<PAGE>
[Graphic Omitted] Tax Free
Fund of
Vermont
Vermont Fund Advisors, Inc.
128 Merchants Row
Rutland, Vermont 05701
1-800-675-3333
ANNUAL
REPORT TO
SHAREHOLDERS
December 31, 1997
[Graphic Omitted]
<PAGE>
December 31, 1997
Dear Shareholder,
During 1997, your Fund's performance was outstanding. The Fund's total return
was 7.74%, making 1997 the second best year in the Fund's history. While the
Fund matched last year's tax free income distribution of 43 cents per share,
the Fund also realized an increase in its net asset value, attributable to
both realized and unrealized net appreciation of bonds in the Fund's
portfolio, of an additional 32 cents per share.
Part of the Fund's appreciation in share price was the result of the
prerefunding, early in 1997, of a large holding of Swanton Village, Vermont,
Electric Department bonds owned by the Fund. This prerefunding alone
contributed approximately 15 cents per share to the Fund's total return for
1997. The Fund has deliberately structured its portfolio to provide for the
opportunity for the Fund to continue benefiting from such potential
prerefundings in 1998 and beyond. The Fund has accomplished this by investing
in several large positions of relatively higher yielding bonds that are
candidates for such prerefundings in the future.
1997 also was a year of anomaly for the Fund, since most investor attention
was focused on the equity markets throughout the entire year. As a result,
bond funds in general, despite the fact that strong total return performances
were commonplace in 1997, took a side seat to stocks in 1997 and growth in
total assets was modest. The Fund shared that performance, with total assets
increasing slightly less than $0.7 million in 1997, from $7.2 million to $7.9
million. Actually, during the last six months of 1997, bond funds held their
own against stocks and investors began to recognize this by increasing their
investments in bonds and bond funds late in the year. We anticipate that this
trend will continue in 1998.
Thank you for your interest in and support of the Fund during 1997. As always,
your comments and suggestions are welcomed and we encourage you to contact us
at any time to discuss any aspect of the Fund's operations and performance. We
look forward to continuing to meet your tax free investment needs and goals in
1998 and beyond.
Yours truly,
/s/ John T. Pearson
John T. Pearson
President
<PAGE>
$10,000 Investment in Fund Compared to
Lehman Muni Bond Index
AVERAGE ANNUAL TOTAL RETURN
1 YEAR 5 YEAR INCEPTION
7.74% 5.90% 5.72%
T/F Fund of Vermont Lehman Muni Bond Index
------------------- ----------------------
9/18/91 $10,000.00 $10,000.00
12/31/91 $10,110.00 $10,389.00
12/31/92 $10,651.00 $11,198.00
12/31/93 $11,211.00 $12,565.00
12/31/94 $11,181.00 $11,915.00
12/31/95 $12,595.00 $13,995.00
12/31/96 $13,169.00 $14,590.00
12/31/97 $14,188.00 $15,931.00
Past performance is not predictive of future performance.
The graph above compares the increase in value of a $10,000 investment in the
Tax Free Fund of Vermont, Inc. with the performance of the Lehman Muni Bond
Index. The objective of the graph is to permit you to compare the performance
of the Fund with the current market and to give perspective to market
conditions and investment strategies and techniques pursued by the investment
manager that materially affected the performance of the Fund. The Lehman Muni
Fund Bond Index reflects reinvestment of interest payments but not the
expenses of the Fund.
From its inception, the Fund has been managed in accordance with a strategy of
producing a high level of income substantially free of both Vermont and
federal income taxes while at the same time minimizing fluctuations in the
Fund's share price. This strategy has been implemented by investing generally
in long term municipal bonds of issuers in Vermont. On average, Vermont
municipal bonds are generally of a higher credit quality than similar bonds
nationwide. Accordingly, as interest rates rise and fall throughout an
interest rate cycle, the Fund's share price tends to fluctuate less than the
share prices of comparable funds nationwide. As a result, the Fund tends to
underperform most municipal bond market indices while retaining more share
price stability overall and more value in markets where interest rates are
rising and share prices are correspondingly declining.
<PAGE>
TAIT, WELLER & BAKER
Cerfified Public Accountants
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Shareholders and Board of Directors
Tax Free Fund of Vermont, Inc.
Rutland, Vermont
We have audited the accompanying statement of assets and liabilities of the
Tax Free Fund of Vermont, Inc., including the portfolio of investments, as of
December 31, 1997, and the related statement of operations for the year then
ended, the statement of changes in net assets for each of the two years in the
period then ended, and the financial highlights for each of the five years in
the period then ended. These financial statements and financial highlights are
the responsibility of the Fund's management. Our responsibility is to express
an opinion on these financial statements and financial highlights based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements and
financial highlights are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. Our procedures included confirmation of securities
owned as of December 31, 1997, by correspondence with the custodian and
brokers. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of the
Tax Free Fund of Vermont, Inc. as of December 31, 1997, and the results of its
operations for the year then ended, the changes in its net assets for each of
the two years in the period then ended, and the financial highlights for each
of the five years in the period then ended, in conformity with generally
accepted accounting principles.
TAIT, WELLER & BAKER
PHILADELPHIA, PENNSYLVANIA
JANUARY 9, 1998
<PAGE>
TAX FREE FUND OF VERMONT, INC.
PORTFOLIO OF INVESTMENTS
DECEMBER 31, 1997
<TABLE>
<CAPTION>
MUNICIPAL BONDS (101.27%) MATURITY PRINCIPAL MARKET
RATE DATE AMOUNT VALUE
---- ---- ------ -----
<S> <C> <C> <C> <C>
VERMONT (85.11%)
Vermont Educational and
Health Buildings Financing Agency
1993 Revenue Bond
(Norwich University Project) ............. 6.0% 09/01/13 $ 105,000 $ 111,694
1991 Revenue Bond (FHA Insured)
(Helen Porter Nursing Home Project) ...... 7.1% 02/01/31 275,000 297,000
1994 Revenue Bond
(St. Johnsbury Academy Project) .......... 7.15% 04/15/14 1,145,000 1,242,325
1994 Revenue Bond
(St. Johnsbury Academy Project) .......... 7.375% 04/15/24 225,000 246,094
1993 Revenue Bond
(Champlain College Project) .............. 6.0% 10/01/13 260,000 276,575
1994 Revenue Bond
(Landmark College Project) ............... 7.15% 11/01/14 500,000 566,250
1996 Revenue Bond
(Lyndon Institute) ....................... 6.60% 12/01/14 335,000 367,662
1996 Revenue Bond
(Northwestern Medical Center) ............ 6.25% 09/01/18 530,000 556,500
1992 Revenue Bond
(Middlebury College Project) ............. 6.0% 11/01/22 100,000 104,500
1996 Revenue Bond
(Middlebury College Project) ............. 5.375% 11/01/26 100,000 102,125
Vermont State Colleges
1997 Revenue Bond ........................ 5.125% 07/01/18 350,000 342,562
Vermont Housing Finance Agency
Single Family Mortgage-Backed Bond
1990 Series 2 ............................ 7.3% 05/01/25 285,000 301,388
1989 Series A ............................ 7.85% 12/01/29 265,000 276,262
1988 Series B ............................ 8.1% 06/01/22 380,000 393,619
1990 Series 1 ............................ 8.15% 05/01/25 185,000 193,556
1994 Series 5 ............................ 6.875% 11/01/16 100,000 108,625
1992 Series 4 ............................ 5.75% 11/01/12 55,000 56,513
1992 Series 4 ............................ 6.4% 11/01/25 660,000 706,200
Vermont Housing Finance Agency
Multi-Family Mortgage-Backed Bond
1977 Series 1 ............................ 6.50% 02/15/17 75,000 75,238
Vermont Student Assistance Corp.
1993 Series D ............................ 6.70% 12/15/12 350,000 381,500
----------
TOTAL VERMONT BONDS .................. 6,706,188
----------
PUERTO RICO (10.78%)
Puerto Rico Electric Power Authority
1995 Revenue Bond, Series X .............. 5.5% 07/01/25 180,000 182,700
Puerto Rico Industrial,
Medical & Environmental Authority
1994 Revenue Bond
(Ryder Memorial Hospital Project) ........ 6.6% 05/01/14 425,000 463,781
1997 Revenue Bond
(Mennonite General Hospital Project) ..... 5.625% 07/01/27 200,000 202,500
----------
TOTAL PUERTO RICO BONDS .............. 848,981
----------
U.S. VIRGIN ISLANDS (5.38%)
U.S. Virgin Islands Public Finance
Authority 1992 Series A .................. 7.25% 10/01/18 375,000 423,750
----------
TOTAL INVESTMENTS IN SECURITIES
(COST $7,692,024) (101.27%) (1) ........ 7,978,919
OTHER ASSETS AND LIABILITIES, NET -
(1.27%) ................................ (99,757)
----------
NET ASSETS - 100% ........................ $7,879,162
==========
(1) The cost of investments for federal income tax purposes amounted to $7,692,024. Gross
unrealized appreciation and depreciation of investments based on identified tax cost
at December 31, 1997 are as follows:
Gross unrealized appreciation ...................................................... $ 288,558
Gross unrealized depreciation ...................................................... (1,663)
----------
Net unrealized appreciation ........................................................ $ 286,895
==========
</TABLE>
See accompanying notes to financial statements.
<PAGE>
STATEMENT OF ASSETS AND LIABILITIES
DECEMBER 31, 1997
ASSETS
- ------
Investments in securities at market value
(identified cost $7,692,024) (Note 1-A) ......................... $7,978,919
Cash .............................................................. 109,873
Receivable for interest ........................................... 97,028
Prepaid expenses and other assets ................................. 34,644
----------
TOTAL ASSETS .................................................. 8,220,464
----------
LIABILITIES
- ------------
Payable for:
Securities purchased ............................................ 339,302
Capital stock redeemed .......................................... 2,000
----------
TOTAL LIABILITIES ............................................. 341,302
----------
NET ASSETS
- ----------
(Applicable to 765,478 shares outstanding, $.01 par value,
10,000,000 shares authorized) ................................. $7,879,162
==========
NET ASSET VALUE, OFFERING AND REPURCHASE PRICE PER SHARE
- --------------------------------------------------------
($7,879,162 / 765,478) .......................................... $10.29
======
NET ASSETS
- ----------
At December 31, 1997, net assets consisted of:
Paid-in capital ................................................. $7,577,288
Accumulated net realized gain on investments .................... 14,979
Unrealized appreciation of investments .......................... 286,895
----------
$7,879,162
==========
See accompanying notes to financial statements.
<PAGE>
STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 1997
INVESTMENT INCOME
- -----------------
INCOME
Interest ...................................................... $446,282
--------
EXPENSES
Investment advisory fees (Note 4) ............................. 52,115
Printing and postage .......................................... 26,394
Audit fees .................................................... 10,944
Insurance ..................................................... 9,525
Administrative and shareholder services (Note 4) .............. 11,192
Portfolio pricing costs ....................................... 2,392
Custody fees .................................................. 2,733
Registration fees ............................................. 1,445
Directors fees and expenses ................................... 10,930
Other ......................................................... 642
--------
TOTAL EXPENSES ................................................ 128,312
--------
NET INVESTMENT INCOME ....................................... 317,970
--------
REALIZED AND UNREALIZED GAIN ON INVESTMENTS
- -------------------------------------------
Net realized gain on investments sold ......................... 147,794
Net change in unrealized appreciation ......................... 98,475
--------
NET GAIN ON INVESTMENTS ................................... 246,269
--------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS .... $564,239
========
See accompanying notes to financial statements.
<PAGE>
STATEMENT OF CHANGES IN NET ASSETS
YEARS ENDED DECEMBER 31, 1997 AND 1996
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
INCREASE (DECREASE) IN NET ASSETS FROM OPERATIONS
- -------------------------------------------------
Net investment income ............................................................... $ 317,970 $ 316,284
Net realized gain on investments .................................................... 147,794 55,649
Net change in unrealized appreciation (depreciation) ................................ 98,475 (48,332)
---------- ----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS .............................. 564,239 323,601
DISTRIBUTIONS TO SHAREHOLDERS FROM
----------------------------------
Net investment income ............................................................. (317,970) (316,284)
CAPITAL SHARE TRANSACTIONS (Note 3)
-----------------------------------
Increase in net assets resulting from capital share
transactions .................................................................... 414,136 250,708
---------- ----------
TOTAL INCREASE IN NET ASSETS ...................................................... 660,405 258,025
NET ASSETS
- ----------
Beginning of year ................................................................... 7,218,757 6,960,732
---------- ----------
END OF YEAR ......................................................................... $7,879,162 $7,218,757
========== ==========
</TABLE>
See accompanying notes to financial statements.
<PAGE>
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, 1997
--------------------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE
- ---------------
BEGINNING OF YEAR ................................ $ 9.97 $ 9.96 $ 9.30 $ 9.86 $ 9.88
------ ------ ------ ------ ------
INCOME FROM INVESTMENT OPERATIONS
Net investment income ........................ .43 .43 .49 .53 .53
Net gain (loss) on securities (both realized
and unrealized) ............................ .32 .01 .66 (.56) (.02)
------ ------ ------ ------ ------
TOTAL FROM INVESTMENT OPERATIONS ............. .75 .44 1.15 (.03) .51
------ ------ ------ ------ ------
LESS DISTRIBUTIONS FROM
Net investment income ........................ (.43) (.43) (.49) (.53) (.53)
------ ------ ------ ------ ------
END OF YEAR .................................... $10.29 $ 9.97 $ 9.96 $ 9.30 $ 9.86
------ ------ ------ ------ ------
TOTAL RETURN ..................................... 7.74% 4.56% 12.65% (0.27)% 5.26%
- ------------
RATIOS/SUPPLEMENTAL DATA
- ------------------------
NET ASSETS AT END OF YEAR (000'S) .............. $7,879 $7,219 $6,961 $5,786 $5,875
RATIO OF
Expenses to average net assets ............... 1.72% 1.55% 1.49% 1.66% 2.48%
Net investment income to average net assets .. 4.26% 4.41% 5.06% 5.61% 5.34%
PORTFOLIO TURNOVER ............................... 60% 98% 182% 44% 61%
- ------------------
</TABLE>
See accompanying notes to financial statements.
<PAGE>
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997
(1) Summary of Significant Accounting Policies
------------------------------------------
The Tax Free Fund of Vermont, Inc. (the "FUND") was incorporated under the
laws of the State of Vermont on May 20, 1991. The Fund is registered under the
Investment Company Act of 1940, as amended, as a non-diversified, open-end
investment company. The Fund's investment goal is to seek the highest level of
current income exempt from Federal and Vermont income taxes for shareholders
as is consistent with the prudent investment management of the principal
invested by shareholders.
The following is a summary of the significant accounting policies consistently
followed by the Fund in the preparation of its financial statements. The
policies are in conformity with generally accepted accounting principles.
(A) Security Valuation
------------------
Portfolio securities are valued by an independent pricing service using
market quotations, prices provided by market makers, or estimates of
market values obtained from yield data relating to instruments or
securities with similar characteristics, in accordance with procedures
established in good faith by the Board of Directors.
(B) Security Transactions and Investment Income
-------------------------------------------
Security transactions are accounted for on the trade date. Interest
income is accrued on a daily basis. Bond premiums and discounts are
amortized/ accreted as required by the Internal Revenue Code.
(C) Income Taxes
------------
It is the Fund's policy to qualify as a regulated investment company by
complying with the requirements of the Internal Revenue Code applicable
to regulated investment companies, including the distribution of all
taxable income to the Fund's shareholders. Therefore, no Federal income
tax provision is required. By qualifying as a "REGULATED INVESTMENT
COMPANY" for Federal income tax purposes, the Fund is not subject to
Vermont income taxes on net income and net capital gains, if any, that
are distributed to the Fund's shareholders. Dividends paid by the Fund to
shareholders which qualify as "EXEMPT INTEREST DIVIDENDS" for Federal
income tax purposes are also excludable from shareholders' gross income
for Vermont state income tax purposes so long as the total assets of the
Fund are invested in Vermont Municipal Bonds and Other Municipal Bonds as
defined in the prospectus.
(D) Distributions to Shareholders
-----------------------------
The Fund intends to declare daily and distribute monthly to its
shareholders dividends from net investment income and to declare and
distribute annually net realized long-term capital gains, if any. Income
and capital gain distributions are determined in accordance with income
tax regulations which may differ from generally accepted accounting
principles. These differences are primarily due to differing treatment of
post-October capital losses. Each distribution will be made in shares or,
at the option of the shareholder, in cash.
(E) Use of Estimates
----------------
In preparing financial statements in conformity with generally accepted
accounting principles, management makes estimates and assumptions that
affect the reported amounts of assets and liabilities at the date of the
financial statements, as well as the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from
those estimates.
(2) Purchases and Sales of Securities
---------------------------------
Realized gains and losses are recorded on the specific identification method.
Costs of purchases and proceeds from sales of securities for the Fund
aggregated $4,988,177 and $4,302,802, respectively.
(3) Capital Share Transactions
--------------------------
Transactions in shares of the Fund for the years ended December 31, 1997 and
1996, were as follows:
1997 1996
---------------------- ---------------------
SHARES AMOUNT SHARES AMOUNT
------ ------ ------ ------
Shares sold .................. 130,732 $1,316,230 113,580 $1,126,288
Shares issued in reinvestment
of dividends 21,950 221,620 19,836 196,725
Shares redeemed .............. (111,499) (1,123,714) (108,155) (1,072,305)
-------- ---------- -------- ----------
NET INCREASE ................. 41,183 $ 414,136 25,261 $ 250,708
======== ========== ======== ==========
(4) Investment Advisory Fee and Other Transactions with Affiliates
--------------------------------------------------------------
As compensation for its management services, the Fund has agreed to pay
Vermont Fund Advisors, Inc. (the "ADVISOR") a fee computed at the annual rate
of.7% (seven-tenths of 1 percent) of average daily net asset value. However,
the Advisor may voluntarily waive or refund investment advisory fees payable
to it under the Advisory Agreement and assume and pay or otherwise reimburse
the Fund for other operating expenses to whatever extent deemed necessary and
appropriate. There was no reimbursement made by the Advisor for the year ended
December 31, 1997.
In addition, the Fund has entered into an Administrative Services Agreement
with the Advisor. The Agreement provides for a fee computed at a rate of.08%
(eight-one hundredths of 1 percent) on the average daily net asset value of
the Fund to be paid for administrative services received by the Fund. For the
year ended December 31, 1997, administrative services fees paid by the Fund
totaled $6,109.
The president, director and sole shareholder of the Advisor also serves as
president and as a director of the Fund. Officers of the Fund receive no
compensation directly from the Fund.
(5) Concentration of Credit Risk
----------------------------
The Fund invests a substantial proportion of its investments in debt
obligations issued by the State of Vermont and its political sub-divisions,
agencies and public authorities to obtain funds for various public purposes.
The Fund is more susceptible to factors adversely affecting issuers of Vermont
municipal securities than is a fund that is not concentrated in these issuers
to the same extent.
