As filed with the Securities and Exchange Commission on July 30, 1999
Securities Act File No. 33-40332
Investment Company Act File No. 811-6304
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM N-1A
REGISTRATION STATEMENT UNDER THE SECURITIES
ACT OF 1933 [X]
Pre-Effective Amendment No. [ ]
Post-Effective Amendment No. 10 [X]
and/or
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 [X]
Amendment No. 11 [X]
(Check appropriate box or boxes)
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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)
Registrant's Telephone Number, including Area Code: (609) 282-2800
Terry K. Glenn
Merrill Lynch Adjustable Rate Securities Fund, Inc.
800 Scudders Mill Road
Plainsboro, New Jersey 08536
Mailing Address: P.O. Box 9011, Princeton, New Jersey 08543-9011
(Name and Address of Agent for Service)
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Copies to:
Counsel for the Fund Michael J. Hennewinkel, Esq.
BROWN & WOOD LLP MERRILL LYNCH
One World Trade Center ASSET MANAGEMENT
New York, New York 10048-0557 P.O. Box 9011
Attention: Thomas R. (SM)ith, Jr., Esq. Princeton, New Jersey 08543-9011
Frank P. Bruno, Esq.
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It is proposed that this filing will become effective (check appropriate box):
[ ] immediately upon filing pursuant to paragraph (b)
[ ] on (date) pursuant to paragraph (b)
[X] 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.
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Title of Securities Being Registered: Common Stock, par value $.10 per share.
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<PAGE>
The information in this prospectus is not complete and may be changed. We may
not use this prospectus to sell securities until the registration statement
containing this prospectus, which has been filed with the Securities and
Exchange Commission, is effective. This prospectus is not an offer to sell these
securities and is not soliciting an offer to buy these securities in any state
where the offer or sale is not permitted.
[LOGO] Merrill Lynch
SUBJECT TO COMPLETION
PRELIMINARY PROSPECTUS DATED JULY 30, 1999
Merrill Lynch Adjustable Rate Securities Fund, Inc.
September __, 1999
This Prospectus contains information you should know before investing, including
information about risks. Please read it before you invest and keep it for future
reference.
The Securities and Exchange Commission has not approved or disapproved these
securities or passed upon the adequacy of this Prospectus. Any representation to
the contrary is a criminal offense.
<PAGE>
Table of Contents
PAGE
[CLIPART] KEY FACTS
- --------------------------------------------------------------------------------
The Merrill Lynch Adjustable Rate Securities Fund at a Glance ............... 3
Risk/Return Bar Chart ....................................................... 5
Fees and Expenses ........................................................... 6
[CLIPART] DETAILS ABOUT THE FUND
- --------------------------------------------------------------------------------
How the Fund Invests ........................................................ 8
Investment Risks ........................................................... 10
[CLIPART] YOUR ACCOUNT
- --------------------------------------------------------------------------------
Merrill Lynch Select Pricing(SM) System .................................... 15
How to Buy, Sell, Transfer and Exchange Shares ............................. 20
Participation in Merrill Lynch Fee-Based Programs .......................... 24
[CLIPART] MANAGEMENT OF THE FUND
- --------------------------------------------------------------------------------
Merrill Lynch Asset Management ............................................. 27
Financial Highlights ....................................................... 28
[CLIPART] FOR MORE INFORMATION
- --------------------------------------------------------------------------------
Shareholder Reports ................................................ Back Cover
Statement of Additional Information ................................ Back Cover
MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC.
<PAGE>
[CLIPART] Key Facts
In an effort to help you better
understand the many concepts involved in
making an investment decision, we have
defined highlighted terms in this
prospectus in the sidebar.
Mortgage backed securities -- securities
backed by pools of mortgages that in
many cases are guaranteed by government
agencies such as Government National
Mortgage Association ("Ginnie Mae").
Asset backed securities -- debt
securities issued by a trust or other
legal entity established for the purpose
of issuing securities and holding
certain assets, such as credit card
receivables or auto leases, that pay
down over time and generate sufficient
cash to pay holders of the securities.
Index -- a measure of value or rates.
Agencies -- entities that are part of or
sponsored by the Federal government,
such as Ginnie Mae, the Tennessee Valley
Authority or the Federal Housing
Administration.
THE MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND AT A GLANCE
- --------------------------------------------------------------------------------
What is the Fund's investment objective?
The Fund's objective 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.
What are the Fund's main investment strategies?
The Fund invests primarily in highly-rated mortgage backed and asset backed debt
securities the interest from which changes based on changes in interest rates or
indexes to which they are tied. In so doing, the Fund's manager attempts to keep
the price of the Fund's shares relatively stable compared to a Fund that invests
in securities with fixed interest rates. However, the Fund does not attempt to
maintain a share price that is as stable as that typically found in a money
market fund. Some securities in which the Fund invests may be guaranteed by the
government or by the government agency or instrumentality issuing the security.
We cannot guarantee that the Fund will achieve its objective.
What are the main risks of investing in the Fund?
As with any mutual fund, and despite the Fund manager's attempts to minimize
share price fluctuation, the value of the Fund's investments -- and therefore
the value of Fund shares -- may fluctuate. These changes may occur because the
stock market or interest rates are rising or falling. At other times, there are
specific factors that may affect the value of a particular investment. If the
value of the Fund's investments goes down, you may lose money.
Although highly-rated securities or securities that are guaranteed by the
government or the issuer may involve minimal credit risk, changes in the value
of the Fund's securities may occur in response to interest rate movements --
generally, when interest rates go up, the value of most mortgage backed and
asset backed securities, like other fixed income instruments, goes down.
Further, mortgage backed and asset backed securities involve special risks,
including prepayment risk and extension risk, and may be more volatile than
other fixed income securities of similar maturities. While the interest paid on
adjustable rate securities may go up and down in response to changes in market
interest rates or an index to which the security relates, these securities
generally are subject to a maximum amount by which interest will fluctuate, and
these securities may not adjust immediately upon changes in market or index
rates. If an
MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC. 3
<PAGE>
[CLIPART] Key Facts
adjustable rate security reaches the maximum level to which it will adjust, or
does not adjust at the same time as a change in the market rate or index, it may
decrease in value.
Although the Fund may invest in derivatives to hedge against risks in its
portfolio, it is not bound to do so and the Fund cannot guarantee the success of
any hedging strategies it does use. Derivatives may be volatile and subject to
liquidity, leverage, credit and other types of risks.
Who should invest?
The Fund may be an appropriate investment for you if you:
o Are investing with long term goals, such as retirement or funding a
child's education
o Want a professionally managed portfolio
o Are looking for an investment that provides income with minimal credit
risk
o Are willing to accept the risk that the value of your investment may
decline as a result of interest rate movements
4 MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC.
<PAGE>
RISK/RETURN BAR CHART
- --------------------------------------------------------------------------------
The bar chart and table shown below provide an indication of the risks of
investing in the Fund. The bar chart shows changes in the Fund's performance for
Class B shares for the periods shown. Sales charges are not reflected in the bar
chart. If these amounts were reflected, returns would be less than those shown.
The table compares the average annual total returns for each class of the Fund's
shares for the periods shown with those of the Lehman Brothers Short-Government
Index (1-2 yr.) and the Salomon Six Month Treasury Bill. How the Fund performed
in the past is not necessarily an indication of how the Fund will perform in the
future.
[The following data was represented as a bar chart in the printed material)
1992 1993 1994 1995 1996 1997 1998
---- ---- ---- ---- ---- ---- ----
2.84% 2.83% (0.14)% 8.13% 6.16% 5.53% 3.76%
During the period shown in the bar chart, the highest return for a quarter was
2.89% (quarter ended March 31, 1995) and the lowest return for a quarter was
- -0.87% (quarter ended June 30, 1994.) The Fund's year-to-date return as of June
30, 1999 was 2.05%.
Average Annual Total Returns (for the Past Past Since
calendar year ended December 31, 1998) One Year Five Years Inception
- --------------------------------------------------------------------------------
Adjustable Rate Securities* -- Class A 0.39% N/A 5.38%+
Lehman Brothers Short-Government Index (1-2yr)** 6.59% N/A 6.69%+++
Salomon Six Month Treasury Bill*** 5.28% N/A 5.52%#
- --------------------------------------------------------------------------------
Adjustable Rate Securities* -- Class B -0.19% 4.65% 4.25%++
Lehman Brothers Short-Government Index (1-2yr)** 6.59% 5.86% 6.17%+++
Salomon Six Month Treasury Bill*** 5.28% 5.28% 4.85%#
- --------------------------------------------------------------------------------
Adjustable Rate Securities*-- Class C 2.63% N/A 5.47%+
Lehman Brothers Short-Government Index (1-2yr)** 6.59% N/A 6.69%+++
Salomon Six Month Treasury Bill*** 5.28% N/A 5.52%#
- --------------------------------------------------------------------------------
Adjustable Rate Securities*-- Class D 0.13% 4.34% 4.22%++
Lehman Brothers Short-Government Index (1-2yr)** 6.59% 5.86% 6.17%+++
Salomon Six Month Treasury Bill*** 5.28% 5.28% 4.85%#
- --------------------------------------------------------------------------------
* Includes sales charge.
** This unmanaged Index is comprised of all U.S. Government agency and
Treasury securities with maturities of one to two years. Past performance
is not predictive of future performance.
*** This unmanaged Index is comprised of all U.S. Treasury bills maturing in
up to six months.
+ Inception date is October 21, 1994.
++ Inception date is August 2, 1991.
+++ Since October 31, 1994.
# Since July 31, 1991.
MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC. 5
<PAGE>
[CLIPART] Key Facts
UNDERSTANDING
EXPENSES
Fund investors pay various fees and
expenses, either directly or indirectly.
Listed below are some of the main types
of expenses, which all mutual funds may
charge:
Expenses paid directly by the
shareholder:
Shareholder fees -- these include sales
charges which you may pay when you buy
or sell shares of the Fund.
Expenses paid indirectly by the
shareholder:
Annual Fund Operating Expenses --
expenses that cover the costs of
operating the Fund.
Management Fee -- a fee paid to the
Manager for managing the Fund.
Distribution Fees -- fees used to
support the Fund's marketing and
distribution efforts, such as
compensating Financial Consultants,
advertising and promotion.
Service (Account Maintenance) Fees --
fees used to compensate securities
dealers for account maintenance
activities.
FEES AND EXPENSES
- --------------------------------------------------------------------------------
The Fund offers four different classes of shares. Although your money will be
invested the same way no matter which class of shares you buy, there are
differences among the fees and expenses associated with each class. Not everyone
is eligible to buy every class. After determining which classes you are eligible
to buy, decide which class best suits your needs. Your Merrill Lynch Financial
Consultant can help you with this decision.
This table shows the different fees and expenses that you may pay if you buy
and hold the different classes of shares of the Fund. Future expenses may be
greater or less than those indicated below.
<TABLE>
<CAPTION>
Shareholder Fees (fees paid directly from
your investment) (a): Class A Class B(b) Class C Class D
---------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Maximum Sales Charge (Load) imposed on
purchases (as a percentage of offering price) 4.00%(c) None None 4.00%(c)
---------------------------------------------------------------------------------------------------
Maximum Deferred Sales Charge (Load) (as
a percentage of original purchase price or
redemption proceeds, whichever is lower) None(d) 4.0%(c) 1.0%(c) None(d)
---------------------------------------------------------------------------------------------------
Maximum Sales Charge (Load) imposed on
Dividend Reinvestments None None None None
---------------------------------------------------------------------------------------------------
Redemption Fee None None None None
---------------------------------------------------------------------------------------------------
Exchange Fee None None None None
---------------------------------------------------------------------------------------------------
Annual Fund Operating Expenses (expenses that are
deducted from Fund assets):
---------------------------------------------------------------------------------------------------
Management Fee 0.50% 0.50% 0.50% 0.50%
---------------------------------------------------------------------------------------------------
Distribution and/or Service (12b-1) Fees(e) None 0.75% 0.80% 0.25%
---------------------------------------------------------------------------------------------------
Other Expenses (including transfer agency
fees)(f) 0.42% 0.45% 0.43% 0.42%
---------------------------------------------------------------------------------------------------
Total Annual Fund Operating Expenses 0.92% 1.70% 1.73% 1.17%
---------------------------------------------------------------------------------------------------
</TABLE>
(a) In addition, Merrill Lynch may charge clients a processing fee (currently
$5.35) when a client buys or sells shares.
(b) Class B shares automatically convert to Class D shares about ten years after
you buy them and will no longer be subject to distribution fees.
(c) Some investors may qualify for reductions in the sales charge (load).
(d) You may pay a deferred sales charge if you purchase $1 million or more and
you redeem within one year.
(e) The Fund calls the "Service Fee" an "Account Maintenance Fee." Account
Maintenance Fee is the term used in this Prospectus and in all other Fund
materials. If you hold Class B or Class C shares for a long time, it may
cost you more in distribution (12b-1) fees than the maximum sales charge
that you would have paid if you had bought one of the other classes.
(f) The Fund pays the Transfer Agent $11.00 for each Class A and Class D
shareholder account and $14.00 for each Class B and Class C shareholder
account and reimburses the Transfer Agent's out-of-pocket expenses. The Fund
pays a 0.10% fee for certain accounts that participate in the Merrill Lynch
Mutual Fund Advisor program. The Fund also pays a $0.20 monthly closed
account charge, which is assessed upon all accounts that close during the
year. This fee begins the month following the month the account is closed
and ends at the end of the calendar year. For the fiscal year ended May 31,
1999, the Fund paid the Transfer Agent fees totaling $108,176. The
Investment Adviser provides accounting services to the Fund at its cost. For
the fiscal year ended May 31, 1999, the Fund reimbursed the Investment
Adviser $51,747 for these services.
6 MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC.
<PAGE>
Examples:
These examples are intended to help you compare the cost of investing in the
Fund with the cost of investing in other mutual funds.
These examples assume that you invest $10,000 in the Fund for the time periods
indicated, that your investment has a 5% return each year, that you pay the
sales charges, if any, that apply to the particular class and that the Fund's
operating expenses remain the same. This assumption is not meant to indicate you
will receive a 5% annual rate of return. Your annual return may be more or less
than the 5% used in this example. Although your actual costs may be higher or
lower, based on these assumptions your costs would be:
EXPENSES IF YOU DID REDEEM YOUR SHARES:
---
1 Year 3 Years 5 Years 10 Years
- --------------------------------------------------------------------------------
Class A $490 $682 $889 $1,486
- --------------------------------------------------------------------------------
Class B $573 $736 $923 $2,009
- --------------------------------------------------------------------------------
Class C $276 $545 $939 $2,041
- --------------------------------------------------------------------------------
Class D $514 $757 $1,018 $1,764
- --------------------------------------------------------------------------------
EXPENSES IF YOU DID NOT REDEEM YOUR SHARES:
1 Year 3 Years 5 Years 10 Years
- --------------------------------------------------------------------------------
Class A $490 $682 $889 $1,486
- --------------------------------------------------------------------------------
Class B $173 $536 $923 $2,009
- --------------------------------------------------------------------------------
Class C $176 $545 $939 $2,041
- --------------------------------------------------------------------------------
Class D $514 $757 $1,018 $1,764
- --------------------------------------------------------------------------------
MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC. 7
<PAGE>
Details About the Fund [CLIPART]
ABOUT THE
PORTFOLIO MANAGER
Gregory Mark Maunz is a Senior Vice
President and the portfolio manager of
the Fund.
Mr. Maunz has been a First Vice
President of Merrill Lynch Asset
Management since 1997 and was a
Portfolio Manager since 1984 and was
Vice President from 1985 to 1997. Vice
President since 1985 and a Portfolio
Manager thereof since 1984.
ABOUT THE
MANAGER
The Fund is managed by Merrill Lynch
Asset Management.
HOW THE FUND INVESTS
- --------------------------------------------------------------------------------
The Fund's objective 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 tries to achieve this objective by
investing at least 65% of its total assets in adjustable rate securities.
Adjustable rate securities pay interest at rates that increase or decrease at
time intervals in response to changes in market levels or interest rates. The
securities in which the Fund invests will either be issued or guaranteed by
agencies and instrumentalities of the United States or be rated in at least the
second-highest rating category by Standard & Poors Ratings Services or Moody's
Investor Service.
The Fund invests primarily in mortgage backed and asset backed securities.
Mortgage backed securities represent the right to receive a portion of principal
and/or interest payments made on a pool of residential or commercial mortgage
loans. Asset backed securities are debt securities issued by a trust or other
legal entity established for the purpose of issuing securities and holding
certain assets, such as credit card receivables or auto leases, that pay down
over time and generate sufficient cash to pay holders of the securities.
Mortgage backed securities in which the Fund invests 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"). Some, but not all, of the asset backed
securities in which the Fund will invest will be guaranteed by the (SM)all
Business Administration ("SBA").
The distinguishing feature of adjustable rate securities is that interest
payments will vary in relation to an index at specific intervals of time
typically ranging from one to sixty months. The Fund's Manager believes that
these characteristics make such securities likely to generate current income in
excess of a portfolio of short term money market instruments but with less
volatility in market value than fixed-rate mortgage backed or asset backed
securities and other fixed-rate debt obligations of comparable maturity.
However, an investor should note that the value of the Fund's shares will likely
be more volatile and will fluctuate more than that of a portfolio of money
market securities.
8 MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC.
<PAGE>
Mortgage backed and asset backed securities frequently react differently to
changes in interest rates than other fixed income securities. When interest
rates fall, borrowers may refinance or otherwise repay principal on their
mortgages or loans earlier than scheduled. If this happens, certain types of
mortgage backed and asset backed securities will be paid off more quickly than
originally anticipated and owners of these securities have to invest the
proceeds in securities with lower yields. This risk is known as "prepayment
risk." When interest rates rise, however, fewer borrowers refinance and certain
types of mortgagem backed and asset backed securities are paid off more slowly
than originally anticipated, which causes the value of these securities to fall.
This risk is known as "extension risk." Although high credit quality
mortgage backed securities have low risk of default, mortgage backed securities
are subject to declines in market value as the result of prepayment risk or
extension risk. Asset backed securities also are subject to prepayment and
extension risk, although perhaps not to the same extent as mortgage backed
securities.
While the interest rates that adjustable rate securities pay generally rise and
fall due to shifts in market interest rates, such securities are subject to
their own unique risks. Many adjustable rate securities are subject to maximum
limitations on the amount their interest rates may increase or decrease during a
stated period. Such maximum limitations are known generally as "caps" and
"floors." During periods in which short term interest rates move within the caps
and floors of portfolio securities, 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, however, the caps and floors may not permit the interest rates
of adjustable rate securities to adjust to the full extent of the movements in
short term rates during any one adjustment interval. In the event of dramatic
increases in interest rates, caps may prevent such securities from adjusting to
prevailing rates over the term of the loan. If this happens, the market value of
adjustable rate securities may be substantially reduced, causing the Fund's net
asset value (price per share) to fall.
The Fund may also invest up to 35% of its total assets in fixed-rate
mortgage backed and asset backed securities as well as U.S. Treasury securities
and U.S. Agency debentures. The interest rate on a fixed-rate security does not
change as the market rate of interest changes. Therefore, such securities may
carry repayment and extension risks that are more sensitive to interest rate
changes than adjustable rate securities.
MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC. 9
<PAGE>
[CLIPART] Details About the Fund
INVESTMENT RISKS
- --------------------------------------------------------------------------------
This section contains a summary discussion of the general risks of investing in
the Fund. As with any fund, there can be no guarantee that the Fund will meet
its goals or that the Fund's performance will be positive for any period of
time.
Market and Selection Risk -- Market risk is the risk that the stock market will
go down in value, including the possibility that the market will go down sharply
and unpredictably. Selection risk is the risk that the investments that Fund
management selects will underperform the stock market or other funds with
similar investment objectives and investment strategies.
Credit Risk -- Credit risk is the risk that the issuer will be unable to pay the
interest or principal when due. The degree of credit risk depends on both the
financial condition of the issuer and the terms of the obligation.
Interest Rate Risk -- Interest rate risk is the risk that prices of bonds
generally increase when interest rates decline and decrease when interest rates
increase. Prices of longer term securities generally change more in response to
interest rate changes than prices of shorter term securities.
Mortgage Backed Securities -- Mortgage backed securities represent the right to
receive a portion of principal and/or interest payments made on a pool of
residential or commercial mortgage loans. When interest rates fall, borrowers
may refinance or otherwise repay principal on their mortgages earlier than
scheduled. When this happens, certain types of mortgage backed securities will
be paid off more quickly than originally anticipated and the Fund has to invest
the proceeds in securities with lower yields. This risk is known as "prepayment
risk." When interest rates rise, certain types of mortgage backed securities
will be paid off more slowly than originally anticipated and the value of these
securities will fall. This risk is known as "extension risk."
Because of prepayment risk and extension risk mortgage backed securities react
differently to changes in interest rates than other fixed income securities.
(SM)all movements in interest rates (both increase and decrease) may quickly and
significantly reduce the value of certain mortgage backed securities.
Most mortgage backed securities are issued by Federal government agencies, such
as the Government National Mortgage Association (Ginnie Mae), the Federal Home
Loan Mortgage Corporation (Freddie Mac) or Federal
10 MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC.
<PAGE>
National Mortgage Association (Fannie Mae). Principal and interest payments on
mortgage backed securities issued by the Federal government agencies are
guaranteed by either the Federal government or the government agency. Such
securities have very little credit risk. Mortgage backed securities that are
issued by private corporations rather than Federal agencies have credit risk as
well as prepayment risk and extension risk.
Mortgage backed securities may be either pass-through securities or
collateralized mortgage obligations (CMOs). Pass-through securities represent a
right to receive principal and interest payments collected on a pool of
mortgages, which are passed through to security holders (less servicing costs).
CMOs are created by dividing the principal and interest payments collected on a
pool of mortgages into several revenue streams (tranches) with different
priority rights to portions of the underlying mortgage payments. Certain CMO
tranches may represent a right to receive interest only (IOs), principal only
(POs) or an amount that remains after other floating-rate tranches are paid (an
inverse floater). These securities are frequently referred to as "mortgage
derivatives" and may be extremely sensitive to changes in interest rates. If the
Fund invests in CMO tranches (including CMOtranches issued by government
agencies) and interest rates move in a manner not anticipated by Fund
management, it is possible that the Fund could lose all or substantially all of
its investment.
Asset Backed Securities -- Like traditional fixed income securities, the value
of asset-backed securities typically increases when interest rates fall and
decreases when interest rates rise. Certain asset-backed securities may also be
subject to the risk of prepayment. In a period of declining interest rates,
borrowers may pay what they owe on the underlying assets more quickly than
anticipated. Prepayment reduces the yield to maturity and the average life of
the asset backed securities. In addition, when the Fund reinvests the proceeds
of a prepayment it may receive a lower interest rate than the rate on the
security that was prepaid. In a period of rising interest rates, prepayments may
occur at a slower rate than expected. As a result, the average maturity of the
Fund's portfolio will increase. The value of long-term securities generally
changes more widely in response to changes in interest rates than shorter term
securities.
Indexed and Inverse Floating Rate Securities -- The Fund may invest in
securities whose potential returns are directly related to changes in an
underlying index or interest rate, known as indexed securities. The return on
indexed securities will rise when the underlying index or interest rate rises
MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC. 11
<PAGE>
[CLIPART] Details About the Fund
and fall when the index or interest rate falls. The Fund may also invest in
securities whose return is inversely related to changes in an interest rate
(inverse floaters). In general, income on inverse floaters will decrease when
interest rates increase and increase when interest rates decrease. Investments
in inverse floaters may subject the Fund to the risks of reduced or eliminated
interest payments and losses of principal. In addition, certain indexed
securities and inverse floaters may increase or decrease in value at a greater
rate than the underlying interest rate, which effectively leverages the Fund's
investment. Indexed securities and inverse floaters are derivative securities
and can be considered speculative. Indexed and inverse securities involve credit
risk and certain indexed and inverse securities may involve leverage risk and
liquidity risk.
Borrowing and Leverage Risk -- The Fund may borrow for temporary emergency
purposes including to meet redemptions. Borrowing may exaggerate changes in the
net asset value of Fund shares and in the yield on the Fund's portfolio.
Borrowing will cost the Fund interest expense and other fees. The cost of
borrowing may reduce the Fund's return. Certain derivative securities that the
Fund buys may create leverage.
Securities Lending -- The Fund may lend securities to financial institutions
which provide government securities as collateral. Securities lending involves
the risk that the borrower may fail to return the securities in a timely manner
or at all. As a result, the Fund may lose money and there may be a delay in
recovering the loaned securities. The Fund could also lose money if it does not
recover the securities and the value of the collateral falls. These events could
trigger adverse tax consequences to the Fund.
Risks associated with certain types of securities in which the Fund may invest
include:
Derivatives -- The Fund may use derivative instruments including options on
portfolio positions or currencies, options on stock or other financial indices,
financial and currency futures, options on such futures and forward
transactions. Derivatives allow the Fund to increase or decrease its risk
exposure more quickly and efficiently than other types of instruments.
Derivatives are volatile and involve significant risks, including:
Credit risk -- the risk that the counterparty (the party on the other side
of the transaction) on a derivative transaction will be unable to honor its
financial obligation to the Fund.
12 MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC.
<PAGE>
Leverage risk -- the risk associated with certain types of investments or
trading strategies that relatively (SM)all market movements may result in
large changes in the value of an investment. Certain investments or trading
strategies that involve leverage can result in losses that greatly exceed
the amount originally invested.
Liquidity risk -- the risk that certain securities may be difficult or
impossible to sell at the time that the seller would like or at the price
that the seller believes the security is currently worth.
The Fund may use derivatives for hedging purposes, including anticipatory
hedges. Hedging is a strategy in which the Fund uses a derivative to offset the
risk that other Fund holdings may decrease in value. While hedging can reduce
losses, it can also reduce or eliminate gains if the market moves in a different
manner than anticipated by the Fund or if the cost of the derivative outweighs
the benefit of the hedge. Hedging also involves the risk that changes in the
value of the derivative will not match those of the holdings being hedged as
expected by the Fund, in which case any losses on the holdings being hedged may
not be reduced. There can be no assurance that the Fund's hedging strategy will
reduce risk or that hedging transactions will be either available or cost
effective. The Fund is not required to use hedging and may choose not to do so.
Debt Securities -- Debt securities, such as bonds, involve credit risk. This is
the risk that the borrower will not make timely payments of principal and
interest. The degree of credit risk depends on the issuer's financial condition
and on the terms of the bonds. These securities are also subject to interest
rate risk. This is the risk that the value of the security may fall when
interest rates rise. In general, the market price of debt securities with longer
maturities will go up or down more in response to changes in interest rates than
the market price of shorter term securities.
Repurchase Agreements -- The Fund may enter into certain types of repurchase
agreements. Under a repurchase agreement, the seller agrees to repurchase a
security at a mutually agreed upon time and price. This
MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC. 13
<PAGE>
[CLIPART] Details About the Fund
insulates the Fund from changes in the market value of the security during the
period, except for currency fluctuations. If the seller fails to repurchase the
security and the market value declines, the Fund may lose money.
Reverse Repurchase Agreements -- Under a reverse repurchase agreement, the Fund
sells a security to another party and agrees to buy it back at a specific time
and price. The Fund may lose money if it must buy securities back at a higher
price than they are worth.
Illiquid Securities -- The Fund may invest up to 15% of its net assets in
illiquid securities that it cannot easily resell within seven days at current
value or that have contractual or legal restrictions on resale. If the Fund buys
illiquid securities it may be unable to quickly resell them or may be able to
sell them only at a price below current value.
Restricted Securities -- Restricted securities have contractual or legal
restrictions on their resale. They may include private placement securities that
the Fund buys directly from the issuer. Private placement and other restricted
securities may not be listed on an exchange and may have no active trading
market.
Restricted securities may be illiquid. The Fund may be unable to sell them on
short notice or may be able to sell them only at a price below current value.
The Fund may get only limited information about the issuer, so it may be less
able to predict a loss. In addition, if Fund management receives material
adverse nonpublic information about the issuer, the Fund will not be able to
sell the security.
Rule 144A Securities -- Rule 144A securities are restricted securities that can
be resold to qualified institutional buyers but not to the general public. Rule
144A securities may have an active trading market, but carry the risk that the
active trading market may not continue.
STATEMENT OF ADDITIONAL INFORMATION
- --------------------------------------------------------------------------------
If you would like further information about the Fund, including how it invests,
please see the Statement of Additional Information.
14 MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC.
<PAGE>
Your Account [CLIP ART]
MERRILL LYNCH SELECT PRICING(SM) SYSTEM
- --------------------------------------------------------------------------------
The Fund offers four share classes, each with its own sales charge and expense
structure, allowing you to invest in the way that best suits your needs. Each
share class represents an ownership interest in the same investment portfolio.
When you choose your class of shares you should consider the size of your
investment and how long you plan to hold your shares. Your Merrill Lynch
Financial Consultant can help you determine which share class is best suited to
your personal financial goals.
For example, if you select Class A or D shares, you generally pay a sales charge
at the time of purchase. If you buy Class D shares, you also pay an ongoing
account maintenance fee of 0.25%. You may be eligible for a sales charge waiver.
The Fund has adopted a plan under Rule 12b-1 to pay distribution fees for the
sale and distribution of its shares. If you select Class B or C shares, you will
invest the full amount of your purchase price, but you will be subject to a
distribution fee of 0.50% for Class B shares and 0.55% for Class C shares and an
account maintenance fee of 0.25% for both classes of shares. Because these fees
are paid out of the Fund's assets on an ongoing basis, over time these fees
increase the cost of your investment and may cost you more than paying an
initial sales charge. In addition, you may be subject to a deferred sales charge
when you sell Class B or C shares.
The Fund's shares are distributed by Merrill Lynch Funds Distributor, a division
of Princeton Funds Distributor, Inc., an affiliate of Merrill Lynch.
MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC. 15
<PAGE>
[CLIPART] Your Account
The table below summarizes key features of the Merrill Lynch Select Pricing(SM)
System.
<TABLE>
<CAPTION>
Class A Class B Class C Class D
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Availability Limited to certain Generally available Generally available Generally available
investors including: through Merrill Lynch. through Merrill Lynch. through Merrill Lynch.
o Current Class A Limited availability Limited availability Limited availability
shareholders through other securities through other securities through other securities
o Certain Retirement dealers. dealers. dealers.
Plans
o Participants in certain
Merrill Lynch-sponsored
programs
o Certain affiliates of
Merrill Lynch
- ------------------------------------------------------------------------------------------------------------------------------------
Initial Sales Yes. Payable at time of No. Entire purchase price No. Entire purchase price Yes. Payable at time of
Charge? purchase. Lower sales is invested in shares of is invested in shares of purchase. Lower sales
charges available for the Fund. the Fund. charges available for
larger investments. larger investments.
- ------------------------------------------------------------------------------------------------------------------------------------
Deferred Sales No. (May be charged for Yes. Payable if you Yes. Payable if you No. (May be charged for
Charge? purchases over $1 million redeem within four years redeem within one year of purchases over $1 million
that are redeemed within of purchase. purchase. that are redeemed within
one year.) one year.)
- ------------------------------------------------------------------------------------------------------------------------------------
Account No. 0.25% Account Maintenance 0.25% Account Maintenance 0.25% Account Maintenance
Maintenance and Fee Fee Fee
Distribution Fees? 0.50% Distribution 0.55% Distribution No Distribution Fee.
Fee. Fee.
- ------------------------------------------------------------------------------------------------------------------------------------
Conversion to No. Yes, automatically after No. No.
Class D shares? approximately ten years.
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
16 MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC.
<PAGE>
Right of Accumulation -- permits you to
pay the sales charge that would apply to
the cost or value (whichever is higher)
of all shares you own in the Merrill
Lynch mutual funds that offer Select
Pricing options.
Letter of Intent -- permits you to pay
the sales charge that would be
applicable if you add up all shares of
Merrill Lynch Select Pricing(SM) System
funds that you agree to buy within a 13
month period. Certain restrictions
apply.
Class A and Class D Shares -- Initial Sales Charge Options
If you select Class A or Class D shares, you will pay a sales charge at the time
of purchase.
Dealer
Compensation
As a % of As a % of as a % of
Your Investment Offering Price Your Investment* Offering Price
- --------------------------------------------------------------------------------
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%
- --------------------------------------------------------------------------------
* Rounded to the nearest one-hundredth percent.
** If you invest $1,000,000 or more in Class A or Class D shares, you may not
pay an initial sales charge. However, if you redeem your shares within one
year after purchase, you may be charged a deferred sales charge. This
charge is 1% of the lesser of the original cost of the shares being
redeemed or your redemption proceeds. 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.
No initial sales charge applies to Class A or Class D shares that you buy
through reinvestment of dividends.
A reduced or waived sales charge on a purchase of Class A or Class D shares may
apply for:
o Purchases under a Right of Accumulation or Letter of Intent
o TMA(SM) Managed Trusts
o Certain Merrill Lynch investment or central asset accounts
MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC. 17
<PAGE>
[CLIPART] Your Account
o Certain employer-sponsored retirement or savings plans
o Purchases using proceeds from the sale of certain Merrill Lynch
closed-end funds under certain circumstances
o Certain investors, including directors or trustees of Merrill Lynch
mutual funds and Merrill Lynch employees
o Certain Merrill Lynch fee-based programs
Only certain investors are eligible to buy Class A shares. Your Merrill Lynch
Financial Consultant can help you determine whether you are eligible to buy
Class A shares or to participate in any of these programs.
If you decide to buy shares under the initial sales charge alternative and you
are eligible to buy both Class A and Class D shares, you should buy Class A
since Class D shares are subject to a 0.25% account maintenance fee, while Class
A shares are not.
If you redeem Class A or Class D shares and within 30 days buy new shares of the
same class, you will not pay a sales charge on the new purchase amount. The
amount eligible for this "Reinstatement Privilege" may not exceed the amount of
your redemption proceeds. To exercise the privilege, contact your Merrill Lynch
Financial Consultant or the Fund's Transfer Agent at 1-800-MER-FUND.
As a result of the implementation of the Merrill Lynch Select Pricing(SM)
System, Class A shares of the Fund outstanding prior to October 21, 1994, were
redesigned as Class D shares. The Class A shares offered here differ from the
Class A shares offered prior to October 21, 1994, in many respects, including
eligible investors, sales charges and exchange privileges.
Class B and Class C Shares -- Deferred Sales Charge Options
If you select Class B or Class C shares, you do not pay an initial sales charge
at the time of purchase. However, if you redeem your Class B shares within four
years after purchase or your Class C shares within one year after purchase, you
may be required to pay a deferred sales charge. You will also pay distribution
fees of 0.50% for Class B shares and 0.55% for Class C shares and account
maintenance fees of 0.25% each year under distribution plans that the Fund has
adopted under Rule 12b-1. Because these fees are paid out of the Fund's assets
on an ongoing basis, over time these fees increase the cost of your investment
and may cost you more than paying an initial sales charge. The Distributor uses
the money that it receives from the deferred sales charges and the distribution
fees to cover the costs of marketing, advertising and compensating the Merrill
Lynch Financial Consultant or other securities dealer who assists you in
purchasing Fund shares.
18 MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC.
<PAGE>
Class B Shares
If you redeem Class B shares within four years after purchase, you may be
charged a deferred sales charge. The amount of the charge gradually decreases as
you hold your shares over time, according to the following schedule:
Years Since Purchase Sales Charge*
------------------------------------------------------------
0 - 1 4.00%
------------------------------------------------------------
1 - 2 3.00%
------------------------------------------------------------
2 - 3 2.00%
------------------------------------------------------------
3 - 4 1.00%
------------------------------------------------------------
4 and thereafter 0.00%
------------------------------------------------------------
* The percentage charge will apply to the lesser of the original cost of the
shares being redeemed or the proceeds of your redemption. Shares acquired
through reinvestment of dividends are not subject to a deferred sales charge.
Not all Merrill Lynch funds have identical deferred sales charge schedules.
If you exchange your shares for shares of another fund, the higher charge
will apply.
The deferred sales charge relating to Class B shares may be reduced or waived in
certain circumstances, such as:
o Certain post-retirement withdrawals from an IRA or other retirement
plan if you are over 59 1/2 years old.
o Redemption by certain eligible 401(a) and 401(k) plans, certain related
accounts, and certain retirement plan rollovers.
o Redemption in connection with participation in certain Merrill Lynch
fee-based programs.
o Withdrawals resulting from shareholder death or disability as long as
the waiver request is made within one year of death or disability or,
if later, reasonably promptly following completion of probate, or in
connection with involuntary termination of an account in which Fund
shares are held.
o Withdrawal through the Merrill Lynch Systematic Withdrawal Plan of up
to 10% per year of your Class B account value at the time the plan is
established.
Your Class B shares convert automatically into Class D shares approximately ten
years after purchase. Any Class B shares received through reinvestment of
MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC. 19
<PAGE>
[CLIPART] Your Account
dividends paid on converting shares will also convert at that time. Class D
shares are subject to lower annual expenses than Class B shares. The conversion
of Class B to Class D shares is not a taxable event for Federal income tax
purposes.
Different conversion schedules apply to Class B shares of different Merrill
Lynch mutual funds. For example, Class B shares of a fixed income fund convert
approximately ten years after purchase compared to approximately eight years for
equity funds. If you acquire your Class B shares in an exchange from another
fund with a shorter conversion schedule, the Fund's ten year conversion
schedule will apply. If you exchange your Class B shares in the Fund for Class B
shares of a fund with a longer conversion schedule, the other fund's conversion
schedule will apply. The length of time that you hold both the original and
exchanged Class B shares in both funds will count toward the conversion
schedule. The conversion schedule may be modified in certain other cases as
well.
Class C Shares
If you redeem Class C shares within one year after purchase, you may be charged
a deferred sales charge of 1.00%. The charge will apply to the lesser of the
original cost of the shares being redeemed or the proceeds of your redemption.
You will not be charged a deferred sales charge when you redeem shares that you
acquire through reinvestment of Fund dividends. The deferred sales charge
relative to Class C shares may be reduced or waived in connection with
involuntary termination of an account in which Fund shares are held and
withdrawals through the Merrill Lynch Systematic Withdrawal Plan.
Class C shares do not offer a conversion privilege.
HOW TO BUY, SELL, TRANSFER AND EXCHANGE SHARES
The chart on the following page summarizes how to buy, sell, transfer and
exchange shares through Merrill Lynch or other securities dealers. You may also
buy shares through the Transfer Agent. To learn more about buying shares through
the Transfer Agent, call 1-800-MER-FUND. Because the selection of a mutual fund
involves many considerations, your Merrill Lynch Financial Consultant may help
you with this decision.
20 MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC.
<PAGE>
<TABLE>
<CAPTION>
If You Want to Your Choices Information Important for You to Know
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Buy Shares First, select the share Refer to the Merrill Lynch Select Pricing table on page 16.
class appropriate for you Be sure to read this Prospectus carefully.
----------------------------------------------------------------------------------------------
Next, determine the amount The minimum initial investment for the Fund is $1,000 for
of your investment all accounts except:
o $250 for certain Merrill Lynch fee-based programs
o $100 for retirement plans.
(The minimums for initial investments may be waived under
certain circumstances.)
----------------------------------------------------------------------------------------------
Have your Merrill Lynch The price of your shares is based on the next calculation of
Financial Consultant or net asset value after your order is placed. Any purchase
securities dealer submit orders placed prior to the close of business on the New York
your purchase order Stock Exchange (generally 4:00 p.m Eastern time) will be
priced at the net asset value determined that day.
Purchase orders placed after that time will be priced at the
net asset value determined on the next business day. The
Fund may reject any order to buy shares and may suspend the
sale of shares at any time. Merrill Lynch may charge a
processing fee to confirm a purchase. This fee is currently
$5.35.
----------------------------------------------------------------------------------------------
Or contact the Transfer To purchase shares directly, call the Transfer Agent at
Agent 1-800-MER-FUND and request a purchase application. Mail the
completed purchase application to the Transfer Agent at the
address on the inside back cover of this Prospectus.
- ------------------------------------------------------------------------------------------------------------------
Add to Your Purchase additional shares The minimum investment for additional purchases is generally
Investment $50 except that retirement plans have a minimum additional
purchase of $1 and certain programs, such as automatic
investment plans, may have higher minimums.
(The minimum for additional purchases may be waived under
certain circumstances.)
----------------------------------------------------------------------------------------------
Acquire additional shares All dividends are automatically reinvested without a sales
through the automatic charge.
dividend reinvestment plan
----------------------------------------------------------------------------------------------
Participate in the automatic You may invest a specific amount on a periodic basis through
investment plan certain Merrill Lynch investment or central asset accounts.
- ------------------------------------------------------------------------------------------------------------------
Transfer Shares Transfer to a participating You may transfer your Fund shares only to another securities
to Another securities dealer dealer that has entered into an agreement with Merrill
Securities Dealer Lynch. Certain shareholder services may not be available for
the transferred shares. You may only purchase additional
shares of funds previously owned before the transfer. All
future trading of these assets must be coordinated by the
receiving firm.
----------------------------------------------------------------------------------------------
Transfer to a You must either:
non-participating securities o Transfer your shares to an account with the Transfer
dealer Agent; or
o Sell your shares.
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC. 21
<PAGE>
[CLIPART] Your Account
<TABLE>
<CAPTION>
If You Want to Your Choices Information Important for You to Know
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Sell Your Shares Have your Merrill Lynch The price of your shares is based on the next calculation of
Financial Consultant or net asset value after your order is placed. For your
securities dealer submit redemption request to be priced at the net asset value on
your sales order the day of your request, you must submit your request to
your dealer prior to that day's close of business on the New
York Stock Exchange (generally 4:00 p.m. Eastern time). Any
redemption request placed after that time will be priced at
the net asset value at the close of business on the next
business day. Dealers must submit redemption requests to the
Fund not more than thirty minutes after the close of
business on the New York Stock Exchange on the day the
request was received.
Securities dealers, including Merrill Lynch, may charge a
fee to process a redemption of shares. Merrill Lynch
currently charges a fee of $5.35. No processing fee is
charged if you redeem shares directly through the Transfer
Agent.
The Fund may reject an order to sell shares under certain
circumstances.
----------------------------------------------------------------------------------------------
Sell through the Transfer You may sell shares held at the Transfer Agent by writing to
Agent the Transfer Agent at the address on the inside back cover
of this prospectus. All shareholders on the account must
sign the letter and signatures must be guaranteed. If you
hold stock certificates, return the certificates with the
letter. The Transfer Agent will normally mail redemption
proceeds within seven days following receipt of a properly
completed request. If you make a redemption request before
the Fund has collected payment for the purchase of shares,
the Fund or the Transfer Agent may delay mailing your
proceeds. This delay will usually not exceed ten days.
If you hold share certificates, they must be delivered to
the Transfer Agent before they can be converted. Check with
the Transfer Agent or your Merrill Lynch Financial
Consultant for details.
- ------------------------------------------------------------------------------------------------------------------
Sell Shares Participate in the Fund's You can choose to receive systematic payments from your Fund
Systematically Systematic Withdrawal Plan account either by check or through direct deposit to your
bank account on a monthly or quarterly basis. If you hold
your Fund shares in a Merrill Lynch CMA(R), CBA(R) or
Retirement Account you can arrange for systematic
redemptions of a fixed dollar amount on a monthly,
bi-monthly, quarterly, semi-annual or annual basis, subject
to certain conditions. Under either method you must have
dividends and other distributions automatically reinvested.
For Class B and C shares your total annual withdrawals
cannot be more than 10% per year of the value of your shares
at the time your plan is established. The deferred sales
charge is waived for systematic redemptions. Ask your
Merrill Lynch Financial Consultant for details.
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
22 MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC.
<PAGE>
<TABLE>
<CAPTION>
If You Want to Your Choices Information Important for You to Know
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Exchange Your Select the fund into which You can exchange your shares of the Fund for shares of many
Shares you want to exchange. Be other Merrill Lynch mutual funds. You must have held the
sure to read that fund's shares used in the exchange for at least 15 calendar days
prospectus before you can exchange to another fund.
Each class of Fund shares is generally exchangeable for
shares of the same class of another fund. If you own Class A
shares and wish to exchange into a fund in which you have no
Class A shares, you will exchange into Class D shares.
Some of the Merrill Lynch mutual funds impose a different
initial or deferred sales charge schedule. If you exchange
Class A or D shares for shares of a fund with a higher
initial sales charge than you originally paid, you will be
charged the difference at the time of exchange. If you
exchange Class B shares for shares of a fund with a
different deferred sales charge schedule, the higher
schedule will apply. The time you hold Class B or C shares
in both funds will count when determining your holding
period for calculating a deferred sales charge at
redemption. If you exchange Class A or D shares for money
market fund shares, you will receive Class A shares of
Summit Cash Reserves Fund. Class B or C shares of the Fund
will be exchanged for Class B shares of Summit.
Although there is currently no limit on the number of
exchanges that you can make, the exchange privilege may be
modified or terminated at any time in the future.
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC. 23
<PAGE>
[CLIPART] Your Account
Net Asset Value -- the market value of
the Fund's total assets after deducting
liabilities, divided by the number of
shares outstanding.
HOW SHARES ARE PRICED
- --------------------------------------------------------------------------------
When you buy shares, you pay the net asset value, plus any applicable sales
charge. This is the offering price. Shares are also redeemed at their net asset
value, minus any applicable deferred sales charge. The Fund calculates its net
asset value (generally by using market quotations) each day the New York Stock
Exchange is open, after the close of business on the Exchange (the Exchange
generally closes at 4:00 p.m. Eastern time). The net asset value used in
determining your price is the next one calculated after your purchase or
redemption order is placed. Foreign securities owned by the Fund may trade on
weekends or other days when the Fund does not price its shares. As a result, the
Fund's net asset value may change on days when you will not be able to purchase
or redeem the Fund's shares.
Generally, Class A shares will have the highest net asset value because that
class has the lowest expenses, and Class D shares will have a higher net asset
value than Class B or Class C shares. Also dividends paid on Class A and Class D
shares will generally be higher than dividends paid on Class B and Class C
shares because Class A and Class D shares have lower expenses.
PARTICIPATION IN MERRILL LYNCH FEE-BASED PROGRAMS
- --------------------------------------------------------------------------------
If you participate in certain fee-based programs offered by Merrill Lynch, you
may be able to buy Class A shares at net asset value, including by exchanges
from other share classes. Sales charges on the shares being exchanged may be
reduced or waived under certain circumstances.
You generally cannot transfer shares held through a fee-based program into
another account. Instead, you will have to redeem your shares held through the
program and purchase shares of another class, which may be subject to
distribution and account maintenance fees. This may be a taxable event and you
will pay any applicable sales charges.
If you leave one of these programs, your shares may be redeemed or automatically
exchanged into another class of Fund shares or into a money market fund. The
class you receive may be the class you originally owned when you entered the
program, or in certain cases, a different class. If the
24 MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC.
<PAGE>
Dividends -- Ordinary income and capital
gains paid to shareholders. Dividends
may be reinvested in additional Fund
shares as they are paid.
exchange is into Class B shares, the period before conversion to Class D shares
may be modified. Any redemption or exchange will be at net asset value. However,
if you participate in the program for less than a specified period, you may be
charged a fee in accordance with the terms of the program.
Details about these features and the relevant charges are included in the client
agreement for each fee-based program and are available from your Merrill Lynch
Financial Consultant.
DIVIDENDS AND TAXES
- --------------------------------------------------------------------------------
The Fund will distribute at least monthly any net investment income and any net
realized long-term capital gains. The Fund may also pay a special distribution
at the end of the calendar year to comply with Federal tax requirements. If your
account is with Merrill Lynch and you would like to receive dividends in cash,
contact your Merrill Lynch Financial Consultant. If your account is with the
Transfer Agent and you would like to receive dividends in cash, contact the
Transfer Agent. Although this cannot be predicted with any certainty, the Fund
anticipates that the majority of its dividends, if any, will consist of ordinary
income, although it may distribute capital gains as well.
You will pay tax on dividends from the Fund whether you receive them in cash or
additional shares. If you redeem Fund shares or exchange them for shares of
another fund, any gain on the transaction may be subject to tax. Capital gain
dividends are generally taxed at different rates than ordinary income dividends.
If you are neither a lawful permanent resident nor a citizen of the U.S. or if
you are a foreign entity, the Fund's ordinary income dividends (which include
distributions of net short-term capital gains) will generally be subject to a
30% U.S. withholding tax, unless a lower treaty rate applies.
MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC. 25
<PAGE>
[CLIPART] Your Account
"BUYING A DIVIDEND"
Unless your investment is in a tax
deferred account, you may want to avoid
buying shares shortly before the Fund
pays a dividend. The reason? If you buy
shares when a fund has realized but not
yet distributed income or capital gains,
you will pay the full price for the
shares and then receive a portion of the
price back in the form of a taxable
dividend. Before investing you may want
to consult your tax adviser.
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. You may be
able to claim a credit or take a deduction for foreign taxes paid by the Fund if
certain requirements are met.
By law, the Fund must withhold 31% of your dividends and proceeds if you have
not provided a taxpayer identification number or social security number or if
the number you have provided is incorrect.
This section summarizes some of the consequences under current Federal tax law
of an investment in the Fund. It is not a substitute for personal tax advice.
Consult your personal tax adviser about the potential tax consequences of an
investment in the Fund under all applicable tax laws.
26 MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC.
<PAGE>
Management of the Fund [CLIPART]
MERRILL LYNCH ASSET MANAGEMENT
- --------------------------------------------------------------------------------
Merrill Lynch Asset Management, the Fund's Manager, manages the Fund's
investments and its business operations under the overall supervision of the
Fund's Board of Directors. The Manager has the responsibility for making all
investment decisions for the Fund. The Manager has a sub-advisory agreement with
Merrill Lynch Asset Management U.K. Limited, an affiliate, under which the
Manager may pay a fee for services it receives. The Fund pays the Manager a fee
at the annual rate of 0.50% of the average daily net assets of the Fund.
Merrill Lynch Asset Management is part of the Merrill Lynch Asset Management
Group which had approximately $516 billion in investment company and other
portfolio assets under management as of June 1999. This amount includes assets
managed for Merrill Lynch affiliates.
A Note About Year 2000
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"). The Fund could be adversely
affected if the computer systems used by the Fund's management or other Fund
service providers do not properly address this problem before January 1, 2000.
The Fund's management expects to have addressed this problem before then, and
does not anticipate that the services it provides will be adversely affected.
The Fund's other service providers have told Fund management that they also
expect to resolve the Year 2000 Problem, and Fund management will continue to
monitor the situation as the Year 2000 approaches. However, if the problem has
not been fully addressed, the Fund could be negatively affected. The Year 2000
Problem could also have a negative impact on the issuers of securities in which
the Fund invests. This negative impact may be greater for companies in foreign
markets, particularly emerging markets, since they may be less prepared for the
Year 2000 Problem than domestic companies and markets. If the companies in which
the Fund invests have Year 2000 Problems, the Fund's returns could be adversely
affected.
MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC. 27
<PAGE>
[CLIPART] Management of the Fund
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
The Financial Highlights table is intended to help you understand the Fund's
financial performance for the periods shown. Certain information reflects
financial results for a single Fund share. The total returns in the table
represent the rate an investor would have earned on an investment in the Fund
(assuming reinvestment of all dividends). This information has been audited by
Deloitte & Touche LLP, whose report, along with the Fund's financial statements,
are included in the Fund's annual report to shareholders, which is available
upon request.
<TABLE>
<CAPTION>
Class A
-------------------------------------------
For the
Period Class B
October -----------------------------------------------
For the Year Ended 21, 1994+ For the Year Ended
May 31, to May 31,
Increase (Decrease) in --------------------------------- May 31, -----------------------------------------------
Net Asset Value: 1999 1998 1997++ 1996++ 1995 1999 1998 1997++ 1996++ 1995
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Per Share Operating Performance:
- ------------------------------------------------------------------------------------------------------------------------------------
Net asset value, beginning of period $ $ 9.65 $ 9.54 $ 9.55 $ 9.46 $ $ 9.62 $ 9.53 $ 9.56 $ 9.53
- ------------------------------------------------------------------------------------------------------------------------------------
Investment income -- net .57 .59 .56 .36 .50 .51 .52 .46
- ------------------------------------------------------------------------------------------------------------------------------------
Realized and unrealized gain (loss)
on investments -- net (.04) .10 .03 .09 (.04) .09 (.02) .04
- ------------------------------------------------------------------------------------------------------------------------------------
Total from investment operations .53 .69 .59 .45 .46 .60 .50 .50
- ------------------------------------------------------------------------------------------------------------------------------------
Less dividends and distributions:
Investment income -- net (.57) (.58) (.60) (.36) (.50) (.51) (.53) (.47)
In excess of investment income -- net -- -- -- -- -- -- -- --
Realized gain on investments -- net -- -- -- -- -- -- -- --
In excess of realized gain on
investments -- net -- -- -- -- -- -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Total dividends and distributions (.57) (.58) (.60) (.36) (.50) (.51) (.53) (.47)
- ------------------------------------------------------------------------------------------------------------------------------------
Net asset value, end of period $ $ 9.61 $ 9.65 $ 9.54 $ 9.55 $ $ 9.58 $ 9.62 $ 9.53 $ 9.56
- ------------------------------------------------------------------------------------------------------------------------------------
Total Investment Return:**
- ------------------------------------------------------------------------------------------------------------------------------------
Based on net asset value per share % 5.66% 7.48% 6.41% 4.85%# % 4.85% 6.44% 5.34% 5.48%
- ------------------------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
- ------------------------------------------------------------------------------------------------------------------------------------
Expenses % .92% .89% .81% .87%* % 1.70% 1.65% 1.59% 1.59%
- ------------------------------------------------------------------------------------------------------------------------------------
Investment income -- net % 5.93% 6.13% 6.20% 6.18%* % 5.19% 5.35% 5.45% 4.88%
- ------------------------------------------------------------------------------------------------------------------------------------
Supplemental Data:
- ------------------------------------------------------------------------------------------------------------------------------------
Net assets, end of period (in thousands) $ $ 1,071 $ 265 $ 281 $ 345 $ $85,094 $106,061 $137,387 $202,334
- ------------------------------------------------------------------------------------------------------------------------------------
Portfolio turnover % 47.55% 18.48% 25.30% 102.55% % 47.55% 18.48% 25.30% 102.55%
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
* Annualized.
** Total investment returns exclude the effects of sales loads.
+ Commencement of Operations.
++ Based on average shares outstanding.
# Aggregate total investment return.
28 MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC.
<PAGE>
FINANCIAL HIGHLIGHTS (concluded)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Class C
-------------------------------------------
For the
Period Class D
October -----------------------------------------------
For the Year Ended 21, 1994+ For the Year Ended
May 31, to May 31,
Increase (Decrease) in --------------------------------- May 31, -----------------------------------------------
Net Asset Value: 1999 1998 1997++ 1996++ 1995 1999 1998 1997++ 1996++ 1995
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Per Share Operating Performance:
- ------------------------------------------------------------------------------------------------------------------------------------
Net asset value, beginning of period $ $ 9.63 $ 9.53 $ 9.56 $ 9.46 $ $ 9.62 $ 9.52 $ 9.55 $ 9.53
- ------------------------------------------------------------------------------------------------------------------------------------
Investment income -- net .49 .50 .48 .31 .55 .57 .56 .51
- ------------------------------------------------------------------------------------------------------------------------------------
Realized and unrealized gain (loss)
on investments -- net (.05) .11 .01 .10 (.04) .09 (.01) .03
- ------------------------------------------------------------------------------------------------------------------------------------
Total from investment operations .44 .61 .49 .41 .51 .66 .55 .54`
- ------------------------------------------------------------------------------------------------------------------------------------
Less distributions from
realized gain on investments -- net (.49) (.51) (.52) (.31) (.55) (.56) (.58) (.52)
In excess of investment income -- net -- -- -- -- -- -- -- --
Realized gain on investments -- net -- -- -- -- -- -- -- --
In excess of realized gain on
investments -- net -- -- -- -- -- -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Total dividends and distributions (.49) (.51) (.52) (.31) (.55) (.56) (.58) (.52)
- ------------------------------------------------------------------------------------------------------------------------------------
Net asset value, end of period $ $ 9.58 $ 9.63 $ 9.53 $ 9.56 $ $ 9.58 $ 9.62 $ 9.52 $ 9.55
- ------------------------------------------------------------------------------------------------------------------------------------
Total Investment Return:**
- ------------------------------------------------------------------------------------------------------------------------------------
Based on net asset value per share 4.71% 6.51% 5.30% 4.47%# % 5.40% 7.11% 5.91% 5.91%
- ------------------------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets:
- ------------------------------------------------------------------------------------------------------------------------------------
Expenses 1.74% 1.70% 1.57% 1.68%* % 1.18% 1.13% 1.06% 1.08%
- ------------------------------------------------------------------------------------------------------------------------------------
Investment income -- net % 5.15% 5.34% 5.40% 5.51%* % 5.70% 5.87% 5.98% 5.44%
- ------------------------------------------------------------------------------------------------------------------------------------
Supplemental Data:
- ------------------------------------------------------------------------------------------------------------------------------------
Net assets, end of period (in thousands) $ $ 4,434 $ 5,315 $ 3,078 $ 1,409 $ $19,193 $ 13,267 $ 12,800 $ 16,993
- ------------------------------------------------------------------------------------------------------------------------------------
Portfolio turnover % 47.55% 18.48% 25.30% 102.55% % 47.55% 18.48% 25.30% 102.55%
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
* Annualized.
** Total investment returns exclude the effects of sales loads.
+ Commencement of operations.
++ Based on average shares outstanding.
# Aggregate total investment return.
MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC. 29
<PAGE>
(This page intentionally left blank)
MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC.
<PAGE>
---------------------------------
POTENTIAL
INVESTORS
Open an account (two options)
---------------------------------
(1) (2)
- ---------------------------- -----------------------------------
MERRILL LYNCH TRANSFER AGENT
FINANCIAL CONSULTANT
OR SECURITIES DEALER Financial Data Services, Inc.
P.O. Box 45289
Advises shareholders on Jacksonville, Florida 32232-5289
their Fund investments.
- ---------------------------- Performs recordkeeping and
reporting services.
-----------------------------------
----------------------------------------------------
DISTRIBUTOR
Merrill Lynch Funds Distributor,
a division of Princeton Funds Distributor, Inc.
P.O. Box 9081
Princeton, New Jersey 08543-9081
Arranges for the sale of Fund shares.
----------------------------------------------------
- ------------------------ -----------------------------------
COUNSEL CUSTODIAN
------------------
Brown & Wood LLP THE FUND The Bank of New York
One World Trade Center 90 Washington Street, 12th Floor
New York, New York The Board of New York, New York
10048-0557 Directors oversees 10286
the Fund.
Provides legal advice ------------------ Holds the Fund's
to the Fund. assets for safekeeping.
- ------------------------ -----------------------------------
- ----------------------------------- ------------------------------------
INDEPENDENT AUDITORS THE MANAGER
Deloitte & Touche LLP Merrill Lynch Asset Management, L.P.
117 Campus Drive
Princeton, New Jersey 08540-6400 ADMINISTRATIVE OFFICES
800 Scudders Mill Road
Audits the financial Plainsboro, New Jersey 08536
statements of the Fund on behalf of
the shareholders. MAILING ADDRESS
- ----------------------------------- P.O. Box 9011
Princeton, New Jersey 08543-9011
TELEPHONE NUMBER
1-800-MER-FUND
Manages the Fund's
day-to-day activities.
------------------------------------
MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC.
<PAGE>
For More Information [CLIPART]
Shareholder Reports
Additional information about the Fund's investments is available in the Funds's
annual and semi-annual reports to shareholders. In the Fund's annual report you
will find a discussion of the market conditions and investment strategies that
significantly affected the Fund's performance during its last fiscal year. You
may obtain these reports at no cost by calling 1-800-MER-FUND.
The Fund will send you one copy of each shareholder report and certain other
mailings, regardless of the number of Fund accounts you have. To receive
separate shareholder reports for each account, call your Merrill Lynch Financial
Consultant or write to the Transfer Agent at its mailing address. Include your
name, address, tax identification number and Merrill Lynch brokerage or mutual
fund account number. If you have any questions, please call your Merrill Lynch
Financial Consultant or the Transfer Agent at 1-800-MER-FUND.
Statement of Additional Information
The Fund's Statement of Additional Information contains further information
about the Fund and is incorporated by reference (legally considered to be part
of this prospectus). You may request a free copy by writing the Fund at
Financial Data Services, Inc. P.O. Box 45289 Jacksonville, Florida 32232-5290 or
by calling 1-800-MER-FUND.
Contact your Merrill Lynch Financial Consultant or the Fund, at the telephone
number or address indicated above, if you have any questions.
Information about the Fund (including the Statement of Additional Information)
can be reviewed and copied at the SEC's Public Reference Room in Washington,
D.C. Call 1-800-SEC-0330 for information on the operation of the public
reference room. This information is also available on the SEC's Internet site at
http://www.sec.gov and copies may be obtained upon payment of a duplicating fee
by writing the Public Reference Section of the SEC, Washington, D.C. 20549-6009.
You should rely only on the information contained in this Prospectus. No one is
authorized to provide you with information that is different from information
contained in this Prospectus
Investment Company Act file #811-6304
Code #13937-09-99
(C)Merrill Lynch Asset Management, L.P.
Prospectus
[LOGO] Merrill Lynch
Merrill Lynch Adjustable Rate
Securities Fund, Inc.
September , 1999
<PAGE>
The information in this statement of additional information is not complete and
may be changed. This statement of additional information is not an offer to sell
these securities and is not soliciting an offer to buy these securities in any
state where the offer or sale is not permitted.
SUBJECT TO COMPLETION
Preliminary Statement of Additional Information Dated July 30, 1999
STATEMENT OF ADDITIONAL INFORMATION
Merrill Lynch Adjustable Rate Securities Fund, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 o 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.For more information on the Fund's investment
objective and policies, see "Investment Objectives and Policies."
Pursuant to the Merrill Lynch Select Pricing(SM) System, the Fund offers
four classes of shares, each with a different combination of sales charges,
ongoing fees and other features. The Merrill Lynch Select 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
"Purchase of Shares."
------------------
This Statement of Additional Information of the Fund is not a prospectus
and should be read in conjunction with the Prospectus of the Fund, dated
September __, 1999 (the "Prospectus"), which has been filed with the Securities
and Exchange Commission (the "Commission") and can be obtained, without charge,
by calling (800) MER-FUND or by writing the Fund at the above address. The
Prospectus is incorporated by reference into this Statement of Additional
Information, and this Statement of Additional Information is incorporated by
reference into the Prospectus. The Fund's audited financial statements are
incorporated in this Statement of Additional Information by reference to its
1999 annual report to shareholders. You may request a copy of the annual report
or the Prospectus at no charge by calling (800) 456-4587 ext. 789 between 8:00
a.m. and 8:00 p.m. on any business day.
------------------
Merrill Lynch Asset Management -- Manager
Merrill Lynch Funds Distributor -- Distributor
The date of this Statement of Additional Information is September __, 1999.
------------------
<PAGE>
TABLE OF CONTENTS
Page
----
Investment Objective and Policies ......................................... 2
Types of Issuers/Quality Standards ..................................... 2
Description of Adjustable Rate Securities .............................. 5
Description of Other Securities ........................................ 7
Description of Money Market Securities ................................. 8
Special Considerations and Risk Factors ................................ 8
Portfolio Strategies Involving Interest Rate Transactions,
Options and Futures .................................................. 10
Other Investment Policies and Practices ................................ 15
Investment Restrictions ................................................ 17
Portfolio Turnover ..................................................... 19
Management of the Fund .................................................... 19
Directors and Officers ................................................. 19
Compensation of Directors .............................................. 20
Management and Advisory Arrangements ................................... 21
Code of Ethics ......................................................... 22
Purchase of Shares ........................................................ 23
Initial Sales Charge Alternatives -- Class A and Class D Shares ........ 23
Deferred Sales Charge Alternatives -- Class B and Class C Shares ....... 27
Distribution Plans ..................................................... 29
Limitations on the Payment of Deferred Sales Charges ................... 31
Redemption of Shares ...................................................... 32
Redemption ............................................................. 32
Repurchase ............................................................. 33
Reinstatement Privilege -- Class A and Class D Shares .................. 33
Pricing of Shares ......................................................... 33
Determination of Net Asset Value ....................................... 33
Computation of Offering Price Per Share ................................ 34
Portfolio Transactions .................................................... 34
Shareholder Services ...................................................... 36
Investment Account ..................................................... 36
Exchange Privilege ..................................................... 36
Fee-Based Programs ..................................................... 38
Retirement and Education Savings Plans ................................. 39
Automatic Investment Plans ............................................. 39
Automatic Dividend Reinvestment Plan ................................... 39
Systematic Withdrawal Plan ............................................. 39
Dividends and Taxes ....................................................... 40
Dividends .............................................................. 40
Taxes .................................................................. 41
Tax Treatment of Interest Rate Transactions, Options and Futures ....... 42
Performance Data .......................................................... 43
General Information ....................................................... 45
Description of Shares .................................................. 45
Independent Auditors ................................................... 46
Custodian .............................................................. 46
Transfer Agent ......................................................... 46
Legal Counsel .......................................................... 46
Reports to Shareholders ................................................ 46
Shareholder Inquiries .................................................. 46
Additional Information ................................................. 46
Financial Statements ...................................................... 47
<PAGE>
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to seek high current income
consistent with a policy of limiting the degree of fluctuation in the net asset
value of Fund shares from movements in interest rates. The Fund will seek to
achieve its objective by investing at least 65% of its total assets in
adjustable rate securities ("Adjustable Rate Securities"). Adjustable Rate
Securities bear interest at rates that adjust at periodic intervals in
conjunction with changes in market levels of interest rates. The Adjustable Rate
Securities in which the Fund will invest will consist principally of
mortgage-backed and asset-backed securities. Such securities will be issued or
guaranteed by agencies or instrumentalities of the United States or be rated at
least AA by Standard & Poor's ("S&P") or Aa by Moody's Investor Services, Inc.
("Moody's"). The investment objective and policies set forth in the first two
sentences of this paragraph are fundamental policies and may not be changed
without shareholder approval.
The 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 collateral backing MBS and ABS 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 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 may invest may also
include debentures of the Federal National Mortgage Association which bear
interest at an adjustable rate. See "Investment Objective and Policies --
Description of Other Securities" for a description of such debentures.
Types of Issuers/Quality Standards
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. 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
2
<PAGE>
default ensures ultimate payment of the obligations on at least a portion of the
assets in the pool. Such protection may be provided through guarantees,
insurance policies or letters of credit obtained by the issuer or sponsor from
third parties, through various means of structuring the transaction or through a
combination of such approaches. The Fund will not pay any additional fees for
such credit support, although the existence of credit support may increase the
price of a security.
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. 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 the 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 I hereto.
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. 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
3
<PAGE>
other eligible mortgage loans. The Housing Act provides that the full faith and
credit of the United States Government is pledged to the payment of all amounts
that may be required to be paid under any guarantee. In order to meet its
obligations under such guarantee, GNMA is authorized to borrow from the United
States Treasury with no limitations as to amount.
GNMA pass-through MBSs may represent a pro rata interest in one or more
pools of the following types of mortgage loans: (i) fixed rate level payment
mortgage loans; (ii) fixed rate graduated payment mortgage loans; (iii) fixed
rate growing equity mortgage loans; (iv) fixed rate mortgage loans secured by
manufactured (mobile) homes; (v) mortgage loans on multifamily residential
properties under construction; (vi) mortgage loans on completed multifamily
projects; (vii) fixed rate mortgage loans as to which escrowed funds are used to
reduce the borrower's monthly payments during the early years of the mortgage
loans ("buydown" mortgage loans); (viii) mortgage loans that provide for
adjustments in payments based on periodic changes in interest rates or in other
payment terms of the mortgage loans; and (ix) mortgage-backed serial notes.
Federal National Mortgage Association. FNMA is a federally chartered and
privately owned corporation established under the Federal National Mortgage
Association Charter Act. FNMA was originally organized in 1938 as a United
States Government agency to add greater liquidity to the mortgage market. FNMA
was transformed into a private sector corporation by legislation enacted in
1968. FNMA 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.
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 Untied 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 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
4
<PAGE>
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.
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 offered quotations to leading banks in the London interbank market for
Eurodollar deposits of a specified duration ("LIBOR") and (v) the cost of funds
of member institutions for the Federal Home Loan Bank ("FHLB") of San Francisco
("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.
The interest rates paid on Adjustable Rate Securities are generally
readjusted periodically to an increment over the chosen interest rate index.
Such readjustments typically occur at intervals ranging from one to sixty
months. The degree of volatility in the market value of the Fund's portfolio and
of the net asset value of Fund shares will be a function primarily of the length
of the adjustment period and the degree of volatility in the applicable indexes.
It will also be a function of the maximum increase or decrease of the interest
rate adjustment on any one adjustment date, in any one year and over the life of
the securities. These maximum increases and decreases are typically referred to
as "caps" and "floors," respectively. The Fund does not seek to maintain an
overall average cap or floor, although the Manager will consider caps or floors
in selecting Adjustable Rate Securities for the Fund.
While the Fund does not attempt to maintain a constant net asset value per
share, during periods in which short term interest rates move within the caps
and floors of the Fund's portfolio the fluctuation in the market value of the
Adjustable Rate Securities portfolio is expected to be relatively limited, since
the interest rate on the portfolio will adjust to market rates within a short
period of time. In periods of substantial short term volatility in short term
interest rates, the value of the portfolio may fluctuate more substantially
because the caps and floors of the Adjustable Rate Securities in the portfolio
may not permit the interest rate to adjust to the full extent of the movements
in short term rates during any one adjustment period. In the event of dramatic
increases in interest rates, the lifetime caps on the Adjustable Rate Securities
may prevent such securities from adjusting to prevailing
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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.
There are many types of CMO Structures. Most CMOs are structured with
multiple classes. Each class is issued at a fixed or, as in the case of
adjustable rate CMOs, a floating coupon rate, and has a specified maturity or
final distribution date. The interest rate paid on CMOs with a floating coupon
rate may adjust regardless of whether the mortgage loans or underlying CMO
Collateral pay a fixed or a floating rate. Principal prepayments on the CMO
Collateral may cause the CMOs to be retired substantially earlier than their
stated maturities or final distribution dates. Interest is paid or accrues on
all classes of the CMOs on a monthly, quarterly or semiannual basis. The
principal of and interest on the CMO Collateral may be allocated among the
several classes of a CMO in many ways. In one structure, payments of principal,
including any principal prepayments, on the CMO Collateral are applied to the
classes of the CMO in the order of their respective stated maturities or final
distribution dates, so that no payment of principal will be made on any class of
CMOs until all other classes having an earlier stated maturity or final
distribution date have been paid in full. For example, 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
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. 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. For example,
Planned Amortization Class CMOs ("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.
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
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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
prevalent 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.
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
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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 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
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mortgages is likely to increase, although a number of other factors may also
influence the prepayment rate, such as the acceleration of mortgage payments due
to transfers of mortgaged properties, liquidations due to default and
refinancings of existing loans. No assurance can be given as to the rate and
timing of principal prepayments on mortgage loans underlying MBSs. High
prepayment rates may have an adverse effect on the value of MBS securities and
in particular SMBSs, such as IOs.
Payments of principal of and interest on MBSs and ABSs are made more
frequently than are payments on conventional debt securities. In addition,
holders of MBSs and of certain ABSs (such as ABSs backed by home equity loans)
may receive unscheduled payments of principal at any time representing
prepayments on the underlying mortgage loans or financial assets. Such
prepayments may usually be made by the related obligor without penalty.
Prepayment rates are affected by changes in prevailing interest rates and
numerous other economic, geographic, social and other factors. (ABSs backed by
other than home equity loans do not generally prepay in response to changes in
interest rates, but may be subject to prepayments in response to other factors.)
Changes in the rate of prepayments will generally affect the yield to maturity
of the security. Moreover, when the holder of the security attempts to reinvest
prepayments or even the scheduled payments of principal and interest, it may
receive a rate of interest which is higher or lower than the rate on the MBS or
ABS originally held. Another consideration is that to the extent that MBSs or
ABSs are purchased at a premium, mortgage foreclosures and principal prepayments
may result in loss to the extent of premium paid. On the other hand, where such
securities are bought at a discount, both scheduled payments of principal and
unscheduled prepayments will increase current and total returns and will
accelerate the recognition of income which, when distributed to shareholders,
will be taxable as ordinary income. The Manager will consider remaining
maturities or estimated average lives of MBSs and ABSs in selecting them for the
Fund. Finally, ABSs may present certain risks not present in MBSs. Additionally,
assets underlying ABSs such as credit-card receivables are generally unsecured,
and debtors are entitled to the protection of various state and Federal consumer
protection laws. Some of those laws give a right of set-off, which may reduce
the balance owed.
Adjustable Rate Securities have several characteristics that should be
considered before investing in the Fund. As indicated above, the interest rate
reset features of Adjustable Rate Securities held by the Fund will reduce the
effect on the net asset value of Fund shares caused by changes in market
interest rates. See "Investment Objective and Policies -- Description of
Adjustable Rate Securities." However, the market value of Adjustable Rate
Securities and, therefore, the Fund's net asset value, may vary to the extent
that the current interest rate on such securities differs from market interest
rates during periods between the interest reset dates. These variations in value
occur inversely to changes in the market interest rates. Thus, if market
interest rates rise above the current rates on the securities, the value of the
securities will decrease; conversely, if market 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
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mortgage loans, thereby decreasing the capital appreciation potential of
Adjustable Rate Securities. In this regard, the Fund is not designed for
investors seeking capital appreciation.
As described above under "Description of Adjustable Rate Securities --
Indexed and Inverse Securities," the Fund may invest in Adjustable Rate
Securities whose potential investment return is inversely based on the change in
particular indices. Such securities may have the effect of providing a degree of
investment leverage because they may increase or decrease in value at a rate
that is a multiple of the changes in applicable indices. As a result, the market
values of such securities will generally be more volatile than the market values
of fixed-rate securities.
Portfolio Strategies Involving Interest Rate Transactions, Options and Futures
The Fund may engage in various portfolio strategies to seek to increase
its return through the use of options on portfolio securities and to hedge its
portfolio against movements in interest rates. The Fund has authority to engage
in interest rate transactions in order to hedge against interest rate movements,
purchase call and put options on securities, write (i.e., sell) covered call and
put options on its portfolio securities, and engage in hedging transactions in
financial futures, and related options on such futures. Each of these portfolio
strategies is described below.
Although certain risks are involved in interest rate, options and futures
transactions, the Manager believes that, because the Fund will (i) write only
covered options on portfolio securities, and (ii) engage in other transactions
only for hedging purposes, these portfolio strategies will not subject the Fund
to the risks frequently 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.
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, such
as interest rate swaps and the purchase or sale of interest rate caps and
floors. 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
preserve a return or spread on a particular investment or a 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 to hedge its portfolio of Adjustable Rate Securities against
fluctuations in interest rates and not as a speculative investment. 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 and Taxes."
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 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
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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, 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. 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 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 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. 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 liquid investments of the Fund exceeds 15% of
the Fund's total assets.
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.
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The Fund also may write put options that give the holder of the option the
right to sell the underlying security to the Fund at the stated exercise price.
The Fund will receive a premium for writing a put option that increases the
Fund's return. The Fund writes only covered put options which means that so long
as the Fund is obligated as the writer of the option it will, through its
custodian, have deposited and maintained cash, cash equivalents, U.S. Government
securities or other liquid securities with the Fund's custodian with a value
equal to or greater than the exercise price of the underlying securities. By
writing a put, the Fund will be obligated to purchase the underlying security at
a price that may be higher than the market value of that security at the time of
exercise for as long as the option is outstanding. The Fund may engage in
closing transactions in order to terminate put options that it has written.
Options referred to herein 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. 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 may purchase either options traded on an exchange or OTC options.
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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 offering all or a portion of the depreciation in the market value
of the Fund's investments which are being hedged. While the Fund will incur
commission expenses in selling and closing out futures positions, these
commissions are generally less than the transaction expenses which the Fund
would have incurred had the Fund sold portfolio securities in order to reduce
its exposure to increases in interest rates. The Fund also may purchase
financial futures contracts in anticipation of a decline in interest rates when
it is not fully invested in a particular market in which it intends to make
investments to gain market exposure that may in part or entirely offset an
increase in the cost of securities it intends to purchase. It is anticipated
that, in a substantial majority of these transactions, the Fund will purchase
securities upon termination of the futures contract.
The Fund also has authority to purchase and write call and put options on
futures contracts in connection with its hedging activities. Generally, these
strategies are utilized under the same market and market sector conditions
(i.e., conditions relating to specific types of investments) in which the Fund
enters into futures transactions. The Fund may purchase put options or write
call options on futures contracts rather than selling the underlying futures
contract in anticipation of a decrease in the market value of a security or an
increase in interest rates. Similarly, the Fund may purchase call options, or
write put options on futures contracts, as a substitute for the purchase of such
futures to hedge against the increased cost resulting from an increase in the
market value or a decline in interest rates of securities which the Fund intends
to purchase.
The Fund may engage in options and futures transactions on exchanges and
options in the over-the-counter markets ("OTC options"). In general,
exchange-traded contracts are third-party contracts (i.e., performance of the
parties' obligations is guaranteed by an exchange or clearing corporation) with
standardized strike prices and expiration dates. OTC options transactions are
two-party contracts with price and terms negotiated by the buyer and seller. See
"Restrictions on OTC Options" below for information as to restrictions on the
use of OTC options.
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.
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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 herein, 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.
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 successful use of options and futures also depends on the
Manager's ability to predict correctly price movements in the market involved in
a particular options or futures transaction.
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Prior to exercise or expiration, an exchange-traded option position can
only be terminated by entering into a closing purchase or sale transaction. This
requires a secondary market on an exchange for call or put options of the same
series. The Fund will enter into an option or futures transaction on an exchange
only if there appears to be a liquid secondary market for such options or
futures. However, there can be no assurance that a liquid secondary market will
exist for any particular call or put option or futures contract at any specific
time. Thus, it may not be possible to close an option or futures position. In
the case of a futures position or an option on a futures position written by the
Fund, in the event of adverse price movements, the Fund would continue to be
required to make daily cash payments of variation margin. In such situations, if
the Fund has insufficient cash, it may have to sell portfolio securities to meet
daily variation margin requirements at a time when it may be disadvantageous to
do so. In addition, the Fund may be required to take or make delivery of the
currency underlying futures contracts it holds. The inability to close options
and futures positions also could have an adverse impact on the Fund's ability to
hedge effectively its portfolio. There is also the risk of loss by the Fund of
margin deposits in the event of bankruptcy of a broker with whom the Fund has an
open position in a futures contract or related option. The risk of loss from
investing in futures transactions is theoretically unlimited.
The exchanges on which the Fund intends to conduct options transactions
have generally established limitations governing the maximum number of call or
put options on the same underlying currency (whether or not covered) that may be
written by a single investor, whether acting alone or in concert with others
(regardless of whether such options are written on the same or different
exchanges or are held or written on one or more accounts or through one or more
brokers). "Trading limits" are imposed on the maximum number of contracts that
any person may trade on a particular trading day. An exchange may order the
liquidation of positions found to be in violation of these limits and it may
impose other sanctions or restrictions. The Manager does not believe that these
trading and position limits will have any adverse impact on the portfolio
strategies for hedging the Fund's portfolio.
Other Investment Policies and Practices
Repurchase Agreements and Purchase and Sale Contracts. The Fund may invest
in securities pursuant to repurchase agreements and purchase and sale contracts.
Repurchase agreements and purchase and sale contracts may be entered into only
with a member bank of the Federal Reserve System or primary dealer in U.S.
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. The Fund may from time to time lend
securities from its portfolio with a value not exceeding 33 1/3% of its total
assets, to banks, brokers and other financial institutions and receive
collateral in cash or securities issued or guaranteed by the United States
Government which will be maintained at all times in an amount equal to at least
102% of the current market value of the loaned securities. During the period of
this loan, the Fund receives the income on the loaned securities and either
receives the income on the collateral or other compensation (i.e., negotiated
loan premium or fee) for entering into the loan and thereby
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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 money market
securities. Dollar rolls in which the Fund may invest will be limited to covered
rolls.
Illiquid or Restricted Securities. The Fund may invest up to 15% of its
net assets in securities that lack an established secondary trading market or
otherwise are considered illiquid. Liquidity of a security relates to the
ability to dispose easily of the security and the price to be obtained upon
disposition of the security, which may be less than would be obtained for a
comparable more liquid security. Illiquid securities may trade at a discount
from comparable, more liquid investments. Investment of the Fund's assets in
illiquid securities may restrict the ability of the Fund to dispose of its
investments in a timely fashion and for a fair price as well as its ability to
take advantage of market opportunities. The risks associated with illiquidity
will be particularly acute where the Fund's operations require cash, such as
when the Fund redeems shares or pays dividends, and could result in the Fund
borrowing to meet short-term cash requirements or incurring capital losses on
the sale of illiquid investments.
The Fund may invest in securities that are not registered under the
Securities Act or that are subject to trading restrictions under the laws of a
foreign jurisdiction ("restricted securities"). Restricted securities may be
sold in private placement transactions between the issuers and their purchasers
and may be neither listed on an exchange nor traded in other established
markets. In many cases, privately placed securities may not be freely
transferable under the laws of the applicable jurisdiction or due to contractual
restrictions on resale. As a result of the absence of a public trading market,
privately placed securities may be less liquid and more difficult to value than
publicly traded securities. To the extent that privately placed securities may
be resold in privately negotiated transactions, the prices realized from the
sales, due to illiquidity, could be less than those originally paid by the Fund
or less than their fair market value. In addition, issuers whose securities are
not publicly traded may not be subject to
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the disclosure and other investor protection requirements that may be applicable
if their securities were publicly traded. If any privately placed securities
held by the Fund are required to be registered under the securities laws of one
or more jurisdictions before being resold, the Fund may be required to bear the
expenses of registration. Certain of the Fund's investments in private
placements may consist of direct investments and may include investments in
smaller, less-seasoned issuers, which may involve greater risks. These issuers
may have limited product lines, markets or financial resources, or they may be
dependent on a limited management group. In making investments in such
securities, the Fund may obtain access to material nonpublic information which
may restrict the Fund's ability to conduct portfolio transactions in such
securities.
144A Securities. The Fund may purchase restricted securities that can be
offered and sold to "qualified institutional buyers" under Rule 144A under the
Securities Act. The Board of Directors has determined to treat as liquid Rule
144A securities that are either freely tradable in their primary markets
offshore or have been determined to be liquid in accordance with the policies
and procedures adopted by the Fund's Board. The Board of Directors has adopted
guidelines and delegated to the Investment Adviser 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. Since it is not possible to predict with
assurance exactly how this market for restricted securities sold and offered
under Rule 144A will continue to develop, the Board of Directors will carefully
monitor the Fund's investments in these securities. This investment practice
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 securities.
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 Investment Company Act of 1940, as
amended (the "Investment Company 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 331/3% 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.
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8. Underwrite securities of other issuers except insofar as the Fund
technically may be deemed an underwriter under the Securities Act of 1933,
as amended (the "Securities Act") in selling portfolio securities.
9. Purchase or sell commodities or contracts on commodities, except
to the extent that the Fund may do so in accordance with applicable law
and the Fund's Prospectus and Statement of Additional Information, as they
may be amended from time to time, and without registering as a commodity
pool operator under the Commodity Exchange Act.
Under the non-fundamental investment restrictions, the Fund may not:
a. Purchase securities of other investment companies, except to the extent
such purchases are permitted by applicable law. As a matter of policy, however,
the Fund will not purchase shares of any registered open-end investment company
or registered unit investment trust, in reliance on Section 12(d)(1)(F) or (G)
(the "fund of funds" provisions) of the Investment Company Act at any time the
Fund's shares are owned by another investment company that is part of the same
group of investment companies as the Fund.
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 taken at market value 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 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.
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, theFund has adopted an investment policy pursuant to which
it will not purchase or sell OTC options if, as a result of such transactions,
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 call
options currently outstanding which were sold by the Fund and margin deposits on
the Fund's existing OTC options on futures contracts exceed 10% of the net
assets of the Fund, taken at market value, together with all other assets of the
Fund which are illiquid or are not otherwise readily marketable. However, if an
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 if 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
securities 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 as to OTC options is not a fundamental
policy of the Fund and may be amended by the Board of 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
theCommission staff of its position.
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The Board of Directors may draft guidelines and delegate to the Manager
the daily function of monitoring the liquidity of restricted securities,
including Rule 144A securities. The Board will, however, maintain sufficient
oversight and be ultimately responsible for the determinations. The Board has
determined that securities that are freely tradable in their primary market
overseas should be deemed liquid.
Because of the affiliation of Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("Merrill Lynch") with theInvestment Adviser, 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 would be
prohibited from engaging in portfolio transactions with Merrill Lynch or any of
its affiliates acting as principal.
Portfolio Turnover
Generally, the Fund does not purchase securities for short-term trading
profits. The Manager will effect portfolio transactions without regard to the
time the securities have been held, if, in its judgment, such transactions are
advisable in light of a change in circumstances of a particular company or
within a particular industry or in general market, financial or economic
conditions. As a result of its investment policies, under certain market
conditions the Fund's portfolio turnover rate may be higher than that of other
investment companies; however, it is extremely difficult to predict portfolio
rates with any degree of accuracy. The portfolio turnover rate is calculated by
dividing the lesser of the Fund's annual sales or purchases of portfolio
securities (exclusive of purchases or sales of U.S. government securities and
all other securities whose maturities at the time of acquisition were one year
or less) by the monthly average value of the securities in the portfolio during
the year. A high portfolio turnover may result in negative tax consequences,
such as an increase in capital gain dividends. High portfolio turnover may also
involve correspondingly greater transaction costs in the form of dealer spreads
and brokerage commissions, which are borne directly by the Fund.
MANAGEMENT OF THE FUND
Directors and Officers
The Directors of the Fund consist of seven individuals, five of whom are
not "interested persons" of the Fund as defined in the Investment Company Act
(the "non-interested Directors"). 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.
Information about the Directors, executive officers and the 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 each
Director, executive officer and the portfolio manager is P.O. Box 9011,
Princeton, New Jersey 08543-9011.
TERRY K. GLENN (58) -- President and Director(1)(2) -- Executive Vice
President of the Manager and Fund Asset Management, L.P. ("FAM") (which terms as
used herein include their corporate predecessors) since 1983; President of
Princeton Funds Distributors, Inc. ("PFD") since 1986 and Director thereof since
1991; Executive Vice President and Director of Princeton Services, Inc.
("Princeton Services") since 1993; President of Princeton Administrators, L.P.
since 1988.
JOE GRILLS (64) -- 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 1993; Assistant Treasurer of
International Business Machines Incorporated ("IBM") and Chief Investment
Officer of IBM Retirement Funds from 1986 until 1993; Member of the Investment
Advisory Committee of the State of New York Common Retirement Fund and the
Howard Hughes Medical Institute since 1997; Director, Duke Management Company
since 1992 and Vice Chairman since 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; Director, Montpelier
Foundation since 1998.
WALTER MINTZ (70) -- Director(2) -- 1114 Avenue of the Americas, New York,
New York 10036. Special Limited Partner of Cumberland Associates (investment
partnership) since 1982.
19
<PAGE>
ROBERT S. SALOMON, JR. (62) -- 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 (68) -- 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 (66) -- 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.
ARTHUR ZEIKEL (67) -- Director(1)(2) -- 300 Woodland Avenue, Westfield,
New Jersey 07090. Chairman of the Manager and FAM from 1997 to 1999 and
President thereof from 1977 to 1997; Chairman of Princeton Services from 1997 to
1999, Director thereof from 1993 to 1999 and President thereof from 1993 to
1997; Executive Vice President of Merrill Lynch & Co., Inc. ("ML & Co.") from
1990 to 1999.
JOSEPH T. MONAGLE, JR. (51) -- Senior Vice President -- Senior Vice
President of the Manager and FAM since 1990; Department Head of Global Fixed
Income Division of the Manager and FAM since 1997: Senior Vice President of
Princeton Services since 1993.
JEFFREY B. HEWSON (48) -- Senior Vice President -- Director (Global Fixed
Income) of the Manager since 1998; Vice president of the Manager from 1989 to
1998; Portfolio Manager of the Manager since 1985.
GREGORY MARK MAUNZ (46) -- Senior Vice President -- First Vice President
of the Manager since 1997; Vice President of the Manager from 1985 to 1997;
Portfolio Manager of the Manager since 1984.
TED MAGNANI (37) -- Vice President -- Vice President of the Manager since
1992.
DONALD C. BURKE (39) -- Vice President and Treasurer(1)(2) -- Senior Vice
President and Treasurer of the Manager and FAM since 1999; Senior Vice President
and Treasurer of Princeton Services since 1999; First Vice President of the
Investment Adviser from 1997 to 1999; Vice President of the Investment Adviser
from 1990 to 1997; Director of Taxation of the Investment Adviser since 1990;
Vice President of PFD since 1999.
IRA P. SHAPIRO (36) -- Secretary -- First Vice President of the Manager
since 1998; Director (Legal Advisory) of the Manager from 1997 to 1998; Vice
President of the Manager and FAM from 1996 to 1997; Attorney 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 trustee, director or officer of certain
other investment companies for which the Investment Adviser or FAM acts as
the investment adviser or manager.
(3) Member of the Fund's Audit and Nominating Committee, which is responsible
for the selection of the independent auditors and the selection and
nomination of non-interested Directors.
As of September , 1999, the Directors and officers of the Fund as a group
(13 persons) owned an aggregate of less than 1% of the outstanding shares of the
Fund. At such date, Mr. Zeikel, a Director of the Fund, Mr. Glenn, a Director
and officer of the Fund, and the other officers of the Fund owned an aggregate
of less than 1% of the outstanding shares of common stock of ML & Co.
Compensation of Directors
The Fund pays each non-interested Director a fee of $1,500 per year plus
$250 per Board meeting attended. The Fund also compensates each member of the
Audit and Nominating Committee (the "Committee"), which consists of the
non-interested Directors at a rate of $1,500 per year, plus $250 per Committee
meeting attended. The Fund reimburses each non-interested Director for his
out-of-pocket expenses relating to attendance at Board and Committee meetings.
20
<PAGE>
The following table shows the compensation earned by the non-interested
Directors for the fiscal year ended May 31, 1999 and the aggregate compensation
paid to them from all registered investment companies advised by the Manager and
its affiliate, FAM ("MLAM/FAM-advised funds"), for the calendar year ended
December 31, 1998.
<TABLE>
<CAPTION>
Aggregate
Pension or Estimated Compensation from
Retirement Benefits Annual Fund and Other
Position with Compensation Accrued as Part of Benefits upon MLAM/FAM-
Name Fund From Fund Fund Expense Retirement Advised Funds(1)
- ----- ----------- ------------ ----------------- ------------- ----------------
<S> <C> <C> <C> <C> <C>
Joe Grills ....................... Director $ None None $198,333
Walter Mintz ..................... Director $ None None $178,583
Robert S. Salomon, Jr. ........... Director $ None None $178,583
Melvin R. Seiden ................. Director $ None None $178,583
Stephen B. Swensrud .............. Director $ None None $195,583
</TABLE>
- ------------
(1) The directors serve on the boards of MLAM/FAM-advised funds as follows:
Joe Grills (23 registered investment companies consisting of 55
portfolios), Walter Mintz (21 registered investment companies consisting
of 42 portfolios), Robert S. Salomon, Jr. (21 registered investment
companies consisting of 42 portfolios), Melvin R. Seiden (21 registered
investment companies consisting of 42 portfolios), Stephen B. Swensrud (24
registered investment companies consisting of 57 portfolios).
Directors of the Fund may purchase Class A shares of the Fund at net asset
value. See "Purchase of Shares -- Initial Sales Charge Alternatives -- Class A
and Class D Shares -- Reduced Initial Sales Charges -- Purchase Privilege of
Certain Persons."
Management and Advisory Arrangements
Investment Advisory Services. The Manager provides the Fund with
investment advisory and management services. Subject to the supervision 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 responsibility for
making decisions to buy, sell or hold a particular security rests 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.
Investment Advisory Fee. The Fund has entered into a management agreement
with the Manager (the "Management Agreement"), pursuant to which 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. The table below sets forth
information about the total management fees paid by the Fund to the Manager for
the periods indicated.
Investment Advisory
Fiscal Year Ended May 31, Fee
------------------------ ---
1999 .......................................... $
1998 .......................................... $3,593,905
1997 .......................................... $3,689,185
Payment of Fund Expenses. 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. 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,
prospectuses and statements of additional information, except to the extent paid
by Merrill Lynch Funds Distributor, a division of PFD (the "Distributor");
charges of the custodian and sub-custodian, and the transfer agent; expenses of
redemption of shares; SEC fees; expenses of registering the shares under
Federal, state or foreign laws; fees and expenses of non-interested Directors;
accounting and pricing costs (including the daily calculations of net asset
value); insurance; interest; brokerage costs; litigation and other extraordinary
or non-recurring expenses; and other expenses properly payable by the Fund.
Accounting services are provided for the Fund by the Manager and the Fund
reimburses the Manager for its costs in connection with such services on a
semi-annual basis. The Distributor will pay certain promotional expenses of the
Fund incurred in connection with the offering of shares
21
<PAGE>
of the Fund. Certain expenses will be financed by the Fund pursuant to
distribution plans in compliance with Rule 12b-1 under the Investment Company
Act. See "Purchase of Shares -- Distribution Plans."
Organization of the Manager. The Manager is a limited partnership, the
partners of which are ML & Co., a financial services holding company and the
parent of Merrill Lynch, 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 continue in effect for a period of two years from
the date of execution and will remain in effect from year to year if approved
annually (a) by the Directors of the Fund 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 or by
vote of the shareholders of the Fund.
Transfer Agency Services. Financial Data Services, Inc. (the "Transfer
Agent"), 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 a fee of
$11.00 per Class A or Class D account and $14.00 per Class B or Class C account
and is entitled to reimbursement for certain transaction charges and
out-of-pocket expenses incurred by the Transfer Agent under the Transfer Agency
Agreement. Additionally, a $.20 monthly closed account charge will be assessed
on all accounts which close during the calendar year. Application of this fee
will commence the month following the month the account is closed. At the end of
the calendar year, no further fees will be due. For purposes of the Transfer
Agency Agreement, the term "account" includes a shareholder account maintained
directly by the Transfer Agent and any other account representing the beneficial
interest of a person in the relevant share class on a recordkeeping system,
provided the recordkeeping system is maintained by a subsidiary of ML & Co.
Distribution Expenses. 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.
Code of Ethics
The Board of Directors of the Fund has adopted a Code of Ethics under Rule
17j-1 of 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 pre-clear any personal
securities investment (with limited exceptions, such as government securities).
The pre-clearance 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).
22
<PAGE>
PURCHASE OF SHARES
Reference is made to "How to Buy, Sell, Transfer and Exchange Shares" in
the Prospectus.
The Fund offers 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 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 (also known as service 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 contingent deferred sales charges ("CDSCs"), distribution fees
and account maintenance fees that are imposed on Class B and Class C shares, as
well as the account maintenance fees that are imposed on Class D shares, are
imposed directly against those classes and not against all assets of the Fund
and, accordingly, such charges do not affect the net asset value of any other
class or have any impact on investors choosing another sales charge option.
Dividends paid by the Fund for each class of shares are calculated in the same
manner at the same time and differ only to the extent that account maintenance
and distribution fees and any incremental transfer agency costs relating to a
particular class are borne exclusively by that class. 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 Merrill Lynch Select Pricing(SM) System is used by more than 50
registered investment companies advised by the Investment Adviser or FAM. Funds
advised by the Investment Adviser or FAM that utilize the Merrill Lynch Select
Pricing SM System are referred to herein as "Select Pricing Funds."
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. 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.
Initial Sales Charge Alternatives -- Class A and Class D Shares
Investors who prefer an initial sales charge alternative may elect to
purchase Class D shares or, if an eligible investor, Class A shares. Investors
choosing the initial sales charge alternative who are eligible to purchase Class
A shares should purchase Class A shares rather than Class D shares because there
is an account maintenance fee imposed on Class D shares. Investors qualifying
for significantly reduced initial sales charges may find the initial sales
charge alternative particularly attractive because similar sales charge
reductions are not available with respect to the deferred sales charges imposed
in connection with purchases of Class B or Class C shares. Investors not
qualifying for reduced initial sales charges who expect to maintain their
investment for an extended period of time also may elect to purchase Class A or
Class D shares, because over time the accumulated ongoing account maintenance
and distribution fees on Class B or Class C shares may exceed the initial sales
charges and, in the case of Class D shares, the account maintenance fee.
Although some investors who previously purchased Class A shares may no longer be
eligible to purchase Class A shares of other Select Pricing Funds, those
previously purchased Class A shares, together with Class B, Class C and Class D
share holdings, will count toward a right of accumulation which may qualify the
investor for a reduced initial sales charge 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.
23
<PAGE>
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 or her spouse and their children under
the age of 21 years purchasing shares for his, her or their own account and to
single purchases by a trustee or other fiduciary purchasing shares for a single
trust estate or single fiduciary account although more than one beneficiary is
involved. The term "purchase" also includes purchases by any "company," as that
term is defined in the investment company act, but does not include purchases by
any such company that has not been in existence for at least six months or which
has no purpose other than the purchase of shares of the fund or shares of other
registered investment companies at a discount; provided, however, that it shall
not include purchases by any group of individuals whose sole organizational
nexus is that the participants therein are credit cardholders of a company,
policyholders of an insurance company, customers of either a bank or
broker-dealer or clients of an investment adviser.
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 who currently own Class A shares in a shareholder account are entitled
to purchase additional Class A shares of the Fund in that account. Certain
employee-sponsored retirement or savings plans, including eligible 401(k) plans,
may purchase Class A shares at net asset value provided such plans meet the
required minimum number of eligible employees or required amount of assets
advised by MLAM or any of its affiliates. Class A shares are available at net
asset value to corporate warranty insurance reserve fund programs and U.S.
branches of foreign banking institutions provided that the program has $3
million or more initially invested in Select Pricing 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 certain 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. Certain persons who acquired shares of certain MLAM-advised
closed-end funds in their initial offerings 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 shares of the Fund if certain conditions
are met. In addition, Class A shares of the Fund and certain other Select
Pricing Funds are offered at net asset value to shareholders of Merrill Lynch
Senior Floating Rate Fund, Inc. and, if certain conditions 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 Select Pricing
Funds.
Class A and Class D Sales Charge Information
<TABLE>
<CAPTION>
Class A Shares
- ---------------------------------------------------------------------------------------------
For the Fiscal Year Gross Sales Sales Charges Sales Charges CDSCs Received on
Ended Charges Retained By Paid To Redemption of
May 31, Collected Distributor Merrill Lynch Load-Waived Shares
----------------- ---------- ------------ ------------ ------------------
<S> <C> <C> <C> <C>
1999 $453 $0 $453 $0
1998 $ 0 $0 $ 0 $0
1997 $ 0 $0 $ 0 $0
</TABLE>
<TABLE>
<CAPTION>
Class D Shares
- ---------------------------------------------------------------------------------------------
For the Fiscal Year Gross Sales Sales Charges Sales Charges CDSCs Received on
Ended Charges Retained by Paid to Redemption of
May 31, Collected Distributor Merrill Lynch Load-Waived Shares
----------------- ---------- ------------ ------------ ------------------
<S> <C> <C> <C> <C>
1999 $11,029 $ 797 $10,232 $0
1998 $14,227 $1,219 $13,008 $0
1997 $11,286 $ 934 $10,352 $0
</TABLE>
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.
24
<PAGE>
Reduced Initial Sales Charges
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.
Reinvested Dividends. No initial sales charges are imposed upon Class A
and Class D shares issued as a result of the automatic reinvestment of
dividends.
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 Select Pricing 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 Intent. 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
Select Pricing Funds made within a 13-month period starting with the first
purchase pursuant to a Letter of Intent. The Letter of Intent is available only
to investors whose accounts are established and maintained at the Fund's
Transfer Agent. The Letter of Intent is not available to employee benefit plans
for which Merrill Lynch provides plan participant recordkeeping services. The
Letter of Intent 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 Intent may be included under a
subsequent Letter of Intent 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 and Class D shares of the Fund and of other Select Pricing
Funds presently held, at cost or maximum offering price (whichever is higher),
on the date of the first purchase under the Letter of Intent, 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 Intent (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 at least 5.0% of the intended amount will be
held in escrow during the 13-month period (while remaining registered in the
name of the purchaser) for this purpose. The first purchase under the Letter of
Intent must be at least 5.0% 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 the further reduced percentage
sales charge that would be applicable to a single purchase equal to the total
dollar value of the Class A or Class D shares then being purchased under such
Letter, but there will be no retroactive reduction of the sales charge 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 Intent will be deducted from
the total purchases made under such Letter. An exchange from the Summit Cash
Reserves Fund into the Fund that creates a sales charge will count toward
completing a new or existing Letter of Intent from the Fund.
TMA(SM) Managed Trusts. Class A shares are offered at net asset value to
TMASM Managed Trusts to which Merrill Lynch Trust Company provides discretionary
trustee services.
Employee Access(SM) Accounts. Provided applicable threshold requirements
are met, either Class A or Class D shares are offered at net asset value to
Employee Access(SM) Accounts available through authorized employers. The initial
minimum investment for such accounts is $500, except that the initial minimum
investment for shares purchased for such accounts pursuant to the Automatic
Investment Program is $50.
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
25
<PAGE>
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. Additional information regarding purchases by employer-sponsored
retirement or savings plans and certain other arrangements is available
toll-free fromMerrill Lynch Business Financial Services at (800) 237-7777.
Purchase Privilege of Certain Persons. Directors of the Fund, members of
the Boards of other MLAM/FAM-advised investment companies, 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. The Fund realizes
economies of scale and reduction of sales-related expenses by virtue of the
familiarity of these persons with the Fund. Employees and directors or trustees
wishing to purchase shares of the Fund must satisfy the Fund's suitability
standards.
Class D shares of the Fund are offered at net asset value, without a sales
charge, to an investor that 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
shares 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 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 also offered at net asset value, without a
sales charge, to an investor that has a business relationship with a Merrill
Lynch Financial Consultant and that 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 ("notice") 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.
Class D shares of the Fund are offered at net asset value, without a sales
charge, to an investor that has a business relationship with a Merrill Lynch
Financial Consultant and that 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 shares of such
other mutual fund 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.
Closed-End Fund Investment Option. Class A shares of the Fund and certain
other Select Pricing Funds ("Eligible Class A Shares") are offered at net asset
value to shareholders of certain closed-end funds advised by FAM or MLAM 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 Select Pricing Funds
("Eligible Class D Shares"), if the following conditions are met. First, the
sale of closed-end fund shares must be made through Merrill Lynch, and the net
proceeds therefrom must be immediately reinvested in Eligible Class A or
Eligible 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.
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
26
<PAGE>
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 eligible fund in connection with a tender offer conducted
by the eligible fund and reinvest the proceeds immediately in the designated
class of shares of the Fund. This investment option is available only with
respect to eligible shares as to which no Early Withdrawal Charge or CDSC (each
as defined in the eligible fund's prospectus) is applicable. Purchase orders
from eligible fund shareholders wishing to exercise this investment option will
be accepted only on the day that the related tender offer terminates and will be
effected at the net asset value of the designated class of the Fund on such day.
Acquisition of Certain Investment Companies. Class D shares may be offered
at net asset value 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.
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 Select Pricing Funds.
Because no initial sales charges are deducted at the time of the 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 that do not qualify for
the 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 eight
years, and thereafter investors will be subject to lower ongoing fees.
The public offering price of Class B and Class C shares for investors
choosing the deferred sales charge alternatives is the next determined net asset
value per share without the imposition of a sales charge at the time of
purchase. See "Pricing of Shares -- Determination of Net Asset Value" below.
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. In determining whether a CDSC is applicable to a
redemption, the calculation will be determined in the manner that results in the
lowest applicable rate being charged. 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. It will be assumed that the
redemption is first of shares held for over four years or shares acquired
pursuant to reinvestment of dividends and then of shares held longest during the
four-year period. 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.
The following table sets forth the Class B CDSC:
CDSC as a Percentage
of Dollar Amount
Year Since Purchase Payment Made Subject to Charge
------------------------------- ----------------
0-1 ............................................ 4.0%
1-2 ............................................ 3.0%
2-3 ............................................ 2.0%
3-4 ............................................ 1.0%
4 and thereafter ............................... None
27
<PAGE>
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 upon dividend reinvestment. If at such time the investor makes
his or her first redemption of 50 shares (proceeds of $600), 10 shares will not
be subject to a CDSC 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).
The Class B CDSC may be waived on redemptions of shares in connection with
certain post-retirement withdrawals from an Individual Retirement Account
("IRA") or other retirement plan or following the death or disability (as
defined in the Internal Revenue Code of 1986, as amended) of a 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 or, if later, reasonably promptly following
completion of probate. The Class B CDSC also may be waived on redemptions of
shares by certain eligible 401(a) and 401(k) plans. The CDSC may also be waived
for any Class B shares that are purchased by eligible 401(k) or eligible 401(a)
plans that are rolled over into a Merrill Lynch or Merrill Lynch Trust Company
custodied IRA and held in such account at the time of redemption. The Class B
CDSC may be waived 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 may also be 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 may also be waived or its terms may be modified in connection with
certain fee-based programs. The Class B CDSC may also be waived in connection
with involuntary termination of an account in which Fund shares are held or for
withdrawals through the Merrill Lynch Systematic Withdrawal Plan. See
"Shareholder Services -- Fee Based Programs" and "-- Systematic Withdrawal
Plan."
Employer-Sponsored Retirement or Savings Plans and Certain Other
Arrangements. Certain employer-sponsored retirement or savings plans and certain
other arrangements may purchase Class B shares with a waiver of the CDSC upon
redemption, 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. Such
Class B shares will convert into Class D shares approximately ten years after
the plan purchases the first share of any Select Pricing 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.
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 the average daily 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 value 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 the 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.
In general, Class B shares of equity Select Pricing Funds will convert
approximately eight years after initial purchase and Class B shares of taxable
and tax-exempt fixed income Select Pricing 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 on to the holding period
for the shares acquired. The Conversion Period also may be modified for
investors that participate in certain fee-based programs. See "Shareholder
Services -- Fee-Based Programs."
28
<PAGE>
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.
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.
Contingent Deferred Sales Charges -- Class C Shares
Class C shares that are redeemed within one year of purchase may be
subject to a 1.0% CDSC charged as a percentage of the dollar amount subject
thereto. 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. 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. It will be assumed
that the redemption is first of shares held for over one year or shares acquired
pursuant to reinvestment of dividends and then of shares held longest during the
one-year period. 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. The Class
C CDSC may be waived in connection with involuntary termination of an account in
which Fund shares are held and withdrawals through the Merrill Lynch Systematic
Withdrawal Plans. See "Shareholder Services -- Systematic Withdrawal Plan." The
Class C CDSC of the Fund and certain other MLAM-advised mutual funds may be
waived with respect to Class C shares purchased by an investor with the net
proceeds of a tender offer made by certain MLAM-advised closed end funds,
including Merrill Lynch Senior Floating Rate Fund II, Inc. Such waiver is
subject to the requirement that the tendered shares shall have been held by the
investor for a minimum of one year and to such other conditions as are set forth
in the prospectus for the related closed end fund.
Class B and Class C Sales Charge Information
Class B Shares*
---------------------------------------------------------------
For the Fiscal Year CDSCs Received CDSCs Paid to
Ended May 31, by Distributor Merrill Lynch
------------------- -------------- -------------
1999 $ $
1998 $ $
1997 $ $
- ------------
* Additional Class B 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.
Class C Shares
---------------------------------------------------------------
For the Fiscal Year CDSCs Received CDSCs Paid to
Ended May 31, by Distributor Merrill Lynch
------------------- -------------- -------------
1999 $ $
1998 $ $
1997 $ $
Merrill Lynch compensates its Financial Consultants for selling Class B
and Class C shares at the time of purchase from its own funds. Proceeds from the
CDSC and the distribution fee are paid to the Distributor and are used in whole
or in part by the Distributor to defray the expenses of dealers (including
Merrill Lynch) related to providing distribution-related services to the Fund in
connection with the sale of the Class B and Class C shares, such as the payment
of compensation to financial consultants for selling Class B and Class C shares
from the dealer's own funds. 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.
See "Distribution Plans" below. 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.
Distribution Plans
Reference is made to "Fees and Expenses" 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
29
<PAGE>
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 Distribution Plans for Class B, Class C and Class D shares each
provides that the Fund pay 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 with respect to Class B, Class C and Class D shares. Each of those
classes has exclusive voting rights with respect to the 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).
The Distribution Plans for Class B and Class C shares each provides that
the Fund also pay 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 shares and 0.55% for Class C shares 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.
The Fund's Distribution Plans are subject to the provisions of Rule 12b-1
under the Investment Company Act. 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 each
related class of shareholders. Each Distribution Plan further provides that, so
long as the Distribution Plan remains in effect, the selection and nomination of
non-interested Directors shall be committed to the discretion of the
non-interested Directors then in office. In approving each Distribution Plan in
accordance with Rule 12b-1, the non-interested Directors concluded that there is
reasonable likelihood that each 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 non-interested 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 shareholders and all material amendments are required to be
approved by the vote of Directors, including a majority of the non-interested
Directors who have no direct or indirect financial interest in the Distribution
Plan, cast in person at a meeting called for that purpose. Rule 12b-1 further
requires that the Fund preserve copies of the Distribution Plan and any report
made pursuant to such plan for a period of not less than six years from the date
of the Distribution Plan or such report, the first two years in an easily
accessible place.
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 and/or distribution fees paid to the
Distributor. 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 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, 1998, the fully allocated accrual revenues of the
Distributor and Merrill Lynch for the period since the commencement of
operations of Class B shares exceeded the fully allocated accrual expenses by
approximately $297,000 (.38% of Class B net assets at that date). As of May 30,
1999, direct cash revenues
30
<PAGE>
for the period since the commencement of operations of Class B shares exceeded
direct cash expenses by $297,000 (.41% of Class B net assets at that date). As
of December 31, 1998, the fully allocated accrual revenues of the Distributor
and Merrill Lynch for the period since the commencement of operations of Class C
shares exceeded the fully allocated accrual expenses by approximately $22,000
(.48% of Class C net assets at that date). As of May 31, 1999, direct cash
revenues for the period since the commencement of operations of Class C shares
exceeded direct cash expenses by $22,000 (.35% of Class C net assets at that
date).
For the fiscal year ended May 31, 1999, the Fund paid the Distributor $
pursuant to the Class B Distribution Plan (based on average daily net assets
subject to such Class B Distribution Plan of approximately $ 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, 1999, the Fund paid the Distributor $ pursuant
to the Class C Distribution Plan (based on average daily net assets subject to
such Class C Distribution Plan of approximately $ 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, 1999, the Fund paid the Distributor $ pursuant to the Class D
Distribution Plan (based on average daily net assets subject to such Class D
Distribution Plan of approximately $ million), all of which was paid to Merrill
Lynch for providing account maintenance activities in connection with 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. The maximum sales charge rule is applied separately to each class. As
applicable to the Fund, the maximum sales charge rule limits the aggregate of
distribution fee payments and CDSCs payable by the Fund to (1) 6.25% of eligible
gross sales of Class B shares and Class C shares, computed separately (defined
to exclude shares issued pursuant to dividend reinvestments and exchanges), plus
(2) interest on the unpaid balance for the respective class, computed
separately, at the prime rate plus 1% (the unpaid balance being the maximum
amount payable minus amounts received from the payment of the distribution fee
and the CDSC). In connection with the Class B shares, the Distributor has
voluntarily agreed to waive interest charges on the unpaid balance in excess of
0.50% of eligible gross sales. Consequently, the maximum amount payable to the
Distributor (referred to as the "voluntary maximum") in connection with the
Class B shares is 6.75% of eligible gross sales. The Distributor retains the
right to stop waiving the interest charges at any time. To the extent payments
would exceed the voluntary maximum, the Fund will not make further payments of
the distribution fee with respect to Class B shares and any CDSCs will be paid
to the Fund rather than to the Distributor; however, the Fund will continue to
make payments of the account maintenance fee. In certain circumstances the
amount payable pursuant to the voluntary maximum may exceed the amount payable
under the NASD formula. In such circumstances payment in excess of the amount
payable under the NASD formula will not be made.
The following table sets forth comparative information as of May 31, 1999
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, with respect to the Class B shares, the Distributor's voluntary
maximum.
<TABLE>
<CAPTION>
Data Calculated as of May 31, 1999
----------------------------------------------------------------------------------------
(in thousands)
Annual
Distribution
Allowable Allowable Amounts Fee at
Eligible Aggregate Interest on Maximum Previously Aggregate Current Net
Gross Sales Unpaid Amount Paid to Unpaid Asset
Sales(1) Charges(2) Balance(3) Payable Distributor(4) Balance Level(5)
---------- ---------- ----------- -------- -------------- --------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Class B Shares for the
period October 21, 1988
(commencement of operations)
to May 31, 1999
Under NASD Rule as Adopted ...... $1,030,989 $ 64,437 $ 42,501 $106,938 $21,443 $ 85,493 $ 364
Under Distributor's Voluntary
Waiver ........................ $1,030,989 $ 64,437 $ 5,155 $ 69,592 $21,443 $ 48,147 $ 364
Class C Shares, for the period
October 21, 1994 (commencement
of operations) to May 31, 1999
Under NASD Rule as Adopted ...... $ 13,941 $ 871 $ 221 $ 1,092 $ 124 $ 967 $ 34
</TABLE>
- ------------
(1) Purchase price of all eligible Class B or Class C shares sold during the
periods indicated other than shares acquired through dividend reinvestment
and the exchange privilege.
31
<PAGE>
(2) Includes amounts attributable to exchanges from Summit Cash Reserves Fund
("Summit") which are not reflected in Eligible Gross Sales. Shares of
Summit can only be purchased by exchange from another fund (the "redeemed
fund"). Upon such an exchange, the maximum allowable sales charge payment
to the redeemed fund is reduced in accordance with the amount of the
redemption. This amount is then added to the maximum allowable sales
charge payment with respect to Summit. Upon an exchange out of Summit, the
remaining balance of this amount is deducted from the maximum allowable
sales charge payment to Summit and added to the maximum allowable sales
charge payment to the fund into which the exchange is made.
(3) Interest is computed on a monthly basis based upon the prime rate, as
reported in The Wall Street Journal, plus 1.0%, as permitted under the
NASD Rule.
(4) Consists of CDSC payments, distribution fee payments and accruals. See
"What are the Fund's fees and expenses?" 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 Fund Advisor (Merrill Lynch MFASM) Program (the "MFA Program"). The
CDSC is booked as a contingent obligation that may be payable if the
shareholder terminates participation in the MFA Program.
(5) 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 voluntary maximum (with respect to
Class B shares) or the NASD maximum (with respect to Class B and Class C
shares).
REDEMPTION OF SHARES
Reference is made to "How to Buy, Sell, Transfer and Exchange Shares" in
the Prospectus.
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 right to redeem shares or to receive payment with respect to any such
redemption may be suspended for more than seven days only for any period during
which trading on the New York Stock Exchange (the "NYSE") is restricted as
determined by the Commission or the NYSE 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 in part on the market value of the securities held
by the Fund at such time.
Redemption
A shareholder wishing to redeem shares held with the Transfer Agent may do
so without charge by tendering the shares directly to the Transfer Agent at
Financial Data Services, Inc., P.O. Box 45289, Jacksonville, Florida 32232-5289.
Redemption requests delivered other than by mail should be delivered to
Financial Data Services, Inc., 4800 Deer Lake Drive East, Jacksonville, Florida
32246-6484. 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 should not be
sent to the Fund. The redemption request in either event requires the
signature(s) of all persons in whose name(s) the shares are registered, signed
exactly as such name(s) appear(s) on the Transfer Agent's register. The
signature(s) on the redemption requests must be guaranteed by an "eligible
guarantor institution" as such is defined in Rule 17Ad-15 under the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), 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 (e.g., cash, Federal funds or certified check drawn on a United States
bank) has been collected for the purchase of such Fund shares, which will not
usually exceed 10 days.
32
<PAGE>
Repurchase
The Fund also will repurchase Fund shares through a shareholder's listed
securities dealer. The Fund normally will accept orders to repurchase Fund
shares by wire or telephone from dealers for their customers at the net asset
value next computed after the order is placed. Shares will be priced at the net
asset value calculated on the day the request is received, provided that the
request for repurchase is submitted to the dealer prior to the regular close of
business on the NYSE (generally, the NYSE closes at 4:00 p.m., Eastern time) 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 foregoing 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
to such customers. Repurchases made directly through the Transfer Agent on
accounts held at the 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 Fund shares as set forth above.
Reinstatement Privilege -- Class A and Class D Shares
Shareholders who have redeemed their class a or class d shares of the fund
have a privilege to reinstate their accounts by purchasing class a or class d
shares, as the case may be, 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.
PRICING OF SHARES
Determination of Net Asset Value
Reference is made to "How Shares are Priced" in the Prospectus.
The net asset value of the shares of all classes of the Fund is determined
once daily Monday through Friday after the close of business on the NYSE on each
day the NYSE is open for trading. The NYSE generally closes at 4:00 p.m.,
Eastern time. Any assets or liabilities initially expressed in terms of non-U.S.
dollar currencies are translated into U.S. dollars at the prevailing market
rates as quoted by one or more banks or dealers on the day of valuation. The
NYSE is not open for trading 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 is computed by dividing the value of the securities held
by the Fund plus any cash or other assets (including interest and dividends
accrued but not yet received) minus all liabilities (including accrued expenses)
by the total number of shares outstanding at such time, rounded to the nearest
cent. Expenses, including the fees payable to the Investment Adviser and
Distributor are accrued daily.
The per share net asset value of Class B, Class C and Class D shares
generally will be lower than the per share net asset value of Class A shares,
reflecting the daily expense accruals of the account maintenance, distribution
and higher transfer agency fees applicable with respect to 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 Class D shares reflecting the daily expense accruals of
the distribution fees and higher transfer agency fees applicable with respect to
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
33
<PAGE>
payment of dividends, which will differ by approximately the amount of the
expense accrual differentials between the classes.
Portfolio securities that are traded on stock exchanges are valued at the
last sale price (regular way) on the exchange on which such securities are
traded as of the close of business on the day the securities are being valued
or, lacking any sales, at the last available bid price for long positions, and
at the last available ask price for short positions. In cases where securities
are traded on more than one exchange, the securities are valued on the exchange
designated by or under the authority of the Directors as the primary market.
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. Portfolio
securities that are traded both in the OTC market and on a stock exchange are
valued according to the broadest and most representative market. 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 financial futures contracts and
related options, are stated at market value. Securities and assets for which
market quotations are not readily available are stated at fair value as
determined in good faith by or under the direction of the Directors of the Fund.
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 the close of business
on the NYSE. The values of such securities used in computing the net asset value
of the Fund's shares are determined as of such times. Foreign currency exchange
rates are also generally determined prior to the close of business on the NYSE.
Occasionally, events affecting the values of such securities and such exchange
rates may occur between the times at which they are determined and the close of
business on the NYSE that may not be reflected in the computation of the Fund's
net asset value.
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, 1999 is set forth below.
<TABLE>
<CAPTION>
Class A Class B Class C Class D
------------ ------------- ------------ ------------
<S> <C> <C> <C> <C>
Net Assets ................................ $ $ $ $
============== ============== ============= =============
Number of Shares Outstanding ..............
============== ============== ============= =============
Net Asset Value Per Share (net assets
divided by number of shares
outstanding) ............................ $ $ $ $
Sales Charge (for Class A and Class D
shares: 4.00% of offering price; 4.17%
of net asset value per share)* .......... ** **
============== ============== ============= =============
Offering Price ............................ $ $ $ $
============== ============== ============= =============
</TABLE>
- ------------
* Rounded to the nearest one-hundredth percent; assumes 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 on redemption of shares. See "Purchase of Shares
--Deferred Sales Charges Alternatives -- Class B and Class C Shares"
herein.
PORTFOLIO TRANSACTIONS
Subject to policies established by the Board of Directors of the Fund, the
Manager is primarily responsible for the execution of the Fund's portfolio
transactions and the allocation of brokerage. The Fund has no obligation to deal
with any broker or group of brokers in the execution of transactions in
portfolio securities and does not use any particular broker or dealer. In
executing transactions with brokers and dealers, the Investment Adviser seeks to
obtain the best net results for the Fund, taking into account such factors as
price (including the applicable
34
<PAGE>
brokerage commission or dealer spread), size of order, difficulty of execution
and operational facilities of the firm and the firm's risk in positioning a
block of securities. While the Investment Adviser generally seeks reasonably
competitive commission rates, the Fund does not necessarily pay the lowest
spread or commission available. In addition, consistent with the Conduct Rules
of the NASD and policies established by the Board of Directors of the Fund, 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; however,
whether or not a particular broker or dealer sells shares of the Fund neither
qualifies nor disqualifies such broker or dealer to execute transactions for the
Fund.
Subject to obtaining the best price and execution, brokers who provide
supplemental investment research services to the Manager may receive orders for
transactions by the Fund. Such supplemental research services ordinarily consist
of assessments and analysis 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, and the expenses of the Manager will not necessarily be
reduced as a result of the receipt of such supplemental information. If in the
judgment of the Manager the Fund will benefit from supplemental research
services, the Manager is authorized to pay brokerage commissions to a broker
furnishing such services that are in excess of commissions that another broker
may have charged for effecting the same transaction. Certain supplemental
research services may primarily benefit one or more other investment companies
or other accounts for which the Investment Adviser exercises investment
discretion. Conversely, the Fund may be the primary beneficiary of the
supplemental research services received as a result of portfolio transactions
effected for such other accounts or investment companies.
For the fiscal years ended May 31, 1997, 1998 and 1999, the Fund paid no
brokerage commissions.
The Fund invests primarily in certain securities traded in the OTC market
and intends to deal directly with the dealers who make a market in 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 and persons who are affiliated with such affiliated persons are
prohibited from dealing with the Fund as principal in the purchase and sale of
securities unless a permissive order allowing such transactions is obtained from
the Commission. Since transactions in the OTC market usually involve
transactions with the dealers acting as principal for their own accounts, the
Fund will not deal with affiliated persons, including Merrill Lynch and its
affiliates, in connection with such transactions. However, an affiliated person
of the Fund may serve as its broker in OTC transactions conducted on an agency
basis provided that, among other things, the fee or commission received by such
affiliated broker is reasonable and fair compared to the fee or commission
received by non-affiliated brokers in connection with comparable transactions.
In addition, the Fund may not purchase securities during the existence of any
underwriting syndicate for such securities 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. See "Investment Objective and Policies -- Investment
Restrictions."
Section 11(a) of the Exchange Act generally prohibits members of the
United States national securities exchanges from executing exchange transactions
for their affiliates and institutional accounts that 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 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.
The Board of Directors of the Fund has considered the possibility of
seeking to recapture for the benefit of the Fund brokerage commissions and other
expenses of possible portfolio transactions by conducting portfolio transactions
through affiliated entities. For example, brokerage commissions received by
affiliated brokers could be offset against the advisory fee paid by the Fund to
the Manager. After considering all factors deemed relevant, the Board of
Directors made a determination not to seek such recapture. The Board will
reconsider this matter from time to time.
35
<PAGE>
Because of different objectives or other factors, a particular security
may be bought for one or more clients of the Manager or an affiliate when one or
more clients of the Manager or an affiliate are selling the same security. If
purchases or sales of securities arise for consideration at or about the same
time that would involve the Fund or other clients or funds for which the Manager
or an affiliate acts as manager 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 an affiliate 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.
SHAREHOLDER SERVICES
The Fund offers a number of shareholder services and investment plans
described below that are designed to facilitate investment in shares of the
Fund. Full details as to each of such services, copies of the various plans and
instructions as to how to participate in the various services or plans, or how
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. Certain of these services are available only to U.S. investors
and certain of these services are not available to investors who place orders
through the Merrill Lynch BlueprintSM Program.
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 dividends. The statements
will also show any other activity in the account since the preceding statement.
Shareholders will also receive separate confirmations for each purchase or sale
transaction other than automatic investment purchases and the reinvestment of
dividends. A shareholder with an account held at the Transfer Agent may make
additions to his or her Investment Account at any time by mailing a check
directly to the Transfer Agent. A shareholder may also maintain an account
through Merrill Lynch. Upon the transfer of shares out of a Merrill Lynch
brokerage account, an Investment Account in the transferring shareholder's name
may be opened automatically at the Transfer Agent.
Share certificates are issued only for full shares and only upon the
specific request of a shareholder who has an Investment Account. 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 may transfer their Fund shares from Merrill Lynch to another
securities dealer that has entered into a selected dealer agreement with Merrill
Lynch. Certain shareholder services may not be available for the transferred
shares. After the transfer, the shareholder may purchase additional shares of
funds owned before the transfer and all future trading of these assets must be
coordinated by the new firm. If a shareholder wishes to transfer his or her
shares to a securities dealer that has not entered into a selected dealer
agreement with Merrill Lynch, the shareholder must either (i) redeem his or her
shares, paying any applicable CDSC or (ii) continue to maintain an Investment
Account at the Transfer Agent for those shares. The shareholder may also request
the new securities dealer to maintain the shares in an account at the Transfer
Agent registered in the name of the securities dealer for the benefit of the
shareholder whether the securities dealer has entered into a selected dealer
agreement or not.
Shareholders considering transferring a tax-deferred retirement account,
such as an individual retirement account, from Merrill Lynch to another
securities dealer 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 Select Pricing Funds and Summit Cash Reserves Fund
("Summit"), a series of Financial Institutions Series Trust, which is a Merrill
Lynch-sponsored money market fund specifically designated for exchange by
holders of Class A, Class B, Class C and Class D shares of Select Pricing Funds.
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. Before effecting an exchange, shareholders
should obtain a currently effective
36
<PAGE>
prospectus of the fund into which the exchange is to be 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.
Exchanges of Class A and Class D Shares. Class A shareholders may exchange
Class A shares of the Fund for Class A shares of a second Select Pricing 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 Select Pricing 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 Select Pricing 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 D shares are exchangeable with shares of the
same class of other Select Pricing Funds.
Exchanges of Class A or Class D shares outstanding ("outstanding Class A
or Class D shares") for Class A or Class D shares of other Select Pricing Funds
or for Class A shares of Summit, ("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 charges paid with respect to such Class A or
Class D shares in the initial purchase and any subsequent exchange. Class A or
Class D shares issued pursuant to dividend reinvestment are sold on a no-load
basis in each of the funds offering Class A or Class D shares. For purposes of
the exchange privilege, Class A or 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 generally
may be exchanged into the Class A or Class D shares, respectively, of the other
funds with a reduced sales charge or without a sales charge.
Exchanges of Class B and Class C Shares. Certain Select Pricing Funds with
Class B or Class C shares outstanding ("outstanding Class B or Class C shares")
offer to exchange their Class B or Class C shares for Class B or Class C shares,
respectively, of certain other Select Pricing Funds or for Class B shares of
Summit ("new Class B or Class C shares") 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 than 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 CDSC 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's 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 Special Value Fund Class
B shares for more than five years.
Exchanges for Shares of a Money Market Fund. Class A and Class D shares
are exchangeable for Class A shares of Summit and Class B and Class C shares are
exchangeable for Class B shares of Summit. Class A shares of Summit have an
exchange privilege back into Class A or Class D shares of Select Pricing Funds;
Class B shares of Summit have an exchange privilege back into Class B or Class C
shares of Select Pricing Funds and, in the event of such an exchange, the period
of time that Class B shares of Summit are held will count toward satisfaction of
the holding period requirement for purposes of reducing any CDSC and toward
satisfaction of any Conversion Period with respect to Class B shares. Class B
shares of Summit will be subject to a distribution fee
37
<PAGE>
at an annual rate of 0.75% of average daily net assets of such Class B shares.
This exchange privilege 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.
Prior to October 12, 1998, exchanges from the Fund and other Select
Pricing Funds into a money market fund were directed to certain Merrill
Lynch-sponsored money market funds other than Summit. Shareholders who exchanged
Select Pricing Fund shares for shares of such other money market funds and
subsequently wish to exchange those money market fund shares for shares of the
Fund will be subject to the CDSC schedule applicable to such Fund shares, if
any. The holding period for the money market fund shares will not count toward
satisfaction of the holding period requirement for reduction of the CDSC imposed
on such shares, if any, and, with respect to Class B shares, toward satisfaction
of the Conversion Period.
Exchanges by Participants in the MFA Program. The exchange privilege is
modified with respect to certain retirement plans which participate in the MFA
Program. Such retirement plans may exchange Class B, Class C or Class D shares
that have been held for at least one year for Class A shares of the same fund on
the basis of relative net asset values in connection with the commencement of
participation in the MFA Program, i.e., no CDSC will apply. The one year holding
period does not apply to shares acquired through reinvestment of dividends. Upon
termination of participation in the MFA Program, Class A shares will be
re-exchanged for the class of shares originally held. For purposes of computing
any CDSC that may be payable upon redemption of Class B or Class C shares so
reacquired, or the Conversion Period for Class B shares so reacquired, the
holding period for the Class A shares will be "tacked" to the holding period for
the Class B or Class C shares originally held. The Fund's exchange privilege is
also modified with respect to purchases of Class A and Class D shares by
non-retirement plan investors under the MFA Program. First, the initial
allocation of assets is made under the MFA Program. Then, any subsequent
exchange under the MFA Program of Class A or Class D shares of a Select Pricing
Fund for Class A or Class D shares of the Fund will be made solely on the basis
of the relative net asset values of the shares being exchanged. Therefore, there
will not be a charge for any difference between the sales charge previously paid
on the shares of the other Select Pricing Fund and the sales charge payable on
the shares of the Fund being acquired in the exchange under the MFA Program.
Exercise of the Exchange Privilege. To exercise the exchange privilege, a
shareholder should contact his or her Merrill Lynch Financial Consultant, who
will advise the Fund of the exchange. Shareholders of the Fund, and shareholders
of the other Select Pricing Funds 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 Commission. The Fund reserves the right to
limit the number of times an investor may exercise the exchange privilege.
Certain funds may suspend the continuous offering of their shares to the general
public at any time and may thereafter resume such offering from time to time.
The exchange privilege is available only to U.S. shareholders in states where
the exchange legally may be made. It is contemplated that the exchange privilege
may be applicable to other new mutual funds whose shares may be distributed by
the Distributor.
Fee-Based Programs
Certain Merrill Lynch fee-based programs, including pricing alternatives
for securities transactions (each referred to in this paragraph as a "Program"),
may permit the purchase of Class A shares at net asset value. Under specified
circumstances, participants in certain Programs may deposit other classes of
shares which will be exchanged for Class A shares. Initial or deferred sales
charges otherwise due in connection with such exchanges may be waived or
modified, as may the Conversion Period applicable to the deposited shares.
Termination of participation in a Program may result in the redemption of shares
held therein or the automatic exchange thereof to another class at net asset
value, which may be shares of a money market fund. In addition, upon termination
of participation in a Program, shares that have been held for less than
specified periods within such Program may be subject to a fee based upon the
current value of such shares. These Programs also generally prohibit such shares
from being transferred to another account at Merrill Lynch, to another
broker-dealer or to the Transfer Agent. Except in limited circumstances (which
may also involve an exchange as described above), such shares must be redeemed
and another class of shares purchased (which may involve the imposition of
initial or deferred sales charges and distribution and account maintenance fees)
in order for the investment not to be subject to Program fees. Additional
information regarding a specific Program (including charges and limitations on
38
<PAGE>
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
1-800-MER-FUND (1-(800)-637-3863).
Retirement and Education Savings Plans
Individual retirement accounts and other retirement and education savings
plans are available from Merrill Lynch. Under these plans, investments may be
made in the Fund and certain of the other mutual funds sponsored by Merrill
Lynch as well as in other securities. Merrill Lynch may charge an initial
establishment fee and an annual fee for each account. Information with respect
to these plans is available on request from Merrill Lynch.
Capital gains and ordinary income received in each of the plans referred
to above are exempt from Federal taxation until distributed from the plans.
Different tax rules apply to RothIRA plans and education savings plans.
Investors considering participation in any retirement or education savings plan
should review specific tax laws relating thereto and should consult their
attorneys or tax advisers with respect to the establishment and maintenance of
any such plan.
Automatic Investment Plans
A shareholder may make additions to an Investment Account at any time by
purchasing Class A shares (if he or she is an eligible Class A investor) or
Class B, Class C or Class D shares at the applicable public offering price.
These purchases may be made either through the shareholder's securities dealer,
or by mail directly to the Transfer Agent, acting as agent for such securities
dealer. Voluntary accumulation also can be made through a service known as the
Fund's Automatic Investment Plan. The Fund would be authorized, on a regular
basis, to provide systematic additions to the Investment Account of such
shareholder through charges of $50 or more to the regular bank account of the
shareholder by either pre-authorized checks or automated clearing house debits.
Alternatively, an investor that maintains a CMA(R) or CBA(R) account may arrange
to have periodic investments made in the Fund in amounts of $100 ($1 for
retirement accounts) or more through the CMA(R) or CBA(R) Automated Investment
Program.
Automatic Dividend Reinvestment Plan
Unless specific instructions are given as to the method of payment,
dividends will be automatically reinvested, without sales charge, in additional
full and fractional shares of the Fund. Such reinvestment will be at the net
asset value of shares of the Fund as of the close of business on the NYSE on the
monthly payment date for such dividends. No CDSC will be imposed upon redemption
of shares issued as a result of the automatic reinvestment of dividends.
Shareholders may, at any time, by written notification to Merrill Lynch if
their account is maintained with Merrill Lynch, or by written notification or by
telephone (1-800-MER-FUND) to the Transfer Agent, if their account is maintained
with the Transfer Agent elect to have subsequent dividends paid in cash, rather
than reinvested in shares of the Fund or vice versa (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). Commencing ten
days after the receipt by the Transfer Agent of such notice, those instructions
will be effected. 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 dividend checks. Cash payments can also be directly
deposited to the shareholder's bank account.
Systematic Withdrawal Plan
A shareholder may elect to receive systematic withdrawals from his or her
Investment Account by check or through automatic payment by direct deposit to
his or her bank account on either a monthly or quarterly basis as provided
below. Quarterly withdrawals are available for shareholders that 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 are available 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 the class of shares to be redeemed. Redemptions will be made at net
asset value
39
<PAGE>
as determined 15 minutes after the close of business on the NYSE (generally, the
NYSE closes at 4:00 p.m., Eastern 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 made, on the next business day following redemption. When a shareholder
is making systematic withdrawals, dividends on all shares in the Investment
Account are reinvested automatically in Fund shares. A shareholder's Systematic
Withdrawal Plan may be terminated at any time, without charge or penalty, by the
shareholder, the Fund, the Transfer Agent or the Distributor.
With respect to redemptions of Class B or 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." 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 be applied thereafter to Class D shares if the shareholder so elects.
If an investor wishes to change the amount being withdrawn in a systematic
withdrawal plan the investor should contact his or her Merrill Lynch Financial
Consultant.
Withdrawal payments should not be considered as dividends. Each withdrawal
is a taxable event. If periodic withdrawals continuously exceed reinvested
dividends, the shareholder's original investment may be reduced correspondingly.
Purchases of additional 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 that maintain a Systematic Withdrawal Plan unless such purchase is
equal to at least one year's scheduled withdrawals or $1,200, whichever is
greater. Automatic 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) or
CBA(R) 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. The minimum fixed dollar amount redeemable is $50. The
proceeds of systematic redemptions will be posted to the shareholder's account
three 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) or CBA(R) Systematic Redemption Program is not available if Fund shares
are being purchased within the account pursuant to the Automated Investment
Program. For more information on the CMA(R) or CBA(R) Systematic Redemption
Program, eligible shareholders should contact their Merrill Lynch Financial
Consultant.
DIVIDENDS AND TAXES
Dividends
The Fund intends to distribute substantially all of its net investment
income, if any. Dividends from such net investment income will be paid at least
monthly. All net realized capital gains, if any, will be distributed to the
Fund's shareholders at least annually. From time to time, the Fund may declare a
special distribution at or about the end of the calendar year in order to comply
with Federal tax requirements that certain percentages of its ordinary income
and capital gains be distributed during the year. If in any fiscal year, the
Fund has net income from certain foreign currency transactions, such income will
be distributed at least annually.
See "Shareholder Services -- Automatic Dividend Reinvestment Plan" for
information concerning the manner in which dividends may be reinvested
automatically in shares of the Fund. A shareholder whose account is maintained
at the Transfer Agent or whose account is maintained through Merrill Lynch may
elect in writing
40
<PAGE>
to receive any such dividends in cash. Dividends are taxable to shareholders, as
discussed below, whether they are reinvested in shares of the Fund or received
in cash. The per share dividends on Class B and Class C shares will be lower
than the per share dividends 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 on Class D shares will be lower than the per share dividends on Class
A shares as a result of the account maintenance fees applicable with respect to
the Class D shares. See "Pricing of Shares -- Determination of Net Asset Value."
Taxes
The Fund intends to continue to qualify for the special tax treatment
afforded regulated investment companies ("RICs") under the Internal Revenue Code
of 1986, as amended (the "Code"). As long as it so qualifies, the Fund (but not
its shareholders) will not be subject to Federal income tax on the part of its
net ordinary income and net realized capital gains which it distributes to Class
A, Class B, Class C and Class D shareholders (together, the "shareholders"). The
Fund intends to distribute substantially all of such income.
Dividends paid by the Fund from its ordinary income or from an excess of
net short-term capital gains over net long-term capital losses (together
referred to hereafter as "ordinary income dividends") are taxable to
shareholders as ordinary income. Distributions made from an excess of net
long-term capital gains over net short-term capital losses (including gains or
losses from certain transactions in futures and options) ("capital gain
dividends") are taxable to shareholders as long-term capital gains, regardless
of the length of time the shareholder has owned Fund shares. 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). Certain categories of
capital gains are taxable at different rates. 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 capital gain dividends, as well
as the amount of capital gain dividends in 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.
Under certain provisions of the Code, some shareholders may be subject to
a 31% withholding tax on ordinary income dividends, capital gain dividends and
redemption payments ("backup withholding"). Generally, shareholders subject to
backup withholding will be those for whom no certified taxpayer identification
number is on file with the Fund or who, to the Fund's knowledge, have furnished
an incorrect number. When establishing an account, an investor must certify
under penalty of perjury that such number is correct and that the investor is
not otherwise subject to backup withholding.
No gain or loss will be recognized by Class B shareholders on the
conversion of their Class B shares into Class D shares. A shareholder's basis in
the Class D shares acquired will be the same as such shareholder's basis in the
Class B shares converted, and the holding period of the acquired Class D shares
will include the holding period for the converted Class B shares.
41
<PAGE>
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 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.
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.
42
<PAGE>
Shareholders are urged to consult their own tax advisers regarding
specific questions as to Federal, foreign, state or local taxes. Foreign
investors should consider applicable foreign taxes in their evaluation of an
investment in the Fund.
PERFORMANCE DATA
From time to time the Fund may include its average annual total return and
other total return data in advertisements or information furnished to present or
prospective shareholders. Total return figures are based on the Fund's
historical performance and are not intended to indicate future performance.
Average annual total return is 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 CDSC that would be applicable to a complete redemption of the
investment at the end of the specified period as in the case of Class B and
Class C shares and the maximum sales charge in the case of Class A and 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 and
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 annual, average annual 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 periods 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 with respect to
annual or annualized rates of return calculations. Aside from the impact on the
performance data calculations of including or excluding the maximum applicable
sales charges, actual annual or annualized total return data generally will be
lower than average annual total return data since the average 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. 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
reduced sales loads in the case of Class A and Class D shares, the performance
data may take into account the reduced, and not the maximum, sales charge or may
not take into account the CDSC and therefore may reflect greater total return
since, due to the reduced sales charges or waiver of the CDSC, a lower amount of
expenses is deducted. See "Purchase of Shares." The Fund's total return may be
expressed either as a percentage or as a dollar amount in order to illustrate
such total return on a hypothetical $1,000 investment in the Fund at the
beginning of each specified period.
43
<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 as Redeemable Value Expressed as Redeemable Value
a percentage of a hypothetical a percentage of a hypothetical
based on a $1,000 investment based on a $1,000 investment
hypothetical at the end of hypothetical at the end of
Period $1,000 investment the period $1,000 investment the period
- ------ ----------------- ----------------- ----------------- -----------------
Average Annual Total Return
(including maximum applicable sales charges)
<S> <C> <C> <C> <C>
One Year Ended May 31, 1999 ..... % $ % $
Five Years Ended May 31,1999 .... % $ % $
Inception (October 21, 1994)
to May 31, 1999 ............... % $ % $
Inception (August 2, 1991)
to May 31, 1999 ............... % $ % $
Annual Total Return
(excluding maximum applicable sales charges)
Year Ended May 31,
1999 ......................... % $ % $
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
1992 ......................... % $ 4.33% $1,043.30
Aggregate Total Return
(including maximum applicable sales charges)
Inception (October 21, 1994) to
May 31, 1999 ................. % $ -- --
Inception (August 2, 1991) to
May 31, 1999 ................. -- -- % $
Class C Shares Class D Shares
------------------------------------ ------------------------------------
Expressed as Redeemable Value Expressed as Redeemable Value
a percentage of a hypothetical a percentage of a hypothetical
based on a $1,000 investment based on a $1,000 investment
hypothetical at the end of hypothetical at the end of
Period $1,000 investment the period $1,000 investment the period
- ------ ----------------- ----------------- ----------------- -----------------
Average Annual Total Return
(including maximum applicable sales charges)
One Year Ended May 31, 1999 ..... % $ % $
Five Years Ended May 31, 1999 ... % $ % $
Inception (October 21, 1994) to
May 31, 1999 ................. % $ % $
Inception (August 2, 1991) to
May 31, 1999 ................. % $ % $
Annual Total Return
(excluding maximum applicable sales charges)
Year Ended May 31,
1999 ......................... % $ % $
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
Inception (October 21, 1994) to
April 30, 1995 ............... % $ % $
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, 1999 ................. % $ % $
</TABLE>
44
<PAGE>
<TABLE>
<CAPTION>
Aggregate Total Return
(including maximum applicable sales charges)
<S> <C> <C> <C> <C>
Inception (October 21, 1994) to
May 31, 1999 ................. % $ % $
Inception (August 2, 1991) to
May 31, 1999 ................. % $ % $
</TABLE>
In order to reflect the reduced sales charges in the case of Class A or
Class D shares, or the waiver of the CDSC in the case of Class B or Class C
shares applicable to certain investors, as described under "Purchase of Shares,"
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 CDSC, and therefore may reflect greater total
return since, due to the reduced sales charges or the waiver of CDSCs, a lower
amount of expenses may be deducted.
On occasion, the Fund may compare its performance to various indices
including the Standard & Poor's 500 Index, the Dow Jones Industrial Average, or
to performance data published by Lipper Analytical Services, Inc., Morningstar
Publications, Inc. ("Morningstar"), CDA Investment Technology, Inc., Money
Magazine, U.S. News & World Report, Business Week, 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 historic performance of the Fund and the index, such as standard deviation
and beta. In addition, from time to time, the Fund may include the Fund's
Morningstar risk-adjusted performance ratings in advertisements 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.
Total return figures are based on the Fund's historical performance and
are not intended to indicate future performance. The Fund's total return 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.
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
45
<PAGE>
solely by such class. Stock certificates will be issued by the Transfer Agent
only on specific request. Certificates for fractional shares are not issued in
any case.
The Manager provided the initial capital for the Fund by purchasing 10,000
shares for $100,000. Such shares will be acquired for investment and can only be
disposed by redemption. The organizational expenses of the Fund were paid by the
Fund and amortized over a period not exceeding five years. The proceeds realized
by the Manager (or any subsequent holder) upon redemption of any of such shares
will be reduced by the proportionate amount of the unamortized organizational
expenses which the number of shares redeemed bears to the number of shares
initially purchased.
Independent Auditors
Deloitte & Touche LLP, 117 Campus Drive, Princeton, New Jersey 08540 has
been selected as the independent auditors of the Fund. The selection of
independent auditors is subject to approval by the non-interested Directors of
the Fund. The independent auditors are responsible for auditing the annual
financial statements of the Fund.
Custodian
The Bank of New York, (the "Custodian"), 90 Washington Street, 12th Floor,
New York, New York 10286, acts as the custodian of the Fund's assets. Under its
contract with the Fund, the Custodian is authorized, among other things, to
establish separate accounts in foreign currencies and to cause foreign
securities owned by the Fund to be held in its offices outside of the United
States and with certain foreign banks and securities depositories. 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 investments.
Transfer Agent
Financial Data Services, Inc., 4800 Deer Lake Drive East, Jacksonville,
Florida 32246-6484, acts as the Fund's Transfer Agent. The Transfer Agent is
responsible for the issuance, transfer and redemption of shares and the opening,
maintenance and servicing of shareholder accounts. See "How to Buy, Sell,
Transfer and Exchange Shares -- Through the Transfer Agent" 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.
Shareholder Inquiries
Shareholder inquiries may be addressed to the Fund at the address or
telephone number set forth on the cover page of this Statement of Additional
Information.
Additional Information
The Prospectus and this Statement of Additional Information do not contain
all the information set forth in the Registration Statement and the exhibits
relating thereto, which the Fund has filed with the Securities and Exchange
Commission, Washington, D.C., under the Securities Act and the Investment
Company Act, to which reference is hereby made.
Under a separate agreement, ML & Co. 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
46
<PAGE>
of such name to any other company, and the Fund has granted ML & Co. under
certain conditions, the use of any other name it might assume in the future,
with respect to any corporation organized by ML & Co.
To the knowledge of the Fund, the following persons or entities owned
beneficially 5% or more of a class of the Fund's shares as of September 1, 1999
<TABLE>
<CAPTION>
Percentage
Name Address and Class
- ------------------------------------ ------------------------- ----------------
<S> <C> <C>
Mr. Gregory M. Maunz 4 Jacob Drive 31.6% of Class A
Lawrenceville, NJ 08646
Merrill Lynch Trust Co. P.O. Box 30531 21.2% of Class A
Successor Trustee New Brunswick, NJ 08989
Florence L. Codman Irrevocable Trust
Attn: Shirley White
Michael Normile and 878 Scioto Drive 14.4% of Class A
Eileen Normille JTWTROS Franklin Lakes, NJ 07417
1998 Deferred Compensation 400 Atrium Drive 8% of Class A
Attn: Victoria Niles Somerset, NJ 08873
99 Short Term Global Deferral 400 Atrium Drive 6.3% of Class A
Attn: Victoria Niles Somerset, NJ 08873
Universities Research Associates 1111 19th Street NW #400 6.3% of Class C
Attn: Dr. Gail Young Washington, D.C. 20036
Sang Hoon Hahn and 4439 Kahala Avenue 5.9% of Class C
Haijoung Hahn JTWTROS Honolulu, HI 96816
Young President's Organization Inc. 451 S. Decker Drive #200 10.5% of Class D
Attn: Kelly Parker Irving, TX 75062
San Fernando Comm Hospital 14850 Roscoe Boulevard 9.2% of Class D
DBA Mission Comm Hospitals Panorama City, CA 91402
Operating Account PC
Attn: Bruce Donaldson
Money PRCH Pension 500 Galland Building 7.6% of Class D
PLN Hills CL 1221 Second Avenue
L. Peterson, M. Clark, G. Martin, Jr. Seattle, WA 98101
PTF Sharing Plan 500 Galland Building 6.6% of Class D
HLLS CLRK Martin 1221 Second Avenue
TTEE: L. Peterson, M. Clark, Seattle, WA 98101
G. Martin Jr.
Fontbonne College Current Fund 6800 Wydown Boulevard 5.7% of Class D
Attn: Sarah Wymore Clayton, MO 63105
</TABLE>
FINANCIAL STATEMENTS
The Fund's audited financial statements are incorporated in this Statement
of Additional Information by reference to its 1999 annual report to
shareholders. You may request a copy of the annual report at no charge by
calling (800) 456-4587 ext. 789 between 8:00 a.m. and 8:00 p.m. on any business
day.
47
<PAGE>
CODE #: 13937-09-99
<PAGE>
PART C
ITEM 23. Exhibits
Exhibit
Number Description
------- ----------
1(a) -- Articles of Incorporation of the Registrant, dated April
18, 1991.(a)
(b) -- Articles of Amendment to Articles of Incorporation of the
Registrant, dated May 31, 1991.(b)
(c) -- Articles of Amendment to Articles of Incorporation of the
Registrant, dated October 17, 1994.(a)
(d) -- Articles Supplementary to Articles of Incorporation of the
Registrant, dated October 17, 1994.(a)
2 -- By-Laws of the Registrant.(a)
3 -- Portions of the Articles of Incorporation, and By-Laws of
the Registrant defining the rights of shareholders of
the Registrant.(c)
4(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)
5(a) -- Form of Class A Shares Distribution Agreement between the
Registrant and Merrill Lynch Funds Distributor, a division
of Princeton Funds Distributor, Inc. (the "Distributor")
(including Selected Dealers Agreement).(c)
(b) -- Class B Shares Distribution Agreement between the
Registrant and the Distributor.(a)
(c) -- Letter Agreement between the Registrant and the Distributor
with respect to the Merrill Lynch Mutual Fund Advisor
Program.(e)
(d) -- Form of Class C Shares Distribution Agreement between the
Registrant and the Distributor, (including Selected Dealers
Agreement).(c)
(e) -- Form of Class D Shares Distribution Agreement between the
Registrant and the Distributor (including Selected Dealers
Agreement).(c)
6 -- None.
7 -- Custody Agreement between the Registrant and The Bank of
New York.(a)
8(a) -- Transfer Agency, Dividend Disbursing Agency and Shareholder
Servicing Agency Agreement between the Registrant and
Financial Data Services, Inc.(a)
(b) -- License Agreement Relating to Use of Name between the
Registrant and Merrill Lynch & Co., Inc.(a)
9(a) -- Opinion of Brown & Wood LLP, counsel to the Registrant.(a)
(b) -- Consent of Brown & Wood LLP, counsel to the Registrant.
10 -- Consent of Deloitte & Touche LLP, independent auditors for
the Registrant.
11 -- None.
12 -- Certificate of Merrill Lynch Asset Management, L.P.(a)
13(a) -- Amended and Restated Class B 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)
14 -- None.
15 -- Merrill Lynch Select Pricing(SM) System Plan pursuant to Rule
18f-3.(d)
C-1
<PAGE>
- ----------
(a) Filed on September 25, 1995, as an Exhibit to Post-Effective Amendment No.
6 to the Registrant's Registration Statement under the Securities Act of
1933, as amended, on Form N-1A (File No. 33-40332)(the "Registration
Statement").
(b) Reference is made to Article V, Article VI (section 3), Article VII,
Article VIII and Article X of the Registrant's Articles of Incorporation,
previously filed as Exhibit 1 to the Registration Statement; and to Article
II, Article III (sections 1, 3, 5, 6 and 17), Article VI, Article VII,
Article XIII and Article XIV of the Registrant's By-Laws previously filed
as Exhibit 2 to the Registration Statement.
(c) Previously filed as an exhibit to Post-Effective Amendment No. 5 to the
Registration Statement.
(d) Incorporated by reference to Exhibit 18 to Post-Effective Amendment No. 13
to the Registration Statement on Form N-1A, filed on January 25, 1996,
relating to shares of Merrill Lynch New York Municipal Bond Fund series 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 24. Persons Controlled by or Under Common Control with Registrant
Not applicable.
Item 25. Indemnification
Reference is made to Article VI of Registrant's Articles of Incorporation,
Article VI of Registrant's By-Laws, Section 2-418 of the Maryland General
Corporation Law and Section 9 of the Class A, Class B, Class C and Class D
Distribution Agreements.
Article VI of the By-Laws provides that each officer and director of the
Registrant shall be indemnified by the Registrant to the full extent permitted
under the General Laws of the State of Maryland, except that such indemnity
shall not protect any such person against any liability to the Registrant or any
stockholder thereof to which such person would otherwise be subject by reason of
willful misfeasance, bad faith, gross negligence or reckless disregard of the
duties involved in the conduct of his office. Absent a court determination that
an officer or director seeking indemnification was not liable on the merits or
guilty of willful misfeaseance, bad faith, gross negligence or reckless
disregard of the duties involved in the conduct of his office, the decision by
the Registrant to indemnify such person must be based upon the reasonable
determination of independent counsel or non-party independent directors, after
review of the facts, that such officer or director is not guilty of willful
misfeasance, bad faith, gross negligence or reckless disregard of the duties
involved in the conduct of his office.
Each officer and director of the Registrant claiming indemnification within
the scope of Article VI of the By-Laws shall be entitled to advances from the
Registrant for payment of the reasonable expenses incurred by him in connection
with proceedings to which he is a party in the manner and to the full extent
permitted under the General Laws of the State of Maryland; provided, however,
that the person seeking indemnification shall provide to the Registrant a
written affirmation of his good faith belief that the standard of conduct
necessary for indemnification by the Registrant has been met and a written
undertaking to repay any such advance, if it should ultimately be determined
that the standard of conduct has not been met, and provided further that at
least one of the following additional conditions is met: (a) the person seeking
indemnification shall provide a security in form and amount acceptable to the
Registrant for his undertaking; (b) the Registrant is insured against losses
arising by reason of the advance; (c) a majority of a quorum of non-party
independent directors, or independent legal counsel in a written opinion, shall
determine, based on a review of facts readily available to the Registrant at the
time the advance is proposed to be made, that there is reason to believe that
the person seeking indemnification will ultimately be found to be entitled to
indemnification.
The Registrant may purchase insurance on behalf of an officer or director
protecting such person to the full extent permitted under the General Laws of
the State of Maryland from liability arising from his activities as officer or
director of the Registrant. The Registrant, however, may not purchase insurance
on behalf of any officer or director of the Registrant that protects or purports
to protect such person from liability to the Registrant or to its stockholders
to which such officer or director would otherwise be subject by reason of
willful misfeasance, bad faith, gross negligence or reckless disregard of the
duties involved in the conduct of his office.
C-2
<PAGE>
The Registrant may indemnify, make advances or purchase insurance to the
extent provided in Article VI of the By-Laws on behalf of an employee or agent
who is not an officer or director of the Registrant.
In Section 9 of the Class A and Class D 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 (the "1933 Act"), against certain types of
civil liabilities arising in connection with the Registration Statement or
Prospectus and Statement of Additional Information.
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, 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.
Item 26. Business and Other Connections of Investment Adviser
Merrill Lynch Asset Management, L.P. ("MLAM" or the "Investment Adviser"),
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 Disciplined Equity Fund,
Inc., Merrill Lynch Dragon Fund, Inc., Merrill Lynch EuroFund, Merrill Lynch
Fundamental Growth Fund, Inc., Merrill Lynch Global Allocation Fund, Inc.,
Merrill Lynch Global Bond Fund for Investment and Retirement, 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: Merrill Lynch High Income Municipal Bond Fund, Inc., Merrill Lynch
Senior Floating Rate Fund, Inc. and Merrill Lynch Senior Floating Rate Fund II,
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 Investment Adviser
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 Fund, Inc., Merrill Lynch Emerging Tigers Fund, Inc., Merrill Lynch
Federal Securities Trust, Merrill Lynch Funds for Institutions Series, Merrill
Lynch Multi-State Limited Maturity Municipal Series Trust, Merrill Lynch
Multi-State 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
C-3
<PAGE>
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 Fund, Inc.,
MuniHoldings Fund II, Inc., MuniHoldings California Insured Fund, Inc.,
MuniHoldings California Insured Fund II, Inc., MuniHoldings California Insured
Fund III, Inc., MuniHoldings California Insured Fund IV, Inc., MuniHoldings
California Insured Fund V, Inc., MuniHoldings Florida Insured Fund, MuniHoldings
Florida Insured Fund II, MuniHoldings Florida Insured Fund III, MuniHoldings
Florida Insured Fund IV, MuniHoldings Florida Insured Fund V, MuniHoldings
Insured Fund, Inc., MuniHoldings Insured Fund II, Inc., MuniHoldings Insured
Fund III, Inc., MuniHoldings Michigan Insured Fund, Inc., MuniHoldings New
Jersey Insured Fund, Inc., MuniHoldings New Jersey Insured Fund II, Inc.,
MuniHoldings New Jersey Insured Fund III, Inc., MuniHoldings New Jersey Insured
Fund IV, Inc., MuniHoldings New York Fund, Inc., MuniHoldings New York Insured
Fund, Inc., MuniHoldings New York Insured Fund II, Inc., MuniHoldings New York
Insured Fund III, Inc., MuniHoldings New York Insured Fund IV, Inc.,
MuniHoldings Pennsylvania Insured Fund, 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, 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 registered 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 Government Bond
Fund is One Financial Center, 23rd Floor, Boston, Massachusetts 02111- 2665. The
address of the Manager, FAM, Princeton Services, Inc. ("Princeton Services") and
Princeton Administrators, L.P. ("Princeton Administrators") is also P.O. Box
9011, Princeton, New Jersey 08543-9011. The address of Princeton Funds
Distributor, Inc. ("PFD") and of Merrill Lynch Funds Distributor ("MLFD") is
P.O. Box 9081, Princeton, New Jersey 08543-9081. The address of Merrill Lynch,
Pierce, Fenner & Smith Incorporated ("Merrill Lynch") and ML & Co. is World
Financial Center, North Tower, 250 Vesey Street, New York, New York 10281-1201.
The address of the Fund's transfer agent, Financial Data Services, Inc. ("FDS"),
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
May 1, 1997 for his, her or its own account or in the capacity of director,
officer, partner or trustee. In addition, Mr. Glenn is President and Mr. Burke
is Vice President and Treasurer of all or substantially all of the investment
companies described in the first two paragraphs of this Item 26, and Messrs.
Giordano and Monagle are officers of one or more of such companies.
<TABLE>
<CAPTION>
Position(s) with the Other Substantial Business,
Name Investment Adviser Profession, Vocation or Employment
- ---- -------------------- ----------------------------------
<S> <C> <C>
ML & Co. ................... Limited Partner Financial Services Holding Company; Limited Partner of FAM
Princeton Services ......... General Partner General Partner of FAM
Jeffrey M. Peek ............ President President of FAM; President and Director of Princeton Services;
Executive Vice President of ML & Co.; Managing Director and
Co-Head of the Investment Banking Division of Merrill Lynch in
1997
Terry K. Glenn ............. Executive Vice Executive Vice President of FAM; Executive Vice
President President and Director of Princeton Services; President and
Director of PFD; Director of FDS; President of Princeton
Administrators
</TABLE>
C-4
<PAGE>
<TABLE>
<CAPTION>
Position(s) with the Other Substantial Business,
Name Investment Adviser Profession, Vocation or Employment
- ---- -------------------- ----------------------------------
<S> <C> <C>
Gregory A. Bundy ........... Managing Director Managing Director and Chief Operating Officer of FAM;
and Chief Managing Director and Chief Operating Officer of
Operating Officer Princeton Services; Co-CEO of Merrill Lynch Australia
from 1997 to 1999; Managing Director of Merrill Lynch
from 1992 to 1996
Donald C. Burke ............ Senior Vice President, Senior Vice President and Treasurer of FAM;
Treasurer and Senior Vice President and Treasurer of Princeton Services;
Director of Taxation Vice President of PFD; First Vice President of the Investment
Adviser from 1997 to 1999; Vice President of the Investment
Adviser from 1990 to 1997
Michael G. Clark ........... Senior Vice President Senior Vice President of FAM; Senior Vice President of FAM; Senior
Vice President of Princeton Services; Treasurer and Director of
PFD; First Vice President of the Investment Adviser from 1997 to
1999; Vice President of the Investment Adviser from 1996 to 1997
Robert C. Doll ............. Senior Vice President Senior Vice President of FAM; Senior Vice President of Princeton
Services; Chief Investment Officer of Oppenheimer Funds, Inc. in
1999 and Executive Vice President thereof from 1991 to 1999
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
Michael J. Hennewinkel ..... Senior Vice President, Senior Vice President, Secretary and General Counsel
Secretary and General of FAM; Senior Vice President of Princeton Services
Counsel
Philip L. Kirstein ......... Senior Vice President Senior Vice President of FAM; Senior Vice President, Secretary,
General Counsel and Director of Princeton Services
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; Senior Vice President of Princeton
Services; Vice President of PFD
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
Brian A. Murdock ........... Senior Vice President Senior Vice President of FAM; Senior Vice President of
Princeton Services
Gregory D. Upah ............ Senior Vice President Senior Vice President of FAM; Senior Vice President of
Princeton Services
</TABLE>
Item 27. Principal Underwriters
(a) MLFD, a division of PFD, 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 26 except 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. 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., Merrill Lynch
Municipal Strategy Fund, Inc., Merrill Lynch Senior Floating Rate Fund, Inc. and
MerrillLynch Senior Floating Rate Fund II, Inc. A separate division of PFD acts
as the principal underwriter of a number of other investment companies.
C-5
<PAGE>
(b) Set forth below is information concerning each director and officer of
PFD. The principal business address of each such person is P.O. Box 9081,
Princeton, New Jersey 08543-9081, except that the address of Messrs. Breen,
Crook, Fatseas and Wasel is One Financial Center, 23rd Floor, Boston,
Massachusetts 02111-2665.
<TABLE>
<CAPTION>
Position(s) and Office(s) Position(s) and Office(s) with
Name with PFD Registrant
- ---- ------------------------- ----------------------------------
<S> <C> <C>
Terry K. Glenn ............. President and Director President and Director
Michael G. Clark ........... Treasurer and 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
Donald C. Burke ............ Vice President Vice President and Treasurer
James T. Fatseas ........... Vice President None
Debra W. Landsman-Yaros .... Vice President None
Michelle T. Lau ............ Vice President None
Salvatore Venezia .......... Vice President None
William Wasel .............. Vice President None
Robert Harris .............. Secretary Secretary
(c) Not applicable.
</TABLE>
Item 28. Location of Accounts and Records
All accounts, books and other documents required to be maintained by
Section 31(a) of the Investment Company Act of 1940, as amended (the "1940 Act")
and the rules thereunder are maintained at the offices of the Registrant (800
Scudders Mill Road, Plainsboro, New Jersey 08536), and its transfer agent,
Financial Data Services, Inc. (4800 Deer Lake Drive East, Jacksonville, Florida
32246-6484).
Item 29. Management Services
Other than as set forth under the caption "Management of the Fund --
Merrill Lynch Asset Management" 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 30. Undertakings.
Not applicable.
C-6
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act and the Investment
Company Act, the Registrant has duly caused this registration statement to be
signed on its behalf by the undersigned, duly authorized, in the Township of
Plainsboro, and State of New Jersey, on the 30th day of July, 1999.
MERRILL LYNCH ADJUSTABLE RATE SECURITIES FUND, INC.
(Registrant)
By /s/ DONALD C. BURKE
-----------------------------------------------
(Donald C. Burke, Vice President and Treasurer)
Pursuant to the requirements of the Securities Act of 1933, this
Post-Effective Amendment to the Registration Statement has been signed below by
the following persons in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
TERRY K. GLENN* President and Director
- ----------------------------- (Principal Executive Officer)
(Terry K. Glenn)
/s/ DONALD C. BURKE Vice President and Treasurer July 30, 1999
- ----------------------------- (Principal Financial
(Donald C. Burke) and Accounting Officer)
DONALD CECIL* Director
- -----------------------------
Donald Cecil)
ROLAND M. MACHOLD* Director
- -----------------------------
(Roland M. Machold)
EDWARD H. MEYER* Director
- -----------------------------
(Edward H. Meyer)
CHARLES C. REILLY* Director
- -----------------------------
(Charles C. Reilly)
RICHARD R. WEST* Director
- -----------------------------
(Richard R. West)
ARTHUR ZEIKEL* Director
- -----------------------------
(Arthur Zeikel)
EDWARD D. ZINBARG* Director
- -----------------------------
(Edward D. Zinbarg)
*By: /s/DONALD C. BURKE July 30, 1999
- -----------------------------
(Donald C. Burke, Attorney-in-Fact)
</TABLE>
C-7
<PAGE>
POWER OF ATTORNEY
The undersigned, the Directors/Trustees and the officers of each of the
registered investment companies listed below, hereby authorzize Terry K. Glenn,
Donald C. Burke and Joseph T. Monagle, Jr. or any of them, as attorney-in-fact,
to sign on his behalf in the capacities indicated any Registration Statement or
amendment thereto (including post-effective amendments) for each of the
following registered investment companies and to file the same, with all
exhibits thereto, with the Securities and Exchange Commission: Merrill Lynch
Adjustable Rate Securities Fund, Inc.; Apex Municipal Fund, Inc.; Merrill Lynch
Asset Builder Program, Inc.; Corporate High Yield Fund, Inc.; Corporate High
Yield Fund II, Inc.; Corporate High Yield Fund III, Inc.; Merrill Lynch Federal
Securities Trust; Merrill Lynch Fundamental Growth Fund, Inc.; Income
Opportunities Fund 1999, Inc.; Income Opportunities Fund 2000, Inc.:
MuniHoldings Insured Fund II, Inc.; MuniHoldings Insured Fund III, Inc.;
MuniInsured Fund, Inc.; MuniYield Insured Fund, Inc.; Merrill Lynch Phoenix
Fund, Inc.; Merrill Lynch Real Estate Fund, Inc.; Merrill Lynch Retirement
Reserves Money Fund of Merrill Lynch Retirement Series Trust and Summit Cash
Reserves Fund of Financial Institution Series Trust.
<TABLE>
<CAPTION>
Signature Title Date
--------- ---- ----
<S> <C> <C> <C>
/s/ TERRY K. GLENN President (Principal Executive
- ----------------------------------------------- Officer), Director and Trustee April 13, 1999
(Terry K. Glenn)
/s/ DONALD C. BURKE Vice President and Treasurer
- ----------------------------------------------- (Principal Financial
(Donald C. Burke) and Accounting Officer) April 13, 1999
/s/ JOE GRILLS Director/Trustee April 13, 1999
- ----------------------------------------------
(Joe Grills)
/s/ WALTER MINTZ Director/Trustee April 13, 1999
- ----------------------------------------------
(Walter Mintz)
/s/ ROBERT S. SALOMAN, JR. Director/Trustee April 13, 1999
- ----------------------------------------------
(Robert S. Saloman, Jr.)
/s/ MELVIN R. SEIDEN Director/Trustee April 13, 1999
- ----------------------------------------------
(Melvin R. Seiden)
/s/ STEPHEN B. SWENSRUD Director/Trustee April 13, 1999
- ----------------------------------------------
(Stephen B. Swensrud)
/s/ARTHUR ZEIKEL Director/Trustee April 13, 1999
- ----------------------------------------------
(Arthur Zeikel)
</TABLE>
C-8
<PAGE>
EXHIBIT INDEX
Exhibit
Numbers Description
- ------- -----------
9(b) -- Consent of Brown & Wood LLP, counsel to the Registrant.
10 -- Consent of Deloitte & Touche LLP, independent auditors for the
Registrant.
EXHIBIT 9(b)
BROWN & WOOD LLP
ONE WORLD TRADE CENTER
NEW YORK, N.Y. 10048-0557
TELEPHONE: 212-839-5300
FACSIMILE: 212-839-5599
July 30, 1999
Merrill Lynch Adjustable Rate Securities Fund, Inc.
800 Scudders Mill Road
Plainsboro, New Jersey 08536
Ladies and Gentlemen:
We consent to the filing in Post-Effective Amendment No. 10 to the Registration
Statement on Form N-1A (File Nos. 33-40332 and 811-6304) of our opinion dated
June 13, 1991 filed on June 14, 1991 as an Exhibit to Pre-Effective
Amendment No. 1 to such Registration Statement and to the use of our name in the
prospectus and statement of additional information constituting parts thereof.
Very truly yours,
/s/ BROWN & WOOD LLP
EXHIBIT 10
INDEPENDENT AUDITORS' CONSENT
Merrill Lynch Adjustable Rate Securities Fund, Inc.:
We consent to the incorporation by reference in this Post-Effective Amendment
No. 10 to Registration Statement No. 33-40332 of our report dated July 12, 1999
appearing in the annual report to shareholders of Merrill Lynch Adjustable Rate
Securities Fund, Inc. for the year ended May 31, 1999, and to the reference to
us under the caption "Financial Highlights" in the Prospectus, which is a part
of such Registration Statement.
/s/ Deloitte & Touche LLP
- -------------------------
Deloitte & Touche LLP
Princeton, New Jersey
July 30, 1999