<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON AUGUST 29, 1997
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. 8 [X]
AND/OR
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 [X]
AMENDMENT NO. 9 [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 21, 1997.
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)................ 14,903,981 $10.05 $329,992 $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 14,871,146 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) All of the shares redeemed during Registrant's previous fiscal year are
being used for the reduction of the registration fee in this amendment to
the Registration Statement.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC.
REGISTRATION STATEMENT ON FORM N-1A
----------------
CROSS REFERENCE SHEET
<TABLE>
<CAPTION>
N-
1A ITEM NO. LOCATION
----------- --------
<C> <S> <C>
Part A
Item 1. Cover Page........................ Cover Page
Item 2. Synopsis.......................... Prospectus Summary and Fee Table
Item 3. Condensed Financial Information... Financial Highlights
Item 4. General Description of Investment Objective and Policies;
Registrant........................ 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 Cover Page; Purchase of Shares; Redemption
Securities........................ of Shares; Shareholder Services;
Additional Information
Item 7. Purchase of Securities Being Cover Page; Fee Table; Merrill Lynch Select
Offered........................... 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
</TABLE>
Part C
Information required to be included in Part C is set forth under the
appropriate Item, so numbered, in Part C to this Registration Statement.
<PAGE>
PROSPECTUS
AUGUST 29, 1997
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
diversified, open-end management investment company that seeks 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 PricingSM System, the Fund offers four
classes of shares, each with a different combination of sales charges, ongoing
fees and other features. The Merrill Lynch Select PricingSM System permits an
investor to choose the method of purchasing shares that the investor believes
is most beneficial given the amount of the purchase, the length of time the
investor expects to hold the shares and other relevant circumstances. See
"Merrill Lynch Select PricingSM 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, and for participants in certain fee-based programs the minimum initial
purchase is $500 and the minimum subsequent purchase is $50. Merrill Lynch may
charge its customers a processing fee (presently $5.35) for confirming
purchases and repurchases. Purchases and redemptions made 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 NOR HAS THE SECURITIES AND EXCHANGE 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 August 29, 1997 (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>
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 open-end 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
at least 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
The types of securities in which the Fund invests have certain unique
attributes that warrant special consideration or that present risks that may
not exist in other types of mutual fund investments. Some of these
considerations and risks pertain to the characteristics of mortgage-backed
securities ("MBSs") or asset-backed securities ("ABSs") generally, while
others are peculiar to Adjustable Rate Securities. One of the principal risks
regarding MBSs and, to a lesser extent, ABSs is the risk of prepayments.
Prepayment rates are affected by changes in prevailing interest rates and
numerous economic, geographic, social and other factors. The special
considerations and risks inherent in investments in MBSs and ABSs are
discussed under "Investment Objective and Policies--Special Considerations and
Risk Factors."
2
<PAGE>
THE MANAGER
The Fund's investment adviser is Merrill Lynch Asset Management, L.P. (the
"Manager" or "MLAM"). The Manager is owned and controlled by Merrill Lynch &
Co., Inc., a financial services holding company and the parent of Merrill
Lynch. The Manager, or an affiliate of the Manager, Fund Asset Management,
L.P. ("FAM"), acts as the investment adviser for more than 140 registered
investment companies. MLAM and FAM also offer portfolio management and
portfolio analysis services to individuals and institutions. As of July 31,
1997, the Manager and FAM had a total of approximately $267.2 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>
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(f)
annually thereafter to
0.0% after the fourth
year(e)
Exchange Fee........... None None None None
ANNUAL FUND OPERATING
EXPENSES (AS A
PERCENTAGE OF AVERAGE
NET ASSETS)
Management Fees(g)..... 0.50% 0.50% 0.50% 0.50%
12b-1 Fees(h):
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(i)............ 0.09% 0.10% 0.10% 0.08%
Other................ 0.28% 0.28% 0.28% 0.28%
---- ---- ---- ----
Total Other
Expenses.......... 0.39% 0.40% 0.40% 0.38%
---- ---- ---- ----
Total Fund Operating
Expenses.............. 0.89% 1.65% 1.70% 1.13%
==== ==== ==== ====
</TABLE>
- --------
(a)Class A shares are sold to a limited group of investors including existing
Class A shareholders, certain retirement plans and certain participants in
fee-based programs. See "Purchase of Shares--Initial Sales Charge
Alternatives--Class A and Class D Shares"--page 31 and "Shareholder Services--
Fee-Based Programs"--page 43.
(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 and participants in connection with
certain fee-based 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 that are
not subject to an initial sales charge may instead be subject to a CDSC of
1.0% of amounts redeemed within the first year after purchase. Such CDSC may
be waived in connection with certain fee-based programs. See "Shareholder
Services--Fee-Based Programs"--page 43.
(Footnotes continued on next page)
4
<PAGE>
(e) The CDSC may be modified in connection with certain fee-based programs.
See "Shareholder Services--Fee-Based Programs"--page 43.
(f) The CDSC may be waived in connection with certain fee-based programs. See
"Shareholder Services--Fee-Based Programs"--page 43.
(g) See "Management of the Fund--Management and Advisory Arrangements"--page
28.
(h) See "Purchase of Shares--Distribution Plans"--page 37.
(i) See "Management of the Fund--Transfer Agency Services"--page 29.
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 (including any applicable CDSC for
Class B and Class C shares):
Class A..................................... $49 $67 $ 87 $145
Class B..................................... $57 $72 $ 90 $195
Class C..................................... $27 $54 $ 92 $201
Class D..................................... $51 $74 $100 $172
An investor would pay the following expenses
on the same $1,000 investment assuming no
redemption at the end of the period:
Class A..................................... $49 $67 $ 87 $145
Class B..................................... $17 $52 $ 90 $195
Class C..................................... $17 $54 $ 92 $201
Class D..................................... $51 $74 $100 $172
</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
Conduct Rules of the National Association of Securities Dealers, Inc. (the
"NASD"). Merrill Lynch may charge its customers a processing fee (presently
$5.35) for confirming purchases and repurchases. Purchases and redemptions
made directly through the Fund's Transfer Agent are not subject to the
processing fee. See "Purchase of Shares" and "Redemption of Shares."
5
<PAGE>
MERRILL LYNCH SELECT PRICING SM SYSTEM
The Fund offers four classes of shares under the Merrill Lynch Select
PricingSM 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 PricingSM System is used
by more than 50 registered investment companies advised by MLAM or an
affiliate of MLAM, FAM. Funds advised by MLAM or FAM that use the Merrill
Lynch Select PricingSM System are referred to herein as "MLAM-advised mutual
funds."
Each Class A, Class B, Class C or Class D share of the Fund represents an
identical interest in the investment portfolio of the Fund and has the same
rights, except that Class B, Class C and Class D shares bear the expenses of
the ongoing account maintenance fees and Class B and Class C shares bear the
expenses of the ongoing distribution fees and the additional incremental
transfer agency costs resulting from the deferred sales charge arrangements.
The CDSCs, distribution and account maintenance fees that are imposed on Class
B and Class C shares, as well as the account maintenance fees that are imposed
on 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 CDSCs and distribution fees with respect to the Class B and Class
C shares in that the sales charges and distribution fees 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 PricingSM 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 PricingSM System that the investor
believes is most beneficial under his or her particular circumstances. More
detailed information as to each class of shares is set forth under "Purchase
of Shares."
6
<PAGE>
<TABLE>
<CAPTION>
ACCOUNT
MAINTENANCE DISTRIBUTION CONVERSION
CLASS SALES CHARGE(/1/) FEE FEE FEATURE
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
A Maximum 4.00% initial No No No
sales charge(/2/),(/3/)
- ------------------------------------------------------------------------------------------
B CDSC for a period of four years, 0.25% 0.50% B shares convert to
at a rate of 4.0% during D shares automatically
the first year, decreasing 1.0% after approximately
annually to 0.0%(/4/) ten years(/5/)
- ------------------------------------------------------------------------------------------
C 1.0% CDSC for one year(/6/) 0.25% 0.55% No
- ------------------------------------------------------------------------------------------
D Maximum 4.00% initial 0.25% No No
sales charge(/3/)
</TABLE>
- --------
(1) Initial sales charges are imposed at the time of purchase as a percentage
of the offering price. CDSCs are imposed if the redemption occurs within
the applicable CDSC time period. The charge will be assessed on an amount
equal to the lesser of the proceeds of redemption or the cost of the
shares being redeemed.
(2) Offered only to eligible investors. See "Purchase of Shares--Initial Sales
Charge Alternatives--Class A and Class D Shares--Eligible Class A
Investors."
(3) Reduced for purchases of $25,000 or more, and waived for purchases of
Class A shares by certain retirement plans and participants in connection
with certain fee-based programs. Class A and Class D share purchases of
$1,000,000 or more may not be subject to an initial sales charge but
instead may be subject to a 1.0% CDSC if redeemed within one year. Such
CDSC may be waived in connection with certain fee-based programs. A .75%
sales charge for 401(k) purchases over $1,000,000 will apply. See "Class
A" and "Class D" below.
(4) The CDSC may be modified in connection with certain fee-based programs.
(5) 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.
(6) The CDSC may be waived in connection with certain fee-based programs.
Class A: Class A shares incur an initial sales charge when they are purchased
and bear no ongoing distribution or account maintenance fees. Class A
shares 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 fee-based programs. In
addition, Class A shares will be offered at net asset value to
Merrill Lynch & Co., Inc. ("ML&Co.") and its subsidiaries (the term
"subsidiaries" when used herein with respect to ML&Co., includes 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 of 4.00%, is reduced for purchases of
$25,000 and over, and waived for purchases by certain retirement
plans and participants in connection with certain fee-based programs.
Purchases of $1,000,000 or more may not be subject to an initial
sales charge but, if the initial sales charge is waived, such
purchases may be subject to a 1.0% CDSC if the shares are redeemed
within one year after purchase. Such CDSC may be waived in connection
with certain fee-based programs. Sales charges also are reduced under
a right of accumulation that 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>
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 Class B shares and a CDSC if they are redeemed within
four years of purchase. Such CDSC may be modified in connection with
certain fee-based programs. Approximately ten years after issuance,
Class B shares will convert automatically into Class D shares of the
Fund, which are subject to 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 1.0% CDSC if they are redeemed within one year of
purchase. Such CDSC may be waived in connection with certain fee-
based programs. Although Class C shares are subject to a CDSC for
only one year (as compared to four years for Class B), Class C shares
have no conversion feature and, accordingly, an investor that
purchases Class C shares will be subject to 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. The maximum initial sales charge of 5.25% is
reduced for purchases of $25,000 and over. Purchases of $1,000,000 or
more may not be subject to an initial sales charge but if the initial
sales charge is waived such purchases may be subject to a CDSC of
1.0% if the shares are redeemed within one year after purchase. Such
CDSC may be waived in connection with certain fee-based programs. 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 in connection with certain fee-based
programs. Class D shares also will be issued upon conversion of Class
B shares as described above under "Class B." See "Purchase of
Shares--Initial Sales Charge Alternatives--Class A and Class D
Shares."
8
<PAGE>
The following is a discussion of the factors that investors should consider
in determining the method of purchasing shares under the Merrill Lynch Select
Pricing SM System that the investor believes is most beneficial under his 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
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
that qualify the investor for reduced initial sales charges on new initial
sales charge purchases. In addition, the ongoing Class B and Class C account
maintenance and distribution fees will cause Class B and Class C shares to
have higher expense ratios, pay lower dividends and have lower total returns
than the initial sales charge shares. The ongoing Class D account maintenance
fees will cause Class D shares to have a higher expense ratio, pay lower
dividends and have a lower total return than Class A shares.
Deferred Sales Charge Alternatives. Because no initial sales charges are
deducted at the time of purchase, Class B and Class C shares provide the
benefit of putting all of the investor's dollars to work from the time the
investment is made. The deferred sales charge alternatives may be particularly
appealing to investors who do not qualify for a reduction in initial sales
charges. Both Class B and Class C shares are subject to ongoing account
maintenance fees and distribution fees; however, the ongoing account
maintenance and distribution fees potentially may be offset to the extent any
return is realized on the additional funds initially invested in Class B or
Class C shares. In addition, Class B shares will be converted into Class D
shares of the Fund after a conversion period of approximately ten years, and
thereafter investors will be subject to lower ongoing fees.
Certain investors may elect to purchase Class B shares if they determine it
to be most advantageous to have all their funds invested initially and intend
to hold their shares for an extended period of time. Investors in Class B
shares should take into account whether they intend to redeem their shares
within the CDSC period and, if not, whether they intend to remain invested
until the end of the conversion period and thereby take advantage of the
reduction in ongoing fees resulting from the conversion into Class D shares.
Other investors, however, may elect to purchase Class C shares if they
determine that it is advantageous to have all 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>
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, 1997 are included
in the Statement of Additional Information. Further information about the
performance of the Fund is contained in the Fund's most recent annual report
to shareholders which may be obtained, without charge, by calling or by
writing the Fund at the telephone number or address on the front cover of this
Prospectus.
The following per share data and ratios have been derived from the
information provided in the financial statements.
<TABLE>
<CAPTION>
CLASS A CLASS B
------------------------------ ----------------------------------------------------------------
FOR THE YEAR FOR THE PERIOD FOR THE YEAR FOR THE PERIOD
ENDED MAY 31, OCT. 21, 1994+ ENDED MAY 31, AUG. 2, 1991+
-------------- TO MAY 31, ------------------------------------------------ TO MAY 31,
1997++ 1996++ 1995 1997++ 1996++ 1995 1994 1993 1992
------ ------ -------------- -------- -------- -------- -------- -------- --------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
INCREASE (DECREASE) IN
NET ASSET VALUE:
PER SHARE OPERATING
PERFORMANCE:
Net asset value,
beginning of period.... $ 9.54 $ 9.55 $ 9.46 $ 9.53 $ 9.56 $ 9.53 $ 9.76 $ 9.92 $ 10.00
------ ------ -------- -------- -------- -------- -------- -------- --------
Investment income--
net................... .59 .56 .36 .51 .52 .46 .32 .40 .52
Realized and unrealized
gain (loss) on
investments--net...... .10 .03 .09 .09 (.02) .04 (.24) (.16) (.08)
------ ------ -------- -------- -------- -------- -------- -------- --------
Total from investment
operations............. .69 .59 .45 .60 .50 .50 .08 .24 .44
------ ------ -------- -------- -------- -------- -------- -------- --------
Less dividends from
investment
income--net............ (.58) (.60) (.36) (.51) (.53) (.47) (.31) (.40) (.52)
------ ------ -------- -------- -------- -------- -------- -------- --------
Net asset value, end of
period................. $ 9.65 $ 9.54 $ 9.55 $ 9.62 $ 9.53 $ 9.56 $ 9.53 $ 9.76 $ 9.92
====== ====== ======== ======== ======== ======== ======== ======== ========
TOTAL INVESTMENT
RETURN:**
Based on net asset value
per share.............. 7.48% 6.41% 4.85%# 6.44% 5.34% 5.48% .77% 2.48% 4.33%#
====== ====== ======== ======== ======== ======== ======== ======== ========
RATIOS TO AVERAGE NET
ASSETS:
Expenses, net of
reimbursement.......... .89% .81% .87%* 1.65% 1.59% 1.59% 1.46% 1.40% 1.36%*
====== ====== ======== ======== ======== ======== ======== ======== ========
Expenses................ .89% .81% .87%* 1.65% 1.59% 1.59% 1.46% 1.40% 1.47%*
====== ====== ======== ======== ======== ======== ======== ======== ========
Investment income--net.. 6.13% 6.20% 6.18%* 5.35% 5.45% 4.88% 3.20% 4.15% 6.07%*
====== ====== ======== ======== ======== ======== ======== ======== ========
SUPPLEMENTAL DATA:
Net assets, end of
period (in thousands).. $ 265 $ 281 $ 345 $106,061 $137,387 $202,334 $374,376 $689,593 $887,110
====== ====== ======== ======== ======== ======== ======== ======== ========
Portfolio turnover...... 18.48% 25.30% 102.55% 18.48% 25.30% 102.55% 60.38% 104.71% 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>
<TABLE>
<CAPTION>
CLASS C CLASS D
------------------------------ ----------------------------------------------------------
FOR THE FOR THE
FOR THE YEAR PERIOD FOR THE YEAR PERIOD
ENDED MAY 31, OCT. 21, 1994+ ENDED MAY 31, AUG. 2, 1991+
-------------- TO MAY 31, ------------------------------------------- TO MAY 31,
1997++ 1996++ 1995 1997++ 1996++ 1995 1994 1993 1992
------ ------ -------------- ------- ------- ------- ------- ------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
INCREASE (DECREASE) IN
NET ASSET VALUE:
PER SHARE OPERATING
PERFORMANCE:
Net asset value,
beginning of period.... $ 9.53 $ 9.56 $ 9.46 $ 9.52 $ 9.55 $ 9.53 $ 9.76 $ 9.92 $ 10.00
------ ------ ------ ------- ------- ------- ------- ------- -------
Investment income--
net................... .50 .48 .31 .57 .56 .51 .37 .45 .56
Realized and unrealized
gain (loss) on
investments--net...... .11 .01 .10 .09 (.01) .03 (.24) (.16) (.08)
------ ------ ------ ------- ------- ------- ------- ------- -------
Total from investment
operations............. .61 .49 .41 .66 .55 .54 .13 .29 .48
------ ------ ------ ------- ------- ------- ------- ------- -------
Less dividends from
investment income--
net.................... (.51) (.52) (.31) (.56) (.58) (.52) (.36) (.45) (.56)
------ ------ ------ ------- ------- ------- ------- ------- -------
Net asset value, end of
period................. $ 9.63 $ 9.53 $ 9.56 $ 9.62 $ 9.52 $ 9.55 $ 9.53 $ 9.76 $ 9.92
====== ====== ====== ======= ======= ======= ======= ======= =======
TOTAL INVESTMENT
RETURN:**
Based on net asset value
per share.............. 6.51% 5.30% 4.47%# 7.11% 5.91% 5.91% 1.28% 2.99% 4.75%#
====== ====== ====== ======= ======= ======= ======= ======= =======
RATIOS TO AVERAGE NET
ASSETS:
Expenses, net of
reimbursement.......... 1.70% 1.57% 1.68%* 1.13% 1.06% 1.08% .96% .91% .87%*
====== ====== ====== ======= ======= ======= ======= ======= =======
Expenses................ 1.70% 1.57% 1.68%* 1.13% 1.06% 1.08% .96% .91% .96%*
====== ====== ====== ======= ======= ======= ======= ======= =======
Investment income--net.. 5.34% 5.40% 5.51%* 5.87% 5.98% 5.44% 3.69% 4.79% 6.54%*
====== ====== ====== ======= ======= ======= ======= ======= =======
SUPPLEMENTAL DATA:
Net assets, end of
period (in thousands).. $5,315 $3,078 $1,409 $13,267 $12,800 $16,993 $23,043 $51,398 $80,411
====== ====== ====== ======= ======= ======= ======= ======= =======
Portfolio turnover...... 18.48% 25.30% 102.55% 18.48% 25.30% 102.55% 60.38% 104.71% 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>
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
at least 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 that
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>
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
13
<PAGE>
rates to determine whether to continue to hold the securities in the Fund's
portfolio. No more than 10% of the Fund's total assets will be invested in
securities rated in the lowest category of investment grade or in comparable
unrated securities. A description of applicable ratings is contained in the
Appendix to the Statement of Additional Information.
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
14
<PAGE>
Bank Prime Loan Rate made available by the Federal Reserve Board, (iv) the
cost of funds of member institutions for the Federal Home Loan Bank of San
Francisco ("COFI"), and (v) the offered quotations to leading banks in the
London interbank market for Eurodollar deposits of a specified duration
("LIBOR").
The interest rates paid on Adjustable Rate Securities are generally
readjusted periodically to an increment over the chosen interest rate index.
Such readjustments typically occur at intervals ranging from one to sixty
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 because 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, multi-family residences or commercial
properties. ARMs typically provide for a fixed initial interest rate for the
first three to sixty 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 specified index. 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 usually 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>
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. 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.
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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 securities other than
Adjustable Rate Securities, either alone or in combination with money market
securities. Other securities in which the Fund may invest consist principally
of fixed rate MBSs and ABSs, stripped securities, and fixed rate debt
securities of FNMA which are not MBSs.
Fixed rate MBSs in which the Fund may invest consist primarily of fixed rate
pass-through securities and fixed rate CMOs. As in the case of Adjustable Rate
Securities, these fixed rate securities may be issued either by agencies or
instrumentalities of the United States or by the types of private issuers
described above. Similarly, the basic structures with respect to fixed rate
MBSs are the same as those described above with respect to Adjustable Rate
Securities. The principal difference between fixed rate securities and
Adjustable Rate Securities is that the interest rate on the former type of
securities is set at a predetermined amount and does not vary according to
changes in any index. As in the case of Adjustable Rate Securities, fixed rate
ABSs reflect basically the same structures as fixed rate MBSs.
Stripped mortgage-backed securities ("SMBSs") are derivative multiclass
mortgage-backed securities. Such securities are typically issued by the same
types of issuers as are MBSs generally. The structure of SMBSs, however, is
different. SMBS arrangements commonly involve two classes of securities that
receive different proportions of the interest and principal distributions on a
pool of mortgage assets. A common variety of SMBS is where one class (the
principal-only or PO class) receives some of the interest and most of the
principal from the underlying assets, while the other class (the interest-only
or IO class) receives most of the interest and the remainder of the principal.
In the most extreme case, the IO class receives all of the interest, while the
PO class receives all of the principal. While the Fund may purchase securities
of a PO class, it is more likely to purchase the securities of an IO class.
The yield to maturity of an IO class is extremely sensitive to the rate of
principal
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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 Commission to be illiquid
securities and, consequently, the Fund will not invest in IOs or POs in an
amount which, taken together with the Fund's other investments in illiquid
securities, exceeds 10% of the Fund's net assets.
The Fund may also purchase debentures issued by FNMA. FNMA debentures are
unsecured general obligations of FNMA. FNMA's obligations have traditionally
been treated as "U.S. Agency" debt in the marketplace and are eligible for
investment by many supervised financial institutions without regard to legal
limits generally imposed on investment securities. However, the debentures
(together with interest thereon) are not guaranteed by the United States and
do not constitute a debt or obligation of the United States or of any agency
or instrumentality thereof other than FNMA. The debentures generally are
issued in book-entry form and are offered through a nationwide group of
securities dealers and dealer banks. FNMA does not generally sell its
debentures directly to investors. The debentures typically bear interest at
fixed rates per annum, payable semiannually in arrears and computed on the
basis of a 360-day year of twelve 30-day months.
DESCRIPTION OF MONEY MARKET SECURITIES
The money market securities in which the Fund may invest consist of United
States Government securities, United States Government agency or
instrumentality securities, domestic bank or savings institution certificates
of deposit and bankers' acceptances, short-term debt securities such as
commercial paper and other corporate debt, and repurchase agreements. These
investments must have a maturity not in excess of one year from the date of
purchase.
The Fund has established the following standards with respect to money
market securities in which the Fund invests. Commercial paper investments at
the time of purchase must be rated "A-1" by Standard & Poor's or "Prime-1" by
Moody's or, if not rated, be issued by companies having such a rating with
respect to comparable short-term debt securities. Investments in corporate
bonds and debentures (which must have maturities at the date of purchase of
one year or less) will be limited to securities of issuers which, at the time
of purchase, have a rating with respect to comparable short-term debt of A-1
by Standard & Poor's or Prime-1 by Moody's. The Fund may not invest in any
security issued by a commercial bank or a savings institution unless the bank
or institution is organized and operating in the United States, has total
assets of at least one billion dollars and is a member of the Federal Deposit
Insurance Corporation.
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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. 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.
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
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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.
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
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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, together with other illiquid investments of the Fund, exceeds
15% of the Fund's total assets.
Call Options on Portfolio Securities. The Fund may purchase call options on
any of the types of securities in which it may invest. A purchased call option
gives the Fund the right to buy, and obligates the seller to sell, the
underlying security at the exercise price at any time during the option
period. The Fund also is authorized to write (i.e., sell) covered call options
on the securities in which it may invest and to enter into closing purchase
transactions with respect to certain of such options. A covered call option is
an option where the Fund, in return for a premium, gives another party a right
to buy specified securities owned by the Fund at a specified future date and
price set at the time of the contract. The principal reason for writing call
options is to attempt to realize, through the receipt of premiums, a greater
return than would be realized on the securities alone. By writing
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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 the Fund has segregated liquid securities having a value at least equal
to the strike price of the put. The Fund will receive a premium for writing a
put option, which increases the Fund's return. In selling puts, there is a
risk that the Fund may be required to buy the underlying security at a
disadvantageous price.
Financial Futures and Options Thereon. The Fund is authorized to engage in
transactions in financial futures contracts ("futures contracts"), and related
options on such futures contracts as a hedge against adverse changes in the
market value of its portfolio securities and interest rates. A futures
contract is an agreement between two parties which obligates the purchaser of
the futures contract to buy and the seller of a futures contract to sell a
security for a set price on a future date or, in the case of an index futures
contract, to make and accept a cash settlement based upon the difference in
value of the index between the time the contract was entered into and the time
of its settlement. Transactions by the Fund in futures contracts and financial
futures are subject to limitations as described below under "Restrictions on
the Use of Futures Transactions."
The Fund may sell financial futures contracts in anticipation of an increase
in the general level of interest rates. Generally, as interest rates rise, the
market values of securities which may be held by the Fund will fall, thus
reducing the net asset value of the Fund. However, as interest rates rise, the
value of the Fund's short position in the futures contract will also tend to
increase, thus offsetting all or a portion of the depreciation in the market
value of the Fund's investments which are being hedged. While the Fund will
incur commission expenses in selling and closing out futures positions, these
commissions are generally less than the transaction expenses which the Fund
would have incurred had the Fund sold portfolio securities in order to reduce
its exposure to increases in interest rates. The Fund also may purchase
financial futures contracts in anticipation of a decline in interest rates
when it is not fully invested in a particular market in which it intends to
make investments to gain market exposure that may in part or entirely offset
an increase in the cost of securities it intends to purchase. It is
anticipated that, in a substantial majority of these transactions, the Fund
will purchase securities upon termination of the futures contract.
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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 Commission which exempts the Fund from
certain provisions of the Investment Company Act of 1940, as amended (the
"Investment Company Act") in connection with transactions involving futures
contracts and options thereon.
Restrictions on OTC Options. The Fund will engage in OTC options only with
member banks of the Federal Reserve System and primary dealers in U.S.
Government securities or with affiliates of such banks or dealers which have
capital of at least $50 million or whose obligations are guaranteed by an
entity having capital of at least $50 million.
The staff of the Commission has taken the position that purchased OTC
options and the assets used as cover for written OTC options are illiquid
securities. Therefore, except to the extent set forth in the Statement of
Additional Information, the Fund has adopted an investment policy pursuant to
which it will not purchase or sell
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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, 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 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
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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 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 102% 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 obligation on the
delivery date may be more or less than its purchase price. A separate account
of the Fund will be established with its custodian consisting of cash, cash
equivalents or liquid securities having a market value at all times at least
equal to the amount of the forward commitment.
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 foregoes principal
25
<PAGE>
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 securities in an amount equal to the forward price. 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 that 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 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
(the "Code"), 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 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
26
<PAGE>
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 that
cannot readily be resold because of legal or contractual restrictions or that
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 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.
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 Investment Company
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 Investment Company Act.
The Directors are:
Arthur Zeikel*--President of the Manager and its affiliate 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 Committees of the State of New
York Common Retirement Fund and the Howard Hughes Medical Institute; Director,
Duke Management Company, LaSalle Street Fund and Kimco Realty Corporation.
Walter Mintz--Special Limited Partner of Cumberland Associates (investment
partnership).
Robert S. Salomon, Jr.--Principal of STI Management (investment adviser).
Melvin R. Seiden--Director of Silbanc Properties, Ltd. (real estate,
investment and consulting).
Stephen B. Swensrud--Chairman of Fernwood Associates (financial
consultants).
- --------
* Interested person, as defined by the Investment Company Act, of the Fund.
27
<PAGE>
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 140 registered
investment companies. The Manager also provides investment advisory services
to individual and institutional clients. As of July 31, 1997, the Manager and
FAM had a total of approximately $267.2 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, 1997, the fee paid by the Fund to the
Manager was $689,185 (based on average daily net assets of approximately
$138.2 million). The Management Agreement obligates the Fund to pay certain
expenses incurred in the Fund's operations, including, among other things, the
management fee, legal and audit fees, unaffiliated Directors' fees and
expenses, registration fees, custodian and transfer agency fees, accounting
and pricing costs, and certain of the costs of printing proxies, shareholder
reports, prospectuses and statements of additional information. Accounting
services are provided to the Fund by the Manager and the Fund reimburses the
Manager for its costs in connection with such services. For the fiscal year
ended May 31, 1997, the amount of such reimbursement was $98,039. For the
fiscal year ended May 31, 1997, the ratio of total expenses to average net
assets was 0.89%, 1.65%, 1.70% and 1.13% 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 that 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 that
at the time is being purchased or sold (as the case may be), or
28
<PAGE>
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 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 up to $11.00 per Class A or Class D account and up to $14.00 per
Class B or Class C account and is entitled to reimbursement for certain
transaction charges and out-of-pocket expenses incurred by the Transfer Agent
under the Transfer Agency Agreement. Additionally, a $.20 monthly closed
account charge will be assessed on all accounts which close during the
calendar year. Application of this fee will commence the month following the
month the account is closed. At the end of the calendar year, no further fees
will be due. For purposes of the Transfer Agency Agreement, the term "account"
includes a shareholder account maintained directly by the Transfer Agent and
any other account representing the beneficial interest of a person in the
relevant share class on a recordkeeping system, provided the recordkeeping
system is maintained by a subsidiary of ML&Co. For the fiscal year ended May
31, 1997, the total fee paid by the Fund to the Transfer Agent was $146,876.
PURCHASE OF SHARES
The Distributor, an affiliate of both the Manager and Merrill Lynch, acts as
the distributor of shares of the Fund. Shares of the Fund are offered
continuously for sale by the Distributor and other eligible securities dealers
(including Merrill Lynch). Shares of the Fund may be purchased from securities
dealers or by mailing a purchase order directly to the Transfer Agent. The
minimum initial purchase is $1,000, and the minimum subsequent purchase is
$50, except that for retirement plans, the minimum initial purchase is $100,
and the minimum subsequent purchase is $1, and for participants in certain
fee-based programs, the minimum initial purchase is $500 and the minimum
subsequent purchase is $50.
The Fund offers its shares in four classes at a public offering price equal
to the next determined net asset value per share plus sales charges imposed
either at the time of purchase or on a deferred basis depending upon the class
of shares selected by the investor under the Merrill Lynch Select PricingSM
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
29
<PAGE>
on the NYSE on that day, 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 $5.35) to confirm a sale of shares to
such customers. Purchases made directly through the Transfer Agent are not
subject to the processing fee.
The Fund issues four classes of shares under the Merrill Lynch Select
PricingSM 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 PricingSM System is set forth under "Merrill Lynch Select
PricingSM 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 CDSCs, distribution and account maintenance fees that are imposed on Class
B and Class C shares, as well as the account maintenance fees that are imposed
on Class D shares, are imposed directly against those classes and not against
all assets of the Fund and, accordingly, such charges 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. 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 (except that Class B shareholders may vote upon any material changes
to expenses charged under the Class D Distribution Plan). 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 CDSC and distribution fees with respect to Class B and Class C shares
in that the sales charges and distribution fees 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, that are
eligible to sell shares.
30
<PAGE>
The following table sets forth a summary of the distribution arrangements
for each class of shares under the Merrill Lynch Select PricingSM System.
<TABLE>
<CAPTION>
ACCOUNT
MAINTENANCE DISTRIBUTION CONVERSION
CLASS SALES CHARGE(/1/) FEE FEE FEATURE
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
A Maximum 4.00% initial sales No No No
charge(/2/),(/3/)
- --------------------------------------------------------------------------------------------
B CDSC for a period of four years, 0.25% 0.50% B shares convert to
at a rate of 4.0% during the D shares automatically
first year, decreasing 1.0% after approximately
annually to 0.0%(/4/) ten years(/5/)
- --------------------------------------------------------------------------------------------
C 1.0% CDSC for one year(/6/) 0.25% 0.55% No
- --------------------------------------------------------------------------------------------
D Maximum 4.00% initial sales 0.25% No No
charge(/3/)
</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."
(3) Reduced for purchases of $25,000 or more, and waived for purchases of
Class A shares by certain retirement plans and participants in connection
with certain fee-based programs. Class A and Class D share purchases of
$1,000,000 or more may not be subject to an initial sales charge but
instead may be subject to a 1.0% CDSC if redeemed within one year. Such
CDSC may be waived in connection with certain fee-based programs. A .75%
sales charge for 401(k) purchases over $1,000,000 will apply.
(4) The CDSC may be modified in connection with certain fee-based programs.
(5) 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.
(6) The CDSC may be waived in connection with certain fee-based programs.
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.
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>
(Footnotes appear on following page)
31
<PAGE>
- --------
* 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 and participants in certain fee-based programs. If the sales
charge is waived in connection with a purchase of $1,000,000 or more, such
purchases may be subject to a 1.0% CDSC if the shares are redeemed within
one year after purchase. Such CDSC may be waived in connection with certain
fee-based programs. The charge will be assessed on an amount equal to the
lesser of the proceeds of redemption or the cost of the shares being
redeemed. 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.
The proceeds from the account maintenance fees are used to compensate the
Distributor and Merrill Lynch (pursuant to a sub-agreement) for providing
continuing account maintenance activities.
During the fiscal year ended May 31, 1997, the Fund sold 965,067 Class A
shares for aggregate net proceeds to the Fund of $9,288,059. 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, 1997, the Fund
sold 2,480,241 Class D shares for aggregate net proceeds to the Fund of
$23,652,524. The gross sales charges for the sale of Class D shares of the
Fund for that period were $11,286, of which $934 and $10,352 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 and U.S. branches of foreign banking
institutions provided that the program or branch has $3 million or more
initially invested in MLAM-advised mutual funds. Also eligible to purchase
Class A shares at net asset value are participants in certain investment
programs including TMA SM Managed Trusts to which Merrill Lynch Trust Company
provides discretionary trustee services, collective investment trusts for
which Merrill Lynch Trust Company serves as trustee and purchases made in
connection with certain fee-based programs. In addition, Class A shares are
offered at net asset value to ML&Co. and its subsidiaries and their directors
and employees and to members of the Boards of MLAM-advised investment
companies, including the 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
32
<PAGE>
reinvest the net proceeds from a sale of certain of their shares of common
stock pursuant to a tender offer conducted by such funds in shares of the Fund
and certain other MLAM-advised mutual funds.
Reduced Initial Sales Charges. No initial sales charges are imposed upon
Class A and Class D shares issued as a result of the automatic reinvestment of
dividends or capital gains distributions. Class A and Class D sales charges
also may be reduced under a Right of Accumulation and a Letter of Intention.
Class A shares are offered at net asset value to certain eligible Class A
investors as set forth above under "Eligible Class A Investors." See
"Shareholder Services--Fee-Based Programs."
Provided applicable threshold requirements are met, either Class A or Class
D shares are offered at net asset value to Employee Access SM Accounts
available through authorized employers. Subject to certain conditions 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. and Class A shares are offered at net asset value to
shareholders of Merrill Lynch Senior Floating Rate 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 time of
purchase. As discussed below, Class B shares are subject to a four-year CDSC,
which declines each year, 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." The proceeds from the
account maintenance fees are used to compensate the Distributor and Merrill
Lynch (pursuant to a sub-agreement) for providing continuing account
maintenance activities.
33
<PAGE>
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 that 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.
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, 1997, the Distributor received CDSCs of
$75,785 with respect to the redemptions of Class B shares, all of which were
paid to Merrill Lynch. Additional CDSCs payable to the Distributor may have
been waived or converted to a contingent obligation in connection with a
shareholder's participation in certain fee-based programs.
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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 four years or shares acquired pursuant to reinvestment of
dividends or distributions and then of shares held longest during the four-
year period. The charge will not be applied to dollar amounts representing an
increase in the net asset value since the time of purchase. A transfer of
shares from a shareholder's account to another account will be assumed to be
made in the same order as a redemption.
To provide an example, assume an investor purchased 100 shares at $10 per
share (at a cost of $1,000) and in the third year after purchase, the net
asset value per share is $12 and, during such time, the investor has acquired
10 additional shares 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.
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 Code) of a shareholder. The Class B CDSC also 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 SM Account available
through employers providing eligible 401(k) plans. The Class B CDSC also is
waived for any Class B shares that are purchased by a Merrill Lynch rollover
IRA that was funded by a rollover from a terminated 401(k) plan managed by the
MLAM Private Portfolio Group and held in such account at the time of
redemption. The Class B CDSC also is waived for any Class B shares that are
purchased within qualifying Employee Access SM Accounts. Additional
information concerning the waiver of the contingent deferred sales charge is
set forth in the Statement of Additional Information. The terms of the CDSC
may be modified in connection with certain fee-based programs. See
"Shareholder Services--Fee-Based Programs."
Contingent Deferred Sales Charges--Class C Shares. Class C shares that 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. The Class C CDSC may be waived in
connection with certain fee-based programs. See "Shareholder Services--Fee-
Based Programs." For the fiscal year ended May 31, 1997, the Distributor
received CDSCs of $22,912 with respect to redemptions of Class C shares, all
of which were paid to Merrill Lynch.
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
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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.
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 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 that 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 may be modified for retirement plan investors who
participate in certain fee-base programs. See "Shareholder Services--Fee-Based
Programs."
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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 provides
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 shares of the
Fund in that the deferred sales charges provide for the financing of the
distribution of the Fund's Class B and Class C shares.
For the fiscal year ended May 31, 1997, the Fund paid the Distributor
$905,720 pursuant to the Class B Distribution Plan (based on average net
assets subject to the Class B Distribution Plan of approximately $121.1
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, 1997, the Fund paid the
Distributor $30,129 pursuant to the Class C Distribution Plan (based on
average net assets subject to the Class C Distribution Plan of approximately
$3.8 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, 1997, the Fund paid the
Distributor $32,462 pursuant to the Class D Distribution Plan (based on
average net assets subject to the Class D Distribution Plan of approximately
$13.0 million), all of which was paid to Merrill Lynch for providing account
maintenance activities in connection with Class D shares.
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
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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.
As of December 31, 1996, 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 $1,032,000 (.87%
of Class B net assets at that date). As of December 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 $14,842,184 (12.49% of
Class B net assets at that date). As of May 31, 1997, for Class B shares,
direct cash revenues for the period since commencement of the offering of
Class B shares exceeded direct cash expenses by $15,154,156 (14.29% of Class B
net assets at that date). As of December 31, 1996, with respect to Class C
shares, the fully allocated accrual expenses incurred by the Distributor and
Merrill Lynch exceeded fully allocated accrual revenues for such period by
approximately $48,000 (1.35% of Class C net assets at that date). As of
December 31, 1996, for Class C shares, direct cash expenses for the period
since commencement of the offering of Class C shares exceeded direct cash
revenues by $9,604 (.27% of Class C net assets at that date). As of May 31,
1997, for Class C shares, direct cash revenues for the period since
commencement of the offering of Class C shares exceeded direct cash expenses
by $43,100 (.81% 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 Conduct Rules of the NASD imposes a
limitation on certain asset-based sales charges such as the distribution fee
and the CDSC borne by the Class B and Class C shares but not the account
maintenance fee. 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 CDSCs). 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
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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.
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 that 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 term is defined in Rule 17Ad-15 under the Securities
Exchange Act of 1934, as amended, the existence and validity of which may be
verified by the Transfer Agent through the use of industry publications.
Notarized signatures are not sufficient. In certain instances, the Transfer
Agent may require additional documents such as, but not limited to, trust
instruments, death certificates, appointments as executor or administrator, or
certificates of corporate authority. For shareholders redeeming directly with
the Transfer Agent, payments will be mailed within seven days of receipt of a
proper notice of redemption.
At various times the 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
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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 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 that 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 $5.35) to confirm a repurchase of shares.
Repurchases made 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
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
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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 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 such 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
account such as an IRA 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 PricingSM 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 the 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.
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Shares of the Fund that are subject to a CDSC are exchangeable on the basis
of relative net asset value per share without the payment of any CDSC that
might otherwise be due upon redemption of the shares of the Fund. For purposes
of computing the CDSC that may be payable upon a disposition of the shares
acquired in the exchange, the holding period for the previously owned shares
of the Fund is "tacked" to the holding period for the newly acquired shares of
the other fund.
Class A, Class B, Class C and Class D shares also are exchangeable for
shares of certain MLAM-advised money market funds specifically designated as
available for exchange by holders of Class A, Class B, Class C or Class D
shares. The period of time that Class A, Class B, Class C or Class D shares
are held in a money 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.
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 to
Merrill Lynch if the shareholder's account is maintained with Merrill Lynch or
by written notification or telephone call (1-800-MER-FUND) to the Transfer
Agent if the shareholder's account is maintained with 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 be imposed
on redemption of the shares issued as a result of the automatic reinvestment
of dividends or capital gains redemptions.
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 CMA(R) or CBA(R) Systematic Redemption Program, subject to
certain conditions.
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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.
FEE-BASED PROGRAMS
Certain Merrill Lynch fee-based programs, including pricing alternatives for
securities transactions (each referred to in this paragraph as "Program"), may
permit the purchase of Class A shares at net asset value. Under specified
circumstances, participants in certain Programs may deposit other classes of
shares which will be exchanged for Class A shares. Initial or deferred sales
charges otherwise due in connection with such exchanges may be waived or
modified, as may the conversion period applicable to the deposited shares.
Termination of participation in a Program may result in the redemption of
shares held therein or the automatic exchange thereof to another class at net
asset value, which may be shares of a money market fund. In addition, upon
termination of participation in a Program, shares that have been held for less
than specified periods within such Program may be subject to a fee based upon
the current value of such shares. These Programs also generally prohibit such
shares from being transferred to another account at Merrill Lynch, to another
broker-dealer or to the Transfer Agent. Except in limited circumstances (which
may also involve an exchange as described above), such shares must be redeemed
and another class of shares purchased (which may involve the imposition of
initial or deferred sales charges and distribution and account maintenance
fees) in order for the investment not to be subject to Program fees.
Additional information regarding a specific Program (including charges and
limitations on transferability applicable to shares that may be held in such
Program) is available in such Program's client agreement and from Merrill
Lynch Investor Services at (800) MER-FUND (637-3863).
TAXES
The Fund intends to continue to qualify for the special tax treatment
afforded regulated investment companies ("RICs") under the Code. As long as 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. Recent legislation creates
additional categories of capital gains taxable at different rates. Although
the legislation does not explain how gain in these categories will be taxed to
shareholders of RICs, it authorizes the issuance of regulations applying the
new categories of gain and the new rates to sales of securities by RICs. In
the absence of guidance, there is some uncertainty as to the manner in which
the categories of gain and related rates will be passed through to
shareholders as capital gains. 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
43
<PAGE>
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. It is anticipated that IRS guidance permitting categories of gain
and related rates to be passed through to shareholders would require this
written notice to designate the amounts of various categories of capital gain
income included in capital gain dividends. Distributions by the Fund, whether
from ordinary income or capital gains, will not be eligible for the dividends
received deduction allowed to corporations under the Code. If the Fund pays a
dividend in January which was declared in the previous October, November or
December to shareholders of record on a specified date in one of such months,
then such dividend will be treated for tax purposes as being paid by the Fund
and received by its shareholders on December 31 of the year in which such
dividend was declared.
Ordinary income dividends paid 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
44
<PAGE>
original issue discount (such as SMBSs), that accrue 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 and to avoid imposition of the excise tax.
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code and Treasury regulations presently in effect. For the
complete provisions, reference should be made to the pertinent Code sections
and the Treasury regulations promulgated thereunder. The Code and the Treasury
regulations are subject to change by legislative, judicial or administrative
action either prospectively or retroactively.
Ordinary income and capital gain dividends may also be subject to state and
local taxes.
Certain states exempt from state income taxation dividends paid by RICs
which are derived from interest on U.S. Government obligations. State law
varies as to whether dividend income attributable to U.S. Government
obligations is exempt from state income tax. In general, state law does not
consider income derived from MBSs to be income attributable to U.S. Government
obligations.
Shareholders are urged to consult their own tax advisers regarding specific
questions as to Federal, 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.
45
<PAGE>
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,
and 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 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, 1997 was 5.68%, 5.18%, 5.12%
and 5.45% 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
46
<PAGE>
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 Investment Company Act, persons affiliated with the Fund, including
Merrill Lynch, are prohibited from dealing with the Fund as a principal in the
purchase and sale of securities unless such trading is permitted by an
exemptive order issued by the 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 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, 1997, the Fund's portfolio turnover rate was
18.48%. (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
47
<PAGE>
"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.
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 or on any other day that there is sufficient trading in
portfolio securities that the net asset value of the Fund's shares may be
materially affected. The net asset value per share is computed by dividing the
sum of the value of the securities held by the Fund plus any cash or other
assets (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, 1997, the Fund paid $2,821 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 1,000,000,000 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,
Class B consists of 600,000,000 shares and Class D 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."
48
<PAGE>
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 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.
49
<PAGE>
[This page intentionally left blank]
50
<PAGE>
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)
Occupation........................... Name and Address of Employer.........
.....................................
.....................................
..................................... .....................................
Signature of Owner Signature of Co-Owner (if any)
(In the case of co-owners, a joint tenancy with rights of survivorship will be
presumed unless otherwise specified.)
- -------------------------------------------------------------------------------
2. DIVIDEND AND CAPITAL GAIN DISTRIBUTION OPTIONS
Ordinary Income Dividends Long-Term Capital Gains
Select [_] Reinvest Select [_] Reinvest
One: [_] Cash One: [_] Cash
If no election is made, dividends and capital gains will be automatically
reinvested at net asset value without a sales charge.
IF CASH, SPECIFY HOW YOU WOULD LIKE YOUR DISTRIBUTIONS PAID TO YOU: [_] CHECK
OR [_] DIRECT DEPOSIT TO BANK ACCOUNT
IF DIRECT DEPOSIT TO BANK ACCOUNT IS SELECTED, PLEASE COMPLETE BELOW:
I hereby authorize payment of dividend and capital gain distributions by
direct deposit to my bank account and, if necessary, debit entries and
adjustments for any credit entries made to my account in accordance with the
terms I have selected on the Merrill Lynch 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>
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.
..................................... .....................................
Signature of Owner Signature of Co-Owner (if any)
- -------------------------------------------------------------------------------
4. LETTER OF INTENTION--CLASS A AND D SHARES ONLY (See terms and conditions in
the Statement of Additional Information)
..................., 19......
Date of Initial Purchase
Dear Sir/Madam:
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.
By .................................. .....................................
Signature of Owner Signature of Co-Owner
(If registered in joint names, both
must sign)
In making purchases under this letter, the following are the related
accounts on which reduced offering prices are to apply:
(1) Name............................. (2) Name.............................
Account Number....................... Account Number.......................
- -------------------------------------------------------------------------------
5. FOR DEALER ONLY
Branch Office, Address, Stamp. We hereby authorize Merrill Lynch
- - - Funds Distributor, Inc. to act as
our agent in connection with
transactions under this
authorization form and agree to
notify the Distributor of any
purchases or sales made under a
Letter of Intention, Automatic
Investment Plan or Systematic
Withdrawal Plan. We guarantee the
Shareholder's signature.
- - -
.....................................
This form when completed should be Dealer Name and Address
mailed to: By ..................................
Merrill Lynch Adjustable Rate Authorized Signature of Dealer
Securities Fund, Inc.
c/o Merrill Lynch Financial [_][_][_] [_][_][_][_].............
Data Services, Inc. Branch-Code F/C No. F/C Last Name
P.O. Box 45289
Jacksonville, Florida 32232-5289 [_][_][_] [_][_][_][_][_]
Dealer's Customer A/C No.
A-2
<PAGE>
MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC. -- AUTHORIZATION FORM
(PART 2)
- -------------------------------------------------------------------------------
NOTE: THIS FORM IS REQUIRED TO APPLY FOR THE SYSTEMATIC WITHDRAWAL OR THE
AUTOMATIC INVESTMENT PLANS ONLY.
- -------------------------------------------------------------------------------
1. ACCOUNT REGISTRATION [ ]
Name of Owner................................... Social Security No. or
Taxpayer Identification
Number
Name of Co-Owner (if any).......................
Address......................................... Account Number ............
(if existing account)
................................................
- -------------------------------------------------------------------------------
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 withdrawals on ________ or as soon as possible
(month)
thereafter.
SPECIFY HOW YOU WOULD LIKE YOUR WITHDRAWAL PAID TO YOU (CHECK ONE): [_] $
or [_] % of the current value of [_] Class A or [_] Class D shares in the
account.
SPECIFY WITHDRAWAL METHOD: [_] check or [_] direct deposit to bank account
(check one and complete part (a) or (b) below):
DRAW CHECKS PAYABLE (CHECK ONE)
(a)I hereby authorize payment by check
[_] as indicated in Item 1.
[_] to the order of..........................................................
Mail to (check one)
[_] the address indicated in Item 1.
[_] Name (Please Print)......................................................
Address .......................................................................
..........................................................................
Signature of Owner........................................ Date...............
Signature of Co-Owner (if any).................................................
(B) I HEREBY AUTHORIZE PAYMENT BY DIRECT DEPOSIT TO BANK ACCOUNT AND (IF
NECESSARY), DEBIT ENTRIES AND ADJUSTMENTS FOR ANY CREDIT ENTRIES MADE 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>
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 AUTHORIZATION TO HONOR ACH DEBITS
DATA SERVICES, INC. DRAWN BY MERRILL LYNCH FINANCIAL
DATA SERVICES, INC.
You are hereby authorized to draw an ACH
debit each month on my bank account for To.............................Bank
investment in Merrill Lynch Adjustable (Investor's Bank)
Rate Securities Fund, Inc., as indicated
below:
Amount of each ACH debit $........... Bank Address.......................
Account Number....................... City..... State..... Zip Code.....
Please date and invest ACH debits on the As a convenience to me, I hereby
20th of each month request and authorize you to pay
and charge to my account ACH deb-
beginning ________ or as soon as its drawn on my account by and
(month) payable to Merrill Lynch Financial
possible thereafter. Data Services, Inc., I agree that
your rights in respect of each
such debit shall be the same as if
I agree that you are drawing these ACH it were a check drawn on you and
debits voluntarily at my request and signed personally by me. This au-
that you shall not be liable for any thority is to remain in effect un-
loss arising from any delay in preparing til revoked by me in writing. Un-
or failure to prepare any such debit. If til you receive such notice, you
I change banks or desire to terminate or shall be fully protected in honor-
suspend this program, I agree to notify ing any such debit. I further
you promptly in writing. I hereby autho- agree that if any such debit be
rize you to take any action to correct dishonored, whether with or with-
erroneous ACH debits of my bank account out cause and whether intention-
or purchases of fund shares including ally or inadvertently, you shall
liquidating shares of the Fund and cred- be under no liability.
iting my bank account. I further agree
that if a debit is not honored upon pre- ............. ...................
sentation, Merrill Lynch Financial Data Date Signature of
Services, Inc. is authorized to discon- Depositor
tinue immediately the Automatic Invest-
ment Plan and to liquidate sufficient ............. ...................
shares held in my account to offset the Bank Account Signature of Depositor
purchase made with the dishonored debit. Number (If joint account,
both must sign)
............. .......................
Date Signature of Depositor
.......................
Signature of Depositor
(If joint account,
both must sign)
NOTE: IF AUTOMATIC INVESTMENT PLAN IS ELECTED, YOUR BLANK, UNSIGNED CHECK
MARKED "VOID" SHOULD ACCOMPANY THIS APPLICATION.
A-4
<PAGE>
MANAGER
Merrill Lynch Asset Management
Administrative Offices:
800 Scudders Mill Road
Plainsboro, New Jersey
Mailing Address:
P.O. Box 9011
Princeton, New Jersey 08543-9011
DISTRIBUTOR
Merrill Lynch Funds Distributor, Inc.
Administrative Offices:
800 Scudders Mill Road
Plainsboro, New Jersey
Mailing Address:
P.O. Box 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>
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....................................... 20
Other Investment Policies and Practices................................... 24
Management of the Fund..................................................... 27
Directors................................................................. 27
Management and Advisory Arrangements...................................... 28
Code of Ethics............................................................ 28
Transfer Agency Services.................................................. 29
Purchase of Shares......................................................... 29
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...................... 38
Redemption of Shares....................................................... 39
Redemption................................................................ 39
Repurchase................................................................ 39
Reinstatement Privilege--Class A and Class D Shares....................... 40
Shareholder Services....................................................... 40
Investment Account........................................................ 40
Exchange Privilege........................................................ 41
Automatic Reinvestment of Dividends and Capital Gains Distributions....... 42
Systematic Withdrawal Plans............................................... 42
Automatic Investment Plans................................................ 43
Fee-Based Programs........................................................ 43
Taxes...................................................................... 43
Performance Data........................................................... 45
Portfolio Transactions..................................................... 46
Portfolio Turnover........................................................ 47
Additional Information..................................................... 47
Dividends and Distributions............................................... 47
Determination of Net Asset Value.......................................... 48
Organization of the Fund.................................................. 48
Shareholder Inquiries..................................................... 49
Shareholder Reports....................................................... 49
Authorization Form......................................................... A-1
</TABLE>
Code #13937-0897
[LOGO] MERRILL LYNCH
Merrill Lynch
Adjustable Rate
Securities Fund, Inc.
[ART]
PROSPECTUS
August 29, 1997
Distributor:
Merrill Lynch
Funds Distributor, Inc.
This prospectus should be retained for future reference.
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC.
P.O. BOX 9011, PRINCETON, NEW JERSEY 08543-9011 . PHONE NO. (609) 282-2800
----------------
The investment objective of Merrill Lynch Adjustable Rate Securities Fund,
Inc. (the "Fund") is to seek high current income consistent with a policy of
limiting the degree of fluctuation in the net asset value of Fund shares from
movements in interest rates. The Fund does not attempt to maintain a constant
net asset value per share. The Fund seeks to achieve this objective by
investing at least 65% of its total assets in adjustable rate securities,
consisting principally of mortgage-backed and asset-backed securities. The
Fund may employ a variety of portfolio strategies to enhance income and to
hedge against changes in interest rates. There can be no assurance that the
investment objective of the Fund will be realized.
Pursuant to the Merrill Lynch Select PricingSM System, the Fund offers four
classes of shares each with a different combination of sales charges, ongoing
fees and other features. The Merrill Lynch Select PricingSM System permits an
investor to choose the method of purchasing shares that the investor believes
is most beneficial given the amount of the purchase, the length of time the
investor expects to hold the shares and other relevant circumstances.
----------------
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 August
29, 1997 (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 August 29, 1997
<PAGE>
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to seek high current income
consistent with a policy of limiting the degree of fluctuation in the net
asset value of Fund shares from movements in interest rates. The Fund will
seek to achieve its objective by investing at least 65% of its total assets in
adjustable rate securities ("Adjustable Rate Securities"), consisting
principally of mortgage-backed and asset-backed securities. Adjustable Rate
Securities bear interest at rates that adjust at periodic intervals in
conjunction with changes in market levels of interest. Such securities will be
issued or guaranteed by agencies or instrumentalities of the United States or
rated at least 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.
2
<PAGE>
Such protection may be provided through guarantees, insurance policies or
letters of credit obtained by the issuer or sponsor from third parties,
through various means of structuring the transaction or through a combination
of such approaches. The Fund will not pay any additional fees for such credit
support, although the existence of credit support may increase the price of a
security.
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)
3
<PAGE>
homes; (v) mortgage loans on multifamily residential properties under
construction; (vi) mortgage loans on completed multifamily projects; (vii)
fixed rate mortgage loans as to which escrowed funds are used to reduce the
borrower's monthly payments during the early years of the mortgage loans
("buydown" mortgage loans); (viii) mortgage loans that provide for adjustments
in payments based on periodic changes in interest rates or in other payment
terms of the mortgage loans; and (ix) mortgage-backed serial notes.
Federal National Mortgage Association. FNMA is a federally chartered and
privately owned corporation established under the Federal National Mortgage
Association Charter Act. FNMA was originally organized in 1938 as a United
States Government agency to add greater liquidity to the mortgage market. FNMA
was transformed into a private sector corporation by legislation enacted in
1968. FNMA 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
4
<PAGE>
participation certificates evidencing fractional undivided interests in pools
of these SBA-guaranteed portions of loans made by private lenders. The SBA's
guarantee of such certificates, and its guarantee of a portion of the
underlying loan, are backed by the full faith and credit of the United States.
ADJUSTABLE RATE SECURITIES--INDEXES
As indicated above and described more fully in the Prospectus, at least 65%
of the Fund's total assets will be comprised of its investments in Adjustable
Rate Securities. The key determinant of the interest rates paid on such
securities is the interest rate index chosen (and the spread relating to such
securities). Certain of such indexes are tied to interest rates paid on
specified securities, such as one, three or five year U.S. Treasury
securities, while other indexes are more general. A prominent example of the
latter type of index is the cost of funds for member institutions (i.e.,
savings and loan associations and savings banks) for the Federal Home Loan
Bank (the "FHLB") of San Francisco (the "COFI"). There are a number of factors
that may affect the COFI and cause it to behave differently from indexes tied
to specific types of securities. The COFI is 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>
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 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
6
<PAGE>
swap the right to receive interest at this variable weekly rate for the right
to receive interest at a rate that is fixed for one year. Such a swap would
protect the Fund from a reduction in yield due to falling interest rates, but
would preclude it from taking full advantage of rising interest rates.
The Fund usually will enter into interest rate swap transactions on a net
basis, i.e., the two payment streams are netted out, with the Fund receiving
or paying, as the case may be, only the net amount of the two payments.
Inasmuch as these transactions are entered into for good faith hedging
purposes, the Manager believes that such obligations do not constitute senior
securities and, accordingly, will not treat them as being subject to its
borrowing restrictions. The net amount of the excess, if any, of the Fund's
obligations over its entitlements with respect to each interest rate swap will
be accrued on a daily basis, and an amount of cash or high grade liquid debt
securities having an aggregate net asset value at least equal to the accrued
excess will be maintained in a segregated account by the Fund's custodian. If
the interest rate swap transaction is entered into on other than a net basis,
the full amount of the Fund's obligations will be accrued on a daily basis,
and the full amount of the Fund's obligations will be maintained in a
segregated account by the Fund's custodian. The Fund will not enter into any
interest rate swap transaction unless the credit quality of the unsecured
senior debt or the claims-paying ability of the other party thereto is rated
in one of the highest two rating categories by at least one nationally
recognized statistical rating organization or is believed by the Manager to be
equivalent to such rating. If there is a default by the other party to such a
transaction, the Fund will have contractual remedies pursuant to the
agreements related to the transaction. The swap market has grown substantially
in recent years with a large number of banks and investment banking firms
acting 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 on
or before a specified future date and at a specified 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>
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 that 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 that 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 liquid securities 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 Commission has taken the
position that OTC options and the assets used as cover for written OTC options
are illiquid securities. However, if the OTC option is sold by the Fund to a
primary U.S. Government securities dealer recognized by the Federal Reserve
Bank of New York and the Fund has the unconditional contractual right to
repurchase such OTC option from the dealer at a predetermined price, then the
Fund will treat as illiquid such amount of the underlying securities as
is equal to the repurchase price less the amount by which the option is "in-
the-money"
8
<PAGE>
(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 is authorized to 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 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 cost. 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. 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 "marking 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 Commission exempting it from the
provisions of Section 17(f) and Section 18(f) of the Investment Company Act of
1940 (the "Investment Company Act") in connection with
9
<PAGE>
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
Investment Company 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 Commission has in the past indicated that a futures contract may
be a "senior security" under the Investment Company 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) that 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
that any person may trade on a particular trading day. An exchange may order
the liquidation of positions found to be in violation of these limits and it
may impose other sanctions or restrictions. The Manager does not believe that
these trading and position limits will have any adverse impact on the
portfolio strategies for hedging the Fund's portfolio.
OTHER INVESTMENT POLICIES AND PRACTICES
Repurchase Agreements and Purchase and Sale Contracts. The Fund may invest
in securities pursuant to repurchase agreements and purchase and sale
contracts. Repurchase agreements and purchase and sale contracts may be
entered into only with a member bank of the Federal Reserve System or primary
dealer in U.S.
10
<PAGE>
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
Investment Company Act means the lesser of (i) 67% of the shares represented
at a meeting at which more than 50% of the outstanding shares are represented
or (ii) more than 50% of the outstanding shares). The Fund may not:
1. Make any investment inconsistent with the Fund's classification as a
diversified company under the 1940 Act.
11
<PAGE>
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 Investment Company Act) in amounts up to 33 1/3% of its
total assets (including the amount borrowed), (ii) the Fund may, to the
extent permitted by applicable law, borrow up to an additional 5% of its
total assets for temporary purposes, (iii) the Fund may obtain such short-
term credit as may be necessary for the clearance of purchases and sales of
portfolio securities and (iv) the Fund may purchase securities on margin to
the extent permitted by applicable law. The Fund may not pledge its assets
other than to secure such borrowings or, to the extent permitted by the
Fund's investment policies as set forth in its Prospectus and Statement of
Additional Information, as they may be amended from time to time, in
connection with hedging transactions, short sales, when-issued and forward
commitment transactions and similar investment strategies.
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.
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. As a matter of
policy, however, the Fund will not purchase shares of any registered open-
end investment company or registered unit investment trust, in reliance on
Section 12(d)(1)(F) or (G) (the "fund of funds" provisions) of the
Investment Company Act at any time the Fund's shares are owned by another
investment company that is part of the same group of investment companies
as the Fund.
12
<PAGE>
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. 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.
d. 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 under the Internal Revenue Code of 1986, as
amended (the "Code") 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 Investment Company Act
involving only usual and customary commissions or transactions pursuant to an
exemptive order under the Investment Company 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.
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.
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<PAGE>
Arthur Zeikel (65)--President and Director(1)(2)--President of the Manager
(which term as used herein includes its corporate predecessors) since 1977;
President of Fund Asset Management, L.P. ("FAM") (which term as used herein
includes its corporate predecessors) since 1977; President and Director of
Princeton Services, Inc. ("Princeton Services") since 1993; Executive Vice
President of Merrill Lynch & Co., Inc. ("ML&Co.") since 1990; Director of
Merrill Lynch Funds Distributor, Inc. (the "Distributor") since 1977.
Joe Grills (62)--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;
Member of the Investment Advisory Committee of the Howard Hughes Medical
Institute; Director, Duke Management Company and LaSalle Street Fund since
1995; Director, Kimco Realty Corporation since January 1997.
Walter Mintz (68)--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. (60)--Director(2)--106 Dolphin Cove Quay, Stamford,
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 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 from 1975 until 1991.
Melvin R. Seiden (66)--Director(2)--780 Third Avenue, Suite 2502, New York,
New York 10017. Director 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 (64)--Director(2)--24 Federal Street, Suite 400, Boston,
Massachusetts 02110. Chairman 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.
Joseph T. Monagle, Jr. (49)--Senior Vice President(1)(2)--Senior Vice
President of the Manager and FAM since 1990; Senior Vice President of
Princeton Services since 1993.
Donald C. Burke (37)--Vice President(1)(2)--Vice President and Director of
Taxation of the Manager since 1990.
Jeffrey B. Hewson (46)--Vice President(1)(2)--Vice President of the Manager
since 1989 and Portfolio Manager of the Manager since 1985; Senior Consultant,
Price Waterhouse from 1981 to 1985.
Theodore J. Magnani (35)--Vice President(1)--Vice President of the Manager
since 1992.
14
<PAGE>
Gregory Mark Maunz (44)--Vice President(1)(2)--Vice President of the Manager
since 1985 and Portfolio Manager of the Manager since 1984.
Gerald M. Richard (48)--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.
Ira P. Shapiro (34)--Secretary(1)(2)--Vice President of the Manager since
1997 and Attorney associated with the Manager and FAM since 1993; Prior to
1993 Mr. Shapiro was an attorney in private practice.
- --------
(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.
At July 31, 1997, the officers and Directors of the Fund as a group (14
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 $1,500 per year plus $250 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 $1,500 per
year plus $250 for each Committee meeting attended. For the fiscal year ended
May 31, 1997, fees and expenses paid to unaffiliated Directors aggregated
$40,439.
The following table sets forth for the fiscal year ended May 31, 1997,
compensation paid by the Fund to the unaffiliated Directors and, for the
calendar year ending December 31, 1996, the aggregate compensation paid by all
registered investment companies advised by MLAM and its affiliate, FAM
("MLAM/FAM Advised Funds"), to the unaffiliated Directors.
<TABLE>
<CAPTION>
PENSION OR AGGREGATE COMPENSATION
RETIREMENT BENEFITS FROM FUND AND
NAME OF COMPENSATION ACCRUED AS PART MLAM/FAM ADVISED
DIRECTOR FROM FUND OF FUND EXPENSE FUNDS PAID TO DIRECTORS
- -------- ------------ ------------------- -----------------------
<S> <C> <C> <C>
Joe Grills(1)........... $8,000 None $167,000
Walter Mintz(1)......... $8,000 None $164,000
Robert S. Salomon,
Jr.(1)................. $8,000 None $187,167
Melvin R. Seiden(1)..... $8,000 None $164,000
Stephen B. Swensrud(1).. $8,000 None $154,250
</TABLE>
- --------
(1) The Directors serve on the boards of MLAM/FAM Advised Funds as follows:
Mr. Grills (19 registered investment companies consisting of 47
portfolios); Mr. Mintz (18 registered investment companies consisting of
37 portfolios); Mr. Salomon (18 registered investment companies consisting
of 37 portfolios); Mr. Seiden (18 registered investment companies
consisting of 38 portfolios); Mr. Swensrud (21 registered investment
companies consisting of 52 portfolios).
15
<PAGE>
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, 1995, 1996 and 1997, the
total management fees paid to the Manager aggregated $1,463,526, $914,312 and
$689,185, respectively.
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 Investment Company
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 Investment Company Act because of their
ownership of its voting securities or their power to exercise a controlling
influence over its management or policies.
Duration and Termination. Unless earlier terminated as described 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 Investment Company 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.
16
<PAGE>
PURCHASE OF SHARES
Reference is made to "Purchase of Shares" in the Prospectus for certain
information as to the purchase of Fund shares.
The Fund issues four classes of shares under the Merrill Lynch Select
Pricing SM System: shares of Class A and Class D are sold to investors
choosing the initial sales charge alternatives, and shares of Class B and
Class C are sold to investors choosing the deferred sales charge alternatives.
Each Class A, Class B, Class C and Class D share of the Fund represents 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.
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
(except that Class B shareholders may vote upon any material changes to
expenses charged under the Class D Distribution Plan). Each class has
different exchange privileges. See "Shareholder Services--Exchange Privilege."
The Merrill Lynch Select Pricing SM System is used by more than 50
registered investment companies advised by the Manager or its affiliate, FAM.
Funds advised by the Manager or FAM that 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 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, 1997, the Fund sold
965,067 Class A shares for aggregate net proceeds of $9,288,059. 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. During the fiscal year ended
17
<PAGE>
May 31, 1997, the Fund sold 2,480,241 Class D shares for aggregate net
proceeds to the Fund of $23,652,524. The gross sales charge for the sale of
its Class D shares for that period was $11,286 of which $10,352 was received
by Merrill Lynch and $934 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 Code) although more than one beneficiary is involved. The
term "purchase" also includes purchases by any "company," as that term is
defined in the Investment Company Act, but does not include purchases by any
such company which has not been in existence for at least six months or which
has no 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
18
<PAGE>
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 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
19
<PAGE>
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.
Employee AccessSM Accounts. Provided applicable threshold requirements are
met, either Class A or Class D shares are offered at net asset value to
Employee Access SM Accounts available through authorized employers. 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
20
<PAGE>
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 adverse tax consequences to
the Fund that might result from an acquisition of assets having net unrealized
appreciation that 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 that (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, that 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
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.
Payments of the account maintenance fees and/or distribution fees are
subject to the provisions of Rule 12b-1 under the Investment Company Act.
Among other things, each Distribution Plan provides that the Distributor
21
<PAGE>
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 Investment
Company 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 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 Conduct Rules 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, 1997
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, 1997, with respect to Class B
shares, and under the NASD maximum sales charge rule for the period October
21, 1994 (commencement of operations) to May 31, 1997, with respect to Class C
shares.
22
<PAGE>
DATA CALCULATED AS OF MAY 31, 1997
<TABLE>
<CAPTION>
ANNUAL
DISTRIBUTION
ALLOWABLE ALLOWABLE AMOUNTS FEE AT
ELIGIBLE AGGREGATE INTEREST MAXIMUM PREVIOUSLY AGGREGATE CURRENT NET
GROSS SALES ON UNPAID AMOUNT PAID TO UNPAID ASSET
CLASS B SALES(1) CHARGES BALANCE(2) PAYABLE DISTRIBUTOR(3) BALANCE LEVEL(4)
- ------- ---------- --------- ---------- ------- -------------- --------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Under NASD Rule As
Adopted................ $1,016,700 $63,544 $28,121 $91,665 $20,340 $71,325 $530
Under Distributor's Vol-
untary Waiver.......... $1,016,700 $63,544 $ 5,084 $68,628 $20,340 $48,288 $530
CLASS C
- -------
Under NASD Rule as
Adopted................ $ 10,344 $ 646 $ 70 $ 716 $ 58 $ 658 $ 29
</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 purchase are subject to a
CDSC under most circumstances, the charge is waived (i) on redemptions of
Class B shares in certain instances including 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
23
<PAGE>
disability of a Class B shareholder. Redemptions for which the waiver applies
in the case of such withdrawals 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, 1995 and 1996,
the Distributor received CDSCs of $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 year ended May 31, 1997, the Distributor received CDSCs
of $75,785, with respect to redemptions of Class B shares, all of which were
paid to Merrill Lynch. Additional CDSCs payable to the Distributor may have
been waived or converted to a contingent obligation in connection with a
shareholder's participation in fee-based program. For the fiscal period
October 21, 1994 (commencement of operations) to May 31, 1995, and for the
fiscal years ended May 31, 1996 and 1997, the Distributor received CDSCs of
$1,343, $3,334 and $22,912 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
("OTC") market. Transactions in the OTC market are generally principal
transactions with dealers and the costs of such transactions involve dealer
spreads rather than brokerage commissions. With respect to over-the-counter
transactions, where possible, the Fund deals directly with the dealers who
make a market in the securities involved, except in those circumstances in
which better prices and execution are available elsewhere. Under the
Investment Company Act, persons affiliated with the Fund are prohibited from
dealing with the Fund as principal in purchase and sale of securities.
24
<PAGE>
Since transactions in the OTC 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 OTC 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, 1995, 1996 and 1997, the Fund paid no
brokerage commissions.
The Directors of the Fund have considered the possibility of seeking to
recapture 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, 1996 and 1997, the Fund's
portfolio turnover rate was 25.30% and 18.48%, 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.
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, Martin Luther King, Jr. Day, Presidents' Day, Good Friday,
Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day.
25
<PAGE>
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 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 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 that 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.
26
<PAGE>
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 IRA 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
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
27
<PAGE>
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 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
28
<PAGE>
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
U.S. 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 the
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 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 certain money market funds with a reduced or without a
sales charge.
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<PAGE>
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.
Shareholders also may exchange shares of the Fund into shares of certain
money market funds advised by the Manager or its affiliates, but the period of
time that Class B or Class C shares are held in a money market fund will not
count towards satisfaction of the holding period requirement for purposes of
reducing the CDSC or with respect to Class B shares, towards satisfaction of
the conversion period. However, shares of a money market fund that 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 the
newly-acquired 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 that the shareholder continues to hold for an additional two and a
half years, any subsequent redemption will not incur a CDSC.
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.
30
<PAGE>
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 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
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"). As long as 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. Recent legislation creates
additional categories of capital gains taxable at different rates. Although
the legislation does not explain how gain in these categories will be taxed to
shareholders of RICs, it authorizes the issuance of regulations applying the
new categories of gain and the new rates to sales of securities by RICs. In
the absence of guidance, there is some uncertainty as to the manner in which
the categories of gain and related rates will be passed through to
shareholders as capital gains. 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
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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. It is anticipated that IRS guidance permitting categories of gain
and related rates to be passed through to shareholders would require this
written notice to designate the amounts of various categories of capital gain
income included in capital gain dividends. Distributions by the Fund, whether
from ordinary income or capital gains, will not be eligible for the dividends
received deduction allowed to corporations under the Code. If the Fund pays a
dividend in January which was declared in the previous October, November or
December to shareholders of record on a specified date in one of such months,
then such dividend will be treated for tax purposes as being paid by the Fund
and received by its shareholders on December 31 of the year in which such
dividend was declared.
Ordinary income dividends paid 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
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beginning 30 days before and ending 30 days after the date that the shares are
disposed of. In such a case, the basis of the shares acquired will be adjusted
to reflect the disallowed loss.
The Code requires a RIC to pay a nondeductible 4% excise tax to the extent
the RIC does not distribute, during each calendar year, 98% of its ordinary
income, determined on a calendar year basis, and 98% of its capital gains,
determined, in general, on an October 31 year end, plus certain undistributed
amounts from previous years. While the Fund intends to distribute its income
and capital gains in the manner necessary to 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 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. Under recently enacted
legislation, this requirement will no longer apply to the Fund after the end
of its May 31, 1998 fiscal year.
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 accrue 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 and to avoid imposition of the excise tax.
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code and Treasury regulations presently in effect. For the
complete provisions, reference should be made to the pertinent Code
33
<PAGE>
sections and the Treasury regulations promulgated thereunder. The Code and the
Treasury regulations are subject to change by legislative, judicial or
administrative action either prospectively or retroactively.
Ordinary income and capital gain dividends may also be subject to state and
local taxes.
Certain states exempt from state income taxation dividends paid by RICs which
are derived from interest on U.S. Government obligations. State law varies as
to whether dividend income attributable to U.S. Government obligations is
exempt from state income tax. In general, state law does not consider income
derived from MBSs to be income attributable to U.S. Government obligations.
Shareholders are urged to consult their own tax advisers regarding specific
questions as to Federal, foreign, state or local taxes. Foreign investors
should consider applicable foreign taxes in their evaluation of an investment
in the Fund.
PERFORMANCE DATA
From time to time the Fund may include its average annual total return and
other total return data, as well as yield, in advertisements or information
furnished to present or prospective shareholders. Total return is based on the
Fund's historical performance and is not intended to indicate future
performance. Average annual total return and yield are determined separately
for Class A, 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.
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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
--------------------------------- ---------------------------------
EXPRESSED REDEEMABLE EXPRESSED REDEEMABLE
AS A PERCENTAGE VALUE OF A AS A PERCENTAGE VALUE OF A
BASED ON A HYPOTHETICAL BASED ON A HYPOTHETICAL
HYPOTHETICAL $1,000 INVESTMENT HYPOTHETICAL $1,000 INVESTMENT
$1,000 AT THE END $1,000 AT THE END
PERIOD INVESTMENT OF THE PERIOD INVESTMENT OF THE PERIOD
------ --------------- ----------------- --------------- -----------------
AVERAGE ANNUAL TOTAL RETURN
(including maximum applicable sales charges)
<S> <C> <C> <C> <C>
One Year Ended May 31,
1997................... 3.19% $1,031.90 2.45% $1,024.50
Five Years Ended May 31,
1997................... 4.08% $1,221.40
Inception (August 2,
1991) to May 31, 1997.. 4.25% $1,274.20
Inception (October 21,
1994) to May 31, 1997*. 5.55% $1,151.30
<CAPTION>
AVERAGE ANNUAL TOTAL RETURN
YEAR ENDED MAY 31,
------------------ (excluding maximum applicable sales charges)
<S> <C> <C> <C> <C>
1997.................... 7.48% $1,074.80 6.44% $1,064.40
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
<CAPTION>
AGGREGATE TOTAL RETURN
(including maximum applicable sales charges)
<S> <C> <C> <C> <C>
Inception (August 2,
1991)
to May 31, 1997........ 27.42% $1,274.20
Inception (October 21,
1994)
to May 31, 1997*....... 15.13% $1,151.30
<CAPTION>
YIELD
<S> <C> <C> <C> <C>
30 days ended May 31,
1997................... 5.68% 5.18%
</TABLE>
- --------
* Information as to Class A and Class C shares is presented only for the
period October 21, 1994 to May 31, 1997. Prior to October 21, 1994, no Class
A or Class C shares were publicly issued.
35
<PAGE>
<TABLE>
<CAPTION>
CLASS C SHARES CLASS D SHARES
--------------------------------- ---------------------------------
EXPRESSED REDEEMABLE EXPRESSED REDEEMABLE
AS A PERCENTAGE VALUE OF A AS A PERCENTAGE VALUE OF A
BASED ON A HYPOTHETICAL BASED ON A HYPOTHETICAL
HYPOTHETICAL $1,000 INVESTMENT HYPOTHETICAL $1,000 INVESTMENT
$1,000 AT THE END $1,000 AT THE END
PERIOD INVESTMENT OF THE PERIOD INVESTMENT OF THE PERIOD
------ --------------- ----------------- --------------- -----------------
AVERAGE ANNUAL TOTAL RETURN
(including maximum applicable sales charges)
<S> <C> <C> <C> <C>
One Year Ended May 31,
1997................... 5.51% $1,055.10 2.82% $1,028.20
Five Years Ended May 31,
1997................... 3.77% $1,203.10
Inception (August 2,
1991) to May 31, 1997.. 4.05% $1,260.20
Inception (October 21,
1994) to May 31, 1997*. 6.26% $1,171.70
<CAPTION>
ANNUAL TOTAL RETURN
YEAR ENDED MAY 31, (excluding maximum applicable sales charges)
------------------
<S> <C> <C> <C> <C>
1997.................... 6.51% $1,065.10 7.11% $1,071.10
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
<CAPTION>
AGGREGATE TOTAL RETURN
(including maximum applicable sales charges)
<S> <C> <C> <C> <C>
Inception (August 2,
1991) to May 31, 1997.. 26.02% $1,260.20
Inception (October 21,
1994) to May 31, 1997*. 17.17% $1,171.70
<CAPTION>
YIELD
<S> <C> <C> <C> <C>
30 days ended May 31,
1997................... 5.12% 5.45%
</TABLE>
- --------
* Information as to Class A and Class C shares is presented only for the
period October 21, 1994 to May 31, 1997. 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.
36
<PAGE>
GENERAL INFORMATION
DESCRIPTION OF SHARES
The Fund was incorporated under Maryland law on April 19, 1991. It has an
authorized capital of 1,000,000,000 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,
Class B consists of 600,000,000 shares and Class D 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.
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, 1997, is as set forth
below.
37
<PAGE>
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C CLASS D
-------- ------------ ---------- -----------
<S> <C> <C> <C> <C>
Net Assets...................... $265,239 $106,060,849 $5,315,233 $13,266,465
======== ============ ========== ===========
Number of Shares Outstanding.... 27,491 11,022,844 552,141 1,379,496
======== ============ ========== ===========
Net Asset Value Per Share (net
assets divided by number of
shares outstanding)............ $ 9.65 $ 9.62 $ 9.63 $ 9.62
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.................. $ 10.05 $ 9.62 $ 9.63 $ 10.02
======== ============ ========== ===========
</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.
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
38
<PAGE>
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 Investment Company 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 August 1, 1997.
39
<PAGE>
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 end
40
<PAGE>
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.
41
<PAGE>
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
42
<PAGE>
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.
43
<PAGE>
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.
44
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders,
Merrill Lynch Adjustable Rate Securities Fund, Inc.:
We have audited the accompanying statement of assets and liabilities,
including the schedule of investments, of Merrill Lynch Adjustable Rate
Securities Fund, Inc. as of May 31, 1997, 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 five-year period then ended. 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, 1997 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, 1997, the results of its
operations, the changes in its net assets, and the financial highlights for
each of the respective stated periods in conformity with generally accepted
accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
June 27, 1997
45
<PAGE>
<TABLE>
SCHEDULE OF INVESTMENTS
<CAPTION>
Face Value Percent of
Index Amount Issue Cost (Note 1a) Net Assets
<S> <S> <C> <S> <C> <C> <C>
Adjustable Rate* Certificate of Deposit $ 4,222,688 Federal National Mortgage
Mortgage-Backed Indexed Obligations Association, #307622, 7.403%
Obligations** due 4/01/2023 $ 4,343,668 $ 4,352,662 3.49%
Constant Maturity Federal Home Loan Mortgage
Treasury Indexed Corporation:
Obligations 2,107,567 #645073, 7.762% due 5/01/2015 2,143,132 2,174,322 1.74
3,830,652 #606108, 7.807% due 9/01/2019 3,907,146 4,031,762 3.23
2,500,737 #775194, 7.131% due 3/01/2020 2,507,515 2,581,236 2.07
65,360 #785173, 7.64% due 8/01/2020 66,871 66,953 0.05
2,913,559 #845139, 8.036% due 3/01/2022 2,957,665 3,061,072 2.45
5,221,670 #845535, 7.881% due 10/01/2023 5,321,716 5,487,662 4.39
7,921,860 #755170, 7.607% due 8/01/2031 8,189,222 8,185,499 6.55
Federal National Mortgage
Association:
531,615 #21041, 7.31% due 10/01/2013 546,899 529,127 0.42
1,417,131 #21059, 7.29% due 11/01/2013 1,457,874 1,413,121 1.13
1,129,257 #20293, 6.78% due 9/01/2015 1,161,723 1,119,625 0.90
4,563,301 #142069, 7.26% due 12/01/2021 4,657,419 4,742,274 3.80
1,969,254 #181278, 7.378% due 9/01/2022 2,018,893 2,012,332 1.61
4,294,267 #200009, 7.58% due 2/01/2023 4,309,933 4,435,849 3.55
5,924,866 #291252, 7.993% due 8/01/2024 6,000,600 6,188,700 4.96
997,662 #309653, 7.22% due 5/01/2025 1,021,237 1,020,269 0.82
2,350,964 #324905, 7.768% due 9/01/2025 2,374,820 2,452,296 1.96
7,736,184 Prudential Home Mortgage Securities
Company, Inc., REMIC (a) 92-35-A1,
8.286% due 11/25/2022 7,929,589 7,899,369 6.32
Cost of Funds 3,743,454 DLJ Mortgage Acceptance Corp.,
Indexed Obligations REMIC (a)91-6-A1, 7.827% due
9/25/2021 3,807,502 3,755,152 3.01
London Interbank 5,400,781 Federal National Mortgage
Offered Rate Indexed Association, #305729, 7.626%
Obligations due 2/01/2025 5,561,013 5,587,270 4.47
Resolution Trust Corporation,
REMIC (a):
6,510,813 91-M7-B, 7.75% due 1/25/2021 6,510,813 6,532,716 5.23
15,005,514 92-C1-B, 7.75% due 8/25/2023 14,452,436 15,080,541 12.07
12,000,000 Saxon Mortgage Securities
Corporation, REMIC (a) 92-3-B,
7.819% due 11/25/2022 12,249,724 12,090,000 9.68
Total Investments in Adjustable
Rate Mortgage-Backed Obligations 103,497,410 104,799,809 83.90
Derivative 14,345,214 Capstead Mortgage Securities
Mortgage-Backed Corporation II, REMIC (a) 93-2I-A3,
Obligations**-- 0.50% due 9/25/2023 218,728 71,726 0.06
Interest Only (b) 60,669,172 DLJ Mortgage Acceptance Corp., REMIC
(a) 92-6-A1, 0.644% due 7/25/2022 839,528 594,558 0.47
76,211 Federal Home Loan Mortgage
Corporation, REMIC (a)(c) 92-1363-C,
323% due 8/15/2022 1,247,520 595,750 0.48
91 Prudential Home Mortgage Securities
Company, Inc., REMIC (a) 92-1-A9,
42,989% due 2/25/2022 22,001 10,325 0.01
Sears Mortgage Securities Corp.,
REMIC (a):
3,924 91-K-A4, 5,879% due 9/25/2021 535,120 370,831 0.30
</TABLE>
46
<PAGE>
<TABLE>
<S> <S> <C> <S> <C> <C> <C>
31,621,325 92-12-A3, 0.51% due 7/25/2022 359,745 331,036 0.26
Total Investments in Derivative
Mortgage-Backed Obligations--
Interest Only 3,222,642 1,974,226 1.58
Fixed Rate 3,811,635 Resolution Trust Corporation, REMIC
Mortgage-Backed (a) 92-CHF-B, 7.15% due 12/25/2020 3,856,685 3,815,804 3.06
Obligations**
Total Investments in Fixed Rate
Mortgage-Backed Obligations 3,856,685 3,815,804 3.06
Total Investments in Mortgage-
Backed Obligations 110,576,737 110,589,839 88.54
US Government United States Treasury Notes:
Obligations 7,000,000 6.125% due 8/31/1998 6,969,922 7,010,920 5.62
5,000,000 6% due 8/15/1999 4,942,656 4,974,200 3.98
Total Investments in US Government
Obligations 11,912,578 11,985,120 9.60
Short-Term Repurchase 2,464,000 Nikko Securities International,
Securities Agreements*** Inc., purchased on 5/30/1997 to
yield 5.58% to 6/02/1997 2,464,000 2,464,000 1.97
Total Short-Term Securities 2,464,000 2,464,000 1.97
Total Investments $124,953,315 125,038,959 100.11
============
Liabilities in Excess of Other
Assets (131,173) (.11)
------------ -------
Net Assets $124,907,786 100.00%
============ =======
<FN>
*Adjustable Rate Obligations have coupon rates which reset
periodically.
**Mortgage-Backed Obligations are subject to principal paydowns as a
result of prepayments or refinancings of the underlying mortgage
instruments. As a result, the average life may be substantially less
than the original maturity.
***Repurchase Agreements are fully collateralized by US Government &
Agency Obligations.
(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.
See Notes to Financial Statements.
</TABLE>
47
<PAGE>
<TABLE>
STATEMENT OF ASSETS AND LIABILITIES
As of May 31, 1997
<S> <S> <C> <C>
Assets: Investments, at value (identified cost--$124,953,315) (Note 1a) $125,038,959
Cash 242
Receivables:
Interest $ 1,047,126
Principal paydowns 286,465
Capital shares sold 10,590 1,344,181
------------
Prepaid registration fees and other assets (Note 1f) 90,988
------------
Total assets 126,474,370
------------
Liabilities: Payables:
Capital shares redeemed 1,141,678
Dividends to shareholders (Note 1g) 180,210
Distributor (Note 2) 76,925
Investment adviser (Note 2) 55,222 1,454,035
------------
Accrued expenses and other liabilities 112,549
------------
Total liabilities 1,566,584
------------
Net Assets: Net assets $124,907,786
============
Net Assets Class A Common Stock, $0.10 par value, 100,000,000 shares authorized $ 2,749
Consist of: Class B Common Stock, $0.10 par value, 600,000,000 shares authorized 1,102,284
Class C Common Stock, $0.10 par value, 100,000,000 shares authorized 55,214
Class D Common Stock, $0.10 par value, 200,000,000 shares authorized 137,950
Paid-in capital in excess of par 158,237,079
Accumulated realized capital losses on investments--net (Note 5) (34,713,134)
Unrealized appreciation on investments--net 85,644
------------
Net assets $124,907,786
============
Net Asset Class A--Based on net assets of $265,239 and 27,491
Value: shares outstanding $ 9.65
============
Class B--Based on net assets of $106,060,849 and 11,022,844
shares outstanding $ 9.62
============
Class C--Based on net assets of $5,315,233 and 552,141
shares outstanding $ 9.63
============
Class D--Based on net assets of $13,266,465 and 1,379,496
shares outstanding $ 9.62
============
See Notes to Financial Statements.
</TABLE>
48
<PAGE>
<TABLE>
STATEMENT OF OPERATIONS
For the Year Ended May 31, 1997
<S> <S> <C>
Investment Income Interest and discount earned, net of premium amortization $ 9,650,937
(Note 1e): ------------
Expenses: Account maintenance and distribution fees--Class B (Note 2) 905,720
Investment advisory fees (Note 2) 689,185
Transfer agent fees--Class B (Note 2) 131,694
Accounting services (Note 2) 98,039
Professional fees 80,005
Registration fees (Note 1f) 73,122
Printing and shareholder reports 68,928
Directors' fees and expenses 40,439
Account maintenance fees--Class D (Note 2) 32,462
Account maintenance and distribution fees--Class C (Note 2) 30,129
Custodian fees 24,582
Transfer agent fees--Class D (Note 2) 11,235
Amortization of organization expenses (Note 1f) 4,003
Transfer agent fees--Class C (Note 2) 3,634
Pricing fees 1,711
Transfer agent fees--Class A (Note 2) 313
Other 14,968
------------
Total expenses 2,210,169
------------
Investment income--net 7,440,768
------------
Realized & Realized loss on investments--net (1,901,359)
Unrealized Gain Change in unrealized depreciation on investments--net 3,283,381
(Loss) on ------------
Investments--Net Net Increase in Net Assets Resulting from Operations $ 8,822,790
(Notes 1c, 1e & 3): ============
See Notes to Financial Statements.
</TABLE>
49
<PAGE>
<TABLE>
STATEMENTS OF CHANGES IN NET ASSETS
<CAPTION>
For the Year Ended May 31,
Increase (Decrease) in Net Assets: 1997 1996
<S> <S> <C> <C>
Operations: Investment income--net $ 7,440,768 $ 10,070,282
Realized gain (loss) on investments--net (1,901,359) 318,695
Change in unrealized appreciation/depreciation on investments--net 3,283,381 (890,435)
------------ ------------
Net increase in net assets resulting from operations 8,822,790 9,498,542
------------ ------------
Dividends to Investment income--net:
Shareholders Class A (21,887) (27,553)
(Note 1g): Class B (6,440,557) (9,248,234)
Class C (200,022) (81,537)
Class D (758,871) (812,697)
------------ ------------
Net decrease in net assets resulting from dividends to shareholders (7,421,337) (10,170,021)
------------ ------------
Capital Share Net decrease in net assets derived from capital share transactions (30,039,497) (66,863,233)
Transactions ------------ ------------
(Note 4):
Net Assets: Total decrease in net assets (28,638,044) (67,534,712)
Beginning of year 153,545,830 221,080,542
------------ ------------
End of year $124,907,786 $153,545,830
============ ============
See Notes to Financial Statements.
</TABLE>
<TABLE>
FINANCIAL HIGHLIGHTS
<CAPTION>
Class A
For the
Period
The following per share data and ratios have been derived For the Oct. 21,
from information provided in the financial statements. Year Ended 1994++ to
May 31, May 31,
Increase (Decrease) in Net Asset Value: 1997+++++ 1996+++++ 1995
<S> <S> <C> <C> <C>
Per Share Net asset value, beginning of period $ 9.54 $ 9.55 $ 9.46
Operating -------- -------- --------
Performance: Investment income--net .59 .56 .36
Realized and unrealized gain on investments--net .10 .03 .09
-------- -------- --------
Total from investment operations .69 .59 .45
-------- -------- --------
Less dividends from investment income--net (.58) (.60) (.36)
-------- -------- --------
Net asset value, end of period $ 9.65 $ 9.54 $ 9.55
======== ======== ========
</TABLE>
50
<PAGE>
<TABLE>
<S> <S> <C> <C> <C>
Total Investment Based on net asset value per share 7.48% 6.41% 4.85%+++
Return:** ======== ======== ========
Ratios to Average Expenses .89% .81% .87%*
Net Assets: ======== ======== ========
Investment income--net 6.13% 6.20% 6.18%*
======== ======== ========
Supplemental Net assets, end of period (in thousands) $ 265 $ 281 $ 345
Data: ======== ======== ========
Portfolio turnover 18.48% 25.30% 102.55%
======== ======== ========
<CAPTION>
The following per share data and ratios have been derived
from information provided in the financial statements. Class B
For the Year Ended May 31,
Increase (Decrease) in Net Asset Value: 1997+++++ 1996+++++ 1995 1994 1993
<S> <S> <C> <C> <C> <C> <C>
Per Share Net asset value, beginning of year $ 9.53 $ 9.56 $ 9.53 $ 9.76 $ 9.92
Operating -------- -------- -------- -------- --------
Performance: Investment income--net .51 .52 .46 .32 .40
Realized and unrealized gain (loss) on
investments--net .09 (.02) .04 (.24) (.16)
-------- -------- -------- -------- --------
Total from investment operations .60 .50 .50 .08 .24
-------- -------- -------- -------- --------
Less dividends from investment income--net (.51) (.53) (.47) (.31) (.40)
-------- -------- -------- -------- --------
Net asset value, end of year $ 9.62 $ 9.53 $ 9.56 $ 9.53 $ 9.76
======== ======== ======== ======== ========
Total Investment Based on net asset value per share 6.44% 5.34% 5.48% .77% 2.48%
Return:** ======== ======== ======== ======== ========
Ratios to Average Expenses 1.65% 1.59% 1.59% 1.46% 1.40%
Net Assets: ======== ======== ======== ======== ========
Investment income--net 5.35% 5.45% 4.88% 3.20% 4.15%
======== ======== ======== ======== ========
Supplemental Net assets, end of year (in thousands) $106,061 $137,387 $202,334 $374,376 $689,593
Data: ======== ======== ======== ======== ========
Portfolio turnover 18.48% 25.30% 102.55% 60.38% 104.71%
======== ======== ======== ======== ========
<FN>
*Annualized.
**Total investment returns exclude the effect of sales loads.
++Commencement of Operations.
+++Aggregate total investment return.
+++++Based on average shares outstanding during the period.
See Notes to Financial Statements.
</TABLE>
51
<PAGE>
FINANCIAL HIGHLIGHTS (concluded)
<TABLE>
<CAPTION>
Class C
For the
Period
The following per share data and ratios have been derived For the Oct. 21,
from information provided in the financial statements. Year Ended 1994++ to
May 31, May 31,
Increase (Decrease) in Net Asset Value: 1997+++++ 1996+++++ 1995
<S> <S> <C> <C> <C>
Per Share Net asset value, beginning of period $ 9.53 $ 9.56 $ 9.46
Operating -------- -------- --------
Performance: Investment income--net .50 .48 .31
Realized and unrealized gain on investments--net .11 .01 .10
-------- -------- --------
Total from investment operations .61 .49 .41
-------- -------- --------
Less dividends from investment income--net (.51) (.52) (.31)
-------- -------- --------
Net asset value, end of period $ 9.63 $ 9.53 $ 9.56
======== ======== ========
Total Investment Based on net asset value per share 6.51% 5.30% 4.47%+++
Return:** ======== ======== ========
Ratios to Average Expenses 1.70% 1.57% 1.68%*
Net Assets: ======== ======== ========
Investment income--net 5.34% 5.40% 5.51%*
======== ======== ========
Supplemental Net assets, end of period (in thousands) $ 5,315 $ 3,078 $ 1,409
Data: ======== ======== ========
Portfolio turnover 18.48% 25.30% 102.55%
======== ======== ========
<CAPTION>
The following per share data and ratios have been derived
from information provided in the financial statements. Class D
For the Year Ended May 31,
Increase (Decrease) in Net Asset Value: 1997+++++ 1996+++++ 1995 1994 1993
<S> <S> <C> <C> <C> <C> <C>
Per Share Net asset value, beginning of year $ 9.52 $ 9.55 $ 9.53 $ 9.76 $ 9.92
Operating -------- -------- -------- -------- --------
Performance: Investment income--net .57 .56 .51 .37 .45
Realized and unrealized gain (loss) on
investments--net .09 (.01) .03 (.24) (.16)
-------- -------- -------- -------- --------
Total from investment operations .66 .55 .54 .13 .29
-------- -------- -------- -------- --------
Less dividends from investment income--net (.56) (.58) (.52) (.36) (.45)
-------- -------- -------- -------- --------
Net asset value, end of year $ 9.62 $ 9.52 $ 9.55 $ 9.53 $ 9.76
======== ======== ======== ======== ========
Total Investment Based on net asset value per share 7.11% 5.91% 5.91% 1.28% 2.99%
Return:** ======== ======== ======== ======== ========
Ratios to Average Expenses 1.13% 1.06% 1.08% .96% .91%
Net Assets: ======== ======== ======== ======== ========
Investment income--net 5.87% 5.98% 5.44% 3.69% 4.79%
======== ======== ======== ======== ========
Supplemental Net assets, end of year (in thousands) $ 13,267 $ 12,800 $ 16,993 $ 23,043 $ 51,398
Data: ======== ======== ======== ======== ========
Portfolio turnover 18.48% 25.30% 102.55% 60.38% 104.71%
======== ======== ======== ======== ========
</TABLE>
52
<PAGE>
[FN]
*Annualized.
**Total investment returns exclude the effect of sales loads.
++Commencement of Operations.
+++Aggregate total investment return.
+++++Based on average shares outstanding during the period.
See Notes to Financial Statements.
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 over-the-counter market are valued at the last available bid
price or on the basis of yield equivalents as obtained from one or
more dealers that make markets in such securities. Options written
on mortgage-backed securities and other securities of the Fund which
are traded on exchanges are valued at their last sale price in the
case of exchange-traded options or, in the case of options traded in
the over-the-counter 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
over-the-counter market, the last bid price. Interest rate futures
contracts and options thereon, which are traded on exchanges, are
stated at market value. 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.
53
<PAGE>
NOTES TO FINANCIAL STATEMENTS (continued)
* 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
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 the "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.
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:
Account Distribution
Maintenance Fee Fee
Class B 0.25% 0.50%
Class C 0.25% 0.55%
Class D 0.25% --
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, 1997, MLFD earned underwriting discounts
and MLPF&S earned dealer concessions on sales of the Fund's Class D
Shares as follows:
MLFD MLPF&S
Class D $934 $10,352
For the year ended May 31, 1997, MLPF&S received contingent deferred
sales charges of $75,785 and $22,912 relating to transactions in
Class B and Class C Shares, respectively.
54
<PAGE>
For the year ended May 31, 1997, the Fund paid Merrill Lynch
Security Pricing Service, an affiliate of MLPF&S, $2,821 for
security price quotations to compute the net asset values 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.
Certain officers and/or directors of the Fund are officers and/or
directors of MLAM, PSI, MLFDS, MLFD, and/or ML & Co.
3. Investments:
Purchases and sales of investments, excluding short-term securities,
for the year ended May 31, 1997 were $24,745,553 and $47,869,879,
respectively.
Net realized and unrealized gains (losses) as of May 31, 1997 were
as follows:
Realized Unrealized
Losses Gains
Long-term investments $ (1,901,359) $ 85,644
------------ ------------
Total $ (1,901,359) $ 85,644
============ ============
As of May 31, 1997, net unrealized depreciation for Federal income
tax purposes aggregated $27,354, of which $1,732,876 related to
appreciated securities and $1,760,230 related to depreciated
securities. The aggregate cost of investments at May 31, 1997 for
Federal income tax purposes was $125,066,313.
4. Capital Share Transactions:
Net decrease in net assets derived from capital share transactions
was $30,039,497 and $66,863,233 for the years ended May 31, 1997 and
May 31, 1996, respectively.
Transactions in capital shares for each class were as follows:
Class A Shares for the
Year Ended Dollar
May 31, 1997 Shares Amount
Shares sold 965,067 $ 9,288,059
Shares issued to shareholders
in reinvestment of dividends 347 1,950
------------- -------------
Total issued 965,414 9,290,009
Shares redeemed (967,393) (9,308,472)
------------- -------------
Net decrease (1,979) $ (18,463)
============= =============
Class A Shares for the
Year Ended Dollar
May 31, 1996 Shares Amount
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)
============= =============
Class B Shares for the
Year Ended Dollar
May 31, 1997 Shares Amount
Shares sold 5,764,174 $ 58,529,269
Shares issued to shareholders
in reinvestment of dividends 674,713 3,158,743
------------- -------------
Total issued 6,438,887 61,688,012
Automatic conversion of shares (51,870) (497,629)
Shares redeemed (9,786,009) (93,754,680)
------------- -------------
Net decrease (3,398,992) $ (32,564,297)
============= =============
Class B Shares for the
Year Ended Dollar
May 31, 1996 Shares Amount
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)
============= =============
Class C Shares for the Year Dollar
Ended May 31, 1997 Shares Amount
Shares sold 1,790,501 $ 17,211,671
Shares issued to shareholders
in reinvestment of dividends 14,275 121,539
------------- -------------
Total issued 1,804,776 17,333,210
Shares redeemed (1,575,517) (15,123,053)
------------- -------------
Net increase 229,259 $ 2,210,157
============= =============
55
<PAGE>
NOTES TO FINANCIAL STATEMENTS (concluded)
Class C Shares for the Year Dollar
Ended May 31, 1996 Shares Amount
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
============= =============
Class D Shares for the Year Dollar
Ended May 31, 1997 Shares Amount
Shares sold 2,480,241 $ 23,652,524
Automatic conversion of shares 51,874 497,629
Shares issued to shareholders
in reinvestment of dividends 45,009 431,306
------------- -------------
Total issued 2,577,124 24,581,459
Shares redeemed (2,542,227) (24,248,353)
------------- -------------
Net increase 34,897 $ 333,106
============= =============
Class D Shares for the Year Dollar
Ended May 31, 1996 Shares Amount
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)
============= =============
5. Capital Loss Carryforward:
At May 31, 1997, the Fund had a net capital loss carryforward of
approximately $32,758,000, of which $20,978,000 expires in 2002
$3,888,000 expires in 2003, $7,641,000 expires in 2004 and $251,000
expires in 2005. This amount will be available to offset like
amounts of any future taxable gains.
56
<PAGE>
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57
<PAGE>
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58
<PAGE>
[This page intentionally left blank]
59
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objective and Policies......................................... 2
Privately Issued Mortgage-Backed and Asset-Backed Securities--Credit En-
hancements............................................................ 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.................................................... 13
Directors and Officers................................................... 13
Compensation of Directors................................................ 15
Management and Advisory Arrangements..................................... 16
Purchase of Shares........................................................ 17
Initial Sales Charge Alternatives-- Class A and Class D Shares........... 17
Reduced Initial Sales Charge............................................. 19
Employer-Sponsored Retirement or Savings Plans and Certain Other Arrange-
ments................................................................. 21
Distribution Plans....................................................... 21
Limitations on the Payment of Deferred Sales Charges..................... 22
Redemption of Shares...................................................... 23
Deferred Sales Charges-- Class B and Class C Shares...................... 23
Portfolio Transactions.................................................... 24
Portfolio Turnover....................................................... 25
Determination of Net Asset Value.......................................... 25
Shareholder Services...................................................... 26
Investment Account....................................................... 27
Automatic Investment Plans............................................... 27
Automatic Reinvestment of Dividends and Capital Gains Distributions...... 27
Systematic Withdrawal Plans--Class A and Class D Shares.................. 28
Exchange Privilege....................................................... 29
Dividends, Distributions and Taxes........................................ 31
Dividends and Distributions.............................................. 31
Taxes.................................................................... 31
Tax Treatment of Interest Rate Transactions, Options and Futures......... 33
Performance Data.......................................................... 34
General Information....................................................... 37
Description of Shares.................................................... 37
Computation of Offering Price per Share.................................. 37
Independent Auditors..................................................... 38
Custodian................................................................ 38
Transfer Agent........................................................... 38
Legal Counsel............................................................ 38
Reports to Shareholders.................................................. 38
Additional Information................................................... 39
Security Ownership of Certain Beneficial Owners.......................... 39
Appendix A--Ratings of Debt Securities.................................... 40
Independent Auditors' Report.............................................. 45
Financial Statements...................................................... 46
</TABLE>
Code #13938-0897
[LOGO] MERRILL LYNCH
Merrill Lynch
Adjustable Rate
Securities Fund, Inc.
[ART]
STATEMENT OF
ADDITIONAL
INFORMATION
August 29, 1997
Distributor:
Merrill Lynch
Funds Distributor, Inc.
<PAGE>
PART C. OTHER INFORMATION
ITEM 24. FINANCIAL STATEMENTS AND EXHIBITS.
(a) FINANCIAL STATEMENTS
Contained in Part A:
Financial Highlights for each of the years in the five year period
ended May 31, 1997, 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, 1997
Statement of Assets and Liabilities as of May 31, 1997
Statement of Operations for the year ended May 31, 1997
Statements of Changes in Net Assets for the years ended May 31, 1997
and 1996
Financial Highlights for each of the years in the five year period
ended May 31, 1997
(c) EXHIBITS:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
-------
<C> <C> <S>
1(a) -- Articles of Incorporation of the Registrant dated April 18,
1991.(a)
(b) -- Articles of Amendment of the Registrant dated May 31, 1991.(a)
(c) -- Articles Supplementary of the Registrant dated October 17,
1994.(a)
(d) -- Articles of Amendment of the Registrant dated October 17, 1994.(a)
2 -- By-Laws of the Registrant.(a)
3 -- None.
4 -- Portions of the Articles of Incorporation and the By-Laws of the
Registrant defining the rights of shareholders of the
Registrant.(b)
Management Agreement between the Registrant and Merrill Lynch
5(a) -- Asset Management L.P.(a)
(b) -- Supplement to Management Agreement between the Registrant and
Merrill Lynch Asset Management, L.P.(c)
6(a) -- Form of Class A Shares Distribution Agreement between the
Registrant and Merrill Lynch Funds Distributor, Inc. (including
Selected Dealers Agreement).(c)
(b) -- Class B Shares Distribution Agreement between the Registrant and
Merrill Lynch Funds Distributor, Inc.(a)
(c) -- Form of Class C Shares Distribution Agreement between the
Registrant and Merrill Lynch Funds Distributor, Inc. (including
Selected Dealers Agreement).(c)
(d) -- Form of Class D Shares Distribution Agreement between the
Registrant and Merrill Lynch Funds Distributor, Inc. (including
Selected Dealers Agreement).(c)
7 -- None.
8 -- Custody Agreement between the Registrant and The Bank of New
York.(a)
9 -- Transfer Agency, Dividend Disbursing Agency and Shareholder
Servicing Agency Agreement between the Registrant and Merrill
Lynch Financial Data Services, Inc.(a)
10 -- Opinion of Brown & Wood LLP, counsel to the Registrant.
11 -- Consent of Deloitte & Touche LLP, independent auditors for the
Registrant.
12 -- None.
13 -- Certificate of Merrill Lynch Asset Management, L.P.(a)
14 -- None.
15(a) -- Amended and Restated Class B Shares Distribution Plan of the
Registrant.(a)
(b) -- Form of Class C Distribution Plan and Class C Distribution Plan
Sub-Agreement of the Registrant.(c)
(c) -- Form of Class D Distribution Plan and Class D Distribution Plan
Sub-Agreement of the Registrant.(c)
16(a) -- Schedule of 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>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
-------
<C> <C> <S>
(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.(a)
(d) -- Schedule for computation of each performance quotation provided in
the Registration Statement in response to item 22 relating to
Class C shares.(a)
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) Filed on September 25, 1995, as an Exhibit to Post-Effective Amendment No.
6 to the Registrant's Registration Statement on Form N-1A under the
Securities Act of 1933, as amended (File No. 33-40332) (the "Registration
Statement").
(b) 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.
(c) Previously filed as an exhibit to Post-Effective Amendment No. 5 to the
Registration Statement.
(d) Incorporated by reference to Exhibit 18 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
(File No. 2-99473).
ITEM 25. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH REGISTRANT.
The 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 JULY 31, 1997*
-------------- --------------
<S> <C>
Class A shares of Common Stock, par value $0.10 per share........ 14
Class B shares of Common Stock, par value $0.10 per share........ 7,603
Class C shares of Common Stock, par value $0.10 per share........ 150
Class D shares of Common Stock, par value $0.10 per share........ 437
</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 the 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 advance which
exceeds the
C-2
<PAGE>
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 the
investment adviser for the following open-end registered 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 Allocation Fund, Merrill Lynch Global Bond Fund for Investment
and Retirement, Inc., Merrill Lynch Global Convertible Fund, Inc., Merrill
Lynch Global Holdings, Inc., Merrill Lynch Global Resources Trust, Merrill
Lynch Global SmallCap Fund, Inc., Merrill Lynch Global Utility Fund, Inc.,
Merrill Lynch Global Value Fund, Inc., Merrill Lynch Growth Fund, Merrill
Lynch Healthcare Fund, Inc., Merrill Lynch Intermediate Government Bond 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., Merrill Lynch Variable Series Funds, Inc. and
Hotchkis and Wiley Funds (advised by Hotchkis and Wiley, a division of MLAM);
and for the following closed-end registered investment companies: Convertible
Holdings, Inc., Merrill Lynch High Income Municipal Bond Fund, Inc. and
Merrill Lynch Senior Floating Rate Fund, Inc. MLAM also acts as sub-adviser to
Merrill Lynch World Strategy Portfolio and Merrill Lynch Basic Value Equity
Portfolio, two investment portfolios of EQ Advisory Trust.
Fund Asset Management, L.P. ("FAM"), an affiliate of the Manager, acts as
the investment adviser for the following open-end registered 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
C-3
<PAGE>
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 Fund Accumulation Program, Inc.; and for the
following closed-end registered investment companies: Apex Municipal Fund,
Inc., Corporate High Yield Fund, Inc., Corporate High Yield Fund II, Inc.,
Debt Strategies Fund, Inc. Income Opportunities Fund 1999, Inc., Income
Opportunities Fund 2000, Inc., Merrill Lynch Municipal Strategy Fund, Inc.,
MuniAssets Fund, Inc., MuniEnhanced Fund, Inc., MuniHoldings Fund, Inc.,
MuniInsured Fund, Inc., MuniVest Fund, Inc., MuniVest Fund II, Inc., MuniVest
Florida Fund, MuniVest Michigan Insured Fund, Inc., MuniVest New Jersey 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 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 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 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
June 1, 1995 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 and Mr. Glenn is Executive Vice President of all or
substantially all of the investment companies described in the first two
paragraphs of this Item 28 and Messrs. Giordano, Kirstein and Monagle are
directors or officers of one or more of such companies.
<TABLE>
<CAPTION>
OTHER SUBSTANTIAL
BUSINESS,
POSITION(S) WITH PROFESSION, VOCATION
NAME INVESTMENT ADVISER OR EMPLOYMENT
---- ------------------ --------------------
<C> <C> <S>
ML&Co......................... Limited Partner Financial Services
Holding Company;
Limited Partner of FAM
Princeton Services, Inc.
("Princeton Services")....... General Partner General Partner of FAM
Arthur Zeikel................. President President of FAM;
President and Director
of Princeton Services;
Director of Merrill
Lynch Funds
Distributor, Inc.
("MLFD"), Executive
Vice President of
ML&Co., Inc.
Terry K. Glenn................ Executive Vice Executive Vice President
President of FAM; Executive Vice
President and Director
of Princeton Services;
President and Director
of MLFD; Director of
the Transfer Agent;
President of Princeton
Administrators, L.P.
</TABLE>
C-4
<PAGE>
<TABLE>
<CAPTION>
OTHER SUBSTANTIAL
BUSINESS,
POSITION(S) WITH PROFESSION, VOCATION
NAME INVESTMENT ADVISER OR EMPLOYMENT
---- ------------------ --------------------
<C> <C> <S>
Vincent R. Giordano........... Senior Vice President Senior Vice President of
FAM; Senior Vice
President of Princeton
Services
Elizabeth Griffin............. Senior Vice President Senior Vice President of
FAM
Michael J. Hennewinkel........ Senior Vice President Senior Vice President of
FAM; Senior Vice
President of Princeton
Services
Philip L. Kirstein............ Senior Vice Senior Vice President,
President, General Counsel and
General Counsel and Secretary of FAM;
Secretary Senior Vice President,
General Counsel;
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
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 Messrs. Aldrich,
Brady, Breen, Crook, Fatseas, and Wasel is One Financial Center, 15th Floor,
Boston, Massachusetts 02111-2665.
C-5
<PAGE>
<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
Michael J. Brady.......... Vice President None
William M. Breen.......... Vice President None
Michael G. Clark.......... Vice President None
James T. Fatseas.......... Vice President None
Debra W. Landsman-Yaros... Vice President None
Michelle T. Lau........... Vice President None
Gerald M. Richard......... Vice President and Treasurer Treasurer
Salvatore Venezia......... Vice President None
William Wasel............. Vice President None
Robert Harris............. Secretary None
</TABLE>
(c) Not applicable.
ITEM 30. LOCATION OF ACCOUNTS AND RECORDS.
All accounts, books and other documents required to be maintained by Section
31(a) of the Investment Company Act 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, the 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>
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 ITS
REGISTRATION STATEMENT PURSUANT TO RULE 485(B) UNDER THE SECURITIES ACT OF
1933 AND HAS DULY CAUSED THIS POST-EFFECTIVE AMENDMENT TO ITS 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
28TH DAY OF AUGUST, 1997.
MERRILL LYNCH ADJUSTABLE RATE
SECURITIES FUND, INC. (REGISTRANT)
/s/ Arthur Zeikel
By__________________________________
(ARTHUR ZEIKEL, PRESIDENT)
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS
REGISTRATION STATEMENT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS IN THE
CAPACITIES AND ON THE DATE(S) INDICATED.
SIGNATURE TITLE DATE(S)
Arthur Zeikel* President and
- ------------------------------------- Director (Principal
(ARTHUR ZEIKEL) Executive Officer)
Treasurer (Principal
Gerald M. Richard* Financial and
- ------------------------------------- Accounting Officer)
(GERALD M. RICHARD)
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)
/s/ Arthur Zeikel August 28, 1997
*By ________________________________
(ARTHUR ZEIKEL, ATTORNEY-IN-FACT)
C-7
<PAGE>
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>
<PAGE>
APPENDIX FOR GRAPHIC AND IMAGE MATERIAL
Pursuant to Rule 304 of Regulation S-T, the following table presents
fair and accurate narrative descriptions of graphic and image material omitted
from this EDGAR Submission file due to ASCII-incompatibility and cross-
references this material to the location of each occurrence in the text.
DESCRIPTION OF OMITTED LOCATION OF GRAPHIC
GRAPHIC OR IMAGE OR IMAGE IN TEXT
- ---------------------- -------------------
Compass plate, circular Back cover of Prospectus and
graph paper and Merrill Lynch back cover of Statement of
logo including stylized market Additional Information
bull
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 6
<SERIES>
<NUMBER> 001
<NAME> MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC. - CLASS A
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> MAY-31-1997
<PERIOD-START> JUN-01-1996
<PERIOD-END> MAY-31-1997
<INVESTMENTS-AT-COST> 124953315
<INVESTMENTS-AT-VALUE> 125038959
<RECEIVABLES> 1344181
<ASSETS-OTHER> 91230
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 126474370
<PAYABLE-FOR-SECURITIES> 0
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 1566584
<TOTAL-LIABILITIES> 1566584
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 159535276
<SHARES-COMMON-STOCK> 27491
<SHARES-COMMON-PRIOR> 29470
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> (34713134)
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 85644
<NET-ASSETS> 265239
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 9650937
<OTHER-INCOME> 0
<EXPENSES-NET> (2210169)
<NET-INVESTMENT-INCOME> 7440768
<REALIZED-GAINS-CURRENT> (1901359)
<APPREC-INCREASE-CURRENT> 3283381
<NET-CHANGE-FROM-OPS> 8822790
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (21887)
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 965067
<NUMBER-OF-SHARES-REDEEMED> (967393)
<SHARES-REINVESTED> 347
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<ACCUMULATED-GAINS-PRIOR> (32811775)
<OVERDISTRIB-NII-PRIOR> 0
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</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 6
<SERIES>
<NUMBER> 002
<NAME> MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC. - CLASS B
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> MAY-31-1997
<PERIOD-START> JUN-01-1996
<PERIOD-END> MAY-31-1997
<INVESTMENTS-AT-COST> 124953315
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<ACCUMULATED-NET-GAINS> (34713134)
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<DIVIDEND-INCOME> 0
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<EXPENSES-NET> (2210169)
<NET-INVESTMENT-INCOME> 7440768
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<NUMBER-OF-SHARES-SOLD> 5764174
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<AVERAGE-NET-ASSETS> 121094410
<PER-SHARE-NAV-BEGIN> 9.53
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</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 6
<SERIES>
<NUMBER> 003
<NAME> MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC. - CLASS C
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> MAY-31-1997
<PERIOD-START> JUN-01-1996
<PERIOD-END> MAY-31-1997
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<SHARES-COMMON-STOCK> 552141
<SHARES-COMMON-PRIOR> 322882
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<ACCUMULATED-NET-GAINS> (34713134)
<OVERDISTRIBUTION-GAINS> 0
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<NET-ASSETS> 5315233
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 9650937
<OTHER-INCOME> 0
<EXPENSES-NET> (2210169)
<NET-INVESTMENT-INCOME> 7440768
<REALIZED-GAINS-CURRENT> (1901359)
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<NET-CHANGE-FROM-OPS> 8822790
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (200022)
<DISTRIBUTIONS-OF-GAINS> 0
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<NUMBER-OF-SHARES-SOLD> 1790501
<NUMBER-OF-SHARES-REDEEMED> (1575517)
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<TABLE> <S> <C>
<PAGE>
<ARTICLE> 6
<SERIES>
<NUMBER> 004
<NAME> MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC. - CLASS D
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> MAY-31-1997
<PERIOD-START> JUN-01-1996
<PERIOD-END> MAY-31-1997
<INVESTMENTS-AT-COST> 124953315
<INVESTMENTS-AT-VALUE> 125038959
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<SHARES-COMMON-STOCK> 1379496
<SHARES-COMMON-PRIOR> 1344599
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<ACCUMULATED-NET-GAINS> (34713134)
<OVERDISTRIBUTION-GAINS> 0
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<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (758871)
<DISTRIBUTIONS-OF-GAINS> 0
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<NUMBER-OF-SHARES-SOLD> 2532115
<NUMBER-OF-SHARES-REDEEMED> (2542227)
<SHARES-REINVESTED> 45009
<NET-CHANGE-IN-ASSETS> (28638044)
<ACCUMULATED-NII-PRIOR> (19431)
<ACCUMULATED-GAINS-PRIOR> (32811775)
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
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<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 2210169
<AVERAGE-NET-ASSETS> 12992423
<PER-SHARE-NAV-BEGIN> 9.52
<PER-SHARE-NII> .57
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<EXPENSE-RATIO> 1.13
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
<PAGE>
EXHIBIT 99.10
BROWN & WOOD LLP
ONE WORLD TRADE CENTER
NEW YORK, NEW YORK 10048-0557
TELEPHONE: (212) 839-5300
FACSIMILE: (212) 839-5599
August 29, 1997
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
"Fund"), of shares of Common Stock, par value $0.10 per share, of the Fund (the
"Shares"), under the Securities Act of 1933, as amended, pursuant to a
registration statement on Form N-1A (File No. 33-40332), as amended (the
"Registration Statement"), in the amount set forth under "Amount Being
Registered" on the facing page of the Registration Statement.
As counsel for the Fund, we are familiar with the proceedings taken by it
in connection with the authorization, issuance and sale of the Shares. In
addition, we have examined and are familiar with the Articles of Incorporation
of the Fund, as amended, the By-Laws of the Fund 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.
We hereby consent to the filing of this opinion as an exhibit to the
Registration Statement and to the use of our name in the Prospectus and
Statement of Additional Information constituting parts thereof.
Very truly yours,
/s/ Brown & Wood
<PAGE>
EXHIBIT 99.11
INDEPENDENT AUDITORS' CONSENT
Merrill Lynch Adjustable Rate Securities Fund, Inc.:
We consent to the use in Post-Effective Amendment No. 8 to Registration
Statement No. 33-40332 of our report dated June 27, 1997 appearing the Statement
of Additional Information, which is a part of such Registration Statement, and
to the reference to us under the caption "Financial Highlights" appearing in the
Prospectus, which also is a part of such Registration Statement.
/s/ Deloitte & Touche LLP
DELOITTE & TOUCHE LLP
Princeton, New Jersey
August 28, 1997
