IN-ASSETS> (343572348)
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> (4192679)
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 2710336
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 7765523
<AVERAGE-NET-ASSETS> 507775371
<PER-SHARE-NAV-BEGIN> 9.76
<PER-SHARE-NII> .32
<PER-SHARE-GAIN-APPREC> (.24)
<PER-SHARE-DIVIDEND> .31
<PER-SHARE-DISTRIBUTIONS> 0
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 9.53
<EXPENSE-RATIO> 1.46
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
<PAGE>
EXHIBIT 99.10
BROWN & WOOD
ONE WORLD TRADE CENTER
NEW YORK, NEW YORK 10048-0557
September 27, 1994
Merrill Lynch Adjustable Rate Securities Fund, Inc.
P.O. Box 9011
Princeton, New Jersey 08543-9011
Dear Sirs:
This opinion is furnished in connection with the registration by Merrill
Lynch Adjustable Rate Securities Fund, Inc. (the "Fund"), a Maryland
corporation, of 41,420,452 shares of common stock of the Fund, par value $.10
per share (the "Shares"), under the Securities Act of 1933 pursuant to a
registration statement on Form N-1A (File No. 33-40332), as amended (the
"Registration Statement").
As counsel for the Fund, we are familiar with the proceedings taken by it
in connection with the authorization, issuance and sale of the Shares. In
addition, we have examined and are familiar with the Articles of Incorporation,
as amended, of the Fund, the By-laws of the Fund and such other documents as we
have deemed relevant to the matters referred to in this opinion.
Based on the foregoing, we are of the opinion that the Shares, upon
issuance and sale in the manner referred to in the Registration Statement for
consideration not less than the par value thereof, will be legally issued, fully
paid and non-assessable shares of common stock of the Fund.
<PAGE>
We hereby consent to the filing of this opinion as an exhibit to the
Registration Statement and to the use of our name in the prospectus and
statement of additional information constituting parts thereof.
Very truly yours,
/s/ BROWN & WOOD
<PAGE>
EXHIBIT 99.11
INDEPENDENT AUDITORS' CONSENT
Merrill Lynch Adjustable Rate Securities Fund, Inc.
We consent to the use in Post-Effective Amendment No. 4 to Registration
Statement No. 33-40332 of our report dated June 30, 1994 appearing in the
Statement of Additional Information, which is a part of such Registration
Statement, and to the reference to us under the caption "Financial Highlights"
appearing in the Prospectus, which also is a part of such Registration
Statement.
/s/ Deloitte & Touche LLP
DELOITTE & TOUCHE LLP
Princeton, New Jersey
September 26, 1994
