MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND INC, 485BPOS, 1998-08-28

MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND INC
485BPOS, 1998-08-28

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<PAGE>

AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON AUGUST 28, 1998

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. 9 [X]

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

AMENDMENT NO. 10 [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
PLAINSBORO, NEW JERSEY 08536
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)

(609) 282-2800
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)

---------------
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:

<TABLE>
<S> <C>
COUNSEL FOR THE FUND: MICHAEL J. HENNEWINKEL, 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
</TABLE>

---------------
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.

TITLE OF SECURITIES BEING REGISTERED: Shares of Beneficial Interest, par value
$.10 per share.

- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>

MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC.

REGISTRATION STATEMENT ON FORM N-1A

CROSS REFERENCE SHEET

<TABLE>
<CAPTION>
N-1A
ITEM NO. LOCATION
- ---------- --------
<S> <C> <C>
PART A
Item 1. Cover Page ................................... Cover Page
Item 2. Synopsis ..................................... Prospectus Summary and Fee Table
Item 3. Condensed Financial Information .............. Financial Highlights
Item 4. General Description of Registrant ............ Investment Objective and Policies; Additional Information
Item 5. Management of the Fund ....................... Fee Table; Management of the Fund; Inside Back Cover Page
Item 5A. Management's Discussion of Fund
Performance .................................. Not Applicable
Item 6. Capital Stock and Other Securities ........... Cover Page; Purchase of Shares; Redemption of Shares;
Shareholder Services; Additional Information
Item 7. Purchase of Securities Being Offered ......... Cover Page; Fee Table; Merrill Lynch Select PricingSM
System; Purchase of Shares; Shareholder Services; Additional
Information; Inside Back Cover Page
Item 8. Redemption or Repurchase ..................... Fee Table; Merrill Lynch Select PricingSM 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 ......................... Annual Report dated May 31, 1998*
PART C
</TABLE>

Information required to be included in Part C is set forth under the
appropriate Item, so numbered, in Part C to this Registration Statement.
- ---------

* Incorporated by reference in the Statement of Additional Information.

<PAGE>

PROSPECTUS
AUGUST 28, 1998

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 (the
"Distributor"), a division of Princeton Funds Distributor, Inc. ("PFD"), 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 $250
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 Financial Data
Services, Inc. ("FDS" or the "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 28, 1998 (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 Commission maintains a Web
site (http://www.sec.gov) that contains the Statement of Additional
Information, material incorporated by reference and other information regarding
the Fund. The Statement of Additional Information is hereby incorporated by
reference into this Prospectus.

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

Merrill Lynch Asset Management -- Manager
Merrill Lynch Funds Distributor -- 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 ("S&P") 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 S&P (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 S&P or Moody's and, for temporary or defensive
purposes, may invest up to 100% of its assets in such money market securities.
See "Investment Objective and Policies."

SPECIAL CONSIDERATIONS AND RISK FACTORS

2
<PAGE>

THE MANAGER

Merrill Lynch Asset Management, L.P. (the "Manager" or "MLAM"), which is
controlled by Merrill Lynch & Co. ("ML & Co."), acts as the investment adviser
for the Fund and provides the Fund with management and investment advisory
services. The Asset Management Group of ML & Co. acts as the investment adviser
for more than 100 registered investment companies. The Asset Management Group
also offers portfolio management services to individuals and institutional
accounts. As of July 1998, the Asset Management Group had a total of
approximately $487.6 billion in investment company and other portfolio assets
under management. This amount includes assets managed for 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 PricingSM 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
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)
---------------
<S> <C>
SHAREHOLDER TRANSACTION EXPENSES:
Maximum Sales Charge Imposed on Purchases
(as a percentage of offering price) ............... 4.00%(c)
Sales Charge Imposed on Dividend
Reinvestments ..................................... None
Deferred Sales Charge (as a percentage of original
purchase price or redemption proceeds, whichever is
lower) ............................................ None(d)
Exchange Fee ....................................... None
ANNUAL FUND OPERATING EXPENSES (AS A PERCENTAGE OF
AVERAGE NET ASSETS)
Management Fees(g) ................................. 0.50%
12b-1 Fees(h):
Account Maintenance Fees .......................... None
Distribution Fees ................................. None
Other Expenses:
Shareholder Servicing Costs(i) .................... 0.09%
Other ............................................. 0.33%
----------
Total Other Expenses ............................. 0.42%
----------
TOTAL FUND OPERATING EXPENSES ...................... 0.92%
==========

<CAPTION>
CLASS B(b) CLASS C CLASS D
-------------------------------- ---------------- ---------------
<S> <C> <C> <C>
SHAREHOLDER TRANSACTION EXPENSES:
Maximum Sales Charge Imposed on Purchases
(as a percentage of offering price) ............... None None 4.00%(c)
Sales Charge Imposed on Dividend
Reinvestments ..................................... None None None
Deferred Sales Charge (as a percentage of original
purchase price or redemption proceeds, whichever is
lower) ............................................ 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
ANNUAL FUND OPERATING EXPENSES (AS A PERCENTAGE OF
AVERAGE NET ASSETS)
Management Fees(g) ................................. 0.50% 0.50% 0.50%
12b-1 Fees(h):
Account Maintenance Fees .......................... 0.25% 0.25% 0.25%
Distribution Fees ................................. 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:
Shareholder Servicing Costs(i) .................... 0.11% 0.10% 0.09%
Other ............................................. 0.34% 0.34% 0.34%
---- ---- --------
Total Other Expenses ............................. 0.45% 0.44% 0.43%
---- ---- --------
TOTAL FUND OPERATING EXPENSES ...................... 1.70% 1.74% 1.18%
==== ==== ========
</TABLE>

- --------
(a) Class A shares are sold to a limited group of investors including existing
Class A shareholders, certain retirement plans and participants in certain
fee-based programs. See "Purchase of Shares -- Initial Sales Charge
Alternatives -- Class A and Class D Shares" -- page 30 and "Shareholder
Services -- Fee-Based Programs" -- page 41.
(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 31.
(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 30.
(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. A
0.75% sales charge for 401(k) purchases over $1,000,000 will apply. See
"Shareholder Services -- Fee-Based Programs" -- page 41.
(e) The CDSC may be modified in connection with certain fee-based programs. See
"Shareholder Services -- Fee-Based Programs" -- page 41.
(f) The CDSC may be waived in connection with certain fee-based programs. See
"Shareholder Services -- Fee-Based Programs" -- page 41.
(g) See "Management of the Fund -- Management and Advisory Arrangements" --
page 26.
(h) See "Purchase of Shares -- Distribution Plans" -- page 35.
(i) See "Management of the Fund -- Transfer Agency Services" -- page 27.

4
<PAGE>

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 $68 $ 89 $149
Class B ........................................................ $57 $74 $ 92 $201
Class C ........................................................ $28 $55 $ 94 $205
Class D ........................................................ $52 $76 $102 $177
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 $68 $ 89 $149
Class B ........................................................ $17 $54 $ 92 $201
Class C ........................................................ $18 $55 $ 94 $205
Class D ........................................................ $52 $76 $102 $177
</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 PRICINGSM 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 its affiliate Fund Asset
Management, L.P. ("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 0.75%
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. A 0.75% sales charge for 401(k) purchases
over $1,000,000 will apply. 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, as well as 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 after 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 shares), 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. A 0.75% sales charge for
401(k) purchases over $1,000,000 will apply. The schedule of initial
sales charges and reductions for Class D shares is the same as the
schedule for Class A shares, except that there is no waiver for purchases
by retirement plans and participants 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."

The following is 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.

8
<PAGE>

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 CDSCs 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 may qualify the
investor for reduced initial sales charges on new initial sales charge
purchases. In addition, the ongoing Class B and Class C account maintenance and
distribution fees will cause Class B and Class C shares to have higher expense
ratios, pay lower dividends and have lower total returns than the initial sales
charge shares. The ongoing Class D account maintenance fees will cause Class D
shares to have a higher expense ratio, pay lower dividends and have a lower
total return than Class A shares.

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

Certain investors may elect to purchase Class B shares if they determine
it to be most advantageous to have all 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 for the fiscal
year ended May 31, 1998 and the independent auditors' report thereon appear in
the annual report of the Fund for the fiscal year ended May 31, 1998, which has
been incorporated by reference into 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
-------------------------------------------------

FOR THE YEAR
ENDED MAY 31, FOR THE PERIOD
-------------------------------- OCT. 21, 1994+
TO MAY 31,
1998 1997++ 1996++ 1995
---------- ---------- ---------- ----------------
<S> <C> <C> <C> <C>
INCREASE (DECREASE) IN NET
ASSET VALUE:
PER SHARE OPERATING
PERFORMANCE:
Net asset value, beginning of
period ............................ $ 9.65 $ 9.54 $ 9.55 $ 9.46
------ ------- ------- --------
Investment income -- net .......... .57 .59 .56 .36
Realized and unrealized
gain (loss) on
investments -- net ............... ( .04) .10 .03 .09
------- ------- ------- --------
Total from investment
operations ........................ .53 .69 .59 .45
------- ------- ------- --------
Less dividends from investment
income -- net ..................... ( .57) ( .58) ( .60) ( .36)
------- -------- -------- --------
Net asset value, end of period ..... $ 9.61 $ 9.65 $ 9.54 $ 9.55
======= ======== ======== ========
TOTAL INVESTMENT RETURN:**
Based on net asset value per
share ............................. 5.66% 7.48% 6.41% 4.85%#
======= ======== ======== ========
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of
reimbursement ..................... .92% .89% .81% .87%*
======= ======== ======== ========
Expenses ........................... .92% .89% .81% .87%*
======= ======== ======== ========
Investment income -- net ........... 5.93% 6.13% 6.20% 6.18%*
======= ======== ======== ========
SUPPLEMENTAL DATA:
Net assets, end of period (in
thousands) ........................ $ 1,071 $ 265 $ 281 $ 345
======= ======== ======== ========
Portfolio turnover ................. 47.55% 18.48% 25.30% 102.55%
======= ======== ======== ========

<CAPTION>
CLASS B
--------------------------------------------------------------------------------------------
FOR THE PERIOD
FOR THE YEAR
ENDED MAY 31, AUG. 2, 1991+
---------------------------------------------------------------------------- TO MAY 31,
1998 1997++ 1996++ 1995 1994 1993 1992
----------- ------------ ------------ ------------ ------------ ------------ ---------------
<S> <C> <C> <C> <C> <C> <C> <C>
INCREASE (DECREASE) IN NET
ASSET VALUE:
PER SHARE OPERATING
PERFORMANCE:
Net asset value, beginning of
period ............................ $ 9.62 $ 9.53 $ 9.56 $ 9.53 $ 9.76 $ 9.92 $ 10.00
------ ------- ------- ------- ------- ------- -------
Investment income -- net .......... .50 .51 .52 .46 .32 .40 .52
Realized and unrealized
gain (loss) on
investments -- net ............... ( .04) .09 ( .02) .04 ( .24) ( .16) ( .08)
------- ------- -------- ------- -------- -------- --------
Total from investment
operations ........................ .46 .60 .50 .50 .08 .24 .44
------- ------- -------- ------- -------- -------- --------
Less dividends from investment
income -- net ..................... ( .50) ( .51) ( .53) ( .47) ( .31) ( .40) ( .52)
------- -------- -------- -------- -------- -------- --------
Net asset value, end of period ..... $ 9.58 $ 9.62 $ 9.53 $ 9.56 $ 9.53 $ 9.76 $ 9.92
======= ======== ======== ======== ======== ======== ========
TOTAL INVESTMENT RETURN:**
Based on net asset value per
share ............................. 4.85% 6.44% 5.34% 5.48% .77% 2.48% 4.33%#
======= ======== ======== ======== ======== ======== ========
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of
reimbursement ..................... 1.70% 1.65% 1.59% 1.59% 1.46% 1.40% 1.36%*
======= ======== ======== ======== ======== ======== ========
Expenses ........................... 1.70% 1.65% 1.59% 1.59% 1.46% 1.40% 1.47%*
======= ======== ======== ======== ======== ======== ========
Investment income -- net ........... 5.19% 5.35% 5.45% 4.88% 3.20% 4.15% 6.07%*
======= ======== ======== ======== ======== ======== ========
SUPPLEMENTAL DATA:
Net assets, end of period (in
thousands) ........................ $85,094 $106,061 $137,387 $202,334 $374,376 $689,593 $ 887,110
======= ======== ======== ======== ======== ======== =========
Portfolio turnover ................. 47.55% 18.48% 25.30% 102.55% 60.38% 104.71% 94.72%
======= ======== ======== ======== ======== ======== =========
</TABLE>

- -------
* Annualized.

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

+ Commencement of Operations.

++ Based on average shares outstanding.

# Aggregate total investment return.

10
<PAGE>

FINANCIAL HIGHLIGHTS (CONCLUDED)

<TABLE>
<CAPTION>
CLASS C
-------------------------------------------------

FOR THE YEAR
ENDED MAY 31, FOR THE PERIOD
-------------------------------- OCT. 21, 1994+
TO MAY 31,
1998 1997++ 1996++ 1995
---------- ---------- ---------- ----------------
<S> <C> <C> <C> <C>
INCREASE (DECREASE) IN NET ASSET
VALUE:
PER SHARE OPERATING
PERFORMANCE:
Net asset value, beginning of
period ........................... $ 9.63 $ 9.53 $ 9.56 $ 9.46
------ ------ ------ --------
Investment income -- net ......... .49 .50 .48 .31
Realized and unrealized gain
(loss) on investments -- net..... ( .05) .11 .01 .10
------- ------ ------ --------
Total from investment operations .44 .61 .49 .41
------- ------ ------ --------
Less dividends from investment
income -- net .................... ( .49) ( .51) ( .52) ( .31)
------- ------- ------- --------
Net asset value, end of period .... $ 9.58 $ 9.63 $ 9.53 $ 9.56
======= ======= ======= ========
TOTAL INVESTMENT RETURN:**
Based on net asset value per
share ............................ 4.71% 6.51% 5.30% 4.47%#
======= ======= ======= ========
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of reimbursement .... 1.74% 1.70% 1.57% 1.68%*
======= ======= ======= ========
Expenses .......................... 1.74% 1.70% 1.57% 1.68%*
======= ======= ======= ========
Investment income -- net .......... 5.15% 5.34% 5.40% 5.51%*
======= ======= ======= ========
SUPPLEMENTAL DATA:
Net assets, end of period (in
thousands) ....................... $ 4,434 $ 5,315 $ 3,078 $ 1,409
======= ======= ======= ========
Portfolio turnover ................ 47.55% 18.48% 25.30% 102.55%
======= ======= ======= ========

<CAPTION>
CLASS D
---------------------------------------------------------------------------------------

FOR THE YEAR FOR THE PERIOD
ENDED MAY 31, AUG. 2, 1991+
----------------------------------------------------------------------- TO MAY 31,
1998 1997++ 1996++ 1995 1994 1993 1992
----------- ----------- ----------- ----------- ----------- ----------- ---------------
<S> <C> <C> <C> <C> <C> <C> <C>
INCREASE (DECREASE) IN NET ASSET
VALUE:
PER SHARE OPERATING
PERFORMANCE:
Net asset value, beginning of
period ........................... $ 9.62 $ 9.52 $ 9.55 $ 9.53 $ 9.76 $ 9.92 $ 10.00
------ ------ ------ ------- ------ ------- --------
Investment income -- net ......... .55 .57 .56 .51 .37 .45 .56
Realized and unrealized gain
(loss) on investments -- net..... (.04) .09 (.01) .03 ( .24) ( .16) ( .08)
------- ------ ------- ------- ------- -------- ---------
Total from investment operations .51 .66 .55 .54 .13 .29 .48
------- ------ ------- ------- ------- -------- ---------
Less dividends from investment
income -- net .................... (.55) ( .56) ( .58) ( .52) ( .36) ( .45) ( .56)
------- ------- ------- -------- ------- -------- ---------
Net asset value, end of period .... $ 9.58 $ 9.62 $ 9.52 $ 9.55 $ 9.53 $ 9.76 $ 9.92
======= ======= ======= ======== ======= ======== =========
TOTAL INVESTMENT RETURN:**
Based on net asset value per
share ............................ 5.40% 7.11% 5.91% 5.91% 1.28% 2.99% 4.75%#
======= ======= ======= ======== ======= ======== =========
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of reimbursement .... 1.18% 1.13% 1.06% 1.08% .96% .91% .87%*
======= ======= ======= ======== ======= ======== =========
Expenses .......................... 1.18% 1.13% 1.06% 1.08% .96% .91% .96%*
======= ======= ======= ======== ======= ======== =========
Investment income -- net .......... 5.70% 5.87% 5.98% 5.44% 3.69% 4.79% 6.54%*
======= ======= ======= ======== ======= ======== =========
SUPPLEMENTAL DATA:
Net assets, end of period (in
thousands) ....................... $19,193 $13,267 $12,800 $ 16,993 $23,043 $ 51,398 $ 80,411
======= ======= ======= ======== ======= ======== =========
Portfolio turnover ................ 47.55% 18.48% 25.30% 102.55% 60.38% 104.71% 94.72%
======= ======= ======= ======== ======= ======== =========
</TABLE>

- -------
* Annualized.

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

+ Commencement of Operations.

++ Based on average shares outstanding.

# 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 S&P or Aa by 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 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 S&P 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 S&P (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 S&P 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. 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."

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.

12
<PAGE>

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
S&P 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 S&P or Aa by Moody's. Any such rated
securities will be rated investment grade by S&P 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 S&P (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 S&P 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 th e time of purchase in one of the two highest rating
categories by S&P or Moody's ceases to be rated, or its rating is reduced, the
Manager will consider such factors as price, credit risk, market conditions and
interest rates to determine whether to continue to hold the securities in the
Fund's portfolio. No more than 10% of the Fund's total assets will be invested
in securities rated in the lowest category of investment grade or in comparable
unrated securities. A description of applicable ratings is contained in the
Appendix to the Statement of Additional Information.

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

13
<PAGE>

or guaranteed mortgage loans or pools of conventional mortgage loans or
participations therein. GNMA, FNMA and FHLMC "pass-through" MBSs are so-named
because they represent undivided interests in the underlying mortgage pools and
a pro rata share of both regular interest and principal payments (net of fees
assessed by GNMA, FNMA and FHLMC and any applicable loan servicing fees), as
well as unscheduled early prepayments on the underlying mortgage pool, are
passed through monthly to the holder of the MBSs (I.E., the Fund). As described
more fully below, FNMA and FHLMC also may issue types of mortgage-backed
securities other than pass-through MBSs.

Timely payment of principal and interest on GNMA MBSs is guaranteed by
GNMA, a wholly owned corporate instrumentality of the United States within the
Department of Housing and Urban Development, which guarantee is backed by the
full faith and credit of the United States. FNMA, a federally chartered and
privately owned corporation organized and existing under the Federal National
Mortgage Association Charter Act, guarantees timely payment of principal and
interest on FNMA MBSs. FHLMC, a corporate instrumentality of the United States,
guarantees (i) the timely payment of interest on all FHLMC MBSs, (ii) the
ultimate collection of principal with respect to some FHLMC MBSs, and (iii) the
timely payment of principal with respect to other FHLMC MBSs. Neither the
obligations of FNMA nor those of FHLMC are backed by the full faith and credit
of the United States. Nevertheless, because of the relationship of each such
entity to the United States, it is widely believed that MBSs issued by such
entities are high quality securities with minimal credit risk.

The SBA is an independent agency of the United States, and ABSs guaranteed
by the SBA carry a guarantee of both principal and interest. The guarantee
given by the SBA is backed by the full faith and credit of the United States.

Set forth below is a description of the mortgage and asset related
securities in which the Fund may invest. The Fund may invest in other similar
types of mortgage and asset related securities, including those which may be
developed in the future, without shareholder approval.

DESCRIPTION OF ADJUSTABLE RATE SECURITIES

As stated above, the Fund will invest primarily in Adjustable Rate
Securities. The interest paid on Adjustable Rate Securities and, therefore, the
current income earned by the Fund by investing in such securities, will be a
function primarily of the indexes upon which adjustments are based and the
applicable spread relating to such securities. Examples of indexes which may be
used are (i) one, three and five year U.S. Treasury securities adjusted to a
constant maturity index, (ii) U.S. Treasury bills of three or six months, (iii)
the daily Bank Prime Loan Rate made available by the Federal Reserve Board,
(iv) the cost of funds of member institutions for the Federal Home Loan Bank of
San Francisco ("COFI"), and (v) the offered quotations to leading banks in the
London interbank market for Eurodollar deposits of a specified duration
("LIBOR").

The interest rates paid on Adjustable Rate Securities are generally
readjusted periodically to an increment over the chosen interest rate index.
Such readjustments 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.

14
<PAGE>

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").

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

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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.

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.

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<PAGE>

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 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

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<PAGE>

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 S&P 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 S&P or
Prime-1 by Moody's. The Fund may not invest in any security issued by a
commercial bank or a savings institution unless the bank or institution is
organized and operating in the United States, has total assets of at least one
billion dollars and is a member of the Federal Deposit Insurance Corporation.

SPECIAL CONSIDERATIONS AND RISK FACTORS

The types of securities in which the Fund invests have certain unique
attributes that warrant special consideration or that present risks that may
not exist in other types of mutual fund investments. Some of these
considerations and risks pertain to the characteristics of MBSs or ABSs
generally, while others are peculiar to Adjustable Rate Securities. One of the
principal risks regarding MBSs and, to a lesser extent, ABSs is the risk of
prepayments. From time to time, prepayment rates on MBSs have been high. The
rate of principal prepayments on MBSs will depend on the rates of principal
payments on the related mortgages. In general, when prevailing mortgage
interest rates decline significantly below the interest rates on the mortgages,
the prepayment rate on the mortgages is likely to increase, although a number
of other factors may also influence the prepayment rate, such as the
acceleration of mortgage payments due to transfers of mortgaged properties,
liquidations due to default and refinancings of existing loans. No assurance
can be given as to the rate and timing of principal prepayments on mortgage
loans underlying MBSs. High prepayment rates may have an adverse effect on the
value of MBS securities and in particular SMBSs, such as IOs.

Payments of principal of and interest on MBSs and ABSs are made more
frequently than are payments on conventional debt securities. In addition,
holders of MBSs and of certain ABSs (such as ABSs backed by home equity loans)
may receive unscheduled payments of principal at any time representing
prepayments on the underlying mortgage loans or financial assets. Such
prepayments may usually be made by the related obligor without penalty.
Prepayment rates are affected by changes in prevailing interest rates and
numerous other economic, geographic, social and other factors. (ABSs backed by
other than home equity loans do not generally prepay in response to changes in
interest rates, but may be subject to prepayments in response to other
factors.) Changes in the rate of prepayments will generally affect the yield to
maturity of the security. Moreover, when the holder of the security attempts to
reinvest prepayments or even the scheduled payments of principal and interest,
it may receive a rate of interest which is higher or lower than the rate on the
MBS or ABS originally held. Another consideration is that to the extent that
MBSs or ABSs are purchased at a premium, mortgage foreclosures and principal
prepayments may result in loss to the extent of premium paid. On the other
hand, where such securities are bought at a discount,

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<PAGE>

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 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 could 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.

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<PAGE>

PORTFOLIO STRATEGIES INVOLVING INTEREST RATE TRANSACTIONS, OPTIONS AND FUTURES

The Fund may engage in various portfolio strategies to seek to increase
its return through the use of options on portfolio securities and to hedge its
portfolio against movements in interest rates. The Fund has authority to engage
in interest rate transactions in order to hedge against interest rate
movements, purchase call and put options on securities, write (I.E., sell)
covered call and put options on its portfolio securities, and engage in hedging
transactions in financial futures, and related options on such futures. Each of
these portfolio strategies is described below.

Although certain risks are involved in interest rate, options and futures
transactions, the Manager believes that, because the Fund will (i) write only
covered options on portfolio securities, and (ii) engage in other transactions
only for hedging purposes, these portfolio strategies will not subject the Fund
to the risks frequently associated with the speculative use of such
transactions. While the Fund's use of hedging strategies is intended to reduce
the volatility of the net asset value of Fund shares, the Fund's net asset
value will fluctuate. There can be no assurance that the Fund's hedging
transactions will be effective. Furthermore, the Fund will only engage in
hedging activities from time to time and may not necessarily be engaging in
hedging activities when movements in interest rates occur. Reference is made to
the Statement of Additional Information for further information concerning
these strategies.

INTEREST RATE HEDGING TRANSACTIONS. In order to hedge the value of the
Fund's portfolio against interest rate fluctuations, the Fund may enter into
various hedging transactions, such as interest rate swaps and the purchase or
sale of interest rate caps and floors. The Fund expects to enter into these
transactions primarily to preserve a return or spread on a particular
investment or portion of its portfolio or to protect against any increase in
the price of securities the Fund anticipates purchasing at a later date. The
Fund intends to use these transactions as a hedge and not as a speculative
investment.

The purchase of an interest rate cap entitles the purchaser, to the extent
that a specified index exceeds a predetermined interest rate, to receive
payments of interest on a notional principal amount from the party selling such
interest rate cap. The purchase of an interest rate floor entitles the
purchaser, to the extent that a specified index falls below a predetermined
interest rate, to receive payments of interest on a notional principal amount
from the party selling such interest rate floor.

In an interest rate swap the Fund exchanges with another party their
respective commitments to pay or receive interest, E.G., an exchange of
floating rate payments for fixed rate payments. The net amount of the excess,
if any, of the Fund's obligations over its entitlement with respect to each
interest rate swap will be accrued on a daily basis and an amount of cash, cash
equivalents or high grade liquid debt securities having an aggregate net asset
value at least equal to the accrued excess will be maintained in a segregated
account by the Fund's custodian.

The Fund will not enter into any interest rate swap, cap or floor
transaction unless the unsecured senior debt or the claims-paying ability of
the other party thereto is rated in one of the highest two rating categories of
at least one nationally recognized statistical rating organization at the time
of entering into such transaction or whose creditworthiness is believed by the
Manager to be equivalent to such rating. If there is a default by the other
party to such a transaction, the Fund will have contractual remedies pursuant
to the agreements related to the transaction. The Manager believes that the
swap market is relatively liquid. Caps and floors, however, are less liquid
than swaps. The Fund will not enter into a cap or floor transaction in an
amount which, together with other illiquid investments of the Fund, exceeds 15%
of the Fund's total assets.

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<PAGE>

CALL OPTIONS ON PORTFOLIO SECURITIES. The Fund may purchase call options
on any of the types of securities in which it may invest. A purchased call
option gives the Fund the right to buy, and obligates the seller to sell, the
underlying security at the exercise price at any time during the option period.
The Fund also is authorized to write (I.E., sell) covered call options on the
securities in which it may invest and to enter into closing purchase
transactions with respect to certain of such options. A covered call option is
an option where the Fund, in return for a premium, gives another party a right
to buy specified securities owned by the Fund at a specified future date and
price set at the time of the contract. The principal reason for writing call
options is to attempt to realize, through the receipt of premiums, a greater
return than would be realized on the securities alone. By writing covered call
options, the Fund gives up the opportunity, while the option is in effect, to
profit from any price increase in the underlying security above the option
exercise price. In addition, the Fund's ability to sell the underlying security
will be limited while the option is in effect unless the Fund effects a closing
purchase transaction. A closing purchase transaction cancels out the Fund's
position as the writer of an option by means of an offsetting purchase of an
identical option prior to the expiration of the option it has written. Covered
call options also serve as a partial hedge against the price of the underlying
security declining.

PUT OPTIONS ON PORTFOLIO SECURITIES. The Fund is authorized to purchase
put options to hedge against a decline in the value of its securities. By
buying a put option the Fund has a right to sell the underlying security at the
exercise price, thus limiting the Fund's risk of loss through a decline in the
market value of the security until the put option expires. The amount of any
appreciation in the value of the underlying security will be partially offset
by the amount of the premium paid for the put option and any related
transaction costs. Prior to its expiration, a put option may be sold in a
closing sale transaction and profit or loss from the sale will depend on
whether the amount received is more or less than the premium paid for the put
option plus the related transaction costs. A closing sale transaction cancels
out the Fund's position as the purchaser of an option by means of an offsetting
sale of an identical option prior to the expiration of the option it has
purchased. The Fund also has authority to write (I.E., sell) put options on the
types of securities which may be held by the Fund, provided that 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

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<PAGE>

exposure that may in part or entirely offset an increase in the cost of
securities it intends to purchase. It is anticipated that, in a substantial
majority of these transactions, the Fund will purchase securities upon
termination of the futures contract.

The Fund also has authority to purchase and write call and put options on
futures contracts in connection with its hedging activities. Generally, these
strategies are utilized under the same market and market sector conditions
(I.E., conditions relating to specific types of investments) in which the Fund
enters into futures transactions. The Fund may purchase put options or write
call options on futures contracts rather than selling the underlying futures
contract in anticipation of a decrease in the market value of a security or an
increase in interest rates. Similarly, the Fund may purchase call options, or
write put options on futures contracts, as a substitute for the purchase of
such futures to hedge against the increased cost resulting from an increase in
the market value or a decline in interest rates of securities which the Fund
intends to purchase.

The Fund may engage in options and futures transactions on exchanges and
options in the over-the-counter markets ("OTC options"). In general,
exchange-traded contracts are third-party contracts (I.E., performance of the
parties' obligations is guaranteed by an exchange or clearing corporation) with
standardized strike prices and expiration dates. OTC options transactions are
two-party contracts with price and terms negotiated by the buyer and seller.
See "Restrictions on OTC Options" below for information as to restrictions on
the use of OTC options.

RESTRICTIONS ON THE USE OF FUTURES TRANSACTIONS. Regulations of the
Commodity Futures Trading Commission ("CFTC") applicable to the Fund provide
that the futures trading activities described herein will not result in the
Fund being deemed a "commodity pool," as defined under such regulations if the
Fund adheres to certain restrictions. In particular, the Fund may purchase and
sell futures contracts and options thereon (i) for bona fide hedging purposes,
and (ii) for non-hedging purposes, if the aggregate initial margin and premiums
required to establish positions in such contracts and options does not exceed
5% of the liquidation value of the Fund's portfolio, after taking into account
unrealized profits and unrealized losses on any such contracts and options.

When the Fund purchases a futures contract or writes a put option or
purchases a call option thereon, an amount of cash and cash equivalents will be
deposited in a segregated account with the Fund's custodian so that the amount
so segregated, plus the amount of variation margin held in the account of its
broker, equals the market value of the futures contract, thereby ensuring that
the use of such futures is unleveraged.

An order has been obtained from the 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 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.

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<PAGE>

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 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

23
<PAGE>

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 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 m oney 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

24
<PAGE>

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 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
determin ed 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.

25
<PAGE>

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* -- Chairman of the Manager and its affiliate FAM; Chairman
and Director of Princeton Services, Inc. ("Princeton Services"); Executive Vice
President of ML & Co.

JOE GRILLS -- Member of the Committee of Investment of Employee Benefit
Assets of the Financial Executives Institute ("CIEBA"); Member of CIEBA's
Executive Committee; Assistant Treasurer of International Business Machines
Incorporated ("IBM") and Chief Investment Officer of IBM Retirement Funds;
Member of the Investment Advisory Committees of the State of New York Common
Retirement Fund, the Howard Hughes Medical Institute and the Virginia
Retirement System; Director and Vice Chairman, Duke Management Company;
Director, LaSalle Street Fund and Kimco Realty Corporation; Director of
Hotchkis and Wiley Mutual Funds.

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 Advisors (investment adviser);
Principal of Fernwood Associates (financial consultant).

- --------
* Interested person, as defined by the Investment Company Act, of the Fund.

MANAGEMENT AND ADVISORY ARRANGEMENTS

The Manager, which is owned and controlled by ML & Co., a financial
services holding company, acts as the investment adviser for the Fund and
provides the Fund with management and investment advisory services. The Asset
Management Group of ML & Co. (which includes the Manager) acts as the investment
adviser to more than 100 registered investment companies, and offers portfolio
management services to individual and institutional accounts. As of July 1998,
the Asset Management Group had a total of approximately $487.6 billion in
investment company and other portfolio assets under management. This amount
includes assets managed for certain affiliates of the Manager.

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, 1998, the fee paid by the Fund to the Manager was
$593,905 (based on average daily net assets of approximately $119.1 million).
The Management Agreement

26
<PAGE>

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, 1998, the amount of such
reimbursement was $102,693. For the fiscal year ended May 31, 1998, the ratio
of total expenses to average net assets was 0.92%, 1.70%, 1.74% and 1.18% for
Class A, Class B, Class C and Class D shares, respectively.

Gregory Mark Maunz, Senior Vice President of the Fund, is primarily
responsible for the day-to-day management of the Fund's portfolio. Mr. Maunz
has been a First Vice President of the Manager since 1997, Vice President
thereof since 1985 and a Portfolio Manager thereof 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 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

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 Transfer Agent receives an annual fee of up to $14.00 per Class A or Class
D account and up to $11.00 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, 1998, the total fee paid by the Fund to
the Transfer Agent was $127,287.

27
<PAGE>

PURCHASE OF SHARES

The Distributor, an affiliate of both the Manager and Merrill Lynch,
Pierce, Fenner & Smith Incorporated ("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 shareholders who are participants in a
Mutual Funds Adviser ("MFA") Program administered by Merrill Lynch, the minimum
initial purchase is $250.

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 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

28
<PAGE>

value of any other class or have any impact on investors choosing another sales
charge option. 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. 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 CDSCs 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.

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 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 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 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 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. Certain 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 0.75%
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 and certain fee-based
programs were 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.

29
<PAGE>

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>

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

** The initial sales charge may be waived on certain 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, 1998, the Fund sold 771,140 Class A
shares for aggregate net proceeds to the Fund of $7,441,376. 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, 1998, the Fund sold
1,464,082 Class D shares for aggregate net proceeds to the Fund of $14,083,453.
The gross sales charges for the sale of Class D shares of the Fund for that
period were $14,227, of which $1,219 and $13,008 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

30
<PAGE>

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 TMASM 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 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 AccessSM 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. Class D shares are offered with
reduced sales charges and, in certain circumstances, at net asset value to
participants in the Merrill Lynch BlueprintSM Program.

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

31
<PAGE>

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.

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 dealers' 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. 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.

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<PAGE>

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, 1998, the Distributor received CDSCs
of $111,552 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.

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 certain
circumstances 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
AccessSM 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 AccessSM 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."

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<PAGE>

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, 1998, the Distributor
received CDSCs of $7,199 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 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. See "Shareholder Services --
Exchange Privilege" in the Statement of Additional Information.

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

34
<PAGE>

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."

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, 1998, the Fund paid the Distributor
$698,910 pursuant to the Class B Distribution Plan (based on average daily net
assets subject to such Class B Distribution Plan of approximately $93.4
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, 1998, the Fund paid the
Distributor $43,254 pursuant to the Class C Distribution Plan (based on average
daily net assets subject to such Class C Distribution Plan of approximately
$5.4 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, 1998, the Fund paid the
Distributor $48,385 pursuant to the Class D Distribution Plan (based on average
daily net assets subject to such Class D Distribution Plan of approximately
$19.4 million), all of which was paid to Merrill Lynch for providing account
maintenance activities in connection with Class D shares.

35
<PAGE>

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

As of December 31, 1997, with respect to Class B shares, the fully
allocated accrual expenses incurred by the Distributor and Merrill Lynch for the
period since August 2, 1991 (commencement of operations) exceeded fully
allocated accrual revenues by approximately $659,000 (0.73% of Class B net
assets at that date). As of May 31, 1998, for Class B shares, direct cash
revenues for the period since August 2, 1991 (commencement of operations)
exceeded direct cash expenses by $15,753,123 (18.51% of Class B net assets at
that date). As of December 31, 1997, with respect to Class C shares, the fully
allocated accrual expenses incurred by the Distributor and Merrill Lynch for the
period since October 21, 1994 (commencement of operations) exceeded fully
allocated accrual revenues by approximately $27,000 (0.45% of Class C net assets
at that date). As of May 31, 1998, for Class C shares, direct cash revenues for
the period since October 21, 1994 (commencement of operations) exceeded direct
cash expenses by $81,474 (1.84% 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 a mount payable to the Distributor (referred to as the "voluntary
maximum") in connection with

36
<PAGE>
the Class B shares is 6.75% of eligible gross sales. The Distributor retains the
right to stop waiving interest charges at any time. To the extent payments would
exceed the voluntary maximum, the Fund will not make further payments of the
distribution fee with respect to the Class B shares and any CDSCs will be paid
to the Fund rather than to the Distributor; however, the Fund will continue to
make payments of the account maintenance fee. In certain circumstances the
amount payable pursuant to the voluntary maximum may exceed the amount payable
under the NASD formula. In such circumstances payment in excess of the amount
payable under the NASD formula will not be made.

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, without charge, 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.

37
<PAGE>

REPURCHASE
The Fund will also repurchase shares through a shareholder's listed
securities dealer. The Fund will normally accept orders to repurchase shares by
wire or telephone from dealers for their customers at the net asset value next
computed after receipt of the order by the dealer, provided that the request
for repurchase is received by the dealer prior to the close of business on the
NYSE (generally, 4:00 P.M., New York time) on the day received and such request
is received by the Fund from such dealer not later than 30 minutes after the
close of business on the NYSE on the same day. Dealers have the responsibility
of submitting such repurchase 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 transaction other than automatic investment purchases and the
reinvestments of ordinary income dividends and long-term capital gain

38
<PAGE>

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.

39
<PAGE>

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.

Effective on or about October 12, 1998, Class A and Class D shares also
will be exchangeable for Class A shares of, and Class B and Class C shares also
will be exchangeable for Class B shares of, Summit Cash Reserves Fund, a series
of Financial Institutions Series Trust, which is a Merrill Lynch-sponsored money
market fund specifically designated as available for exchange by holders of
Class A, Class B, Class C and Class D shares. Class A shares of Summit Cash
Reserves Fund have an exchange privilege back into Class A or Class D shares of
MLAM-advised funds; Class B shares of Summit Cash Reserves Fund have an exchange
privilege back into Class B or Class C shares of MLAM-advised funds. The period
of time that Class B shares of Summit Cash Reserves Fund are held will count
toward satisfaction of the holding period requirement for purposes of reducing
any CDSC and, with respect to Class B shares, toward satisfaction of any
Conversion Period. Class B shares of Summit Cash Reserves Fund will be subject
to a distribution fee at an annual rate of 0.75% of average daily net assets of
such Class B shares.

The exchange privilege described above does not apply with respect to
certain Merrill Lynch fee-based programs, for which alternative exchange
arrangements may exist. Please see your Merrill Lynch Financial Consultant for
further information.

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 by telephone (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 (provided that, in the event that a payment on an
account maintained at the Transfer Agent would amount to $10.00 or less, a
shareholder will not receive such payment

40
<PAGE>

in cash and such payment will automatically be reinvested in additional shares).
The Fund is not responsible for any failure of delivery to the shareholder's
address of record and no interest will accrue on amounts represented by uncashed
distribution or redemption checks. 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 distributions.

SYSTEMATIC WITHDRAWAL PLANS

A Class A or Class D shareholder may elect to receive systematic withdrawal
payments from his or her Investment Account in the form of payments by check or
through automatic payment by direct deposit to the investor's bank account on
either a monthly or quarterly basis. A Class A or Class D shareholder whose
shares are held within a CMA(R), CBA(R) or Retirement Account may elect to have
shares redeemed on a monthly, bimonthly, quarterly, semiannual or annual basis
through the CMA(R) or CBA(R) Systematic Redemption Program, subject to certain
conditions. With respect to redemptions of Class B and Class C shares pursuant
to a systematic withdrawal plan, the maximum number of Class B or Class C shares
that can be redeemed from an account annually shall not exceed 10% of the value
of shares of such class in that account at the time the election to join the
systematic withdrawal plan was made. Any CDSC that otherwise might be due on
such redemption of Class B or Class C shares will be waived. Shares redeemed
pursuant to a systematic withdrawal plan will be redeemed in the same order as
Class B or Class C shares are otherwise redeemed. See "Purchase of Shares --
Deferred Sales Charge Alternatives -- Class B and Class C Shares -- Contingent
Deferred Sales Charges -- Class B Shares" and " -- Contingent Deferred Sales
Charges -- Class C Shares." Where the systematic withdrawal plan is applied to
Class B shares, upon conversion of the last Class B shares in an account to
Class D shares, the systematic withdrawal plan will automatically be applied
thereafter to Class D shares. See "Purchase of Shares -- Deferred Sales Charge
Alternatives -- Class B and Class C Shares -- Conversion of Class B Shares to
Class D Shares."

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

41
<PAGE>

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 the Transfer Agent 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. Any loss upon the
sale or exchange of Fund shares held for six months or less will be treated as
long-term capital loss to the extent of any capital gain dividends received by
the shareholder. Distributions in excess of the Fund's earnings and profits
will first reduce the adjusted tax basis of a holder's shares and, after such
adjusted tax basis is reduced to zero, will constitute capital gains to such
holder (assuming the shares are held as a capital asset). Recent legislation
created additional categories of capital gains taxable at different rates.
Additional legislation eliminates the highest 28% category for most sales of
capital assets occurring after December 31, 1997. Generally 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, as well as the amount of capital
gain dividends in the different categories of capital gain referred to above.

Dividends are taxable to shareholders even though they are reinvested in
additional shares of the Fund. 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.

42
<PAGE>
subject to backup withholding will be those for whom no certified taxpayer
identification number is on file with the Fund or who, to the Fund's knowledge,
have furnished an incorrect number. When establishing an account, an investor
must certify under penalty of perjury that such number is correct and that the
investor is not otherwise subject to backup withholding.

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

If a shareholder exercises an exchange privilege within 90 days of
acquiring the shares, then the loss the shareholder can recognize on the
exchange will be reduced (or the gain increased) to the extent any sales charge
paid to the Fund on the exchanged shares reduces any sales charge the
shareholder would have owed upon the purchase of the new shares in the absence
of the exchange privilege. Instead, such sales charge will be treated as an
amount paid for the new shares.

A loss realized on a sale or exchange of shares of the Fund will be
disallowed if other Fund shares are acquired (whether through the automatic
reinvestment of dividends or otherwise) within a 61-day period beginning 30
days before and ending 30 days after the date that the shares are disposed of.
In such a case, the basis of the shares acquired will be adjusted to reflect
the disallowed loss.

The Fund may make investments that produce taxable income that is not
matched by a corresponding receipt of cash or an offsetting loss deduction. Such
investments would include dollar rolls and obligations that have original issue
discount (such as SMBSs) that 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.

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

43
<PAGE>
return and yield are computed separately for Class A, Class B, Class C and Class
D shares in accordance with formulas specified by the Commission.

Average annual total return quotations for the specified period will be
computed by finding the average annual compounded rates of return (based on net
investment income and any realized and unrealized capital gains or losses on
portfolio investments over such periods) that would equate the initial amount
invested to the redeemable value of such investment at the end of each period.
Average annual total return will be computed assuming all dividends and
distributions are reinvested and taking into account all applicable recurring
and nonrecurring expenses, including any CDSC that would be applicable to a
complete redemption of the investment at the end of the specified period in the
case of Class B shares and Class C shares and the maximum sales charge in the
case of Class A shares and Class D shares. Dividends paid by the Fund with
respect to all shares to the extent any dividends are paid, will be calculated
in the same manner at the same time on the same day and will be in the same
amount, except that account maintenance fees, distribution charges and any
incremental transfer agency costs relating to each class of shares will be borne
exclusively by that class. The Fund will include performance data for all
classes of shares of the Fund in any advertisement or information including
performance data of the Fund.

The Fund also may quote total return and aggregate total return
performance data for various specified time periods. Such data will be
calculated substantially as described above, except that (1) the rates of
return calculated will not be average annual rates, but rather, actual annual,
annualized or aggregate rates of return and (2) the maximum applicable sales
charges will not be included with respect to annual or annualized rates of
return calculations. Aside from the effect on the performance data calculations
of including or excluding the maximum applicable sales charges, 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, 1998 was 5.23%, 4.67%, 4.63%
and 4.98% 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.

44
<PAGE>

On occasion, the Fund may compare its performance to that of the Standard &
Poor's 500 Composite Stock Index, the Dow Jones Industrial Average, other market
indices or performance data published by Lipper Analytical Services, Inc.,
Morningstar Publications, Inc., MONEY MAGAZINE, U.S. NEWS AND WORLD REPORT,
BUSINESS WEEK, CDA INVESTMENT TECHNOLOGY, INC., FORBES MAGAZINE, FORTUNE
MAGAZINE, or other industry publications. When comparing its performance to a
market index, the Fund may refer to various statistical measures derived from
the historical performances of the Fund and the index, such as standard
deviation and beta. In addition from time to time the Fund may include its risk
adjusted performance ratings assigned by Morningstar Publications, Inc., in
advertising or supplemental sales literature. As with other performance data,
performance comparisons should not be considered indicative of the Fund's
relative performance for any future period.

PORTFOLIO TRANSACTIONS

The Fund has no obligation to deal with any dealer or group of dealers in
the execution of transactions in portfolio securities of the Fund. The
securities in which the Fund invests are normally purchased directly from the
issuer or from an underwriter or dealer in such securities. Where possible, the
Fund deals directly with the dealers who make a market in the securities
involved except in those circumstances where better prices and execution are
available elsewhere. It is the policy of the Fund to obtain the best net
results in conducting portfolio transactions, taking into account such factors
as price (including the applicable dealer spread), the size, type and
difficulty of the transactions involved, the firm's general execution and
operations facilities, and the firm's risk in positioning the securities
involved and the provision of supplemental investment research by the firm.
While reasonably competitive spreads or commissions are sought, the Fund will
not necessarily be paying the lowest spread or commission available. The
portfolio securities of the Fund generally are traded on a net basis and
normally do not involve either brokerage commissions or transfer taxes. The
cost of portfolio securities transactions of the Fund primarily consists of
dealer or underwriter spreads. Under the 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 or in a private
placement in which Merrill Lynch serves as a placement agent except pursuant to
procedures approved by the Directors of the Fund which either comply with rules
adopted by the Commission or with interpretations of Commission staff.
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, 1998, the Fund's portfolio turnover rate was
47.55%. (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.

45
<PAGE>

ADDITIONAL INFORMATION

DIVIDENDS AND DISTRIBUTIONS

The per share dividends and distributions on each class of shares will be
reduced as a result of any account maintenance, distribution and higher transfer
agency fees applicable with respect to that class. See "Determination of Net
Asset Value" below. Dividends and distributions may be reinvested automatically
in shares of the Fund at net asset value. Shareholders may elect in writing to
receive any such dividends or distributions, or both, in cash (provided that, in
the event that a payment on an account maintained at the Transfer Agent would
amount to $10.00 or less, a shareholder will not receive such payment in cash
and such payment will automatically be reinvested in additional shares).
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 tax requirements that
certain percentages of its ordinary income and capital gains be distributed
during the 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 market values 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, 1998, the Fund paid $1,404 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

46
<PAGE>
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.

YEAR 2000 ISSUES

Many computer systems were designed using only two digits to designate
years. These systems may not be able to distinguish the Year 2000 from the Year
1900 (commonly known as the "Year 2000 Problem"). Like other investment
companies and financial and business organizations, the Fund could be adversely
affected if the computer systems used by the Manager or other Fund service
providers do not properly address this problem prior to January 1, 2000. The
Manager has established a dedicated group to analyze these issues and to
implement any systems modifications necessary to prepare for the Year 2000.
Currently, the Manager does not anticipate that the transition to the Year 2000
will have any material impact on its ability to continue to service the Fund at
current levels. In addition, the Manager has sought assurances from the Fund's
other service providers that they are taking all necessary steps to ensure that
their computer systems will accurately reflect the Year 2000, and the Manager
will continue to monitor the situation. At this time, however, no assurance can
be given that the Fund's other service providers have anticipated every step
necessary to avoid any adverse effect on the Fund attributable to the Year 2000
Problem.

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."

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.

47
<PAGE>
SHAREHOLDER REPORTS

Only one copy of each shareholder report and certain shareholder
communications will be mailed to each identified shareholder regardless of the
number of accounts such shareholder has. If a shareholder wishes to receive
separate copies of each report and communication for each of the shareholder's
related accounts the shareholder should notify in writing:

Financial Data Services, Inc.
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 Financial
Data Services, Inc. at 800-637-3863.

48
<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
BLUEPRINTSM 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 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................................................................ ..
(Zip Code)
Date................................................................... ..

Occupation............................ Name and Address of Employer............
........................................
........................................
........................................
Signature of Co-Owner (if any)
.......................................
Signature of Owner

(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 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 CLASS 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 the
Merrill Lynch Funds Distributor 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, 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 Co-Owner Signature of 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

[ ]

This form when completed should be mailed to:

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

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

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

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

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

[ ][ ][ ] [ ][ ][ ][ ][ ]
Dealer's Customer A/C No.

A-2
<PAGE>

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

NOTE: THIS FORM IS REQUIRED TO APPLY FOR THE SYSTEMATIC WITHDRAWAL PLAN OR THE
AUTOMATIC INVESTMENT 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 -- (SEE TERMS AND CONDITIONS IN THE STATEMENT OF
ADDITIONAL INFORMATION)

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

SPECIFY THE AMOUNT OF THE WITHDRAWAL YOU WOULD LIKE PAID TO YOU (CHECK ONE): [ ]
$------ or [ ]---- % of the current value of [ ] Class A, [ ] Class B*, [ ]
Class C* 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 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.
*ANNUAL WITHDRAWAL CANNOT EXCEED 10% OF THE VALUE OF SHARES OF SUCH CLASS HELD
IN THE ACCOUNT AT THE TIME THE ELECTION TO JOIN THE SYSTEMATIC WITHDRAWAL PLAN
IS MADE.

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 Financial Data Services, Inc. draw an automated clearing
house ("ACH") debit on my checking account as 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.

FINANCIAL DATA SERVICES, INC.

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

Amount of each ACH debit $................................................
Account Number............................................................
Please date and invest ACH debits on the 20th of each month beginning
- ---------- or as soon as possible thereafter.
(month}

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

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

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

AUTHORIZATION TO HONOR ACH DEBITS
DRAWN BY FINANCIAL DATA
SERVICES, INC.
To...........................................................Bank
(Investor's Bank)

Bank Address.....................................................
City ...........................State............Zip Code........

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

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

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

[This page intentionally left blank.]
<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

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

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 PricingSM 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 ............ 18
Portfolio Strategies Involving Interest Rate
Transactions, Options and Futures ............... 20
Other Investment Policies and Practices ............ 23
Management of the Fund ............................... 26
Directors .......................................... 26
Management and Advisory Arrangements ............... 26
Code of Ethics ..................................... 27
Transfer Agency Services ........................... 27
Purchase of Shares ................................... 28
Initial Sales Charge Alternatives -- Class A and
Class D Shares .................................. 30
Deferred Sales Charge Alternatives -- Class B and
Class C Shares .................................. 31
Distribution Plans ................................. 35
Limitations on the Payment of Deferred Sales
Charges ......................................... 36
Redemption of Shares ................................. 37
Redemption ......................................... 37
Repurchase ......................................... 38
Reinstatement Privilege -- Class A and Class D
Shares .......................................... 38
Shareholder Services ................................. 38
Investment Account ................................. 38
Exchange Privilege ................................. 39
Automatic Reinvestment of Dividends and Capital
Gains Distributions ............................. 40
Systematic Withdrawal Plans ........................ 41
Automatic Investment Plans ......................... 41
Fee-Based Programs ................................. 41
Taxes ................................................ 42
Performance Data ..................................... 43
Portfolio Transactions ............................... 45
Portfolio Turnover ................................. 45
Additional Information ............................... 46
Dividends and Distributions ........................ 46
Determination of Net Asset Value ................... 46
Year 2000 Issues ................................... 47
Organization of the Fund ........................... 47
Shareholder Inquiries .............................. 47
Shareholder Reports ................................ 48
Authorization Form ................................... A-1
</TABLE>

Code #13937-0898

MERRILL LYNCH
ADJUSTABLE RATE
SECURITIES FUND, INC.

PROSPECTUS

August 28, 1998

Distributor:
Merrill Lynch
Funds Distributor

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
28, 1998 (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 -- Distributor

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

The date of this Statement of Additional Information is August 28, 1998

<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 ("S&P") 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 S&P 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 S&P
(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 S&P 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 S&P or Aa by Moody's or, if
unrated, which are of comparable quality as determined by Merrill Lynch Asset
Management, L.P. (the "Manager"). As further indicated in the Prospectus, such
a rating may be based, in part, on certain credit enhancements. These credit
enhancements may offer two types of protection: (i) liquidity protection, and
(ii) protection against losses resulting from ultimate default by an obligor
and the underlying assets. Liquidity protection refers to the provision of
advances, generally by the entity administering the pool of assets, to ensure
that the receipt of payments on the underlying pool occurs in a timely fashion.
Protection against losses resulting from ultimate default ensures ultimate
payment of the obligations on at least a portion of the assets in the pool.
Such protection may be provided through guarantees, insurance policies or
letters of credit obtained by the issuer or sponsor from third parties, through

2
<PAGE>

various means of structuring the transaction or through a combination of such
approaches. The Fund will not pay any additional fees for such credit support,
although the existence of credit support may increase the price of a security.

Credit enhancements can come from external providers such as banks or
financial insurance companies. Alternatively, they may come from the structure
of a transaction itself. Examples of credit support arising out of the
structure of the transaction include "senior-subordinated securities" (multiple
class securities with one or more classes subordinate to other classes as to
the payment of principal thereof and interest thereon, with the result that
defaults on the underlying assets are borne first by the holders of the
subordinated class), creation of "reserve funds" (where cash or investments,
sometimes funded from a portion of the payments on the underlying assets, are
held in reserve against future losses) and "overcollateralization" (where the
scheduled payments on, or the principal amount of, the underlying assets
exceeds that required to make payment of the securities and pay any servicing
or other fees). The degree of credit support provided for each issue is
generally based on historical information respecting the level of credit risk
associated with the underlying assets. Delinquencies or losses in excess of
those anticipated could adversely affect the return on an investment in such
issue. In addition, the Fund may purchase subordinated securities which, as
noted above, may serve as a form of credit support for senior securities
purchased by other investors.

UNITED STATES GOVERNMENT AGENCIES OR INSTRUMENTALITIES

As indicated in the Prospectus, at the present time, the majority of MBSs
in which the Fund may invest are either guaranteed by the Government National
Mortgage Association ("GNMA"), or issued by the Federal National Mortgage
Association ("FNMA") or the Federal Home Loan Mortgage Corporation ("FHLMC").
In addition, the Fund may invest in ABSs guaranteed by the U.S. Small Business
Administration. See "Investment Objective and Policies" in the Prospectus. Set
forth below is a more detailed description of those agencies and
instrumentalities, together with a description of the types of assets typically
comprising the pools underlying the securities of those entities.

GOVERNMENT NATIONAL MORTGAGE ASSOCIATION. GNMA is a wholly-owned corporate
instrumentality of the United States within the Department of Housing and Urban
Development. The National Housing Act of 1934, as amended (the "Housing Act"),
authorizes GNMA to guarantee the timely payment of the principal of and
interest on securities that are based on and backed by a pool of specified
mortgage loans. To qualify such securities for a GNMA guarantee, the underlying
mortgages must be insured by the Federal Housing Administration under the
Housing Act, or Title V of the Housing Act of 1949 ("FHA Loans"), or be
guaranteed by the Veterans' Administration under the Servicemen's Readjustment
Act of 1944, as amended ("VA Loans"), or be pools of other eligible mortgage
loans. The Housing Act provides that the full faith and credit of the United
States Government is pledged to the payment of all amounts that may be required
to be paid under any guarantee. In order to meet its obligations under such
guarantee, GNMA is authorized to borrow from the United States Treasury with no
limitations as to amount.

GNMA pass-through MBSs may represent a pro rata interest in one or more
pools of the following types of mortgage loans: (i) fixed rate level payment
mortgage loans; (ii) fixed rate graduated payment mortgage loans; (iii) fixed
rate growing equity mortgage loans; (iv) fixed rate mortgage loans secured by
manufactured (mobile) homes; (v) mortgage loans on multifamily residential
properties under construction; (vi) mortgage loans on completed multifamily
projects; (vii) fixed rate mortgage loans as to which escrowed funds are used
to reduce the borrower's monthly payments during the early years of the
mortgage loans ("buydown" 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.

3
<PAGE>

FEDERAL NATIONAL MORTGAGE ASSOCIATION. FNMA is a federally chartered and
privately owned corporation established under the Federal National Mortgage
Association Charter Act. FNMA was originally organized in 1938 as a United
States Government agency to add greater liquidity to the mortgage market. FNMA
was transformed into a private sector corporation by legislation enacted in
1968. FNMA provides funds to the mortgage market primarily by purchasing home
mortgage loans from local lenders, thereby providing them with funds for
additional lending. FNMA acquires funds to purchase such loans from investors
that may not ordinarily invest in mortgage loans directly, thereby expanding
the total amount of funds available for housing.

Each FNMA pass-through MBS represents a pro rata interest in one or more
pools of FHA Loans, VA Loans or conventional mortgage loans (I.E., mortgage
loans that are not insured or guaranteed by any governmental agency). The loans
contained in those pools consist of: (i) fixed rate level payment mortgage
loans; (ii) fixed rate growing equity mortgage loans; (iii) fixed rate
graduated payment mortgage loans; (iv) variable rate mortgage loans; (v) other
adjustable rate mortgage loans; and (vi) fixed rate mortgage loans secured by
multifamily projects.

FEDERAL HOME LOAN MORTGAGE CORPORATION. FHLMC is a corporate
instrumentality of the United States established by the Emergency Home Finance
Act of 1970, as amended (the "FHLMC Act"). FHLMC was organized primarily for
the purpose of increasing the availability of mortgage credit to finance needed
housing. The operations of FHLMC currently consist primarily of the purchase of
first lien, conventional, residential mortgage loans and participation
interests in such mortgage loans and the resale of the mortgage loans so
purchased in the form of mortgage-backed securities.

The mortgage loans underlying the FHLMC MBSs typically consist of fixed
rate or adjustable rate mortgage loans with original terms to maturity of
between ten and thirty years, substantially all of which are secured by first
liens on one- to four-family residential properties or multifamily projects.
Each mortgage loan must meet the applicable standards set forth in the FHLMC
Act. Mortgage loans underlying FHLMC MBSs may include whole loans,
participation interests in whole loans and undivided interests in whole loans
and participations in another FHLMC MBS.

U.S. SMALL BUSINESS ADMINISTRATION. The U.S. Small Business Administration
(the "SBA") is an independent agency of the United States established by the
Small Business Act of 1953. The SBA was organized primarily to assist
independently owned and operated businesses that are not dominant in their
respective markets. The SBA provides financial assistance, management
counseling and training for small businesses, as well as acting generally as an
advocate of small businesses.

The SBA guarantees the payment of principal and interest on portions of
loans made by private lenders to certain small businesses. The loans are
generally commercial loans such as working capital loans and equipment loans.
The SBA is authorized to issue from time to time, through its fiscal and
transfer agent, SBA-guaranteed participation certificates evidencing fractional
undivided interests in pools of these SBA-guaranteed portions of loans made by
private lenders. The SBA's guarantee of such certificates, and its guarantee of
a portion of the underlying loan, are backed by the full faith and credit of
the United States.

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

4
<PAGE>

(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.

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

5
<PAGE>

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 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

6
<PAGE>

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 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.

7
<PAGE>

Options referred to herein and in the Fund's Prospectus may be options
issued by The Options Clearing Corporation (the "Clearing Corporation") which
are currently traded on the Chicago Board Options Exchange, 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" (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.

8
<PAGE>

FUTURES AND FINANCIAL FUTURES. As described in the Prospectus, the Fund is
authorized to engage in transactions in financial futures, and related options
on such futures. Set forth below is further information concerning futures
transactions.

A futures contract is an agreement between two parties to buy and sell a
security or, in the case of an index-based futures contract, to make and accept
a cash settlement for a set price on a future date. A majority of transactions
in futures contracts, however, do not result in the actual delivery of the
underlying instrument or cash settlement, but are settled through liquidation,
I.E., by entering into an offsetting transaction. Futures contracts have been
designed by boards of trade which have been designated "contracts markets" by
the Commodity Futures Trading Commission ("CFTC").

The purchase or sale of a futures contract differs from the purchase or
sale of a security in that no price or premium is paid or received. Instead, an
amount of cash or securities acceptable to the broker and the relevant contract
market, which varies, but is generally about 5% of the contract amount, must be
deposited with the broker. This amount is known as "initial margin" and
represents a "good faith" deposit assuring the performance of both the
purchaser and seller under the futures contract. Subsequent payments to and
from the broker, called "variation margin," are required to be made on a daily
basis as the price of the futures contracts fluctuates making the long and
short positions in the futures contracts more or less valuable, a process known
as "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 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,

9
<PAGE>

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. 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

10
<PAGE>

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.

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.

11
<PAGE>

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.

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.

12
<PAGE>

MANAGEMENT OF THE FUND
DIRECTORS AND OFFICERS

Information about the Directors and executive officers and portfolio
manager 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 the portfolio manager and of each executive officer and Director is
P.O. Box 9011, Princeton, New Jersey 08543-9011.

ARTHUR ZEIKEL (66) -- PRESIDENT AND DIRECTOR(1)(2) -- Chairman of the
Manager and FAM (which terms as used herein include their corporate
predecessors) since 1997; President of the Manager and FAM from 1977 to 1997;
Chairman of Princeton Services, Inc. ("Princeton Services") since 1997 and
Director thereof since 1993; President of Princeton Services from 1993 to 1997;
Executive Vice President of Merrill Lynch & Co., Inc. ("ML & Co.") since 1990.

JOE GRILLS (63) -- DIRECTOR(2) -- P.O. Box 98, Rapidan, Virginia 22773.
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 since 1997; Director, Duke Management Company since 1992, elected
Vice Chairman in May 1998; Director, LaSalle Street Fund since 1995; Director,
Hotchkis and Wiley Mutual Funds since 1996; Director, Kimco Realty Corporation
since January 1997; Member of the Investment Advisory Committee of the Virginia
Retirement System since 1998.

WALTER MINTZ (69) -- 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. (61) -- DIRECTOR(2) -- 106 Dolphin Cove Quay,
Stamford, Connecticut 06902. Principal of STI Management (investment adviser)
since 1994; Trustee, Common Fund since 1980; Chairman and CEO of Salomon
Brothers Asset Management from 1992 until 1995; Chairman of Salomon Brothers
equity mutual funds from 1992 until 1995; Monthly columnist with FORBES
magazine since 1992; Director of Stock Research and U.S. Equity Strategist at
Salomon Brothers from 1975 until 1991.

MELVIN R. SEIDEN (67) -- 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 (65) -- DIRECTOR(2) -- 24 Federal Street, Suite 400,
Boston, Massachusetts 02110. Chairman of Fernwood Advisors (investment adviser)
since 1996; Principal, Fernwood Associates (financial consultant) since 1975.

TERRY K. GLENN (57) -- 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 Princeton Funds
Distributor, Inc. since 1986 and Director thereof since 1991; President of
Princeton Administrators, L.P. since 1988.

JOSEPH T. MONAGLE, JR. (50) -- SENIOR VICE PRESIDENT(1)(2) -- Senior Vice
President of the Manager and FAM since 1990; Department Head of the Global
Fixed Income Division of the Manager and FAM since 1997; Senior Vice President
of Princeton Services since 1993.

DONALD C. BURKE (38) -- VICE PRESIDENT(1)(2) -- First Vice President of
the Manager since 1997; Vice President of the Manager from 1990 to 1997;
Director of Taxation of the Manager since 1990.

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<PAGE>

JEFFREY B. HEWSON (47) -- VICE PRESIDENT(1)(2) -- Director (Global Fixed
Income) since 1998; Vice President of the Manager from 1989 to 1997 and
Portfolio Manager of the Manager since 1985; Senior Consultant, Price
Waterhouse from 1981 to 1985.

THEODORE J. MAGNANI (36) -- VICE PRESIDENT(1) -- Vice President of the
Manager since 1992.

GREGORY MARK MAUNZ (45) -- SENIOR VICE PRESIDENT(1)(2) -- First Vice
President of the Manager since 1997; Vice President from 1985 to 1997 and
Portfolio Manager of the Manager since 1984.

GERALD M. RICHARD (49) -- TREASURER(1)(2) -- Senior Vice President and
Treasurer of the Manager and FAM since 1984; Vice President of Princeton Funds
Distributor, Inc. since 1981 and Treasurer thereof since 1984; Senior Vice
President and Treasurer of Princeton Services since 1993.

IRA P. SHAPIRO (35) -- SECRETARY(1)(2) -- Director (Legal Advisory) of the
Manager since 1997 and Attorney associated with the Manager and FAM from 1993
to 1996.

- --------

(1) Interested person, as defined in the Investment Company 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, 1998, 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
"non-affiliated 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 non-affiliated Directors, an additional $1,500 per
year plus $250 for each Committee meeting attended. For the fiscal year ended
May 31, 1998, fees and expenses paid to unaffiliated Directors aggregated
$32,832.

The following table sets forth the compensation earned by non-affiliated
Directors from the Fund for the fiscal year ended May 31, 1998, and the
aggregate compensation paid to non-affiliated Directors from all registered
investment companies advised by MLAM and its affiliate, FAM ("MLAM/FAM Advised
Funds"), for the calendar year ended December 31, 1997.

<TABLE>
<CAPTION>
PENSION OR AGGREGATE COMPENSATION
RETIREMENT BENEFITS FROM FUND AND
COMPENSATION ACCRUED AS PART MLAM/FAM ADVISED
NAME OF DIRECTOR FROM FUND OF FUND EXPENSE FUNDS PAID TO DIRECTORS
- ----------------------------------- -------------- --------------------- ------------------------
<S> <C> <C> <C>
Joe Grills(1) ..................... $6,500 None $171,500
Walter Mintz(1) ................... $6,500 None $159,500
Robert S. Salomon, Jr.(1) ......... $6,500 None $159,500
Melvin R. Seiden(1) ............... $6,500 None $159,500
Stephen B. Swensrud(1) ............ $6,500 None $175,500
</TABLE>

- --------

(1) The Directors serve on the boards of MLAM/FAM Advised Funds as follows: Mr.
Grills (22 registered investment companies consisting of 55 portfolios);
Mr. Mintz (20 registered investment companies consisting of 41
portfolios); Mr. Salomon (20 registered investment companies consisting of
41 portfolios); Mr. Seiden (20 registered investment companies consisting
of 41 portfolios); Mr. Swensrud (23 registered investment companies
consisting of 56 portfolios).

14
<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 years ended May 31, 1996, 1997 and 1998, the total
management fees paid to the Manager aggregated $914,312, $689,185 and $593,905,
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.

PURCHASE OF SHARES

Reference is made to "Purchase of Shares" in the Prospectus for certain
information as to the purchase of Fund shares.

15
<PAGE>

The Fund issues four classes of shares under the Merrill Lynch Select
PricingSM 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 PricingSM 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 use the Merrill Lynch Select PricingSM
System are referred to herein as "MLAM-advised mutual funds."

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

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

During the fiscal year ended May 31, 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, 1998, the Fund sold 771,140 Class A shares for aggregate net proceeds to
the Fund of $7,441,376. There was no gross sales charge for the sale of its
Class A shares for that period. 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 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. During the fiscal year ended May 31, 1998, the
Fund sold 1,464,082 Class D shares for aggregate net proceeds to the Fund of
$14,083,453. The gross sales charge for that period was $14,227 of which
$13,008 was received by Merrill Lynch and $1,219 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

16
<PAGE>

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 PricingSM System commenced operations) and wish to
reinvest the net proceeds from a sale of their closed-end fund shares of common
stock in Eligible Class A Shares, if the conditions set forth below are
satisfied. Alternatively, closed-end fund shareholders who purchased such
shares on or after October 21, 1994 and wish to reinvest the net proceeds from
a sale of their closed-end fund shares are offered Class A shares (if eligible
to buy Class A shares) or Class D shares of the Fund and other MLAM-advised
mutual funds ("Eligible Class D Shares"), if the following conditions are met.
First, the sale of the closed-end fund shares must be made through Merrill
Lynch, and the net proceeds therefrom must be immediately reinvested in
Eligible Class A or Class D Shares. Second, the closed-end fund shares must
either have been acquired in the initial public offering or be shares
representing dividends from shares of common stock acquired in such offering.
Third, the closed-end fund shares must have been continuously maintained in a
Merrill Lynch securities account. Fourth, there must be a minimum purchase of
$250 to be eligible for the investment option. Class A shares of the Fund are
offered at net asset value to shareholders of Merrill Lynch Senior Floating
Rate Fund, Inc. ("Senior Floating Rate Fund") who wish to reinvest the net
proceeds from a sale of certain of their shares of common stock of Senior
Floating Rate Fund in shares of the Fund. In order to exercise this investment
option, Senior Floating Rate Fund shareholders must sell their Senior Floating
Rate Fund shares to the Senior Floating Rate Fund in connection with a tender
offer conducted by the Senior Floating Rate Fund and reinvest the proceeds
immediately in the Fund. This investment option is available only with respect
to the proceeds of Senior Floating Rate Fund shares as to which no Early
Withdrawal Charge (as defined in the Senior Floating Rate Fund prospectus) is
applicable. Purchase orders from Senior Floating Rate Fund shareholders wishing
to exercise this investment option will be accepted only on the day that the
related Senior Floating Rate Fund tender offer terminates and will be effected
at the net asset value of the Fund at such day.

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

17
<PAGE>

fund shareholders wishing to exercise this investment option will be accepted
only on the day that the related tender offer terminates and will be effected
at the net asset value of the designated class of the Fund on such day.

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

LETTER OF INTENTION. Reduced sales charges are applicable to purchases
aggregating $25,000 or more of the Class A or Class D shares of the Fund or any
other MLAM-advised mutual funds, made within a thirteen-month period starting
with the first purchase pursuant to the Letter of Intention in the form
provided in the Prospectus. The Letter of Intention is available only to
investors whose accounts are maintained at the Fund's Transfer Agent. The
Letter of Intention is not available to employee benefit plans for which
Merrill Lynch provides plan-participant, recordkeeping services. The Letter of
Intention is not a binding obligation to purchase any amount of Class A or
Class D shares; however, its execution will result in the purchaser paying a
lower sales charge at the appropriate quantity purchase level. A purchase not
originally made pursuant to a Letter of Intention may be included under a
subsequent Letter of Intention executed within 90 days of such purchase if the
Distributor is informed in writing of this intent within such 90-day period.
The value of Class A shares of the Fund and of other MLAM-advised mutual funds,
presently held at cost or maximum offering price (whichever is higher), on the
date of the first purchase under the Letter of Intention, may be included as a
credit toward the completion of such Letter, but the reduced sales charge
applicable to the amount covered by such Letter will be applied only to new
purchases. If the total amount of shares does not equal the amount stated in
the Letter of Intention (minimum of $25,000), the investor will be notified and
must pay, within 20 days of the expiration of such Letter, the difference
between the sales charge on the Class A or Class D shares purchased at the
reduced rate and the sales charge applicable to the shares actually purchased
through the Letter. Class A or Class D shares equal to five percent of the
intended amount will be held in escrow during the thirteen-month period (while
remaining registered in the name of the purchaser) for this purpose. The first
purchase under the Letter of Intention must be at least five percent of the
dollar amount of such Letter. If a purchase during the term of such Letter
would otherwise be subject to a further reduced sales charge based on the right
of accumulation, the purchaser will be entitled on that purchase and subsequent
purchases to that further reduced percentage sales charge but there will be no
retroactive reduction of the sales charges on any previous purchase. The value
of any shares redeemed or otherwise disposed of by the purchaser prior to
termination or completion of the Letter of Intention will be deducted from the
total purchases made under such Letter. An exchange from a MLAM-advised money
market fund into the Fund that creates a sales charge will count toward
completing a new or existing Letter of Intention from the Fund.

EMPLOYEE ACCESSSM ACCOUNTS. Provided applicable threshold requirements are
met, either Class A or Class D shares are offered at net asset value to
Employee AccessSM 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.

18
<PAGE>

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

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

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

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

TMASM MANAGED TRUSTS. Class A shares are offered to TMASM 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).

19
<PAGE>

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 Merrill Lynch Funds
Distributor (the "Distributor"), a division of Princeton Funds Distributor,
Inc. 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 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

20
<PAGE>
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, 1998
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, 1998, 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, 1998, with respect to Class C shares.

DATA CALCULATED AS OF MAY 31, 1998

<TABLE>
<CAPTION>
ANNUAL
DISTRIBUTION
ALLOWABLE ALLOWABLE AMOUNTS FEE AT
ELIGIBLE AGGREGATE INTEREST MAXIMUM PREVIOUSLY AGGREGATE CURRENT
GROSS SALES OR UNPAID AMOUNT PAID TO UNPAID NET 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 .. $1,026,737 $64,171 $35,178 $99,349 $20,922 $78,427 $426
Under Distributor's Voluntary
Waiver ..................... $1,026,737 $64,171 $ 5,133 $69,304 $20,922 $48,382 $426
CLASS C
Under NASD Rule as Adopted .. $ 12,542 $ 784 $ 140 $ 924 $ 94 $ 830 $ 24
</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.
This figure may include CDSCs that were deferred when a shareholder
redeemed shares prior to the expiration of the applicable CDSC period and
invested the proceeds, without the imposition of a sales charge, in Class
A shares in conjunction with the shareholder's participation in the
Merrill Lynch Mutual Funds Advisor ("MFA") program. The CDSC is booked as
a contingent obligation that may be payable if the shareholder terminates
participation in the MFA program.

(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.

21
<PAGE>

REDEMPTION OF SHARES

Reference is made to "Redemption of Shares" in the Prospectus for certain
information as to the redemption and purchase of Fund shares.

The right to redeem shares or to receive payment with respect to any such
redemption may be suspended for more than seven days only for periods during
which trading on the 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 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, 1996, the Distributor
received CDSCs of $12,780 with respect to redemptions of Class B shares, all of
which were paid to Merrill Lynch. For the fiscal years ended May 31, 1997 and
1998, the Distributor received CDSCs of $66,930 and $111,552, respectively,
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 programs. Similarly, for the fiscal years ended May
31, 1996, 1997 and 1998, the Distributor received CDSCs of $3,334, $22,912 and
$7,199 respectively, with respect to redemptions of Class C shares, all of
which were paid to Merrill Lynch.

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<PAGE>

PORTFOLIO TRANSACTIONS

Subject to policies established by the Directors, the Manager is
responsible for the execution of the Fund's portfolio transactions. The Fund
has no obligation to deal with any dealer or broker or group of brokers in the
execution of transactions in portfolio securities. Orders for transactions in
portfolio securities are placed for the Fund with a number of brokers and
dealers, including Merrill Lynch. In placing orders, it is the policy of the
Fund to obtain the most favorable net results, taking into account various
factors, including price (including applicable dealer spread or brokerage
commissions), size of the transaction and difficulty of execution. Where
practicable, the Manager surveys a number of brokers and dealers in connection
with proposed portfolio transactions and selects the broker or dealer which
offers the Fund best price and execution or other services which are of benefit
to the Fund. Securities firms also may receive brokerage commissions on
transactions including covered call options written by the Fund and the sale of
underlying securities upon the exercise of such options. In addition,
consistent with the Rules of Fair Practice of the National Association of
Securities Dealers, Inc. and policies established by the Fund's Directors, the
Manager may consider sales of shares of the Fund as a factor in the selection
of brokers or dealers to execute portfolio transactions for the Fund.

The Fund does not use any particular broker or dealer, and brokers who
provide supplemental investment research to the Manager (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. 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 during the
existence of any underwriting syndicate of which Merrill Lynch is a member or
in a private placement in which Merrill Lynch serves as placement agent except
pursuant to procedures approved by the Board of Directors of the Fund that
either comply with rules adopted by the Commission or with interpretations of
the Commission staff. Rule 10f-3 under the Investment Company Act sets forth
conditions under which the Fund may purchase securities from an underwriting
syndicate of which Merrill Lynch is a member. The rule sets forth requirements
relating to, among other things, the terms of an issue of securities purchased
by the Fund, the amount of securities which may be purchased in any one issue
and the assets of the Fund which may be invested in a particular issue.

For the fiscal years ended May 31, 1995, 1996, 1997 and 1998, 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

23
<PAGE>

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. For the fiscal years ended May 31, 1997
and 1998, the Fund's portfolio turnover rate was 18.48% and 47.55%,
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.

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.

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<PAGE>

Long positions in securities traded in the OTC market are valued at the
last available bid price in the OTC market prior to the time of valuation.
Short positions in securities traded in the OTC market are valued at the last
available ask 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.

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

25
<PAGE>

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 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 Merrill Lynch in writing if the
shareholder's account is maintained with Merrill Lynch or notify the Transfer
Agent in writing or by telephone (1-800-MER-FUND) if their account is
maintained with the Transfer Agent 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 (provided that, in the event
that a payment on an account maintained at the Transfer Agent would amount to
$10.00 or less, a shareholder will not receive such payment in cash and such
payment will automatically be reinvested in additional shares). The Fund is not
responsible for any failure of delivery to the shareholder's address of record
and no interest will accrue on amounts represented by uncashed distribution or
redemption checks. Cash payments can also be directly deposited to the
shareholder's bank account. No CDSC will be imposed on redemption of shares
issued as a result of the automatic reinvestment of dividends or capital gains
distributions.

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<PAGE>

SYSTEMATIC WITHDRAWAL PLANS

A shareholder may elect to make systematic withdrawals from an Investment
Account of Class A, Class B, Class C or Class D shares in the form of payments
by check or through automatic payment by direct deposit to such shareholder's
bank account on either a monthly or quarterly basis as provided below.
Quarterly withdrawals are available for shareholders who have acquired 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 shares having a
value of $10,000 or more.

At the time of each withdrawal payment, sufficient 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 the dollar
amount and class of shares to be redeemed. 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
NYSE is not open for business on such date, the 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 shares in the
Investment Account are reinvested automatically in shares of the Fund. 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 correspondingly reduced. Purchases of additional 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 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.

Alternatively, a 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
$50. The proceeds of systematic redemptions will be posted to the shareholder's
account five business days after the date the shares are redeemed. All
redemptions are made at net asset value. A shareholder may elect to have his or
her shares redeemed on the first, second, third or fourth Monday of each month,
in the case of monthly redemptions, or of every other month, in the case of
bimonthly redemptions. For quarterly, semiannual or annual redemptions, the
shareholder may select the month in which the shares are to be redeemed and may
designate whether the redemption is to be made on the first, second, third or
fourth Monday of the month. If the Monday selected is not a business day, 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.

With respect to redemptions of Class B and Class C shares pursuant to a
systematic withdrawal plan, the maximum number of Class B or Class C shares
that can be redeemed from an account annually shall not exceed 10% of the value
of shares of such class in that account at the time the election to join the
systematic withdrawal plan was made. Any CDSC that otherwise might be due on
such redemption of Class B or Class C shares will be waived. Shares redeemed
pursuant to a systematic withdrawal plan will be redeemed in the same order as

27
<PAGE>

Class B or Class C shares otherwise redeemed. See "Purchase of Shares --
Deferred Sales Charge Alternatives -- Class B and Class C Shares -- Contingent
Deferred Sales Charges -- Class B Shares" and " -- Contingent Deferred Sales
Charges -- Class C Shares" in the Prospectus. Where the systematic withdrawal
plan is applied to Class B shares, upon conversion of the last Class B shares
in an account to Class D shares, the systematic withdrawal plan will
automatically be applied thereafter to Class D shares. See "Purchase of Shares
- -- Deferred Sales Charge Alternatives -- Class B and Class C Shares --
Conversion of Class B Shares to Class D Shares" in the Prospectus; if an
investor wishes to change the amount being withdrawn in a systematic withdrawal
plan the investor should contact his or her 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 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 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 as follows: Class A shares may be exchanged for shares of
Merrill Lynch Ready Assets Trust, Merrill Lynch Retirement Reserves Money Fund
(available only for exchanges within certain retirement plans), Merrill Lynch
U.S.A. Government Reserves and Merrill Lynch U.S. Treasury Money Fund; Class B,
Class C and Class D shares may be exchanged for shares of Merrill Lynch
Government Fund, Merrill Lynch Institutional Fund, Merrill Lynch Institutional
"Tax-Exempt Fund and Merrill Lynch Treasury Fund. Effective on or about October
12, 1998, Class A and Class D shares also will be exchangeable for Class A
shares, and Class B and Class C shares also will be exchangeable for Class B
shares, of Summit Cash Reserves Fund, a series of Financial Institutions Series
Trust, which is a Merrill Lynch-sponsored money market fund specifically
designated as available for exchange by holders of Class A, Class B, Class C and
Class D shares as more fully described below. Shares with a net asset value of
at least $100 are required to qualify for the exchange privilege, and any shares
utilized in an exchange must have been held by the shareholder for at least 15
days. 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

28
<PAGE>
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.

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.

Effective on or about October 12, 1998, shareholders also may exchange
their shares into shares of Summit Cash Reserves Fund, which is a Merrill
Lynch-sponsored money market fund specifically designated as available for
exchange by holders of Class A, Class B, Class C and Class D shares. Class A and
Class D shares will be exchangeable for Class A shares of, and Class B and Class
C shares will be
29
<PAGE>
exchangeable for Class B shares of, Summit Cash Reserves Fund. Class A shares of
Summit Cash Reserves Fund have an exchange privilege back into Class A or Class
D shares of MLAM-advised funds: Class B shares of Summit Cash Reserves Fund have
and exchange privilege back into Class B or Class C shares of MLAM-advised
funds. The period of time that Class B shares of Summit Cash Reserves Fund are
held will count toward satisfaction of the holding period requirement for
purposes of reducing any CDSC and, with respect to Class B shares, toward
satisfaction of any conversion period. Class B shares of Summit Cash Reserves
Fund will be subject to a distribution fee at an annual rate of 0.75% of average
daily net assets of such Class B shares.

To exercise the exchange privilege, shareholders should contact their
Merrill Lynch financial consultant, who will advise the Fund of the exchange.
Shareholders of the Fund, and shareholders of the other funds described above
with shares for which certificates have not been issued, may exercise the
exchange privilege by wire through their securities dealers. The Fund reserves
the right to require a properly completed Exchange Application. This exchange
privilege may be modified or terminated in accordance with the rules of the
Securities and Exchange Commission. The Fund reserves the right to limit the
number of times an investor may exercise the exchange privilege. Certain funds
may suspend the continuous offering of their shares at any time and may
thereafter resume such offering from time to time. The exchange privilege is
available only in states where the exchange legally may be made.

DIVIDENDS, DISTRIBUTIONS AND TAXES

DIVIDENDS AND DISTRIBUTIONS

All or a portion of the Fund's net investment income will be declared as
dividends daily prior to the determination of net asset value on that day and
paid monthly. The Fund may at times pay out less than the entire amount of net
investment income earned in any particular period and may at times pay out such
accumulated undistributed income in addition to net investment income earned in
any particular period in order to permit the Fund to maintain a more stable
level of distributions. As a result, the distribution paid by the Fund for any
particular period may be more or less than the amount of net investment income
earned by the Fund during such period. However, it is the Fund's intention to
distribute during any fiscal year all its net investment income. Shares will
accrue dividends as long as they are issued and outstanding. Shares are issued
and outstanding as of the settlement date of a purchase order to the settlement
date of a redemption order. All net realized 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."

30
<PAGE>
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. Any loss upon the
sale or exchange of Fund shares held for six months or less will be treated as
long-term capital loss to the extent of any capital gain dividends received by
the shareholder. Distributions in excess of the Fund's earnings and profits
will first reduce the adjusted tax basis of a holder's shares and, after such
adjusted tax basis is reduced to zero, will constitute capital gains to such
holder (assuming the shares are held as a capital asset). Recent legislation
created additional categories of capital gains taxable at different rates.
Additional legislation eliminates the highest 28% category for most sales of
capital assets occuring after December 31, 1997. Generally 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, as well as the amount of capital
gain dividends in different categories of capital gain referred to above.

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

31
<PAGE>
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.

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.

32
<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.

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.

33
<PAGE>

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, 1998 ........... 1.44% $ 1,014.40 0.87% $ 1,008.70
Five Years Ended May 31, 1998 ......... 4.56% $ 1,249.70
Inception (August 2, 1991) to May 31,
1998 ................................. 4.34% $ 1,336.10
Inception (October 21, 1994) to May 31,
1998* ................................ 5.58% $ 1,216.50
AVERAGE ANNUAL TOTAL RETURN
YEAR ENDED MAY 31, (EXCLUDING MAXIMUM APPLICABLE SALES CHARGES)
- ----------------------------------------
1998 .................................. 5.66% $ 1,056.60 4.85% $ 1,048.50
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
AGGREGATE TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGES)
Inception (August 2, 1991) to May 31,
1998 ................................. 33.61% $ 1,336.10
Inception (October 21, 1994) to May 31,
1998 ................................. 21.65% $ 1,216.50
YIELD
30 days ended May 31, 1998 ............ 5.23% 4.67%
</TABLE>

- --------

* Information as to Class A and Class C shares is presented only for the period
October 21, 1994 to May 31, 1998. Prior to October 21, 1994, no Class A or
Class C shares were publicly issued.

34
<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, 1998 ........... 3.71% $ 1,037.10 1.18% $ 1,011.80
Five Years Ended May 31, 1998 ......... 4.25% $ 1,231.11
Inception (August 2, 1991) to May 31,
1998 ................................. 4.25% $ 1,328.20
Inception (October 21, 1994) to May 31,
1998* ................................ 5.83% $ 1,226.90
ANNUAL TOTAL RETURN
YEAR ENDED MAY 31, (EXCLUDING MAXIMUM APPLICABLE SALES CHARGES)
- ----------------------------------------
1998 .................................. 4.71% $ 1,047.10 5.40% $ 1,054.00
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
AGGREGATE TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGES)
Inception (August 2, 1991) to May 31,
1998 ................................. 32.82% $ 1,328.20
Inception (October 21, 1994) to May 31,
1998 ................................. 22.69% $ 1,226.90
YIELD
30 days ended May 31, 1998 ............ 4.63% 4.98%
</TABLE>

- --------

* Information as to Class A and Class C shares is presented only for the period
October 21, 1994 to May 31, 1998. Prior to October 21, 1994, no Class A or
Class C shares were publicly issued.

35
<PAGE>

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.

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.

36
<PAGE>
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, 1998, is as set
forth below.

<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C CLASS D
--------------- ---------------- --------------- ----------------
<S> <C> <C> <C> <C>
Net Assets ..................................... $ 1,070,654 $ 85,093,922 $ 4,434,496 $ 19,192,598
=========== ============ =========== ============
Number of Shares Outstanding ................... 111,404 8,881,698 462,766 2,004,113
=========== ============ =========== ============
Net Asset Value Per Share (net assets divided by
number of shares outstanding) ................. $ 9.61 $ 9.58 $ 9.58 $ 9.58
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 ................................. $ 10.01 $ 9.58 $ 9.58 $ 9.98
=========== ============ =========== ============
</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

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

37
<PAGE>

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 July 31, 1998.

FINANCIAL STATEMENTS

The Fund's audited financial statements are incorporated by reference to
the 1998 annual report to shareholders. You may request a copy of the annual
report at no charge by calling 1 800 456-4587 Ext. 789 between 8:00A.M. and
8:00P.M. on any business day.

38
<PAGE>

APPENDIX A: LONG-TERM AND SHORT-TERM OBLIGATION RATINGS
(INCLUDING MORTGAGE-BACKED AND ASSET-BACKED SECURITIES)

DESCRIPTION OF STANDARD & POOR'S ("S&P") LONG-TERM ISSUE CREDIT RATINGS

An S&P issue credit rating is a current opinion of the creditworthiness of
an obligor with respect to a specific financial obligation, a specific class of
financial obligations, or a specific financial program (including ratings on
medium term note programs and commercial paper programs). It takes into
consideration the creditworthiness of guarantors, insurers, or other forms of
credit enhancement on the obligation and takes into account the currency in
which the obligation is denominated. The issue credit rating is not a
recommendation to purchase, sell, or hold a financial obligation, inasmuch as
it does not comment as to market price or suitability for a particular
investor.

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

Issue credit ratings can be either long-term or short-term. Short-term
ratings are generally assigned to those obligations considered short-term in
the relevant market. In the U.S., for example, that means obligations with an
original maturity of no more than 365 days including commercial paper.
Short-term ratings are also used to indicate the creditworthiness of an obligor
with respect to put features on long-term obligations. The result is a dual
rating, in which the short-term rating addresses the put feature, in addition
to the usual long-term rating. Medium-term notes are assigned long-term
ratings.

Issue credit ratings are based, in varying degrees, on the following
considerations:

1. Likelihood of payment capacity and willingness of the obligor to meet
its financial commitment on an obligation in accordance with the terms of the
obligation;

2. Nature of and provisions of the obligation;

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.

The issue rating definitions are expressed in terms of default risk. As
such, they pertain to senior obligations of an entity. Junior obligations are
typically rated lower than senior obligations, to reflect the lower priority in
bankruptcy, as noted above. (Such differentiation applies when an entity has
both senior and subordinated obligations, secured and unsecured obligations, or
operating company and holding company obligations.) Accordingly, in the case of
junior debt, the rating may not conform exactly with the category definition.

AAA An obligation rated AAA has the highest rating assigned by S&P. The
obligor's capacity to meet its financial commitment is extremely
strong.

AA An obligation rated AA differs from the highest rated obligations only
in small degree. The obligor's capacity to meet its financial
commitment is very strong.

A An obligation rated A is somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than
obligations in higher rated categories. However, the obligor's
capacity to meet its financial commitment on the obligation is still
strong.

39
<PAGE>

BBB An obligation rated BBB exhibits adequate protection parameters.
However, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity of the obligor to meet its
financial commitment on the obligation.

Obligations rated BB, B, CCC, CC and C are regarded as having
significant speculative characteristics. BB indicates the least degree
of speculation and C the highest. While such obligations will likely
have some quality and protective characteristics, these may be
outweighed by large uncertainties or major exposures to adverse
conditions.

BB An obligation rated BB is less vulnerable to nonpayment than other
speculative issues. However, it faces major ongoing uncertainties or
exposure to adverse business, financial, or economic conditions which
could lead to the obligor's inadequate capacity to meet its financial
commitment on the obligation.

B An obligation rated B is more vulnerable to nonpayment than
obligations rated BB, but the obligor currently has the capacity to
meet its financial commitment on the obligation. Adverse business,
financial, or economic conditions will likely impair the obligor's
capacity or willingness to meet its financial commitment on the
obligation. 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 An obligation rated CCC is currently vulnerable to nonpayment, 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 An obligation rated CC is currently highly vulnerable to nonpayment.

C The C rating may be used to cover a situation where a bankruptcy
petition has been filed or similar action has been taken, but payments
on this obligation are continued.

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

D An obligation rated D is in payment default. The D rating category is
used when payments on an obligation 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 or the taking of similar action if payments on an obligation
are jeopardized.

Plus (+) The ratings from AA to CCC may be modified by the addition of a
or plus or minus sign to show
minus (-): 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.

40
<PAGE>

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 S&P's receipt of an
executed copy of the escrow agreement or closing documentation
confirming investments and cash flows.

N.R. Not rated.

Obligations of issuers outside the United States and its territories are
rated on the same basis as domestic long-term and short-term 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 S&P'S SHORT-TERM ISSUE CREDIT RATINGS

An S&P short-term issue credit rating is a current opinion of the
likelihood of timely payment of an obligation 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 A short-term obligation rated "A-1" is rated in the highest category by
S&P. The obligor's capacity to meet its financial commitment on the
obligation is strong. Within this category, certain obligations are
designated with a plus sign (+). This indicates that the obligor's
capacity to meet its financial commitment on these obligations is
extremely strong.

A-2 An obligation rated "A-2" is somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than
obligations in higher rating categories. However, the obligor's capacity
to meet its financial commitment on the obligation is satisfactory.

A-3 An obligation rated "A-3" exhibits adequate protection parameters.
However, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity of the obligor to meet its
financial commitment on the obligation.

B An obligation rated "B" is regarded as having significant speculative
characteristics. The obligor currently has the capacity to meet its
financial commitment on the obligation; however, it faces major ongoing
uncertainties which could lead to the obligor's inadequate capacity to
meet its financial commitment on the obligation.

C An obligation rated "C" is currently vulnerable to nonpayment and is
dependent upon favorable business, financial, and economic conditions
for the obligor to meet its financial commitment on the obligation.

D An obligation rated "D" is in payment default. The "D" rating category
is used when payments on an obligation are not made on the date due even
if the applicable grace period has not expired, unless

41
<PAGE>

S&P 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 or the taking of a similar action if payments on an obligation
are jeopardized.

A short-term issue credit 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 S&P by the issuer or obtained by S&P from other
sources it considers reliable. S&P 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.

DESCRIPTION OF MOODY'S INVESTORS SERVICE, INC. ("MOODY'S") LONG-TERM DEBT
RATINGS

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 edge." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be
visualized are most unlikely to impair the fundamentally strong position
of such issues.

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 risks
appear somewhat larger than in 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 sometime in
the future.

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

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

B Bonds which are rated B generally lack characteristics of desirable
investments. Assurance of interest and principal payments 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.

42
<PAGE>

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 Caa. The modifier 1 indicates that the
security ranks in the higher end of its generic rating category; the modifier 2
indicates a mid-range ranking; and the modifier 3 indicates a ranking in the
lower end of its generic rating category.

DESCRIPTION OF MOODY'S SHORT-TERM DEBT RATINGS

Moody's short-term debt ratings are opinions of the ability of issuers to
repay punctually senior debt obligations. These obligations have an original
maturity not exceeding one year, unless explicitly noted. Moody's employs the
following three designations, all judged to be investment grade, to indicate
the relative repayment ability 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 debt 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 senior short-term 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 short-term debt 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.

43
<PAGE>

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Investment Objective and Policies .......................... 2
Privately Issued Mortgage-Backed and Asset-Backed
Securities -- Credit Enhancements ..................... 2
United States Government Agencies or Instrumen-
talities .............................................. 3
Adjustable Rate Securities -- Indexes .................... 4
Additional Collateralized Mortgage Obligation
Structures ............................................ 5
Portfolio Strategies Involving Interest Rate
Transactions, Options and Futures ..................... 5
Other Investment Policies and Practices .................. 10
Investment Restrictions .................................. 11
Management of the Fund ..................................... 13
Directors and Officers ................................... 13
Compensation of Directors ................................ 14
Management and Advisory Arrangements ..................... 15
Purchase of Shares ......................................... 15
Initial Sales Charge Alternatives -- Class A and
Class D Shares ........................................ 16
Reduced Initial Sales Charge ............................. 18
Employer-Sponsored Retirement or Savings Plans and
Certain Other Arrangements ............................ 20
Distribution Plans ....................................... 20
Limitations on the Payment of Deferred Sales
Charges ............................................... 20
Redemption of Shares ....................................... 22
Deferred Sales Charges -- Class B and Class C
Shares ................................................ 22
Portfolio Transactions ..................................... 23
Portfolio Turnover ....................................... 24
Determination of Net Asset Value ........................... 24
Shareholder Services ....................................... 25
Investment Account ....................................... 25
Automatic Investment Plans ............................... 26
Automatic Reinvestment of Dividends and Capital
Gains Distributions ................................... 26
Systematic Withdrawal Plans .............................. 27
Exchange Privilege ....................................... 28
Dividends, Distributions and Taxes ......................... 30
Dividends and Distributions .............................. 30
Taxes .................................................... 31
Tax Treatment of Interest Rate Transactions, Options
and Futures ........................................... 32
Performance Data ........................................... 33
General Information ........................................ 36
Description of Shares .................................... 36
Computation of Offering Price Per Share .................. 37
Independent Auditors ..................................... 37
Custodian ................................................ 37
Transfer Agent ........................................... 37
Legal Counsel ............................................ 37
Reports to Shareholders .................................. 37
Additional Information ................................... 38
Security Ownership of Certain Beneficial Owners .......... 38
Financial Statements ....................................... 38
Appendix A -- Long-Term and Short-Term Obligation
Ratings .................................................. 39
</TABLE>
Code #13938-0898

MERRILL LYNCH
ADJUSTABLE RATE
SECURITIES FUND, INC.

STATEMENT OF
ADDITIONAL
INFORMATION

August 28, 1998

Distributor:
Merrill Lynch
Funds Distributor

<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 six year period ended
May 31, 1998, and for the period August 2, 1991 (commencement of
operations) through May 31, 1992

Incorporated by reference in Part B:
Schedule of Investments as of May 31, 1998*
Statement of Assets and Liabilities as of May 31, 1998*
Statement of Operations for the year ended May 31, 1998*
Statements of Changes in Net Assets for each of the years in the two-year
period ended May 31, 1998*.
Financial Highlights for each of the years in the five year period ended
May 31, 1998*

- ---------

* Incorporated by reference to the Registrant's 1997 Annual Report to
shareholders filed with the Securities and Exchange Commission for the fiscal
year ended May 31, 1998 pursuant to Rule 30b2-1 under the Investment Company
Act of 1940, as amended ("the Investment Company Act").
(b) Exhibits:

<TABLE>
<CAPTION>
EXHIBIT
NUMBER
- ------------
<S> <C>
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)
5(a) -- Management Agreement between the Registrant and Merrill Lynch 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(e).
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)
</TABLE>

C-1
<PAGE>

<TABLE>
<CAPTION>
EXHIBIT
NUMBER
- -------------
<S> <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)
(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.

(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).

(e) Previously filed as an exhibit to Post-Effective Amendment No. 8 to the
Registration Statement.

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, 1998*
- ----------------------------------------------------------------- ---------------
<S> <C>
Class A shares of Common Stock, par value $0.10 per share........ 36
Class B shares of Common Stock, par value $0.10 per share ....... 6,117
Class C shares of Common Stock, par value $0.10 per share ....... 151
Class D shares of Common Stock, par value $0.10 per share ....... 417
</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 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,

C-2
<PAGE>

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 Convertible 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 Growth Fund, Inc., Merrill Lynch Global
Holdings, Inc., Merrill Lynch Global Resources Trust, Merrill Lynch Global
SmallCap Fund, Inc., Merrill Lynch Global Technology 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 Real Estate Fund, Inc., 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
Advisors 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 Lynch Corporate High
Yield, Inc., Merrill Lynch Emerging Tigers Fund, Inc., Merrill Lynch Federal
Securities Trust, Merrill Lynch Funds for Institutions Series, Merrill Lynch
Multi-State Municipal Series Trust, Merrill Lynch Multi-State Limited Maturity
Municipal Series Trust, Merrill Lynch Municipal Bond Fund, Inc., Merrill Lynch
Phoenix Fund, Inc., Merrill Lynch Special Value Fund, Inc., Merrill Lynch World
Income Fund, Inc. and The Municipal 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.,
Corporate High Yield Fund III, Inc., Debt Strategies Fund, Inc., Debt
Strategies Fund II, Inc., Debt Strategies Fund III, Inc., Income Opportunities
Fund 1999, Inc., Income Opportunities Fund 2000, Inc., Merrill Lynch Municipal
Strategy Fund, Inc., MuniAssets Fund, Inc., MuniEnhanced Fund, Inc.,
MuniHoldings California Insured Fund, Inc., MuniHoldings California Insured
Fund II, Inc., MuniHoldings Florida Insured Fund, MuniHoldings Florida Insured
Fund II, MuniHoldings Fund, Inc., MuniHoldings

C-3
<PAGE>

Fund II, Inc., MuniHoldings New Jersey Insured Fund, Inc., MuniHoldings New
York Fund, Inc., MuniHoldings New York Insured 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., and Worldwide DollarVest Fund, Inc.

The address of each of these investment companies is P.O. Box 9011,
Princeton, New Jersey 08543-9011, except that the address of Merrill Lynch
Funds for Institutions Series and Merrill Lynch Intermediate Bond Fund is One
Financial Center, 23rd 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 North Tower, World
Financial Center, 250 Vesey Street, New York, New York 10281-1201. The address
of 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 Director
or Trustee, Mr. Richard is Treasurer and Mr. Glenn is Executive Vice President
of all or substantially all of the investment companies listed in the first two
paragraphs of this Item 28 and Messrs. Giordano, Harvey, 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 ADVISOR OR EMPLOYMENT
- ----------------------------- --------------------------- -----------------------------------------------------------
<S> <C> <C>
ML & Co. .................... Limited Partner Financial Services Holding Company;
Limited Partner of FAM
Princeton Services, Inc. General Partner General Partner of FAM
("Princeton Services") .....
Arthur Zeikel ............... Chairman Chairman of FAM; President of the Manager and FAM from
1977 to 1997; Chairman and Director of Princeton
Services; President of Princeton Services from 1993 to
1997; Executive Vice President of ML & Co., Inc.
Jeffrey M. Peek ............. President President of FAM since 1997; President and Director of
Princeton Services since 1997; Executive Vice President
of ML & Co.
Terry K. Glenn .............. Executive Vice President Executive Vice President of FAM; Executive Vice President
and Director of Princeton Services; President and Director
of Princeton Funds Distributor, Inc.; Director of FDS;
President of Princeton Administrators, L.P.
Linda L. Federici ........... Senior Vice President Senior Vice President of FAM; Senior Vice President of
Princeton Services
Vincent R. Giordano ......... Senior Vice President Senior Vice President of FAM; Senior Vice President of
Princeton Services
Elizabeth A. Griffin ........ Senior Vice President Senior Vice President of FAM
Norman R. Harvey ............ Senior Vice President Senior Vice President of FAM; Senior Vice President of
Princeton Services
Michael J. Hennewinkel ...... Senior Vice President and Senior Vice President and General Counsel of FAM; Senior
General Counsel Vice President of Princeton Services
Philip L. Kirstein .......... Senior Vice President and Senior Vice President and Secretary of FAM; Senior Vice
Secretary President, General Counsel; Director and Secretary of
Princeton Services; Director of Princeton Funds
Distributor, Inc.
</TABLE>

C-4
<PAGE>

<TABLE>
<CAPTION>
OTHER SUBSTANTIAL BUSINESS,
POSITION(S) WITH PROFESSION, VOCATION
NAME INVESTMENT ADVISOR OR EMPLOYMENT
- ------------------------- --------------------------- -------------------------------------------------------------
<S> <C> <C>
Ronald M. Kloss ......... Senior Vice President Senior Vice President of FAM; Senior Vice President of
Princeton Services
Debra W. Landsman-Yaros.. Senior Vice President Senior Vice President of FAM; Vice President of Princeton
Funds Distributor, Inc.; Senior Vice President 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
Richard L. Reller ....... Senior Vice President Senior Vice President of FAM; Senior Vice President of
Princeton Services; Director of Princeton Funds
Distributor, Inc.
Gerald M. Richard ....... Senior Vice President and Senior Vice President and Treasurer of FAM; Senior Vice
Treasurer President and Treasurer of Princeton Services; Vice
President and Treasurer of Princeton Funds Distributor,
Inc.
Gregory D. Upah ......... Senior Vice President Senior Vice President of FAM; Senior Vice President of
Princeton Services
Ronald L. Welburn ....... Senior Vice President Senior Vice President of FAM; Senior Vice President of
Princeton Services
</TABLE>

ITEM 29. PRINCIPAL UNDERWRITERS.

(a) MLFD, a division of Princeton Funds Distributor, Inc. acts as the
principal underwriter for the Registrant and for each of the open-end registered
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.; MLFD also acts as the
principal underwriter for the following closed-end registered investment
companies: Merrill Lynch High Income Municipal Bond Fund, Inc. and Merrill
Lynch Senior Floating Rate Fund, Inc. A separate division of Princeton Funds
Distributor, Inc. acts as the principal underwriter of a number of other
investment companies.

(b) Set forth below is information concerning each director and officer of
Princeton Funds Distributor, Inc. The principal business address of each such
person is P.O. Box 9011, Princeton, New Jersey 08543-9011, except that the
address of Messrs. Brady, Breen, Crook, Fatseas, and Wasel is One Financial
Center, 23rd 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
Richard L. Reller ........... Director None
Thomas J. Verage ............ Director 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>

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, Financial Data Services,
Inc. (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, 1998.

MERRILL LYNCH ADJUSTABLE RATE
SECURITIES FUND, INC. (Registrant)

By /s/ ARTHUR ZEIKEL

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

(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.

<TABLE>
<CAPTION>
SIGNATURE TITLE DATE(S)
- -------------------------------------- ------------------------------------ --------------
<S> <C> <C>
* President and Director (Principal
- ------------------------------------- Executive Officer)
(ARTHUR ZEIKEL)
GERALD M. RICHARD* Treasurer (Principal 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)
*By /s/ Arthur Zeikel August 28, 1998
----------------------------------
(ARTHUR ZEIKEL, ATTORNEY-IN-FACT )
</TABLE>

C-7

<PAGE>

EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------------- -----------------------------------------------------------------------
<S> <C> <C>

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>

<ARTICLE> 6
<SERIES>
<NUMBER> 001
<NAME> MERRILL LYNCH ADJUSTABLE RATE SEC.--CLASS A

<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> MAY-31-1998
<PERIOD-START> JUN-01-1997
<PERIOD-END> MAY-31-1998
<INVESTMENTS-AT-COST> 108946141
<INVESTMENTS-AT-VALUE> 108851724
<RECEIVABLES> 1627260
<ASSETS-OTHER> 80155
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 110559139
<PAYABLE-FOR-SECURITIES> 0
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 767469
<TOTAL-LIABILITIES> 767469
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 144898222
<SHARES-COMMON-STOCK> 111404
<SHARES-COMMON-PRIOR> 27491
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> (35012135)
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> (94417)
<NET-ASSETS> 1070654
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 8179160
<OTHER-INCOME> 0
<EXPENSES-NET> (1913775)
<NET-INVESTMENT-INCOME> 6265385
<REALIZED-GAINS-CURRENT> (299001)
<APPREC-INCREASE-CURRENT> (180061)
<NET-CHANGE-FROM-OPS> 5786323
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (49343)
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 771140
<NUMBER-OF-SHARES-REDEEMED> (690516)
<SHARES-REINVESTED> 3289
<NET-CHANGE-IN-ASSETS> (15116116)
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> (34713134)
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 593905
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 1913775
<AVERAGE-NET-ASSETS> 834487
<PER-SHARE-NAV-BEGIN> 9.65
<PER-SHARE-NII> .57
<PER-SHARE-GAIN-APPREC> (.04)
<PER-SHARE-DIVIDEND> (.57)
<PER-SHARE-DISTRIBUTIONS> 0
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 9.61
<EXPENSE-RATIO> .92
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0

</TABLE>

<ARTICLE> 6
<SERIES>
<NUMBER> 002
<NAME> MERRILL LYNCH ADJUSTABLE RATE SEC.--CLASS B

<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> MAY-31-1998
<PERIOD-START> JUN-01-1997
<PERIOD-END> MAY-31-1998
<INVESTMENTS-AT-COST> 108946141
<INVESTMENTS-AT-VALUE> 108851724
<RECEIVABLES> 1627260
<ASSETS-OTHER> 80155
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 110559139
<PAYABLE-FOR-SECURITIES> 0
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 767469
<TOTAL-LIABILITIES> 767469
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 144898222
<SHARES-COMMON-STOCK> 8881698
<SHARES-COMMON-PRIOR> 11022844
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> (35012135)
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> (94417)
<NET-ASSETS> 85093922
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 8179160
<OTHER-INCOME> 0
<EXPENSES-NET> (1913775)
<NET-INVESTMENT-INCOME> 6265385
<REALIZED-GAINS-CURRENT> (299001)
<APPREC-INCREASE-CURRENT> (180061)
<NET-CHANGE-FROM-OPS> 5786323
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (4834537)
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 4070396
<NUMBER-OF-SHARES-REDEEMED> (6509518)
<SHARES-REINVESTED> 297976
<NET-CHANGE-IN-ASSETS> (15116116)
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> (34713134)
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 593905
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 1913775
<AVERAGE-NET-ASSETS> 93443987
<PER-SHARE-NAV-BEGIN> 9.62
<PER-SHARE-NII> .50
<PER-SHARE-GAIN-APPREC> (.04)
<PER-SHARE-DIVIDEND> (.50)
<PER-SHARE-DISTRIBUTIONS> 0
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 9.58
<EXPENSE-RATIO> 1.70
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0

</TABLE>

<ARTICLE> 6
<SERIES>
<NUMBER> 003
<NAME> MERRILL LYNCH ADJUSTABLE RATE SEC.--CLASS C

<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> MAY-31-1998
<PERIOD-START> JUN-01-1997
<PERIOD-END> MAY-31-1998
<INVESTMENTS-AT-COST> 108946141
<INVESTMENTS-AT-VALUE> 108851724
<RECEIVABLES> 1627260
<ASSETS-OTHER> 80155
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 110559139
<PAYABLE-FOR-SECURITIES> 0
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 767469
<TOTAL-LIABILITIES> 767469
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 144898222
<SHARES-COMMON-STOCK> 462766
<SHARES-COMMON-PRIOR> 552141
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> (35012135)
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> (94417)
<NET-ASSETS> 4434496
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 8179160
<OTHER-INCOME> 0
<EXPENSES-NET> (1913775)
<NET-INVESTMENT-INCOME> 6265385
<REALIZED-GAINS-CURRENT> (299001)
<APPREC-INCREASE-CURRENT> (180061)
<NET-CHANGE-FROM-OPS> 5786323
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (278673)
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 1544770
<NUMBER-OF-SHARES-REDEEMED> (1656902)
<SHARES-REINVESTED> 22757
<NET-CHANGE-IN-ASSETS> (15116116)
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> (34713134)
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 593905
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 1913775
<AVERAGE-NET-ASSETS> 5421622
<PER-SHARE-NAV-BEGIN> 9.63
<PER-SHARE-NII> .49
<PER-SHARE-GAIN-APPREC> (.05)
<PER-SHARE-DIVIDEND> (.49)
<PER-SHARE-DISTRIBUTIONS> 0
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 9.58
<EXPENSE-RATIO> 1.74
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0

</TABLE>

<ARTICLE> 6
<SERIES>
<NUMBER> 004
<NAME> MERRILL LYNCH ADJUSTABLE RATE SEC.--CLASS D

<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> MAY-31-1998
<PERIOD-START> JUN-01-1997
<PERIOD-END> MAY-31-1998
<INVESTMENTS-AT-COST> 108946141
<INVESTMENTS-AT-VALUE> 108851724
<RECEIVABLES> 1627260
<ASSETS-OTHER> 80155
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 110559139
<PAYABLE-FOR-SECURITIES> 0
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 767469
<TOTAL-LIABILITIES> 767469
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 144898222
<SHARES-COMMON-STOCK> 2004113
<SHARES-COMMON-PRIOR> 1379496
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> (35012135)
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> (94417)
<NET-ASSETS> 19192598
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 8179160
<OTHER-INCOME> 0
<EXPENSES-NET> (1913775)
<NET-INVESTMENT-INCOME> 6265385
<REALIZED-GAINS-CURRENT> (299001)
<APPREC-INCREASE-CURRENT> (180061)
<NET-CHANGE-FROM-OPS> 5786323
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (1102832)
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 1483618
<NUMBER-OF-SHARES-REDEEMED> (945839)
<SHARES-REINVESTED> 86838
<NET-CHANGE-IN-ASSETS> (15116116)
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> (34713134)
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 593905
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 1913775
<AVERAGE-NET-ASSETS> 19407291
<PER-SHARE-NAV-BEGIN> 9.62
<PER-SHARE-NII> .55
<PER-SHARE-GAIN-APPREC> (.04)
<PER-SHARE-DIVIDEND> (.55)
<PER-SHARE-DISTRIBUTIONS> 0
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 9.58
<EXPENSE-RATIO> 1.18
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0

</TABLE>

INDEPENDENT AUDITOR'S CONSENT

Merrill Lynch Adjustable Rate Securities Fund, Inc.:

We consent to the incorporation by reference in this Post-Effective Amendment
No. 9 to Registration Statement No. 33-40332 of our report dated July 7, 1998
appearing in the annual report to shareholders of the Merrill Lynch Adjustable
Rate Securities Fund, Inc. for the year ended May 31, 1998, and to the reference
to us under the caption "Financial Highlights" in the Prospectus.

Deloitte & Touche LLP
Princeton, New Jersey
August 28, 1998