MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND INC, 485B24E, 1996-09-27

MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND INC
485B24E, 1996-09-27

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<PAGE> 1

AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON SEPTEMBER 27, 1996

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. / /

POST-EFFECTIVE AMENDMENT NO. 7 /X/

AND/OR
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 /X/

AMENDMENT NO. 8 /X/

(CHECK APPROPRIATE BOX OR BOXES)
------------------------
MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)

800 SCUDDERS MILL ROAD 08536
PLAINSBORO, 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 LLP MERRILL LYNCH ASSET
ONE WORLD TRADE CENTER MANAGEMENT
NEW YORK, NEW YORK 10048-0557 P.O. BOX 9011
ATTENTION: THOMAS R. SMITH, JR. PRINCETON, NEW JERSEY 08543-9011

------------------------
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)(1)
/ / on (date) pursuant to paragraph (a)(1)
/ / 75 days after filing pursuant to paragraph (a)(2)
/ / on (date) pursuant to paragraph (a)(2) of Rule 485.

IF APPROPRIATE, CHECK THE FOLLOWING BOX:
/ / this post-effective amendment designates a new effective date for
a previously filed post-effective amendment.
------------------------

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, 1996.

CALCULATION OF REGISTRATION FEE UNDER THE SECURITIES ACT OF 1933

<TABLE>
<CAPTION>
==================================================================================================
PROPOSED PROPOSED
TITLE OF SECURITIES AMOUNT OF SHARES MAXIMUM OFFERING MAXIMUM AGGREGATE AMOUNT OF
BEING REGISTERED BEING REGISTERED PRICE PER UNIT OFFERING PRICE* REGISTRATION FEE
- --------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Shares of Common Stock (par
value $0.10 per share)........ 16,057,340 $9.95 $289,993 $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 16,028,195 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) 16,028,195 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> 2

MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC.

REGISTRATION STATEMENT ON FORM N-1A

------------------------

CROSS REFERENCE SHEET

<TABLE>
<CAPTION>
N-1A ITEM NO. LOCATION
- -------------- ---------------------------------------
<S> <C> <C>
PART A
Item 1. Cover Page............................. Cover Page
Item 2. Synopsis............................... Prospectus Summary and Fee Table
Item 3. Condensed Financial Information........ Financial Highlights
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 5A. Management's Discussion of Fund
Performance.......................... Not Applicable
Item 6. Capital Stock and Other Securities..... Cover Page; Purchase of Shares;
Redemption of Shares; Shareholder
Services; Additional Information
Item 7. Purchase of Securities Being Offered... Cover Page; Fee Table; Merrill Lynch
Select Pricing(SM) System; Purchase of
Shares; Shareholder Services;
Additional Information; Inside Back
Cover Page
Item 8. Redemption or Repurchase............... Fee Table; Merrill Lynch Select
Pricing(SM) System; 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 Objective 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; General
Information
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
PART C
</TABLE>

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> 3

PROSPECTUS

SEPTEMBER 27, 1996

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. For more information on the Fund's investment
objective and policies, please see "Investment Objective and Policies" on page
12.

-------------------------

Pursuant to the Merrill Lynch Select Pricing(SM) System, the Fund offers
four classes of shares, each with a different combination of sales charges,
ongoing fees and other features. The Merrill Lynch Select Pricing(SM) System
permits an investor to choose the method of purchasing shares that the investor
believes is most beneficial given the amount of the purchase, the length of time
the investor expects to hold the shares and other relevant circumstances. See
"Merrill Lynch Select Pricing(SM) System" on page 6.

Shares may be purchased directly from Merrill Lynch Funds Distributor, Inc.
(the "Distributor"), P.O. Box 9081, Princeton, New Jersey 08543-9081 [(609)
282-2800], or from other securities dealers which have entered into selected
dealer agreements with the Distributor, including Merrill Lynch, Pierce, Fenner
& Smith Incorporated ("Merrill Lynch"). The minimum initial purchase is $1,000
and the minimum subsequent purchase is $50, 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 PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.

-------------------------

This Prospectus is a concise statement of information about the Fund that
is relevant to making an investment in the Fund. This Prospectus should be
retained for future reference. A statement containing additional information
about the Fund, dated September 27, 1996 (the "Statement of Additional
Information"), has been filed with the Securities and Exchange Commission (the
"Commission") and is available, without charge, by calling or by writing 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> 4

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 Ratings Group ("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 debt securities which
are not Adjustable Rate Securities, including fixed rate treasury bills, notes
and bonds, fixed rate mortgage and asset related securities, and derivative
securities relating thereto, including 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

2
<PAGE> 5

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 130 registered investment
companies. MLAM and FAM also offer portfolio management and portfolio analysis
services to individuals and institutions. As of August 31, 1996, the Manager and
FAM had a total of approximately $212.3 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 subject to the sales charges and ongoing fee
arrangements described below. See "Merrill Lynch Select Pricing(SM) System" and
"Purchase 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, 15
minutes after the close of business on the New York Stock Exchange ("NYSE")
(generally, 4:00 P.M., New York time), on each day during which the NYSE is open
for trading. See "Additional Information--Determination of Net Asset Value."

3
<PAGE> 6

FEE TABLE

A general comparison of the sales arrangements and other nonrecurring and
recurring expenses applicable to shares of the Fund follows:

<TABLE>
<CAPTION>
CLASS A(a) CLASS B(b) CLASS C CLASS D
---------- ---------------------- ------------ -------
<S> <C> <C> <C> <C>
SHAREHOLDER TRANSACTION EXPENSES:
Maximum Sales Charge Imposed on Purchases
(as a percentage of offering price).... 4.00% (c) None None 4.00% (c)
Sales Charge Imposed on Dividend
Reinvestments.......................... None None None None
Deferred Sales Charge (as a percentage of
original purchase price or redemption
proceeds, whichever is lower).......... None (d) 4.0% during the first 1.0% for one None (d)
year, decreasing 1.0% year
annually thereafter to
0.0% after the fourth
year
Exchange Fee............................. None None None None
ANNUAL FUND OPERATING EXPENSES (AS A
PERCENTAGE OF AVERAGE NET ASSETS)
Management Fees(e)....................... 0.50% 0.50% 0.50% 0.50%
12b-1 Fees(f):
Account Maintenance Fees............... None 0.25% 0.25% 0.25%
Distribution Fees...................... None 0.50% 0.55% None
(Class B shares
convert to Class D
shares automatically
after approximately
ten years and cease
being subject to
distribution fees)
Other Expenses:
Custodial Fees...................... 0.02% 0.02% 0.02% 0.02%
Shareholder Servicing Costs(g)...... 0.09% 0.12% 0.09% 0.09%
Other............................... 0.20% 0.20% 0.16% 0.20%
----- ---- ---- -----
Total Other Expenses............ 0.31% 0.34% 0.27% 0.31%
----- ---- ---- -----
Total Fund Operating Expenses............ 0.81% 1.59% 1.57% 1.06%
----- ---- ---- -----
----- ---- ---- -----
</TABLE>

- ---------------

(a) Class A shares are sold to a limited group of investors including existing
Class A shareholders, certain retirement plans and certain investment
programs. See "Purchase of Shares--Initial Sales Charge Alternatives--Class
A and Class D Shares"--page 31.

(b) Class B shares convert to Class D shares automatically approximately ten
years after initial purchase. See "Purchase of Shares-- Deferred Sales
Charge Alternatives--Class B and Class C Shares"--page 33.

(c) Reduced for purchases of $25,000 and over, and waived for purchases of Class
A shares by certain retirement plans in connection with certain investment
programs. Class A or Class D purchases of $1,000,000 or more may not be
subject to an initial sales charge. See "Purchase of Shares--Initial Sales
Charge Alternatives--Class A and Class D Shares"--page 31.

(d) Class A and Class D shares are not subject to a contingent deferred sales
charge ("CDSC"), except that certain purchases of $1,000,000 or more which
may not be subject to an initial sales charge may instead be subject to a
CDSC of 1.0% of amounts redeemed within the first year after purchase.

(e) See "Management of the Fund--Management and Advisory Arrangements"--page 28.

(f) See "Purchase of Shares--Distribution Plans"--page 37.

(g) See "Management of the Fund--Transfer Agency Services"--page 29.

4
<PAGE> 7

EXAMPLE:

<TABLE>
<CAPTION>
CUMULATIVE EXPENSES PAID
FOR THE PERIOD OF:
----------------------------------------
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
An investor would pay the following expenses on a $1,000 investment
including the maximum $40 initial sales charge (Class A and Class
D shares only) and assuming (1) the Total Fund Operating Expenses
for each class set forth on page 4; (2) a 5% annual return
throughout the periods and (3) redemption at the end of the
period:
Class A......................................................... $ 48 $65 $83 $136
Class B......................................................... $ 56 $70 $87 $189
Class C......................................................... $ 26 $50 $86 $187
Class D......................................................... $ 50 $72 $96 $164

An investor would pay the following expenses on the same $1,000
investment assuming no redemption at the end of the period:
Class A......................................................... $ 48 $65 $83 $136
Class B......................................................... $ 16 $50 $87 $189
Class C......................................................... $ 16 $50 $86 $187
Class D......................................................... $ 50 $72 $96 $164
</TABLE>

The foregoing Fee Table is intended to assist investors in understanding
the costs and expenses that a shareholder in the Fund will bear directly or
indirectly. The Example set forth above assumes reinvestment of all dividends
and distributions and utilizes a 5% annual rate of return as mandated by
Commission regulations. THE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF
PAST OR FUTURE EXPENSES OR ANNUAL 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 and Class C shareholders who hold their shares for an extended
period of time may pay more in Rule 12b-1 distribution fees than the economic
equivalent of the maximum front-end sales charges permitted under the Rules of
Fair Practice of the National Association of Securities Dealers, Inc. (the
"NASD"). Merrill Lynch may charge its customers a processing fee (presently
$4.85) for confirming purchases and repurchases. Purchases and redemptions
directly through the Fund's Transfer Agent are not subject to the processing
fee. See "Purchase of Shares" and "Redemption of Shares."

5
<PAGE> 8

MERRILL LYNCH SELECT PRICING(SM) SYSTEM

The Fund offers four classes of shares under the Merrill Lynch Select
Pricing(SM) System. The shares of each class may be purchased at a price equal
to the next determined net asset value per share subject to the sales charges
and ongoing fee arrangements described below. Shares of Class A and Class D are
sold to investors choosing the initial sales charge alternatives, and shares of
Class B and Class C are sold to investors choosing the deferred sales charge
alternatives. The Merrill Lynch Select Pricing(SM) System is used by more than
50 mutual funds advised by MLAM or an affiliate of MLAM, FAM. Funds advised by
MLAM or FAM which utilize the Merrill Lynch Select Pricing(SM) System are
referred to herein as "MLAM-advised mutual funds".

Each Class A, Class B, Class C or Class D share of the Fund represents an
identical interest in the investment portfolio of the Fund and has the same
rights, except that Class B, Class C and Class D shares bear the expenses of the
ongoing account maintenance fees and Class B and Class C shares bear the
expenses of the ongoing distribution fees and the additional incremental
transfer agency costs resulting from the deferred sales charge arrangements. The
deferred sales charges, distribution and account maintenance fees that are
imposed on Class B and Class C shares, as well as the account maintenance fees
that are imposed on the Class D shares, are imposed directly against those
classes and not against all assets of the Fund and, accordingly, such charges do
not affect the net asset value of any other class or have any impact on
investors choosing another sales charge option. Dividends paid by the Fund for
each class of shares are calculated in the same manner at the same time and will
differ only to the extent that account maintenance and distribution fees and any
incremental transfer agency costs relating to a particular class are borne
exclusively by that class. Each class has different exchange privileges. See
"Shareholder Services--Exchange Privilege".

Investors should understand that the purpose and function of the initial
sales charges with respect to the Class A and Class D shares are the same as
those of the deferred sales charges with respect to the Class B and Class C
shares in that the sales charges applicable to each class provide for the
financing of the distribution of the shares of the Fund. The
distribution-related revenues paid with respect to a class will not be used to
finance the distribution expenditures of another class. Sales personnel may
receive different compensation for selling different classes of shares.

The following table sets forth a summary of the distribution arrangements
for each class of shares under the Merrill Lynch Select Pricing(SM) System,
followed by a more detailed description of each class and a discussion of the
factors that investors should consider in determining the method of purchasing
shares under the Merrill Lynch Select Pricing(SM) System that the investor
believes is most beneficial under his or her

6
<PAGE> 9

particular circumstances. More detailed information as to each class of shares
is set forth under "Purchase of Shares".

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------
ACCOUNT
MAINTENANCE DISTRIBUTION
CLAS SALES CHARGE(1) FEE FEE CONVERSION FEATURE
-----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
A Maximum 4.00% initial sales
charge(2)(3) No No No
-----------------------------------------------------------------------------------------------
B CDSC for a period of 4 years, at
a rate of 4.0% during the first
year, decreasing 1.0% annually to B shares convert to D
0.0% 0.25% 0.50% shares
automatically after
approximately ten years(4)
-----------------------------------------------------------------------------------------------
C 1.0% CDSC for one year 0.25% 0.55% No
-----------------------------------------------------------------------------------------------
D Maximum 4.00% initial sales
charge(3) 0.25% No No
-----------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------
</TABLE>

- ---------------
(1) Initial sales charges are imposed at the time of purchase as a percentage of
the offering price. CDSCs are imposed if the redemption occurs within the
applicable CDSC time period. The charge will be assessed on an amount equal
to the lesser of the proceeds of redemption or the cost of the shares being
redeemed.
(2) Offered only to eligible investors. See "Purchase of Shares--Initial Sales
Charge Alternatives--Class A and Class D Shares-- Eligible Class A
Investors".

(3) Reduced for purchases of $25,000 or more, and waived for purchases of Class
A shares by certain retirement plans in connection with certain investment
programs. Class A and Class D share purchases of $1,000,000 or more may not
be subject to an initial sales charge but instead may be subject to a 1.0%
CDSC for one year. A .75% sales charge for 401(k) purchases over $1,000,000
will apply. See "Class A" and "Class D" below.

(4) The conversion period for dividend reinvestment shares and the conversion
and holding periods for certain retirement plans was modified. Also, Class B
shares of certain other MLAM-advised mutual funds into which exchanges may
be made have an eight-year conversion period. If Class B shares of the Fund
are exchanged for Class B shares of another MLAM-advised mutual fund, the
conversion period applicable to the Class B shares acquired in the exchange
will apply, and the holding period for the shares exchanged will be tacked
onto the holding period for the shares acquired.

Class A: Class A shares incur an initial sales charge when they are purchased
and bear no ongoing distribution or account maintenance fees. Class A
shares of the Fund are offered to a limited group of investors and also
will be issued upon reinvestment of dividends on outstanding Class A
shares of the Fund. Eligible investors include certain retirement plans
and participants in certain investment programs. In addition, Class A
shares will be offered at net asset value to Merrill Lynch & Co., Inc.
("ML&Co.") and its subsidiaries (the term "subsidiaries", when used
herein with respect to ML&Co., includes the Manager, FAM and certain
other entities directly or indirectly wholly-owned and controlled by
ML&Co.) and their directors and employees, and to members of the Boards
of MLAM-advised mutual funds. The maximum initial sales charge is
4.00%, which is reduced for purchases of $25,000 and over, and waived
for purchases by certain retirement plans in connection with certain
investment programs. Purchases of $1,000,000 or more may not be subject
to an initial sales charge but, if the initial sales charge is waived,
such purchases may be subject to a 1.0% CDSC if the shares are redeemed
within one year after purchase. Sales charges also are reduced under a
right of accumulation which takes into account the investor's holdings
of all classes of all MLAM-advised mutual funds. See "Purchase of
Shares--Initial Sales Charge Alternatives--Class A and Class D Shares".

7
<PAGE> 10

Class B: Class B shares do not incur a sales charge when they are purchased, but
they are subject to an ongoing account maintenance fee of 0.25%, an
ongoing distribution fee of 0.50% of the Fund's average net assets
attributable to the Class B shares and a CDSC if they are redeemed
within four years of purchase. Approximately ten years after issuance,
Class B shares will convert automatically into Class D shares of the
Fund, which are subject to an account maintenance fee but no
distribution fee; Class B shares of certain other MLAM-advised mutual
funds into which exchanges may be made convert into Class D shares
automatically after approximately ten years. If Class B shares of the
Fund are exchanged for Class B shares of another MLAM-advised mutual
fund, the conversion period applicable to the Class B shares acquired
in the exchange will apply, and the holding period for the shares
exchanged will be tacked onto the holding period for the shares
acquired. Automatic conversion of Class B shares into Class D shares
will occur at least once a month on the basis of the relative net asset
values of the shares of the two classes on the conversion date, without
the imposition of any sales load, fee or other charge. Conversion of
Class B shares to Class D shares will not be deemed a purchase or sale
of the shares for Federal income tax purposes. Shares purchased through
reinvestment of dividends on Class B shares also will convert
automatically to Class D shares. The conversion period for dividend
reinvestment shares and the conversion and holding periods for certain
retirement plans are modified as described under "Purchase of
Shares--Deferred Sales Charge Alternatives--Class B and Class C
Shares--Conversion of Class B Shares to Class D Shares".

Class C: Class C shares do not incur a sales charge when they are purchased, but
they are subject to an ongoing account maintenance fee of 0.25% and an
ongoing distribution fee of 0.55% of the Fund's average net assets
attributable to Class C shares. Class C shares are also subject to a
CDSC if they are redeemed within one year of purchase. Although Class C
shares are subject to a 1.0% CDSC for only one year (as compared to
four years for Class B), Class C shares have no conversion feature and,
accordingly, an investor that purchases Class C shares will be subject
to distribution fees that will be imposed on Class C shares for an
indefinite period subject to annual approval by the Fund's Board of
Directors and regulatory limitations.

Class D: Class D shares incur an initial sales charge when they are purchased
and are subject to an ongoing account maintenance fee of 0.25% of the
Fund's average net assets attributable to Class D shares. Class D
shares are not subject to an ongoing distribution fee or any CDSC when
they are redeemed. Purchases of $1,000,000 or more may not be subject
to an initial sales charge but if the initial sales charge is waived
such purchases may be subject to a CDSC of 1.0% if the shares are
redeemed within one year after purchase. The schedule of initial sales
charges and reductions for Class D shares is the same as the schedule
for Class A shares, except that there is no waiver for purchases by
retirement plans in connection with certain investment programs. Class
D shares also will be issued upon conversion of Class B shares as
described above under "Class B". See "Purchase of Shares-- Initial
Sales Charge Alternatives--Class A and Class D Shares".

The following is a discussion of the factors that investors should consider
in determining the method of purchasing shares under the Merrill Lynch Select
Pricing(SM) System that the investor believes is most beneficial under his or
her particular circumstances.

Initial Sales Charge Alternatives. Investors who prefer an initial sales
charge alternative may elect to purchase Class D shares or, if an eligible
investor, Class A shares. Investors choosing the initial sales charge

8
<PAGE> 11

alternative who are eligible to purchase Class A shares should purchase Class A
shares rather than Class D shares because there is an account maintenance fee
imposed on Class D shares. Investors qualifying for significantly reduced
initial sales charges may find the initial sales charge alternative particularly
attractive because similar sales charge reductions are not available with
respect to the deferred sales charges imposed in connection with purchases of
Class B or Class C shares. Investors not qualifying for reduced initial sales
charges who expect to maintain their investment for an extended period of time
also may elect to purchase Class A or Class D shares, because over time the
accumulated ongoing account maintenance and distribution fees on Class B or
Class C shares may exceed the initial sales charge and, in the case of Class D
shares, the account maintenance fee. Class A, Class B, Class C and Class D share
holdings will count toward a right of accumulation which may qualify the
investor for reduced initial sales charges on new initial sales charge
purchases. In addition, the ongoing Class B and Class C account maintenance and
distribution fees will cause Class B and Class C shares to have higher expense
ratios, pay lower dividends and have lower total returns than the initial sales
charge shares. The ongoing Class D account maintenance fees will cause Class D
shares to have a higher expense ratio, pay lower dividends and have a lower
total return than Class A shares.

Deferred Sales Charge Alternatives. Because no initial sales charges are
deducted at the time of purchase, Class B and Class C shares provide the benefit
of putting all of the investor's dollars to work from the time the investment is
made. The deferred sales charge alternatives may be particularly appealing to
investors who do not qualify for a reduction in initial sales charges. Both
Class B and Class C shares are subject to ongoing account maintenance fees and
distribution fees; however, the ongoing account maintenance and distribution
fees potentially may be offset to the extent any return is realized on the
additional funds initially invested in Class B or Class C shares. In addition,
Class B shares will be converted into Class D shares of the Fund after a
conversion period of approximately ten years, and thereafter investors will be
subject to lower ongoing fees.

Certain investors may elect to purchase Class B shares if they determine it
to be most advantageous to have all of their funds invested initially and intend
to hold their shares for an extended period of time. Investors in Class B shares
should take into account whether they intend to redeem their shares within the
CDSC period and, if not, whether they intend to remain invested until the end of
the conversion period and thereby take advantage of the reduction in ongoing
fees resulting from the conversion into Class D shares. Other investors,
however, may elect to purchase Class C shares if they determine that it is
advantageous to have all of their assets invested initially and they are
uncertain as to the length of time they intend to hold their assets in
MLAM-advised mutual funds. Although Class C shareholders are subject to a
shorter CDSC period at a lower rate, they forgo the Class B conversion feature,
making their investment subject to account maintenance and distribution fees for
an indefinite period of time. In addition, while both Class B and Class C
distribution fees are subject to the limitations on asset-based sales charges
imposed by the NASD, the Class B distribution fees are further limited under a
voluntary waiver of asset-based sales charges. See "Purchase of
Shares--Limitations on the Payment of Deferred Sales Charges".

9
<PAGE> 12

FINANCIAL HIGHLIGHTS

The financial information in the table below has been audited in
conjunction with the annual audits of the financial statements of the Fund by
Deloitte & Touche LLP, independent auditors. Financial statements and the
independent auditors' report thereon for the fiscal year ended May 31, 1996 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.

CLASS A CLASS B
---------------------------------------------- -------------------------
FOR THE YEAR
FOR THE FOR THE PERIOD ENDED MAY 31,
YEAR ENDED MAY 31, OCT. 21, 1994+ TO MAY 31, -------------------------
1996++ 1995 1996++
------------------ ------------------------- -------------------------
<S> <C> <C> <C>
INCREASE (DECREASE) IN NET ASSET VALUE:
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of
period........................... $ 9.55 $ 9.46 $ 9.56
------ ------- ---------
Investment income--net........... .56 .36 .52
Realized and unrealized gain
(loss) on investments--net..... .03 .09 (.02)
------ ------- ---------
Total from investment
operations....................... .59 .45 .50
------ ------- ---------
Less dividends from investment
income--net...................... (.60) (.36) (.53)
------ ------- ---------
Net asset value, end of period.... $ 9.54 $ 9.55 $ 9.53
====== ======= =========
TOTAL INVESTMENT RETURN:**
Based on net asset value per
share............................ 6.41% 4.85%# 5.34%
====== ======= =========
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of reimbursement.... .81% .87%* 1.59%
====== ======= =========
Expenses.......................... .81% .87%* 1.59%
====== ======= =========
Investment income--net............ 6.20% 6.18%* 5.45%
====== ======= =========
SUPPLEMENTAL DATA:
Net assets, end of period (in
thousands)....................... $ 281 $ 345 $ 137,387
====== ======= =========
Portfolio turnover................ 25.30% 102.55% 25.30%
====== ======= =========

1995 1994 1993
------------------------- ------------------------- -------------------------
<S> <C> <C> <C>
INCREASE (DECREASE) IN NET ASSET VALUE
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of
period........................... $ 9.53 $ 9.76 $ 9.92
--------- --------- ---------
Investment income--net........... .46 .32 .40
Realized and unrealized gain
(loss) on investments--net..... .04 (.24) (.16)
--------- --------- ---------
Total from investment
operations....................... .50 .08 .24
--------- --------- ---------
Less dividends from investment
income--net...................... (.47) (.31) (.40)
--------- --------- ---------
Net asset value, end of period.... $ 9.56 $ 9.53 $ 9.76
========= ========= =========
TOTAL INVESTMENT RETURN:**
Based on net asset value per
share............................ 5.48% .77% 2.48%
========= ========= =========
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of reimbursement.... 1.59% 1.46% 1.40%
========= ========= =========
Expenses.......................... 1.59% 1.46% 1.40%
========= ========= =========
Investment income--net............ 4.88% 3.20% 4.15%
========= ========= =========
SUPPLEMENTAL DATA:
Net assets, end of period (in
thousands)....................... $ 202,334 $ 374,376 $ 689,593
========= ========= =========
Portfolio turnover................ 102.55% 60.38% 104.71%
========= ========= =========

FOR THE PERIOD
AUG. 2, 1991+ TO MAY 31,
1992
------------------------
<S> <C>
INCREASE (DECREASE) IN NET ASSET VALUE
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of
period........................... $ 10.00
-------
Investment income--net........... .52
Realized and unrealized gain
(loss) on investments--net..... (.08)
-------
Total from investment
operations....................... .44
-------
Less dividends from investment
income--net...................... (.52)
-------
Net asset value, end of period.... $ 9.92
========
TOTAL INVESTMENT RETURN:**
Based on net asset value per
share............................ 4.33%#
========
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of reimbursement.... 1.36%*
========
Expenses.......................... 1.47%*
========
Investment income--net............ 6.07%*
========
SUPPLEMENTAL DATA:
Net assets, end of period (in
thousands)....................... $887,110
========
Portfolio turnover................ 94.72%
========
</TABLE>

- ---------------

* Annualized.

** Total investment returns exclude the effect of sales loads.

+ Commencement of Operations.

++ Based on average shares outstanding during the period.

# Aggregate total investment return.

10
<PAGE> 13

CLASS C CLASS D
---------------------------------------------- -------------------------
FOR THE YEAR
FOR THE FOR THE PERIOD ENDED MAY 31,
YEAR ENDED MAY 31, OCT. 21, 1994+ TO MAY 31, -------------------------
1996++ 1995 1996++
------------------ ------------------------- -------------------------
<S> <C> <C> <C>
INCREASE (DECREASE) IN NET ASSET
VALUE:
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of
period.............................. $ 9.56 $ 9.46 $ 9.55
------ ------- --------
Investment income--net.............. .48 .31 .56
Realized and unrealized gain (loss)
on investments--net............... .01 .10 (.01)
------ ------- --------
Total from investment operations..... .49 .41 .55
------ ------- --------
Less dividends from investment
income-- net........................ (.52) (.31) (.58)
------ ------- --------
Net asset value, end of period....... $ 9.53 $ 9.56 $ 9.52
====== ======= ========
TOTAL INVESTMENT RETURN:**
Based on net asset value per share... 5.30% 4.47%# 5.91%
====== ======= ========
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of reimbursement....... 1.57% 1.68%* 1.06%
====== ======= ========
Expenses............................. 1.57% 1.68%* 1.06%
====== ======= ========
Investment income--net............... 5.40% 5.51%* 5.98%
====== ======= ========
SUPPLEMENTAL DATA:
Net assets, end of period (in
thousands).......................... $3,078 $ 1,409 $ 12,800
====== ======= ========
Portfolio turnover................... 25.30% 102.55% 25.30%
====== ======= ========

1995 1994 1993
------------------------- ------------------------- -------------------------
<S> <C> <C> <C>
INCREASE (DECREASE) IN NET ASSET
VALUE:
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of
period.............................. $ 9.53 $ 9.76 $ 9.92
-------- -------- --------
Investment income--net.............. .51 .37 .45
Realized and unrealized gain (loss)
on investments--net............... .03 (.24) (.16)
-------- -------- --------
Total from investment operations..... .54 .13 .29
-------- -------- --------
Less dividends from investment
income-- net........................ (.52) (.36) (.45)
-------- -------- --------
Net asset value, end of period....... $ 9.55 $ 9.53 $ 9.76
======== ======== ========
TOTAL INVESTMENT RETURN:**
Based on net asset value per share... 5.91% 1.28% 2.99%
======== ======== ========
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of reimbursement....... 1.08% .96% .91%
======== ======== ========
Expenses............................. 1.08% .96% .91%
======== ======== ========
Investment income--net............... 5.44% 3.69% 4.79%
======== ======== ========
SUPPLEMENTAL DATA:
Net assets, end of period (in
thousands).......................... 16,993 $ 23,043 $ 51,398
======== ======== ========
Portfolio turnover................... $102.55% 60.38% 104.71%
======== ======== ========

FOR THE PERIOD
AUG. 2, 1991+ TO MAY 31,
1992
------------------------
<S> <C>
INCREASE (DECREASE) IN NET ASSET
VALUE:
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of
period.............................. $ 10.00
--------
Investment income--net.............. .56
Realized and unrealized gain (loss)
on investments--net............... (.08)
--------
Total from investment operations..... .48
--------
Less dividends from investment
income-- net........................ (.56)
--------
Net asset value, end of period....... $ 9.92
========
TOTAL INVESTMENT RETURN:**
Based on net asset value per share... 4.75%#
========
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of reimbursement....... .87%*
========
Expenses............................. .96%*
========
Investment income--net............... 6.54%*
========
SUPPLEMENTAL DATA:
Net assets, end of period (in
thousands).......................... $ 80,411
========
Portfolio turnover................... 94.72%
========
</TABLE>

- ---------------

* Annualized.

** Total investment returns exclude the effect of sales loads.

+ Commencement of Operations.

++ Based on average shares outstanding during the period.

# Aggregate total investment return.

11
<PAGE> 14

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 Ratings Group ("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 debt securities which
are not Adjustable Rate Securities, including fixed rate treasury bills, notes
and bonds, fixed rate mortgage and asset related securities, and derivative
securities relating thereto, including 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."

12
<PAGE> 15

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

13
<PAGE> 16

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.

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

14
<PAGE> 17

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 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").

15
<PAGE> 18

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
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.

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<PAGE> 19

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 total assets.

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

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<PAGE> 20

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 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

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<PAGE> 21

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 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.

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<PAGE> 22

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 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.

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<PAGE> 23

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 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,

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<PAGE> 24

together with other illiquid investments of the Fund, exceeds 15% of the Fund's
total assets (or 10% of the Fund's total assets as presently required by certain
state laws).

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 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, 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,

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<PAGE> 25

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.

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

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<PAGE> 26

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 15% of the total assets of the Fund (or 10% of the
total assets of the Fund as presently required by certain state laws), 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.

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

24
<PAGE> 27

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. The Fund may invest in securities pursuant to
repurchase agreements. Repurchase agreements may be entered into only with a
member bank of the Federal Reserve System or 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 15% of the Fund's total assets (or 10% of the Fund's total
assets as presently required by certain state laws) 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 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

25
<PAGE> 28

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.

Restricted Securities. The Fund may purchase securities that are not
registered ("restricted securities") under the Securities Act of 1933, as
amended (the "Securities Act"), but can be offered and sold to "qualified
institutional buyers" under Rule 144A under the Securities Act. However, the
Fund will not invest more than 15% of its total assets in illiquid investments,
which includes securities for which there is no readily available market,
securities subject to contractual restrictions on resale, certain investments in
asset-backed and receivable-backed securities and restricted securities, unless
the Fund's Board of Directors continuously determines, based on the trading
markets for the specific restricted 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 these
securities purchased pursuant to Rule 144A, focusing on such factors, among
others, as valuation, liquidity and availability of information. These
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.

Investment Restrictions. The Fund's investment activities are subject to
further restrictions that are described in the Statement of Additional
Information. Investment restrictions and policies which are fundamental policies
may not be changed without the approval of the holders of a majority of the
Fund's outstanding voting securities (which for this purpose and under the
Investment Company Act of 1940, as amended (the "Investment Company Act") means
the lesser of (a) 67% of the shares represented at a meeting at which more than
50% of the outstanding shares are represented or (b) more than 50% of the
outstanding shares). Among its fundamental policies, the Fund may not 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 (excluding
the U.S. Government and its agencies and instrumentalities). Investment
restrictions and policies that are non-fundamental policies may be changed by
the Board of Directors without shareholder approval. As a non-fundamental
policy, the Fund may not 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

26
<PAGE> 29

emergency purposes; provided, however, that for purposes of this restriction,
transactions involving "cover" or for which segregated accounts have been
established as described 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.

As a non-fundamental policy, the Fund will not invest in securities which
cannot readily be resold because of legal or contractual restrictions or which
are not readily marketable, including repurchase agreements and purchase and
sale contracts maturing in more than seven days, if, regarding all such
securities, more than 15% of its total assets (or 10% of its total assets as
presently required by certain state laws) taken at market value would be
invested in such securities. Notwithstanding the foregoing, the Fund may
purchase without regard to this limitation securities that are not registered
under 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 has
determined that securities which are freely tradeable in their primary market
offshore should be deemed liquid. The Board, however, will retain sufficient
oversight and be ultimately responsible for the determinations.

27
<PAGE> 30

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 of the Manager and FAM; President and Director of
Princeton Services, Inc. ("Princeton Services"); Executive Vice President of
ML&Co.; and Director of the Distributor.

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
Director, LaSalle Street Fund.

WALTER MINTZ--Special Limited Partner of Cumberland Associates (investment
partnership) since 1982.

ROBERT S. SALOMON, JR.--Principal of STI Management (investment adviser).

MELVIN R. SEIDEN--President of Silbanc Properties, Ltd. (real estate,
investment and consulting).

STEPHEN B. SWENSRUD--Principal of Fernwood Associates (financial
consultants).

- ---------------

* Interested person, as defined by the 1940 Act, of the Fund.

MANAGEMENT AND ADVISORY ARRANGEMENTS

The Manager, which is owned and controlled by ML&Co., a financial services
holding company, acts as the investment adviser for the Fund and provides the
Fund with management and investment advisory services. The Manager or its
affiliate, FAM, acts as the investment adviser to more than 130 registered
investment companies. The Manager also provides investment advisory services to
individual and institutional clients. As of August 31, 1996, the Manager and FAM
had a total of approximately $212.3 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, 1996, the fee paid by the Fund to the Manager was
$914,312 (based on average net assets of approximately $181.9 million). The
Management

28
<PAGE> 31

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. For the fiscal year ended May 31, 1996, the amount of such
reimbursement was $90,588. For the fiscal year ended May 31, 1996, the ratio of
total expenses to average net assets was 0.81%, 1.59%, 1.57% and 1.06% for Class
A, Class B, Class C and Class D shares, respectively.

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.

CODE OF ETHICS

The Board of Directors of the Fund has adopted a Code of Ethics pursuant to
Rule 17j-1 under the Investment Company Act which incorporates the Code of
Ethics of the Manager (together, the "Codes"). The Codes significantly restrict
the personal investing activities of all employees of the Manager and, as
described below, impose additional, more onerous, restrictions on Fund
investment personnel.

The Codes require that all employees of the Manager preclear any personal
securities investment (with limited exceptions, such as government securities).
The preclearance requirement and associated procedures are designed to identify
any substantive prohibition or limitation applicable to the proposed investment.
The substantive restrictions applicable to all employees of the Manager include
a ban on acquiring any securities in a "hot" initial public offering and a
prohibition from profiting on short-term trading in securities. In addition, no
employee may purchase or sell any security which at the time is being purchased
or sold (as the case may be), or to the knowledge of the employee is being
considered for purchase or sale, by any fund advised by the Manager.
Furthermore, the Codes provide for trading "blackout periods" which prohibit
trading by investment personnel of the Fund within periods of trading by the
Fund in the same (or equivalent) security (15 or 30 days depending upon the
transaction).

TRANSFER AGENCY SERVICES

Merrill Lynch Financial Data Services, Inc. (the "Transfer Agent"), which
is a wholly-owned subsidiary of ML&Co., acts as the 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 or Class D shareholder account and
$14.00 per Class B or Class C 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, 1996, the Fund paid
$213,301 to the Transfer Agent pursuant to the Transfer Agency Agreement. At
August 31, 1996, the Fund had 10 Class A shareholder accounts, 9,620 Class B
shareholder accounts, 84 Class C shareholder accounts and 496 Class D
shareholder accounts. At this level of accounts, the annual fee payable to the
Transfer Agent would aggregate approximately $141,422 plus miscellaneous and
out-of-pocket expenses.

29
<PAGE> 32

PURCHASE OF SHARES

The Distributor, an affiliate of both the Manager and Merrill Lynch, acts
as the distributor of shares of the Fund.

The Fund offers its shares in four classes at a public offering price equal
to the next determined net asset value per share plus sales charges imposed
either at the time of purchase or on a deferred basis depending upon the class
of shares selected by the investor under the Merrill Lynch Select Pricing(SM)
System, as described below. The applicable offering price for purchase orders is
based upon the net asset value of the Fund next determined after receipt of the
purchase orders by the Distributor. As to purchase orders received by securities
dealers prior to the close of business on the NYSE (generally, 4:00 P.M., New
York time) which includes orders received after the close of business on the
previous day, the applicable offering price will be based on the net asset value
determined as of 15 minutes after the close of business on the NYSE on that day,
provided the Distributor in turn receives the orders from the securities dealer
prior to 30 minutes after the close of business on the NYSE on that day. If the
purchase orders are not received by the Distributor prior to 30 minutes after
the close of business on the NYSE, such orders shall be deemed received on the
next business day. The Fund or the Distributor may suspend the continuous
offering of the Fund's shares of any class at any time in response to conditions
in the securities markets or otherwise and may thereafter resume such offering
from time to time. Any order may be rejected by the Distributor or the Fund.
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 Transfer Agent are not subject to the
processing fee.

The Fund issues four classes of shares under the Merrill Lynch Select
Pricing(SM) System, which permits each investor to choose the method of
purchasing shares that the investor believes is most beneficial given the amount
of the purchase, the length of time the investor expects to hold the shares and
other relevant circumstances. Shares of Class A and Class D are sold to
investors choosing the initial sales charge alternatives, and shares of Class B
and Class C are sold to investors choosing the deferred sales charge
alternatives. Investors should determine whether under their particular
circumstances it is more advantageous to incur an initial sales charge or to
have the entire initial purchase price invested in the Fund with the investment
thereafter being subject to a contingent deferred sales charge and ongoing
distribution fees. A discussion of the factors that investors should consider in
determining the method of purchasing shares under the Merrill Lynch Select
Pricing(SM) System is set forth under "Merrill Lynch Select Pricing(SM) System"
on page 6.

Each Class A, Class B, Class C and Class D share of the Fund represents an
identical interest in the investment portfolio of the Fund and has the same
rights, except that Class B, Class C and Class D shares bear the expenses of the
ongoing account maintenance fees, and Class B and Class C shares bear the
expenses of the ongoing distribution fees and the additional incremental
transfer agency costs resulting from the deferred sales charge arrangements. The
deferred sales charges, distribution and account maintenance fees that are
imposed on Class B and Class C shares, as well as the account maintenance fees
that are imposed on Class D shares, are imposed directly against those classes
and not against all assets of the Fund and, accordingly, such charges do not
affect the net asset value of any other class or have any impact on investors
choosing another sales charge option. Dividends paid by the Fund for each class
of shares are calculated in the same manner at the same time and differ only to
the extent that account maintenance and distribution fees and any incremental
transfer agency costs relating to a particular class are borne exclusively by
that class.

30
<PAGE> 33

Class B, Class C and Class D shares each have exclusive voting rights with
respect to the Rule 12b-1 distribution plan adopted with respect to such class
pursuant to which account maintenance and/or distribution fees are paid. See
"Distribution Plans" below. Each class has different exchange privileges. See
"Shareholder Services--Exchange Privilege".

Investors should understand that the purpose and function of the initial
sales charges with respect to Class A and Class D shares are the same as those
of the deferred sales charges with respect to Class B and Class C shares in that
the sales charges applicable to each class provide for the financing of the
distribution of the shares of the Fund. The distribution-related revenues paid
with respect to a class will not be used to finance the distribution
expenditures of another class. Sales personnel may receive different
compensation for selling different classes of shares. Investors are advised that
only Class A and Class D shares may be available for purchase through securities
dealers, other than Merrill Lynch, which are eligible to sell shares.

The following table sets forth a summary of the distribution arrangements
for each class of shares under the Merrill Lynch Select Pricing(SM) System.

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------
ACCOUNT
MAINTENANCE DISTRIBUTION
CLASS SALES CHARGE(1) FEE FEE CONVERSION FEATURE
-----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
A Maximum 4.00% initial sales
charge(2)(3) No No No
-----------------------------------------------------------------------------------------------
B CDSC for a period of 4 years, at a
rate of 4.0% during the first
year, decreasing 1.0% annually to B shares convert to D
0.0% 0.25% 0.50% shares
automatically after
approximately ten years(4)
-----------------------------------------------------------------------------------------------
C 1.0% CDSC for one year 0.25% 0.55% No
-----------------------------------------------------------------------------------------------
D Maximum 4.00% initial sales
charge(3) 0.25% No No
-----------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------
</TABLE>

- ---------------
(1) Initial sales charges are imposed at the time of purchase as a percentage of
the offering price. CDSCs may be imposed if the redemption occurs within the
applicable CDSC time period. The charge will be assessed on an amount equal
to the lesser of the proceeds of redemption or the cost of the shares being
redeemed.
(2) Offered only to eligible investors. See "Initial Sales Charge
Alternatives--Class A and Class D Shares--Eligible Class A Investors".

(4) The conversion period for dividend reinvestment shares and the conversion
and holding periods for certain retirement plans are modified. Also, Class B
shares of certain other MLAM-advised mutual funds into which exchanges may
be made have an eight-year conversion period. If Class B shares of the Fund
are exchanged for Class B shares of another MLAM-advised mutual fund, the
conversion period applicable to the Class B shares acquired in the exchange
will apply, and the holding period for the shares exchanged will be tacked
onto the holding period for the shares acquired.

INITIAL SALES CHARGE ALTERNATIVES--CLASS A AND CLASS D SHARES

Investors choosing the initial sales charge alternative who are eligible to
purchase Class A shares should purchase Class A shares rather than Class D
shares because there is an account maintenance fee imposed on Class D shares.

31
<PAGE> 34

The public offering price of Class A and Class D shares for purchasers
choosing the initial sales charge alternative is the next determined net asset
value plus varying sales charges (i.e., sales loads), as set forth below.

<TABLE>
<CAPTION>
SALES CHARGE AS DISCOUNT TO
SALES CHARGE AS PERCENTAGE* SELECTED DEALERS
PERCENTAGE OF OF THE NET AS PERCENTAGE OF
AMOUNT OF PURCHASE OFFERING PRICE AMOUNT INVESTED THE OFFERING PRICE
- ----------------------------------------------- --------------- --------------- ------------------
<S> <C> <C> <C>
Less than $25,000.............................. 4.00% 4.17% 3.75%
$25,000 but less than $50,000.................. 3.75 3.40 3.50
$50,000 but less than $100,000................. 3.25 3.36 3.00
$100,000 but less than $250,000................ 2.50 2.56 2.25
$250,000 but less than $1,000,000.............. 1.50 1.52 1.25
$1,000,000 and over**.......................... 0.00 0.00 0.00
</TABLE>

- ---------------
* Rounded to the nearest one-hundredth percent.

** The initial sales charge may be waived on Class A and Class D purchases of
$1,000,000 or more, and on Class A share purchases by certain retirement plan
investors in connection with certain investment programs, made on or after
October 21, 1994. If the sales charge is waived in connection with a purchase
of $1,000,000 or more, such purchases may be subject to a CDSC of 1.0% if the
shares are redeemed within one year after purchase. Class A purchases of $5
million or more in a single transaction made prior to October 21, 1994 might
have been subject to a CDSC of 0.25% of the dollar amount of the purchase if
the shares were redeemed within one year of purchase in lieu of paying an
initial sales charge. The charge will be assessed on an amount equal to the
lesser of the proceeds of redemption or the cost of the shares being
redeemed. A sales charge of 0.75% will be charged on purchases of $1,000,000
or more of Class A or Class D shares by certain employer-sponsored retirement
or savings plans.

The Distributor may reallow discounts to selected dealers and retain the
balance over such discounts. At times the Distributor may reallow the entire
sales charge to such dealers. Since securities dealers selling Class A and Class
D shares of the Fund will receive a concession equal to most of the sales
charge, they may be deemed to be underwriters under the Securities Act.

During the fiscal year ended May 31, 1996, the Fund sold 893,429 Class A
shares for aggregate net proceeds to the Fund of $8,512,092. There were no gross
sales charges for the sale of Class A shares for that period. During such
period, the Distributor did not receive CDSCs with respect to redemption within
one year after purchase of Class A shares purchased subject to front-end sales
charge waivers. During the fiscal year ended May 31, 1996, the Fund sold
2,963,785 Class D shares for aggregate net proceeds to the Fund of $28,203,483.
The gross sales charges for the sale of Class D shares of the Fund for that
period were $21,444, of which $2,485 and $18,959 were received by the
Distributor and Merrill Lynch, respectively. During such period, the Distributor
did not receive CDSCs with respect to redemption within one year after purchase
of Class D shares purchased subject to front-end sales charge waivers.

Eligible Class A Investors. Class A shares are offered to a limited group
of investors and also will be issued upon reinvestment of dividends on
outstanding Class A shares. Investors that currently own Class A shares of the
Fund in a shareholder account are entitled to purchase additional Class A shares
of the Fund in that account. Certain employer sponsored retirement or savings
plans, including 401(k) plans, may purchase Class A shares of the Fund at net
asset value provided such plans meet the required minimum number of eligible
employees or required amount of assets advised by MLAM or any of its affiliates.
Class A shares are available at net asset value to corporate warranty insurance
reserve fund programs provided that the program has $3 million or more initially
invested in MLAM-advised mutual funds. Also eligible to purchase Class A

32
<PAGE> 35

shares at net asset value are participants in certain investment programs
including TMA(SM) Managed Trusts to which Merrill Lynch Trust Company provides
discretionary trustee services, collective investment trusts for which Merrill
Lynch Trust Company serves as trustee and certain purchases made in connection
with the Merrill Lynch Mutual Fund Adviser program. In addition, Class A shares
are offered at net asset value to ML&Co. and its subsidiaries and their
directors and employees and to members of the Boards of MLAM-advised investment
companies, including the Fund. Certain persons who acquired shares of certain
MLAM-advised closed-end funds who wish to reinvest the net proceeds from a sale
of their closed-end fund shares of common stock in shares of the Fund also may
purchase Class A or Class D shares of the Fund if certain conditions set forth
in the Statement of Additional Information are met (for closed-end funds that
commenced operations prior to October 21, 1994). In addition, Class A shares of
the Fund and certain other MLAM-advised mutual funds are offered at net asset
value to shareholders of Merrill Lynch Senior Floating Rate Fund, Inc. and, if
certain conditions set forth in the Statement of Additional Information are met,
to shareholders of Merrill Lynch Municipal Strategy Fund, Inc. and Merrill Lynch
High Income Municipal Bond Fund, Inc. who wish to reinvest the net proceeds from
a sale of certain of their shares of common stock pursuant to a tender offer
conducted by such funds in shares of the Fund and certain other MLAM-advised
mutual funds.

Reduced Initial Sales Charges. No initial sales charges are imposed upon
Class A and Class D shares issued as a result of the automatic reinvestment of
dividends or capital gains distributions. Class A and Class D sales charges also
may be reduced under a Right of Accumulation and a Letter of Intention. Class A
shares are offered at net asset value to certain eligible Class A investors as
set forth above under "Eligible Class A Investors".

Class A and Class D shares are offered at net asset value to certain
employer-sponsored retirement or savings plans and to Employee Access
Accounts(SM) available through employers which provide such plans. Class A and
Class D shares are offered at net asset value to shareholders of Merrill Lynch
Municipal Strategy Fund, Inc. and Merrill Lynch High Income Municipal Bond Fund,
Inc. who wish to reinvest in shares of the Fund the net proceeds from a sale of
certain of their shares of common stock, pursuant to tender offers conducted by
those funds.

Class D shares are offered at net asset value to an investor who has a
business relationship with a Merrill Lynch financial consultant, if certain
conditions set forth in the Statement of Additional Information are met. Class D
shares may be offered at net asset value in connection with the acquisition of
assets of other investment companies.

Additional information concerning these reduced initial sales charges
including information regarding investments by Employee Sponsored Retirement or
Savings Plans is set forth in the Statement of Additional Information.

DEFERRED SALES CHARGE ALTERNATIVES--CLASS B AND CLASS C SHARES

Investors choosing the deferred sales charge alternatives should consider
Class B shares if they intend to hold their shares for an extended period of
time and Class C shares if they are uncertain as to the length of time they
intend to hold their assets in MLAM-advised mutual funds.

The public offering price of Class B and Class C shares for investors
choosing the deferred sales charge alternatives is the next determined net asset
value per share without the imposition of a sales charge at the

33
<PAGE> 36

time of purchase. As discussed below, Class B shares are subject to a four-year
CDSC, while Class C shares are subject only to a one-year 1.0% CDSC. On the
other hand, approximately ten years after Class B shares are issued, such Class
B shares, together with shares issued upon dividend reinvestment with respect to
those shares, are automatically converted into Class D shares of the Fund and
thereafter will be subject to lower continuing fees. See "Conversion of Class B
Shares to Class D Shares" below. Both Class B and Class C shares are subject to
an account maintenance fee of 0.25% of net assets and Class B shares are subject
to a distribution fee of 0.50% of net assets and Class C shares are subject to a
distribution fee of 0.55% of net assets as discussed below under "Distribution
Plans".

Class B and Class C shares are sold without an initial sales charge so that
the Fund will receive the full amount of the investor's purchase payment.
Merrill Lynch compensates its financial consultants for selling Class B and
Class C shares at the time of purchase from its own funds. See "Distribution
Plans" below.

Proceeds from the CDSC and the distribution fee are paid to the Distributor
and are used in whole or in part by the Distributor to defray the expenses of
dealers (including Merrill Lynch) related to providing distribution-related
services to the Fund in connection with the sale of the Class B and Class C
shares, such as the payment of compensation to financial consultants for selling
Class B and Class C shares from the dealer's own funds. 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 CDSC and the ongoing distribution fee
facilitates the ability of the Fund to sell the Class B and Class C shares
without a sales charge being deducted at the time of purchase. Approximately ten
years after issuance, Class B shares will convert automatically into Class D
shares of the Fund, which are subject to an account maintenance fee but no
distribution fee; Class B shares of certain other MLAM-advised mutual funds into
which exchanges may be made convert into Class D shares automatically after
approximately eight years. If Class B shares of the Fund are exchanged for Class
B shares of another MLAM-advised mutual fund, the conversion period applicable
to the Class B shares acquired in the exchange will apply, and the holding
period for the shares exchanged will be tacked onto the holding period for the
shares acquired.

Imposition of the CDSC and the distribution fee on Class B and Class C
shares is limited by the NASD asset-based sales charge rule. See "Limitations on
the Payment of Deferred Sales Charges" below. The proceeds from the ongoing
account maintenance fee are used to compensate Merrill Lynch for providing
continuing account maintenance activities. Class B shareholders of the Fund
exercising the exchange privilege described under "Shareholder
Services--Exchange Privilege" will continue to be subject to the Fund's CDSC
schedule if such schedule is higher than the CDSC schedule relating to the Class
B shares acquired as a result of the exchange.

Contingent Deferred Sales Charges--Class B Shares. Class B shares which
are redeemed within four years of purchase may be subject to a CDSC at the rates
set forth below charged as a percentage of the dollar amount subject thereto.
The charge will be assessed on an amount equal to the lesser of the proceeds of
redemption or the cost of the shares being redeemed. Accordingly, no CDSC will
be imposed on increases in net asset value above the initial purchase price. In
addition, no CDSC will be assessed on shares derived from reinvestment of
dividends or capital gains distributions.

34
<PAGE> 37

The following table sets forth the rates of the Class B CDSC:

<TABLE>
<CAPTION>
CLASS B CDSC
AS A PERCENTAGE
YEAR SINCE PURCHASE OF DOLLAR AMOUNT
PAYMENT MADE SUBJECT TO CHARGE
------------------------------------------------------------- -----------------
<S> <C>
0-1.................................................... 4.0%
1-2.................................................... 3.0%
2-3.................................................... 2.0%
3-4.................................................... 1.0%
4 and thereafter....................................... 0.0%
</TABLE>

During the fiscal year ended May 31, 1996, the Distributor received CDSCs
of $12,780 with respect to the redemptions of Class B shares, all of which was
paid to Merrill Lynch.

In determining whether a CDSC is applicable to a redemption, the
calculation will be determined in the manner that results in the lowest possible
rate being charged. Therefore, it will be 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 2.0% (the
applicable rate in the third year after purchase) for shares purchased on or
after October 21, 1994.

In the event that Class B shares are exchanged by certain retirement plans
for Class A shares in connection with a transfer to the Merrill Lynch Mutual
Fund Adviser ("MFA") program, the time period that such Class A shares are held
in the MFA program will be included in determining the holding period of Class B
shares reacquired upon the termination of participation in the MFA program (see
"Shareholder Services--Exchange Privilege").

The Class B CDSC is waived on redemptions of shares in connection with
certain post-retirement withdrawals from an Individual Retirement Account
("IRA") or other retirement plans or following the death or disability (as
defined in the Internal Revenue Code) of a shareholder. The Class B CDSC is
waived on redemptions of shares by certain eligible 401(a) and eligible 401(k)
plans. The Class B CDSC 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 IRA and held in such
account at the time of redemption and for any Class B shares that were acquired
and held at the time of the redemption in an Employee Access Account(SM)
available through employers providing eligible 401(k) plans. The Class B CDSC
also is waived for any Class B shares which are purchased by a Merrill Lynch
rollover IRA that was

35
<PAGE> 38

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. Additional
information concerning the waiver of the contingent deferred sales charge is set
forth in the Statement of Additional Information.

Contingent Deferred Sales Charges--Class C Shares. Class C shares which
are redeemed within one year after purchase may be subject to a 1.0% CDSC
charged as a percentage of the dollar amount subject thereto. The charge will be
assessed on an amount equal to the lesser of the proceeds of redemption or the
cost of the shares being redeemed. Accordingly, no Class C CDSC will be imposed
on increases in net asset value above the initial purchase price. In addition,
no Class C CDSC will be assessed on shares derived from reinvestment of
dividends or capital gains distributions.

In determining whether a Class C CDSC is applicable to a redemption, the
calculation will be determined in the manner that results in the lowest possible
rate being charged. Therefore, it will be assumed that the redemption is first
of shares held for over one year or shares acquired pursuant to reinvestment of
dividends or distributions and then of shares held longest during the one-year
period. The charge will not be applied to 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.

During the fiscal year ended May 31, 1996, the Distributor received CDSCs
of $3,334 with respect to redemptions of Class C shares, all of which were paid
to Merrill Lynch.

Conversion of Class B Shares to Class D Shares. After approximately ten
years (the "Conversion Period"), Class B shares will be converted automatically
into Class D shares of the Fund. Class D shares are subject to an ongoing
account maintenance fee of 0.25% of net assets but are not subject to the
distribution fee that is borne by Class B shares. Automatic conversion of Class
B shares into Class D shares will occur at least once each month (on the
"Conversion Date") on the basis of the relative net asset values of the shares
of the two classes on the Conversion Date, without the imposition of any sales
load, fee or other charge. Conversion of Class B shares to Class D shares will
not be deemed a purchase or sale of the shares for Federal income tax purposes.

In addition, shares purchased through reinvestment of dividends on Class B
shares also will convert automatically to Class D shares. The Conversion Date
for dividend reinvestment shares will be calculated taking into account the
length of time the shares underlying such dividend reinvestment shares were
outstanding. If at a Conversion Date the conversion of Class B shares to Class D
shares of the Fund in a single account will result in less than $50 worth of
Class B shares being left in the account, all of the Class B shares of the Fund
held in the account on the Conversion Date will be converted to Class D shares
of the Fund.

Share certificates for Class B shares of the Fund to be converted must be
delivered to the Transfer Agent at least one week prior to the Conversion Date
applicable to those shares. In the event such certificates are not received by
the Transfer Agent at least one week prior to the Conversion Date, the related
Class B shares will convert to Class D shares on the next scheduled Conversion
Date after such certificates are delivered.

In general, Class B shares of equity MLAM-advised mutual funds will convert
approximately eight years after initial purchase, and Class B shares of taxable
and tax-exempt fixed income MLAM-advised mutual funds will convert approximately
ten years after initial purchase. If, during the Conversion Period, a
shareholder exchanges Class B shares with an eight-year Conversion Period for
Class B shares with a ten-year

36
<PAGE> 39

Conversion Period, or vice versa, the Conversion Period applicable to the Class
B shares acquired in the exchange will apply, and the holding period for the
shares exchanged will be tacked onto the holding period for the shares acquired.

The Conversion Period is modified for shareholders who purchased Class B
shares through certain retirement plans which qualified for a waiver of the CDSC
normally imposed on purchases of Class B shares ("Class B Retirement Plans").
When the first share of any MLAM-advised mutual fund purchased by a Class B
Retirement Plan has been held for ten years (i.e., ten years from the date the
relationship between MLAM-advised mutual funds and the Class B Retirement Plan
was established), all Class B shares of all MLAM-advised mutual funds held in
that Class B Retirement Plan will be converted into Class D shares of the
appropriate funds. Subsequent to such conversion, that Class B Retirement Plan
will be sold Class D shares of the appropriate funds at net asset value per
share.

The Conversion Period also is modified for retirement plan investors who
participate in the MFA program. While participating in the MFA program, such
investors will hold Class A shares. If these Class A shares were acquired
through exchange of Class B shares (see "Shareholder Services--Exchange
Privilege"), then the holding period for such Class A shares will be "tacked" to
the holding period of the Class B shares originally held for purposes of
calculating the Conversion Period on Class B shares reacquired upon termination
of participation in the MFA program.

DISTRIBUTION PLANS

The Fund has adopted separate distribution plans for Class B, Class C and
Class D shares pursuant to Rule 12b-1 under the Investment Company Act (each a
"Distribution Plan") with respect to the account maintenance and/or distribution
fees paid by the Fund to the Distributor with respect to such classes. The Class
B and Class C Distribution Plans provide for the payment of account maintenance
fees and distribution fees, and the Class D Distribution Plan provides for the
payment of account maintenance fees.

The Distribution Plans for Class B, Class C and Class D shares each provide
that the Fund pays the Distributor an account maintenance fee relating to the
shares of the relevant class, accrued daily and paid monthly, at the annual rate
of 0.25% of the average daily net assets of the Fund attributable to shares of
the relevant class in order to compensate the Distributor and Merrill Lynch
(pursuant to a sub-agreement) in connection with account maintenance activities.

The Distribution Plans for Class B and Class C shares each provide that the
Fund also pays the Distributor a distribution fee relating to the shares of the
relevant class, accrued daily and paid monthly, at the annual rates of 0.50% for
Class B and 0.55% for Class C, of the average daily net assets of the Fund
attributable to the shares of the relevant class in order to compensate the
Distributor and Merrill Lynch (pursuant to a sub-agreement) for providing
shareholder and distribution services, and bearing certain distribution-related
expenses of the Fund, including payments to financial consultants for selling
Class B and Class C shares of the Fund. The Distribution Plans relating to Class
B and Class C shares are designed to permit an investor to purchase Class B and
Class C shares through dealers without the assessment of an initial sales charge
and at the same time permit the dealer to compensate its financial consultants
in connection with the sale of the Class B and Class C shares. In this regard,
the purpose and function of the ongoing distribution fees and the CDSC are the
same as those of the initial sales charge with respect to the Class A and Class
D

37
<PAGE> 40

shares of the Fund in that the deferred sales charges provide for the financing
of the distribution of the Fund's Class B and Class C shares.

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 payable 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, 1996, the Fund paid the Distributor
$1,256,198 pursuant to the Class B Distribution Plan (based on average net
assets subject to the Class B Distribution Plan of approximately $166.6
million), all of which was paid to Merrill Lynch for providing account
maintenance and distribution-related activities and services in connection with
Class B shares. For the fiscal year ended May 31, 1996, the Fund paid the
Distributor $11,933 pursuant to the Class C Distribution Plan (based on average
net assets subject to the Class C Distribution Plan of approximately $1.5
million), all of which was paid to Merrill Lynch for providing account
maintenance and distribution-related activities and services in connection with
Class C shares. For the fiscal year ended May 31, 1996, the Fund paid the
Distributor $33,515 pursuant to the Class D Distribution Plan (based on average
net assets subject to the Class D Distribution Plan of approximately $13.4
million), all of which was paid to Merrill Lynch for providing account
maintenance activities in connection with Class D shares. At August 31, 1996,
the net assets of the Fund subject to the Class B Distribution Plan aggregated
approximately $127.9 million. At this asset level, the annual fee payable
pursuant to the Class B Distribution Plan would aggregate approximately
$958,966. At August 31, 1996, the net assets of the Fund subject to the Class C
Distribution Plan aggregated approximately $2.1 million. At this asset level,
the annual fee payable pursuant to the Class C Distribution Plan would aggregate
approximately $17,058. At August 31, 1996, the net assets of the Fund subject to
the Class D Distribution Plan aggregated approximately $12.7 million. At this
asset level, the annual fee payable pursuant to the Class D Distribution Plan
would aggregate approximately $31,792.

The payments under the Distribution Plans are based on a percentage of
average daily net assets attributable to the shares regardless of the amount of
expenses incurred and, accordingly, distribution-related revenues from the
Distribution Plans may be more or less than distribution-related expenses.
Information with respect to the distribution-related revenues and expenses is
presented to the Directors for their consideration in connection with their
deliberations as to the continuance of the Class B and Class C Distribution
Plans. This information is presented annually as of December 31 of each year on
a "fully allocated accrual" basis and quarterly on a "direct expense and
revenue/cash" basis. On the fully allocated accrual basis, revenues consist of
the account maintenance fees, distribution fees, the CDSCs and certain other
related revenues, and expenses consist of financial consultant compensation,
branch office and regional operation center selling and transaction processing
expenses, advertising, sales promotion and 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 CDSCs
and the expenses consist of financial consultant compensation.

At December 31, 1995, with respect to Class B shares, the fully allocated
accrual expenses incurred by the Distributor and Merrill Lynch exceeded fully
allocated accrual revenues for such period by approximately $1,489,000 (.92% of
Class B net assets at that date). As of December 31, 1995, for Class B shares,
direct cash

38
<PAGE> 41

revenues for the period since commencement of the offering of Class B shares
exceeded direct cash expenses by $13,969,974 (8.67% of Class B net assets at
that date). As of May 31, 1996, for Class B shares, direct cash revenues for the
period since commencement of the offering of Class B shares exceeded direct cash
expenses by $14,384,842 (10.47% of Class B net assets at that date). Similar
fully allocated accrual data is not presented with respect to Class C shares
because such revenues and expenses for the period from October 21, 1994
(commencement of operations) to December 31, 1995 are de minimis. As of December
31, 1995, for Class C shares, direct cash expenses for the period since
commencement of the offering of Class C shares exceeded direct cash revenues by
$1,813 (.16% of Class C net assets at that date). As of May 31, 1996, for Class
C shares, direct cash revenues for the period since commencement of the offering
of Class C shares exceeded direct cash expenses by $2,151 (0.07% of Class C net
assets at that date).

The Fund has no obligation with respect to distribution and/or account
maintenance-related expenses incurred by the Distributor and Merrill Lynch in
connection with Class B, Class C and Class D shares, and there is no assurance
that the 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 account maintenance and/or distribution of each class of
shares separately. The initial sales charges, the account maintenance fee, the
distribution fee and/or the CDSCs received with respect to one class will not be
used to subsidize the sale of shares of another class. Payments of the
distribution fee on Class B shares will terminate upon conversion of those Class
B shares into Class D shares as set forth under "Deferred Sales Charge
Alternatives--Class B and Class C Shares--Conversion of Class B Shares to Class
D Shares".

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 distribution fee and the CDSC borne by the
Class B and Class C shares but not the account maintenance fee. 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) 6.25%
of eligible gross sales of Class B shares and Class C shares, computed
separately (defined to exclude shares issued pursuant to dividend reinvestments
and exchanges) plus (2) interest on the unpaid balance for the respective class,
computed separately, at the prime rate plus 1% (the unpaid balance being the
maximum amount payable minus amounts received from the payment of the
distribution fee and the contingent deferred sales charge). In connection with
the Class B shares, the Distributor has voluntarily agreed to waive interest
charges on the unpaid balance in excess of 0.50% of eligible gross sales.
Consequently the maximum amount payable to the Distributor (referred to as the
"voluntary maximum") in connection with the Class B shares is 6.75% of eligible
gross sales. The Distributor retains the right to stop waiving interest charges
at any time. To the extent payments would exceed the voluntary maximum, the Fund
will not make further payments of the distribution fee with respect to the Class
B shares and any CDSCs will be paid to the Fund rather than to the Distributor;
however, the Fund will continue to make payments of the account maintenance fee.
In certain circumstances the amount payable pursuant to the voluntary maximum
may exceed the amount payable under the NASD formula. In such circumstances
payment in excess of the amount payable under the NASD formula will not be made.

39
<PAGE> 42

REDEMPTION OF SHARES

The Fund is required to redeem for cash all shares of the Fund upon receipt
of a written request in proper form. The redemption price is the net asset value
per share next determined after the initial receipt of proper notice of
redemption. Except for any CDSC which may be applicable, there will be no charge
for redemption if the redemption request is sent directly to the Transfer Agent.
Shareholders liquidating their holdings will receive upon redemption all
dividends reinvested through the date of redemption. The value of shares at the
time of redemption may be more or less than the shareholder's cost, depending on
the market value of the securities held by the Fund at such time.

REDEMPTION

A shareholder wishing to redeem shares may do so by tendering the shares
directly to the Fund's Transfer Agent, Merrill Lynch Financial Data Services,
Inc., P.O. Box 45289, Jacksonville, Florida 32232-5289. 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 Merrill Lynch Financial Data Services, Inc., 4800 Deer
Lake Drive East, Jacksonville, Florida 32246-6484. Redemption requests should
not be sent to the Fund. A redemption 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 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. 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. Normally, this
delay will not exceed 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 close of business on the NYSE
(generally, 4:00 P.M., New York time) on the day received and such request is
received by the Fund from such dealer not later than 30 minutes after the close
of business on the NYSE on the same day. Dealers have the responsibility of
submitting such repurchase

40
<PAGE> 43

requests to the Fund not later than 30 minutes after the close of business on
the NYSE 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 CDSC); securities
firms which do not have selected dealer agreements with the Distributor,
however, may impose a transaction charge on the shareholder for transmitting the
notice of repurchase to the Fund. Merrill Lynch may charge its customers a
processing fee (presently $4.85) to confirm a repurchase of shares. Repurchases
directly through the Fund's Transfer Agent are not subject to the processing
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 AND CLASS D SHARES

Shareholders who have redeemed their Class A or Class D shares have a
one-time privilege to reinstate their accounts by purchasing Class A or Class D
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. Alternatively, the
reinstatement privilege may be exercised through the investor's Merrill Lynch
financial consultant within 30 days after the date the request for redemption
was accepted by the Transfer Agent or the Distributor. The reinstatement will be
made at the net asset value per share next determined after the notice of
reinstatement is received and cannot exceed the amount of the redemption
proceeds.

SHAREHOLDER SERVICES

The 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 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 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 or Class D shares from Merrill Lynch to
another

41
<PAGE> 44

brokerage firm or financial institution should be aware that, if the firm to
which the Class A or Class D shares are to be transferred will not take delivery
of shares of the Fund, a shareholder either must redeem the Class A or Class D
shares (paying any applicable CDSC) so that the cash proceeds can be transferred
to the account at the new firm or such shareholder must continue to maintain an
Investment Account at the Transfer Agent for those Class A or Class D shares.
Shareholders interested in transferring their Class B or Class C shares from
Merrill Lynch and who do not wish to have an Investment Account maintained for
such shares at the Transfer Agent may request their new brokerage firm to
maintain such shares in an account registered in the name of the brokerage firm
for the benefit of the shareholder at the Transfer Agent. If the new brokerage
firm is willing to accommodate the shareholder in this manner, the shareholder
must request that he or she be issued certificates for his or her shares and
then must turn the certificates over to the new firm for re-registration as
described in the preceding sentence. 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 CDSC) 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

U.S. shareholders of each class of shares of the Fund have an exchange
privilege with certain other MLAM-advised mutual funds. There is currently no
limitation on the number of times a shareholder may exercise the exchange
privilege. The exchange privilege may be modified or terminated in accordance
with the rules of the Commission.

Under the Merrill Lynch Select Pricing(SM) System, Class A shareholders may
exchange Class A shares of the Fund for Class A shares of a second MLAM-advised
mutual fund if the shareholder holds any Class A shares of the second fund in
his or her account in which the exchange is made at the time of the exchange or
is otherwise eligible to purchase Class A shares of the second fund. If the
Class A shareholder wants to exchange Class A shares for shares of a second
MLAM-advised mutual fund, and the shareholder does not hold Class A shares of
the second fund in his or her account at the time of the exchange and is not
otherwise eligible to acquire Class A shares of the second fund, the shareholder
will receive Class D shares of the second fund as a result of the exchange.
Class D shares also may be exchanged for Class A shares of a second MLAM-advised
mutual fund at any time as long as, at the time of the exchange, the shareholder
holds Class A shares of the second fund in the account in which the exchange is
made or is otherwise eligible to purchase Class A shares of the second fund.

Exchanges of Class A and Class D shares are made on the basis of the
relative net asset values per Class A or Class D share, respectively, plus an
amount equal to the difference, if any, between the sales charge previously paid
on the Class A or Class D shares being exchanged and the sales charge payable at
the time of the exchange on the shares being acquired.

Class B, Class C and Class D shares are exchangeable with shares of the
same class of other MLAM-advised mutual funds.

Shares of the Fund which are subject to a CDSC are exchangeable on the
basis of relative net asset value per share without the payment of any CDSC that
might otherwise be due upon redemption of the shares of the

42
<PAGE> 45

Fund. For purposes of computing the CDSC that may be payable upon a disposition
of the shares acquired in the exchange, the holding period for the previously
owned shares of the Fund is "tacked" to the holding period for the newly
acquired shares of the other fund.

Class A, Class B, Class C and Class D shares also are exchangeable for
shares of certain MLAM-advised money market funds specifically designated as
available for exchange by holders of Class A, Class B, Class C or Class D
shares. The period of time that Class A, Class B, Class C or Class D shares are
held in a money market fund, however, will not count toward satisfaction of the
holding period requirement for reduction of any CDSC imposed on such shares, if
any, and, with respect to Class B shares, toward satisfaction of the Conversion
Period.

Class B shareholders of the Fund exercising the exchange privilege will
continue to be subject to the Fund's CDSC schedule if such schedule is higher
than the CDSC schedule relating to the new Class B shares. In addition, Class B
shares of the Fund acquired through use of the exchange privilege will be
subject to the Fund's CDSC schedule if such schedule is higher than the CDSC
schedule relating to the Class B shares of the MLAM-advised mutual fund from
which the exchange has been made.

Exercise of the exchange privilege is treated as a sale of the exchanged
shares and a purchase of the acquired shares for Federal income tax purposes.
For further information, see "Shareholder Services-- Exchange Privilege" in the
Statement of Additional Information.

The exchange privilege is modified with respect to certain retirement plans
which participate in the MFA program. Such retirement plans may exchange Class
B, Class C or Class D shares that have been held for at least one year for Class
A shares of the same fund on the basis of relative net asset values in
connection with the commencement of participation in the MFA program, i.e., no
CDSC will apply. The one-year holding period does not apply to shares reacquired
through reinvestment of dividends. Upon termination of participation in the MFA
program, Class A shares will be re-exchanged for the class of shares originally
held. For purposes of computing any CDSC that may be payable upon redemption of
Class B or Class C shares so reacquired, or the Conversion Period for Class B
shares so reacquired, the holding period for the Class A shares will be "tacked"
to the holding period for the Class B or Class C shares originally held. The
Fund's exchange privilege also is modified with respect to purchases of Class A
and Class D shares by non-retirement plan investors under the MFA program.
First, the initial allocation of assets is made under the MFA program. Then, any
subsequent exchange under the MFA program of Class A or Class D shares of a
MLAM-advised mutual fund for Class A or Class D 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 MLAM-advised mutual fund
and the sales charge payable on the shares of the Fund being acquired in the
exchange under the MFA program.

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 on or about the
payment date. Cash payments can also be directly deposited to the shareholder's
bank account. No CDSC will

43
<PAGE> 46

be imposed on redemption of shares issued as a result of the automatic
reinvestment of dividends or capital gains distributions.

SYSTEMATIC WITHDRAWAL PLANS

A Class A or Class D shareholder may elect to receive systematic withdrawal
payments from his or her Investment Account in the form of payments by check or
through automatic payment by direct deposit to the investor's bank account on
either a monthly or quarterly basis. A Class A or Class D shareholder whose
shares are held within a CMA(R), CBA(R) or Retirement Account may elect to have
shares redeemed on a monthly, bimonthly, quarterly, semiannual or annual basis
through the Systematic Redemption Program, subject to certain conditions.

AUTOMATIC INVESTMENT PLANS

Regular additions of Class A, Class B, Class C or Class D shares may be
made to an investor's Investment Account by prearranged charges of $50 or more
to his or her regular bank account. Investors who maintain CMA(R) or CBA(R)
accounts may arrange to have periodic investments made in the Fund in their
CMA(R) or CBA(R) accounts or in certain related accounts in amounts of $100 or
more through the CMA(R) or CBA(R) Automated Investment Program.

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,
Class B, Class C and Class D shareholders (together, the "shareholders"). The
Fund intends to distribute substantially all of such income.

Dividends paid by the Fund from its ordinary income or from an excess of
net short-term capital gains over net long-term capital losses (together
referred to hereafter as "ordinary income dividends") are taxable to
shareholders as ordinary income. Distributions made from an excess of net
long-term capital gains over net short-term capital losses (including gains or
losses from certain transactions in futures and options) ("capital gain
dividends") are taxable to shareholders 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

44
<PAGE> 47

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 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.

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.

No gain or loss will be recognized by Class B shareholders on the
conversion of their Class B shares into Class D shares. A shareholder's basis in
the Class D shares acquired will be the same as such shareholder's basis in the
Class B shares converted, and the holding period of the acquired Class D shares
will include the holding period for the converted Class B shares.

If a shareholder exercises an exchange privilege within 90 days of
acquiring the shares, then the loss the shareholder can recognize on the
exchange will be reduced (or the gain increased) to the extent any sales charge
paid to the Fund on the exchanged shares reduces any sales charge 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), that 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 treatment as a RIC 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

45
<PAGE> 48

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.

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, Class B, Class C and Class D
shares in accordance with formulas specified by the 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 any CDSC 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 and Class C shares and the maximum sales charge in the
case of Class A shares and Class D shares. Dividends paid by the Fund with
respect to all shares to the extent any dividends are paid, will be calculated
in the same manner at the same time on the same day and will be in the same
amount, except that account maintenance fees, distribution charges and any
incremental transfer agency costs relating to each class of shares will be borne
exclusively by that class. The Fund will include performance data for all
classes of shares of the Fund in any advertisement or information including
performance data of the Fund.

The Fund also may quote total return and aggregate total return performance
data for various specified time periods. Such data will be calculated
substantially as described above, except that (1) the rates of return calculated
will not be average annual rates, but rather, actual annual, annualized or
aggregate rates of return and (2) the maximum applicable sales charges will not
be included with respect to annual or annualized rates of return calculations.
Aside from the 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 waiver
of the CDSC in the case of Class B and Class C shares (such as investors in
certain retirement plans) or to reduce sales charges in the case of Class A and
Class D shares, performance data may

46
<PAGE> 49

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 may be 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.

The yield for the 30-day period ended May 31, 1996 was 5.69%, 5.18%, 5.13%
and 5.46% for Class A, Class B, Class C and Class D shares, respectively.

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, 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 that of the Standard &
Poor's 500 Composite Stock Price Index, The Financial Times/Standard & Poor's
Actuarial World Indices, the Morgan Stanley Capital International Indices, the
Dow Jones Industrial Average, or 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 Magazine,
Fortune Magazine, or other industry publications. In addition, from time to time
the Fund may include its 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
indicative 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

47
<PAGE> 50

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, 1996, the Fund's portfolio turnover rate was
25.30%. (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.

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 of 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 each class of shares will be
reduced as a result of any account maintenance, distribution and higher transfer
agency fees applicable with respect to that class. See "Determination of Net
Asset Value" below. 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. From time to
time, the Fund may declare a special distribution at or about the end of the
calender year in order to comply with a Federal income tax requirement that
certain percentages of its ordinary income and capital gains be distributed
during the calendar year.

48
<PAGE> 51

DETERMINATION OF NET ASSET VALUE

The net asset value of the shares of all classes of the Fund is determined
by the Manager once daily, 15 minutes after the close of business on the NYSE
(generally, 4:00 P.M., New York time), on each day during which the NYSE is open
for trading. The net asset value per share is computed by dividing the 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 management fees and
any account maintenance and/or distribution fees payable to 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. For the fiscal year ended May 31, 1996, the Fund paid
$1,593 to MLSPS for such service.

The per share net asset value of Class A shares will generally be higher
than the per share net asset value of shares of the other classes, reflecting
the daily expense accruals of the account maintenance, distribution and higher
transfer agency fees applicable with respect to the Class B and Class C shares
and the daily expense accruals of the account maintenance fees applicable with
respect to Class D shares; moreover, the per share net asset value of Class D
shares generally will be higher than the per share net asset value of Class B
and Class C shares, reflecting the daily expense accruals of the distribution
and higher transfer agency fees applicable with respect to Class B and Class C
shares. It is expected, however, that the per share net asset value of the
classes will tend to converge (although not necessarily meet) immediately after
the payment of dividends or distributions, which will differ by approximately
the amount of the expense accrual differentials between the classes.

ORGANIZATION OF THE FUND

The Fund was incorporated under Maryland law on April 19, 1991. It has an
authorized capital of 600,000,000 shares of common stock, par value $0.10 per
share, divided into four classes, designated Class A, Class B, Class C and Class
D Common Stock. Class A and Class C each consists of 100,000,000 shares and
Class B and Class D each consists of 200,000,000 shares. Shares of Class A,
Class B, Class C and Class D Common Stock represent an interest in the same
assets of the Fund and are identical in all respects except that Class B, Class
C and Class D shares bear certain expenses related to the account maintenance
associated with such shares, and Class B and Class C shares bear certain
expenses related to the distribution of such shares. Each class has exclusive
voting rights with respect to matters relating to account maintenance and
distribution expenditures, as applicable. See "Purchase of Shares." The
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 rights. Shares

49
<PAGE> 52

have the conversion rights described in this Prospectus. Each share of 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, the
Class B, Class C and Class D shares bear certain additional expenses.

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:

Merrill Lynch Financial Data Services, Inc.
P.O. Box 45289
Jacksonville, FL 32232-5289

The written notification should include the shareholder's name, address,
tax identification number and Merrill Lynch, Pierce, Fenner & Smith Incorporated
and/or mutual fund account numbers. If you have any questions regarding this
please call your Merrill Lynch financial consultant or Merrill Lynch Financial
Data Services, Inc. at 800-637-3863.

50
<PAGE> 53

MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC. -- AUTHORIZATION FORM
(PART 1)
- --------------------------------------------------------------------------------

NOTE: THIS FORM MAY NOT BE USED FOR PURCHASES THROUGH THE MERRILL LYNCH
BLUEPRINT(SM) PROGRAM.
- --------------------------------------------------------------------------------
1. SHARE PURCHASE APPLICATION

I, being of legal age, wish to purchase: (choose one)
/ / Class A shares / / Class B shares / / Class C shares
/ / Class D shares
of Merrill Lynch Adjustable Rate Securities Fund, Inc., and establish an
Investment Account as described in the Prospectus. In the event that I am not
eligible to purchase Class A shares, I understand that Class D shares will be
purchased.

Basis for establishing an Investment Account:

A. I enclose a check for $.......... payable to Merrill Lynch Financial
Data Services, Inc. as an initial investment (minimum $1,000). I understand
that this purchase will be executed at the applicable offering price next to
be determined after this Application is received by you.

B. I already own shares of the following Merrill Lynch mutual funds that
would qualify for the Right of Accumulation as outlined in the Statement of
Additional Information: Please list all funds. (Use a separate sheet of paper
if necessary.)

1. ............................... 4. ..........................

2. ............................... 5. ..........................

3. ............................... 6. ..........................

Name...........................................................................
First Name Initial Last Name

Name of Co-Owner (if any).......................................................
First Name Initial Last Name

Address.........................................................................

..................................................... Date...............
(Zip Code)
<TABLE>
<S> <C>
Occupation ......................................... Name and Address of Employer.................................................

.............................................................................

................................................... .............................................................................
Signature of Owner Signature of Co-Owner (if any)
</TABLE>

(In the case of co-owners, a joint tenancy with rights of survivorship will be
presumed unless otherwise specified.)
- --------------------------------------------------------------------------------
2. DIVIDEND AND CAPITAL GAIN DISTRIBUTION OPTIONS

<TABLE>
<S> <C>
Ordinary Income Dividends Long-Term Capital Gains
--------------------------------- ---------------------------------
SELECT / / Reinvest SELECT / / Reinvest
ONE: / / Cash ONE: / / Cash
--------------------------------- ---------------------------------
</TABLE>

If no election is made, dividends and capital gains will be automatically
reinvested at net asset value without a sales charge.

IF CASH, SPECIFY HOW YOU WOULD LIKE YOUR DISTRIBUTIONS PAID TO YOU: / / Check
or / / Direct Deposit to bank account

IF DIRECT DEPOSIT TO BANK ACCOUNT IS SELECTED, PLEASE COMPLETE BELOW:

I hereby authorize payment of dividend and capital gain distributions by direct
deposit to my bank account and, if necessary, debit entries and adjustments for
any credit entries made to my account in accordance with the terms I have
selected on the Merrill Lynch Adjustable Rate Securities Fund, Inc.
Authorization Form.

SPECIFY TYPE OF ACCOUNT (check one): / / checking / / savings

Name on your account............................................................

Bank Name.......................................................................

Bank Number ...................................... Account Number..............

Bank Address....................................................................

I agree that this authorization will remain in effect until I provide written
notification to Merrill Lynch Financial Data Services, Inc. amending or
terminating this service.

Signature of Depositor..........................................................

Signature of Depositor ..................................Date...................
(if joint account, both must sign)

NOTE: If direct deposit to bank account is selected, your blank, unsigned check
marked "VOID" or a deposit slip from your savings account should accompany this
application.

A-1
<PAGE> 54

MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC. -- AUTHORIZATION FORM
(PART 1) -- (CONTINUED)
- --------------------------------------------------------------------------------

3. SOCIAL SECURITY NUMBER OR TAXPAYER IDENTIFICATION NUMBER
___________________________________________
/__________________________________________/
Social Security Number or Taxpayer Identification Number

Under penalty of perjury, I certify (1) that the number set forth above is my
correct Social Security Number or Taxpayer Identification Number and (2) that I
am not subject to backup withholding (as discussed in the Prospectus under
"Taxes") either because I have not been notified that I am subject thereto as a
result of a failure to report all interest or dividends, or the Internal Revenue
Service ("IRS") has notified me that I am no longer subject thereto.

INSTRUCTION: YOU MUST STRIKE OUT THE LANGUAGE IN (2) ABOVE IF YOU HAVE BEEN
NOTIFIED THAT YOU ARE SUBJECT TO BACKUP WITHHOLDING DUE TO UNDER-REPORTING AND
IF YOU HAVE NOT RECEIVED A NOTICE FROM THE IRS THAT BACKUP WITHHOLDING HAS BEEN
TERMINATED. THE UNDERSIGNED AUTHORIZES THE FURNISHING OF THIS CERTIFICATION TO
OTHER MERRILL LYNCH SPONSORED MUTUAL FUNDS.

<TABLE>
<S> <C>
............................................................. ............................................................
Signature of Owner Signature of Co-Owner (if any)
</TABLE>

- --------------------------------------------------------------------------------

4. LETTER OF INTENTION--CLASS A AND D SHARES ONLY (See terms and conditions in
the Statement of Additional Information)

<TABLE>
<S> <C>
......................, 19 . . . .
Dear Sir/Madam: Date of Initial Purchase
</TABLE>

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 distributor over the next 13 month period which will
equal or exceed:

/ / $25,000 / / $50,000 / / $100,000 / / $250,000 / / $1,000,000

Each purchase will be made at the then reduced offering price applicable to
the amount checked above, as described in the Fund's prospectus.

I agree to the terms and conditions of this Letter of Intention. I hereby
irrevocably constitute and appoint Merrill Lynch Funds Distributor, Inc. my
attorney, with full power of substitution, to surrender for redemption any or
all shares of Merrill Lynch Adjustable Rate Securities Fund, Inc. held as
security.

<TABLE>
<S> <C>
By:.............................................................. ...............................................................
Signature of Owner Signature of Co-Owner
(If registered in joint names, both 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....................................................

Account Number ............................................ Account Number..............................................
</TABLE>

- --------------------------------------------------------------------------------

5. FOR DEALER ONLY

- --- Branch Office, Address, Stamp ---
- --- ---

- --- ---
- --- ---

This form when completed should be mailed to:

Merrill Lynch Adjustable Rate Securities Fund, Inc.
c/o Merrill Lynch Financial Data Services, Inc.
P.O. Box 45289
Jacksonville, Florida 32232-5289

We hereby authorize Merrill Lynch Funds Distributor, Inc. to act as our agent in
connection with transactions under this authorization form and agree to notify
the Distributor of any purchases or sales made under a Letter of Intention,
Automatic Investment Plan or Systematic Withdrawal Plan. We guarantee the
Shareholder's signature.

................................................................................
Dealer Name and Address

By .............................................................................
Authorized Signature of Dealer

- ----------- ------------

- ----------- ------------ ..............................
Branch-Code F/C No. F/C Last Name

- ----------- ---------------

- ----------- ---------------
Dealer's Customer A/C No.

A-2
<PAGE> 55

MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC. -- AUTHORIZATION FORM
(PART 2)
- --------------------------------------------------------------------------------
NOTE: THIS FORM IS REQUIRED TO APPLY FOR THE SYSTEMATIC WITHDRAWAL PLAN OR THE
AUTOMATIC INVESTMENT PLAN ONLY.
- --------------------------------------------------------------------------------

1. ACCOUNT REGISTRATION
<TABLE>
<S> <C>

------------------------------------

Name of Owner....................................................................... ------------------------------------
Social Security No.
or Taxpayer Identification Number
Name of Co-Owner (if any)...........................................................

Address.............................................................................

.................................................................................... Account Number...........................
(if existing account)
</TABLE>

- --------------------------------------------------------------------------------
2. SYSTEMATIC WITHDRAWAL PLAN--CLASS A AND CLASS D SHARES ONLY (SEE TERMS AND
CONDITIONS IN THE STATEMENT OF ADDITIONAL INFORMATION)

MINIMUM REQUIREMENTS: $10,000 for monthly disbursements, $5,000 for
quarterly, of / / Class A or / / Class D shares in Merrill Lynch Adjustable Rate
Securities Fund, Inc., at cost or current offering price. Withdrawals to be made
either (check one) / / Monthly on the 24th day of each month, or / / Quarterly
on the 24th day of March, June, September and December. If the 24th falls on a
weekend or holiday, the next succeeding business day will be utilized. Begin
systematic withdrawal on ________________ or as soon as possible thereafter.
(month)

SPECIFY HOW YOU WOULD LIKE YOUR WITHDRAWAL PAID TO YOU (CHECK ONE): / /
$________ or / / ____% of the current value of / / Class A or / / Class D shares
in the account.

SPECIFY WITHDRAWAL METHOD: / / check or / / direct deposit to bank account
(check one and complete part (a) or (b) below):

DRAW CHECKS PAYABLE (CHECK ONE)

(a) I hereby authorize payment by check
/ / as indicated in Item 1.
/ / to the order of..........................................................

Mail to (check one)
/ / the address indicated in Item 1.
/ / Name (Please Print)......................................................

Address.........................................................................

...........................................................................

Signature of Owner..........................................Date................

Signature of Co-Owner (if any)..................................................

(b) I HEREBY AUTHORIZE PAYMENT BY DIRECT DEPOSIT TO BANK ACCOUNT AND (IF
NECESSARY), DEBIT ENTRIES AND ADJUSTMENTS FOR ANY CREDIT ENTRIES MADE IN ERROR
TO MY ACCOUNT. I AGREE THAT THIS AUTHORIZATION WILL REMAIN IN EFFECT UNTIL I
PROVIDE WRITTEN NOTIFICATION TO MERRILL LYNCH FINANCIAL DATA SERVICES, INC.
AMENDING OR TERMINATING THIS SERVICE.

Specify type of account (check one): / / checking / / savings

Name on your Account............................................................

Bank Name.......................................................................

Bank Number ..............................Account Number........................

Bank Address....................................................................

....................................................................

Signature of Depositor.....................................Date.................

Signature of Depositor..........................................................
(If joint account, both must sign)

NOTE: IF DIRECT DEPOSIT IS ELECTED, YOUR BLANK, UNSIGNED CHECK MARKED "VOID" OR
A DEPOSIT SLIP FROM YOUR SAVINGS ACCOUNT SHOULD ACCOMPANY THIS APPLICATION.

A-3
<PAGE> 56

MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC. -- AUTHORIZATION FORM
(PART 2) -- (CONTINUED)
- --------------------------------------------------------------------------------

3. APPLICATION FOR AUTOMATIC INVESTMENT PLAN

I hereby request that Merrill Lynch Financial Data Services, Inc. draw an
automated clearing house ("ACH") debit on my checking account described below
each month to purchase: (choose one)
/ / Class A shares / / Class B shares / / Class C shares
/ / Class D shares

of Merrill Lynch Adjustable Rate Securities Fund, Inc. subject to the terms set
forth below. In the event that I am not eligible to purchase Class A shares, I
understand that Class D shares will be purchased.

MERRILL LYNCH FINANCIAL DATA SERVICES, INC.

You are hereby authorized to draw an ACH debit each month on my bank account for
investment in Merrill Lynch Adjustable Rate Securities Fund, Inc., as indicated
below:

Amount of each check or ACH debit $..........................................

Account Number...............................................................
Please date and invest ACH debits on the 20th of each month

beginning ________________ or as soon as possible thereafter.
(month)

I agree that you are drawing these ACH debits voluntarily at my request and
that you shall not be liable for any loss arising from any delay in preparing or
failure to prepare any such debit. If I change banks or desire to terminate or
suspend this program, I agree to notify you promptly in writing. I hereby
authorize you to take any action to correct erroneous ACH debits of my bank
account or purchases of fund shares including liquidating shares of the Fund and
crediting my bank account. I further agree that if a debit is not honored upon
presentation, Merrill Lynch Financial Data 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
dishonored debit.

................. .......................................
Date Signature of Depositor

.......................................
Signature of Depositor
(If joint account, both must sign)

AUTHORIZATION TO HONOR ACH DEBITS DRAWN
BY MERRILL LYNCH FINANCIAL DATA SERVICES, INC.

To..........................................................................Bank
(Investor's Bank)

Bank Address....................................................................

City .......... State .......... Zip Code.......................................

As a convenience to me, I hereby request and authorize you to pay and charge to
my account ACH debits drawn on my account by and payable to Merrill Lynch
Financial Data Services, Inc. I agree that your rights in respect of each such
debit shall be the same as if it were a check drawn on you and signed personally
by me. This authority is to remain in effect until revoked by me in writing.
Until you receive such notice, you shall be fully protected in honoring any such
debit. I further agree that if any such debit be dishonored, whether with or
without cause and whether intentionally or inadvertently, you shall be under no
liability.

................. .......................................
Date Signature of Depositor

................. .......................................
Bank Account Signature of Depositor
Number (If joint account, both must sign)

NOTE: IF AUTOMATIC INVESTMENT PLAN IS ELECTED, YOUR BLANK, UNSIGNED CHECK MARKED
"VOID" SHOULD ACCOMPANY THIS APPLICATION.

A-4
<PAGE> 57

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 9081

Princeton, New Jersey 08543-9081

CUSTODIAN
The Bank of New York
90 Washington Street
12th Floor
New York, New York 10286

TRANSFER AGENT
Merrill Lynch Financial Data Services, Inc.
Administrative Offices:
4800 Deer Lake Drive East
Jacksonville, Florida 32246-6484
Mailing Address:
P.O. Box 45289
Jacksonville, Florida 32232-5289

INDEPENDENT AUDITORS
Deloitte & Touche LLP
117 Campus Drive
Princeton, New Jersey 08540-6400

COUNSEL

Brown & Wood LLP

One World Trade Center
New York, New York 10048-0557
<PAGE> 58

NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, IN CONNECTION
WITH THE OFFER CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER
INFORMATION OR 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
Merrill Lynch Select Pricing(SM) System........ 6
Financial Highlights........................... 10
Investment Objective and Policies.............. 12
Types of Issuers/Quality Standards........... 13
Description of Adjustable Rate Securities.... 14
Description of Other Securities.............. 17
Description of Money Market Securities....... 18
Special Considerations and Risk Factors...... 19
Portfolio Strategies Involving Interest Rate
Transactions, Options and Futures.......... 21
Other Investment Policies and Practices...... 25
Management of the Fund......................... 28
Directors.................................... 28
Management and Advisory Arrangements......... 28
Code of Ethics............................... 29
Transfer Agency Services..................... 29
Purchase of Shares............................. 30
Initial Sales Charge Alternatives--
Class A and Class D Shares................. 31
Deferred Sales Charge Alternatives--
Class B and Class C Shares................. 33
Distribution Plans........................... 37
Limitations on the Payment of Deferred Sales
Charges.................................... 39
Redemption of Shares........................... 40
Redemption................................... 40
Repurchase................................... 40
Reinstatement Privilege--
Class A and Class D Shares................. 41
Shareholder Services........................... 41
Investment Account........................... 41
Exchange Privilege........................... 42
Automatic Reinvestment of Dividends and
Capital Gains Distributions................ 43
Systematic Withdrawal Plans.................. 44
Automatic Investment Plans................... 44
Taxes.......................................... 44
Performance Data............................... 46
Portfolio Transactions......................... 47
Portfolio Turnover........................... 48
Additional Information......................... 48
Dividends and Distributions.................. 48
Determination of Net Asset Value............. 49
Organization of the Fund..................... 49
Shareholder Inquiries........................ 50
Shareholder Reports.......................... 50
Authorization Form............................. A-1
Code #13937-0996
</TABLE>

[MERRILL LYNCH LOGO]

MERRILL LYNCH
ADJUSTABLE RATE
SECURITIES FUND, INC.
[MERRILL LYNCH COMPASS]

PROSPECTUS

September 27, 1996

Distributor:
Merrill Lynch
Funds Distributor, Inc.

This prospectus should be
retained for future reference.
<PAGE> 59

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.

Pursuant to the Merrill Lynch Select Pricing(SM) System, the Fund offers
four classes of shares each with a different combination of sales charges,
ongoing fees and other features. The Merrill Lynch Select Pricing(SM) System
permits an investor to choose the method of purchasing shares that the investor
believes is most beneficial given the amount of the purchase, the length of time
the investor expects to hold the shares and other relevant circumstances.
-------------------------

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 27, 1996 (the "Prospectus"), which has been filed with the Securities
and Exchange Commission (the "Commission") and can be obtained, without charge,
by calling or by writing the Fund at the above telephone number or address. This
Statement of Additional Information has been incorporated by reference into the
Prospectus.

-------------------------
MERRILL LYNCH ASSET MANAGEMENT -- MANAGER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
-------------------------

The date of this Statement of Additional Information is September 27, 1996

<PAGE> 60

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 debt securities which
are not Adjustable Rate Securities, including fixed rate treasury bills, notes
and bonds, fixed rate mortgage and asset related securities, and derivative
securities relating thereto, including 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

2
<PAGE> 61

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.

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.

Government 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"

3
<PAGE> 62

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 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.

4
<PAGE> 63

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 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.

5
<PAGE> 64

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.

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

6
<PAGE> 65

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 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

7
<PAGE> 66

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.

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, the American Stock
Exchange, the Philadelphia Stock Exchange, the Pacific Stock Exchange, the New
York Stock Exchange (the "NYSE") or the 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

8
<PAGE> 67

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.

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

9
<PAGE> 68

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 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

10
<PAGE> 69

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 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 (5)
below, the Fund may lend securities from its portfolio to approved borrowers and
receive collateral in cash or securities issued or guaranteed by the U.S.
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

11
<PAGE> 70

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. Make any investment inconsistent with the Fund's classification as
a diversified company under the 1940 Act.

2. Invest more than 25% of its assets, taken at market value, in the
securities of issuers in any particular industry (excluding the U.S.
Government and its agencies and instrumentalities).

3. Make investments for the purpose of exercising control or
management.

4. Purchase or sell real estate, except that, to the extent permitted
by applicable law, the Fund may invest in securities directly or indirectly
secured by real estate or interests therein or issued by companies which
invest in real estate or interests therein.

5. Make loans to other persons, except that the acquisition of bonds,
debentures or other corporate debt securities and investment in government
obligations, commercial paper, pass-through instruments, certificates of
deposit, bankers acceptances, repurchase agreements or any similar
instruments shall not be deemed to be the making of a loan, and except
further that the Fund may lend its portfolio securities, provided that the
lending of portfolio securities may be made only in accordance with
applicable law and the guidelines set forth in the Fund's Prospectus and
Statement of Additional Information, as they may be amended from time to
time.

6. Issue senior securities to the extent such issuance would violate
applicable law.

7. Borrow money, except that (i) the Fund may borrow from banks (as
defined in the 1940 Act) in amounts up to 33 1/3% of its total assets
(including the amount borrowed), (ii) the Fund may, to the extent permitted
by applicable law, borrow up to an additional 5% of its total assets for
temporary purposes (currently Ohio regulations prohibit any borrowing in
excess of 33 1/3% of the Fund's total assets), (iii) the Fund may obtain
such short-term credit as may be necessary for the clearance of purchases
and sales of portfolio securities and (iv) the Fund may purchase securities
on margin to the extent permitted by applicable law. The Fund may not
pledge its assets other than to secure such borrowings or, to the extent
permitted by the Fund's investment policies as set forth in its Prospectus
and Statement of Additional Information, as they may be amended from time
to time, in connection with hedging transactions, short sales, when-issued
and forward commitment transactions and similar investment strategies.

8. Underwrite securities of other issuers except insofar as the Fund
technically may be deemed an underwriter under the Securities Act of 1933,
as amended (the "Securities Act") in selling portfolio securities.

9. Purchase or sell commodities or contracts on commodities, except to
the extent that the Fund may do so in accordance with applicable law and
the Fund's Prospectus and Statement of Additional Information, as they may
be amended from time to time, and without registering as a commodity pool
operator under the Commodity Exchange Act.

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<PAGE> 71

Under the non-fundamental investment restrictions, the Fund may not:

a. Purchase securities of other investment companies, except to the
extent such purchases are permitted by applicable law.

b. Make short sales of securities or maintain a short position, except
to the extent permitted by applicable law. The Fund currently does not
intend to engage in short sales, except short sales "against the box".

c. Invest in securities which cannot be readily resold because of
legal or contractual restrictions or which cannot otherwise be marketed,
redeemed or put to the issuer or a third party, if at the time of
acquisition more than 15% of its total assets would be invested in such
securities. This restriction shall not apply to securities which mature
within seven days or securities which the Board of Directors of the Fund
has otherwise determined to be liquid pursuant to applicable law.
Notwithstanding the 15% limitation herein, to the extent the laws of any
state in which the Fund's shares are registered or qualified for sale
require a lower limitation, the Fund will observe such limitation. As of
the date hereof, therefore, the Fund will not invest more than 10% of its
total assets in securities which are subject to this investment restriction
(c). Securities purchased in accordance with Rule 144A under the Securities
Act (each, a "Rule 144A security") and determined to be liquid by the
Fund's Board of Directors are not subject to the limitations set forth in
this investment restriction (c).

d. Invest in warrants if, at the time of acquisition, its investments
in warrants, valued at the lower of cost or market value, would exceed 5%
of the Fund's net assets; included within such limitation, but not to
exceed 2% of the Fund's net assets, are warrants which are not listed on
the NYSE or American Stock Exchange or a major foreign exchange. For
purposes of this restriction, warrants acquired by the Fund in units or
attached to securities may be deemed to be without value.

e. Invest in securities of companies having a record, together with
predecessors, of less than three years of continuous operation, if more
than 5% of the Fund's total assets would be invested in such securities.
This restriction shall not apply to mortgage-backed securities,
asset-backed securities or obligations issued or guaranteed by the U.S.
Government, its agencies or instrumentalities.

f. Purchase or retain the securities of any issuer, if those
individual officers and directors of the Fund, the officers and general
partner of the Manager, the directors of such general partner or the
officers and directors of any subsidiary thereof each owning beneficially
more than one-half of one percent of the securities of such issuer own in
the aggregate more than 5% of the securities of such issuer.

g. Invest in real estate limited partnership interests or interests in
oil, gas or other mineral leases, or exploration or development programs,
except that the Fund may invest in securities issued by companies that
engage in oil, gas or other mineral exploration or development activities.

h. Write, purchase or sell puts, calls, straddles, spreads or
combinations thereof, except to the extent permitted in the Fund's
Prospectus and Statement of Additional Information, as they may be amended
from time to time.

i. Notwithstanding fundamental investment restriction (7) above,
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

13
<PAGE> 72

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.

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 any of 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.

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<PAGE> 73

MANAGEMENT OF THE FUND

DIRECTORS AND OFFICERS

Information about the Directors and executive officers of the Fund,
including their ages and their principal occupations for at least the last five
years is set forth below. Unless otherwise noted, the address of each executive
officer and Director is P.O. Box 9011, Princeton, New Jersey 08543-9011.

ARTHUR ZEIKEL (64)--President and Director(1)(2)--President of the Manager
(which term as used herein includes the Manager's corporate predecessors) since
1977; President of Fund Asset Management, L.P. ("FAM") (which term as used
herein includes FAM's corporate predecessors) since 1977; President and Director
of Princeton Services, Inc. ("Princeton Services") since 1993; Executive Vice
President of Merrill Lynch & Co., Inc. ("ML&Co.") since 1990; and Director of
Merrill Lynch Funds Distributor, Inc. (the "Distributor") since 1977.

JOE GRILLS (61)--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 Corporation ("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 since 1993; Director, LaSalle Street Fund since 1995.

WALTER MINTZ (67)--Director(2)--1114 Avenue of the Americas, New York, New
York 10036. Special Limited Partner of Cumberland Associates (investment
partnership) since 1982.

ROBERT S. SALOMON, JR. (59)--Director(2)(3)--106 Dolphin Cove Quay,
Stanford, Connecticut 06902. Principal of STI Management (investment adviser);
Director, Common Fund and the Norwalk Community Technical College Foundation;
Chairman and CEO of Salomon Brothers Asset Management, Inc from 1992 until 1995;
Chairman of Salomon Brothers equity mutual funds from 1992 until 1995; Director
of Stock Research and U.S. Equity Strategist at Salomon Brothers Inc from 1975
until 1991.

MELVIN R. SEIDEN (65)--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 (63)--Director(2)--24 Federal Street, Suite 400,
Boston, Massachusetts 02110. Principal of Fernwood Associates (financial
consultants) since 1975.

TERRY K. GLENN (56)--Executive Vice President(1)(2)--Executive Vice
President of the Manager and FAM 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 (47)--Treasurer(1)(2)--Senior Vice President and
Treasurer of the Manager and FAM 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 (45)--Vice President(1)(2)--Vice President of the Manager
since 1989 and Portfolio Manager of the Manager since 1985; Senior Consultant,
Price Waterhouse 1981 to 1985.

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<PAGE> 74

GREGORY MARK MAUNZ (44)--Vice President(1)(2)--Vice President of the
Manager since 1985 and Portfolio Manager of the Manager since 1984.

THEODORE J. MAGNANI (34)--Vice President(1)--Vice President of the Manager
since 1992.

DONALD C. BURKE (36)--Vice President(1)(2)--Vice President and Director of
Taxation of the Manager since 1990; employee of Deloitte & Touche LLP from 1982
to 1990.

JAMES W. HARSHAW (37)--Secretary(1)(2)--Attorney associated with the
Manager and FAM since 1994; associate at a law firm from 1990 to 1994; judicial
law clerk for the United States Court of Appeals for the Third Circuit from 1989
to 1990.

- ---------------
(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.

(3) On January 17, 1996, Robert S. Salomon, Jr. was elected a Director of the
Fund to fill the vacancy created by the retirement of Harry Woolf, who
retired as Director, effective December 31, 1995, pursuant to the Fund's
retirement policy.

At August 31, 1996, the officers and Directors of the Fund as a group (13
persons) owned an aggregate of less than 1% of the outstanding shares of the
Fund. At that date, Mr. Zeikel, an officer and Director of the Fund, and the
other officers of the Fund, owned less than 1% of the outstanding common stock
of ML&Co.

COMPENSATION OF DIRECTORS

The Fund pays each Director not affiliated with the Manager (each an
"unaffiliated Director") a fee of $2,000 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 pays members of its Audit Committee,
which consists of all of the unaffiliated Directors, an additional $2,000 per
year plus $500 for each Committee meeting attended. For the fiscal year ended
May 31, 1996, fees and expenses paid to unaffiliated Directors aggregated
$47,900.

The following table sets forth for the fiscal year ended May 31, 1996,
compensation paid by the Fund to the unaffiliated Directors and, for the
calendar year ending December 31, 1995, the aggregate compensation

16
<PAGE> 75

paid by all registered investment companies advised by MLAM and its affiliate,
FAM (MLAM/FAM Advised Funds"), to the unaffiliated Directors.

<TABLE>
<CAPTION>
AGGREGATE COMPENSATION
PENSION OR FROM FUND AND
RETIREMENT BENEFITS MLAM/FAM ADVISED
NAME OF COMPENSATION ACCRUED AS PART FUNDS PAID TO
DIRECTOR FROM FUND OF FUND EXPENSE DIRECTORS
- --------------------------------------- ------------ ------------------- ----------------------
<S> <C> <C> <C>
Joe Grills(1).......................... $9,500 None $153,883
Walter Mintz(1)........................ $9,500 None $153,883
Robert S. Salomon, Jr.(1)(2)........... $3,167 None None
Melvin R. Seiden(1).................... $9,500 None $153,883
Stephen B. Swensrud(1)................. $8,500 None $161,883
Harry Woolf(1)......................... $7,500 None $153,883
</TABLE>

- ---------------

(1) The Directors serve on the boards of MLAM/FAM Advised Funds as follows: Mr.
Grills (18 registered investment companies consisting of 38 portfolios); Mr.
Mintz (18 registered investment companies consisting of 38 portfolios); Mr.
Salomon (18 registered investment companies consisting of 38 portfolios);
Mr. Seiden (18 registered investment companies consisting of 38 portfolios);
Mr. Swensrud (20 registered investment companies consisting of 49
portfolios); and Mr. Woolf, prior to his retirement, effective December 31,
1995, pursuant to the Fund's retirement policy (18 registered investment
companies consisting of 38 portfolios).

(2) Mr. Salomon was elected a Director of the Fund on January 17, 1996.

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, 1996, the total management fees
paid to the Manager aggregated $914,312. For the fiscal year ended May 31, 1995,
the total management fees paid to the Manager aggregated $1,463,526. For the
fiscal year ended May 31, 1994, the total management fees paid to the Manager
aggregated $2,710,336.

The State of 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

17
<PAGE> 76

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, 1996, 1995 and 1994, no reimbursement was required pursuant to such expense
limitations. Effective January 1, 1997, provided certain conditions are met, the
State of California will exempt securities issued by registered open-end
investment companies from registration in California and this expense limitation
will no longer apply to such open-end investment companies.

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 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 affiliates. 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, Commission fees, expenses of
registering the shares under Federal, state or foreign laws, fees and expenses
of unaffiliated 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--Distribution Plans."

The Manager is a limited partnership, the partners of which are ML&Co. and
Princeton Services. ML&Co. and Princeton Services are "controlling persons" of
the Manager as defined under the 1940 Act because of their ownership of its
voting securities or their power to exercise a controlling influence over its
management or policies.

Duration and Termination. Unless earlier terminated as described herein,
the Management Agreement will remain in effect from year to year if approved
annually (a) by the 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.

The Fund issues four classes of shares under the Merrill Lynch Select
Pricing(SM) System: shares of Class A and Class D are sold to investors choosing
the initial sales charge alternatives, and shares of Class B and Class C are
sold to investors choosing the deferred sales charge alternatives. Each Class A,
Class B, Class C and Class D share of the Fund represents an identical interest
in the investment portfolio of the Fund and has the same rights, except that
Class B, Class C and Class D shares bear the expenses of the ongoing account
maintenance fees, and Class B and Class C shares bear the expenses of the
ongoing distribution fees

18
<PAGE> 77

and the additional incremental transfer agency costs resulting from the deferred
sales charge arrangements. Class B, Class C and Class D shares each have
exclusive voting rights with respect to the Rule 12b-1 distribution plan adopted
with respect to such class pursuant to which account maintenance and/or
distribution fees are paid. Each class has different exchange privileges. See
"Shareholder Services--Exchange Privilege."

The Merrill Lynch Select Pricing(SM) System is used by more than 50 mutual
funds advised by the Manager or its affiliate, FAM. Funds advised by the Manager
or FAM which utilize the Merrill Lynch Select Pricing(SM) System are referred to
herein as "MLAM-advised mutual funds."

The Fund has entered into four separate distribution agreements with the
Distributor in connection with the continuous offering of each class of shares
of the Fund (the "Distribution Agreements"). The Distribution Agreements
obligate the Distributor to pay certain expenses in connection with the offering
of each class of shares of the Fund. After the prospectuses, statements of
additional information and periodic reports have been prepared, set in type and
mailed to shareholders, the Distributor pays for the printing and distribution
of copies thereof used in connection with the offering to dealers and investors.
The Distributor also pays for other supplementary sales literature and
advertising costs. The Distribution Agreements are subject to the same renewal
requirements and termination provisions as the Management Agreement described
above.

INITIAL SALES CHARGE ALTERNATIVES--CLASS A AND CLASS D SHARES

During the fiscal year ended May 31, 1994, the Fund sold 1,365,792 of its
Class A shares for aggregate net proceeds to the Fund of $13,269,165. The gross
sales charge for the sale of its 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. During the period October 21, 1994 (commencement of operations) to
May 31, 1995, the Fund sold 68,974 Class A shares for aggregate net proceeds to
the Fund of $651,499. The gross sales charge for the sale of its Class A shares
for that period was $91 of which $84 was received by Merrill Lynch and $7 was
received by the Distributor. During the fiscal year ended May 31, 1996, the Fund
sold 893,429 Class A shares for aggregate net proceeds to the Fund of
$8,512,092. There was no gross sales charge for the sale of its Class A shares
for that period. During the fiscal year ended May 31, 1995, the Fund sold
403,735 Class D shares for aggregate net proceeds to the Fund of $3,830,957. The
gross sales charge for the sale of its Class D shares for that period was
$29,513, of which $25,380 was received by Merrill Lynch and $4,133 was received
by the Distributor. During the fiscal year ended May 31, 1996, the Fund sold
2,963,785 Class D shares for aggregate net proceeds to the Fund of $28,203,483.
The gross sales charge for the sale of its Class D shares for that period was
$21,444 of which $18,959 was received by Merrill Lynch and $2,485 was received
by the Distributor.

The term "purchase," as used in the Prospectus and this Statement of
Additional Information in connection with an investment in Class A and Class D
shares of the Fund, refers to a single purchase by an individual or to
concurrent purchases, which in the aggregate are at least equal to the
prescribed amounts, by an individual, his spouse and their children under the
age of 21 years purchasing shares for his or their own account and to single
purchases by a trustee or other fiduciary purchasing shares for a single trust
estate or single fiduciary account (including a pension, profit-sharing or other
employee benefit trust created pursuant to a plan qualified under Section 401 of
the Internal Revenue Code of 1986, as amended (the "Code")) 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

19
<PAGE> 78

which has not been in existence for at least six months or which has no purchase
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 other
MLAM-advised mutual funds ("Eligible Class A Shares") are offered at net asset
value to shareholders of certain closed-end funds advised by FAM or the Manager
who purchased such closed-end fund shares prior to October 21, 1994 (the date
the Merrill Lynch Select Pricing(SM) System commenced operations) and wish to
reinvest the net proceeds 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. Alternatively, closed-end fund shareholders who purchased such shares
on or after October 21, 1994 and wish to reinvest the net proceeds from a sale
of their closed-end fund shares are offered Class A shares (if eligible to buy
Class A shares) or Class D shares of the Fund and other MLAM-advised mutual
funds ("Eligible Class D Shares"), if the following conditions are met. First,
the sale of the closed-end fund shares must be made through Merrill Lynch, and
the net proceeds therefrom must be immediately reinvested in Eligible Class A or
Class D Shares. Second, the closed-end fund shares must either have been
acquired in the initial public offering or be shares representing dividends from
shares of common stock acquired in such offering. Third, the closed-end fund
shares must have been continuously maintained in a Merrill Lynch securities
account. Fourth, there must be a minimum purchase of $250 to be eligible for the
investment option. Class A shares of the Fund are offered at net asset value to
shareholders of Merrill Lynch Senior Floating Rate Fund, Inc. ("Senior Floating
Rate Fund") who wish to reinvest the net proceeds from a sale of certain of
their shares of common stock of Senior Floating Rate Fund in shares of the Fund.
In order to exercise this investment option, Senior Floating Rate Fund
shareholders must sell their Senior Floating Rate Fund shares to the Senior
Floating Rate Fund in connection with a tender offer conducted by the Senior
Floating Rate Fund and reinvest the proceeds immediately in the Fund. This
investment option is available only with respect to the proceeds of Senior
Floating Rate Fund shares as to which no Early Withdrawal Charge (as defined in
the Senior Floating Rate Fund prospectus) is applicable. Purchase orders from
Senior Floating Rate Fund shareholders wishing to exercise this investment
option will be accepted only on the day that the related Senior Floating Rate
Fund tender offer terminates and will be effected at the net asset value of the
Fund at such day.

Shareholders of certain MLAM-advised continuously offered closed-end funds
may reinvest at net asset value the net proceeds from a sale of certain shares
of common stock of such funds in shares of the Fund. Upon exercise of this
investment option, shareholders of Merrill Lynch Senior Floating Rate Fund, Inc.
will receive Class A shares of the Fund and shareholders of Merrill Lynch
Municipal Strategy Fund, Inc. and Merrill Lynch High Income Municipal Bond Fund,
Inc. will receive Class D shares of the Fund, except that shareholders already
owning Class A shares of the Fund will be eligible to purchase additional Class
A shares pursuant to this option, if such additional Class A shares will be held
in the same account as the existing Class A shares and the other requirements
pertaining to the reinvestment privilege are met. In order to exercise this
investment option, a shareholder of one of the above-referenced continuously
offered closed-end funds (an "eligible fund") must sell his or her shares of
common stock of the eligible fund (the "eligible shares") back to the fund in
connection with a tender offer conducted by the eligible fund and reinvest the
proceeds immediately in the designated class of shares of the Fund. This
investment option is available only with respect to eligible shares as to which
no Early Withdrawal Charge or CDSC (each as defined in the

20
<PAGE> 79

eligible fund's prospectus) is applicable. Purchase orders from eligible fund
shareholders wishing to exercise this investment option will be accepted only on
the day that the related tender offer terminates and will be effected at the net
asset value of the designated class of the Fund on such day.

REDUCED INITIAL SALES CHARGE

Right of Accumulation. Reduced sales charges are applicable through a
right of accumulation under which eligible investors are permitted to purchase
shares of the Fund subject to an initial sales charge at the offering price
applicable to the total of (a) the public offering price of the shares then
being purchased plus (b) an amount equal to the then current net asset value or
cost, whichever is higher, of the purchaser's combined holdings of all classes
of shares of the Fund and of any other MLAM-advised mutual funds. For any such
right of accumulation to be made available the Distributor must be provided at
the time of purchase, by the purchaser or the purchaser's securities dealer,
with sufficient information to permit confirmation of qualification. Acceptance
of the purchase order is subject to such confirmation. The right of accumulation
may be amended or terminated at any time. Shares held in the name of a nominee
or custodian under pension, profit-sharing, or other employee benefit plans may
not be combined with other shares to qualify for the right of accumulation.

Letter of Intention. Reduced sales charges are applicable to purchases
aggregating $25,000 or more of the Class A or Class D shares of the Fund or any
other MLAM-advised mutual funds, 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, recordkeeping services. The Letter of Intention is not a
binding obligation to purchase any amount of Class A or Class D shares; however,
its execution will result in the purchaser paying a lower sales charge at the
appropriate quantity purchase level. A purchase not originally made pursuant to
a Letter of Intention may be included under a subsequent Letter of Intention
executed within 90 days of such purchase if the Distributor is informed in
writing of this intent within such 90-day period. The value of Class A shares of
the Fund and of other MLAM-advised mutual funds, presently held at cost or
maximum offering price (whichever is higher), on the date of the first purchase
under the Letter of Intention, may be included as a credit toward the completion
of such Letter, but the reduced sales charge applicable to the amount covered by
such Letter will be applied only to new purchases. If the total amount of shares
does not equal the amount stated in the Letter of Intention (minimum of
$25,000), the investor will be notified and must pay, within 20 days of the
expiration of such Letter, the difference between the sales charge on the Class
A or Class D shares purchased at the reduced rate and the sales charge
applicable to the shares actually purchased through the Letter. Class A or Class
D shares equal to 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 a MLAM-advised money market fund into the Fund that creates a sales charge
will count toward completing a new or existing Letter of Intention from the
Fund.

21
<PAGE> 80

Employee Access Accounts(SM). Class A or Class D shares are offered at net
asset value to Employee Access Accounts available through qualified employers
that provide employer sponsored retirement or savings plans that are eligible to
purchase such shares at net asset value. The initial minimum for such accounts
is $500, except that the initial minimum for shares purchased for such accounts
pursuant to the Automatic Investment Program is $50.

Purchase Privileges of Certain Persons. Directors of the Fund, members of
the Board of other MLAM-advised investment companies, directors and employees of
ML&Co. and its subsidiaries (the term "subsidiaries," when used herein with
respect to ML&Co., includes MLAM, FAM and certain other entities directly or
indirectly wholly-owned and controlled by ML&Co.) and their directors and
employees, and any trust, pension, profit-sharing or other benefit plan for such
persons, may purchase Class A shares of the Fund at net asset value.

Class D shares of the Fund will be offered at net asset value, without a
sales charge, to an investor who has a business relationship with a financial
consultant who joined Merrill Lynch from another investment firm within six
months prior to the date of purchase by such investor if the following
conditions are satisfied: first, the investor must advise Merrill Lynch that it
will purchase Class D shares of the Fund with proceeds from a redemption of a
mutual fund that was sponsored by the financial consultant's previous firm and
was subject to a sales charge either at the time of purchase or on a deferred
basis; and second, the investor also must establish that such redemption had
been made within 60 days prior to the investment in the Fund, and the proceeds
from the redemption had been maintained in the interim in cash or a money market
fund.

Class D shares of the Fund are offered at net asset value, without a sales
charge, to an investor who has a business relationship with a Merrill Lynch
financial consultant and who has invested in a mutual fund for which Merrill
Lynch has not served as a selected dealer if the following conditions are
satisfied: first, the investor must advise Merrill Lynch that it will purchase
Class D shares of the Fund with proceeds from the redemption of such shares of
other mutual funds and that such shares have been outstanding for a period of no
less than six months; and second, such purchase of Class D shares must be made
within 60 days after the redemption and the proceeds from the redemption must be
maintained in the interim in cash or a money market fund.

Class D shares of the Fund are also offered at net asset value, without
sales charge, to an investor who has a business relationship with a Merrill
Lynch financial consultant and who has invested in a mutual fund sponsored by a
non-Merrill Lynch company for which Merrill Lynch has served as a selected
dealer and where Merrill Lynch has either received or given notice that such
arrangement will be terminated, if the following conditions are satisfied:
first, the investor must purchase Class D shares of the Fund with proceeds from
a redemption of shares of such other mutual fund and the shares of such other
fund were subject to a sales charge either at the time of purchase or on a
deferred basis; and second, such purchase of Class D shares must be made within
90 days after such notice of termination.

TMA(SM) Managed Trusts. Class A shares are offered to TMA(SM) Managed
Trusts to which Merrill Lynch Trust Company provides discretionary trustee
services at net asset value.

Acquisition of Certain Investment Companies. The public offering price of
Class D shares may be reduced to the net asset value per Class D share in
connection with the acquisition of the assets of or merger or consolidation with
a personal holding company or a public or private investment company. The value
of the assets or company acquired in a tax-free transaction may be adjusted in
appropriate cases to reduce possible

22
<PAGE> 81

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. The issuance of Class D shares for consideration other than cash is
limited to bona fide reorganizations, statutory mergers or other acquisitions of
portfolio securities which (i) meet the investment objectives and policies of
the Fund; (ii) are acquired for investment and not for resale (subject to the
understanding that the disposition of the Fund's portfolio securities shall at
all times remain within its control); and (iii) are liquid securities, the value
of which is readily ascertainable, which are not restricted as to transfer
either by law or liquidity of market (except that the Fund may acquire through
such transactions restricted or illiquid securities to the extent the Fund does
not exceed the applicable limits on acquisition of such securities set forth
under "Investment Objective and Policies" herein).

Reductions in or exemptions from the imposition of a sales load are due to
the nature of the investors and/or the reduced sales efforts that will be needed
in obtaining such investments.

EMPLOYER-SPONSORED RETIREMENT OR SAVINGS PLANS AND CERTAIN OTHER ARRANGEMENTS

Certain employer-sponsored retirement or savings plans and certain other
arrangements may purchase Class A or Class D shares at net asset value, based on
the number of employees or number of employees eligible to participate in the
plan, the aggregate amount invested by the plan in specified investments and/or
the services provided by Merrill Lynch to the plan. Certain other plans may
purchase Class B shares with a waiver of the CDSC upon redemption, based on
similar criteria. Such Class B shares will convert into Class D shares
approximately ten years after the plan purchases the first share of any
MLAM-advised mutual fund. Minimum purchase requirements may be waived or varied
for such plans. Additional information regarding purchases by employer-sponsored
retirement or savings plans and certain other arrangements is available toll-
free from Merrill Lynch Business Financial Services at (800) 237-7777.

DISTRIBUTION PLANS

Reference is made to "Purchase of Shares--Distribution Plans" in the
Prospectus for certain information with respect to the separate distribution
plans for Class B, Class C and Class D shares pursuant to Rule 12b-1 under the
1940 Act (each a "Distribution Plan") with respect to the account maintenance
and/or distribution fees paid by the Fund to the Distributor with respect to
such classes.

Payments of the account maintenance fees and/or distribution fees are
subject to the provisions of Rule 12b-1 under the 1940 Act. Among other things,
each Distribution Plan provides that the Distributor shall provide and the
Directors shall review quarterly reports of the disbursement of the account
maintenance fees and/or distribution fees paid to the Distributor. In their
consideration of each Distribution Plan, the Directors must consider all factors
they deem relevant, including information as to the benefits of the Distribution
Plan to the Fund and its related class of shareholder. 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 a reasonable likelihood that such Distribution
Plan will benefit the Fund and its related class of shareholders. Each
Distribution Plan can be terminated at any time, without penalty, by the vote of
a majority of the Independent Directors or by the vote of the holders of a
majority of the outstanding related class of voting securities of the Fund. A
Distribution Plan cannot be

23
<PAGE> 82

amended to increase materially the amount to be spent by the Fund without the
approval of the related class of shareholder, and all material amendments are
required to be approved by the vote of the Directors, including a majority of
the Independent Directors who have no direct or indirect financial interest in
such Distribution Plan, cast in person at a meeting called for that purpose.
Rule 12b-1 further requires that the Fund preserve copies of each Distribution
Plan and any report made pursuant to such plan for a period of not less than six
years from the date of such Distribution Plan or such report, the first two
years in an easily accessible place.

LIMITATIONS ON THE PAYMENT OF DEFERRED SALES CHARGES

The maximum sales charge rule in the Rules of Fair Practice of the National
Association of Securities Dealers, Inc. (the "NASD") imposes a limitation on
certain asset-based sales charges such as the distribution fee and the CDSC
borne by the Class B and Class C shares but not the account maintenance fee. The
maximum sales charge rule is applied separately to each class. As applicable to
the Fund, the maximum sales charge rule limits the aggregate of distribution fee
payments and CDSCs payable by the Fund to (1) 6.25% of eligible gross sales of
Class B shares and Class C shares, computed separately (defined to exclude
shares issued pursuant to dividend reinvestments and exchanges), plus (2)
interest on the unpaid balance for the respective class, computed separately, at
the prime rate plus 1% (the unpaid balance being the maximum amount payable
minus amounts received from the payment of the distribution fee and the CDSC).
In connection with the Class B shares, the Distributor has voluntarily agreed to
waive interest charges on the unpaid balance in excess of 0.50% of eligible
gross sales. Consequently, the maximum amount payable to the Distributor
(referred to as the "voluntary maximum") in connection with the Class B shares
is 6.75% of eligible gross sales. The Distributor retains the right to stop
waiving the interest charges at any time. To the extent payments would exceed
the voluntary maximum, the Fund will not make further payments of the
distribution fee with respect to Class B shares, and any CDSCs will be paid to
the Fund rather than to the Distributor; however, the Fund will continue to make
payments of the account maintenance fee. In certain circumstances the amount
payable pursuant to the voluntary maximum may exceed the amount payable under
the NASD formula. In such circumstances payment in excess of the amount payable
under the NASD formula will not be made.

The following table sets forth comparative information as of May 31, 1996
with respect to the Class B and Class C shares of the Fund, indicating the
maximum allowable payments that can be made under the NASD maximum sales charge
rule and the Distributor's voluntary maximum for the period August 2, 1991
(commencement of operations) to May 31, 1996, with respect to Class B shares,
and under the NASD

24
<PAGE> 83

maximum sales charge rule for the period October 21, 1994 (commencement of
operations) to May 31, 1996, with respect to Class C shares.

DATA CALCULATED AS OF MAY 31, 1996

(IN THOUSANDS)

<TABLE>
<CAPTION>
ANNUAL
DISTRIBUTION
ALLOWABLE ALLOWABLE AMOUNTS FEE AT
ELIGIBLE AGGREGATE INTEREST MAXIMUM PREVIOUSLY AGGREGATE CURRENT
GROSS SALES ON UNPAID AMOUNT PAID TO UNPAID NET ASSET
CLASS B SALES(1) CHARGES BALANCE(2) PAYABLE DISTRIBUTOR(3) BALANCE LEVEL(4)
- -------------------- ---------- --------- ---------- ------- -------------- --------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Under NASD Rule As
Adopted........... $1,008,543 $63,034 $ 21,831 $84,865 $ 19,661 $65,204 $687
Under Distributor's
Voluntary
Waiver............ $1,008,543 $63,034 $ 5,043 $68,077 $ 19,661 $48,416 $687

<CAPTION>
CLASS C
- --------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Under NASD Rule as
Adopted........... $ 5,533 $ 346 $ 25 $ 371 $ 14 $ 357 $ 17
</TABLE>

- ---------------
(1) Purchase price of all eligible Class B shares sold since August 2, 1991
(commencement of operations) and all eligible Class C shares sold since
October 21, 1994 (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 prime rate, as
reported in The Wall Street Journal, plus 1%, as permitted under the NASD
Rule.
(3) Consists of CDSC payments, distribution fee payments and accruals. Of the
distribution fee payments made with respect to Class B shares prior to July
7, 1993, under the distribution plan in effect at that time, at a 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. See
"Purchase of Shares--Distribution Plans" in the Prospectus.
(4) Provided to illustrate the extent to which the current level of distribution
fee payments (not including any CDSC payments) is amortizing the unpaid
balance. No assurance can be given that payments of the distribution fee
will reach either the NASD maximum or, with respect to the Class B shares,
the voluntary maximum.

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 NYSE is restricted as determined by the 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 Commission, as a
result of which disposal of portfolio securities or determination of the net
asset value of the Fund is not reasonably practicable, and for such other
periods as the Commission may by order permit for the protection of shareholders
of the Fund.

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.

DEFERRED SALES CHARGES--CLASS B AND CLASS C SHARES

As discussed in the Prospectus under "Purchase of Shares--Alternative Sale
Arrangements--Deferred Sales Charge Alternatives--Class B and Class C Shares",
while Class B shares redeemed within four years of

25
<PAGE> 84

purchase are subject to a CDSC under most circumstances, the charge is waived
(i) on redemptions of Class B shares in connection with certain post-retirement
withdrawals from an Individual Retirement Account ("IRA") or other retirement
plan or (ii) on redemptions of Class B following the death or disability of a
Class B shareholder. Redemptions for which the waiver applies are (a) any
partial or complete redemption in connection with a tax-free distribution
following retirement under a tax-deferred retirement plan or attaining age
59 1/2 in the case of an IRA or other retirement plan, or part of a series of
equal periodic payments (not less frequently than annually) made for the life
(or life expectancy) or any redemption resulting from the tax-free return of an
excess contribution to an IRA; or (b) any partial or complete redemption
following the death or disability (as defined in the Code) of a Class B
shareholder (including one who owns the Class B shares as joint tenant with his
or her spouse), provided the redemption is requested within one year of the
death or initial determination of disability. For the fiscal years ended May 31,
1994, 1995 and 1996, the Distributor received CDSCs of $2,010,325, $672,278 and
$12,780, respectively, with respect to redemptions of Class B shares, all of
which was paid to Merrill Lynch. For the fiscal period October 21, 1994
(commencement of operations) to May 31, 1995, and for the fiscal year ended May
31, 1996, the Distributor received CDSCs of $1,343 and $3,334, respectively,
with respect to redemptions of Class C shares, all of which was paid to Merrill
Lynch.

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 (including Merrill
Lynch) 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

26
<PAGE> 85

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 Commission.

For the fiscal years ended May 31, 1994, 1995 and 1996, the Fund paid no
brokerage commissions.

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.

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%. For the fiscal years ended May 31, 1995 and 1996, the Fund's portfolio
turnover rate was 102.55% and 25.30%, respectively. (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.

27
<PAGE> 86

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 all classes of the Fund is determined
by the Manager once daily, Monday through Friday, as of 15 minutes after the
close of business on the NYSE (generally, 4:00 P.M., New York time), on each day
during which the NYSE is open for trading. The NYSE is not open on New Year's
Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving Day and Christmas Day.

Net asset value per share is computed by dividing the sum of the value of
the securities held by the Fund plus any cash or other assets minus all
liabilities by the total number of shares outstanding at such time, rounded to
the nearest cent. Expenses, including the management fees and any account
maintenance and/or distribution fees, are accrued daily. The per share net asset
value of the Class B, Class C and Class D shares generally will be lower than
the per share net asset value of the Class A shares reflecting the daily expense
accruals of the account maintenance, distribution and higher transfer agency
fees applicable with respect to the Class B and Class C shares and the daily
expense accruals of the account maintenance fees applicable with respect to the
Class D shares; moreover the per share net asset value of the Class B and Class
C shares generally will be lower than the per share net asset value of its Class
D shares reflecting the daily expense accruals of the distribution fees and
higher transfer agency fees applicable with respect to the Class B and Class C
shares of the Fund. It is expected, however, that the per share net asset value
of the four classes will tend to converge (although not necessarily meet)
immediately after the payment of dividends or distributions, which will differ
by approximately the amount of the expense accrual differential between the
classes.

Portfolio securities traded in the over-the-counter ("OTC") market are
valued at the last available bid price in the OTC market prior to the time of
valuation. When the Fund writes an option, the amount of the premium received is
recorded on the books of the Fund as an asset and an equivalent liability. The
amount of the liability is subsequently valued to reflect the current market
value of the option written, based upon the last sale price in the case of
exchange-traded options or, in the case of options traded in the OTC market, the
last asked price. Options purchased by the Fund are valued at their last sale
price in the case of exchange-traded options or, in the case of options traded
in the OTC market, the last bid price. Other investments, including futures
contracts and related options, are stated at market value. Securities and assets
for which market quotations are not readily available are valued at fair value
as determined in good faith by or under the direction of the Board of Directors
of the Fund.

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 15 minutes after the
close of business on the NYSE (generally, 4:00 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

28
<PAGE> 87

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 the firm to which the Class A
or Class D shares are to be transferred will not take delivery of shares of the
Fund, a shareholder either must redeem the Class A or Class D shares (paying any
applicable CDSC) so that the cash proceeds can be transferred to the account at
the new firm or such shareholder must continue to maintain an Investment Account
at the Transfer Agent for those Class A or Class D shares. Shareholders
interested in transferring their Class B or Class C shares from Merrill Lynch
and who do not wish to have an Investment Account maintained for such shares at
the Transfer Agent may request their new brokerage firm to maintain such shares
in an account registered in the name of the brokerage firm for the benefit of
the shareholder at the Transfer Agent. 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 CDSC) 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.

AUTOMATIC INVESTMENT PLANS

A shareholder may make additions to an Investment Account at any time by
purchasing Class A (if the shareholder is an eligible Class A investor as
described in the Prospectus) or Class B, Class C or Class D shares at the
applicable public offering price either through the shareholder's securities
dealer, or by mail directly to the Transfer Agent, acting as agent for such
securities dealer. Voluntary accumulation can also be made through a service
known as the Automatic Investment Plan whereby the Fund is authorized through

29
<PAGE> 88

pre-authorized checks or automated clearing house debits of $50 or more to
charge the regular bank account of the shareholder on a regular basis to provide
systematic additions to the Investment Account of such shareholder. Investors
whose shares of the Fund are held within a CMA(R) or CBA(R) account may arrange
to have periodic investments made in the Fund, in their CMA(R) or CBA(R)
accounts or in certain related accounts in the amount of $100 or more ($1 for
retirement accounts) through the CMA(R) or CBA(R) Automated Investment Program.

AUTOMATIC REINVESTMENT OF DIVIDENDS AND CAPITAL GAINS DISTRIBUTIONS

Unless specific instructions are given as to the method of payment of
dividends and capital gains distributions, dividends and distributions will be
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 or
direct deposited 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 AND CLASS D SHARES

A Class A or Class D shareholder may elect to make systematic withdrawals
from an Investment Account on either a monthly or quarterly basis as provided
below. Quarterly withdrawals are available for shareholders who have acquired
Class A or Class D shares of the Fund having a value, based on cost or the
current offering price, of $5,000 or more, and monthly withdrawals for
shareholders with Class A or Class D shares with such a value of $10,000 or
more.

At the time of each withdrawal payment, sufficient Class A or Class D
shares are redeemed from those on deposit in the shareholder's account to
provide the withdrawal payment specified by the shareholder. The shareholder may
specify either a dollar amount or a percentage of the value of his or her Class
A or Class D shares. Redemptions will be made at net asset value as determined
as of 15 minutes after the close of business on the NYSE (generally, 4:00 P.M.,
New York time) on the 24th day of each month or the 24th day of the last month
of each quarter, whichever is applicable. If the Exchange is not open for
business on such date, the Class A or Class D shares will be redeemed at the
close of business on the following business day. The check for the withdrawal
payment will be mailed, or the direct deposit for the withdrawal payment will be
made, on the next business day following redemption. When a shareholder is
making systematic withdrawals, dividends and distributions on all Class A or
Class D shares in the Investment Account are reinvested automatically in Fund
Class A or Class D shares, respectively. A shareholder's Systematic Withdrawal
Plan may be terminated at any time, without charge or penalty, by the
shareholder, the 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 or Class D 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
or Class D shares of the Fund from investors who

30
<PAGE> 89

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.

A Class A or Class D shareholder whose shares are held within a CMA(R),
CBA(R) or Retirement Account may elect to have shares redeemed on a monthly,
bimonthly, quarterly, semiannual or annual basis through the CMA(R)/CBA(R)
Systematic Redemption Program. The minimum fixed dollar amount redeemable is
$25. The proceeds of systematic redemptions will be posted to the shareholder's
account five business days after the date the shares are redeemed. Monthly
systematic redemptions will be made at net asset value on the first Monday of
each month, bimonthly systematic redemptions will be made at net asset value on
the first Monday of every other month, and quarterly, semiannual or annual
redemptions are made at net asset value on the first Monday of months selected
at the shareholder's option. If the first Monday of the month is a holiday, the
redemption will be processed at net asset value on the next business day. The
CMA(R)/CBA(R) Systematic Redemption Program is not available if Fund shares are
being purchased within the account pursuant to the Automatic Investment Program.
For more information on the CMA(R)/CBA(R) Systematic Redemption Program,
eligible shareholders should contact their Financial Consultant.

EXCHANGE PRIVILEGE

Shareholders of each class of shares of the Fund have an exchange privilege
with certain other MLAM-advised mutual funds listed below. Under the Merrill
Lynch Select Pricing(SM) System, Class A shareholders may exchange Class A
shares of the Fund for Class A shares of a second MLAM-advised mutual fund if
the shareholder holds any Class A shares of the second fund in his or her
account in which the exchange is made at the time of the exchange or is
otherwise eligible to purchase Class A shares of the second fund. If the Class A
shareholder wants to exchange Class A shares for shares of a second MLAM-advised
mutual fund but does not hold Class A shares of the second fund in his or her
account at the time of the exchange and is not otherwise eligible to acquire
Class A shares of the second fund, the shareholder will receive Class D shares
of the second fund as a result of the exchange. Class D shares also may be
exchanged for Class A shares of a second MLAM-advised mutual fund at any time as
long as, at the time of the exchange, the shareholder holds Class A shares of
the second fund in the account in which the exchange is made or is otherwise
eligible to purchase Class A shares of the second fund. Class B, Class C and
Class D shares are exchangeable with shares of the same class of other
MLAM-advised mutual funds. For purposes of computing the CDSC that may be
payable upon a disposition of the shares acquired in the exchange, the holding
period for the previously owned shares of the Fund is "tacked" to the holding
period of the newly acquired shares of the other Fund as more fully described
below. Class A, Class B, Class C and Class D shares also are exchangeable for
shares of certain MLAM-advised money market funds specifically designated below
as available for exchange by holders of Class A, Class B, Class C or Class D
shares. 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. It is contemplated that the
exchange privilege may be applicable to other new mutual funds whose shares may
be distributed by the Distributor.

Exchanges of Class A or Class D shares outstanding ("outstanding Class A or
Class D shares") for Class A or Class D shares of another MLAM-advised mutual
fund ("new Class A or Class D shares") are transacted on the basis of relative
net asset value per Class A or Class D share, respectively, plus an amount equal
to the difference, if any, between the sales charge previously paid on the
outstanding Class A or Class D

31
<PAGE> 90

shares and the sales charge payable at the time of the exchange on the new Class
A or Class D shares. With respect to outstanding Class A or Class D shares as to
which previous exchanges have taken place, the "sales charge previously paid"
shall include the aggregate of the sales charge paid with respect to such Class
A or Class D shares in the initial purchase and any subsequent exchange. Class A
or Class D shares issued pursuant to dividend reinvestment are sold on a no-load
basis in each of the funds offering Class A or Class D shares. For purposes of
the exchange privilege, Class A and Class D shares acquired through dividend
reinvestment shall be deemed to have been sold with a sales charge equal to the
sales charge previously paid on the Class A or Class D shares on which the
dividend was paid. Based on this formula, Class A and Class D shares of the Fund
generally may be exchanged into the Class A or Class D shares of the other funds
or into shares of the Class A and Class D money market funds with a reduced or
without a sales charge.

In addition, each of the funds with Class B and Class C shares outstanding
("outstanding Class B or Class C shares") offers to exchange its Class B or
Class C shares for Class B or Class C shares, respectively ("new Class B or
Class C shares"), of another MLAM-advised mutual fund on the basis of relative
net asset value per Class B or Class C share, without the payment of any CDSC
that might otherwise be due on redemption of the outstanding shares. Class B
shareholders of the Fund exercising the exchange privilege will continue to be
subject to the Fund's CDSC schedule if such schedule is higher then the CDSC
schedule relating to the new Class B shares acquired through use of the exchange
privilege. In addition, Class B shares of the Fund acquired through use of the
exchange privilege will be subject to the Fund's CDSC schedule if such schedule
is higher than the CDSC schedule relating to the Class B shares of the fund from
which the exchange has been made. For purposes of computing the sales charge
that may be payable on a disposition of the new Class B or Class C shares, the
holding period for the outstanding Class B or Class C shares is "tacked" to the
holding period of the new Class B or Class C shares. For example, an investor
may exchange Class B shares of the Fund for those of Merrill Lynch Special Value
Fund, Inc. ("Special Value Fund") after having held the Fund Class B shares for
two and a half years. The 2% CDSC 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 CDSC due on this redemption, since by "tacking" the two and a half year
holding period of Fund Class B shares to the three-year holding period for the
Special Value Fund Class B shares, the investor will be deemed to have held the
new Special Value Fund Class B shares for more than five years.

The exchange privilege is modified with respect to certain retirement plans
which participate in the Merrill Lynch Mutual Fund Adviser ("MFA") program. Such
retirement plans may exchange Class B, Class C or Class D shares that have been
held for at least one year for Class A shares of the same fund on the basis of
relative net asset values in connection with the commencement of participation
in the MFA program, i.e., no CDSC will apply. The one-year holding period does
not apply to shares acquired through reinvestment of dividends. Upon termination
of participation in the MFA program, Class A shares will be re-exchanged for the
class of shares originally held. For purposes of computing any CDSC that may be
payable upon redemption of Class B or Class C shares so reacquired, or the
Conversion Period for Class B shares so reacquired, the holding period for the
Class A shares will be "tacked" to the holding period for the Class B or Class C
shares originally held.

Shareholders also may exchange shares of the Fund into shares of a money
market fund advised by the Manager or its affiliates, but the period of time
that Class B or Class C shares are held in a money market fund will not count
towards satisfaction of the holding period requirement for purposes of reducing
the CDSC or

32
<PAGE> 91

with respect to Class B shares, towards satisfaction of the conversion period.
However, shares of a money market fund which were acquired as a result of an
exchange for Class B or Class C shares of the Fund, may, in turn, be exchanged
back into Class B shares of any fund offering such shares, in which event the
holding period for Class B or Class C shares of that 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 or Class C
shares of the Fund for shares of Merrill Lynch Institutional Fund after having
held the Class B or Class C shares for two and a 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% CDSC that would have been due had the
Class B or Class C 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 or
Class C 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
CDSC.

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.

Before effecting an exchange, shareholders should obtain a currently
effective prospectus of the fund into which the exchange is to be made.

To exercise the exchange privilege, shareholders should contact their
Merrill Lynch financial consultant, who will advise the Fund of the exchange.
Shareholders of the Fund, and shareholders of the other funds described above
with shares for which certificates have not been issued, may exercise the
exchange privilege by wire through their securities dealers. The Fund reserves
the right to require a properly completed Exchange Application. This exchange
privilege may be modified or terminated 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 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 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

33
<PAGE> 92

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. The per share dividends and distributions on Class B
and Class C shares will be lower than the per share dividends and distributions
on Class A and Class D shares as a result of the account maintenance,
distribution and higher transfer agency fees applicable with respect to the
Class B and Class C shares; similarly, the per share dividends and distributions
on Class D shares will be lower than the per share dividends and distributions
on Class A shares as a result of the account maintenance fees applicable with
respect to the Class D shares. See "Determination of Net Asset Value".

TAXES

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<PAGE> 93

applicable treaty law. Nonresident shareholders are urged to consult their own
tax advisers concerning the applicability of the United States withholding tax.

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 minimize 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 write, purchase or sell options and futures. In general,
unless an election is available to the Fund or an exception applies, 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
attributable to Section 1256 contracts will be 60% long-term and 40% short-term
capital gain or loss. Application of these rules to Section 1256 contracts held
by the Fund may alter the timing and character of

35
<PAGE> 94

distributions to shareholders. The mark-to-market rules outlined above, however,
will not apply to certain transactions entered into by the Fund solely to reduce
the risk of changes in price or interest rates with respect to its investments.

Code Section 1092, which applies to certain "straddles", may affect the
taxation of the Fund's sales of securities and transactions in options and
futures contracts. Under Section 1092, the Fund may be required to postpone
recognition for tax purposes of losses incurred in certain sales of securities
and closing transactions in options and futures contracts.

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.

Ordinary income and capital gain dividends may also be subject to state and
local taxes.

PERFORMANCE DATA

From time to time the Fund may include its average annual total return and
other total return data, as well as yield, 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

36
<PAGE> 95

annual total return and yield are determined separately for Class A, Class B,
Class C and Class D shares in accordance with formulas specified by the
Commission.

Average annual total return quotations for the specified periods are
computed by finding the average annual compounded rates of return (based on net
investment income and any realized and unrealized capital gains or losses on
portfolio investments over such periods) that would equate the initial amount
invested to the redeemable value of such investment at the end of each period.
Average annual total return is computed assuming all dividends and distributions
are reinvested and taking into account all applicable recurring and nonrecurring
expenses, including the maximum sales charge in the case of Class A and Class D
shares and the 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 and Class C 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.

37
<PAGE> 96

Set forth below is total return information for the Class A, Class B, Class
C and Class D shares of the Fund for the periods indicated.

<TABLE>
<CAPTION>
CLASS A SHARES CLASS B SHARES
-------------------------------------- --------------------------------------
REDEEMABLE REDEEMABLE
EXPRESSED VALUE OF A EXPRESSED VALUE OF A
AS A PERCENTAGE HYPOTHETICAL AS A PERCENTAGE HYPOTHETICAL
BASED ON A $1,000 INVESTMENT BASED ON A $1,000 INVESTMENT
HYPOTHETICAL AT THE END HYPOTHETICAL AT THE END
PERIOD $1,000 INVESTMENT OF THE PERIOD $1,000 INVESTMENT OF THE PERIOD
- ---------------------------- ------------------ ----------------- ------------------ -----------------
AVERAGE ANNUAL TOTAL RETURN
(including maximum applicable sales charges)
<S> <C> <C> <C> <C>
One Year Ended May 31,
1996...................... 2.16% $1,021.60 1.36% $1,013.60
Inception (August 2, 1991)
to May 31, 1996........... 3.79% $1,197.10
Inception (October 21, 1994)
to May 31, 1996*.......... 4.36% $1,071.20
ANNUAL TOTAL RETURN
YEAR ENDED MAY 31, (excluding maximum applicable sales charges)
- ---------------------------
1996........................ 6.41% $1,064.10 5.34% $1,053.40
1995........................ 5.48% $1,054.80
1994........................ 0.77% $1,007.70
1993........................ 2.48% $1,024.80
Inception (August 2, 1991)
to May 31, 1992........... 4.33% $1,043.30
Inception (October 21, 1994)
to May 31, 1995*.......... 4.85% $1,048.50
AGGREGATE TOTAL RETURN
(including maximum applicable sales charges)
Inception (August 2, 1991)
to May 31, 1996........... 19.71% $1,197.10
Inception (October 21, 1994)
to May 31, 1996*.......... 7.12% $1,071.20
YIELD
30 days ended May 31,
1996...................... 5.69% 5.18%
</TABLE>

- ---------------

* Information as to Class A and Class C shares is presented only for the period
October 21, 1994 to May 31, 1996. Prior to October 21, 1994, no Class A or
Class C shares were publicly issued.

38
<PAGE> 97

<TABLE>
<CAPTION>
CLASS C SHARES CLASS D SHARES
-------------------------------------- --------------------------------------
REDEEMABLE REDEEMABLE
EXPRESSED VALUE OF A EXPRESSED VALUE OF A
AS A PERCENTAGE HYPOTHETICAL AS A PERCENTAGE HYPOTHETICAL
BASED ON A $1,000 INVESTMENT BASED ON A $1,000 INVESTMENT
HYPOTHETICAL AT THE END HYPOTHETICAL AT THE END
PERIOD $1,000 INVESTMENT OF THE PERIOD $1,000 INVESTMENT OF THE PERIOD
- ---------------------------- ------------------ ----------------- ------------------ -----------------
AVERAGE ANNUAL TOTAL RETURN
(including maximum applicable sales charges)
<S> <C> <C> <C> <C>
One Year Ended May 31,
1996...................... 4.30% $1,043.00 1.68% $1,016.80
Inception (August 2, 1991)
to May 31, 1996........... 3.42% $1,176.60
Inception (October 21, 1994)
to May 31, 1996*.......... 6.10% $1,100.10
ANNUAL TOTAL RETURN
YEAR ENDED MAY 31, (excluding maximum applicable sales charges)
- ----------------------------
1996........................ 5.30% $1,053.00 5.91% $1,059.10
1995........................ 5.91% $1,059.10
1994........................ 1.28% $1,012.80
1993........................ 2.99% $1,029.90
Inception (August 2, 1991)
to May 31, 1992........... 4.75% $1,047.50
Inception (October 21, 1994)
to May 31, 1995*.......... 4.47% $1,044.70
AGGREGATE TOTAL RETURN
(including maximum applicable sales charges)
Inception (August 2, 1991)
to May 31, 1996........... 17.66% $1,176.60
Inception (October 21, 1994)
to May 31, 1996*.......... 10.01% $1,100.10
YIELD
30 days ended May 31,
1996...................... 5.13% 5.46%
</TABLE>

- ---------------

* Information as to Class A and Class C shares is presented only for the period
October 21, 1994 to May 31, 1996. Prior to October 21, 1994, no Class A or
Class C shares were publicly issued.

In order to reflect the reduced sales charges in the case of Class A or
Class D shares, or the waiver of the contingent deferred sales charge in the
case of Class B or Class C shares applicable to certain investors, as described
under "Purchase of Shares" and "Redemption of Shares", respectively, the total
return data quoted by the Fund in advertisements directed to such investors may
take into account the reduced, and not the maximum, sales charge or may not take
into account the CDSCs and therefore may reflect greater total return since, due
to the reduced sales charges or the waiver of sales charges, a lower amount of
expenses may be deducted.

39
<PAGE> 98

GENERAL INFORMATION

DESCRIPTION OF SHARES

The Fund was incorporated under Maryland law on April 19, 1991. It has an
authorized capital of 600,000,000 shares of Common Stock, par value $0.10 per
share, divided into four classes, designated Class A, Class B, Class C and Class
D Common Stock. Class A and Class C each consists of 100,000,000 shares and
Class B and Class D each consists of 200,000,000 shares. Class A, Class B, Class
C and Class D Common Stock all represent an interest in the same assets of the
Fund and are identical in all respects except that the Class B, Class C and
Class D shares bear certain expenses related to the account maintenance and/or
distribution of such shares and have exclusive voting rights with respect to
matters relating to such account maintenance and/or distribution expenditures.
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 rights. Redemption and conversion rights
are discussed elsewhere herein and in the Prospectus. Each share of 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.

40
<PAGE> 99

COMPUTATION OF OFFERING PRICE PER SHARE

An illustration of the computation of the offering price for Class A, Class
B, Class C and Class D shares of the Fund based on the value of the Fund's net
assets and number of shares outstanding on May 31, 1996, is as set forth below.

<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C CLASS D
-------- ------------ ---------- -----------
<S> <C> <C> <C> <C>
Net Assets.................................... $281,218 $137,386,527 $3,077,953 $12,800,132
======== =========== ========= ==========
Number of Shares Outstanding.................. 29,470 14,421,836 322,882 1,344,599
======== =========== ========= ==========
Net Asset Value Per Share (net assets divided
by number of shares outstanding)............ $9.54 $9.53 $9.53 $9.52
Sales Charge for Class A and Class D shares:
4.00% of offering price (4.17% of net asset
value*)..................................... 0.40 ** ** 0.40
----- ----- ----- -----
Offering Price................................ $9.94 $9.53 $9.53 $9.92
===== ===== ===== =====
</TABLE>

- ---------------
* Rounded to the nearest one-hundredth percent; assumes the maximum sales
charge is applicable.
** Class B and Class C shares are not subject to an initial sales charge but may
be subject to a CDSC upon redemption. See "Purchase of Shares--Deferred Sales
Charge Alternatives--Class B and Class C Shares" in the Prospectus and
"Redemption of Shares-- Deferred Sales Charges--Class B and Class C Shares"
herein.

INDEPENDENT AUDITORS

Deloitte & Touche LLP, 117 Campus Drive, Princeton, New Jersey 08540, 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

Merrill Lynch Financial Data Services, Inc., 4800 Deer Lake Drive East,
Jacksonville, Florida 32246-6484, acts as the Fund's transfer agent (the
"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.

LEGAL COUNSEL

Brown & Wood LLP, One World Trade Center, New York, New York 10048-0557, is
counsel for the Fund.

41
<PAGE> 100

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 of the information set forth in the Registration Statement and the exhibits
relating thereto, which the Fund has filed with the 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.

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS

To the knowledge of the Fund, no person or entity owned beneficially 5% or
more of the Fund's common stock on September 1, 1996.

42
<PAGE> 101

APPENDIX A

RATINGS OF DEBT SECURITIES

DESCRIPTION OF CORPORATE DEBT RATINGS OF MOODY'S INVESTORS SERVICE, INC.
("MOODY'S")

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

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

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

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

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

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

Caa Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to
principal or interest.

Ca Bonds which are rated Ca represent obligations which are speculative in a
high degree. Such issues are often in default or have other marked
shortcomings.

C Bonds which are rated C are the lowest rated class of bonds, and issues
so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.

Note: 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

43
<PAGE> 102

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.

DESCRIPTION OF MOODY'S COMMERCIAL PAPER RATINGS

The term "commercial paper" as used by Moody's means promissory obligations
not having an original maturity in excess of nine months. Moody's makes no
representations as to whether such commercial paper is by any other definition
"commercial paper" or is exempt from registration under the Securities Act of
1933, as amended.

Moody's Commercial Paper ratings are opinions of the ability of issuers to
repay punctually promissory obligations not having an original maturity in
excess of nine months. Moody's makes no representation that such obligations are
exempt from registration under the Securities Act of 1933, nor does it represent
that any specific note is a valid obligation of a rated issuer or issued in
conformity with any applicable law. Moody's employs the following three
designations, all judged to be investment grade, to indicate the relative
repayment capacity of rated issuers.

Issuers rated Prime-1 (or supporting institutions) have a superior ability
for repayment of short-term promissory obligations. Prime-1 repayment ability
will often be evidenced by many of the following characteristics:

- Leading market positions in well-established industries.

- High rates of return on funds employed.

- Conservative capitalization structure with moderate reliance on debt and
ample asset protection.

- Broad margins in earnings coverage of fixed financial charges and high
internal cash generation.

- Well-established access to a range of financial markets and assured
sources of alternate liquidity.

Issuers rated Prime-2 (or supporting institutions) have a strong ability
for repayment of short-term promissory obligations. This will normally be
evidenced by many of the characteristics cited above but to a lesser degree.
Earnings trends and coverage ratios, while sound, may be more subject to
variation. Capitalization characteristics, while still appropriate, may be more
affected by external conditions. Ample alternate liquidity is maintained.

Issuers rated Prime-3 (or supporting institutions) have an acceptable
ability for repayment of short-term promissory obligations. The effect of
industry characteristics and market compositions may be more pronounced.
Variability in earnings and profitability may result in changes in the level of
debt protection measurements and may require relatively high financial leverage.
Adequate alternate liquidity is maintained.

Issuers rated Not Prime do not fall within any of the Prime rating
categories.

If an issuer represents to Moody's that its Commercial Paper obligations
are supported by the credit of another entity or entities, in assigning ratings
to such issuers, Moody's evaluates the financial strength of the affiliated
corporations, commercial banks, insurance companies, foreign governments or
other entities, but only as one factor in the total rating assessment. Moody's
makes no representation and gives no opinion on the legal validity or
enforceability of any support arrangement.

44
<PAGE> 103

DESCRIPTION OF CORPORATE DEBT RATINGS OF STANDARD & POOR'S RATINGS GROUP
("STANDARD & POOR'S")

A Standard & Poor's corporate or municipal debt rating is a current
assessment of the creditworthiness of an obligor with respect to a specific
obligation. This assessment may take into consideration obligors such as
guarantors, insurers or lessees.

The debt rating is not a recommendation to purchase, sell or hold a
security, inasmuch as it does not comment as to market price or suitability for
a particular investor.

The ratings are based on current information furnished by the issuer or
obtained by Standard & Poor's from other sources it considers reliable. Standard
& Poor's does not perform an audit in connection with any rating and may, on
occasion, rely on unaudited financial information. The ratings may be changed,
suspended or withdrawn as a result of changes in, or unavailability of, such
information, or based on other circumstances.

The ratings are based, in varying degrees, on the following considerations:
(1) likelihood of default-capacity and willingness of the obligor as to the
timely payment of interest and repayment of principal in accordance with the
terms of the obligation; (2) nature of and provisions of the obligation; and (3)
protection afforded by, and relative position of, the obligation in the event of
bankruptcy, reorganization or other arrangement under the laws of bankruptcy and
other laws affecting creditors' rights.

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

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

A Debt rated A has a strong capacity to pay interest and repay principal
although it is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher
rated categories.

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

Debt rated BB, B, CCC, CC and C is regarded as having predominantly
speculative characteristics with respect to capacity to pay interest and
repay principal. BB indicates the least degree of speculation and C the
highest. While such debt will likely have some quality and protective
characteristics, these are outweighed by large uncertainties or major
exposures to adverse conditions.

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

B Debt rated B has a greater vulnerability to default but currently has the
capacity to meet interest payments and principal repayments. Adverse
business, financial, or economic conditions will likely

45
<PAGE> 104

impair capacity or willingness to pay interest and repay principal. The B
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied BB or BB- rating.

CCC Debt rated CCC has a currently identifiable vulnerability to default, and
is dependent upon favorable business, financial, and economic conditions
to meet timely payment of interest and repayment of principal. In the
event of adverse business, financial, or economic conditions, it is not
likely to have the capacity to pay interest and repay principal. The CCC
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied B or B- rating.

CC The rating CC is typically applied to debt subordinated to senior debt
that is assigned an actual or implied CCC rating.

C The rating C typically is applied to debt subordinated to senior debt
which is assigned an actual or implied CCC- debt rating. The C rating may
be used to cover a situation where a bankruptcy petition has been filed,
but debt service payments are continued.

CI The rating CI is reserved for income bonds on which no interest is being
paid.

D Debt rated D is in payment default. The D rating category is used when
interest payments or principal repayments are not made on the date due
even if the applicable grace period has not expired, unless Standard &
Poor's believes that such payments will be made during such grace period.
The D rating also will be used upon the filing of a bankruptcy petition
if debt service payments are jeopardized.

PLUS (+) OR MINUS (-):

The ratings from AA to CCC may be modified by the addition of a plus or
minus sign to show relative standing within the major rating categories.

c The letter c indicates that the holder's option to tender the security
for purchase may be canceled under certain prestated conditions
enumerated in the tender option documents.

L The letter L indicates that the rating pertains to the principal amount
of those bonds to the extent that the underlying deposit collateral is
federally insured and interest is adequately collateralized. In the case
of certificates of deposit, the letter L indicates that the deposit,
combined with other deposits being held in the same right and capacity,
will be honored for principal and accrued pre-default interest up to the
federal insurance limits within 30 days after closing of the insured
institution or, in the event that the deposit is assumed by a successor
insured institution, upon maturity.

p The letter p indicates that the rating is provisional. A provisional
rating assumes the successful completion of the project being financed by
the debt being rated and indicates that payment of debt service
requirements is largely or entirely dependent upon the successful and
timely completion of the project. This rating, however, while addressing
credit quality subsequent to completion of the project, makes no comment
on the likelihood of, or the risk of default upon failure of, such
completion. The investor should exercise his own judgment with respect to
such likelihood and risk.

* Continuance of the rating is contingent upon Standard & Poor's receipt of
an executed copy of the escrow agreement or closing documentation
confirming investments and cash flows.

N.R. Not rated.

46
<PAGE> 105

Debt obligations of issuers outside the United States and its territories
are rated on the same basis as domestic corporate and municipal issues. The
ratings measure the creditworthiness of the obligor but do not take into account
currency exchange and related uncertainties.

Bond Investment Quality Standards: Under present commercial bank
regulations issued by the Comptroller of the Currency, bonds rated in the top
four categories ("AAA", "AA", "A", "BBB", commonly known as "Investment Grade"
ratings) are generally regarded as eligible for bank investment. In addition,
the laws of various states governing legal investments impose certain rating or
other standards for obligations eligible for investment by savings banks, trust
companies, insurance companies and fiduciaries generally.

DESCRIPTION OF STANDARD & POOR'S COMMERCIAL PAPER RATINGS

A Standard & Poor's commercial paper rating is a current assessment of the
likelihood of timely payment of debt considered short-term in the relevant
market. Ratings are graded into several categories, ranging from "A-1" for the
highest quality obligations to "D" for the lowest. These categories are as
follows:

A-1 This highest category indicates that the degree of safety regarding
timely payment is strong. Those issues determined to possess extremely
strong safety characteristics are denoted with a plus sign (+)
designation.

A-2 Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as
for issues designated "A-1".

A-3 Issues carrying this designation have adequate capacity for timely
payment. They are, however, more vulnerable to the adverse effects of
changes in circumstances than obligations carrying the higher
designations.

B Issues rated "B" are regarded as having only speculative capacity for
timely payment.

C This rating is assigned to short-term debt obligations with a doubtful
capacity for payment.

D Debt rated "D" is in payment default. The "D" rating category is used
when interest payments or principal repayments are not made on the date
due, even if the applicable grace period has not expired, unless Standard
& Poor's believes that such payments will be made during such grace
period.

A commercial paper rating is not a recommendation to purchase, sell, or
hold a security inasmuch as it does not comment as to market price or
suitability for a particular investor. The ratings are based on current
information furnished to Standard & Poor's by the issuer or obtained by Standard
& Poor's from other sources it considers reliable. Standard & Poor's does not
perform an audit in connection with any rating and may, on occasion, rely on
unaudited financial information. The ratings may be changed, suspended, or
withdrawn as a result of changes in, or unavailability of, such information, or
based on other circumstances.

47
<PAGE> 106

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, 1996, the related statements of operations for the year then
ended, and changes in net assets for each of the years in the two-year period
then ended, and the financial highlights for each of the years in the four-year
period then ended and the period August 2, 1991 (commencement of operations) to
May 31, 1992. These financial statements and the financial highlights are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements and the financial highlights based on our
audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and the financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned at May 31,
1996 by correspondence with the custodian and broker. 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, 1996, the results of its
operations, the changes in its net assets, and the financial highlights for the
respective stated periods in conformity with generally accepted accounting
principles.

Deloitte & Touche LLP
Princeton, New Jersey

June 28, 1996

48
<PAGE> 107
MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC., MAY 31, 1996
SCHEDULE OF INVESTMENTS
<TABLE>
<CAPTION>
Face Value Percent of
Index Amount Issue Cost (Note 1a) Net Assets
<S> <C> <C> <C> <C> <C> <C>
Adjustable* Certificate Federal National Mortgage Association:
Rate of Deposit $ 547,425 #162619, 6.829% due 6/01/2022 $ 550,675 $ 548,622 0.36%
Mortgage- Indexed 4,797,361 #307622, 6.962% due 4/01/2023 4,936,446 4,900,793 3.19
Backed Obligations
Obliga- ---------------------------------------------------------------------------------------------------------------
tions** Constant Maturity Federal Home Loan Mortgage
Treasury Indexed Corporation:
Obligations 2,552,014 #645073, 7.753% due 5/01/2015 2,595,079 2,607,903 1.70
4,634,245 #606108, 7.752% due 9/01/2019 4,728,294 4,805,156 3.13
3,192,019 #755194, 7.204% due 3/01/2020 3,200,819 3,253,880 2.12
66,401 #785173, 7.416% due 8/01/2020 67,937 66,971 0.04
3,795,906 #845139, 7.783% due 3/01/2022 3,854,041 3,891,411 2.54
6,607,927 #845535, 7.925% due 10/01/2023 6,735,972 6,788,852 4.42
8,892,228 #755170, 7.44% due 8/01/2031 9,192,341 9,089,546 5.92
Federal National Mortgage Association:
572,396 #21041, 6.73% due 10/01/2013 588,852 571,869 0.37
1,790,325 #21059, 6.96% due 11/01/2013 1,841,796 1,791,667 1.17
1,258,817 #20293, 6.17% due 9/01/2015 1,295,008 1,246,367 0.81
5,408,767 #142069, 6.817% due 12/01/2021 5,520,323 5,497,525 3.58
4,834,880 #200009, 7.566% due 2/01/2023 4,852,733 4,949,708 3.22
8,489,796 #291252, 7.76% due 8/01/2024 8,599,332 8,751,112 5.70
3,326,499 #324905, 7.205% due 9/01/2025 3,360,549 3,373,278 2.20
10,811,981 Prudential Home Mortgage Securities
Company, Inc.,REMIC (a) 92-35-A1,
8.166% due 10/01/2022 11,082,281 10,947,131 7.13
---------------------------------------------------------------------------------------------------------------
Cost of Funds 4,954,328 DLJ Mortgage Acceptance Corp.,
Indexed REMIC (a) 91-6-A1, 7.817% due
Obligations 9/01/2021 5,039,094 5,000,775 3.26
820,867 Resolution Trust Corporation, REMIC
(a) 91-M3-A, 7.909% due 2/25/2020 792,106 720,545 0.47
---------------------------------------------------------------------------------------------------------------
London Interbank 7,510,783 Federal National Mortgage Association,
Offered Rate Indexed #305729, 7.751% due 2/01/2025 7,736,043 7,756,086 5.05
Obligations Resolution Trust Corporation, REMIC (a):
6,510,813 91-M7-B, 7.50% due 1/25/2021 6,510,813 6,514,915 4.24
15,005,310 92-C1-B, 7.50% due 8/25/2023 14,452,231 15,155,363 9.87
12,000,000 Saxon Mortgage Securities Corporation,
REMIC (a) 92-3-B, 7.48% due
11/25/2022 12,270,781 12,180,000 7.93
---------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN ADJUSTABLE RATE
MORTGAGE-BACKED OBLIGATIONS 119,803,546 120,409,475 78.42

Derivative 18,631,373 Capstead Mortgage Securities
Mortgage-Backed Corporation II, REMIC (a) 93-2I-A3,
Obligations**-- 0.50% due 9/25/2023 264,842 122,967 0.08
Interest Only (b) 75,850,364 DLJ Mortgage Acceptance Corp., REMIC (a)
92-6-A1, 0.646% due 7/25/2022 1,091,130 849,524 0.55
90,204 Federal Home Loan Mortgage Corporation,
REMIC (a)(c) 92-1363-C, 371% due
8/15/2022 1,470,159 739,674 0.48
212 Federal National Mortgage Association,
REMIC (a) 90-142-K, 1,163% due 7/25/2014 62,139 521 0.00
</TABLE>

49
<PAGE> 108
SCHEDULE OF INVESTMENTS
<TABLE>
<CAPTION>
Face Value Percent of
Index Amount Issue Cost (Note 1a) Net Assets
<S> <C> <C> <C> <C> <C> <C>

188 Prudential Home Mortgage Securities
Company, Inc., REMIC (a) 92-1-A9,
42,989% due 2/25/2022 29,067 40,031 0.03
19,883,411 Residential Funding Mortgage
Securities I, Inc., REMIC (a) 92-S3-A9,
0.50% due 1/25/2007 1,936,972 15,111 0.01
Sears Mortgage Securities Corp.,
REMIC (a):
5,033 91-K-A4, 5,829% due 9/25/2021 670,212 503,311 0.33
40,927,726 92-12-A3, 0.52% due 7/25/2022 476,020 390,092 0.25
---------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN DERIVATIVE
MORTGAGE-BACKED OBLIGATIONS--
INTEREST ONLY 6,000,541 2,661,231 1.73

Fixed Rate 7,707,487 Kidder Peabody Acceptance Corporation,
Mortgage-Backed REMIC (a) 93-M1-A2, 7.15% due 4/25/2025 7,674,144 7,408,822 4.83
Obligations**
5,333,847 Resolution Trust Corporation, REMIC
(a) 92-CHF-B, 7.15% due 12/25/2020 5,397,895 5,324,680 3.47
---------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN FIXED RATE
MORTGAGE-BACKED OBLIGATIONS 13,072,039 12,733,502 8.30

TOTAL INVESTMENTS IN MORTGAGE-BACKED
OBLIGATIONS 138,876,126 135,804,208 88.45

US Government 10,000,000 United States Treasury Notes, 5.125%
Obligations due 2/28/1998 9,949,219 9,823,400 6.40
---------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN US GOVERNMENT
OBLIGATIONS 9,949,219 9,823,400 6.40

Short-Term Repurchase 4,351,000 Nikko Securities International,
Securities Agreements*** Inc., purchased on 5/31/1996 to
yield 5.33% to 6/03/1996 4,351,000 4,351,000 2.83
---------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM SECURITIES 4,351,000 4,351,000 2.83

TOTAL INVESTMENTS $153,176,345 149,978,608 97.68
============
OTHER ASSETS LESS LIABILITIES 3,567,222 2.32
------------ -------
NET ASSETS $153,545,830 100.00%
============ =======
</TABLE>

(a)Real Estate Mortgage Investment Conduits (REMIC).
(b)Securities which receive some or all of the interest portion of
the underlying collateral and little or no principal. Interest only
securities have either a nominal or a notional amount of principal.
(c)Adjustable rate coupon that resets inversely to changes in the
London Interbank Offered Rate.
*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.

See Notes to Financial Statements.

50
<PAGE> 109
MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC., MAY 31, 1996
STATEMENT OF ASSETS AND LIABILITIES
<TABLE>
<CAPTION>
As of May 31, 1996
<S> <C> <C> <C>
Assets: Investments, at value (identified cost--$153,176,345) (Note 1a) ........ $ 149,978,608
Cash ................................................................... 383
Receivables:
Capital shares sold .................................................. $2,497,271
Interest ............................................................. 1,220,892
Principal paydowns ................................................... 814,419
Loaned securities .................................................... 2,917 4,535,499
----------
Deferred organization expenses (Note 1f) ............................... 4,003
Prepaid registration fees and other assets (Note 1f) ................... 82,744
-------------
Total assets ........................................................... 154,601,237
-------------

Liabilities: Payables:
Capital shares redeemed .............................................. 488,926
Dividends to shareholders (Note 1g) .................................. 216,198
Distributor (Note 2) ................................................. 97,961
Investment adviser (Note 2) .......................................... 68,994 872,079
----------
Accrued expenses and other liabilities ................................ 183,328
-------------
Total liabilities ...................................................... 1,055,407
-------------

Net Assets: Net assets ............................................................. $ 153,545,830
=============

Net Assets Class A Common Stock, $0.10 par value, 100,000,000 shares authorized ... $ 2,947
Consist of: Class B Common Stock, $0.10 par value, 200,000,000 shares authorized ... 1,442,184
Class C Common Stock, $0.10 par value, 100,000,000 shares authorized ... 32,288
Class D Common Stock, $0.10 par value, 200,000,000 shares authorized ... 134,460
Paid-in capital in excess of par ....................................... 187,962,894
Accumulated investment loss--net ....................................... (19,431)
Accumulated realized capital losses on investments--net (Note 5) ....... (32,811,775)
Unrealized depreciation on investments--net ............................ (3,197,737)
-------------
Net assets ............................................................. $ 153,545,830
=============

Net Asset Class A--Based on net assets of $281,218 and 29,470 shares
Value: outstanding ................................................... $ 9.54
=============
Class B--Based on net assets of $137,386,527 and 14,421,836
shares outstanding ............................................ $ 9.53
=============
Class C--Based on net assets of $3,077,953 and 322,882
shares outstanding ............................................ $ 9.53
=============
Class D--Based on net assets of $12,800,132 and 1,344,599
shares outstanding ............................................ $ 9.52
=============
</TABLE>

See Notes to Financial Statements.

51
<PAGE> 110
STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE YEAR ENDED MAY 31, 1996
<S> <C> <C>
Investment Income Interest and discount earned, net of premium amortization ....................... $ 12,899,854
(Note 1e): Other ........................................................................... 2,917
-------------
Total income .................................................................... 12,902,771
-------------

Expenses: Account maintenance and distribution fees--Class B (Note 2) ..................... 1,256,198
Investment advisory fees (Note 2) ............................................... 914,312
Transfer agent fees--Class B (Note 2) ........................................... 198,647
Accounting services (Note 2) .................................................... 90,588
Printing and shareholder reports ................................................ 79,815
Registration fees (Note 1f) ..................................................... 69,155
Professional fees ............................................................... 53,094
Directors' fees and expenses .................................................... 47,900
Custodian fees .................................................................. 33,881
Account maintenance fees--Class D (Note 2) ...................................... 33,515
Amortization of organization expenses (Note 1f) ................................. 23,629
Transfer agent fees--Class D (Note 2) ........................................... 12,866
Account maintenance and distribution fees--Class C (Note 2) ..................... 11,933
Pricing fees .................................................................... 1,593
Transfer agent fees--Class C (Note 2) ........................................... 1,374
Transfer agent fees--Class A (Note 2) ........................................... 414
Other ........................................................................... 3,575
-------------
Total expenses .................................................................. 2,832,489
-------------
Investment income--net .......................................................... 10,070,282
-------------

Realized & Realized gain on investments--net ............................................... 318,695
Unrealized Gain Change in unrealized depreciation on investments--net ........................... (890,435)
Investments--Net -------------
(Notes 1c, NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS ............................ $ 9,498,542
1e & 3): =============
</TABLE>

See Notes to Financial Statements.

52
<PAGE> 111
MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC., MAY 31, 1996
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
For the Year Ended May 31,
-------------------------
Increase (Decrease) in Net Assets: 1996 1995
<S> <C> <C> <C>
Operations: Investment income--net ........................................... $ 10,070,282 $ 14,383,007
Realized gain (loss) on investments--net ......................... 318,695 (9,607,152)
Change in unrealized depreciation on investments--net ............ (890,435) 8,689,257
------------- -------------
Net increase in net assets resulting from operations ............. 9,498,542 13,465,112
------------- -------------

Dividends to Investment income--net:
Shareholders Class A ........................................................ (27,553) (14,494)
(Note 1g): Class B ........................................................ (9,248,234) (13,293,732)
Class C ........................................................ (81,537) (11,227)
Class D ........................................................ (812,697) (1,017,584)
------------- -------------
Net decrease in net assets resulting from dividends to
shareholders ..................................................... (10,170,021) (14,337,037)
------------- -------------

Capital Shares Net decrease in net assets derived from capital share
Transactions transactions ..................................................... (66,863,233) (175,466,828)
(Note 4): ------------- -------------

Net Assets: Total decrease in net assets ..................................... (67,534,712) (176,338,753)
Beginning of year ................................................ 221,080,542 397,419,295
------------- -------------
End of year* ..................................................... $ 153,545,830 $ 221,080,542
============= =============

*Undistributed (accumulated) investment income (loss)--net ........ $ (19,431) $ 80,308
============= =============
</TABLE>

See Notes to Financial Statements.

53
<PAGE> 112
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
Class A Class B
----------------------- --------------------------------------------------
The following per share data
and ratios have been derived For the For the
from information provided Period Period
in the financial statements. For the Oct. 21, Aug.2,
Year Ended 1994++ to For the Year Ended May 31, 1991++ to
Increase (Decrease) in May 31, May 31, --------------------------------------- May 31,
Net Asset Value: 1996+++++ 1995 1996+++++ 1995 1994 1993 1992
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Per Share Net asset value,
Operating beginning of period ........ $ 9.55 $ 9.46 $ 9.56 $ 9.53 $ 9.76 $ 9.92 $ 10.00
Performance: -------- -------- -------- -------- -------- -------- --------
Investment income--net ..... .56 .36 .52 .46 .32 .40 .52
Realized and unrealized
gain (loss) on investments
--net ...................... .03 .09 (.02) .04 (.24) (.16) (.08)
-------- -------- -------- -------- -------- -------- --------
Total from investment
operations ................. .59 .45 .50 .50 .08 .24 .44
-------- -------- -------- -------- -------- -------- --------
Less dividends from
investment income--net ..... (.60) (.36) (.53) (.47) (.31) (.40) (.52)
-------- -------- -------- -------- -------- -------- --------
Net asset value, end
of period .................. $ 9.54 $ 9.55 $ 9.53 $ 9.56 $ 9.53 $ 9.76 $ 9.92
======== ======== ======== ======== ======== ======== ========

Total Investment Based on net asset value
Return:** per share .................. 6.41% 4.85%+++ 5.34% 5.48% .77% 2.48% 4.33%+++
======== ======== ======== ======== ======== ======== ========

Ratios to Average Expenses, net of
Net Assets: reimbursement .............. .81% .87%* 1.59% 1.59% 1.46% 1.40% 1.36%*
======== ======== ======== ======== ======== ======== ========
Expenses ................... .81% .87%* 1.59% 1.59% 1.46% 1.40% 1.47%*
======== ======== ======== ======== ======== ======== ========
Investment income--net ..... 6.20% 6.18%* 5.45% 4.88% 3.20% 4.15% 6.07%*
======== ======== ======== ======== ======== ======== ========

Supplemental Net assets, end of
Data: period (in thousands) ...... $ 281 $ 345 $137,387 $202,334 $374,376 $689,593 $887,110
======== ======== ======== ======== ======== ======== ========
Portfolio turnover ......... 25.30% 102.55% 25.30% 102.55% 60.38% 104.71% 94.72%
======== ======== ======== ======== ======== ======== ========
</TABLE>

++Commencement of Operations.
*Annualized.
**Total investment returns exclude the effects of sales loads.
+++Aggregate total investment return.
+++++Based on average shares outstanding during the period.

See Notes to Financial Statements.

54
<PAGE> 113
MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC., MAY 31, 1996
FINANCIAL HIGHLIGHTS (concluded)
<TABLE>
<CAPTION>
Class C Class D
---------------------- ------------------------------------------
The following per share data
and ratios have been derived For the For the
from information provided For the Period Period
in the financial statements. Year Oct. 21, Aug.2,
Ended 1994++ to For the Year Ended May 31, 1991++ to
Increase (Decrease) in May 31, May 31, ------------------------------------------ May 31,
Net Asset Value: 1996+++++ 1995 1996+++++ 1995 1994 1993 1992
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Per Share Net asset value,
Operating beginning of period ....... $ 9.56 $ 9.46 $ 9.55 $ 9.53 $ 9.76 $ 9.92 $ 10.00
Performance: -------- -------- -------- -------- -------- -------- --------
Investment income--net .... .48 .31 .56 .51 .37 .45 .56
Realized and unrealized
gain (loss) on investments
--net ..................... .01 .10 (.01) .03 (.24) (.16) (.08)
-------- -------- -------- -------- -------- -------- --------
Total from investment
operations ................ .49 .41 .55 .54 .13 .29 .48
-------- -------- -------- -------- -------- -------- --------
Less dividends from
investment income--net .... (.52) (.31) (.58) (.52) (.36) (.45) (.56)
-------- -------- -------- -------- -------- -------- --------
Net asset value, end of
period .................... $ 9.53 $ 9.56 $ 9.52 $ 9.55 $ 9.53 $ 9.76 $ 9.92
======== ======== ======== ======== ======== ======== ========

Total Investment Based on net asset value
Return:** per share ................. 5.30% 4.47%+++ 5.91% 5.91% 1.28% 2.99% 4.75%+++
======== ======== ======== ======== ======== ======== ========

Ratios to Average Expenses, net of
Net Assets: reimbursement ............. 1.57% 1.68%* 1.06% 1.08% .96% .91% .87%*
======== ======== ======== ======== ======== ======== ========
Expenses .................. 1.57% 1.68%* 1.06% 1.08% .96% .91% .96%*
======== ======== ======== ======== ======== ======== ========
Investment income--net .... 5.40% 5.51%* 5.98% 5.44% 3.69% 4.79% 6.54%*
======== ======== ======== ======== ======== ======== ========

Supplemental Net assets, end of
Data: period (in thousands) ..... $ 3,078 $ 1,409 $ 12,800 $ 16,993 $ 23,043 $ 51,398 $ 80,411
======== ======== ======== ======== ======== ======== ========
Portfolio turnover ........ 25.30% 102.55% 25.30% 102.55% 60.38% 104.71% 94.72%
======== ======== ======== ======== ======== ======== ========
</TABLE>

See Notes to Financial Statements.

55
<PAGE> 114
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 diversified, open-end management
investment company. The Fund offers four classes of shares under the Merrill
Lynch Select Pricing (SM) System. Shares of Class A and Class D are sold with a
front-end sales charge. Shares of Class B and Class C may be subject to a
contingent deferred sales charge. All classes of shares have identical voting,
dividend, liquidation and other rights and the same terms and conditions, except
that Class B, Class C and Class D Shares bear certain expenses related to the
account maintenance of such shares, and Class B and Class C Shares also bear
certain expenses related to the distribution of such shares. Each class has
exclusive voting rights with respect to matters relating to its account
maintenance and distribution expenditures. The following is a summary of
significant accounting policies followed by the Fund.

(a) Valuation of investments--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 dealers 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 securities pursuant
to repurchase agreements with a member bank of the Federal 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 securities and, if necessary, receives additions to such securities
daily to ensure that the contract is fully collateralized.

(c) Derivative financial instruments--The Fund may engage in various portfolio
strategies to seek to increase its return by hedging its portfolio against
adverse movements in the debt markets. Losses may arise due to changes in the
value of the contract or if the counterparty does not perform under the
contract.

* Options--The Fund is authorized to purchase and write covered call and put
options. When the Fund writes an option, an amount equal to the premium received
by the Fund is reflected as an asset and an equivalent 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 the cost of the
closing transaction exceeds the premium paid or received).

Written and purchased options are non-income producing investments.

* Financial futures contracts--The Fund may purchase or sell interest rate
futures contracts and related options on such futures contracts for the purpose
of hedging the market risk on existing securities or the intended purchase of
securities. Futures contracts are contracts for delayed delivery of securities
at a specific future date and at a specific price or yield. Upon entering into a
contract, the Fund deposits and maintains as collateral such initial margin as
required by the exchange on which the transaction is effected. Pursuant to the
contract, the Fund agrees to receive from or pay to the broker an amount of cash
equal to the daily fluctuation in value of the contract. Such receipts or
payments are known as variation margins and are recorded by the Fund as
unrealized gains or losses. When the contract is closed, the Fund records a
realized gain or loss equal to the difference between the value of the contract
at the time it was opened and the value at the time is was closed.

(d) Income taxes--It is the Fund's policy to comply with the requirements of the
Internal Revenue Code applicable to regulated

56
<PAGE> 115
MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC., MAY 31, 1996
NOTES TO FINANCIAL STATEMENTS (continued)

investment companies and to distribute substantially all of its taxable income
to its shareholders. Therefore, no Federal income tax provision is required.

(e) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Interest income (including amortization of discount and premiums) is recognized
on the accrual basis. Realized gains and losses on security transactions are
determined on the identified cost basis.

(f) 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.

(g) 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.

(h) 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.

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"). The general partner of MLAM is Princeton
Services, Inc. ("PSI"), an indirect wholly- owned subsidiary of Merrill Lynch &
Co., Inc. ("ML & Co."), which is the limited partner. The Fund has entered into
a Distribution Agreement and Distribution Plans with Merrill Lynch Funds
Distributor, Inc. ("MLFD" or "Distributor"), a wholly-owned subsidiary of
Merrill Lynch Group, Inc.

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.
The Investment 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.

Pursuant to the distribution plans (the "Distribution Plans") adopted by the
Fund in accordance with Rule 12b-1 under the Investment Company Act of 1940, the
Fund pays the Distributor ongoing account maintenance and distribution fees. The
fees are accrued daily and paid monthly at annual rates based upon the average
daily net assets of the shares as follows:

<TABLE>
<CAPTION>
- ------------------------------------------------------------------
ACCOUNT DISTRIBUTION
MAINTENANCE FEE FEE
- ------------------------------------------------------------------
<S> <C> <C>
Class B ......................... 0.25% 0.50%
Class C ......................... 0.25% 0.55%
Class D ......................... 0.25% --
- ------------------------------------------------------------------
</TABLE>

Pursuant to a sub-agreement with the Distributor, Merrill Lynch, Pierce, Fenner
& Smith Inc. ("MLPF&S"), a subsidiary of ML & Co., also provides account
maintenance and distribution services to the Fund. The ongoing account
maintenance fee compensates the Distributor and MLPF&S for providing account
maintenance services to Class B, Class C and Class D shareholders. The ongoing
distribution fee compensates the Distributor and MLPF&S for providing
shareholder and distribution-related services to Class B and Class C
shareholders.

For the year ended May 31, 1996, MLFD earned underwriting discounts and MLPF&S
earned dealer concessions on sales of the Fund's Class D Shares as follows:

<TABLE>
<CAPTION>
- ------------------------------------------------------------------
MLFD MLPF&S
- ------------------------------------------------------------------
<S> <C> <C>
Class D ............................ $2,485 $18,959
- ------------------------------------------------------------------
</TABLE>

For the year ended May 31, 1996, MLPF&S received contingent deferred sales
charges of $12,780 and $3,334 relating to transactions in Class B and Class C
Shares, respectively.

For the year ended May 31, 1996, the Fund paid Merrill Lynch Security Pricing
Service, an affiliate of MLPF&S, $1,593 for security price quotations to compute
the net asset value of the Fund.

Merrill Lynch Financial Data Services, Inc. ("MLFDS"), a wholly- owned
subsidiary of ML & Co., is the Fund's transfer agent.

Accounting services are provided to the Fund by MLAM at cost.

57
<PAGE> 116
Certain officers and/or directors of the Fund are officers and/or directors of
MLAM, PSI, MLPF&S, MLFDS, MLFD, and/or ML & Co.

3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the
year ended May 31, 1996 were $47,048,206 and $94,021,253, respectively.

Net realized and unrealized gains (losses) as of May 31, 1996 were
as follows:

<TABLE>
<CAPTION>
- -----------------------------------------------------------------
REALIZED UNREALIZED
GAINS LOSSES
- -----------------------------------------------------------------
<S> <C> <C>
Long-term investments ....... $ 318,695 $ (3,197,737)
------------- -------------
Total ....................... $ 318,695 $ (3,197,737)
============= =============
- -----------------------------------------------------------------
</TABLE>

As of May 31, 1996, net unrealized depreciation for Federal income tax purposes
aggregated $3,432,624 of which $1,221,756 related to appreciated securities and
$4,654,380 related to depreciated securities. The aggregate cost of investments
at May 31, 1996 for Federal income tax purposes was $153,411,232.

4. Capital Share Transactions:
Net decrease in net assets derived from capital share transactions was
$66,863,233 and $175,466,828 for the years ended May 31, 1996 and May 31, 1995,
respectively.

Transactions in capital shares for each class were as follows:

<TABLE>
<CAPTION>
- --------------------------------------------------------------
CLASS A SHARES FOR THE YEAR DOLLAR
ENDED MAY 31, 1996 SHARES AMOUNT
- --------------------------------------------------------------
<S> <C> <C>
Shares sold ........................ 893,429 $ 8,512,092
Shares issued to shareholders
in reinvestment of dividends ....... 151 1,444
------- -----------
Total issued ....................... 893,580 8,513,536
Shares redeemed .................... (900,177) (8,576,542)
------- -----------
Net decrease ....................... (6,597) $ (63,006)
======= ===========
- --------------------------------------------------------------
</TABLE>

<TABLE>
<CAPTION>
- ---------------------------------------------------------------
CLASS A SHARES FOR THE PERIOD DOLLAR
OCTOBER 21, 1994++ TO MAY 31, 1995 SHARES AMOUNT
- ---------------------------------------------------------------
<S> <C> <C>
Shares sold .......................... 68,974 $ 651,499
Shares issued to shareholders
in reinvestment of dividends ......... 60 570
------ ---------
Total issued ......................... 69,034 652,069
Shares redeemed ...................... (32,967) (310,911)
------ ---------
Net increase ......................... 36,067 $ 341,158
====== =========
- ---------------------------------------------------------------
</TABLE>

++Commencement of Operations.

<TABLE>
<CAPTION>
- ---------------------------------------------------------------------
CLASS B SHARES FOR THE YEAR DOLLAR
ENDED MAY 31, 1996 SHARES AMOUNT
- ---------------------------------------------------------------------
<S> <C> <C>
Shares sold ........................ 3,209,190 $ 30,564,309
Shares issued to shareholders
in reinvestment of dividends ....... 566,087 5,393,795
---------- -------------
Total issued ....................... 3,775,277 35,958,104
Automatic conversion of shares ..... (2,712) (25,846)
Shares redeemed .................... (10,524,204) (100,276,738)
---------- -------------
Net decrease ....................... (6,751,639) $ (64,344,480)
========== =============
- ---------------------------------------------------------------------
</TABLE>

<TABLE>
<CAPTION>
- ----------------------------------------------------------------------
CLASS B SHARES FOR THE YEAR DOLLAR
ENDED MAY 31, 1995 SHARES AMOUNT
- ----------------------------------------------------------------------
<S> <C> <C>
Shares sold ........................ 3,506,784 $ 33,206,006
Shares issued to shareholders
in reinvestment of dividends ....... 809,890 7,574,701
---------- -------------
Total issued ....................... 4,316,674 40,780,707
Automatic conversion of shares ..... (364) (3,468)
Shares redeemed .................... (22,411,721) (211,944,078)
---------- -------------
Net decrease ....................... (18,095,411) $(171,166,839)
========== =============
- ----------------------------------------------------------------------
</TABLE>

<TABLE>
<CAPTION>
- ---------------------------------------------------------------------
CLASS C SHARES FOR THE YEAR DOLLAR
ENDED MAY 31, 1996 SHARES AMOUNT
- ---------------------------------------------------------------------
<S> <C> <C>
Shares sold ..................... 1,331,201 $ 12,686,096
Shares issued to shareholders
in reinvestment of dividends .... 3,955 37,684
--------- -----------
Total issued .................... 1,335,156 12,723,780
Shares redeemed ................. (1,159,725) (11,052,376)
--------- ------------
Net increase .................... 175,431 $ 1,671,404
========= ============
- ---------------------------------------------------------------------
</TABLE>

<TABLE>
<CAPTION>
- -------------------------------------------------------------------
CLASS C SHARES FOR THE PERIOD DOLLAR
OCTOBER 21, 1994++ TO MAY 31, 1995 SHARES AMOUNT
- -------------------------------------------------------------------
<S> <C> <C>
Shares sold ....................... 231,275 $ 2,187,668
Shares issued to shareholders
in reinvestment of dividends ...... 794 7,491
------- -----------
Total issued ...................... 232,069 2,195,159
Shares redeemed ................... (84,618) (795,090)
------ -----------
Net increase ...................... 147,451 $ 1,400,069
======= ===========
- -------------------------------------------------------------------
</TABLE>

++Commencement of Operations.

58
<PAGE> 117
NOTES TO FINANCIAL STATEMENTS (concluded)

- --------------------------------------------------------------------
CLASS D SHARES FOR THE YEAR DOLLAR
ENDED MAY 31, 1996 SHARES AMOUNT
- --------------------------------------------------------------------
<S> <C> <C>
Shares sold ..................... 2,963,785 $ 28,203,483
Automatic conversion of shares .. 2,713 25,846
Shares issued to shareholders
in reinvestment of dividends .... 43,150 410,938
--------- ------------
Total issued .................... 3,009,648 28,640,267
Shares redeemed ................. (3,444,089) (32,767,418)
--------- ------------
Net decrease .................... (434,441) $ (4,127,151)
========= ============
- --------------------------------------------------------------------
</TABLE>

<TABLE>
<CAPTION>
- -------------------------------------------------------------------
CLASS D SHARES FOR THE YEAR DOLLAR
ENDED MAY 31, 1995 SHARES AMOUNT
- -------------------------------------------------------------------
<S> <C> <C>
Shares sold ..................... 403,735 $ 3,830,957
Automatic conversion of shares .. 364 3,468
Shares issued to shareholders
in reinvestment of dividends. ... 65,091 614,664
--------- ------------
Total issued .................... 469,190 4,449,089
Shares redeemed ................. (1,108,309) (10,490,305)
--------- ------------
Net decrease .................... (639,119) $ (6,041,216)
========== ============
- -------------------------------------------------------------------
</TABLE>

As a result of the implementation of the Merrill Lynch Select Pricing SM System,
Class A Shares of the Fund outstanding prior to October 21, 1994 were
redesignated Class D Shares. There were 2,010,429 shares redesignated, amounting
to $21,918,414.

5. CAPITAL LOSS CARRYFORWARD:
At May 31, 1996, the Fund had a net capital loss carryforward of approximately
$32,506,000, of which $20,978,000 expires in 2002, $3,887,000 expires in 2003
and $7,641,000 expires in 2004. This amount will be available to offset like
amounts of any future taxable gains.

59
<PAGE> 118

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objective and Policies.................. 2
Privately Issued Mortgage-Backed and Asset-Backed
Securities--Credit Enhancements................. 2
United States Government Agencies or
Instrumentalities............................... 3
Adjustable Rate Securities--Indexes............... 5
Additional Collateralized Mortgage Obligation
Structures...................................... 5
Portfolio Strategies Involving Interest Rate
Transactions, Options and Futures............... 6
Other Investment Policies and Practices........... 10
Investment Restrictions........................... 11
Management of the Fund............................. 15
Directors and Officers............................ 15
Compensation of Directors......................... 16
Management and Advisory Arrangements.............. 17
Purchase of Shares................................. 18
Initial Sales Charge Alternatives--
Class A and Class D Shares...................... 19
Reduced Initial Sales Charge...................... 21
Employer-Sponsored Retirement or Savings Plans and
Certain Other Arrangements...................... 23
Distribution Plans................................ 23
Limitations on the Payment of Deferred Sales
Charges......................................... 24
Redemption of Shares............................... 25
Deferred Sales Charges--
Class B and Class C Shares...................... 25
Portfolio Transactions............................. 26
Portfolio Turnover................................ 27
Determination of Net Asset Value................... 28
Shareholder Services............................... 29
Investment Account................................ 29
Automatic Investment Plans........................ 29
Automatic Reinvestment of Dividends and Capital
Gains Distributions............................. 30
Systematic Withdrawal Plans--
Class A and Class D Shares...................... 30
Exchange Privilege................................ 31
Dividends, Distributions and Taxes................. 33
Dividends and Distributions....................... 33
Taxes............................................. 34
Tax Treatment of Interest Rate Transactions,
Options and Futures............................. 35
Performance Data................................... 36
General Information................................ 40
Description of Shares............................. 40
Computation of Offering Price per Share........... 41
Independent Auditors.............................. 41
Custodian......................................... 41
Transfer Agent.................................... 41
Legal Counsel..................................... 41
Reports to Shareholders........................... 42
Additional Information............................ 42
Security Ownership of Certain Beneficial Owners... 42
Appendix A--Ratings of Debt Securities............. 43
Independent Auditors' Report....................... 48
Financial Statements............................... 49
Code #13938-0996
</TABLE>

[MERRILL LYNCH LOGO]
MERRILL LYNCH
ADJUSTABLE RATE
SECURITIES FUND, INC.

[MERRILL LYNCH COMPASS]

STATEMENT OF
ADDITIONAL
INFORMATION

September 27, 1996

Distributor:
Merrill Lynch
Funds Distributor, Inc.
<PAGE> 119
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.

<TABLE>
<CAPTION>
DESCRIPTION OF OMITTED LOCATION OF GRAPHIC
GRAPHIC OR IMAGE OR IMAGE IN TEXT
- ---------------------- -------------------
<S> <C>
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>
<PAGE> 120

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, 1996, 1995, 1994
and 1993 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, 1996

Statement of Assets and Liabilities as of May 31, 1996

Statement of Operations for the year ended May 31, 1996

Statements of Changes in Net Assets for the years ended May 31,
1996 and 1995

Financial Highlights for the years ended May 31, 1996, 1995, 1994
and 1993 and for the period August 2, 1991 (commencement of operations)
to May 31, 1992

<TABLE>
<CAPTION>
EXHIBIT
NUMBER
- ------
<S> <C>
1(a) -- Articles of Incorporation of Registrant.(a)
(b) -- Articles of Amendment, dated May 31, 1991, of Registrant.(a)
(c) -- Articles Supplementary, dated October 17, 1994, of Registrant.(a)
(d) -- Articles of Amendment, dated October 17, 1994, of Registrant.(e)
2 -- By-Laws of Registrant.(a)
3 -- None.
4(a) -- Portions of the Articles of Incorporation and the By-Laws of the Registrant
defining the rights of holders of shares of the Registrant.(c)
5(a) -- Management Agreement between Registrant and Merrill Lynch Asset Management,
Inc.(a)
(b) -- Supplement to Management Agreement between Registrant and Merrill Lynch Asset
Management, L.P.(b)
6(a) -- Form of Class A Distribution Agreement between Registrant and Merrill Lynch Funds
Distributor, Inc. (including Selected Dealers Agreement).(b)
(b) -- Class B Distribution Agreement between Registrant and Merrill Lynch Funds
Distributor, Inc.(a)
(c) -- Form of Class C Distribution Agreement between Registrant and Merrill Lynch Funds
Distributor, Inc. (including Selected Dealers Agreement).(b)
(d) -- Form of Class D Distribution Agreement between Registrant and Merrill Lynch Funds
Distributor, Inc. (including Selected Dealers Agreement).(b)
7 -- None.
8 -- Custody Agreement between Registrant and The Bank of New York.(a)
9 -- Transfer Agency, Dividend Disbursing Agency and Shareholder Servicing Agency
Agreement between Registrant and Financial Data Services, Inc.(a)
10 -- Opinion of Brown & Wood LLP, counsel to the Registrant.
11 -- Consent of Deloitte & Touche LLP, independent auditors for Registrant.
12 -- None.
13 -- Certificate of Merrill Lynch Asset Management, Inc.(a)
14 -- None.
15(a) -- Amended and Restated Class B Shares Distribution Plan of Registrant.(a)
(b) -- Form of Class C Distribution Plan Sub-Agreement of Registrant.(b)
(c) -- Form of Class D Distribution Plan Sub-Agreement of Registrant.(a)
16(a) -- Schedule for computation of each performance quotation provided in the
Registration Statement in response to item 22 relating to Class D shares.(a)
</TABLE>

C-1
<PAGE> 121

<TABLE>
<CAPTION>
EXHIBIT
NUMBER
- ------
<S> <C>
(b) -- Schedule for computation of each performance quotation provided in the
Registration Statement in response to item 22 relating to Class B shares.(a)
(c) -- Schedule for computation of each performance quotation provided in the
Registration Statement in response to item 22 relating to Class A shares.(e)
(d) -- Schedule for computation of each performance quotation provided in the
Registration Statement in response to item 22 relating to Class C shares.(e)
17(a) -- Financial Data Schedule for Class A Shares.
(b) -- Financial Data Schedule for Class B Shares.
(c) -- Financial Data Schedule for Class C Shares.
(d) -- Financial Data Schedule for Class D Shares.
18 -- Merrill Lynch Select Pricing(SM) System Plan Pursuant to Rule 18f-3.(d)
</TABLE>

- -------------------------
(a) Refiled pursuant to the Electronic Data Gathering, Analysis and Retrieval
("EDGAR") phase-in requirements.

(b) Previously filed as an exhibit to Post-Effective Amendment No. 5 to the
Registration Statement.

(c) 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.

(d) Incorporated by reference to Post-Effective Amendment No. 13 to the
Registration Statement on Form N-1A of Merrill Lynch New York Municipal Bond
Fund of Merrill Lynch Multi-State Municipal Series Trust filed on January
25, 1996.

(e) Previously filed as an exhibit to Post-Effective Amendment No. 6 to
Registrant's Registration Statement on Form N-1A, filed September 27, 1995.

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
HOLDERS AT
TITLE OF CLASS AUGUST 31, 1996*
- ----------------------------------------------------------------------------- ----------------
<S> <C>
Class A shares of Common Stock, par value $0.10 per share.................... 10
Class B shares of Common Stock, par value $0.10 per share.................... 9,620
Class C shares of Common Stock, par value $0.10 per share.................... 84
Class D shares of Common Stock, par value $0.10 per share.................... 496
</TABLE>

- -------------------------

* The number of holders shown in the table includes holders of record plus
beneficial owners, whose shares are held of record by Merrill Lynch, Pierce,
Fenner & Smith Incorporated.

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, Class B, Class C and Class D
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

C-2
<PAGE> 122

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)
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.

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 open-end investment companies: Merrill
Lynch Adjustable Rate Securities Fund, Inc., Merrill Lynch Americas Income Fund,
Inc., Merrill Lynch Asset Builder Program, Inc., Merrill Lynch Asset Growth
Fund, Inc., Merrill Lynch Asset Income Fund, Inc., 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 Inc.,
Merrill Lynch Healthcare Fund, Inc., Merrill Lynch Institutional Intermediate
Fund, Merrill Lynch International Equity Fund, Merrill Lynch Latin America Fund,
Inc., Merrill Lynch Middle East/Africa Fund, Inc., Merrill Lynch Municipal
Series Trust, Merrill Lynch Pacific Fund, Inc., Merrill Lynch Ready Assets
Trust, Merrill Lynch Retirement Series Trust, 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.; and for the
following closed-end investment companies: Convertible Holdings, Inc., Merrill
Lynch High Income Municipal Bond Fund, Inc., Merrill Lynch Senior Floating Rate
Fund, Inc. and Merrill Lynch Municipal Strategy Fund, Inc.

Fund Asset Management, L.P. ("FAM"), an affiliate of the Manager, acts as
the investment adviser for the following open-end investment companies: 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., Financial Institutions Series Trust, Merrill
Lynch Basic Value Fund, Inc., Merrill Lynch California Municipal Series Trust,
Merrill Lynch Corporate Bond Fund, Inc., Merrill Lynch Emerging Tigers 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. and The
Municipal

C-3
<PAGE> 123

Fund Accumulation Program, Inc.; and for the following closed-end investment
companies: Apex Municipal Fund, 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., 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 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., 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 Merrill Lynch
Financial Data Services is 4800 Deer Lake Drive East, Jacksonville, Florida
32246-6484.

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, 1993 for his or her 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. Glenn, Giordano, Harvey,
Kirstein and Monagle are directors or officers of one or more of such companies.

C-4
<PAGE> 124

<TABLE>
<CAPTION>
OTHER SUBSTANTIAL BUSINESS,
POSITION(S) WITH PROFESSION, VOCATION
NAME INVESTMENT ADVISER OR EMPLOYMENT
- ------------------------------ ------------------------ -------------------------------------
<S> <C> <C>
Norman R. Harvey.............. Senior Vice President Senior Vice President of FAM; Senior
Vice President of Princeton Services
Michael J. Hennewinkel........ Senior Vice President Senior Vice President of FAM
N. John Hewitt................ Senior Vice President Senior Vice President of FAM; Senior
Vice President of Princeton Services
Philip L. Kirstein............ Senior Vice President, Senior Vice President, General
General Counsel and Counsel and Secretary of FAM; Senior
Secretary Vice President, Director and
Secretary of Princeton Services;
Director of MLFD
Ronald M. Kloss............... Senior Vice President Senior Vice President and Controller
and Controller of FAM; Senior Vice President and
Controller of Princeton Services
Stephen M.M. Miller........... Senior Vice President Executive Vice President of Princeton
Administrators; Senior Vice President
of Princeton Services
Joseph T. Monagle, Jr......... Senior Vice President Senior Vice President of FAM; Senior
Vice President of Princeton Services
Michael L. Quinn.............. Senior Vice President Senior Vice President of FAM, Senior
Vice President of Princeton Services,
Managing Director and First Vice
President of Merrill Lynch, Pierce,
Fenner & Smith Incorporated from 1989
to 1995
Richard L. Reller............. Senior Vice President Senior Vice President of FAM; Senior
Vice President of Princeton Services
Gerald M. Richard............. Senior Vice President Senior Vice President and Treasurer
and Treasurer of FAM; Senior Vice President and
Treasurer of Princeton Services; Vice
President and Treasurer of MLFD
Ronald L. Welburn............. Senior Vice President Senior Vice President of FAM; Senior
Vice President of Princeton Services
Anthony Wiseman............... Senior Vice President Senior Vice President of FAM; Senior
Vice President of Princeton Services
</TABLE>

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 two paragraphs of
Item 28 except 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.,
MuniAssets Fund, Inc., and The Municipal Fund Accumulation Program, Inc.; and
MLFD also acts as the principal underwriter for the following closed-end
investment companies: Merrill Lynch High Income Municipal Bond Fund, Inc. and
Merrill Lynch Senior Floating Rate 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

C-5
<PAGE> 125

Messrs. Crook, Aldrich, Brady, Breen, 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
Mark A. DeSario........................ Vice President None
James T. Fatseas....................... Vice President None
Michelle T. Lau........................ Vice President None
Gerald M. Richard...................... Vice President and Treasurer Treasurer
Debra W. Landsman-Yaros................ Vice President None
Salvatore Venezia...................... Vice President None
William Wasel.......................... Vice President None
Robert Harris.......................... Secretary None
</TABLE>

ITEM 30. LOCATION OF ACCOUNTS AND RECORDS.

All accounts, books and other documents required to be maintained by
Section 31(a) of the 1940 Act and the rules thereunder will be maintained at the
offices of the Registrant, 800 Scudders Mill Road, Plainsboro, New Jersey 08536
and the Transfer Agent, 4800 Deer Lake Drive East, Jacksonville, Florida
32246-6484.

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 to each person to whom a prospectus is
delivered a copy of the Registrant's latest annual report to shareholders, upon
request and without charge.

C-6
<PAGE> 126

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 POST-EFFECTIVE AMENDMENT TO THE
REGISTRATION STATEMENT PURSUANT TO RULE 485(b) UNDER THE SECURITIES ACT OF 1933
AND HAS DULY CAUSED THIS POST-EFFECTIVE AMENDMENT TO THE REGISTRATION STATEMENT
TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN THE
TOWNSHIP OF PLAINSBORO, AND THE STATE OF NEW JERSEY, ON THE 26TH DAY OF
SEPTEMBER, 1996.

Merrill Lynch Adjustable Rate
Securities Fund, Inc.
(Registrant)

By /s/ GERALD M. RICHARD

------------------------------------
(Gerald M. Richard, Treasurer)

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 DATE(S) INDICATED.

<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- --------------------------------------------- ------------------------ -------------------
<S> <C> <C>
ARTHUR ZEIKEL* President and Director
- --------------------------------------------- (Principal Executive
(Arthur Zeikel) Officer)

/s/ GERALD M. RICHARD Treasurer (Principal September 26, 1996
- --------------------------------------------- Financial and
(Gerald M. Richard) Accounting Officer)

JOE GRILLS* Director
- ---------------------------------------------
(Joe Grills)

WALTER MINTZ* Director
- ---------------------------------------------
(Walter Mintz)

ROBERT S. SALOMON, JR.* Director
- ---------------------------------------------
(Robert S. Salomon, Jr.)

MELVIN R. SEIDEN* Director
- ---------------------------------------------
(Melvin R. Seiden)

STEPHEN B. SWENSRUD* Director
- ---------------------------------------------
(Stephen B. Swensrud)

*By /s/ GERALD M. RICHARD September 26, 1996
------------------------------------------
(Gerald M. Richard, Attorney-in-fact)
</TABLE>

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<PAGE> 127

EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------ ----------------------------------------------------------------------------------
<S> <C>
10 -- Opinion of Brown & Wood LLP, counsel to the Registrant.
11 -- Consent of Deloitte & Touche LLP, independent auditors for Registrant.
17(a) -- Financial Data Schedule for Class A Shares.
(b) -- Financial Data Schedule for Class B Shares.
(c) -- Financial Data Schedule for Class C Shares.
(d) -- Financial Data Schedule for Class D Shares.
</TABLE>

C-8

<PAGE> 1
EXHIBIT 10

BROWN & WOOD LLP
One World Trade Center
New York, NY 10048-0557

September 27, 1996

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., a Maryland corporation (the
"Company"), of 16,057,340 shares of common stock, par value $0.10 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 Company, 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
of the Company, as amended, the By-Laws of the Company and such other
documents as we have deemed relevant to the matters referred to in this
opinion.

Based upon 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 Company.

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 LLP

<PAGE> 1
EXHIBIT 11

INDEPENDENT AUDITORS' CONSENT

Merrill Lynch Adjustable Rate Securities Fund, Inc.:

We consent to the use in Post-Effective Amendment No. 7 to Registration
Statement No. 33-40332 of our report dated June 28, 1996 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
Princeton, New Jersey
September 26, 1996

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<CIK> 0000874619
<NAME> MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC.
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<ARTICLE> 6
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<ARTICLE> 6
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