75 P
SUPPLEMENT DATED FEBRUARY 1, 1995
TO THE PROSPECTUS OF
FRANKLIN CALIFORNIA HIGH YIELD MUNICIPAL FUND
FRANKLIN MUNICIPAL SECURITIES TRUST
DATED OCTOBER 1, 1994
The prospectus language is revised, as noted, to reflect current operational
policies of the Fund:
1. EXPENSE TABLE
Revised to reflect that investments of $1,000,000 or more in the Fund are not
subject to a front-end sales charge but a contingent deferred sales charge of
1% will be imposed on certain redemptions within 12 months of the calendar
month following such investments. See "How to Sell Shares of the Fund -
Contingent Deferred Sales Charge."
2. MANAGEMENT OF THE FUND
Revised to add the definition "Franklin Templeton Group" to describe the
subsidiaries of Resources.
3. HOW TO BUY SHARES OF THE FUND:
a) Add the following language as paragraph two:
The Fund may impose a $10 charge for each returned item, against any
shareholder account which, in connection with the purchase of Fund shares,
submits a check or a draft which is returned unpaid to the Fund.
b) Substitute the following for the sales charge table and the ensuing two
paragraphs:
<TABLE>
<CAPTION>
TOTAL SALES CHARGE
------------------------------------------------------------
AS A AS A DEALER CONCESSION
SIZE OF TRANSACTION PERCENTAGE OF PERCENTAGE OF NET AS A PERCENTAGE
AT OFFERING PRICE OFFERING PRICE AMOUNT INVESTED OF OFFERING PRICE*,***
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Less than $100,000.................................... 4.25% 4.44% 4.00%
$100,000 but less than $250,000....................... 3.50% 3.63% 3.25%
$250,000 but less than $500,000....................... 2.75% 2.83% 2.50%
$500,000 but less than $1,000,000..................... 2.15% 2.20% 2.00%
$1,000,000 or more.................................... none none (see below)**
</TABLE>
*Financial institutions or their affiliated brokers may receive an agency
transaction fee in the percentages set forth above.
**The following commissions will be paid by Distributors, from its own
resources, to securities dealers who initiate and are responsible for
purchases of $1 million or more: 0.75% on sales of $1 million but less than
$2 million, plus 0.60% on sales of $2 million but less than $3 million, plus
0.50% on sales of $3 million but less than $50 million, plus 0.25% on sales
of $50 million but less than $100 million, plus 0.15% on sales of $100
million or more. Dealer concession breakpoints are reset every 12 months for
purposes of additional purchases.
***At the discretion of Distributors, all sales charges may at times be
allowed to the securities dealer. If 90% or more of the sales commission is
allowed, such securities dealer may be deemed to be an underwriter as that
term is defined in the Securities Act of 1933, as amended.
No front-end sales charge applies on investments of $1 million or more, but
a contingent deferred sales charge of 1% is imposed on certain redemptions
of investments of $1 million or more within 12 months of the calendar month
following such investments ("contingency period"). See "How to Sell Shares
of the Fund - Contingent Deferred Sales Charge."
The size of a transaction which determines the applicable sales charge on
the purchase of Fund shares is determined by adding the amount of the
shareholder's current purchase plus the cost or current value (whichever is
higher) of a shareholder's existing investment in one or more of the funds
in the Franklin Group of Funds(R) and the Templeton Group of Funds. Included
for these aggregation purposes are (a) the mutual funds in the Franklin
Group of Funds except Franklin Valuemark Funds and Franklin Govern-
1
<PAGE>
ment Securities Trust (the "Franklin Funds"), (b) other investment products
underwritten by Distributors or its affiliates (although certain investments
may not have the same schedule of sales charges and/or may not be subject to
reduction) and (c) the U.S. mutual funds in the Templeton Group of Funds
except Templeton American Trust, Inc., Templeton Capital Accumulator Fund,
Inc., Templeton Variable Annuity Fund, and Templeton Variable Products
Series Fund (the "Templeton Funds"). (Franklin Funds and Templeton Funds are
collectively referred to as the "Franklin Templeton Funds.") Sales charge
reductions based upon aggregate holdings of (a), (b) and (c) above
("Franklin Templeton Investments") may be effective only after notification
to Distributors that the investment qualifies for a discount. References
throughout the Prospectus, for purposes of aggregating assets or describing
the exchange privilege, refer to the above descriptions.
Distributors, or one of its affiliates, may make payments, out of its own
resources, of up to 1% of the amount purchased to securities dealers who
initiate and are responsible for purchases made at net asset value by
certain trust companies and trust departments of banks. See definition under
"Description of Special Net Asset Value Purchases" and as set forth in the
SAI.
As of March 1, 1995, "Timing Accounts" will no longer be permitted to buy
shares of the Fund. See "Exchange Privilege" for a description.
c) Substitute the following for the current "Purchases at Net Asset Value"
subsection:
PURCHASES AT NET ASSET VALUE
Shares of the Fund may be purchased without the imposition of either a
front-end sales charge ("net asset value") or a contingent deferred sales
charge by (1) officers, directors, trustees and full-time employees of the
Trust, any of the Franklin Templeton Funds, or of the Franklin Templeton
Group, and by their spouses and family members; (2) companies exchanging
shares with or selling assets pursuant to a merger, acquisition or exchange
offer; (3) registered securities dealers and their affiliates, for their
investment account only, and (4) registered personnel and employees of
securities dealers and by their spouses and family members, in accordance
with the internal policies and procedures of the employing securities
dealer.
Shares of the Fund may be purchased at net asset value by persons who have
redeemed, within the previous 120 days, their shares of the Fund or another
of the Franklin Templeton Funds which were purchased with a front-end sales
charge or assessed a contingent deferred sales charge on redemption. An
investor may reinvest an amount not exceeding the redemption proceeds. While
credit will be given for any contingent deferred sales charge paid on the
shares redeemed a new contingency period will begin. Shares of the Fund
redeemed in connection with an exchange into another fund (see "Exchange
Privilege") are not considered "redeemed" for this privilege. In order to
exercise this privilege, a written order for the purchase of shares of the
Fund must be received by the Fund or the Fund's Shareholder Services Agent
within 120 days after the redemption. The 120 days, however, do not begin to
run on redemption proceeds placed immediately after redemption in a Franklin
Bank Certificate of Deposit ("CD") until the CD (including any rollover)
matures. Reinvestment at net asset value may also be handled by a securities
dealer or other financial institution, who may charge the shareholder a fee
for this service. The redemption is a taxable transaction but reinvestment
without a sales charge may affect the amount of gain or loss recognized and
the tax basis of the shares reinvested. If there has been a loss on the
redemption, the loss may be disallowed if a reinvestment in the same fund is
made within a 30-day period. Information regarding the possible tax
consequences of such a reinvestment is included in the tax section of this
Prospectus and the SAI.
Dividends and capital gains received in cash by the shareholder may also be
used to purchase shares of the Fund or another of the Franklin Templeton
Funds at net asset value and without the imposition of a contingent deferred
sales charge within 120 days of the payment date of such distribution. To
exercise this privilege, a written request to reinvest the distribution must
accompany the purchase order. Addi-
2
<PAGE>
tional information may be obtained from Shareholder Services at
1-800/632-2301. See "Distributions in Cash" under "Distributions to
Shareholders."
Shares of the Fund may be purchased at net asset value and without the
imposition of a contingent deferred sales charge by investors who have,
within the past 60 days, redeemed an investment in an unaffiliated mutual
fund which charged the investor a contingent deferred sales charge upon
redemption and which has investment objectives similar to those of the Fund.
Shares of the Fund may be purchased at net asset value and without the
imposition of a contingent deferred sales charge by registered investment
advisors and/or their affiliated broker-dealers, who have entered into a
supplemental agreement with Distributors, on behalf of their clients who are
participating in a comprehensive fee program (also known as a wrap fee
program).
Shares of the Fund may also be purchased at net asset value and
without the imposition of a contingent deferred sales charge by any state,
county, or city, or any instrumentality, department, authority or agency
thereof which has determined that the Fund is a legally permissible
investment and which is prohibited by applicable investment laws from paying
a sales charge or commission in connection with the purchase of shares of
any registered management investment company ("an eligible governmental
authority"). SUCH INVESTORS SHOULD CONSULT THEIR OWN LEGAL ADVISORS TO
DETERMINE WHETHER AND TO WHAT EXTENT THE SHARES OF THE FUND CONSTITUTE LEGAL
INVESTMENTS FOR THEM. Municipal investors considering investment of proceeds
of bond offerings into the Fund should consult with expert counsel to
determine the effect, if any, of various payments made by the Fund or its
investment manager on arbitrage rebate calculations. If an investment by an
eligible governmental authority at net asset value is made through a
securities dealer who has executed a dealer agreement with Distributors,
Distributors or one of its affiliates may make a payment, out of their own
resources, to such securities dealer in an amount not to exceed 0.25% of the
amount invested. Contact Franklin's Institutional Sales Department for
additional information.
DESCRIPTION OF SPECIAL NET ASSET VALUE PURCHASES
Shares of the Fund may be purchased at net asset value and without the
imposition of a contingent deferred sales charge by trust companies and bank
trust departments for funds over which they exercise exclusive discretionary
investment authority and which are held in a fiduciary, agency, advisory,
custodial or similar capacity. Such purchases are subject to minimum
requirements with respect to amount of purchase, which may be established by
Distributors. Currently, those criteria require that the amount invested or
to be invested during the subsequent 13-month period in this Fund or any of
the Franklin Templeton Investments must total at least $1,000,000. Orders
for such accounts will be accepted by mail accompanied by a check or by
telephone or other means of electronic data transfer directly from the bank
or trust company, with payment by federal funds received by the close of
business on the next business day following such order.
Refer to the SAI for further information.
4. EXCHANGE PRIVILEGE
a) The following option is added to "Exchanges by Telephone":
The automatic TeleFACTS(R) system at 1-800/247-1753 is available for
processing exchanges (day or night). During periods of drastic economic or
market changes, however, this option may not be available, in which event the
shareholder should follow other exchange procedures discussed in the
Prospectus.
b) Substitute the following for the subsection "Timing Accounts."
As of March 1, 1995, "Timing Accounts" will no longer be permitted to
exchange into the Fund. This policy does not affect any other types of
investor. "Timing Accounts" generally include market timing or allocation
services; accounts administered as to redeem or purchase shares based upon
certain predetermined market indicators; or any person whose transactions
seem to follow a timing pattern.
3
<PAGE>
c) Add the following paragraph under the subsection "Additional Information
Regarding Exchanges":
A contingent deferred sales charge will not be imposed on exchanges. If,
however, the exchanged shares were subject to a contingent deferred sales
charge in the original fund purchased, and shares are subsequently redeemed
within the contingency period, a contingent deferred sales charge will be
imposed. The contingency period will be tolled (or stopped) for the period
such shares are exchanged into and held in a Franklin or Templeton money
market fund. See also "How to Sell Shares of the Fund - Contingent Deferred
Sales Charge."
5. HOW TO SELL SHARES OF THE FUND
Add the following subsection:
CONTINGENT DEFERRED SALES CHARGE
In order to recover commissions paid to securities dealers on investments of
$1 million or more, a contingent deferred sales charge of 1% applies to
redemptions of those investments within the contingency period of 12 months
of the calendar month following such purchase. The charge is 1% of the
lesser of the value of the shares redeemed (exclusive of reinvested
dividends and capital gain distributions) or the total cost of such shares,
and is retained by Distributors. In determining if a charge applies, shares
not subject to a contingent deferred sales charge are deemed to be redeemed
first, in the following order: (i) Shares representing amounts attributable
to capital appreciation of those shares held less than 12 months; (ii)
shares purchased with reinvested dividends and capital gain distributions;
and (iii) other shares held longer than 12 months; and followed by any
shares held less than 12 months, on a "first in, first out" basis.
The contingent deferred sales charge is waived for: exchanges; redemptions
through a Systematic Withdrawal Plan set up prior to February 1, 1995, and,
for Systematic Withdrawal Plans set up thereafter, redemptions of up to 1%
monthly of an account's net asset value (3% quarterly, 6% semiannually or
12% annually); and redemptions initiated by the Fund due to a shareholder's
account falling below the minimum specified account size.
Requests for redemptions for a specified dollar amount will result in
additional shares being redeemed to cover any applicable contingent deferred
sales charge while requests for redemption of a specific number of shares
will result in the applicable contingent deferred sales charge being
deducted from the total dollar amount redeemed.
4
<PAGE>
FRANKLIN
CALIFORNIA HIGH YIELD
MUNICIPAL FUND
Franklin Municipal Securities Trust
PROSPECTUS OCTOBER 1, 1994
[FRANKLIN LOGO]
777 Mariners Island Blvd., P.O. Box 7777
San Mateo, CA 94403-7777 1-800/DIAL BEN
Franklin California High Yield Municipal Fund (the "Fund"), a separate
non-diversifed series of Franklin Municipal Securities Trust, seeks to provide
investors with a high current yield exempt from federal and California state
income taxes by investing in lower rated or unrated municipal securities. The
Fund also seeks to provide a maximum level of income which is exempt from
California personal income taxes. There can be no assurance that the Fund's
investment objective will be met.
The Fund invests primarily in municipal securities issued by California and its
political subdivisions, agencies and instrumentalities and in municipal
obligations of non-state issuers which pay interest exempt, in the opinion of
counsel, from California state and regular federal income taxes.
Although exempt from regular federal and state personal income tax, interest
paid on certain types of municipal obligations is deemed to be a preference
item under federal income tax law and subject to the federal alternative
minimum tax. It is possible that the Fund's investments could consist entirely
of bonds subject to the federal alternative minimum tax.
THE FUND MAY INVEST UP TO 100% OF ITS PORTFOLIO IN NON-INVESTMENT GRADE BONDS,
COMMONLY KNOWN AS "JUNK BONDS," WHICH ENTAIL DEFAULT AND OTHER RISKS GREATER
THAN THOSE ASSOCIATED WITH HIGHER RATED SECURITIES. INVESTORS SHOULD CAREFULLY
ASSESS THE RISKS ASSOCIATED WITH AN INVESTMENT IN THE FUND. SEE "INVESTMENT
RISK CONSIDERATIONS - RISK FACTORS RELATING TO HIGH YIELDING, FIXED-INCOME
SECURITIES."
This Prospectus is intended to set forth in a clear and concise manner
information about the Fund that a prospective investor should know before
investing. After reading the Prospectus, it should be retained for future
reference; it contains information about the purchase and sale of shares and
other items which a prospective investor will find useful to have.
SHARES OF THE FUND ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR
ENDORSED BY, ANY BANK; FURTHER, SUCH SHARES ARE NOT FEDERALLY INSURED BY THE
FEDERAL DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD, OR ANY OTHER
AGENCY. SHARES OF THE FUND INVOLVE INVESTMENT RISKS, INCLUDING THE POSSIBLE
LOSS OF PRINCIPAL.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS
A CRIMINAL OFFENSE.
1
<PAGE>
A Statement of Additional Information ("SAI"), concerning the Trust and its
series, dated October 1, 1994 and as may be further amended from time to time,
provides a further discussion of certain areas in this Prospectus and other
matters which may be of interest to some investors. It has been filed with the
Securities and Exchange Commission ("SEC") and is incorporated herein by
reference. A copy is available without charge from the Trust or from the
Trust's principal underwriter, Franklin/Templeton Distributors, Inc.
("Distributors"), at the address or telephone number listed above.
This Prospectus is not an offering of the securities herein described in any
state in which the offering is not authorized. No sales representative, dealer,
or other person is authorized to give any information or make any
representations other than those contained in this Prospectus. Further
information may be obtained from the underwriter.
<TABLE>
<CAPTION>
CONTENTS PAGE
<S> <C>
Expense Table.................................... 3
Financial Highlights............................. 4
About the Trust.................................. 4
Investment Objectives and Policies
of the Fund..................................... 5
Management of the Fund........................... 13
Distributions to Shareholders.................... 15
Taxation of the Fund
and Its Shareholders............................ 16
How to Buy Shares of the Fund.................... 18
Other Programs and Privileges
Available to Fund Shareholders.................. 24
Exchange Privilege............................... 25
How to Sell Shares of the Fund .................. 27
Telephone Transactions........................... 30
Valuation of Shares of the Fund ................. 31
How to Get Information Regarding
an Investment in the Fund....................... 32
Performance...................................... 32
General Information.............................. 33
Account Registrations............................ 34
Important Notice Regarding
Taxpayer IRS Certifications..................... 35
Portfolio Operations............................. 35
Appendix - Description of Municipal
Securities Ratings.............................. 36
</TABLE>
2
<PAGE>
EXPENSE TABLE
The purpose of this table is to assist an investor in understanding the various
costs and expenses that a shareholder will bear directly or indirectly in
connection with an investment in the Fund. These figures are based on aggregate
annual operating expenses, including fees set by contract, payable for the
fiscal year ended May 31, 1994.
<TABLE>
<S> <C>
SHAREHOLDER TRANSACTION EXPENSES
Maximum Sales Charge Imposed on Purchases ....................... 4.25%
Maximum Sales Charge Imposed on Reinvested Dividends
(as a percentage of offering price) ............................ NONE
Deferred Sales Charge ........................................... NONE
Redemption Fees ................................................. NONE
Exchange Fee (per transaction) .................................. $5.00*
ANNUAL FUND OPERATING EXPENSES
Management Fees ................................................. 0.63%**
12b-1 Fees ...................................................... 0.10%***
Other Expenses
Reports to shareholders .......................... 0.11%
Shareholder services cost ........................ 0.02%
Other ............................................ 0.01%
-----
Total Other Expenses ............................................ 0.14%
-----
Total Fund Operating Expenses ................................... 0.87%**
=====
</TABLE>
*$5.00 fee imposed only on Timing Accounts as described under "Exchange
Privilege." All other exchanges are processed without a fee.
**Represents the amount that would have been payable to the investment manager,
absent a fee reduction by the investment manager. The investment manager,
however, has voluntarily agreed to limit its management fees and assume
responsibility for making payments to offset certain operating expenses
otherwise payable by the Fund. With this reduction, the Fund paid no management
fees and total operating expenses represented 0.07% of the average net assets
of the Fund. This arrangement may be terminated by the investment manager at
any time.
***Consistent with National Association of Securities Dealers, Inc.'s rules, it
is possible that the combination of front-end sales charges and Rule 12b-1 fees
could cause long-term shareholders to pay more than the economic equivalent of
the maximum front-end sales charges permitted under those same rules. Given the
Fund's maximum initial sales charge and the rate of the Fund's Rule 12b-1 fee,
however, it is estimated that this would take a substantial number of years.
Investors should be aware that the preceding table is not intended to reflect
in precise detail the fees and expenses associated with an individual's own
investment in the Fund. Rather the table has been provided only to assist
investors in gaining a more complete understanding of such fees, charges and
expenses. For a more detailed discussion of these matters, investors should
refer to the appropriate sections of this Prospectus.
EXAMPLE
As required by regulations of the SEC, the following example illustrates the
expenses, including the initial sales charge, that apply to a $1,000 investment
in the Fund over various time periods assuming (1) a 5%
3
<PAGE>
annual rate of return and (2) redemption at the end of each time period. As
noted in the table above, the Fund charges no redemption fees:
<TABLE>
<S> <C> <C> <C>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
$51 $69 $89 $145
</TABLE>
THIS EXAMPLE IS BASED ON THE AGGREGATE ANNUAL OPERATING EXPENSES, INCLUDING
FEES SET BY CONTRACT, SHOWN ABOVE AND SHOULD NOT BE CONSIDERED A REPRESENTATION
OF PAST OR FUTURE EXPENSES, WHICH MAY BE MORE OR LESS THAN THOSE SHOWN. The
operating expenses are borne by the Fund and only indirectly by shareholders as
a result of their investment in the Fund. See "Management of the Fund" for a
description of the Fund's expenses. In addition, federal regulations require
the example to assume an annual return of 5%, but the Fund's actual return may
be more or less than 5%.
FINANCIAL HIGHLIGHTS
Set forth below is a table containing the financial highlights for a share of
the Fund from the effective date of the Fund's registration statement, as
indicated below, through the period ended May 31, 1994. The information for the
period ended May 31, 1994 has been audited by Coopers & Lybrand, independent
auditors, whose audit report appears in the financial statements in the Trust's
SAI. See the discussion "Reports to Shareholders" under "General Information."
<TABLE>
<CAPTION>
DISTRI-
NET DISTRI- BUTIONS
NET ASSET NET REALIZED OR TOTAL BUTIONS FROM
PERIOD VALUE INVEST- UNREALIZED FROM FROM NET REALIZED
ENDED BEGINNING MENT GAIN (LOSS) INVESTMENT INVESTMENT CAPITAL
MAY 31 OF PERIOD INCOME ON SECURITIES OPERATIONS INCOME GAIN (LOSS)
- ------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
1994 $ 9.97 $ .53 $(.199) $ .331 $(.558) $(.013)
1993+ 10.00 0.3 (.060) (.030) -- --
</TABLE>
<TABLE>
<CAPTION>
NET ASSET NET ASSETS RATIO OF
PERIOD VALUE AT END EXPENSES NET INCOME PORTFOLIO
ENDED TOTAL AT END TOTAL OF PERIOD TO AVERAGE TO AVERAGE TURNOVER
MAY 31 DISTRIBUTION OF PERIOD RETURN++ (IN 000's) NET ASSETS** NET ASSETS RATE
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
1994 $(.571) $9.73 3.22% $31,938 .07% 6.14% 40.74%
1993+ -- $9.97 (3.60)% $ 2,245 -- 3.85% 8.89%
</TABLE>
*Annualized
**During the period indicated, Franklin Advisers, Inc., the investment manager,
reduced its management fees and reimbursed other expenses incurred by the Fund.
Had such action not been taken, the ratio of operating expenses to average net
assets would have been 1.42% and 0.87%, for fiscal years ended May 31, 1993 and
1994, respectively.
+For the period May 3, 1993 (effective date of registration) to May 31, 1993.
++Total return measures the change in value of an investment over the periods
indicated. It does not include the maximum 4.25% initial sales charge and
assumes reinvestment of dividends and capital gains at net asset value.
ABOUT THE TRUST
The Fund is a non-diversified series of the Trust, a Delaware business trust
organized on November 19, 1991, and has registered with the SEC as an open-end
management investment company, commonly called a "mutual fund," under the
Investment Company Act of 1940 (the "1940 Act"). The Fund and the other
separate series of the Trust each issue a separate series of shares of
beneficial interest and maintain a totally separate investment portfolio.
Shares of the Fund may be purchased (minimum investment of $100 initially and
$25 thereafter) at the current public offering price, which is equal to the
Fund's net asset value (see "Valuation of Shares of the Fund") plus a sales
charge based upon a variable percentage (ranging from 4.25% to less than 1.0%
of the offering price) depending on the amount invested. (See "How to Buy
Shares of the Fund.")
4
<PAGE>
INVESTMENT OBJECTIVES AND POLICIES OF THE FUND
The Fund's principal and secondary investment objectives and other fundamental
policies may not be changed unless approved by the holders of a majority of the
outstanding shares of the Fund, as defined in the 1940 Act. The Fund seeks to
provide investors with a high current yield exempt from federal and California
state personal income taxes by investing in lower-rated or unrated municipal
securities. As a secondary objective, the Fund will seek capital appreciation
to the extent this is possible and is consistent with its principal investment
objective.
The Fund invests primarily in municipal securities issued by California and its
political subdivisions, agencies and instrumentalities, and in any municipal
obligations of non-state issuers which pay interest exempt from regular federal
and California personal income taxes.
The Fund attempts to invest 100% and, as a matter of fundamental policy,
invests at least 80% of the value of its net assets in municipal securities,
the interest on which is exempt from regular federal income taxes, but which
may be deemed to be a preference item under the federal alternative minimum tax
system. It is also the policy of the Fund to invest at least 65% of its total
assets in bonds which pay interest which is exempt from California personal
income tax. Although exempt from regular federal income tax, interest paid on
certain types of municipal obligations, such as "private activity bonds," and
the dividends to be paid by the Fund therefrom, is deemed to be a preference
item under the federal alternative minimum tax system and therefore subject to
the federal alternative minimum tax.
Thus, it is possible, although not anticipated, that up to 20% of the Fund's
net assets could be in obligations subject to regular federal taxation and/or
up to 35% of the Fund's total assets could be in municipal securities from
other states. In addition, it is possible that the Fund's investments could
consist entirely of bonds subject to the federal alternative minimum tax. As a
result, dividends that would otherwise be tax-exempt may not be completely
tax-exempt to an investor who is subject to the federal alternative minimum
tax. An investment in the Fund may not be appropriate for investors who are
already subject to the federal alternative minimum tax.
The interest on bonds issued to finance public purpose state and local
government operations is generally tax-exempt for regular federal income tax
purposes. Interest on certain "private activity bonds" (including those for
housing and student loans) issued after August 7, 1986, while still tax-exempt,
constitutes a preference item for taxpayers in determining the federal
alternative minimum tax under the Internal Revenue Code of 1986, as amended
(the "Code"), and under the income tax provisions of some states. This interest
could subject a shareholder to, or increase liability under, the federal
alternative minimum tax, depending on the shareholder's tax situation. In
addition, all distributions derived from interest exempt from regular federal
income tax may subject a corporate shareholder to, or increase liability under,
the federal alternative minimum tax because such distributions are included in
the corporation's "adjusted current earnings." In states with a corporate
franchise tax, distributions of the Fund may also be fully taxable to a
corporate shareholder under the state franchise tax system.
Consistent with the Fund's investment objectives, the Fund may acquire such
private activity bonds if, in the investment manager's opinion, such bonds
5
<PAGE>
represent the most attractive investment opportunity then available to the
Fund. As of May 31, 1994, the Fund had derived 32.55% of its income from bonds,
the interest on which constitutes a preference item subject to the federal
alternative minimum tax for certain investors.
In the event the rating on an issue held in the Fund's portfolio is changed by
a nationally recognized statistical rating organization ("NRSRO"), such event
will be considered by the Fund in its evaluation of the overall investment
merits of that security but will not necessarily result in an automatic sale of
the security. A description of the ratings is contained in Appendix B of this
Prospectus. For temporary defensive purposes only, when the investment manager
believes that market conditions, such as rising interest rates or other adverse
factors, would cause serious erosion of portfolio value, the Fund may invest
(i) more than 20% of its assets (which could be up to 100%) in fixed-income
obligations the interest on which is subject to regular federal income tax and
(ii) more than 35% of the value of its total assets (which could be up to 100%)
in instruments the interest on which is exempt from regular federal income
taxes but not California personal income tax. Such temporary investments will
be limited to obligations issued or guaranteed by the full faith and credit of
the U.S. government or in the highest quality commercial paper, rated A-1 by
Standard & Poor's Corporation ("S&P").
The Fund may borrow from banks for temporary or emergency purposes up to 5% of
its total assets and pledge up to 5% of its total assets in connection
therewith. As approved by the Board of Trustees and subject to the following
conditions, the Fund may lend its portfolio securities to qualified securities
dealers or other institutional investors, provided that such loans do not
exceed 10% of the value of the Fund's total assets at the time of the most
recent loan. The borrower must deposit and maintain with the Fund's custodian
cash collateral with an initial market value at least 102% of the initial
market value of the securities loaned, including any accrued interest, with the
value of the collateral and loaned securities marked-to-market daily. The
lending of securities is a common practice in the securities industry. The Fund
engages in security loan arrangements with the primary objective of increasing
the Fund's income either through investing the cash collateral in short-term
interest bearing obligations or by receiving a loan premium from the borrower.
Under the securities loan agreement, the Fund continues to be entitled to all
dividends or interest on any loaned securities. As with any extension of
credit, there are risks of delay in recovery and loss of rights in the
collateral should the borrower of the security fail financially. These
restrictions have been adopted as fundamental policies of the Fund and may not
be changed without the approval of a majority of the Fund's outstanding voting
securities. A complete discussion of these restrictions is included under
"Investment Restrictions" in the SAI.
The Fund expects that its portfolio turnover rate will generally not exceed
100%, but this rate should not be construed as a limiting factor. High
portfolio turnover increases transaction costs which must be paid by the Fund.
High turnover may also result in the realization of net capital gain, which is
taxable when distributed to shareholders.
MUNICIPAL SECURITIES
The term "municipal securities," as used in this Prospectus, means obligations
issued by or on behalf of California, obligations of non-state issuers, such as
the territories and possessions of the United States ("U.S."), any state, or
the District of Columbia, and their political subdivisions, agencies, and in-
6
<PAGE>
strumentalities, the interest on which is exempt from regular federal income
tax. A portion or all of the interest on such securities may be deemed to be
preference items under the federal alternative minimum tax system and thus
subject to the federal alternative minimum tax. An opinion as to the tax-exempt
status of a municipal security generally is rendered to the issuer by the
issuer's counsel at the time of issuance of the security.
Municipal securities are used to raise money for various public purposes such
as constructing public facilities and making loans to public institutions.
Certain types of municipal bonds are issued to provide funding for privately
operated facilities. Further information on the maturity and funding
classifications of municipal securities is included in the SAI.
The Fund has no restrictions on the maturities of municipal securities in which
the Fund may invest. The manager will consider the Fund's investment objective
and current market conditions in determining which securities to buy or hold.
It is possible that the Fund from time to time will invest more than 25% of its
assets in a particular segment of the municipal securities market, such as
hospital revenue bonds, housing agency bonds, industrial development bonds,
transportation bonds, pollution control revenue bonds, or in securities the
interest on which is paid from revenues of a similar type of project. In such
circumstances, economic, business, political, or other changes affecting one
bond (such as proposed legislation affecting the financing of a project;
shortages or price increases of needed materials; or declining markets or needs
for the projects) might also affect other bonds in the same segment, thereby
potentially increasing market risk.
Yields on municipal securities vary, depending on a variety of factors,
including the general condition of the financial markets and of the municipal
securities market, the size of a particular offering, the maturity of the
obligation and the credit rating of the issuer. Generally, municipal securities
of longer maturities produce higher current yields than municipal securities
with shorter maturities but are subject to greater price fluctuation due to
changes in interest rates, tax laws and other general market factors.
Lower-rated municipal securities generally produce a higher yield than
higher-rated municipal securities due to the perception of a greater degree of
risk as to the ability of the issuer to make timely payment of principal and
interest on its obligations.
The Fund may purchase "floating-rate" and "variable-rate" obligations. These
obligations bear interest at prevailing market rates. The Fund may also invest
in variable or floating rate demand notes ("VRDNs"). VRDNs are tax-exempt
obligations which contain a floating or variable interest rate and a right of
demand, which may be unconditional, to receive payment of the unpaid principal
balance plus accrued interest according to the terms of the obligation, which
amount may be more or less than the amount the Fund paid for such obligation.
Because of the demand feature, the prices of VRDNs may be higher and the yields
lower than they otherwise would be for obligations without a demand feature.
The Fund may purchase and sell municipal securities on a "when-issued" and
"delayed-delivery" basis. These transactions are subject to market fluctuation,
and the value at delivery may be more or less than the purchase price. Although
the Fund will generally purchase municipal securities on a when-issued basis
with the intention of acquiring such securities, it may sell such securities
before the settlement date if it is deemed advisable. When the Fund is the
buyer in such a transaction, it will maintain, in a segregated account with its
custodian bank, cash or high-grade marketable securities having an aggregate
value equal to the amount of such pur-
7
<PAGE>
chase commitments until payment is made. To the extent the Fund engages in
"when-issued" and "delayed delivery" transactions, it will do so for the
purpose of acquiring securities for the Fund's portfolio consistent with its
investment objectives and policies and not for the purpose of investment
leverage.
The Fund may also invest in municipal lease obligations primarily through
certificates of participation ("COPs"). COPs, which are widely used by state
and local governments to finance state and local government needs, function
much like installment purchase agreements. For example, a COP may be created
when long-term lease revenue bonds are issued by a governmental corporation to
pay for the acquisition of property or facilities which are then leased to a
municipality. The payments made by the municipality under the lease are used to
repay interest and principal on the bonds issued to purchase the property. Once
these lease payments are completed, the municipality gains ownership of the
property for a nominal sum. This lease format is generally not subject to
constitutional limitations on the issuance of state debt, and COPs enable a
governmental issuer to increase government liabilities beyond constitutional
debt limits.
A feature which distinguishes COPs from municipal debt is that the lease which
is the subject of the transaction contains a "nonappropriation" or "abatement"
clause. A nonappropriation clause provides that, while the municipality will
use its best efforts to make lease payments, the municipality may terminate the
lease without penalty if the municipality's appropriating body does not
allocate the necessary funds. Local administrations, being faced with
increasingly tight budgets, therefore, have more discretion to curtail payments
under COPs than they do to curtail payments on traditionally funded debt
obligations. If the government lessee does not appropriate sufficient monies to
make lease payments, the lessor or its agent is typically entitled to repossess
the property. In most cases, however, the private sector value of the property
will be less than the amount the government lessee was paying.
The Board of Trustees reviews the COPs held in the Fund's portfolio to assure
that they constitute liquid investments based on various factors reviewed by
the investment manager and monitored by the Board of Trustees. Such factors
include (a) the credit quality of such securities and the extent to which they
are rated or unrated, including an assessment of the likelihood that the leases
will not be canceled; (b) the size of the municipal securities market, both in
general and with respect to COPs; and (c) the extent to which the type of COPs
held by the Fund trade on the same basis and with the same degree of dealer
participation as other municipal bonds of comparable credit rating or quality.
The Fund may invest in lower-rated or unrated COPs.
The Fund may purchase and hold callable municipal bonds which contain a
provision in the indenture permitting the issuer to redeem the bonds prior to
their maturity dates at a specified price which typically reflects a premium
over the bonds' original issue price. These bonds generally have call
protection (that is, a period of time during which the bonds may not be called)
which usually lasts for 5 to 10 years, after which time such bonds may be
called away. An issuer may generally be expected to call its bonds, or a
portion of them, during periods of declining interest rates, when borrowings
may be replaced at lower rates than those obtained in prior years. If the
purchase price of such bonds included a premium related to the appreciated
value of the bonds, some or all of that premium may not be recovered by
bondholders, such as the Fund, depending on the price at which such bonds were
redeemed.
8
<PAGE>
GENERAL INVESTMENT RISK CONSIDERATIONS
While an investment in the Fund is not without risk, certain policies are
followed in managing the Fund which may help to reduce such risk. There are two
categories of risks to which a Fund is subject: credit risk and market risk.
Credit risk is a function of the ability of an issuer of a municipal security
to maintain timely interest payments and to pay the principal of a security
upon maturity. It is generally reflected in a security's underlying credit
rating and its stated interest rate (normally the coupon rate). A change in the
credit risk associated with a municipal security may cause a corresponding
change in the security's price.
Market risk is the risk of price fluctuation of a municipal security caused by
changes in general economic and interest rate conditions generally affecting
the market as a whole. A municipal security's maturity length also affects its
price. As with other debt instruments, the price of the debt securities in
which the Fund invests are likely to decrease in times of rising interest
rates. Conversely, when rates fall, the value of the Fund's debt investments
may rise. Price changes of debt securities held by a Fund have a direct impact
on the net asset value per share of the Fund securities, there are certain
specific factors and considerations concerning California which may affect the
credit and market risk of the these municipal securities. These factors are
described below and in greater detail in the SAI.
As a non-diversified Fund, there is no restriction under the 1940 Act on the
percentage of assets that may be invested by the Fund at any time in the
securities of any one issuer. However, the Fund intends to comply with the
asset diversification, income, distribution and other requirements of the Code
applicable to "regulated investment companies" so that it will not be subject
to federal income tax and distributions to shareholders will be free from
regular federal income tax to the extent that they are derived from municipal
securities. Accordingly, the Fund will not purchase a security if, as a result,
more than 25% of its total assets would be invested in the securities of a
single issuer, or with respect to 50% of its total assets, more than 5% of such
assets would be invested in the securities of a single issuer. To the extent
the Fund is not fully diversified, under the 1940 Act, it may be more
susceptible to adverse economic, political or regulatory developments affecting
a single issuer than would be the case if the Fund were more broadly
diversified.
The Fund seeks to provide California investors with a high current yield exempt
from federal and California personal income taxes by investing primarily in
lower-rated or unrated municipal securities. Higher yields are ordinarily
available from securities in the lower-rated categories of the NRSRO (that is,
municipal securities rated Baa or lower by Moody's Investors Service
("Moody's"), BBB or lower by S&P), or BBB or lower by Fitch Investors Service,
Inc. ("Fitch") or from unrated securities of comparable quality. These ratings
represent the opinions of the NRSROs with respect to the generally higher risk
associated with the issuer's ability to pay interest and repay principal. They
do not purport to reflect the risk of fluctuations in market value and are not
absolute standards of quality but will be considered in connection with the
investment of the Fund's assets.
The Fund may invest in municipal securities regardless of their rating
(including municipal securities in the lowest-rating categories) or in
unrated securities. It will generally invest in municipal securities which have
received one of the middle four ratings assigned by Moody's (Ba, B, Caa and
Ca), S&P (BB, B, CCC and CC), or Fitch (BB, B, CCC and CC) or in unrated
securities which are judged by management to be of equal quality. Securities in
these ratings categories are regarded, on balance,
9
<PAGE>
as predominantly speculative with respect to the capacity to pay interest and
repay principal in accordance with the terms of the obligation. The Fund may
invest in municipal securities regardless of their rating, including, from time
to time, defaulted debt securities if, in the opinion of the investment
manager, the issuer may resume interest payments or other advantageous
developments appear likely, in the near term. The Fund will not invest more
than 5% of its total assets (at the time of purchase) in defaulted securities.
A purchase of a security which is in default carries a high degree of risk and
may have the consequence that interest payments with respect to such security
may be reduced, deferred, suspended, or canceled, causing the loss of the
entire amount of the investment. See also the disclosure of lower rated
securities under "Risk Factors Relating to High Yielding, Fixed-Income
Securities. While it is expected that the portfolio of the Fund will normally
consist of lower-rated, higher yielding bonds, there may be instances when the
portfolio will contain medium grade (BBB or Baa rated), lower yielding bonds
because adequate quantities of attractive lower-rated bonds are not available
at that time. In addition, there may be times when, due to unusual market
conditions, or when the difference in yields on higher and lower-rated bonds is
narrowed to the extent that higher risk is not justified by higher return, that
the Fund may acquire higher-rated bonds for its portfolio. It is expected that
the Fund's portfolio will generally consist of longer-term municipal securities
as these normally return higher yields than short-term issues.
The Fund's investment in lower-rated and unrated municipal securities may cause
the Fund to recognize income and make distributions to shareholders prior to
the receipt of cash payments. For example, with respect to non-performing
obligations, the Fund may be required to accrue as income the original amount
of interest due on its obligations even though such interest is not received by
the Fund.
In order to generate cash to satisfy these distribution requirements, the Fund
may be required to dispose of portfolio securities that it otherwise would have
continued to hold or to use cash flows from other sources such as the sale of
Fund shares.
RISK FACTORS IN CALIFORNIA
The following information as to certain California risk factors is given to
investors in view of the Fund's policy of investing primarily in California
state and municipal issuers. The information is based primarily upon
information derived from public documents relating to securities offerings of
California state and municipal issuers, from independent municipal credit
reports and historically reliable sources, but has not been independently
verified by the Fund. See the "Appendix" in the Trust's SAI for additional
information regarding the California economy.
Changes in California constitutional and other laws during the last several
years have raised questions about the ability of California state and municipal
issuers to obtain sufficient revenue to pay their bond obligations. In 1978,
California voters approved an amendment to the California Constitution known as
Proposition 13. Proposition 13 limits ad valorem taxes on real property and
restricts the ability of taxing entities to increase real property taxes.
Legislation passed subsequent to Proposition 13, however, provided for the
redistribution of California's General Fund surplus to local agencies, the
reallocation of revenues to local agencies and the assumption of certain local
obligations by the state so as to help California municipal issuers to raise
revenue to pay their bond obligations. It is unknown, however, whether
additional revenue redistribution legislation will be enacted in the future and
whether,
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<PAGE>
if enacted, such legislation would provide sufficient revenue for such
California issuers to pay their obligations. The state is also subject to
another constitutional amendment, Article XIIIB, which may have an adverse
impact on California state and municipal issuers. Article XIIIB restricts the
state from spending certain appropriations in excess of an appropriations limit
imposed for each state and local government entity. If revenues exceed such
appropriations limit, such revenues must be returned either as revisions in the
tax rates or fee schedules. Because of the uncertain impact of the
aforementioned statutes and cases, the possible inconsistencies in the
respective terms of the statutes and the impossibility of predicting the level
of future appropriations and applicability of related statutes to such
questions, it is not currently possible to assess the impact of such
legislation, cases and policies on the long-term ability of California state
and municipal issuers to pay interest or repay principal on their obligations.
California's economy is larger than most sovereign nations. During the 1980s,
California experienced growth rates well in excess of the rest of the nation.
The state's major employment sectors are services, trade, and manufacturing.
Industrial concentration is in electronics, aerospace, and non-electrical
equipment. Also significant are agriculture and oil production.
Key sectors of California's economy have been severely affected by the
recession. Since May of 1990, job losses total over 850,000. Declines in the
aerospace and high technology sectors have been especially severe. The
continuing drive in population and labor force growth has produced higher
unemployment rates in the state. Although total job loss has declined, weakness
continues in key areas of California's economy, including government, real
estate and aerospace. Wealth levels still remain high in the state, although
the difference between state and national levels continues to narrow.
In July of 1994, both S&P and Moody's lowered the general obligation bond
ratings of the state of California. These revisions reflect the state's heavy
reliance on the short-term note market to finance its cash imbalance and the
likelihood that this exposure will persist for at least another two years. For
more information on these ratings revisions and the state's current budget,
please refer to the Fund's SAI.
RISK FACTORS RELATING TO HIGH YIELDING, FIXED-INCOME SECURITIES
As indicated above, the Fund's portfolio is subject to greater risks due to its
ability to invest in municipal securities rated below investment grade by the
NRSROs, or which are unrated by an NRSRO but deemed by the investment manager
to be of comparable quality. The market values of such securities tend to
reflect individual developments affecting the issuer to a greater extent than
do higher-rated securities, which react primarily to fluctuations in the
general interest rate levels. Such lower-rated securities also tend to be more
sensitive to economic conditions than higher-rated securities. These
lower-rated fixed-income securities are considered by the NRSROs, on balance,
to be predominantly speculative with respect to the issuer's capacity to pay
interest and repay principal in accordance with the terms of the obligation
and will generally involve more credit risk than securities in the higher
rating categories. Even securities rated BBB or Baa by S&P and Moody's),
ratings which are considered investment grade, possess some speculative
characteristics.
Projects which are financed by the issuance of high yielding, fixed-income
securities are often highly leveraged and may not have more traditional methods
of financing available to them. Therefore, the risk associated with acquiring
the securities of
11
<PAGE>
such issuers is generally greater than is the case with higher-rated
securities. For example, during an economic downturn or a sustained period of
rising interest rates, projects financed by high yielding securities may
experience financial stress. During such periods, such projects may not have
sufficient funds to meet their interest payment obligations. The issuer's
ability to service its debt obligations may also be adversely affected by
specific developments, or the issuer's inability to meet specific projected
revenue forecasts, or by the unavailability of additional financing.
The Fund may have difficulty disposing of certain high yielding securities
because there may be a thin trading market for a particular security at any
given time. The market for lower-rated fixed-income securities generally tends
to be concentrated among a smaller number of dealers than is the case for
securities which trade in a broader secondary retail market. Generally,
purchasers of these securities are predominantly dealers and other
institutional buyers, rather than individuals. To the extent a secondary
trading market for high yielding, fixed-income securities does exist, it is
generally not as liquid as the secondary market for higher-rated securities.
Reduced liquidity in the secondary market may have an adverse impact on market
price and the Fund's ability to dispose of particular issues, when necessary,
to meet the Fund's liquidity needs or in response to a specific economic event,
such as the deterioration in the creditworthiness of the issuer. Reduced
liquidity in the secondary market for certain securities may also make it more
difficult for the Fund to obtain market quotations based on actual trades for
purposes of valuing the Fund's portfolio. Current value for these high yield
issues are obtained from pricing services and/or a limited number of dealers
and may be based upon factors other than actual sales. (See "Valuation of
Shares of the Fund.") Factors adversely impacting the market value of high
yielding securities may adversely impact the Fund's net asset value. In
addition, the Fund may incur additional expenses to the extent it is required
to seek recovery upon a default in the payment of principal or interest on its
portfolio holdings. The Fund will rely on the investment manager's judgment,
analysis and experience in evaluating the creditworthiness of an issuer. In
this evaluation, the investment manager will take into consideration, among
other things, the issuer's financial resources, its sensitivity to economic
conditions and trends, its operating history, the quality of the issuer's
management and regulatory matters.
Current prices for defaulted bonds are generally significantly lower than their
purchase price, and the Fund may have unrealized losses on such defaulted
securities which are reflected in the price of the Fund's shares. In general,
securities which default lose much of their value in the period prior to the
actual default so that the Fund's net assets are impacted prior to the default.
The Fund may retain an issue which has defaulted because such issue may present
an opportunity for subsequent price recovery. As previously noted, the Fund may
also, consistent with its investment objectives and policies purchase debt
obligations of issuers not currently paying interest as well as issuers who
are in default. Issues that are in default carry a high degree of risk and may
have the consequence that interest payments with respect to such securities may
be reduced, deferred, suspended, eliminated or never begin, and may have the
further consequences that principal payments may likewise be reduced, suspended
or canceled, causing the loss of the entire amount of the investment. On May
31, 1994, the Trust's fiscal year end, none of the securities in the Fund's
portfolio were in default on their contractual provisions.
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<PAGE>
As of May 31, 1994, approximately 5.2% of the Fund's assets were invested in
municipal securities which were rated lower than investment grade (rated below
the four highest grades assigned by the NRSROs) or in securities unrated by any
NRSRO but deemed by the investment manager to be of comparable credit
characteristics. (A breakdown of the bonds' ratings in the Fund's portfolio,
based on a dollar weighted average for the fiscal year ended May 31, 1994, is
included under "Asset Composition Table" below.)
Because of the Fund's policy of seeking high current yield and its ability to
invest in lower-grade debt securities including defaulted securities, a higher
degree of risk accompanies an investment in the Fund's shares than is the case
in a more conservative tax-free, income-type investment company. As with any
other investment, there is no assurance that the Fund's objective will be
obtained.
The Fund's investment in lower-rated and unrated municipal securities may cause
the Fund to recognize income and make distributions to shareholders prior to
the receipt of cash payments by the Fund. For example, with respect to any
non-performing obligations, this Fund may be required to accrue as income the
original amount of interest due on its obligations even though such interest is
not received by the Fund. In order to generate cash to satisfy the Fund's
distribution requirements, it may be required to dispose of portfolio
securities that it otherwise would have continued to hold or to use cash flows
from other sources such as the sale of Fund shares.
ASSET COMPOSITION TABLE
A credit rating by an NRSRO evaluates only the safety of principal and interest
on the bond, and does not consider the market value risk associated with an
investment in such a bond. The table below shows the percentage invested in
each of the specific rating categories and those that are not rated. The
information was prepared based on the dollar weighted average of the Fund's
portfolio at the end of each of the last 10 months in the fiscal year ended May
31, 1994. The Appendix to the Prospectus includes a description of each rating
category.
<TABLE>
<CAPTION>
AVERAGE WEIGHTED
RATING PERCENTAGE OF ASSETS
----------------------------------- --------------------
<S> <C>
AAA................................ 2.6%
AA................................. 2.3%
A.................................. 13.8%
BBB................................ 32.8%
N/R*............................... 48.5%
</TABLE>
*Bonds to which no equivalent rating have been assigned by an NRSRO but which
have been determined by the investment manager to be consistent with the Fund's
objective without exposing the Fund to excessive risk.
MANAGEMENT OF THE FUND
The Board of Trustees has the primary responsibility for the overall management
of the Fund and for electing the officers of the Trust who are responsible for
administering its day-to-day operations. Franklin Advisers, Inc. ("Advisers" or
"Manager"), serves as the Fund's investment manager. Advisers is a wholly-owned
subsidiary of Franklin Resources, Inc. ("Resources"), a publicly-owned holding
company, the principal shareholders of which are Charles B. Johnson, Rupert
H. Johnson, Jr. and R. Martin Wiskemann, who own approximately 20%, 16% and
10%, respectively, of Resources' outstanding shares. Through its subsidiaries,
Resources is engaged in various aspects of the financial services industry.
Advisers acts as investment manager or administrator to 34 U.S. registered
investment companies (112 separate series) with aggregate assets of over $75
billion, approximately $40.9 billion of which are in the municipal securities
market.
Pursuant to the management agreement, the Manager supervises and implements the
Fund's investment activities and provides certain administrative
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<PAGE>
services and facilities which are necessary to conduct the Fund's business.
The Fund is responsible for its own operating expenses including, but not
limited to, the Manager's fee; taxes, if any; custodian, legal and auditing
fees; fees and expenses of trustees who are not members of, affiliated with, or
interested persons of the Manager; salaries of any personnel not affiliated
with the Manager; insurance premiums; trade association dues; expenses of
obtaining quotations for calculating the value of the Fund's net assets;
printing and other expenses which are not expressly assumed by the Manager.
Under the management agreement, dated February 26, 1992, the Fund is obligated
to pay the Manager a fee equal to an annual rate of 0.625 of 1% for the first
$100 million of net assets of the Fund; 0.50% of 1% on net assets of the Fund
in excess of $100 million up to and including $250 million; and 0.45% of 1% on
net assets of the Fund in excess of $250 million. The fee is computed and paid
monthly based on the average daily net assets of the Fund during the month.
During the start-up period of the Fund, Advisers has limited its management
fees and has assumed responsibility for making payments to offset certain
operating expenses otherwise payable by the Fund. This action by Advisers to
limit its management fees and assume responsibility for payment of expenses
related to the operations of the Fund may be terminated by Advisers at any
time. The management agreement specifies that the management fee will be
reduced to the extent necessary to comply with the most stringent limits on the
expenses which may be borne by the Fund as prescribed by any state in which the
Fund's shares are offered for sale. Currently, the most restrictive of such
provisions limits a fund's allowable expenses as a percentage of its average
net assets for each fiscal year to 2.5% of the first $30 million in assets, 2%
of the next $70 million, and 1.5% of assets in excess of $100 million.
During the fiscal year ended May 31, 1994, fees totaling .63% of the average
monthly net assets of the Fund would have accrued to Advisers. Total operating
expenses, including management fees, would have represented .87% of the average
monthly net assets of the Fund. Pursuant to the action by Advisers, the Fund
paid no management fees and total operating expenses of 0.7%.
It is not anticipated that the Fund will incur a significant amount of
brokerage expenses because municipal securities are generally traded on a "net"
basis, that is, in principal transactions without the addition or deduction of
brokerage commissions or transfer taxes. To the extent that the Fund does
participate in transactions involving brokerage commissions, it is the
Manager's responsibility to select brokers through whom such transactions will
be effected. The Manager tries to obtain the best execution on all such
transactions. If it is felt that more than one broker is able to provide the
best execution, the Manager will consider the furnishing of quotations and of
other market services, research, statistical and other data for the Manager and
its affiliates, as well as the sale of shares of the Fund as factors in
selecting a broker. Further information is included under "The Trust's Policies
Regarding Brokers Used on Portfolio Transactions" in the SAI.
Shareholder accounting and many of the clerical functions for the Funds are
performed by Franklin/Templeton Investor Services, Inc. ("Investor Services" or
"Shareholder Services Agent") in its capacity as transfer agent and
dividend-paying agent. Investor Services is a wholly-owned subsidiary of
Resources. During the fiscal year ended May 31, 1994, ex-
14
<PAGE>
penses borne by the Fund, including fees paid to Advisers and to Investor
Services, totaled 0.07% of the average monthly net assets of the Fund.
PLAN OF DISTRIBUTION
The Fund has adopted a plan pursuant to Rule 12b-1 under the 1940 Act (the
"Plan"), whereby it may reimburse Distributors or others for all expenses
incurred by Distributors or others in the promotion and distribution of the
Fund's shares. Such expenses may include, but are not limited to, the printing
of prospectuses and reports used for sales purposes, expenses of preparing and
distributing sales literature and related expenses, advertisements, and other
distribution-related expenses, including a prorated portion of Distributors'
overhead expenses attributable to the distribution of Fund shares, as well as
any distribution or service fees paid to securities dealers or their firms or
others who have executed a servicing agreement with the Fund, Distributors or
its affiliates. The maximum amount which the Fund may pay to Distributors or
others for such distribution expenses is 0.15% per annum of the average daily
net assets of the Fund, payable on a quarterly basis. All expenses of
distribution and marketing in excess of 0.15% per annum will be borne by
Distributors, or others who have incurred them, without reimbursement from the
Fund. The Plan also covers any payments to or by the Fund, Advisers,
Distributors, or other parties on behalf of the Fund, Advisers, or
Distributors, to the extent such payments are deemed to be for the financing of
any activity primarily intended to result in the sale of shares issued by the
Fund within the context of Rule 12b-1. The payments under the Plan are included
in the maximum operating expenses which may be borne by the Fund.
DISTRIBUTIONS TO SHAREHOLDERS
There are two types of distributions which the Fund may make to its
shareholders:
1. Income dividends. The Fund receives income in the form of interest and other
income derived from its investments. This income, less the expenses incurred in
the Fund's operations, is its net investment income from which income dividends
may be distributed. Thus, the amount of dividends paid per share may vary with
each distribution.
2. Capital gain distributions. The Fund may derive capital gains or losses in
connection with sales or other dispositions of its portfolio securities.
Distributions by the Fund derived from net short-term and net long-term capital
gains (after taking into account any net capital loss carryovers) may generally
be made once a year in December to reflect any net short-term and net long-term
capital gains realized by the Fund as of October 31 of the current fiscal year
and any undistributed net capital gains from the prior fiscal year. These
distributions, when made, will generally be fully taxable to the Fund's
shareholders. The Fund may make more than one distribution derived from net
short-term and net long-term capital gain in any year or adjust the timing of
these distributions for operational or other reasons.
DISTRIBUTION DATE
Although subject to change by the Trust's Board of Trustees without prior
notice to or approval by shareholders, the Fund's current policy is to declare
income dividends daily and pay them monthly on or about the last business day
of that month. The amount of income dividend payments by the Fund is dependent
upon the amount of net income received by the Fund from its portfolio holdings,
is not guaranteed and is subject to the discretion of the Trust's Board of
Trustees.
15
<PAGE>
The Fund does not pay "interest" or guarantee any fixed rate of return on an
investment in its shares.
DIVIDEND REINVESTMENT
Unless requested otherwise in writing or on the Shareholder Application, income
dividends and capital gain distributions, if any, will be automatically
reinvested in the shareholder's account in the form of additional shares,
valued at the closing net asset value (without sales charge) on the dividend
reinvestment date. Shareholders have the right to change their election with
respect to the receipt of distributions by notifying the Fund, but any such
change will be effective only as to distributions for which the reinvestment
date is seven or more business days after the Fund has been notified. See the
SAI for more information.
Many of the Fund's shareholders receive their distributions in the form of
additional shares. This is a convenient way to accumulate additional shares and
maintain or increase the shareholder's earnings base. Of course, any shares so
acquired remain at market risk.
HOW SHAREHOLDERS PARTICIPATE IN THE RESULTS OF THE FUND'S ACTIVITIES
The assets of the Fund are invested in portfolio securities. If the securities
owned by the Fund increase in value, the value of the shares of the Fund which
the shareholder owns will increase. If the securities owned by the Fund
decrease in value, the value of the shareholder's shares will also decline. In
this way, shareholders participate in any change in the value of the securities
owned by the Fund.
DISTRIBUTIONS IN CASH
A shareholder may elect to receive income dividends, or both income dividends
and capital gain distributions, in cash. By completing the "Special Payment
Instructions for Distributions" section of the Shareholder Application included
with this Prospectus, a shareholder may direct the selected distributions to
another fund in the Franklin Group of Funds(R) or the Templeton Group, to
another person, or directly to a checking account. If the bank at which the
account is maintained is a member of the Automated Clearing House, the payments
may be made automatically by electronic funds transfer. If this last option is
requested, the shareholder should allow at least 15 days for initial
processing. Dividends which may be paid in the interim will be sent to the
address of record. Additional information regarding automated fund transfers
may be obtained from Franklin's Shareholder Services Department. Dividend and
capital gain distributions are eligible for investment in another fund in the
Franklin Group of Funds or the Templeton Group at net asset value.
TAXATION OF THE FUND AND ITS SHAREHOLDERS
The following discussion reflects some of the tax considerations that affect
mutual funds and their shareholders. Additional information on tax matters
relating to the Fund and its shareholders is included in the section entitled
"Additional Information Regarding Taxation" in the SAI.
All series of the Trust are treated as separate entities for federal and state
income tax purposes. The Fund has elected to be treated as a regulated
investment company under Subchapter M of the Code, qualified as such and
intends to so qualify.
By distributing all of its income and by meeting certain other requirements
relating to the sources of its income and diversification of its assets, the
Fund will not be liable for federal income or excise taxes.
By meeting certain requirements of the Code, the Fund has qualified and
continues to qualify to pay exempt-interest dividends to its shareholders. Such
exempt-interest dividends are derived from interest income exempt from regular
federal income tax
16
<PAGE>
and are not subject to regular federal income tax for Fund shareholders.
To the extent that dividends paid by the Fund are derived from interest income
from debt obligations of California or its political subdivisions or from
interest on U.S. territorial obligations (including Puerto Rico, the U.S.
Virgin Islands or Guam) which are exempt from regular federal and California
personal income tax, they will not be subject to either federal or California
personal income tax when received by the Fund's shareholders. The pass through
of exempt interest dividends is allowed only if the Fund meets its federal and
California requirements that at least 50% of its total assets are invested in
such exempt obligations at the end of each quarter of its fiscal year. In
addition, to the extent that dividends are derived from direct obligations of
the federal government, they will also be exempt from California personal
income taxes. However, for corporate taxpayers subject to the California
franchise tax, all distributions will be fully taxable.
To the extent dividends paid by the Fund are derived from taxable income from
temporary investments (including the discount from certain stripped obligations
or their coupons or income from securities loans or other taxable
transactions), from the excess of net short-term capital gain over net
long-term capital loss, or from ordinary income derived from the sale or
disposition of bonds purchased with market discount after April 30, 1993 they
are treated as ordinary income whether the shareholder has elected to receive
them in cash or in additional shares.
From time to time, the Fund may purchase a tax-exempt obligation with market
discount; that is, for a price that is less than the principal amount of the
bond. For such obligations purchased after April 30, 1993, a portion of the
gain on sale or disposition (not to exceed the accrued portion of market
discount as of the time of sale or disposition) is treated as ordinary income
rather than capital gain. Any distribution by the Fund of such ordinary income
to its shareholders will be subject to regular federal and state income taxes
in the hands of Fund shareholders. In any fiscal year, the Fund may elect not
to distribute to its shareholders its taxable ordinary income and to, instead,
pay federal income or excise taxes on this income at the Fund level. The amount
of such distributions, if any, is expected to be small.
Pursuant to the Code, certain distributions which are declared in October,
November or December but which, for operational reasons, may not be paid to the
shareholder until the following January, will be treated, for tax purposes, as
if received by the shareholder on December 31 of the calendar year in which
they are declared.
Distributions derived from the excess of net long-term capital gain over net
short-term capital loss are treated as long-term capital gain regardless of the
length of time the shareholder has owned shares of the Fund and regardless of
whether such distributions are received in cash or in additional shares.
Redemptions and exchanges of Fund shares are taxable events on which a
shareholder may realize a gain or loss. Any loss incurred on a sale or exchange
of the Fund's shares, held for six months or less, will be treated as a
long-term capital loss to the extent of capital gain dividends received with
respect to such shares and will be disallowed to the extent of exempt interest
dividends paid with respect to such shares. All or a portion of the sales
charge incurred in purchasing shares of the Fund will not be included in the
federal tax basis of such shares sold or exchanged within ninety (90) days of
their purchase (for purposes of determining gain or loss with respect to such
shares) if the sales proceeds
17
<PAGE>
are reinvested in the Fund or in another fund in the Franklin/Templeton Group
of Funds and a sales charge which would otherwise apply to the reinvestment is
reduced or eliminated. Any portion of such sales charge excluded from the tax
basis of the shares sold will be added to the tax basis of the shares acquired
in the reinvestment. Shareholders should consult with their tax advisors
concerning the tax rules applicable to the redemption or exchange of Fund
shares.
The Fund will inform shareholders of the source of their dividends and
distributions at the time they are paid and will, promptly after the close of
each calendar year, advise them of the tax status for federal income tax
purposes of such dividends and dis tributions, including the portion of the
dividends on an average basis which constitutes taxable income or interest
income that is a tax preference item under the federal alternative minimum tax.
Shareholders who have not held shares of the Fund for a full calendar year may
have designated as tax-exempt or as tax preference income a percentage of
income which is not equal to the actual amount of tax-exempt or tax preference
income earned during the period of their investment in the Fund.
Exempt-interest dividends of the Fund, although exempt from regular federal
income tax in the hands of a shareholder, are includable in the tax base for
determining the extent to which a shareholder's social security or railroad
retirement benefits will be subject to regular federal income tax. Shareholders
are required to disclose the receipt of tax-exempt interest on their federal
income tax returns.
Interest on indebtedness incurred (directly or indirectly) by shareholders to
purchase or carry Fund shares may not be fully deductible for federal income
tax purposes.
Shareholders who are not U.S. persons for purposes of federal income taxation
should consult with their financial or tax advisors regarding the applicability
of U.S. withholding or other taxes to distributions received by them from the
Fund and the application of foreign tax laws to these distributions.
The foregoing description relates solely to federal income tax law and to
California personal income tax treatment to the extent indicated. Shareholders
should consult their tax advisors with respect to the applicability of other
state and local income taxes to their shares in the Fund and to distributions
and redemption proceeds received from the Fund. Corporate, individual and trust
shareholders should contact their tax advisors to determine the impact of Fund
dividends and capital gain distributions under the federal alternative minimum
tax that may be applicable to a shareholder's particular tax situation.
HOW TO BUY SHARES OF THE FUND
Shares of the Fund are continuously offered through securities dealers who
execute an agreement with Distributors, the principal underwriter of the Fund's
shares. The use of the term "securities dealer" shall include other financial
institutions which, pursuant to an agreement with Distributors (directly or
through affiliates), handle customer orders and accounts with the Fund. Such
reference, however, is for convenience only and does not indicate a legal
conclusion of capacity. The minimum initial investment in each Fund is $100 and
subsequent investments must be $25 or more. These minimums may be waived when
the shares are being purchased through plans established at Franklin. The Trust
and Distributors reserve the right to refuse any order for the purchase of
shares.
PURCHASE PRICE OF SHARES OF THE FUND
Shares of the Fund are offered at public offering price, which is the net asset
value per share plus a sales charge, next computed (1) after the share-
18
<PAGE>
holder's securities dealer receives the order which is promptly transmitted to
the Fund or (2) after receipt of an order by mail from the shareholder directly
in proper form (which generally means a completed Shareholder Application
accompanied by a negotiable check). The sales charge is a variable percentage
of the offering price depending upon the amount of the sale. On orders for
100,000 shares or more, the offering price will be calculated to four decimal
places. On orders for less than 100,000 shares, the offering price will be
calculated to two decimal places using standard rounding criteria. A
description of the method of calculating net asset value per share is included
under the caption "Valuation of Shares of the Fund."
Set forth below is a table of total sales charges or underwriting commissions
and dealer concessions.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------
TOTAL SALES CHARGE
---------------------------------------------------------------
AS A PERCENTAGE DEALER CONCESSION
SIZE OF TRANSACTION AS A PERCENTAGE OF NET AMOUNT AS A PERCENTAGE
AT OFFERING PRICE OF OFFERING PRICE INVESTED OF OFFERING PRICE*
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Less than $100,000 4.25% 4.44% 4.00%
$100,000 but less than $250,000 3.50% 3.63% 3.25%
$250,000 but less than $500,000 2.75% 2.83% 2.50%
$500,000 but less than $1,000,000 2.15% 2.20% 2.00%
$1,000,000 through $2,500,000 1.00% 1.01% 1.00%
- ----------------------------------------------------------------------------------------------------------
</TABLE>
*Financial institutions or their affiliated brokers may receive an agency
transaction fee in the percentages set forth above.
On purchases in excess of $2,500,000, the sales charge is 1% of the offering
price on the first $2,500,000, plus 0.5% on the next $2,500,000, plus 0.25% on
the excess over $5,000,000. Sales charges on purchases of $1,000,000 or more
are paid to the securities dealer, if any, involved in the trade, who may
therefore be deemed an "underwriter" under the Securities Act of 1933, as
amended.
The size of a transaction which determines the applicable sales charge on the
purchase of Fund shares is determined by adding the amount of the shareholder's
current purchase plus the cost or current value (whichever is higher) of a
shareholder's existing investment in one or more of the many funds in the
Franklin Group of Funds(R) and in the Templeton Group of Funds. Included for
these purposes are (a) the open-end investment companies in the Franklin Group
(except Franklin Valuemark Funds and Franklin Government Securities Trust) (the
"Franklin Group of Funds"), (b) other investment products in the Franklin Group
underwritten by Distributors or its affiliates (although certain investments
may not have the same schedule of sales charges and/or may not be subject to
reduction) (the products in subparagraphs (a) and (b) are referred to as the
"Franklin Group") and (c) the open-end U.S. registered investment companies in
the Templeton Group of Funds except Templeton American Trust, Inc., Templeton
Capital Accumulator Fund, Inc., Templeton Variable Annuity Fund, and Templeton
Variable Products Series Fund (the "Templeton Group"). Purchases pursuant to a
Letter of Intent for more than $2,500,000 will be at a 1.00% sales charge until
cumulative purchases reach $2,500,000 and at the incremental sales charge on
the excess over $2,500,000. Purchases pursuant to the Rights of Accumulation
will be at the applicable sales charge of 1.00% or more until the additional
purchase, plus the value of the account or the amount previously invested, less
redemptions, exceeds $2,500,000, in which event the sales charge on the excess
will be calculated as stated above. Sales charge reductions
19
<PAGE>
based upon purchases in more than one of the funds in the Franklin Group or
Templeton Group (the "Franklin/Templeton Group") may be effective only after
notification to Distributors that the investment qualifies for a discount.
Distributors or its affiliates, at their expense, may also provide additional
compensation to dealers in connection with sales of shares of the Fund and
other funds in the Franklin Group of Funds or the Templeton Group. Compensation
may include financial assistance to dealers in connection with conferences,
sales or training programs for their employees, seminars for the public,
advertising, sales campaigns and/or shareholder services and programs regarding
one or more of the Franklin Group of Funds or the Templeton Group and other
dealer-sponsored programs or events. In some instances, this compensation may
be made available only to certain dealers whose representatives have sold or
are expected to sell significant amounts of such shares. Compensation may
include payment for travel expenses, including lodging, incurred in connection
with trips taken by invited registered representatives and members of their
families to locations within or outside of the U.S. for meetings or seminars of
a business nature. Dealers may not use sales of the Fund's shares to qualify
for this compensation to the extent such may be prohibited by the laws of any
state or any self-regulatory agency, such as the National Association of
Securities Dealers, Inc. None of the aforementioned additional compensation is
paid for by the Fund or its shareholders.
Certain officers and trustees of the Trust are also affiliated with
Distributors. A detailed description is included in the SAI.
QUANTITY DISCOUNTS IN SALES CHARGES
Shares may be purchased under a variety of plans which provide for a reduced
sales charge. To be certain to obtain the reduction of the sales charge, the
investor or the dealer should notify Distributors at the time of each purchase
of shares which qualifies for the reduction. In determining whether a purchase
qualifies for any of the discounts, investments in any of the
Franklin/Templeton Group may be combined with those of the investor's spouse
and children under the age of 21. In addition, the aggregate investments of a
trustee or other fiduciary account (for an account under exclusive investment
authority) may be considered in determining whether a reduced sales charge is
available, even though there may be a number of beneficiaries of the account.
In addition, an investment in the Fund may qualify for a reduction in the sales
charge under the following programs:
1. Rights of Accumulation. The cost or current value (whichever is higher) of
existing investments in the Franklin/Templeton Group may be combined with the
amount of the current purchase in determining the sales charge to be paid.
2. Letter of Intent. An investor may immediately qualify for a reduced sales
charge on a purchase of shares of the Fund by completing the Letter of Intent
section of the Shareholder Application (the "Letter of Intent" or "Letter"). By
completing the Letter, the investor expresses an intention to invest during the
next 13 months a specified amount which if made at one time would qualify for a
reduced sales charge. At any time within 90 days after the first investment
which the investor wants to qualify for the reduced sales charge, a signed
Shareholder Application, with the Letter of Intent section completed, may be
filed with the Fund. After the Letter of Intent is filed, each additional
investment made will be entitled to the sales charge applicable to the level of
investment indicated on the Letter of Intent as described above. Sales charge
reductions based upon purchases in more than one company in the
Franklin/Templeton Group will be effective only
20
<PAGE>
after notification to Distributors that the investment qualifies for a
discount. The shareholder's holdings in the Franklin/Templeton Group acquired
more than 90 days before the Letter of Intent is filed will be counted towards
completion of the Letter of Intent but will not be entitled to a retroactive
downward adjustment of sales charge. Any redemptions made by the shareholder
during the 13-month period will be subtracted from the amount of the purchases
for purposes of determining whether the terms of the Letter of Intent have been
completed. If the Letter of Intent is not completed within the 13-month period,
there will be an upward adjustment of the sales charge as specified below,
depending upon the amount actually purchased (less redemptions) during the
period. An investor who executes a Letter of Intent prior to the change in the
sales charge structure for the Fund will be entitled to complete the Letter at
the lower of (i) the new sales charge structure; or (ii) the sales charge
structure in effect at the time the Letter was filed with the Fund.
AN INVESTOR ACKNOWLEDGES AND AGREES TO THE FOLLOWING PROVISIONS BY COMPLETING
THE LETTER OF INTENT SECTION OF THE SHAREHOLDER APPLICATION: Five percent (5%)
of the amount of the total intended purchase will be reserved in shares of the
Fund, registered in the investor's name, to assure that the full applicable
sales charge will be paid if the intended purchase is not completed. The
reserved shares will be included in the total shares owned as reflected on
periodic statements; income dividends and capital gain distributions on the
reserved shares will be paid as directed by the investor. The reserved shares
will not be available for disposal by the investor until the Letter of Intent
has been completed or the higher sales charge paid. If the total purchases,
less redemptions, equal the amount specified under the Letter, the reserved
shares will be deposited to an account in the name of the investor or delivered
to the investor or the investor's order. If the total purchases, less
redemptions, exceed the amount specified under the Letter and is an amount
which would qualify for a further quantity discount, a retroactive price
adjustment will be made by Distributors and the dealer through whom purchases
were made pursuant to the Letter of Intent (to reflect such further quantity
discount) on purchases made within 90 days before and on those made after
filing the Letter. The resulting difference in offering price will be applied
to the purchase of additional shares at the offering price applicable to a
single purchase or the dollar amount of the total purchases. If the total
purchases, less redemptions, are less than the amount specified under the
Letter, the investor will remit to Distributors an amount equal to the
difference in the dollar amount of sales charge actually paid and the amount of
sales charge which would have applied to the aggregate purchases if the total
of such purchases had been made at a single time. Upon such remittance the
reserved shares held for the investor's account will be deposited to an account
in the name of the investor or delivered to the investor or to the investor's
order. If within 20 days after written request such difference in sales charge
is not paid, the redemption of an appropriate number of reserved shares to
realize such difference will be made. In the event of a total redemption of the
account prior to fulfillment of the Letter of Intent, the additional sales
charge due will be deducted from the proceeds of the redemption, and the
balance will be forwarded to the investor. By completing the Letter of Intent
section of the Shareholder Application, an investor grants to Distributors a
security interest in the reserved shares and irrevocably appoints Distributors
as attorney-in-fact with full power of substitution to surrender for redemption
any or all shares for the purpose of paying any additional sales charge
21
<PAGE>
due. Purchases under the Letter of Intent will conform with the requirements of
Rule 22d-1 under the 1940 Act. The investor or the investor's securities dealer
must inform Investor Services or Distributors that this Letter is in effect
each time a purchase is made. Additional terms concerning the offering of the
Fund's shares are included in the SAI.
GROUP PURCHASES
An individual who is a member of a qualified group may also purchase shares of
the Fund at the reduced sales charge applicable to the group as a whole. The
sales charge is based upon the aggregate dollar value of shares previously
purchased and still owned by the group, plus the amount of the current
purchase. For example, if members of the group had previously invested and
still held $80,000 of Fund shares and now were investing $25,000, the sales
charge would be 3.50%. Information concerning the current sales charge
applicable to a group may be obtained by contacting Distributors.
A "qualified group" is one which (i) has been in existence for more than six
months, (ii) has a purpose other than acquiring Fund shares at a discount and
(iii) satisfies uniform criteria which enable Distributors to realize economies
of scale in its costs of distributing shares. A qualified group must have more
than 10 members, be available to arrange for group meetings between
representatives of the Fund or Distributors and the members, agree to include
sales and other materials related to the Fund in its publications and mailings
to members at reduced or no cost to Distributors and seek to arrange for
payroll deduction or other bulk transmission of investments to the Fund.
If an investor selects a payroll deduction plan, subsequent investments will be
automatic and will continue until such time as the investor notifies the Fund
and the investor's employer to discontinue further investments. Due to the
varying procedures used to prepare, process and forward the payroll deduction
information to the Fund, there may be a delay between the time of the payroll
deduction and the time the money reaches the Fund. The investment in the Fund
will be made at the offering price per share determined on the day that both
the check and payroll deduction data are received in required form by the Fund.
PURCHASES AT NET ASSET VALUE
Shares of the Fund may be purchased at net asset value by trust companies and
bank trust departments for funds over which they exercise exclusive
discretionary investment authority and which are held in a fiduciary, agency,
advisory, custodial or similar capacity. Such purchases are subject to minimum
requirements with respect to amount of purchase, which may be established by
Distributors. Currently, those criteria require that the amount invested or to
be invested during the subsequent 13-month period in this Fund or any other
company in the Franklin/Templeton Group must total at least $1,000,000. Orders
for such accounts will be accepted by mail accompanied by a check, or by
telephone or other means of electronic data transfer directly from the bank or
trust company, with payment by federal funds received by the close of business
on the next business day following such order. If an investment by a trust
company or bank trust department at net asset value is made through a dealer
who has executed a dealer agreement with Distributors, Distributors or one of
its affiliates may make payment, out of their own resources, to such dealer in
an amount not to exceed 0.25% of the amount invested. Contact Franklin's
Institutional Sales Department for additional information.
Shares of the Fund may be purchased at net asset value by persons who have
redeemed, within the previous 120 days, their shares of the Fund or another
fund in the Franklin Group of Funds or the
22
<PAGE>
Templeton Group which were purchased with a sales charge. An investor may
reinvest an amount not exceeding the redemption proceeds. Shares of the Fund
redeemed in connection with an exchange into another fund (see "Exchange
Privilege") are not considered "redeemed" for this privilege. In order to
exercise this privilege, a written order for the purchase of shares of the Fund
must be received by the Fund or the Fund's Shareholder Services Agent within
120 days after the redemption. The 120 days, however, do not begin to run on
redemption proceeds placed immediately after redemption in a Franklin Bank
Certificate of Deposit ("CD") until the CD (including any rollover) matures.
Reinvestment at net asset value may also be handled by a securities dealer or
other financial institution, who may charge the shareholder a fee for this
service. The redemption is a taxable transaction but reinvestment without a
sales charge may affect the amount of gain or loss recognized and the tax basis
of the shares reinvested. If there has been a loss on the redemption, the loss
may be disallowed if a reinvestment in the same fund is made within a 30-day
period. Information regarding the possible tax consequences of such a
reinvestment is included in the tax section of this Prospectus and the SAI.
Dealers may place trades to purchase shares of the Fund at net asset value on
behalf of investors who have, within the past 60 days, redeemed an investment
in a registered management investment company which charges a contingent
deferred sales charge, and which has investment objectives similar to those of
the Fund.
Shares of the Fund may also be purchased at net asset value by (1) officers,
trustees or directors and full-time employees of the Trust or any fund in the
Franklin Group of Funds or the Templeton Group, the Manager and Distributors
and affiliates of such companies, if they have been such for at least 90 days,
and by their spouses and family members (2) registered securities dealers and
their affiliates, for their investment account only, and (3) registered
personnel and employees of securities dealers and by their spouses and family
members in accordance with the internal policies and procedures of the
employing securities dealer. Such sales are made upon the written assurance of
the purchaser that the purchase is made for investment purposes and that the
securities will not be transferred or resold except through redemption or
repurchase by or on behalf of the Fund. Employees of securities dealers must
obtain a special application from their employers or from Franklin's Sales
Department in order to qualify.
Shares of the Fund may also be purchased at net asset value by any state,
county, or city, or any instrumentality, department, authority or agency
thereof, which has determined that the Fund is a legally permissible investment
and which is prohibited by applicable investment laws from paying a sales
charge or commission in connection with the purchase of shares of any
registered management investment company ("an eligible governmental
authority"). SUCH INVESTORS SHOULD CONSULT THEIR OWN LEGAL ADVISORS TO
DETERMINE WHETHER AND TO WHAT EXTENT THE SHARES OF THE FUND CONSTITUTE LEGAL
INVESTMENTS FOR THEM. Municipal investors considering investment of proceeds of
bond offerings into the Fund should consult with expert counsel to determine
the effect, if any, of various payments made by the Fund or its investment
manager on arbitrage rebate calculations. If an investment by an eligible
governmental authority at net asset value is made through a dealer who has
executed a dealer agreement with Distributors, Distributors or one of its
affiliates may make a payment, out of their own resources, to such dealer in an
amount not to exceed 0.25% of the amount invested. Contact Franklin's
Institutional Sales Department for additional information.
23
<PAGE>
GENERAL
Securities laws of states in which the Fund's shares are offered for sale may
differ from the interpretations of federal law, and banks and financial
institutions selling Fund shares may be required to register as dealers
pursuant to state law.
OTHER PROGRAMS AND PRIVILEGES AVAILABLE TO FUND SHAREHOLDERS
CERTAIN OF THE PROGRAMS AND PRIVILEGES DESCRIBED IN THIS SECTION MAY NOT BE
AVAILABLE DIRECTLY FROM THE FUND TO SHAREHOLDERS WHOSE SHARES ARE HELD, OF
RECORD, BY A FINANCIAL INSTITUTION OR IN A "STREET NAME" ACCOUNT OR NETWORKED
ACCOUNT THROUGH THE NATIONAL SECURITIES CLEARING CORPORATION ("NSCC") (SEE THE
SECTION CAPTIONED "ACCOUNT REGISTRATIONS" IN THIS PROSPECTUS).
SHARE CERTIFICATES
Shares for an initial investment, as well as subsequent investments, including
the reinvestment of dividends and capital gain distributions, are generally
credited to an account in the name of an investor on the books of the Fund,
without the issuance of a share certificate. Maintaining shares in
uncertificated form (also known as "plan balance") minimizes the risk of loss
or theft of a share certificate. A lost, stolen or destroyed certificate cannot
be replaced without obtaining a sufficient indemnity bond. The cost of such a
bond, which is generally borne by the shareholder, can be 2% or more of the
value of the lost, stolen or destroyed certificate. A certificate will be
issued if requested in writing by the shareholder or by the securities dealer.
CONFIRMATIONS
A confirmation statement will be sent to each shareholder quarterly to reflect
the dividends reinvested during that period and after each other transaction
which affects the shareholder's account. This statement will also show the
total number of shares owned by the shareholder, including the number of shares
in "plan balance" for the account of the shareholder.
AUTOMATIC INVESTMENT PLAN
Under the Automatic Investment Plan, a shareholder may be able to arrange to
make additional purchases of shares automatically on a monthly basis by
electronic funds transfer from a checking account, if the bank which maintains
the account is a member of the Automated Clearing House, or by preauthorized
checks drawn on the shareholder's bank account. A shareholder may, of course,
terminate the program at any time. The Shareholder Application included with
this Prospectus contains the requirements applicable to this program. In
addition, shareholders may obtain more information concerning this program from
their securities dealers or from Distributors.
The market value of the Fund's shares is subject to fluctuation. Before
undertaking any plan for systematic investment, the investor should keep in
mind that such a program does not assure a profit or protect against a loss.
SYSTEMATIC WITHDRAWAL PLAN
A shareholder may establish a Systematic Withdrawal Plan and receive regular
periodic payments from the account, provided that the net asset value of the
shares held by the shareholder is at least $5,000. There are no service charges
for establishing or maintaining a Systematic Withdrawal Plan. The minimum
amount which the shareholder may withdraw is $50 per withdrawal transaction,
although this is merely the minimum amount allowed under the plan and should
not be mistaken for a recommended amount. The plan may be established on a
monthly, quarterly, semiannual or annual basis. If the shareholder establishes
a plan, any capital gain distributions and income dividends paid by the Fund
will be reinvested for the shareholder's account in addi-
24
<PAGE>
tional shares at net asset value. Payments will then be made from the
liquidation of shares at net asset value on the day of the transaction (which
is generally the first business day of the month in which the payment is
scheduled) with payment generally received by the shareholder three to five
days after the date of liquidation. By completing the "Special Payment
Instructions for Distributions" section of the Shareholder Application included
with this Prospectus, a shareholder may direct the selected withdrawals to
another fund in the Franklin Group of Funds or the Templeton Group, to another
person, or directly to a checking account. If the bank at which the account is
maintained is a member of the Automated Clearing House, the payments may be
made automatically by electronic funds transfer. If this last option is
requested, the shareholder should allow at least 15 days for initial
processing. Withdrawals which may be paid in the interim will be sent to the
address of record. Liquidation of shares may reduce or possibly exhaust the
shares in the shareholder's account, to the extent withdrawals exceed shares
earned through dividends and distributions, particularly in the event of a
market decline. If the withdrawal amount exceeds the total plan balance, the
account will be closed and the remaining balance will be sent to the
shareholder. As with other redemptions, a liquidation to make a withdrawal
payment is a sale for federal income tax purposes. Because the amount withdrawn
under the plan may be more than the shareholder's actual yield or income, part
of the payment may be a return of the shareholder's investment.
The maintenance of a Systematic Withdrawal Plan concurrently with purchases of
additional shares of the Fund would be disadvantageous because of the sales
charge on the additional purchases. The shareholder should ordinarily not make
additional investments of less than $5,000 or three times the annual
withdrawals under the plan during the time such a plan is in effect. A
Systematic Withdrawal Plan may be terminated on written notice by the
shareholder or the Fund, and it will terminate automatically if all shares are
liquidated or withdrawn from the account, or upon the Fund's receipt of
notification of the death or incapacity of the shareholder. Shareholders may
change the amount (but not below the specified minimums) and schedule of
withdrawal payments or suspend one such payment by giving written notice to
Investor Services at least seven business days prior to the end of the month
preceding a scheduled payment. Share certificates may not be issued while a
Systematic Withdrawal Plan is in effect.
INSTITUTIONAL ACCOUNTS
There may be additional methods of purchasing, redeeming or exchanging shares
of the Fund available to institutional accounts. For further information,
contact Franklin's Institutional Services Department at 1-800/321-8563.
EXCHANGE PRIVILEGE
The Franklin Group of Funds and the Templeton Group consist of a number of
investment companies with various investment objectives or policies. The shares
of most of these investment companies are offered to the public with a sales
charge. If a shareholder's investment objective or outlook for the securities
markets changes, the Fund shares may be exchanged for shares of the other
mutual funds in the Franklin Group of Funds or the Templeton Group (as defined
under "How to Buy Shares of the Fund") which are eligible for sale in the
shareholder's state of residence and in conformity with such fund's stated
eligibility requirements and investment minimums. Investors should review the
prospectus of the fund they wish to exchange from and the fund they wish to
exchange into for all specific requirements or limitations on exercising the
exchange privilege, for example, minimum hold-
25
<PAGE>
ing periods or applicable sales charges. Exchanges may be made in any of the
following ways:
EXCHANGES BY MAIL
Send written instructions signed by all account owners and accompanied by any
outstanding share certificates properly endorsed. The transaction will be
effective upon receipt of the written instructions together with any
outstanding share certificates.
EXCHANGES BY TELEPHONE
SHAREHOLDERS, OR THEIR INVESTMENT REPRESENTATIVE OF RECORD, IF ANY, MAY
EXCHANGE SHARES OF THE FUND BY TELEPHONE BY CALLING INVESTOR SERVICES AT
1-800/632-2301. IF THE SHAREHOLDER DOES NOT WISH THIS PRIVILEGE EXTENDED TO A
PARTICULAR ACCOUNT, THE FUND OR INVESTOR SERVICES SHOULD BE NOTIFIED.
The Telephone Exchange Privilege allows a shareholder to effect exchanges from
the Fund into an identically registered account in one of the other available
funds in the Franklin Group of Funds or the Templeton Group. The Telephone
Exchange Privilege is available only for uncertificated shares or those which
have previously been deposited in the shareholder's account. The Fund and
Investor Services will employ reasonable procedures to confirm that
instructions communicated by telephone are genuine. Please refer to "Telephone
Transactions - Verification Procedures."
During periods of drastic economic or market changes, it is possible that the
Telephone Exchange Privilege may be difficult to implement. In this event,
shareholders should follow the other exchange procedures discussed in this
section, including the procedures for processing exchanges through securities
dealers.
EXCHANGES THROUGH SECURITIES DEALERS
As is the case with all purchases and redemptions of the Fund's shares,
Investor Services will accept exchange orders by telephone or by other means of
electronic transmission from securities dealers who execute a dealer or similar
agreement with Distributors. See also "Exchanges By Telephone" above. Such a
dealer-ordered exchange will be effective only for uncertificated shares on
deposit in the shareholder's account or for which certificates have previously
been deposited. A securities dealer may charge a fee for handling an exchange.
ADDITIONAL INFORMATION REGARDING EXCHANGES
Exchanges are made on the basis of the net asset values of the funds involved,
except as set forth below. Exchanges of shares of the Fund which were purchased
without a sales charge will be charged a sales charge in accordance with the
terms of the prospectus of the fund being purchased, unless the investment on
which no sales charge was paid was transferred in from a fund on which the
investor paid a sales charge. Exchanges of shares of the Fund which were
purchased with a lower sales charge to a fund which has a higher sales charge
will be charged the difference, unless the shares were held in the Fund for at
least six months prior to executing the exchange. When an investor requests the
exchange of the total value of the Fund account, accrued but unpaid income
dividends and capital gain distributions will be reinvested in the Fund at the
net asset value on the date of the exchange, and then the entire share balance
will be exchanged into the new fund in accordance with the procedures set forth
above. Because the exchange is considered a redemption and purchase of shares,
the shareholder may realize a gain or loss for federal income tax purposes.
Backup withholding and information reporting may also apply. Information
regarding the possible tax consequences of such an exchange is included in the
tax section in this Prospectus and in the Statement of Additional Information.
There are differences among the many funds in the Franklin Group of Funds and
the Templeton Group. Before making an exchange, a shareholder should
26
<PAGE>
obtain and review a current prospectus of the fund into which the shareholder
wishes to transfer.
If a substantial portion of the Fund's shareholders should, within a short
period, elect to redeem their shares of the Fund pursuant to the exchange
privilege, the Fund might have to liquidate portfolio securities it might
otherwise hold and incur the additional costs related to such transactions. On
the other hand, increased use of the exchange privilege may result in periodic
large inflows of money. If this should occur, it is the general policy of the
Fund to initially invest this money in short-term, interest-bearing municipal
securities, unless it is felt that attractive investment opportunities
consistent with the Fund's investment objectives exist immediately.
Subsequently, this money will be withdrawn from such short-term municipal
securities and invested in portfolio securities in as orderly a manner as is
possible when attractive investment opportunities arise.
The Exchange Privilege may be modified or discontinued by the Fund at any time
upon 60 days' written notice to shareholders.
TIMING ACCOUNTS
Accounts which are administered by allocation or market timing services to
purchase or redeem shares based on predetermined market indicators ("Timing
Accounts") will be charged a $5.00 administrative service fee per each such
exchange. All other exchanges are without charge.
RESTRICTIONS ON EXCHANGES
In accordance with the terms of their respective prospectuses, certain funds do
not accept or may place differing limitations than those below on exchanges by
Timing Accounts.
The Fund reserves the right to temporarily or permanently terminate the
exchange privilege or reject any specific purchase order for any Timing Account
or any person whose transactions seem to follow a timing pattern who: (i) make
an exchange request out of the Fund within two weeks of an earlier exchange
request out of the Fund, or (ii) make more than two exchanges out of the Fund
per calendar quarter, or (iii) exchange shares equal in value to at least $5
million, or more than 1% of the Fund's net assets. Accounts under common
ownership or control, including accounts administered so as to redeem or
purchase shares based upon certain predetermined market indicators, will be
aggregated for purposes of the exchange limits.
The Fund reserves the right to refuse the purchase side of exchange requests by
any Timing Account, person, or group if, in the Manager's judgment, the Fund
would be unable to invest effectively in accordance with its investment
objectives and policies, or would otherwise potentially be adversely affected.
A shareholder's purchase exchanges may be restricted or refused if the Fund
receives or anticipates simultaneous orders affecting significant portions of
the Fund's assets. In particular, a pattern of exchanges that coincide with a
"market timing" strategy may be disruptive to the Fund and therefore may be
refused.
The Fund and Distributors also, as indicated in "How to Buy Shares of the
Fund," reserve the right to refuse any order for the purchase of shares.
HOW TO SELL SHARES OF THE FUND
A shareholder may at any time liquidate shares owned and receive from the Fund
the value of the shares. Shares may be redeemed in any of the following ways:
REDEMPTIONS BY MAIL
Send a written request, signed by all registered owners, to Investor Services,
at the address shown on the back cover of this Prospectus, and any share
certificates which have been issued for the shares
27
<PAGE>
being redeemed, properly endorsed and in order for transfer. The shareholder
will then receive from the Fund the value of the shares based upon the net
asset value per share next computed after the written request in proper form is
received by Investor Services. Redemption requests received after the time at
which the net asset value is calculated (at 1:00 p.m. Pacific time) each day
that the New York Stock Exchange (the "Exchange") is open for business will
receive the price calculated on the following business day. Shareholders are
requested to provide a telephone number(s) where they may be reached during
business hours, or in the evening if preferred. Investor Services' ability to
contact a shareholder promptly when necessary will speed the processing of the
redemption.
TO BE CONSIDERED IN PROPER FORM, SIGNATURE(S) MUST BE GUARANTEED IF THE
REDEMPTION REQUEST INVOLVES ANY OF THE FOLLOWING:
(1) the proceeds of the redemption are over $50,000;
(2) the proceeds (in any amount) are to be paid to someone other than the
registered owner(s) of the account;
(3) the proceeds (in any amount) are to be sent to any address other than the
shareholder's address of record, preauthorized bank account or brokerage
firm account;
(4) share certificates, if the redemption proceeds are in excess of $50,000; or
(5) the Fund or Investor Services believes that a signature guarantee would
protect against potential claims based on the transfer instructions,
including, for example, when (a) the current address of one or more joint
owners of an account cannot be confirmed, (b) multiple owners have a
dispute or give inconsistent instructions to the Fund, (c) the Fund has
been notified of an adverse claim, (d) the instructions received by the
Fund are given by an agent, not the actual registered owner, (e) the Fund
determines that joint owners who are married to each other are separated
or may be the subject of divorce proceedings, or (f) the authority of a
representative of a corporation, partnership, association, or other entity
has not been established to the satisfaction of the Fund.
Signature(s) must be guaranteed by an "eligible guarantor institution" as
defined under Rule 17Ad-15 under the Securities Exchange Act of 1934.
Generally, eligible guarantor institutions include (1) national or state banks,
savings associations, savings and loan associations, trust companies, savings
banks, industrial loan companies and credit unions; (2) national securities
exchanges, registered securities associations and clearing agencies; (3)
securities dealers which are members of a national securities exchange or a
clearing agency or which have minimum net capital of $100,000; or (4)
institutions that participate in the Securities Transfer Agent Medallion
Program ("STAMP") or other recognized signature guarantee medallion program. A
notarized signature will not be sufficient for the request to be in proper
form.
Where shares to be redeemed are represented by share certificates, the request
for redemption must be accompanied by the share certificate and a share
assignment form signed by the registered shareholders exactly as the account is
registered, with the signature(s) guaranteed as referenced above. Shareholders
are advised, for their own protection, to send the share certificate and
assignment form in separate envelopes if they are being mailed in for
redemption.
Liquidation requests of corporate, partnership, trust and custodianship
accounts, and accounts
28
<PAGE>
under court jurisdiction require the following documentation to be in proper
form:
Corporation - (1) Signature guaranteed letter of instruction from the
authorized officer(s) of the corporation and (2) a corporate resolution.
Partnership - (1) Signature guaranteed letter of instruction from a general
partner and (2) pertinent pages from the partnership agreement identifying the
general partners or a certification for a partnership agreement.
Trust - (1) Signature guaranteed letter of instruction from the trustee(s) and
(2) a copy of the pertinent pages of the trust document listing the trustee(s)
or a Certification for Trust if the trustee(s) are not listed on the account
registration.
Custodial (other than a retirement account) - Signature guaranteed letter of
instruction from the custodian.
Accounts under court jurisdiction - Check court documents and the applicable
state law since these accounts have varying requirements, depending upon the
state of residence.
Payment for redeemed shares will be sent to the shareholder within seven days
after receipt of the request in proper form.
REDEMPTIONS BY TELEPHONE
Shareholders who file a Franklin/Templeton Telephone Redemption Authorization
Agreement (the "Agreement"), included with this Prospectus, may redeem shares
of the Fund by telephone. INFORMATION MAY ALSO BE OBTAINED BY WRITING TO THE
FUND OR INVESTOR SERVICES AT THE ADDRESS SHOWN ON THE COVER OR BY CALLING
1-800/632-2301. THE FUND AND INVESTOR SERVICES WILL EMPLOY REASONABLE
PROCEDURES TO CONFIRM THAT INSTRUCTIONS GIVEN BY TELEPHONE ARE GENUINE.
SHAREHOLDERS, HOWEVER, BEAR THE RISK OF LOSS IN CERTAIN CASES AS DESCRIBED
UNDER "TELEPHONE TRANSACTIONS - VERIFICATION PROCEDURES." For shareholder
accounts with the completed Agreement on file, redemptions of uncertificated
shares or shares which have previously been deposited with the Fund or Investor
Services may be made for up to $50,000 per day per Fund account. Telephone
redemption requests received before 1:00 p.m. Pacific time on any business day
will be processed that same day. The redemption check will be sent within seven
days, made payable to all the registered owners on the account, and will be
sent only to the address of record. Redemption requests by telephone will not
be accepted within 30 days following an address change by telephone. In that
case, a shareholder should follow the other redemption procedures set forth in
this Prospectus. Institutional accounts (certain corporations, bank trust
departments, government entities, and qualified retirement plans which qualify
to purchase shares at net asset value pursuant to the terms of this Prospectus)
which wish to execute redemptions in excess of $50,000 must complete an
Institutional Telephone Privileges Agreement which is available from Franklin's
Institutional Services Department by telephoning 1-800/321-8563.
REDEEMING SHARES THROUGH SECURITIES DEALERS
The Fund will accept redemption orders by telephone or other means of
electronic transmission from securities dealers who have entered into a dealer
or similar agreement with Distributors. This is known as a repurchase. The only
difference between a normal redemption and a repurchase is that if the
shareholder redeems shares through a dealer, the redemption price will be the
net asset value next calculated after the shareholder's dealer receives the
order which is promptly transmitted to the Fund, rather than on the day the
Fund receives the shareholder's written request in proper form. These
documents, as described in the preceding section, are required even if the
shareholder's secu-
29
<PAGE>
rities dealer has placed the repurchase order. After receipt of a repurchase
order from the dealer, the Fund will still require a signed letter of
instruction and all other documents set forth above. A shareholder's letter
should reference the Fund, the account number, the fact that the repurchase was
ordered by a dealer and the dealer's name. Details of the dealer-ordered trade,
such as trade date, confirmation number, and the amount of shares or dollars,
will help speed processing of the redemption. The seven-day period within which
the proceeds of the shareholder's redemption will be sent will begin when the
Fund receives all documents required to complete ("settle") the repurchase in
proper form. The redemption proceeds will not earn dividends or interest during
the time between receipt of the dealer's repurchase order and the date the
redemption is processed upon receipt of all documents necessary to settle the
repurchase. Thus, it is in a shareholder's best interest to have the required
documentation completed and forwarded to the Fund as soon as possible. The
shareholder's dealer may charge a fee for handling the order. The SAI contains
more information on the redemption of shares.
ADDITIONAL INFORMATION REGARDING REDEMPTIONS
The Fund may delay the mailing of the redemption check, or a portion thereof,
until the clearance of the check used to purchase Fund shares, which may take
up to 15 days or more. Although the use of a certified or cashier's check will
generally reduce this delay, shares purchased with these checks will also be
held pending clearance. Shares purchased by federal funds wire are available
for immediate redemption. In addition, the right of redemption may be suspended
or the date of payment postponed if the Exchange is closed (other than
customary closing) or upon the determination of the SEC that trading on the
Exchange is restricted or an emergency exists, or if the SEC permits it, by
order, for the protection of shareholders. Of course, the amount received may
be more or less than the amount invested by the shareholder, depending on
fluctuations in the market value of securities owned by the Fund.
OTHER
For any information required about a proposed liquidation, a shareholder may
call Franklin's Shareholder Services Department or the securities dealer may
call Franklin's Dealer Services Department.
TELEPHONE TRANSACTIONS
Shareholders of the Fund and their investment representative of record, if any,
may be able to execute various transactions by calling Investor Services at
1-800/632-2301.
All shareholders will be able to: (i) effect a change in address, (ii) change a
dividend option, (iii) transfer Fund shares in one account to another
identically registered account in the Fund, (iv) exchange Fund shares as
described in this Prospectus by telephone. In addition, shareholders who
complete and file an Agreement as described under "How to Sell Shares of the
Fund - Redemptions by Telephone" will be able to redeem shares of the Fund.
VERIFICATION PROCEDURES
The Fund and Investor Services will employ reasonable procedures to confirm
that instructions communicated by telephone are genuine. These will include:
recording all telephone calls requesting account activity by telephone,
requiring that the caller provide certain personal and/or account information
requested by the telephone service agent at the time of the call for the
purpose of establishing the caller's identification, and by sending a
confirmation statement on redemptions to the address of record each time
account activity is initiated by telephone. So long as the Fund and Investor
Services follow instructions communicated by telephone
30
<PAGE>
which were reasonably believed to be genuine at the time of their receipt,
neither they nor their affiliates will be liable for any loss to the
shareholder caused by an unauthorized transaction. Shareholders are, of course,
under no obligation to apply for or accept telephone transaction privileges. In
any instance where the Fund or Investor Services is not reasonably satisfied
that instructions received by telephone are genuine, the requested transaction
will not be executed, and neither the Fund nor Investor Services will be liable
for any losses which may occur because of a delay in implementing a
transaction.
GENERAL
During periods of drastic economic or market changes, it is possible that the
telephone transaction privileges will be difficult to execute because of heavy
telephone volume. In such situations, shareholders may wish to contact their
investment representative for assistance, or to send written instructions to
the Fund as detailed elsewhere in this Prospectus.
Neither the Fund nor Investor Services will be liable for any losses resulting
from the inability of a shareholder to execute a telephone transaction.
The telephone transaction privilege may be modified or discontinued by the Fund
at any time upon 60 days' written notice to shareholders.
VALUATION OF SHARES OF THE FUND
The net asset value per share of the Fund is determined as of 1:00 p.m. Pacific
time each day that the Exchange is open for trading. Many newspapers carry
daily quotations of the prior trading day's closing "bid" (net asset value) and
"ask" (offering price, which includes the maximum sales charge of the Fund).
The net asset value per share of the Fund is determined in the following
manner: The aggregate of all liabilities, accrued expenses and taxes and any
necessary reserves is deducted from the aggregate gross value of all assets,
and the difference is divided by the number of shares of the Fund outstanding
at the time. For the purpose of determining the aggregate net assets of the
Fund, cash and receivables are valued at their realizable amounts. Interest is
recorded as accrued. Portfolio securities for which market quotations are
readily available are valued within the range of the most recent bid and ask
prices as obtained from one or more dealers that make markets in the
securities. Portfolio securities which are traded both in the over-the-counter
market and on a stock exchange are valued according to the broadest and most
representative market as determined by the Manager. Municipal securities
generally trade in the over-the-counter market rather than on a securities
exchange. Other securities for which market quotations are readily available
are valued at the current market price, which may be obtained from a pricing
service, based on a variety of factors, including recent trades, institutional
size trading in similar types of securities (considering yield, risk and
maturity) and/or developments related to specific issues. Securities and other
assets for which market prices are not readily available are valued at fair
value as determined following procedures approved by the Board of Trustees.
All money market instruments with a maturity of more than 60 days are valued at
current market, as discussed above. All money market instruments with a
maturity of 60 days or less are valued at their amortized cost, which the Board
of Trustees has determined in good faith constitutes fair value for purposes of
complying with the 1940 Act. This valuation method will continue to be used
until such time as the trustees determine that it does not constitute fair
value for such purposes. With the approval of Trustees, the Trust may utilize a
pricing service, bank or securities dealer to perform any of the above
described functions.
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<PAGE>
HOW TO GET INFORMATION REGARDING AN INVESTMENT IN THE FUND
Any questions or communications regarding a shareholder's account should be
directed to Investor Services at the address shown on the back cover of this
Prospectus.
From a touch-tone phone, shareholders may obtain current price, yield or
performance information specific to a fund in the Franklin Group of Funds by
calling the automated Franklin TeleFACTS system (day or night) at
1-800/247-1753. Information about the Fund may be accessed by entering Fund
Code 75 followed by the sign when requested to do so by the automated operator.
To assist shareholders and securities dealers wishing to speak directly with a
representative, the following is a list of the various Franklin departments,
telephone numbers and hours of operation to call. The same numbers may be used
when calling from a rotary phone:
<TABLE>
<CAPTION>
HOURS OF OPERATION (PACIFIC TIME)
DEPARTMENT NAME TELEPHONE NO. (MONDAY THROUGH FRIDAY)
- ------------------------------------------------------------------------------
<S> <C> <C>
Shareholder Services 1-800/632-2301 6:00 a.m. to 5:00 p.m.
Dealer Services 1-800/524-4040 6:00 a.m. to 5:00 p.m.
Fund Information 1-800/DIAL BEN 6:00 a.m. to 8:00 p.m.
8:30 a.m. to 5:00 p.m. (Saturday)
Retirement Plans 1-800/527-2020 6:00 a.m. to 5:00 p.m.
</TABLE>
PERFORMANCE
Advertisements, sales literature and communications to shareholders may contain
various measures of the Fund's performance, including current yield, tax
equivalent yield, various expressions of total return, current distribution
rate and taxable equivalent distribution rate. They may occasionally cite
statistics to reflect its volatility or risk.
Average annual total return figures as prescribed by the SEC represent the
average annual percentage change in value of $1,000 invested at the maximum
public offering price (offering price includes sales charge) for one-, five-
and ten-year periods, or portion thereof, to the extent applicable, through the
end of the most recent calendar quarter, assuming reinvestment of all
distributions. The Fund may also furnish total return quotations for other
periods or based on investments at various sales charge levels or at net asset
value. For such purposes, total return equals the total of all income and
capital gain paid to shareholders, assuming reinvestment of all distributions,
plus (or minus) the change in the value of the original investment, expressed
as a percentage of the purchase price.
Current yield reflects the income per share earned by the Fund's portfolio
investments; it is calculated by dividing the Fund's net investment income per
share during a recent 30-day period by the maximum public offering price on the
last day of that period and annualizing the result. Tax equivalent yield
demonstrates the yield from a taxable investment necessary to produce an
after-tax yield equivalent to that of a fund which invests in tax-exempt
obligations. It is computed by dividing the tax-exempt portion of a fund's
yield (calculated as indicated) by one minus a stated income tax rate and
adding the product to the taxable portion (if any) of the fund's yield.
32
<PAGE>
Current yield and tax equivalent yield which are calculated according to a
formula prescribed by the SEC (see the SAI) are not indicative of the dividends
or distributions which were or will be paid to the Fund's shareholders.
Dividends or distributions paid to shareholders are reflected in the current
distribution rate or taxable equivalent distribution rate, which may be quoted
to shareholders. The current distribution rate is computed by dividing the
total amount of dividends per share paid by the Fund during the past 12 months
by a current maximum offering price. A taxable equivalent distribution rate
demonstrates the taxable distribution rate necessary to produce an after-tax
distribution rate equivalent to the Fund's distribution rate (calculated as
indicated above). Under certain circumstances, such as when there has been a
change in the amount of dividend payout, or a fundamental change in investment
policies, it might be appropriate to annualize the dividends paid during the
period such policies were in effect, rather than using the dividends during the
past 12 months. The current distribution rate differs from the current yield
computation because it may include distributions to shareholders from sources
other than dividends and interest, such as short-term capital gain, and is
calculated over a different period of time.
In each case, performance figures are based upon past performance, reflect all
recurring charges against Fund income and will assume the payment of the
maximum sales charge on the purchase of shares. When there has been a change in
the sales charge structure, the historical performance figures will be restated
to reflect the new rate. The investment results of the Fund, like all other
investment companies, will fluctuate over time; thus, performance figures
should not be considered to represent what an investment may earn in the future
or what the Fund's yield, tax equivalent yield, distribution rate, taxable
equivalent distribution rate or total return may be in any future period.
GENERAL INFORMATION
REPORTS TO SHAREHOLDERS
The Fund's fiscal year ends May 31. Annual Reports containing audited financial
statements of the Trust, including the auditors' report, and Semi-Annual
Reports containing unaudited financial statements are automatically sent to
shareholders. Additional copies may be obtained, without charge, upon request
to the Trust at the telephone number or address set forth on the cover page of
this prospectus. Additional information on Fund performance is included in the
Trust's Annual Report to Shareholders and the Statement of Additional
Information.
ORGANIZATION
The Trust was organized as a Delaware business trust on November 19, 1991. The
Agreement and Declaration of Trust permits the Trustees to issue an unlimited
number of full and fractional shares of beneficial interest without par value,
which may be issued in any number of series. Shares issued will be fully paid
and non-assessable and will have no preemptive, conversion, or sinking rights.
Shares of each series have equal and exclusive rights as to dividends and
distributions, as declared by such series, and the net assets of such series
upon liquidation or dissolution. Additional series may be added in the future
by the Board of Trustees.
VOTING RIGHTS
Shares of each series have equal rights as to voting and vote separately as to
issues affecting that series, or the Trust, unless otherwise permitted by the
1940 Act. Voting rights are noncumulative, so that in any election of trustees,
the holders of more than 50% of the shares voting can elect all of the
Trustees, if they choose to do so, and, in such event, the holders of the
remaining shares voting will not be able to elect any person or persons to the
Board of Trustees. The Trust does not intend to hold annu-
33
<PAGE>
al shareholders' meetings. The Trust may, however, hold a special shareholders'
meeting for such purposes as changing fundamental investment restrictions,
approving a new management agreement or any other matters which are required to
be acted on by shareholders under the 1940 Act. A meeting may also be called by
the Trustees in their discretion or by shareholders holding at least 10% of the
outstanding shares of any series. Shareholders will receive assistance in
communicating with other shareholders in connection with the election or
removal of trustees such as that provided in Section 16(c) of the 1940 Act.
REDEMPTIONS BY THE FUND
The Fund reserves the right to redeem, at net asset value, shares of any
shareholder whose account has a value of less than $50, but only where the
value of such account has been reduced by the shareholder's prior voluntary
redemption of shares and has been inactive (except for the reinvestment of
distributions) for a period of at least six months, provided advance notice is
given to the shareholder. More information is included in the SAI.
OTHER INFORMATION
Distribution or redemption checks sent to shareholders do not earn interest or
any other income during the time such checks remain uncashed and neither the
Fund nor its affiliates will be liable for any loss to the shareholder caused
by the shareholder's failure to cash such check(s).
"Cash" payments to or from the Fund may be made by check, draft or wire. The
Fund has no facility to receive, or pay out, cash in the form of currency.
ACCOUNT REGISTRATIONS
An account registration should reflect the investor's intentions as to
ownership. Where there are two co-owners on the account, the account will be
registered as "Owner 1" and "Owner 2"; the "or" designation is not used except
for money market fund accounts. If co-owners wish to have the ability to redeem
or convert on the signature of only one owner, a limited power of attorney may
be used.
Accounts should not be registered in the name of a minor, either as sole or
co-owner of the account. Transfer or redemption for such an account may require
court action to obtain release of the funds until the minor reaches the legal
age of majority. The account should be registered in the name of one "Adult" as
custodian for the benefit of the "Minor" under the Uniform Transfer or Gifts to
Minors Act.
A trust designation such as "trustee" or "in trust for" should only be used if
the account is being established pursuant to a legal, valid trust document. Use
of such a designation in the absence of a legal trust document may cause
difficulties and require court action for transfer or redemption of the funds.
Shares, whether in certificate form or not, registered as joint tenants or "Jt
Ten" shall mean "as joint tenants with rights of survivorship" and not "as
tenants in common."
Except as indicated, a shareholder may transfer an account in the Fund carried
in "street" or "nominee" name by the shareholder's securities dealer to a
comparably registered Fund account maintained by another securities dealer.
Both the delivering and receiving securities dealers must have executed dealer
agreements on file with Distributors. Unless a dealer agreement has been
executed and is on file with Distributors, the Fund will not process the
transfer and will so inform the shareholder's delivering securities dealer. To
effect the transfer, a shareholder should instruct the securities dealer to
transfer the account to a receiving securities dealer and sign any documents
required by the securities dealer(s) to evidence consent to the transfer. Under
current procedures the account transfer may be processed
34
<PAGE>
by the delivering securities dealer and the Fund after the Fund receives
authorization in proper form from the shareholder's delivering securities
dealer. In the future it may be possible to effect such transfers
electronically through the services of the NSCC.
The Fund may conclusively accept instructions from an owner or the owner's
nominee listed in publicly available nominee lists, regardless of whether the
account was initially registered in the name of or by the owner, the nominee,
or both. If a securities dealer or other representative is of record on an
investor's account, the investor will be deemed to have authorized the use of
electronic instructions on the account, including, without limitation, those
initiated through the services of the NSCC, to have adopted as the owner's
instruction and signature any such electronic instructions received by the Fund
and the Shareholder Services Agent, and to have authorized them to execute the
instructions without further inquiry. At the present time, such services which
are available, or which are anticipated to be made available in the near
future, include the NSCC's "Networking," "Fund/SERV," and "ACATS" systems.
Any questions regarding an intended registration should be answered by the
securities dealer handling the investment or by calling Franklin's Fund
Information Department.
IMPORTANT NOTICE REGARDING TAXPAYER IRS CERTIFICATIONS
Pursuant to the Code and U.S. Treasury regulations, the Fund may be required to
report to the IRS any taxable dividend, capital gain distribution, or other
reportable payment (including share redemption proceeds) and withhold 31% of
any such payments made to individuals and other non-exempt shareholders who
have not provided a correct taxpayer identification number ("TIN") and made
certain required certifications that appear in the Shareholder Application. A
shareholder may also be subject to backup withholding if the IRS or a
securities dealer notifies the Fund that the TIN furnished by the shareholder
is incorrect or that the shareholder is subject to backup withholding for
previous under-reporting of interest or dividend income.
The Fund reserves the right to (1) refuse to open an account for any person
failing to provide a TIN along with the required certifications and (2) close
an account by redeeming its shares in full at the then current net asset value
upon receipt of notice from the IRS that the TIN certified as correct by the
shareholder is in fact incorrect or upon the failure of a shareholder who has
completed an "awaiting TIN" certification to provide the Fund with a certified
TIN within 60 days after opening the account.
PORTFOLIO OPERATIONS
The following persons have been primarily responsible for the day-to-day
management of the Fund's portfolio since its inception.
Andrew Jennings, Sr., Vice President and Senior Portfolio Manager, joined
Advisers in 1990. He attended Villanova University in Philadelphia, has been in
the securities industry for over 33 years, and is a member of several municipal
securities industry-related committees and associations. From 1985 to 1990, Mr.
Jennings was First Vice President and Manager of the Municipal Institutional
Bond Department at Dean Witter Reynolds Inc.
Thomas Kenny, Senior Vice President and Portfolio Manager. Mr. Kenny is
director of Franklin's municipal bond department. He joined Franklin in 1986
and has been responsible for making portfolio recommendations and decisions for
the Fund since August 1994. He received a Bachelor of Arts degree in Business
and Economics from the University of California at Santa Barbara and Master of
Science degree in Finance from Golden Gate Uni-
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<PAGE>
versity. He is a member of several municipal securities industry-related
committees and associations.
Bernie Schroer, Vice President and Senior Portfolio Manager, joined Advisers in
1987. From 1974 to 1984, he was the manager of trading at Kidder Peabody and
Company, Inc. He has a degree in finance from Santa Clara University and is a
member of municipal securities industry-related committees and associations.
APPENDIX - DESCRIPTION OF MUNICIPAL SECURITIES RATINGS
MUNICIPAL BONDS
Moody's Investors Service ("Moody's")
Aaa: Municipal bonds which are rated Aaa are judged to be of the best quality.
They carry the smallest degree of investment risk and are generally referred to
as "gilt-edged." Interest payments are protected by a large or by an
exceptionally stable margin, and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized are
most unlikely to impair the fundamentally strong position of such issues.
Aa: Municipal bonds which are rated Aa are judged to be high quality by all
standards. Together with the Aaa group, they comprise what are generally known
as high-grade bonds. They are rated lower than the best bonds because margins
of protection may not be as large as in Aaa securities, fluctuation of
protective elements may be of greater amplitude, or there may be other elements
present which make the long-term risks appear somewhat larger than in Aaa
securities.
A: Municipal bonds which are rated A possess many favorable investment
attributes and are to be considered as upper medium-grade obligations. Factors
giving security to principal and interest are considered adequate, but elements
may be present which suggest a susceptibility to impairment sometime in the
future.
Baa: Bonds which are rated Baa are considered as medium-grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and, in
fact, have speculative characteristics as well.
Ba: Bonds which are rated Ba are judged to have predominantly speculative
elements; their future cannot be considered as well assured. Often the
protection of interest and principal payments may be very moderate and,
thereby, not well safeguarded during both good and bad times over the future.
Uncertainty of position characterizes bonds in this class.
B: Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
Caa: Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal or
interest.
Ca: Bonds which are rated Ca represent obligations which are speculative to a
high degree. Such issues are often in default or have other marked
shortcomings.
C: Bonds which are rated C are the lowest-rated class of bonds, and issues so
rated can be regarded as having extremely poor prospects of ever attaining any
real investment standing.
Con. (-): Bonds for which the security depends upon the completion of some act
or the fulfillment of some
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<PAGE>
condition are rated conditionally. These are bonds secured by (a) earnings of
projects under construction, (b) earnings of projects unseasoned in operation
experience, (c) rentals which begin when facilities are completed, or (d)
payments to which some other limiting condition attaches. Parenthetical rating
denotes probable credit stature upon completion of construction or elimination
of basis condition.
Note: Moody's applies numerical modifiers 1, 2 and 3 in each generic rating
classification from Aa through B in its corporate bond ratings. The modifier 1
indicates that the security ranks in the higher end of its generic rating
category; modifier 2 indicates a mid-range ranking; and modifier 3 indicates
that the issue ranks in the lower end of its generic rating category.
Standard & Poor's Corporation ("S&P")
AAA: Municipal bonds rated AAA are highest-grade obligations. They possess the
ultimate degree of protection as to principal and interest. In the market they
move with interest rates and, hence, provide the maximum safety on all counts.
AA: Municipal bonds rated AA also qualify as high-grade obligations, and in the
majority of instances differ from AAA issues only in a small degree. Here, too,
prices move with the long-term money market.
A: Municipal bonds rated A are regarded as upper medium-grade. They have
considerable investment strength but are not entirely free from adverse effects
of changes in economic and trade conditions. Interest and principal are
regarded as safe. They predominantly reflect money rates in their market
behavior, but also, to some extent, economic conditions.
BBB: Bonds rated BBB are regarded as having an adequate capacity to pay
principal and interest. Whereas they normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay principal and interest for bonds
in this category than for bonds in the A category.
BB, B, CCC, CC: Bonds rated BB, B, CCC and CC are regarded, on balance, as
predominantly speculative with respect to the issuer's capacity to pay interest
and repay principal in accordance with the terms of the obligations. BB
indicates the lowest degree of speculation and CC the highest degree of
speculation. While such bonds will likely have some quality and protective
characteristics, these are outweighed by large uncertainties or major risk
exposures to adverse conditions.
C: This rating is reserved for income bonds on which no interest is being paid.
D: Debt rated "D" is in default, and payment of interest and/or repayment of
principal is in arrears.
Note: The S&P ratings may be modified by the addition of a plus (+) or minus
(-) sign to show relative standing within the major rating categories.
Fitch Investors Services, Inc. ("Fitch")
AAA bonds: Considered to be of investment grade and of the highest credit
quality. The obligor has an exceptionally strong ability to pay interest and
repay principal which is unlikely to be affected by reasonably foreseeable
events.
AA bonds: Considered to be investment grade and of very high credit quality.
The obligor's ability to pay interest and repay principal is very strong
although not quite as strong as bonds rated AAA and not significantly
vulnerable to foreseeable future developments.
A bonds: Considered to be investment grade and of high credit quality. The
obligor's ability to pay interest and repay principal is considered to be
strong, but may be more vulnerable to adverse changes in economic conditions
and circumstances than bonds with higher ratings.
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<PAGE>
BBB bonds: Considered to be investment grade and of satisfactory credit
quality. The obligor's ability to pay interest and repay principal is
considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have adverse impact on these bonds,
and therefore impair timely payment. The likelihood that the ratings of these
bonds will fall below investment grade is higher than for bonds with higher
ratings.
BB bonds: Considered speculative. The obligor's ability to pay interest and
repay principal may be affected over time by adverse economic changes. However,
business and financial alternatives can be identified which could assist the
obligor in satisfying its debt service requirements.
B bonds: Considered highly speculative. While bonds in this class are currently
meeting debt service requirements, the probability of continued timely payment
of principal and interest reflects the obligor's limited margin of safety and
the need for reasonable business and economic activity throughout the life of
the issue.
CCC bonds: Have certain identifiable characteristics which, if not remedied,
may lead to default. The ability to meet obligations requires an advantageous
business and economic environment.
CC bonds: Minimally protected. Default in payment of interest and/or principal
seems probable over time.
C bonds: Imminent default in payment of interest or principal.
DDD, DD and D bonds: Are in default on interest and/or principal payments. Such
bonds are extremely speculative and should be valued on the basis of their
ultimate recovery value in liquidation or reorganization of the obligor. DDD
represents the highest potential for recovery while D represents the lowest
potential for recovery.
Plus (+) or minus (-) signs are used with a rating symbol to indicate the
relative position of a credit within the rating category. Plus or minus are not
used for the AAA and the DDD, DD or D categories.
MUNICIPAL NOTES
Moody's
Moody's ratings for state, municipal, and other short-term obligations will be
designated Moody's Investment Grade ("MIG"). This distinction is in recognition
of the differences between short-term credit risk and long-term risk. Factors
affecting the liquidity of the borrower are uppermost in importance in
short-term borrowing; factors of the first importance in long-term borrowing
risk are of lesser importance in the short run. Symbols used will be as
follows:
MIG 1: Notes are of the best quality, enjoying strong protection from
established cash flows of funds for their servicing or from established and
broad-based access to the market for refinancing, or both.
MIG 2: Notes are of high quality, with margins of protection ample, although
not so large as in the preceding group.
MIG 3: Notes are of favorable quality, with all security elements accounted
for, but lacking the undeniable strength of the preceding grades. Market access
for refinancing, in particular, is likely to be less well established.
MIG 4: Notes are of adequate quality, carrying specific risk but having
protection and not distinctly or predominantly speculative.
S&P
Until June 29, 1984, S&P used the same rating symbols for notes and bonds.
After June 29, 1984, for new municipal note issues due in three years or less,
the ratings below will usually be assigned. Notes maturing beyond three years
will most likely receive a bond rating of the type recited above.
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<PAGE>
SP-1: Issues carrying this designation have a very strong or strong capacity to
pay principal and interest. Issues determined to possess overwhelming safety
characteristics will be given a "plus" (+) designation.
SP-2: Issues carrying this designation have a satisfactory capacity to pay
principal and interest.
COMMERCIAL PAPER
Moody's
Moody's Commercial Paper ratings, which are also applicable to municipal paper
investments permitted to be made by the Fund, are opinions of the ability of
issuers to repay punctually their promissory obligations not having an original
maturity in excess of nine months. Moody's employs the following designations,
all judged to be investment grade, to indicate the relative repayment capacity
of rated issuers:
P-1 (Prime-1): Superior capacity for repayment.
P-2 (Prime-2): Strong capacity for repayment.
S&P
S&P's ratings are a current assessment of the likelihood of timely payment of
debt having an original maturity of no more than 365 days. Ratings are graded
into four categories, ranging from "A" for the highest quality obligations to
"D" for the lowest. Issues within the "A" category are delineated with the
numbers 1, 2 and 3 to indicate the relative degree of safety, as follows:
A-1: This designation indicates the degree of safety regarding timely payment
is very strong. A "plus" (+) designation indicates an even stronger likelihood
of timely payment.
A-2: Capacity for timely payment on issues with this designation is strong.
However, the relative degree of safety is not as overwhelming as for issues
designated A-1.
A-3: Issues carrying this designation have a satisfactory capacity for timely
payment. They are, however, somewhat more vulnerable to the adverse effects of
changes in circumstances than obligations carrying the higher designations.
Fitch
Fitch's short-term ratings apply to debt obligations that are payable on demand
or have original maturities of generally up to three years, including
commercial paper, certificates of deposit, medium-term notes, and municipal and
investment notes. The short-term rating places greater emphasis than a
long-term rating on the existence of liquidity necessary to meet the issuer's
obligations in a timely manner.
F-1+: Exceptionally strong credit quality. Regarded as having the strongest
degree of assurance for timely payment.
F-1: Very strong credit quality. Reflect on assurance of timely payment only
slightly less in degree than issues rated F-1+.
F-2: Good credit quality. A satisfactory degree of assurance for timely
payment, but the margin of safety is not as great as for issues assigned F-1+
and F-1 ratings.
F-3: Fair credit quality. Have characteristics suggesting that the degree of
assurance for timely payment is adequate; however, near-term adverse changes
could cause these securities to be rated below investment grade.
F-S: Weak credit quality. Have characteristics suggesting a minimal degree of
assurance for timely payment and are vulnerable to near-term adverse changes in
financial and economic conditions.
D: Default. Actual or imminent payment default.
LOC: The symbol LOC indicates that the rating is based on a letter of credit
issued by a commercial bank.
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<PAGE>
MUNPP295
SUPPLEMENT DATED FEBRUARY 1, 1995
TO THE PROSPECTUS OF
FRANKLIN MUNICIPAL SECURITIES TRUST
(Franklin Arkansas Municipal Bond Fund, Franklin Hawaii Municipal Bond Fund,
Franklin Tennessee Municipal Bond Fund and Franklin Washington Municipal Bond
Fund) dated November 1, 1994
The prospectus language is revised, as noted, to reflect current operational
policies of the Funds:
1. EXPENSE TABLE
Revised to reflect that investments of $1,000,000 or more in the Funds are not
subject to a front-end sales charge but a contingent deferred sales charge of
1% will be imposed on certain redemptions within 12 months of the calendar
month following such investments. See "How to Sell Shares of Each Fund -
Contingent Deferred Sales Charge."
2. MANAGEMENT OF THE TRUST
Revised to add the definition "Franklin Templeton Group" to describe the
subsidiaries of Resources.
3. HOW TO BUY SHARES OF EACH FUND:
a) Add the following language under "How to Buy Shares of the Fund - General":
The Fund may impose a $10 charge for each returned item, against any
shareholder account which, in connection with the purchase of Fund shares,
submits a check or a draft which is returned unpaid to the Fund.
b) Substitute the following for the sales charge table and the ensuing two
paragraphs:
<TABLE>
<CAPTION>
TOTAL SALES CHARGE
---------------------------------------------------------
AS A AS A DEALER CONCESSION
Size of Transaction PERCENTAGE OF PERCENTAGE OF NET AS A PERCENTAGE
at Offering Price OFFERING PRICE AMOUNT INVESTED OF OFFERING PRICE*,***
------------------- -------------- ----------------- ----------------------
<S> <C> <C> <C>
Less than $100,000.................................... 4.25% 4.44% 4.00%
$100,000 but less than $250,000....................... 3.50% 3.63% 3.25%
$250,000 but less than $500,000....................... 2.75% 2.83% 2.50%
$500,000 but less than $1,000,000..................... 2.15% 2.20% 2.00%
$1,000,000 or more.................................... none none (see below)**
</TABLE>
*Financial institutions or their affiliated brokers may receive an agency
transaction fee in the percentages set forth above.
**The following commissions will be paid by Distributors from its resources
to securities dealers who initiate and are responsible for purchases of
$1 million or more: 0.75% on sales of $1 million but less than $2 million,
plus 0.60% on sales of $2 million but less than $3 million, plus 0.50% on
sales of $3 million but less than $50 million, plus 0.25% on sales of
$50 million but less than $100 million, plus 0.15% on sales of $100 million
or more. Dealer concession breakpoints are reset every 12 months for
purposes of additional purchases.
***At the discretion of Distributors, all sales charges may at times be
allowed to the securities dealer. If 90% or more of the sales commission is
allowed, such securities dealer may be deemed to be an underwriter as that
term is defined in the Securities Act of 1933, as amended.
No front-end sales charge applies on investments of $1 million or more, but
a contingent deferred sales charge of 1% is imposed on certain redemptions
of investments of $1 million or more within 12 months of the calendar month
following such investments ("contingency period"). See "How to Sell Shares
of Each Fund - Contingent Deferred Sales Charge."
The size of a transaction which determines the applicable sales charge on
the purchase of Fund shares is determined by adding the amount of the
shareholder's current purchase plus the cost or current value (whichever is
higher) of a shareholder's existing investment in one or more of the funds
in the Franklin Group of Funds(R) and the Templeton Group of Funds. Included
for these aggregation purposes are (a)
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<PAGE>
the mutual funds in the Franklin Group of Funds except Franklin Valuemark
Funds and Franklin Government Securities Trust (the "Franklin Funds"), (b)
other investment products underwritten by Distributors or its affiliates
(although certain investments may not have the same schedule of sales
charges and/or may not be subject to reduction) and (c) the U.S. mutual
funds in the Templeton Group of Funds except Templeton American Trust, Inc.,
Templeton Capital Accumulator Fund, Inc., Templeton Variable Annuity Fund,
and Templeton Variable Products Series Fund (the "Templeton Funds").
(Franklin Funds and Templeton Funds are collectively referred to as the
"Franklin Templeton Funds.") Sales charge reductions based upon aggregate
holdings of (a), (b) and (c) above ("Franklin Templeton Investments") may be
effective only after notification to Distributors that the investment
qualifies for a discount. References throughout the Prospectus, for purposes
of aggregating assets or describing the exchange privilege, refer to the
above descriptions.
Distributors, or one of its affiliates, may make payments, out of its own
resources, of up to 1.00% of the amount purchased to securities dealers who
initiate and are responsible for purchases made at net asset value by
certain trust companies and trust departments of banks. See definition under
"Description of Special Net Asset Value Purchases and as set forth in the
SAI. As of March 31, 1995, "Timing Accounts" will no longer be permitted to
buy shares of the Funds. See "Exchange Privilege" for a description.
c) Substitute the following for the current "Purchases at Net Asset Value"
subsection:
PURCHASES AT NET ASSET VALUE
Shares of each Fund may be purchased without the imposition of either a
front-end sales charge ("net asset value") or a contingent deferred sales
charge by (1) officers, trustees and full-time employees of the Trust, any
of the Franklin Templeton Funds, or of the Franklin Templeton Group, and by
their spouses and family members; (2) companies exchanging shares with or
selling assets pursuant to a merger, acquisition or exchange offer; (3)
registered securities dealers and their affiliates, for their investment
account only, and (4) registered personnel and employees of securities
dealers, and by their spouses and family members, in accordance with the
internal policies and procedures of the employing securities dealer.
Shares of each Fund may be purchased at net asset value by persons who have
redeemed, within the previous 120 days, their shares of the Fund or another
of the Franklin Templeton Funds which were purchased with a front-end sales
charge or assessed a contingent deferred sales charge on redemption. An
investor may reinvest an amount not exceeding the redemption proceeds. While
credit will be given for any contingent deferred sales charge paid on the
shares redeemed, a new contingency period will begin. Shares of the Fund
redeemed in connection with an exchange into another fund (see "Exchange
Privilege") are not considered "redeemed" for this privilege. In order to
exercise this privilege, a written order for the purchase of shares of the
Fund must be received by the Fund or the Fund's Shareholder Services Agent
within 120 days after the redemption. The 120 days, however, do not begin to
run on redemption proceeds placed immediately after redemption in a Franklin
Bank Certificate of Deposit ("CD") until the CD (including any rollover)
matures. Reinvestment at net asset value may also be handled by a securities
dealer or other financial institution, who may charge the shareholder a fee
for this service. The redemption is a taxable transaction but reinvestment
without a sales charge may affect the amount of gain or loss recognized and
the tax basis of the shares reinvested. If there has been a loss on the
redemption, the loss may be disallowed if a reinvestment in the same fund is
made within a 30-day period. Information regarding the possible tax
consequences of such a reinvestment is included in the tax section of this
Prospectus and the SAI.
Dividends and capital gains received in cash by the shareholder may also be
used to purchase shares of the Funds or another of the Franklin Templeton
Funds at net asset value or without the imposition of a contingent deferred
sales charge within 120 days of the payment date of such distribution. To
exercise
2
<PAGE>
This privilege, a written request to reinvest the distribution must
accompany the purchase order. Additional information may be obtained
from Shareholder Services at 1-800/632-2301. See "Distributions in Cash"
under "Distributions to Shareholders."
Shares of each Fund may be purchased at net asset value or without the
imposition of a contingent deferred sales charge by investors who have,
within the past 60 days, redeemed an investment in an unaffiliated mutual
fund which charged the investor a contingent deferred sales charge upon
redemption and which has investment objectives similar to those of the Fund.
Shares of each Fund may be purchased at net asset value or without the
imposition of a contingent deferred sales charge by registered investment
advisors and/or their affiliated broker-dealers, who have entered into a
supplemental agreement with Distributors, on behalf of their clients who are
participating in a comprehensive fee program (also known as a wrap fee
program).
Shares of each Fund may also be purchased at net asset value or without the
imposition of a contingent deferred sales charge by any state, county, or
city, or any instrumentality, department, authority or agency thereof which
has determined that the Fund is a legally permissible investment and which
is prohibited by applicable investment laws from paying a sales charge or
commission in connection with the purchase of shares of any registered
management investment company ("an eligible governmental authority"). SUCH
INVESTORS SHOULD CONSULT THEIR OWN LEGAL ADVISORS TO DETERMINE WHETHER AND
TO WHAT EXTENT THE SHARES OF THE FUND CONSTITUTE LEGAL INVESTMENTS FOR THEM.
Municipal investors considering investment of proceeds of bond offerings
into the Fund should consult with expert counsel to determine the effect, if
any, of various payments made by the Fund or its investment manager on
arbitrage rebate calculations. If an investment by an eligible governmental
authority at net asset value is made through a securities dealer who has
executed a dealer agreement with Distributors, Distributors or one of its
affiliates may make a payment, out of their own resources, to such
securities dealer in an amount not to exceed 0.25% of the amount invested.
Contact Franklin's Institutional Sales Department for additional
information.
DESCRIPTION OF SPECIAL NET ASSET VALUE PURCHASES
Shares of each Fund may be purchased at net asset value or without the
imposition of a contingent deferred sales charge by trust companies and bank
trust departments for funds over which they exercise exclusive discretionary
investment authority and which are held in a fiduciary, agency, advisory,
custodial or similar capacity. Such purchases are subject to minimum
requirements with respect to amount of purchase, which may be established by
Distributors. Currently, those criteria require that the amount invested or
to be invested during the subsequent 13-month period in this Fund or any of
the Franklin Templeton Investments must total at least $1,000,000. Orders
for such accounts will be accepted by mail accompanied by a check or by
telephone or other means of electronic data transfer directly from the bank
or trust company, with payment by federal funds received by the close of
business on the next business day following such order.
Refer to the SAI for further information.
4. EXCHANGE PRIVILEGE
a) The following option is added to "Exchanges by Telephone":
The automatic TeleFACTS(R) system at 1-800/247-1753 is available for
processing exchanges (day or night). During periods of drastic economic or
market changes, however, this option may not be available, in which event
the shareholder should follow other exchange procedures discussed in the
Prospectus.
b) Substitute the following for the subsection "Timing Accounts."
As of March 1, 1995, "Timing Accounts" will no longer be permitted to
exchange into the Funds. This policy does not affect any other type of
investor. "Timing Accounts" generally include market timing or
3
<PAGE>
allocation services; accounts administered as to redeem or purchase shares
based upon certain predetermined market indicators; or any person whose
transactions seem to follow a timing pattern.
c) Add the following paragraph under the subsection "Additional Information
Regarding Exchanges":
A contingent deferred sales charge will not be imposed on exchanges. If,
however, the exchanged shares were subject to a contingent deferred sales
charge in the original fund purchased, and shares are subsequently redeemed
within the contingent period a contingent deferred sales charge will be
imposed. The contingency period will be tolled (or stopped) for the period
such shares are exchanged into and held in a Franklin or Templeton money
market fund. See also "How to Sell Shares of Each Fund - Contingent Deferred
Sales Charge."
5. HOW TO SELL SHARES OF EACH FUND
Add the following subsection:
CONTINGENT DEFERRED SALES CHARGE
In order to recover commissions paid to securities dealers on investments of
$1 million or more, a contingent deferred sales charge of 1% applies to
redemptions of those investments of each Fund within the contingency period
of 12 months of the calendar month following such purchase. The charge is 1%
of the lesser of the value of the shares redeemed (exclusive of reinvested
dividends and capital gain distributions) or the total cost of such shares,
and is retained by Distributors. In determining if a charge applies, shares
not subject to a contingent deferred sales charge are deemed to be redeemed
first, in the following order: (i) shares representing amounts attributable
to capital appreciation of those shares held less than 12 months; (ii)
shares purchased with reinvested dividends and capital gain distributions;
and (iii) other shares held longer than 12 months; and followed by any
shares held less than 12 months, on a "first in, first out" basis.
The contingent deferred sales charge is waived for: exchanges; redemptions
through a Systematic Withdrawal Plan set up prior to February 1, 1995, and
for Systematic Withdrawal Plans set up thereafter, redemptions of up to 1%
monthly of an account's net asset value (3% quarterly, 6% semiannually or
12% annually); and redemptions initiated by the Fund due to a shareholder's
account falling below the minimum specified account size.
Requests for redemptions for a specified dollar amount will result in
additional shares being redeemed to cover any applicable contingent deferred
sales charge while requests for redemption of a specific number of shares
will result in the applicable contingent deferred sales charge being
deducted from the total dollar amount redeemed.
6. The section "Portfolio Operations" is changed to add Thomas Kenny as
Portfolio Manager in place of Gregory Harrington. Mr. Kenny is Senior Vice
President of the investment manager and director of Franklin's municipal
bond department. He joined Franklin in 1986. He received a Bachelor of Arts
degree in Business and Economics from the University of California at Santa
Barbara and Master of Science degree in Finance from Golden Gate University.
He is a member of several municipal securities industry related committees
and associations.
4
<PAGE>
FRANKLIN
MUNICIPAL
SECURITIES TRUST
Franklin Arkansas Municipal Bond Fund
(the "Arkansas Fund")
Franklin Hawaii Municipal Bond Fund
(the "Hawaii Fund")
Franklin Tennessee Municipal Bond Fund
(the "Tennessee Fund")
Franklin Washington Municipal Bond Fund
(the "Washington Fund")
PROSPECTUS October 1, 1994
[LOGO]
777 Mariners Island Blvd., P.O. Box 7777
San Mateo, CA 94403-7777 1-800/DIAL BEN
Franklin Municipal Securities Trust (the "Trust") is an open-end management
investment company consisting of five separate, non-diversified series. This
Prospectus relates only to the Franklin Arkansas Municipal Bond Fund, the
Franklin Hawaii Municipal Bond Fund, the Franklin Tennessee Municipal Bond Fund
and the Franklin Washington Municipal Bond Fund, each of which may collectively
or separately be referred to hereafter as the "Funds" or "Fund." The Funds seek
to provide investors with as high a level of income exempt from regular federal
income taxes as is consistent with prudent investing, while seeking
preservation of shareholders' capital. The Arkansas, Hawaii and Tennessee Funds
also seek to provide a maximum level of income which is exempt from the state
personal income taxes for resident shareholders of each such state. The state
of Washington currently imposes no state income tax.
Each Fund invests primarily in municipal securities issued by its respective
state and the state's political subdivisions, agencies and instrumentalities
and in municipal obligations of non-state issuers which pay interest exempt, in
the opinion of bond counsel to the issuer, from named-state personal income
taxes (if any) and regular federal income taxes.
This Prospectus is intended to set forth in a clear and concise manner
information about each Fund that a prospective investor should know before
investing. After reading the Prospectus, it should be retained for future
reference; it contains information about the purchase and sale of shares and
other items which a prospective investor will find useful to have.
SHARES OF THE FUNDS ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR
ENDORSED BY, ANY BANK; FURTHER, SUCH SHARES ARE NOT FEDERALLY INSURED BY THE
FEDERAL DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD, OR ANY OTHER
AGENCY. SHARES OF THE FUNDS INVOLVE INVESTMENT RISKS, INCLUDING THE POSSIBLE
LOSS OF PRINCIPAL.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS
A CRIMINAL OFFENSE.
1
<PAGE>
A Statement of Additional Information, concerning the Trust and its series,
dated October 1, 1994, and as may be further amended from time to time,
provides a further discussion of certain areas in this Prospectus and other
matters which may be of interest to some investors. It has been filed with the
Securities and Exchange Commission ("SEC") and is incorporated herein by
reference. A copy is available without charge from the Trust or the Trust's
principal underwriter, Franklin/Templeton Distributors, Inc. ("Distributors"),
at the address or telephone number listed above.
This Prospectus is not an offering of the securities herein described in any
state in which the offering is not authorized. No sales representative, dealer,
or other person is authorized to give any information or make any
representations other than those contained in this Prospectus. Further
information may be obtained from the underwriter.
<TABLE>
<CAPTION>
CONTENTS PAGE
<S> <C>
Expense Table ............................................................. 2
Financial Highlights ...................................................... 4
About the Trust ........................................................... 5
Investment Objective and Policies of the Funds ............................ 5
Management of the Trust ................................................... 11
Distributions to Shareholders ............................................. 13
Taxation of the Funds and Their Shareholders .............................. 14
How to Buy Shares of Each Fund ............................................ 16
Other Programs and Privileges Available to Fund Shareholders .............. 22
Exchange Privilege ........................................................ 24
How to Sell Shares of Each Fund ........................................... 26
Telephone Transactions .................................................... 29
Valuation of Shares of Each Fund .......................................... 29
How to Get Information Regarding an Investment in Each Fund ............... 30
Performance ............................................................... 31
General Information ....................................................... 32
Account Registrations ..................................................... 33
Important Notice Regarding Taxpayer IRS Certifications .................... 34
Portfolio Operations ...................................................... 34
Special Factors Affecting Each State Fund ................................. 34
</TABLE>
EXPENSE TABLE
The purpose of this table is to assist an investor in understanding the various
costs and expenses that a shareholder will bear directly or indirectly in
connection with an investment in each Fund. With respect to the Hawaii and
Washington Funds, these figures are based on aggregate operating expenses
(including fees set by contract) for the fiscal year ended May 31, 1994. With
respect to the Arkansas and Tennessee Funds, the figures are based on estimated
amounts for the current fiscal year.
2
<PAGE>
<TABLE>
<CAPTION>
ARKANSAS HAWAII TENNESSEE WASHINGTON
FUND FUND FUND FUND
-------- ------ --------- ----------
<S> <C> <C> <C> <C>
SHAREHOLDER TRANSACTION EXPENSES
Maximum Sales Charge Imposed on Purchases
(as a percentage of offering price).................... 4.25% 4.25% 4.25% 4.25%
Maximum Sales Charge Imposed on Reinvested Dividends
(as a percentage of offering price).................... None None None None
Deferred Sales Charge................................... None None None None
Redemption Fees......................................... None None None None
Exchange Fee (per transaction).......................... $5.00 * $5.00 * $5.00 * $5.00 *
ANNUAL FUND OPERATING EXPENSES
Management Fees......................................... 0.63%** 0.63%** 0.63%** 0.63%**
12b-1 Fees***........................................... 0.03% 0.10% 0.03% 0.08%
Other Expenses.......................................... 0.54% 0.19% 0.39% 0.00%
----- ----- ----- -----
Total Fund Operating Expenses........................... 1.20%** 0.92%** 1.05%** 0.71%**
===== ===== ===== =====
</TABLE>
*$5.00 fee imposed only on Timing Accounts as described under "Exchange
Privilege." All other exchanges are processed without a fee.
**Represents the amount that would have been payable to the investment manager,
absent a fee reduction by the investment manager. The investment manager,
however, voluntarily limited its management fees and assumed responsibility for
making payments to offset certain operating expenses otherwise payable by the
Funds. With this reduction, the Funds paid no management fees and total
operating expenses represented .03%, .05%, .03% and .05% of the average net
assets of the Arkansas, Hawaii, Tennessee and Washington Funds, respectively.
This arrangement may be terminated by the investment manager at any time.
***Consistent with National Association of Securities Dealers, Inc.'s rules, it
is possible that the combination of front-end sales charges and Rule 12b-1 fees
could cause long-term shareholders to pay more than the economic equivalent of
the maximum front-end sales charges permitted under those same rules.
Investors should be aware that the preceding table is not intended to reflect
in precise detail the fees and expenses associated with an individual's own
investment in a Fund. Rather the table has been provided only to assist
investors in gaining a more complete understanding of fees, charges and
expenses. For a more detailed discussion of these matters, investors should
refer to the appropriate sections of this Prospectus.
EXAMPLE
As required by regulations of the SEC, the following example illustrates the
expenses, including the initial sales charge, that apply to a $1,000 investment
in a Fund over various time periods assuming (1) a 5% annual rate of return and
(2) redemption at the end of each time period. As noted in the preceding table,
none of the Funds charge a redemption fee:
<TABLE>
<CAPTION>
ARKANSAS HAWAII TENNESSEE WASHINGTON
FUND FUND FUND FUND
-------- ------ --------- ----------
<S> <C> <C> <C> <C>
1 Year........................................ $ 54 $ 51 $ 53 $ 49
3 Years....................................... 79 71 74 64
5 Years....................................... 106 91 98 80
10 Years...................................... 182 151 165 127
</TABLE>
3
<PAGE>
THIS EXAMPLE IS BASED ON THE AGGREGATE ANNUAL OPERATING EXPENSES OF EACH FUND,
INCLUDING FEES SET BY CONTRACT, SHOWN ABOVE, AND SHOULD NOT BE CONSIDERED A
REPRESENTATION OF FUTURE EXPENSES, WHICH MAY BE MORE OR LESS THAN THOSE SHOWN.
The operating expenses are borne by each Fund and only indirectly by
shareholders as a result of their investment in such Fund. See "Management of
the Trust" for a description of the Funds' expenses. In addition, federal
regulations require the example to assume an annual return of 5%, but a Fund's
actual return may be more or less than 5%.
FINANCIAL HIGHLIGHTS
Set forth below is a table containing the financial highlights for a share of
each of the Funds from the effective date of the registration statement for
each Fund, as indicated below, through the fiscal year ended May 31, 1994. The
information for each period has been audited by Coopers & Lybrand, independent
auditors, whose audit report appears in the financial statements in the Trust's
Statement of Additional Information. See the discussion "Report to
Shareholders" under "General Information."
<TABLE>
<CAPTION>
DISTRIBUTIONS
NET ASSET NET REALIZED DISTRIBUTIONS FROM
PERIOD VALUE NET & UNREALIZED TOTAL FROM FROM NET REALIZED
ENDED BEGINNING INVESTMENTS GAIN (lOSS) INVESTMENT INVESTMENT CAPITAL
MAY 31 OF PERIOD INCOME ON SECURITIES OPERATIONS INCOME GAIN (LOSS)
- ------ --------- ----------- ------------- ---------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
FRANKLIN HAWAII MUNICIPAL BOND FUND
1992(1) $10.00 $.09 $ .158 $ .248 ($0.68) --
1993 10.18 .63 .634 1.264 (.644) --
1994 10.80 .62 (.459) .161 (.601) --
FRANKLIN WASHINGTON MUNICIPAL BOND FUND
1993(2) 10.00 .03 (.040) (.010) -- --
1994 9.99 .51 (.464) .046 (.472) (.014)
FRANKLIN ARKANSAS MUNICIPAL BOND FUND
1994(3) 10.00 .01 .050 .060 -- -- --
FRANKLIN TENNESSEE MUNICIPAL BOND FUND
1994(3) 10.00 .01 .100 .110 -- -- --
</TABLE>
<TABLE>
<CAPTION>
NET ASSET NET ASSETS RATIO OF RATIO OF
PERIOD VALUE AT AT END EXPENSES NET INCOME PORTFOLIO
ENDED TOTAL END OF TOTAL OF PERIOD TO AVERAGE TO AVERAGE TURNOVER
MAY 31 DISTRIBUTIONS PERIOD RETURN+ (IN 000'S) NET ASSETS++ NET ASSETS RATE
- ------ ------------ --------- ------- ---------- ------------ ---------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
FRANKLIN HAWAII MUNICIPAL BOND FUND
1992(1) (.68) $10.18 8.96%* $ 2,978 --% 4.55%* --%
1993 (.644) 10.80 12.77 18,657 -- 5.95 48.70
1994 (.601) 10.36 1.35 26,904 .05 5.76 31.35
FRANKLIN WASHINGTON MUNICIPAL BOND FUND
1993(2) -- 9.99 (1.20)* 2,198 -- 3.44* --
1994 (.486) 9.55 2.88 4,272 .05 5.59 39.52
FRANKLIN ARKANSAS MUNICIPAL BOND FUND
1994(3) -- 10.06 .60 2,213 .03* 2.00* --
FRANKLIN TENNESSEE MUNICIPAL BOND FUND
1994(3) -- 10.11 1.10 2,224 .03* 1.89* 22.64
</TABLE>
(1)For the period February 26, 1992 (effective date of registration) to May 31,
1992.
(2)For the period May 3, 1993 (effective date of registration) to May 31, 1993.
(3)For the period May 10, 1994 (effective date of registration) to May 31,
1994.
+Total return measures the change in value of an investment over the periods
indicated. It does not include the maximum sales charge and assumes
reinvestment of dividends and capital gains at net asset value.
++During the periods indicated below the investment manager reduced its
management fees and reimbursed other expenses incurred by the Funds. Had such
action not been taken, the ratios of operating expenses to average net assets
would have been as follows:
<TABLE>
<CAPTION>
RATIO OF
EXPENSES
TO AVERAGE
NET ASSETS
----------
<S> <C>
FRANKLIN HAWAII MUNICIPAL BOND FUND
1992(1)..................................... 1.57%*
1993........................................ 1.06
1994........................................ .92
FRANKLIN WASHINGTON MUNICIPAL BOND FUND
1993(2)..................................... 1.44*
1994........................................ .71
FRANKLIN ARKANSAS MUNICIPAL BOND FUND
1994(3)..................................... 1.20%*
FRANKLIN TENNESSEE MUNICIPAL BOND FUND
1994(3)..................................... 1.05*
</TABLE>
*Annualized
4
<PAGE>
ABOUT THE TRUST
The Trust is an open-end management investment company, or mutual fund,
organized as a Delaware business trust on November 19, 1991, and registered
with the SEC under the Investment Company Act of 1940, as amended (the "1940
Act"). Each Fund issues a separate series of the Trust's shares and maintains a
totally separate investment portfolio.
Shares of each Fund may be purchased (minimum investment of $100 initially and
$25 thereafter) at the current public offering price, which is equal to each
Fund's net asset value (see "Valuation of Shares of Each Fund"), plus a sales
charge based upon a variable percentage (ranging from 4.25% to less than 1.00%
of the offering price) depending on the amount invested. (See "How to Buy
Shares of Each Fund.")
INVESTMENT OBJECTIVE
AND POLICIES OF THE FUNDS
Each Fund's investment objective and other fundamental policies may not be
changed unless approved by the holders of a majority of the outstanding shares
of the Fund, as defined in the 1940 Act. The Funds seek to provide investors
with as high a level of income exempt from regular federal and named-state
personal income taxes, where such named-state imposes an income tax, as is
consistent with prudent investing, while seeking preservation of shareholders'
capital. The state of Washington currently imposes no personal income tax.
Each Fund will invest primarily in municipal securities issued by its
respective state, the state's political subdivisions, agencies and
instrumentalities, and in any municipal obligations of non-state issuers which
pay interest exempt from regular federal income taxes.
Each Fund will attempt to invest 100% and, as a matter of fundamental policy,
will invest at least 80% of the value of its net assets in municipal securities
the interest on which is exempt from regular federal income taxes, but which
may be deemed to be a preference item under the federal alternative minimum
tax. It is also the policy of each Fund to invest at least 65% of its total
assets in bonds which pay interest exempt from personal income tax in the
respective states, where such state imposes an income tax. Although exempt from
regular federal income tax, interest paid on certain types of municipal
obligations, such as "private activity bonds," and the dividends to be paid by
each Fund therefrom, is deemed to be a preference item under the federal
alternative minimum tax and therefore subject to the federal alternative
minimum tax.
Thus, it is possible, although not anticipated, that up to 20% of each Fund's
net assets could be in obligations subject to regular federal taxation and/or
up to 35% of each Fund's total assets could be in municipal securities from
other states. In addition, it is possible that each Fund's investments could
consist entirely of bonds subject to the federal alternative minimum tax. As a
result, dividends that would otherwise be tax-exempt may not be completely
tax-exempt to an investor who is subject to the alternative minimum tax. An
investment in a Fund may not be appropriate for investors who are already
subject to the federal alternative minimum tax.
The interest on bonds issued to finance public purpose state and local
government operations is generally tax-exempt for regular federal income tax
purposes. Interest on certain "private activity bonds" (including those for
housing and student
5
<PAGE>
loans) issued after August 7, 1986, while still tax-exempt, constitutes a
preference item for tax payers in determining the federal alternative minimum
tax under the Internal Revenue Code of 1986, as amended (the "Code"), and under
the income tax provisions of some states. This interest could subject a
shareholder to, or increase liability under, the federal and state alternative
minimum taxes, depending on the shareholder's tax situation. In addition, all
distributions derived from interest exempt from regular federal income tax may
subject a corporate shareholder to, or increase liability under, the federal
alternative minimum tax, because such distributions are included in the
corporation's "adjusted current earnings." In states with a corporate franchise
tax, distributions of a Fund may also be fully taxable to a corporate
shareholder under the state franchise tax system.
Consistent with each Fund's investment objectives, a Fund may acquire such
private activity bonds if, in the investment manager's opinion, such bonds
represent the most attractive investment opportunity then available to a Fund.
As of May 31, 1994, each Fund derived the following percentages of its income
from bonds, the interest on which constitutes a preference item subject to the
federal alternative minimum tax for certain investors:
<TABLE>
<CAPTION>
FUND PERCENTAGE
- ---- ----------
<S> <C>
Arkansas Fund.............................. 4.5%
Hawaii Fund................................ 32.55%
Tennessee Fund............................. 21.85%
Washington Fund............................ 23.27%
</TABLE>
The Funds may invest, without percentage limitation, in securities having, at
the time of purchase, one of the four highest ratings of Moody's Investors
Service ("Moody's") (Aaa, Aa, A, Baa), Standard & Poor's Corporation ("S&P")
(AAA, AA, A, BBB), Fitch Investors Service, Inc. ("Fitch") (AAA, AA, A, BBB),
or in securities which are not rated, provided that, in the opinion of the
Fund's investment manager, such securities are comparable in quality to those
within the four highest ratings. These are considered to be "investment grade"
securities, although bonds rated in the fourth highest rating category of the
foregoing ratings services are regarded as having an adequate capacity to pay
principal and interest but with greater vulnerability to adverse economic
conditions and to have some speculative characteristics.
In the event the rating on an issue held in a Fund's portfolio is changed by
the ratings service, such event will be considered by the Fund in its
evaluation of the overall investment merits of that security but will not
necessarily result in an automatic sale of the security. A description of the
ratings is contained in the Statement of Additional Information.
For temporary defensive purposes only, when the investment manager believes
that market conditions, such as rising interest rates or other adverse factors,
would cause serious erosion of portfolio value, each Fund may invest (i) more
than 20% of its assets (which could be up to 100%) in fixed-income obligations,
the interest on which is subject to regular federal income tax and (ii) more
than 35% of the value of its total assets (which could be up to 100%) in
instruments the interest on which is exempt from regular federal income taxes
but not the respective state's personal income tax, where such state imposes
an income tax. Such temporary investments will be limited to obligations
issued or guaranteed by the full faith and credit of the U.S. government or
in the highest quality commercial paper, rated A-1 by S&P.
Each Fund may borrow from banks for temporary or emergency purposes up to 5% of
its total assets and pledge up to 5% of its total assets in connection
therewith. As approved by the Board of Trustees
6
<PAGE>
and subject to the following conditions, each Fund may lend its portfolio
securities to qualified securities dealers or other institutional investors,
provided that such loans do not exceed 10% of the value of the Fund's total
assets at the time of the most recent loan. The borrower must deposit and
maintain with the Fund's custodian cash collateral with an initial market value
at least 102% of the initial market value of the securities loaned, including
any accrued interest, with the value of the collateral and loaned securities
marked-to-market daily. The lending of securities is a common practice in the
securities industry. A Fund engages in security loan arrangements with the
primary objective of increasing the Fund's income either through investing the
cash collateral in short-term interest bearing obligations or by receiving a
loan premium from the borrower. Under the securities loan agreement, the Fund
continues to be entitled to all dividends or interest on any loaned securities.
As with any extension of credit, there are risks of delay in recovery and loss
of rights in the collateral should the borrower of the security fail
financially. These restrictions have been adopted as fundamental policies of
each Fund and may not be changed without the approval of a majority of the
outstanding voting securities of each Fund. A complete discussion of these
restrictions is included under "Investment Restrictions" in the Statement of
Additional Information.
Each Fund expects that its portfolio turnover rate will generally not exceed
100%, but this rate should not be construed as a limiting factor. High
portfolio turnover increases transaction costs which must be paid by a Fund.
High turnover may also result in the realization of capital gains, which are
taxable when distributed to shareholders.
The Statement of Additional Information contains additional details concerning
each Fund's objective and investment restrictions.
MUNICIPAL SECURITIES
The term "municipal securities," as used in this Prospectus, means obligations
issued by or on behalf of the named state, obligations of non-state issuers,
such as the territories and possessions of the United States ("U.S."), any
state, or the District of Columbia, and their political subdivisions, agencies,
and instrumentalities, the interest on which is exempt from regular federal
income tax. A portion or all of the interest on such securities may be deemed
to be a preference item under the federal alternative minimum tax system and
thus subject to the federal alternative minimum tax. An opinion as to the
tax-exempt status of a municipal security generally is rendered to the issuer
by the issuer's counsel at the time of issuance of the security.
Municipal securities are used to raise money for various public purposes such
as constructing public facilities and making loans to public institutions.
Certain types of municipal bonds are issued to obtain funding for privately
operated facilities. Further information on the maturity and funding
classifications of municipal securities is included in the Statement of
Additional Information.
The Funds have no restrictions on the maturities of municipal securities in
which they may invest. The investment manager will consider each Fund's
investment objective and current market conditions in determining which
securities to buy or hold.
It is possible that a Fund from time to time will invest more than 25% of its
assets in a particular segment of the municipal securities market, such as
hospital revenue bonds, housing agency bonds, industrial development bonds or
airport bonds, or in securities the interest on which is paid from revenues of
a similar type of project. In such circumstances, economic, business, political
or other changes affecting one bond (such as proposed legislation af # fecting
the financing of a project; shortages or
7
<PAGE>
price increases of needed materials; or declining markets or needs for the
projects) may also affect other bonds in the same segment, thereby potentially
increasing market risk.
Yields on municipal securities vary, depending on a variety of factors,
including the general condition of the financial markets and of the municipal
securities market, the size of a particular offering, the maturity of the
obligation and the credit rating of the issuer. Generally, municipal securities
of longer maturities produce higher current yields than municipal securities
with shorter maturities but are subject to greater price fluctuation due to
changes in interest rates, tax laws and other general market factors.
Lower-rated municipal securities generally produce a higher yield than
higher-rated municipal securities due to the perception of a greater degree of
risk as to the ability of the issuer to pay interest and repay principal.
Each Fund may purchase floating rate and variable rate obligations. These
obligations bear interest at prevailing market rates. The Funds may also invest
in variable or floating rate demand notes ("VRDNs"). VRDNs are tax-exempt
obligations which contain a floating or variable interest rate and a right of
demand, which may be unconditional, to receive payment of the unpaid principal
balance plus accrued interest according to its terms upon a short notice period
(generally up to 30 days) prior to specified dates, either from the issuer or
by drawing on a bank letter of credit, a guarantee or insurance issued with
respect to such instrument. Although it is not a put option in the usual sense,
such a demand feature is sometimes known as a "put".
Each Fund may purchase and sell municipal securities on a "when-issued" and
"delayed-delivery" basis. These transactions are subject to market fluctuation
and the value at delivery may be more or less than the purchase price. Although
the Funds will generally purchase municipal securities on a when-issued basis
with the intention of acquiring such securities, they may sell such securities
before the settlement date if it is deemed advisable. When a Fund is the buyer
in such a transaction, it will maintain, in a segregated account with its
custodian, cash or high-grade marketable securities having an aggregate value
equal to the amount of such purchase commitments until payment is made. To the
extent a Fund engages in "when-issued" and "delayed delivery" transactions, it
will do so for the purpose of acquiring securities for that Fund's portfolio
consistent with its investment objectives and policies and not for the purpose
of investment leverage.
The Funds may also invest in municipal lease obligations primarily through
certificates of participation ("COPs"). As with its other investments, each
Fund expects that its investments in municipal lease obligations will consist
of such obligations which are exempt from regular federal income taxes but
which may be deemed to be preference items under the federal alternative
minimum tax system. COPs, which are widely used by state and local governments
to finance the purchase of property, function much like installment purchase
agreements. For example, a COP may be created when long-term lease revenue
bonds are issued by a governmental corporation to pay for the acquisition of
property or facilities which are then leased to a municipality. The payments
made by the municipality under the lease are used to repay interest and
principal on the bonds issued to purchase the property. Once these lease
payments are completed, the municipality gains ownership of the property for a
nominal sum. The lessor is, in effect, a lender secured by the property being
leased. This lease format is generally not subject to constitutional
limitations on the issuance of state debt, and COPs
8
<PAGE>
enable a governmental issuer to increase government liabilities beyond
constitutional debt limits.
A feature which distinguishes COPs from municipal debt is that the lease which
is the subject of the transaction typically contains a "nonappropriation" or
"abatement" clause. A nonappropriation clause provides that, while the
municipality will use its best efforts to make lease payments, the municipality
may terminate the lease without penalty if the municipality's appropriating
body does not allocate the necessary funds. Substantially all of the COPs
purchased by the Fund are expected to contain a "nonappropriation" or
"abatement" clause. Local administrations, being faced with increasingly tight
budgets, therefore have more discretion to curtail payments under COPs than
they do to curtail payments on traditionally funded debt obligations. If the
government lessee does not appropriate sufficient monies to make lease
payments, the lessor or its agent is typically entitled to repossess the
property. In most cases, however, the private sector value of the property will
be less than the amount the government lessee was paying.
While the risk of nonappropriation is inherent to COP financing, the Funds
believe that this risk is mitigated by the policy of investing only in COPs
rated within the four highest rating categories of Moody's, S&P or Fitch, or in
unrated COPs believed to be of comparable quality. Criteria considered by the
rating agencies and the investment manager in assessing such risk include the
issuing municipality's credit rating, the importance of the leased property to
the municipality and the term of the lease compared to the useful life of the
leased property. The Board of Trustees has determined that COPs held in a
Fund's portfolio constitute liquid investments based on various factors
reviewed by the investment manager and monitored by the Board of Trustees. Such
factors include (1) the credit quality of such securities and the extent to
which they are rated; (2) the size of the municipal securities market, both in
general and with respect to COPs; and (3) the extent to which the type of COPs
held by a Fund trade on the same basis and with the same degree of dealer
participation as other municipal bonds of comparable credit rating or quality.
While there is no limit as to the amount of assets which each Fund may invest
in COPs, as of May 31, 1994, none of the Funds held more than five percent of
their total assets in COPs and other municipal leases.
Each Fund may purchase and hold callable municipal bonds which contain a
provision in the indenture permitting the issuer to redeem the bonds prior to
their maturity dates at a specified price which typically reflects a premium
over the bonds' original issue price. These bonds generally have
call-protection (that is, a period of time during which the bonds may not be
called) which usually lasts for 5 to 10 years, after which time such bonds may
be called away. An issuer may generally be expected to call its bonds, or a
portion of them, during periods of declining interest rates, when borrowings
may be replaced at lower rates than those obtained in prior years. If the
proceeds of a bond called under such circumstances are reinvested, the result
may be a lower overall yield due to lower current interest rates. If the
purchase price of such bonds included a premium related to the appreciated
value of the bonds, some or all of that premium may not be recovered by
bondholders, such as the Funds, depending on the price at which such bonds were
redeemed.
INVESTMENT RISK CONSIDERATIONS
While an investment in any of the Funds is not without risk, certain policies
are followed in managing the Funds which may help to reduce such risk. There
are two categories of risks to which a
9
<PAGE>
Fund is subject: credit risk and market risk. Credit risk is a function of the
ability of an issuer of a municipal security to maintain timely interest
payments and to pay the principal of a security upon maturity. It is generally
reflected in a security's underlying credit rating and its stated interest rate
(normally the coupon rate). A change in the credit risk associated with a
municipal security may cause a corresponding change in the security's price.
Market risk is the risk of price fluctuation of a municipal security caused by
changes in general economic and interest rate conditions generally affecting
the market as a whole. A municipal security's maturity length also affects its
price. As with other debt instruments, the price of the debt securities in
which a Fund invests are likely to decrease in times of rising interest rates.
Conversely, when rates fall, the value of the Fund's debt investments may rise.
Price changes of debt securities held by a Fund have a direct impact on the net
asset value per share of that Fund. Since each Fund generally will invest
primarily in the securities of its respective state, there are certain specific
factors and considerations concerning each state which may affect the credit
and market risk of the municipal securities which each Fund purchases. These
factors are described in "Special Factors Affecting Each State Fund" and in
greater detail in the SAI.
As non-diversified Funds, there is no restriction under the 1940 Act on the
percentage of assets that may be invested by a Fund at any time in the
securities of any one issuer. Each Fund, however, intends to comply with the
asset diversification, income, distribution and other requirements of the Code
applicable to "regulated investment companies" so that it will not be subject
to federal income tax and distributions to shareholders will be free from
regular federal income tax to the extent that they are derived from municipal
securities.
Accordingly, a Fund will not purchase a security if, as a result, more than 25%
of its total assets would be invested in the securities of a single issuer, or
with respect to 50% of its total assets, more than 5% of such assets would be
invested in the securities of a single issuer. To the extent a Fund is not
fully diversified, it may be more susceptible to adverse economic, political or
regulatory developments affecting a single issuer than would be the case if the
Fund were more broadly diversified.
CONVERSION TO MASTER/FEEDER FUND STRUCTURE
Currently, in seeking to accomplish its objective of providing investors with
as high a level of income exempt from regular federal and named-state personal
income taxes, where such named-state imposes an income tax, as is consistent
with prudent investing, while seeking preservation of shareholders' capital,
each Fund invests directly in a portfolio of municipal securities. Certain
funds administered by the investment manager participate as feeder funds in
master/feeder fund structures. Under a master/feeder structure one or more
feeder funds, such as the Funds, invest their assets in a master fund, which,
in turn, invests its assets directly in the securities. Each Fund hereby
reserves the right to convert to a master/feeder fund structure at a future
date. Various state governments have adopted the North American Securities
Administrators Association Guidelines for registration of master/feeder funds.
If required by those guidelines, as then in effect, the Trust on behalf of each
Fund will seek shareholder approval prior to converting a Fund to the
master/feeder structure, subject to there not being adopted a provision or
ruling under federal law which removes the requirement for shareholder
approval. If it is determined by the requisite regulatory authorities that such
approval is not required, shareholders will be deemed to have consented to such
conversion by
10
<PAGE>
their purchase of Fund shares and no further shareholder approval will be
sought or needed. Shareholders will, however, be informed in writing in advance
of the conversion. A determination to convert a Fund to a master/feeder
structure would not be expected to result in an increase in the level of fees
or expenses paid by a Fund or its shareholders. The investment objective and
other fundamental policies of each Fund, which can be changed only with
shareholder approval, are structured so as to permit a Fund to invest directly
in securities or indirectly in securities through a master/feeder fund
structure.
MANAGEMENT OF THE TRUST
The Board of Trustees has the primary responsibility for the overall management
of the Trust and for electing the officers of the Trust who are responsible for
administering its day-to-day operations.
Franklin Advisers, Inc. ("Advisers" or "Manager"), serves as each Fund's
investment manager. Advisers is a wholly-owned subsidiary of Franklin
Resources, Inc. ("Resources"), a publicly owned holding company, the principal
shareholders of which are Charles B. Johnson, Rupert H. Johnson, Jr. and R.
Martin Wiskemann, who own approximately 20%, 16% and 10%, respectively, of
Resources' outstanding shares. Through its subsidiaries, Resources is engaged
in various aspects of the financial services industry. Advisers acts as
investment manager or administrator to 34 U.S. registered investment companies
(112 separate series) with aggregate assets of over $74 billion, approximately
$40.9 billion of which are in the municipal securities market.
Pursuant to the management agreement, the Manager supervises and implements
each Fund's investment activities and provides certain administrative services
and facilities which are necessary to conduct each Fund's business.
Each Fund is responsible for its own operating expenses including, but not
limited to, the Manager's fee; taxes, if any; custodian, legal and auditing
fees; fees and expenses of trustees who are not members of, affiliated with, or
interested persons of the Manager; salaries of any personnel not affiliated
with the Manager; insurance premiums; trade association dues; expenses of
obtaining quotations for calculating the value of each Fund's net assets;
printing and other expenses which are not expressly assumed by the Manager.
Under the management agreement, each Fund is obligated to pay the Manager a fee
equal to a monthly rate of 5/96 of 1% (approximately 5/8 of 1% per year) for
the first $100 million of net assets of the Fund; 1/24 of 1% (approximately 1/2
of 1% per year) on net assets of the Fund in excess of $100 million up to $250
million; and 9/240 of 1% (approximately 45/100 of 1% per year) of net assets of
the Fund in excess of $250 million. The fee is computed and paid monthly based
on the average daily net assets of the Fund during the month.
During the start-up period of each Fund, Advisers has not imposed any or has
limited its management fees and has assumed responsibility for making payments
to offset certain operating expenses otherwise payable by a Fund. This action
by Advisers to limit its management fee and assume responsibility for payment
of expenses related to the operations of a Fund may be terminated by Advisers
at any time. The management agreement specifies that the management fee will be
reduced to the extent necessary to comply with the most stringent limits on the
expenses which may be borne by a Fund as prescribed by any state in which a
Fund's shares are offered for sale. Currently, the most restrictive of such
provisions lim-
11
<PAGE>
its a fund's allowable expenses as a percentage of its average net assets for
each fiscal year to 2.5% of the first $30 million in assets, 2% of the next $70
million, and 1.5% of assets in excess of $100 million.
During the period ended May 31, 1994, fees totaling 0.63% of the average daily
net assets of each of the Funds would have been accrued by Advisers. Total
operating expenses, including management fees, would have represented 1.20%,
0.92%, 1.05% and 0.71% of the average daily net assets of the Arkansas, Hawaii,
Tennessee and Washington Funds, respectively. Pursuant to the action by
Advisers, the Funds paid no management fees and total operating expenses
represented 0.03%, 0.05%, 0.03% and 0.05% of the average daily net assets of
the Arkansas, Hawaii, Tennessee and Washington Funds, respectively.
It is not anticipated that any of the Funds will incur a significant amount of
brokerage expenses because municipal securities are generally traded on a "net"
basis, that is, in principal transactions without the addition or deduction of
brokerage commissions or transfer taxes. To the extent that a Fund does
participate in transactions involving brokerage commissions, it is the
Manager's responsibility to select brokers through whom such transactions will
be effected. The Manager tries to obtain the best execution on all such
transactions. If it is felt that more than one broker is able to provide the
best execution, the Manager will consider the furnishing of quotations and of
other market services, research, statistical and other data for the Manager and
its affiliates, as well as the sale of shares of a Fund as factors in selecting
a broker. Further information is included under "The Trust's Policies Regarding
Brokers Used on Portfolio Transactions" in the Statement of Additional
Information.
Shareholder accounting and many of the clerical functions for the Funds are
performed by Franklin/Templeton Investor Services, Inc. ("Investor Services" or
"Shareholder Services Agent"), in its capacity as transfer agent and
dividend-paying agent. Investor Services is a wholly-owned subsidiary of
Resources.
PLAN OF DISTRIBUTION
The Funds have adopted plans pursuant to Rule 12b-1 under the 1940 Act (the
"Plans"), whereby they may reimburse Distributors or others for all expenses
incurred by Distributors or others in the promotion and distribution of the
Fund's shares. Such expenses may include, but are not limited to, the printing
of prospectuses and reports used for sales purposes, expenses of preparing and
distributing sales literature and related expenses, advertisements, and other
distribution-related expenses, including a prorated portion of Distributors'
overhead expenses attributable to the distribution of Fund shares, as well as
any distribution or service fees paid to securities dealers or their firms or
others who have executed a servicing agreement with the Fund, Distributors or
its affiliates. The maximum amount which the Hawaii Fund may pay to
Distributors or others for such distribution expenses is 0.10% per annum of the
average daily net assets of the Fund, payable on a quarterly basis. All
expenses of distribution and marketing in excess of 0.10% per annum will be
borne by Distributors, or others who have incurred them, without reimbursement
from the Hawaii Fund. The maximum amount which the Arkansas, Tennessee and
Washington Funds may pay to Distributors or others for such distribution
expenses is 0.15% per annum of the average daily net assets of the Fund,
payable on a quarterly basis. All expenses of distribution and marketing in
excess of 0.15% per annum will be borne by Distributors, or others who have
incurred them, without reimbursement from the Funds. The Plans also cover any
payments to or by a Fund, Distributors, or other parties on behalf of a Fund or
Distributors, to the extent such payments are deemed to be for the financing of
any activity primarily intended to result in the sale of shares issued by a
Fund within the context of Rule 12b-1. The payments under the Plans are
included in the maximum operating expenses which may be borne by a Fund.
DISTRIBUTIONS TO SHAREHOLDERS
There are two types of distributions which each Fund may make to its
shareholders:
1. Income dividends. Each Fund receives income in the form of interest and
other income derived from its investments. This income, less the expenses
incurred in the Fund's operations, is its net investment income from which
income dividends may be distributed. Thus, the amount of dividends paid per
share may vary with each distribution.
2. Capital gain distributions. Each Fund may derive capital gains or losses in
connection with sales or other dispositions of portfolio securities.
Distributions by each Fund derived from net short-term and net long-term
capital gains (after taking into account any net capital loss carryovers) may
generally be made once a year in December to reflect any net short-term and net
long-term capital gains realized by the Fund as of October 31 of the current
fiscal year and any undistributed net capital gains from the prior fiscal year.
These distributions, when made, will generally be fully taxable to the Fund's
shareholders. Each Fund may make more than one distribution derived from net
short-term and net long-term capital gain in any year or adjust the timing of
these distributions for operational or other reasons.
DISTRIBUTION DATE
Although subject to change by the Board of Trustees without prior notice to or
approval by shareholders, the current policy of the Funds is to declare income
dividends daily and pay them monthly on or about the last business day of the
month. The amount of income dividend payments by each Fund is dependent upon
the amount of net income received by each Fund from its portfolio holdings, is
not guaranteed and is subject to the discretion of the Board of Trustees. The
FUNDS DO NOT PAY "INTEREST" OR GUARANTEE ANY FIXED RATE OF RETURN ON AN
INVESTMENT IN THEIR SHARES.
DIVIDEND REINVESTMENT
Unless requested otherwise in writing or on the Shareholder Application, income
dividends and capital gain distributions, if any, will be automatically
reinvested in the shareholder's account in the form of additional shares,
valued at the closing net asset value (without sales charge) on the dividend
reinvestment date. Shareholders have the right to change their election with
respect to the receipt of distributions by notifying the Fund, but any such
change will be effective only as to distributions for which the reinvestment
date is seven or more business days after such Fund has been notified. See the
Statement of Additional Information for more information.
Many of each Fund's shareholders receive their distributions in the form of
additional shares. This is a convenient way to accumulate additional shares and
maintain or increase the shareholder's earnings base. Of course, any shares so
acquired remain at market risk.
HOW SHAREHOLDERS PARTICIPATE IN
THE RESULTS OF EACH FUND'S ACTIVITIES
The assets of each Fund are invested in portfolio securities. If the securities
owned by a Fund increase in value, the value of the shares of such Fund which
the shareholder owns will increase. If the securities owned by a Fund decrease
in value, the value of the shareholder's shares in that Fund will also decline.
In this way, shareholders partici-
13
<PAGE>
pate in any change in the value of the securities owned by such Fund.
DISTRIBUTIONS IN CASH
A shareholder may elect to receive income dividends, or both income dividends
and capital gain distributions, in cash. By completing the "Special Payment
Instructions for Distributions" section of the Shareholder Application
included with this Prospectus, a shareholder may direct the selected
distributions to another fund in the Franklin Group of Funds(R) or the
Templeton Group, to another person, or directly to a checking account. If the
bank at which the account is maintained is a member of the Automated Clearing
House, the payments may be made automatically by electronic funds transfer. If
this last option is requested, the shareholder should allow at least 15 days
for initial processing. Dividends which may be paid in the interim will be sent
to the address of record. Additional information regarding automated fund
transfers may be obtained from Franklin's Shareholder Services Department.
Dividend and capital gain distributions are eligible for investment in another
fund in the Franklin Group of Funds or the Templeton Group at net asset value.
TAXATION OF THE FUNDS
AND THEIR SHAREHOLDERS
The following discussion reflects some of the tax considerations that affect
mutual funds and their shareholders. Additional information on tax matters
relating to the Funds and their shareholders is included in the section
entitled "Additional Information Regarding Taxation" in the Statement of
Additional Information.
All series of the Trust are treated as separate entities for federal and state
income tax purposes. The Hawaii and Washington Funds have each elected to be
treated as a regulated investment company under Subchapter M of the Code,
qualified as such, and intend to continue to so qualify, while the Arkansas and
Tennessee Funds each intend to qualify and elect to be treated as such.
By distributing all of its income and by meeting certain other requirements
relating to the sources of its income and diversification of its assets, a Fund
will not be liable for federal income or excise taxes.
By meeting certain requirements of the Code, the Hawaii and Washington Funds
have qualified and continue to qualify to pay exempt-interest dividends to
shareholders. The Arkansas and Tennessee Funds intend to qualify and pay
exempt-interest dividends to shareholders. Such exempt-interest dividends are
derived from interest income exempt from regular federal income tax and are not
subject to regular federal income tax for Fund shareholders.
ARKANSAS TAXES - The Arkansas Fund has received a ruling from the Arkansas
Department of Revenue and Finance dated January 25, 1994, to the effect that
distributions from the Arkansas Fund that are attributable to (1) interest from
obligations of the State of Arkansas or its political subdivisions, and (2)
interest derived from obligations of the United States government or its
territories and possessions will not be taxable to shareholders for purposes of
the Arkansas personal income tax. All other dividends paid by the Arkansas Fund
will be subject to the Arkansas personal income tax. The Fund has also received
a ruling to the effect that distributions paid by the Arkansas Fund from that
Fund's long-term capital gains and designated as capital gain dividends will be
treated as long-term capital gains in the hands of Arkansas Fund shareholders
subject to Arkansas personal income tax.
HAWAII TAXES - To the extent that exempt-interest dividends paid by the Hawaii
Fund are derived from interest on obligations of Hawaii or its political
14
<PAGE>
subdivisions, from interest on direct obligations of the federal government, or
from interest on obligations of Puerto Rico, the U.S. Virgin Islands, Guam or
the District of Columbia, they will also be exempt from personal income tax in
Hawaii.
TENNESSEE TAXES - Under existing Tennessee law, as long as the Tennessee Fund
qualifies as a "regulated investment company" under the Code, distributions
from the Tennessee Fund will not be subject to the Tennessee stock and bond
income tax, also known as the Hall Income Tax, to the extent that such
distributions are attributable to interest on (i) bonds or securities of the
United States government or any agency, or instrumentality thereof, or (ii)
bonds of the State of Tennessee or any county, municipality, or political
subdivision thereof, including any agency, board, authority, or commission.
Other distributions from the Tennessee Fund, including dividends attributable
to obligations of issuers in states other than Tennessee and capital gain
dividends, will be fully taxable for purposes of the Tennessee stock and bond
income tax.
To the extent dividends paid by a Fund are derived from taxable income from
temporary investments (including the discount from certain stripped obligations
or their coupons or income from securities loans or other taxable
transactions), from the excess of net short-term capital gain over net
long-term capital loss, or from ordinary income derived from the sale or
disposition of bonds purchased with market discount after April 30, 1993, they
are treated as ordinary income for federal income tax purposes whether the
shareholder has elected to receive them in cash or in additional shares.
From time to time, a Fund may purchase a tax-exempt obligation with market
discount; that is, for a price that is less than the principal amount of the
bond. For such obligations purchased after April 30, 1993, a portion of the
gain on sale or disposition (not to exceed the accrued portion of market
discount as of the time of sale or disposition) is treated as ordinary income
rather than capital gain. Any distribution by the Fund of such ordinary income
to its shareholders will be subject to regular federal and state income taxes
in the hands of Fund shareholders. In any fiscal year, the Fund may elect not
to distribute to its shareholders its taxable ordinary income and to, instead,
pay federal income or excise taxes on this income at the Fund level. The amount
of such distributions, if any, is expected to be small.
Pursuant to the Code, certain distributions which are declared in October,
November or December but which, for operational reasons, may not be paid to the
shareholder until the following January, will be treated, for tax purposes, as
if received by the shareholder on December 31 of the calendar year in which
they are declared.
Distributions derived from the excess of net long-term capital gain over net
short-term capital loss are treated as long-term capital gain regardless of the
length of time the shareholder has owned shares of a Fund and regardless of
whether such distributions are received in cash or in additional shares.
Redemptions and exchanges of Fund shares are taxable events on which a
shareholder may realize a gain or loss. Any loss incurred on sale or exchange
of a Fund's shares, held for six months or less, will be treated as a long-term
capital loss to the extent of capital gain dividends received with respect to
such shares and will be disallowed to the extent of exempt-interest dividends
paid with respect to such shares. All or a portion of the sales charge incurred
in purchasing shares of a Fund will not be included in the federal tax basis of
such shares sold or exchanged within 90 days of their purchase (for purposes of
determining gain or loss with respect
15
<PAGE>
to such shares) if the sales proceeds are reinvested in the Fund or in another
fund in the Franklin/Templeton Group (defined under "How to Buy Shares of Each
Fund") and a sales charge which would otherwise apply to the reinvestment is
reduced or eliminated. Any portion of such sales charge excluded from the tax
basis of the shares sold will be added to the tax basis of the shares acquired
in the reinvestment. Shareholders should consult with their tax advisors
concerning the tax rules applicable to the redemption or exchange of Fund
shares.
Each Fund will inform shareholders of the source of their dividends and
distributions at the time they are paid and will, promptly after the close of
each calendar year, advise them of the tax status for federal income tax
purposes of such dividends and distributions, including the portion of the
dividends on an average basis which constitutes taxable income or a tax
preference item under the alternative minimum tax. Shareholders who have not
held shares of a Fund for a full calendar year may have designated as
tax-exempt or as tax preference income a percentage of income which is not
equal to the actual amount of tax-exempt or tax preference income earned during
the period of their investment in a Fund.
Exempt-interest dividends of a Fund, although exempt from regular federal
income tax in the hands of a shareholder, are includable in the tax base for
determining the extent to which a shareholder's social security or railroad
retirement benefits will be subject to regular federal income tax. Shareholders
are required to disclose the receipt of tax-exempt interest dividends on their
federal income tax returns.
Interest on indebtedness incurred (directly or indirectly) by shareholders to
purchase or carry Fund shares may not be fully deductible for federal income
tax purposes.
Shareholders who are not U.S. persons for purposes of federal income taxation
should consult with their financial or tax advisors regarding the applicability
of U.S. withholding or other taxes to distributions received by them from a
Fund and the application of foreign tax laws to these distributions.
The foregoing description relates solely to federal income tax law and to
Arkansas, Hawaii and Tennessee income tax treatment to the extent indicated.
Shareholders should consult their tax advisors with respect to the
applicability of other state and local income taxes to their shares in a Fund
and to distributions and redemption proceeds received from a Fund. Corporate,
individual and trust shareholders should contact their tax advisors to
determine the impact of Fund dividends and capital gain distributions under the
alternative minimum tax that may be applicable to a shareholder's particular
tax situation.
HOW TO BUY SHARES OF EACH FUND
Shares of each Fund are continuously offered through securities dealers which
execute an agreement with Distributors, the principal underwriter of the Funds'
shares. The use of the term "securities dealer" shall include other financial
institutions which, pursuant to an agreement with Distributors (directly or
through affiliates), handle customer orders and accounts with the Fund. Such
reference, however, is for convenience only and does not indicate a legal
conclusion of capacity. The minimum initial investment in each Fund is $100 and
subsequent investments must be $25 or more. These minimums may be waived when
the shares are purchased through plans established at Franklin. The Trust and
Distributors reserve the right to refuse any order for the purchase of shares.
16
<PAGE>
PURCHASE PRICE OF SHARES OF EACH FUND
Shares of each Fund are offered at their public offering price, which is the
net asset value per share plus a sales charge, next computed (1) after the
shareholder's securities dealer receives the order which is promptly
transmitted to the Fund or (2) after receipt of an order by mail from the
shareholder directly in proper form (which generally means a completed
Shareholder Application accompanied by a negotiable check). The sales charge is
a variable percentage of the offering price depending upon the amount of the
sale. On orders for 100,000 shares or more, the offering price will be
calculated to four decimal places. On orders for less than 100,000 shares, the
offering price will be calculated to two decimal places using standard rounding
criteria. A description of the method of calculating net asset value per share
is included under the caption "Valuation of Fund Shares."
<TABLE>
<CAPTION>
Set forth below is a table of total sales charges or underwriting commissions
and dealer concessions.
TOTAL SALES CHARGE
------------------------------------------------------------
AS A PERCENTAGE DEALER CONCESSION
Size of Transaction AS A PERCENTAGE OF NET AMOUNT AS A PERCENTAGE
at Offering Price OF OFFERING PRICE INVESTED OF OFFERING PRICE*
----------------- ------------------ ------------------
<S> <C> <C> <C>
Less than $100,000 4.25% 4.44% 4.00%
$100,000 but less than $250,000 3.50% 3.63% 3.25%
$250,000 but less than $500,000 2.75% 2.83% 2.50%
$500,000 but less than $1,000,000 2.15% 2.20% 2.00%
$1,000,000 through $2,500,000 1.00% 1.01% 1.00%
</TABLE>
*Financial institutions or their affiliated brokers may receive an agency
transaction fee in the percentages set forth above.
On purchases in excess of $2,500,000, the sales charge is 1% of the offering
price on the first $2,500,000, plus 0.5% on the next $2,500,000, plus 0.25% on
the excess over $5,000,000. Sales charges on purchases of $1,000,000 or more
are paid to the securities dealer, if any, involved in the trade, who may
therefore be deemed an "underwriter" under the Securities Act of 1933, as
amended.
The size of a transaction which determines the applicable sales charge on the
purchase of Fund shares is determined by adding the amount of the shareholder's
current purchase plus the cost or current value (whichever is higher) of a
shareholder's existing investment in one or more of the many funds in the
Franklin Group of Funds(R) and the Templeton Group of Funds. Included for these
purposes are (a) the open-end investment companies in the Franklin Group
(except Franklin Valuemark Funds and Franklin Government Securities Trust) (the
"Franklin Group of Funds"), (b) other investment products in the Franklin Group
underwritten by Distributors or its affiliates (although certain investments
may not have the same schedule of sales charges and/or may not be subject to
reduction) (the products in subparagraphs (a) and (b) are referred to as the
"Franklin Group") and (c) the open-end U.S. registered investment companies in
the Templeton Group of Funds except Templeton American Trust, Inc., Templeton
Capital Accumulator Fund, Inc., Templeton Variable Annuity Fund, and Templeton
Variable Products Series Fund (the "Templeton Group"). Purchases pursuant to a
Letter of Intent for more than $2,500,000 will be at a 1%, sales charge until
cumulative purchases reach
17
<PAGE>
$2,500,000 and at the incremental sales charge on the excess over $2,500,000.
Purchases pursuant to the Rights of Accumulation will be at the applicable
sales charge of 1% or more until the additional purchase, plus the value of the
account or the amount previously invested, less redemptions, exceeds
$2,500,000, in which event the sales charge on the excess will be calculated as
stated above. Sales charge reductions based upon purchases in more than one of
the funds in the Franklin Group or Templeton Group (the "Franklin/Templeton
Group") may be effective only after notification to Distributors that the
investment qualifies for a discount.
Distributors or its affiliates, at their expense, may also provide additional
compensation to dealers in connection with sales of shares of a Fund and other
funds in the Franklin Group of Funds or the Templeton Group. Compensation may
include financial assistance to dealers in connection with conferences, sales
or training programs for their employees, seminars for the public, advertising,
sales campaigns and/or shareholder services and programs regarding one or more
of the Franklin Group of Funds or the Templeton Group and other
dealer-sponsored programs or events. In some instances, this compensation may
be made available only to certain dealers whose representatives have sold or
are expected to sell significant amounts of such shares. Compensation may
include payment for travel expenses, including lodging, incurred in connection
with trips taken by invited registered representatives and members of their
families to locations within or outside of the United States for meetings or
seminars of a business nature. Dealers may not use sales of a Fund's shares to
qualify for this compensation to the extent such may be prohibited by the laws
of any state or any self-regulatory agency, such as the National Association of
Securities Dealers, Inc. None of the aforementioned additional compensation is
paid for by a Fund or its shareholders.
Certain officers and trustees of the Trust are also affiliated with
Distributors. A detailed description is included in the Statement of Additional
Information.
QUANTITY DISCOUNTS IN SALES CHARGES
Shares may be purchased under a variety of plans which provide for a reduced
sales charge. To be certain to obtain the reduction of the sales charge, the
investor or the dealer should notify Distributors at the time of each purchase
of shares which qualifies for the reduction. In determining whether a purchase
qualifies for any of the discounts, investments in any of the
Franklin/Templeton Group may be combined with those of the investor's spouse
and children under the age of 21. In addition, the aggregate investments of a
trustee or other fiduciary account (for an account under exclusive investment
authority) may be considered in determining whether a reduced sales charge is
available, even though there may be a number of beneficiaries of the account.
In addition, an investment in the Fund may qualify for a reduction in the sales
charge under the following programs:
1. Rights of Accumulation. The cost or current value (whichever is higher) of
existing investments in the Franklin/Templeton Group may be combined with the
amount of the current purchase in determining the sales charge to be paid.
2. Letter of Intent. An investor may immediately qualify for a reduced sales
charge on a purchase of shares of a Fund by completing the Letter of Intent
section of the Shareholder Application (the "Letter of Intent" or "Letter"). By
completing the Letter, the investor expresses an intention to invest during the
next 13 months a specified amount which, if made at one time, would qualify for
a reduced
18
<PAGE>
sales charge. At any time within 90 days after the first investment
which the investor wants to qualify for the reduced sales charge, a signed
Shareholder Application, with the Letter of Intent section completed, may be
filed with a Fund. After the Letter of Intent is filed, each additional
investment made will be entitled to the sales charge applicable to the level of
investment indicated on the Letter of Intent as described above. Sales charge
reductions based upon purchases in more than one company in the
Franklin/Templeton Group will be effective only after notification to
Distributors that the investment qualifies for a discount. The shareholder's
holdings in the Franklin/Templeton Group acquired more than 90 days before the
Letter of Intent is filed will be counted towards completion of the Letter of
Intent but will not be entitled to a retroactive downward adjustment of sales
charge. Any redemptions made by the shareholder during the 13-month period will
be subtracted from the amount of the purchases for purposes of determining
whether the terms of the Letter of Intent have been completed. If the Letter of
Intent is not completed within the 13-month period, there will be an upward
adjustment of the sales charge as specified below, depending upon the amount
actually purchased (less redemptions) during the period. An investor who
executes a Letter of Intent prior to a change in the sales charge structure for
a fund will be entitled to complete the Letter at the lower of (i) the new
sales charge structure; or (ii) the sales charge structure in effect at the
time the Letter was filed with the fund.
AN INVESTOR ACKNOWLEDGES AND AGREES TO THE FOLLOWING PROVISIONS BY
COMPLETING THE LETTER OF INTENT SECTION OF THE SHAREHOLDER APPLICATION: Five
percent (5%) of the amount of the total intended purchase will be reserved in
shares of the Fund, registered in the investor's name, to assure that the full
applicable sales charge will be paid if the intended purchase is not completed.
The reserved shares will be included in the total shares owned as reflected on
periodic statements; income dividends and capital gain distributions on the
reserved shares will be paid as directed by the investor. The reserved shares
will not be available for disposal by the investor until the Letter of Intent
has been completed or the higher sales charge paid. If the total purchases,
less redemptions, equal the amount specified under the Letter, the reserved
shares will be deposited to an account in the name of the investor or delivered
to the investor or the investor's order. If the total purchases, less
redemptions, exceed the amount specified under the Letter and is an amount
which would qualify for a further quantity discount, a retroactive price
adjustment will be made by Distributors and the dealer through whom purchases
were made pursuant to the Letter of Intent (to reflect such further quantity
discount) on purchases made within 90 days before, and on those made after
filing the Letter. The resulting difference in offering price will be applied
to the purchase of additional shares at the offering price applicable to a
single purchase or the dollar amount of the total purchases. If the total
purchases, less redemptions, are less than the amount specified under the
Letter, the investor will remit to Distributors an amount equal to the
difference in the dollar amount of sales charge actually paid and the amount of
sales charge which would have applied to the aggregate purchases if the total
of such purchases had been made at a single time. Upon such remittance, the
reserved shares held for the investor's account will be deposited to an account
in the name of the investor or delivered to the investor or to the investor's
order. If within 20 days after written request such difference in sales charge
is not paid, the redemption of an appropri-
19
<PAGE>
ate number of reserved shares to realize such difference will be made. In the
event of a total redemption of the account prior to fulfillment of the Letter
of Intent, the additional sales charge due will be deducted from the proceeds
of the redemption and the balance will be forwarded to the investor. By
completing the Letter of Intent section of the Shareholder Application, an
investor grants to Distributors a security interest in the reserved shares and
irrevocably appoints Distributors as attorney-in-fact with full power of
substitution to surrender for redemption any or all shares for the purpose of
paying any additional sales charge due. Purchases under the Letter of Intent
will conform with the requirements of Rule 22d-1 under the 1940 Act. The
investor or the investor's securities dealer must inform Investor Services or
Distributors that this Letter is in effect each time a purchase is made.
Additional terms concerning the offering of the Fund's shares are included in
the Statement of Additional Information.
GROUP PURCHASES
An individual who is a member of a qualified group may also purchase shares of
each Fund at the reduced sales charge applicable to the group as a whole. The
sales charge is based upon the aggregate dollar value of shares previously
purchased and still owned by the group, plus the amount of the current
purchase. For example, if members of the group had previously invested and
still held $80,000 of shares of the Funds and now were investing $25,000, the
sales charge would be 3.50%. Information concerning the current sales charge
applicable to a group may be obtained by contacting Distributors.
A "qualified group" is one which (i) has been in existence for more than six
months, (ii) has a purpose other than acquiring Fund shares at a discount and
(iii) satisfies uniform criteria which enable Distributors to realize
economies of scale in its costs of distributing shares. A qualified group must
have more than 10 members, be available to arrange for group meetings between
representatives of a Fund or Distributors and the members, agree to include
sales and other materials related to the Funds in its publications and
mailings to members at reduced or no cost to Distributors and seek to arrange
for payroll deduction or other bulk transmission of investments to the Fund.
If an investor selects a payroll deduction plan, subsequent investments will be
automatic and will continue until such time as the investor notifies the Fund
and the investor's employer to discontinue further investments. Due to the
varying procedures used to prepare, process and forward the payroll deduction
information to the Fund, there may be a delay between the time of the payroll
deduction and the time the money reaches the Fund. The investment in such Fund
will be made at the offering price per share determined on the day that both
the check and payroll deduction data are received in required form by the Fund.
PURCHASES AT NET ASSET VALUE
Shares of the each Fund may be purchased at net asset value by trust companies
and bank trust departments for funds over which they exercise exclusive
discretionary investment authority and which are held in a fiduciary, agency,
advisory, custodial or similar capacity. Such purchases are subject to minimum
requirements with respect to amount of purchase, which may be established by
Distributors. Currently, those criteria require that the amount invested or to
be invested during the subsequent 13-month period in such Fund or any other
company in the Franklin/Templeton Group must total at least $1,000,000. Orders
for such accounts will be accepted by mail accompanied by a check or by
telephone or other means of electronic
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data transfer directly from the bank or trust company, with payment by federal
funds received by the close of business on the next business day following such
order. If an investment by a trust company or bank trust department at net
asset value is made through a dealer who has executed a dealer agreement with
Distributors, Distributors or one of its affiliates may make payment, out of
their own resources, to such dealer in an amount not to exceed 0.25% of the
amount invested. Contact Franklin's Institutional Sales Department for
additional information.
Shares of each Fund may be purchased at net asset value by persons who have
redeemed, within the previous 120 days, their shares of the Fund or another
fund in the Franklin Group of Funds or the Templeton Group which were purchased
with a sales charge. An investor may reinvest an amount not exceeding the
redemption proceeds. Shares of the Fund redeemed in connection with an exchange
into another fund (see "Exchange Privilege") are not considered "redeemed" for
this privilege. In order to exercise this privilege, a written order for the
purchase of shares of the Fund must be received by the Fund or the Fund's
Shareholder Services Agent within 120 days after the redemption. The 120 days,
however, do not begin to run on redemption proceeds placed immediately after
redemption in a Franklin Bank Certificate of Deposit ("CD") until the CD
(including any rollover) matures. Reinvestment at net asset value may also be
handled by a securities dealer or other financial institution, who may charge
the shareholder a fee for this service. The redemption is a taxable transaction
but reinvestment without a sales charge may affect the amount of gain or loss
recognized and the tax basis of the shares reinvested. If there has been a loss
on the redemption, the loss may be disallowed if a reinvestment in the same
fund is made within a 30-day period. Information regarding the possible tax
consequences of such a reinvestment is included in the tax section of this
Prospectus and the Statement of Additional Information.
Dealers may place trades to purchase shares of a Fund at net asset value on
behalf of investors who have, within the past 60 days, redeemed an investment
in a registered management investment company which charges a contingent
deferred sales charge, and which has investment objectives similar to those of
the Fund it intends to purchase.
Shares of each Fund may also be purchased at net asset value by (1) officers,
trustees, directors and full-time employees of the Fund or any fund in the
Franklin Group of Funds or the Templeton Group, the Manager and Distributors
and affiliates of such companies, if they have been such for at least 90 days,
and by their spouses and family members, (2) registered securities dealers and
their affiliates, for their investment account only, and (3) registered
personnel and employees of securities dealers and by their spouses and family
members in accordance with the internal policies and procedures of the
employing securities dealer. Such sales are made upon the written assurance of
the purchaser that the purchase is made for investment purposes and that the
securities will not be transferred or resold except through redemption or
repurchase by or on behalf of the Fund. Employees of securities dealers must
obtain a special application from their employers or from Franklin's Sales
Department in order to qualify.
Shares of each Fund may also be purchased at net asset value by any state,
county, or city, or any instrumentality, department, authority or agency
thereof, which has determined that the Fund is a legally permissible investment
and which is prohibited by applicable investment laws from paying a sales
charge or commission in connection with
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<PAGE>
the purchase of shares of any registered management investment company ("an
eligible governmental authority"). SUCH INVESTORS SHOULD CONSULT THEIR OWN
LEGAL ADVISORS TO DETERMINE WHETHER AND TO WHAT EXTENT THE SHARES OF THE FUND
CONSTITUTE LEGAL INVESTMENTS FOR THEM. Municipal investors considering
investment of proceeds of bond offerings into a Fund should consult with expert
counsel to determine the effect, if any, of various payments made by the Fund
or its investment manager on arbitrage rebate calculations. If an investment by
an eligible governmental authority at net asset value is made through a dealer
who has executed a dealer agreement with Distributors, Distributors or one of
its affiliates may make a payment, out of their own resources, to such dealer
in an amount not to exceed 0.25% of the amount invested. Contact Franklin's
Institutional Sales Department for additional information.
GENERAL
Securities laws of states in which each Fund's shares are offered for sale may
differ from the interpretations of federal law, and banks and financial
institutions selling shares of such Fund may be required to register as dealers
pursuant to state law.
OTHER PROGRAMS AND PRIVILEGES
AVAILABLE TO FUND SHAREHOLDERS
CERTAIN OF THE PROGRAMS AND PRIVILEGES DESCRIBED IN THIS SECTION MAY NOT BE
AVAILABLE DIRECTLY FROM THE FUND TO SHAREHOLDERS WHOSE SHARES ARE HELD, OF
RECORD, BY A FINANCIAL INSTITUTION OR IN A "STREET NAME" ACCOUNT OR NETWORKED
ACCOUNT THROUGH THE NATIONAL SECURITIES CLEARING CORPORATION ("NSCC") (SEE THE
SECTION CAPTIONED "ACCOUNT REGISTRATIONS" IN THIS PROSPECTUS).
SHARE CERTIFICATES
Shares for an initial investment, as well as subsequent investments, including
the reinvestment of dividends and capital gain distributions, are generally
credited to an account in the name of an investor on the books of the Funds,
without the issuance of a share certificate. Maintaining shares in
uncertificated form (also known as "plan balance") minimizes the risk of loss or
theft of a share certificate. A lost, stolen or destroyed certificate cannot be
replaced without obtaining a sufficient indemnity bond. The cost of such a bond,
which is generally borne by the shareholder, can be 2% or more of the value of
the lost, stolen or destroyed certificate. A certificate will be issued if
requested in writing by the shareholder or by the securities dealer.
CONFIRMATIONS
A confirmation statement will be sent to each shareholder quarterly to reflect
the dividends reinvested during that period and after each other transaction
which affects the shareholder's account. This statement will also show the
total number of shares owned by the shareholder, including the number of shares
in "plan balance" for the account of the shareholder.
AUTOMATIC INVESTMENT PLAN
Under the Automatic Investment Plan, a shareholder may be able to arrange to
make additional purchases of shares automatically on a monthly basis by
electronic funds transfer from a checking account if the bank which maintains
the account is a member of the Automated Clearing House, or by preauthorized
checks drawn on the shareholder's bank account. A shareholder may, of course,
terminate the program at any time. The Shareholder Application included with
this Prospectus contains the requirements applicable to this program. In
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<PAGE>
addition, shareholders may obtain more information concerning this program from
their securities dealers or from Distributors.
The market value of each Fund's shares is subject to fluctuation. Before
undertaking any plan for systematic investment, the investor should keep in
mind that such a program does not assure a profit or protect against a loss.
SYSTEMATIC WITHDRAWAL PLAN
A shareholder may establish a Systematic Withdrawal Plan and receive regular
periodic payments from the account, provided that the net asset value of the
shares held by the shareholder is at least $5,000. There are no service charges
for establishing or maintaining a Systematic Withdrawal Plan. The minimum
amount which the shareholder may withdraw is $50 per withdrawal transaction
although this is merely the minimum amount allowed under the plan and should
not be mistaken for a recommended amount. The plan may be established on a
monthly, quarterly, semiannual or annual basis. If the shareholder establishes
a plan, any capital gain distributions and income dividends paid by the Fund
will be reinvested for the shareholder's account in additional shares at net
asset value. Payments will then be made from the liquidation of shares at net
asset value on the day of the transaction (which is generally the first
business day of the month in which the payment is scheduled) with payment
generally received by the shareholder three to five days after the date of
liquidation. By completing the "Special Payment Instructions for Distributions"
section of the Shareholder Application included with this Prospectus, a
shareholder may direct the selected withdrawals to another fund in the Franklin
Group of Funds or the Templeton Group, to another person, or directly to a
checking account. If the bank at which the account is maintained is a member of
the Automated Clearing House, the payments may be made automatically by
electronic funds transfer. If this last option is requested, the shareholder
should allow at least 15 days for initial processing. Withdrawals which may be
paid in the interim will be sent to the address of record. Liquidation of
shares may reduce or possibly exhaust the shares in the shareholder's account,
to the extent withdrawals exceed shares earned through dividends and
distributions, particularly in the event of a market decline. If the withdrawal
amount exceeds the total plan balance, the account will be closed and the
remaining balance will be sent to the shareholder. As with other redemptions, a
liquidation to make a withdrawal payment is a sale for federal income tax
purposes. Because the amount withdrawn under the plan may be more than the
shareholder's actual yield or income, part of the payment may be a return of
the shareholder's investment.
The maintenance of a Systematic Withdrawal Plan concurrently with purchases of
additional shares of the Fund would be disadvantageous because of the sales
charge on the additional purchases. The shareholder should ordinarily not make
additional investments of less than $5,000 or three times the annual
withdrawals under the plan during the time such a plan is in effect. A
Systematic Withdrawal Plan may be terminated on written notice by the
shareholder or the Fund, and it will terminate automatically if all shares are
liquidated or withdrawn from the account, or upon the Fund's receipt of
notification of the death or incapacity of the shareholder. Shareholders may
change the amount (but not below the specified minimum) and schedule of
withdrawal payments, or suspend one such payment, by giving written notice to
Investor Services at least seven business days prior to the end of the month
preceding a scheduled payment. Share certificates may not be issued while a
Systematic Withdrawal Plan is in effect.
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<PAGE>
INSTITUTIONAL ACCOUNTS
There may be additional methods of purchasing, redeeming or exchanging
shares of the Fund available to institutional accounts. For further
information, contact Franklin's Institutional Services Department at
1-800/321-8563.
EXCHANGE PRIVILEGE
The Franklin Group of Funds(R) and the Templeton Group consist of a number of
investment companies with various investment objectives or policies. The shares
of most of these investment companies are offered to the public with a sales
charge. If a shareholder's investment objective or outlook for the securities
markets changes, Fund shares may be exchanged for shares of other mutual funds
in the Franklin Group of Funds or the Templeton Group (as defined under "How to
Buy Shares of Each Fund") which are eligible for sale in the shareholder's
state of residence and in conformity with such fund's stated eligibility
requirements and investment minimums. Investors should review the prospectus of
the fund they wish to exchange from and the fund they wish to exchange into for
all specific requirements or limitations on excercising the exchange privilege,
for example, minimum holding periods or applicable sales charges. Exchanges may
be made in any of the following ways:
EXCHANGES BY MAIL
Send written instructions signed by all account owners and accompanied by any
outstanding share certificates properly endorsed. The transaction will be
effective upon receipt of the written instructions together with any
outstanding share certificates.
EXCHANGES BY TELEPHONE
Shareholders, or their investment representative of record, if any, may
exchange shares of a Fund by telephone by calling Investor Services at
1-800/632-2301. If the shareholder does not wish this privilege extended to a
particular account, the Fund or Investor Services should be notified.
The Telephone Exchange Privilege allows a shareholder to effect exchanges from
a Fund into an identically registered account in one of the other available
funds in the Franklin Group of Funds or the Templeton Group. The Telephone
Exchange Privilege is available only for uncertificated shares or those which
have previously been deposited in the shareholder's account. The Fund and
Investor Services will employ reasonable procedures to confirm that
instructions communicated by telephone are genuine. Please refer to "Telephone
Transactions - Verification Procedures."
During periods of drastic economic or market changes, it is possible that the
Telephone Exchange Privilege may be difficult to implement. In this event,
shareholders should follow the other exchange procedures discussed in this
section, including the procedures for processing exchanges through securities
dealers.
EXCHANGES THROUGH SECURITIES DEALERS
As is the case with all purchases and redemptions of each Fund's shares,
Investor Services will accept exchange orders by telephone or by other means of
electronic transmission from securities dealers who execute a dealer or similar
agreement with Distributors. See also "Exchanges By Telephone" above. Such a
dealer-ordered exchange will be effective only for uncertificated shares on
deposit in the shareholder's account or for which certificates have previously
been deposited. A securities dealer may charge a fee for handling an exchange.
ADDITIONAL INFORMATION REGARDING EXCHANGES
Exchanges are made on the basis of the net asset values of the funds involved,
except as set forth below. Exchanges of shares of a Fund which were purchased
without a sales charge will be charged a
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<PAGE>
sales charge in accordance with the terms of the prospectus of the
fund being purchased, unless the investment on which no sales charge was paid
was transferred in from a fund on which the investor paid a sales charge.
Exchanges of shares of a Fund which were purchased with a lower sales charge to
a fund which has a higher sales charge will be charged the difference, unless
the shares were held in the Fund for at least six months prior to executing the
exchange. When an investor requests the exchange of the total value of the Fund
account, accrued but unpaid income dividends and capital gain distributions
will be reinvested in the Fund at the net asset value on the date of the
exchange, and then the entire share balance will be exchanged into the new fund
in accordance with the procedures set forth above. Because the exchange is
considered a redemption and purchase of shares, the shareholder may realize a
gain or loss for federal income tax purposes. Backup withholding and
information reporting may also apply. Information regarding the possible tax
consequences of such an exchange is included in the tax section in this
Prospectus and in the Statement of Additional Information.
There are differences among the many funds in the Franklin Group of Funds and
the Templeton Group. Before making an exchange, a shareholder should obtain and
review a current prospectus of the fund into which the shareholder wishes to
transfer.
If a substantial portion of a Fund's shareholders should, within a
short period, elect to redeem their shares of the Fund pursuant to the exchange
privilege, the Fund might have to liquidate portfolio securities it might
otherwise hold and incur the additional costs related to such transactions. On
the other hand, increased use of the exchange privilege may result in periodic
large inflows of money. If this should occur, it is the general policy of the
Fund to initially invest this money in short-term, interest-bearing municipal
securities, unless it is felt that attractive investment opportunities
consistent with the Fund's investment objectives exist immediately.
Subsequently, this money will be withdrawn from such short-term municipal
securities and invested in portfolio securities in as orderly a manner as is
possible when attractive investment opportunities arise.
The Exchange Privilege may be modified or discontinued by each Fund at any time
upon 60 days' written notice to shareholders.
TIMING ACCOUNTS
Accounts which are administered by allocation or market timing services to
purchase or redeem shares based on predetermined market indicators ("Timing
Accounts") will be charged a $5.00 administrative service fee per each such
exchange. All other exchanges are without charge.
RESTRICTIONS ON EXCHANGES
In accordance with the terms of their respective prospectuses, certain funds do
not accept or may place differing limitations than those below on exchanges by
Timing Accounts.
Each Fund reserves the right to temporarily or permanently terminate the
exchange privilege or reject any specific purchase order for any Timing Account
or any person whose transactions seem to follow a timing pattern who: (i) make
an exchange request out of the Fund within two weeks of an earlier exchange
request out of the Fund, or (ii) make more than two exchanges out of the Fund
per calendar quarter, or (iii) exchange shares equal in value to at least $5
million, or more than 1% of the Fund's net assets. Accounts under common
ownership or control, including accounts administered so as to redeem or
purchase shares based upon certain predetermined market indicators, will be
aggregated for purposes of the exchange limits.
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Each Fund reserves the right to refuse the purchase side of exchange requests
by any Timing Account, person, or group if, in the Manager's judgment, the Fund
would be unable to invest effectively in accordance with its investment
objectives and policies, or would otherwise potentially be adversely affected.
A shareholder's purchase exchanges may be restricted or refused if the Fund
receives or anticipates simultaneous orders affecting significant portions of
the Fund's assets. In particular, a pattern of exchanges that coincide with a
"market timing" strategy may be disruptive to the Fund and therefore may be
refused.
Each Fund and Distributors also, as indicated in "How to Buy Shares of
Each Fund," reserve the right to refuse any order for the purchase of shares.
HOW TO SELL SHARES OF EACH FUND
A shareholder may at any time liquidate shares owned and receive from a Fund
the value of the shares. Shares may be redeemed in any of the following ways:
REDEMPTIONS BY MAIL
Send a written request, signed by all registered owners, to Investor Services,
at the address shown on the back cover of this Prospectus, and any share
certificates which have been issued for the shares being redeemed, properly
endorsed and in order for transfer. The shareholder will then receive from the
Fund the value of the shares based upon the net asset value per share next
computed after the written request in proper form is received by Investor
Services. Redemption requests received after the time at which the net asset
value is calculated (at 1:00 p.m. Pacific time) each day that the New York
Stock Exchange (the "Exchange") is open for business will receive the price
calculated on the following business day. Shareholders are requested to provide
a telephone number(s) where they may be reached during business hours, or in
the evening if preferred. Investor Services' ability to contact a shareholder
promptly when necessary will speed the processing of the redemption.
TO BE CONSIDERED IN PROPER FORM, SIGNATURE(S) MUST BE GUARANTEED IF THE
REDEMPTION REQUEST INVOLVES ANY OF THE FOLLOWING:
(1) the proceeds of the redemption are over $50,000;
(2) the proceeds (in any amount) are to be paid to someone other than the
registered owner(s) of the account;
(3) the proceeds (in any amount) are to be sent to any address other than the
shareholder's address of record, preauthorized bank account or brokerage
firm account;
(4) share certificates, if the redemption proceeds are in excess of $50,000;
or
(5) the Fund or Investor Services believes that a signature guarantee would
protect against potential claims based on the transfer instructions,
including, for example, when (a) the current address of one or more joint
owners of an account cannot be confirmed, (b) multiple owners have a
dispute or give inconsistent instructions to the Fund, (c) the Fund has
been notified of an adverse claim, (d) the instructions received by the
Fund are given by an agent, not the actual registered owner, (e) the Fund
determines that joint owners who are married to each other are separated
or may be the subject of divorce proceedings, or (f) the authority of a
representative of a corporation, partnership, association, or other entity
has not been established to the satisfaction of the Fund.
Signature(s) must be guaranteed by an "eligible guarantor institution" as
defined under Rule 17Ad-15 under the Securities Exchange Act of
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1934. Generally, eligible guarantor institutions include (1)
national or state banks, savings associations, savings and loan associations,
trust companies, savings banks, industrial loan companies and credit unions;
(2) national securities exchanges, registered securities associations and
clearing agencies; (3) securities dealers which are members of a national
securities exchange or a clearing agency or which have minimum net capital of
$100,000; or (4) institutions that participate in the Securities Transfer Agent
Medallion Program ("STAMP") or other recognized signature guarantee medallion
program. A notarized signature will not be sufficient for the request to be in
proper form.
Where shares to be redeemed are represented by share certificates,
the request for redemption must be accompanied by the share certificate and a
share assignment form signed by the registered shareholders exactly as the
account is registered, with the signature(s) guaranteed as referenced above.
Shareholders are advised, for their own protection, to send the share
certificate and assignment form in separate envelopes if they are being mailed
in for redemption.
Liquidation requests of corporate, partnership, trust and custodianship
accounts, and accounts under court jurisdiction require the following
documentation to be in proper form:
Corporation - (1) Signature guaranteed letter of instruction from the
authorized officer(s) of the corporation, and (2) a corporate resolution.
Partnership - (1) Signature guaranteed letter of instruction from a general
partner and (2) pertinent pages from the partnership agreement identifying the
general partners or a certification for a partnership agreement.
Trust - (1) Signature guaranteed letter of instruction from the trustee(s) and
(2) a copy of the pertinent pages of the trust document listing the trustee(s)
or a Certification for Trust if the trustee(s) are not listed on the account
registration.
Custodial (other than a retirement account) - Signature guaranteed letter of
instruction from the custodian.
Accounts under court jurisdiction - Check court documents and the applicable
state law since these accounts have varying requirements, depending upon the
state of residence.
Payment for redeemed shares will be sent to the shareholder within seven days
after receipt of the request in proper form.
REDEMPTIONS BY TELEPHONE
Shareholders who complete the Franklin/Templeton Telephone Redemption
Authorization Agreement (the "Agreement"), included with this Prospectus, may
redeem shares of the Fund by telephone, subject to the Restricted Account
exception noted under "Telephone Transactions - Restricted Accounts."
INFORMATION MAY ALSO BE OBTAINED BY WRITING TO THE FUND OR INVESTOR SERVICES AT
THE ADDRESS SHOWN ON THE COVER OR BY CALLING 1-800/632-2301. THE FUND AND
INVESTOR SERVICES WILL EMPLOY REASONABLE PROCEDURES TO CONFIRM THAT
INSTRUCTIONS GIVEN BY TELEPHONE ARE GENUINE. SHAREHOLDERS, HOWEVER, BEAR THE
RISK OF LOSS IN CERTAIN CASES AS DESCRIBED UNDER "TELEPHONE TRANSACTIONS -
VERIFICATION PROCEDURES."
For shareholder accounts with the completed Agreement on file, redemptions of
uncertificated shares or shares which have previously been deposited with the
Fund or Investor Services may be made for up to $50,000 per day per Fund
account. Telephone redemption requests received before 1:00 p.m. Pacific time
on any business day will be processed that same day. The redemption check will
be sent within seven days, made payable to all the registered owners on the
account, and will be sent only to the address of record. Redemption re-
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quests by telephone will not be accepted within 30 days
following an address change by telephone. In that case, a shareholder should
follow the other redemption procedures set forth in this Prospectus.
Institutional accounts (certain corporations, bank trust departments,
government entities, and qualified retirement plans which qualify to purchase
shares at net asset value pursuant to the terms of this Prospectus) which wish
to execute redemptions in excess of $50,000 must complete an Institutional
Telephone Privileges Agreement, which is available from Franklin's
Institutional Services Department by telephoning 1-800/321-8563.
REDEEMING SHARES THROUGH SECURITIES DEALERS
Each Fund will accept redemption orders by telephone or other means of
electronic transmission from securities dealers who have entered into a dealer
or similar agreement with Distributors. This is known as a repurchase. The only
difference between a normal redemption and a repurchase is that if the
shareholder redeems shares through a dealer, the redemption price will be the
net asset value next calculated after the shareholder's dealer receives the
order which is promptly transmitted to the Fund, rather than on the day the
Fund receives the shareholder's written request in proper form. These
documents, as described in the preceding section, are required even if the
shareholder's securities dealer has placed the repurchase order. After receipt
of a repurchase order from the dealer, the Fund will still require a signed
letter of instruction and all other documents set forth above. A shareholder's
letter should reference the Fund, the account number, the fact that the
repurchase was ordered by a dealer and the dealer's name. Details of the
dealer-ordered trade, such as trade date, confirmation number, and the amount
of shares or dollars, will help speed processing of the redemption. The
seven-day period within which the proceeds of the shareholder's redemption will
be sent will begin when the Fund receives all documents required to complete
("settle") the repurchase in proper form. The redemption proceeds will not earn
dividends or interest during the time between receipt of the dealer's
repurchase order and the date the redemption is processed upon receipt of all
documents necessary to settle the repurchase. Thus, it is in a shareholder's
best interest to have the required documentation completed and forwarded to the
Fund as soon as possible. The shareholder's dealer may charge a fee for
handling the order. The Statement of Additional Information contains more
information on the redemption of shares.
ADDITIONAL INFORMATION REGARDING REDEMPTIONS
A Fund may delay the mailing of the redemption check, or a portion thereof,
until the clearance of the check used to purchase Fund shares, which may take
up to 15 days or more. Although the use of a certified or cashier's check will
generally reduce this delay, shares purchased with these checks will also be
held pending clearance. Shares purchased by federal funds wire are available
for immediate redemption. In addition, the right of redemption may be suspended
or the date of payment postponed if the Exchange is closed (other than
customary closing) or upon the determination of the SEC that trading on the
Exchange is restricted or an emergency exists, or if the SEC permits it, by
order, for the protection of shareholders. Of course, the amount received may
be more or less than the amount invested by the shareholder, depending on
fluctuations in the market value of securities owned by the Fund.
OTHER
For any information required about a proposed liquidation, a shareholder may
call Franklin's Shareholder Services Department or the securities dealer may
call Franklin's Dealer Services Department.
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TELEPHONE TRANSACTIONS
Shareholders of each Fund and their investment representative of record, if
any, may be able to execute various transactions by calling Investor Services
at 1-800/632-2301.
All shareholders will be able to: (i) effect a change in address, (ii) change a
dividend option, (iii) transfer Fund shares in one account to another
identically registered account in the Fund, (iv) exchange Fund shares as
described in this Prospectus by telephone. In addition, shareholders who
complete and file the Agreement as described under "How to Sell Shares of the
Fund - Redemptions by Telephone" will be able to redeem shares of the Fund.
VERIFICATION PROCEDURES
Each Fund and Investor Services will employ reasonable procedures to confirm
that instructions communicated by telephone are genuine. These will include:
recording all telephone calls requesting account activity by telephone,
requiring that the caller provide certain personal and/or account information
requested by the telephone service agent at the time of the call for the
purpose of establishing the caller's identification, and by sending a
confirmation statement on redemptions to the address of record each time
account activity is initiated by telephone. So long as the Fund and Investor
Services follow instructions communicated by telephone which were reasonably
believed to be genuine at the time of their receipt, neither they nor their
affiliates will be liable for any loss to the shareholder caused by an
unauthorized transaction. Shareholders are, of course, under no obligation to
apply for or accept telephone transaction privileges. In any instance where the
Fund or Investor Services is not reasonably satisfied that instructions
received by telephone are genuine, the requested transaction will not be
executed, and neither the Fund nor Investor Services will be liable for any
losses which may occur because of a delay in implementing a transaction.
GENERAL
During periods of drastic economic or market changes, it is possible that the
telephone transaction privileges will be difficult to execute because of heavy
telephone volume. In such situations, shareholders may wish to contact their
investment representative for assistance, or to send written instructions to
the Fund as detailed elsewhere in this Prospectus.
Neither the Fund nor Investor Services will be liable for any losses resulting
from the inability of a shareholder to execute a telephone transaction.
The telephone transaction privilege may be modified or discontinued by the Fund
at any time upon 60 days' written notice to shareholders.
VALUATION OF SHARES OF EACH FUND
The net asset value per share of each Fund is determined as of 1:00 p.m.
Pacific time each day that the Exchange is open for trading. Many newspapers
carry daily quotations of the prior trading day's closing "bid" (net asset
value) and "ask" (offering price, which includes the maximum sales charge of
each Fund).
The net asset value per share of the Fund is determined in the
following manner: The aggregate of all liabilities, accrued expenses and taxes
and any necessary reserves is deducted from the aggregate gross value of all
assets, and the difference is divided by the number of shares of the Fund
outstanding at the time. For the purpose of determining the aggregate net
assets of the Fund, cash and receivables are valued at their realizable
amounts. Interest is recorded as accrued. Portfolio securities for which market
quotations are readily available are valued within the range of the most recent
bid and ask prices as obtained from one or more dealers that make markets in
the securities. Portfolio securities which are traded both in the
over-the-counter market and on a stock exchange are valued according to the
broadest and most representative market as determined by the Manager. Municipal
securities generally trade in the over-the-counter mar ket rather than on a
securities exchange. Other securities for which market quotations are readily
available
29
<PAGE>
are valued at the current market price, which may be obtained from a
pricing service, based on a variety of factors, including recent trades,
institutional size trading in similar types of securities (considering yield,
risk and maturity) and/or developments related to specific issues. Securities
and other assets for which market prices are not readily available are valued
at fair value as determined following procedures approved by the Board of
Trustees.
All money market instruments with a maturity of more than 60 days are
valued at current market, as discussed above. All money market instruments with
a maturity of 60 days or less are valued at their amortized cost, which the
Board of Trustees has determined in good faith constitutes fair value for
purposes of complying with the 1940 Act. This valuation method will continue to
be used until such time as the Trustees determine that it does not constitute
fair value for such purposes. With the approval of trustees, the Trust may
utilize a pricing service, bank or securities dealer to perform any of the
above described functions.
How to Get Information Regarding an Investment in Each Fund
Any questions or communications regarding a shareholder's account should be
directed to Investor Services at the address shown on the back cover of this
Prospectus.
From a touch-tone phone, shareholders may obtain current price, yield or
performance information specific to a fund in the Franklin Group of Funds(R) by
calling the automated Franklin TeleFACTS system (day or night) at
1-800/247-1753. Information about each Fund may be accessed by entering a
Fund's Code followed by the # sign when requested to do so by the automated
operator. The Funds' Codes are 221 for the Arkansas Fund, 73 for the Hawaii
Fund, 220 for the Tennessee Fund, and 76 for the Washington Fund.
To assist shareholders and securities dealers wishing to speak directly with a
representative, the following is a list of the various Franklin departments,
telephone numbers and hours of operation to call. The same numbers may be used
when calling from a rotary phone:
<TABLE>
<CAPTION>
HOURS OF OPERATION (PACIFIC TIME)
DEPARTMENT NAME TELEPHONE NO. (MONDAY THROUGH FRIDAY)
- --------------- ------------- ---------------------------------
<S> <C> <C>
Shareholder Services 1-800/632-2301 6:00 a.m. to 5:00 p.m.
Dealer Services 1-800/524-4040 6:00 a.m. to 5:00 p.m.
Fund Information 1-800/DIAL BEN 6:00 a.m. to 8:00 p.m.
8:30 a.m. to 5:00 p.m. (Saturday)
Retirement Plans 1-800/527-2020 6:00 a.m. to 5:00 p.m.
TDD (hearing impaired) 1-800/851-0637 6:00 a.m. to 5:00 p.m.
</TABLE>
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<PAGE>
Performance
Advertisements, sales literature and communications to shareholders may contain
various measures of each Fund's performance including current yield, tax
equivalent yield, various expressions of total return, current distribution
rate and taxable equivalent distribution rate. They may occasionally cite
statistics to reflect its volatility or risk.
Average annual total return figures as prescribed by the SEC represent the
average annual percentage change in value of $1,000 invested at the maximum
public offering price (offering price includes sales charge) for one-, five-
and ten-year periods, or portion thereof, to the extent applicable, through
the end of the most recent calendar quarter, assuming reinvestment of all
distributions. Each Fund may also furnish total return quotations for other
periods or based on investments at various sales charge levels or at net asset
value. For such purposes, total return equals the total of all income and
capital gain paid to shareholders, assuming reinvestment of all distributions,
plus (or minus) the change in the value of the original investment, expressed
as a percentage of the purchase price.
Current yield reflects the income per share earned by each Fund's portfolio
investments; it is calculated by dividing the Fund's net investment income per
share during a recent 30-day period by the maximum public offering price on the
last day of that period and annualizing the result. Tax equivalent yield
demonstrates the yield from a taxable investment necessary to produce an
after-tax yield equivalent to that of a fund which invests in tax-exempt
obligations. It is computed by dividing the tax-exempt portion of a fund's
yield (calculated as indicated) by one minus a stated income tax rate and
adding the product to the taxable portion (if any) of the fund's yield.
Current yield and tax equivalent yield which are calculated according to a
formula prescribed by the SEC (see the Statement of Additional Information) are
not indicative of the dividends or distributions which were or will be paid to
the Fund's shareholders. Dividends or distributions paid to shareholders are
reflected in the current distribution rate or taxable equivalent distribution
rate, which may be quoted to shareholders. The current distribution rate is
computed by dividing the total amount of dividends per share paid by the Fund
during the past 12 months by a current maximum offering price. A taxable
equivalent distribution rate demonstrates the taxable distribution rate
necessary to produce an after-tax distribution rate equivalent to the Fund's
distribution rate (calculated as indicated above). Under certain circumstances,
such as when there has been a change in the amount of dividend payout or a
fundamental change in investment policies, it might be appropriate to annualize
the dividends paid during the period such policies were in effect, rather than
using the dividends during the past 12 months. The current distribution rate
differs from the current yield computation because it may include distributions
to shareholders from sources other than dividends and interest, such as
short-term capital gain, and is calculated over a different period of time.
In each case, performance figures are based upon past performance, reflect all
recurring charges against Fund income and will assume the payment of the
maximum sales charge on the purchase of shares. When there has been a change in
the sales charge structure, the historical performance figures will be restated
to reflect the new rate. The investment results of each Fund, like all other
investment companies, will fluctuate over time; thus, performance figures
should not be considered to represent what an investment may earn in the future
or what each Fund's yield, tax equivalent yield, distribution rate,
31
<PAGE>
taxable equivalent distribution rate or total return may be in any future
period.
GENERAL INFORMATION
REPORTS TO SHAREHOLDERS
Annual Reports containing audited financial statements of the Trust, including
the auditors' report, and Semi-Annual Reports containing unaudited financial
statements are automatically sent to shareholders. Additional copies may be
obtained, without charge, upon request to the Trust at the telephone number or
address set forth on the cover page of this Prospectus.
Additional information on Fund performance is included in the Fund's Annual
Report to Shareholders and the Statement of Additional Information.
ORGANIZATION
The Trust was organized as a Delaware business trust on November 19, 1991. The
Agreement and Declaration of Trust permits the Trustees to issue an unlimited
number of full and fractional shares of beneficial interest without par value,
which may be issued in any number of series. Shares issued will be fully paid
and non-assessable and will have no preemptive, conversion, or sinking rights.
Shares of each series have equal and exclusive rights as to dividends and
distributions, as declared by such series, and the net assets of such series
upon liquidation or dissolution. Additional series may be added in the future
by the Board of Trustees.
VOTING RIGHTS
Shares of each series have equal rights as to voting and vote separately as to
issues affecting that series, or the Trust, unless otherwise permitted by the
1940 Act. Voting rights are noncumulative, so that in any election of trustees,
the holders of more than 50% of the shares voting can elect all of the trustees
if they choose to do so and in such event, the holders of the remaining shares
voting will not be able to elect any person or persons to the Board of
Trustees. The Trust does not intend to hold annual shareholders meetings.
The Trust may, however, hold a special shareholders' meeting for such purposes
as changing fundamental investment restrictions, approving a new management
agreement or any other matters which are required to be acted on by
shareholders under the 1940 Act. A meeting may also be called by the trustees
in their discretion or by shareholders holding at least ten percent of the
outstanding shares of any series entitled to vote at the meeting. Shareholders
will receive assistance in communicating with other shareholders in connection
with the election or removal of trustees such as that provided in Section 16(c)
of the 1940 Act.
Each Fund reserves the right to redeem, at net asset value, shares of any
shareholder whose account has a value of less than $50, but only where the
value of such account has been reduced by the shareholder's prior voluntary
redemption of shares and has been inactive (except for the reinvestment of
distributions) for a period of at least six months, provided advance notice is
given to the shareholder. More information is included in the Statement of
Additional Information.
Distribution or redemption checks sent to shareholders do not earn interest or
any other income during the time such checks remain uncashed and neither a Fund
nor their affiliates will be liable for any loss to the shareholder caused by
the shareholder's failure to cash such check(s).
"Cash" payments to or from a Fund may be made by check, draft or wire. The
Funds have no facility to receive, or pay out, cash in the form of currency.
32
<PAGE>
ACCOUNT REGISTRATIONS
An account registration should reflect the investor's intentions as to
ownership. Where there are two co-owners on the account, the account will be
registered as "Owner 1" and "Owner 2"; the "or" designation is not used except
for money market fund accounts. If co-owners wish to have the ability to redeem
or convert on the signature of only one owner, a limited power of attorney may
be used.
Accounts should not be registered in the name of a minor, either as
sole or co-owner of the account. Transfer or redemption for such an account may
require court action to obtain release of the funds until the minor reaches the
legal age of majority. The account should be registered in the name of one
"Adult" as custodian for the benefit of the "Minor" under the Uniform Transfer
or Gifts to Minors Act.
A trust designation such as "trustee" or "in trust for" should only be used if
the account is being established pursuant to a legal, valid trust document. Use
of such a designation in the absence of a legal trust document may cause
difficulties and require court action for transfer or redemption of the funds.
Shares, whether in certificate form or not, registered as joint tenants or "Jt
Ten" shall mean "as joint tenants with rights of survivorship" and not "as
tenants in common."
Except as indicated, a shareholder may transfer an account in a Fund carried in
"street" or "nominee" name by the shareholder's securities dealer to a
comparably registered Fund account maintained by another securities dealer.
Both the delivering and receiving securities dealers must have executed dealer
agreements on file with Distributors. Unless a dealer agreement has been
executed and is on file with Distributors, the Fund will not process the
transfer and will so inform the shareholder's delivering securities dealer. To
effect the transfer, a shareholder should instruct the securities dealer to
transfer the account to a receiving securities dealer and sign any documents
required by the securities dealer to evidence consent to the transfer. Under
current procedures the account transfer may be processed by the delivering
securities dealer and the Fund after the Fund receives authorization in proper
form from the shareholder's delivering securities dealer. In the future it may
be possible to effect such transfers electronically through the services of the
NSCC.
The Funds may conclusively accept instructions from an owner or the owner's
nominee listed in publicly available nominee lists, regardless of whether the
account was initially registered in the name of or by the owner, the nominee,
or both. If a securities dealer or other representative is of record on an
investor's account, the investor will be deemed to have authorized the use of
electronic instructions on the account, including, without limitation, those
initiated through the services of the NSCC, to have adopted as instruction and
signature any such electronic instructions received by a Fund and the
Shareholder Services Agent, and to have authorized them to execute the
instructions without further inquiry. At the present time, such services which
are available, or which are anticipated to be made available in the near
future, include the NSCC's "Networking," "Fund/SERV," and "ACATS" systems.
Any questions regarding an intended registration should be answered by the
securities dealer handling the investment or by calling Franklin's Fund
Information Department.
33
<PAGE>
IMPORTANT NOTICE REGARDING
TAXPAYER IRS CERTIFICATIONS
Pursuant to the Code and U.S. Treasury regulations, a Fund may be required to
report to the Internal Revenue Service ("IRS") any taxable dividend, capital
gain distribution, or other reportable payment (including share redemption
proceeds) and withhold 31% of any such payments made to individuals and other
non-exempt shareholders who have not provided a correct taxpayer identification
number ("TIN") and made certain required certifications that appear in the
Shareholder Application. A shareholder may also be subject to backup
withholding if the IRS or a securities dealer notifies the Fund that the number
furnished by the shareholder is incorrect or that the shareholder is subject to
backup withholding for previous under-reporting of interest or dividend income.
The Fund reserves the right to (1) refuse to open an account for any person
failing to provide a TIN along with the required certifications and (2) close
an account by redeeming its shares in full at the then-current net asset value
upon receipt of notice from the IRS that the TIN certified as correct by the
shareholder is in fact incorrect or upon the failure of a shareholder who has
completed an "awaiting TIN" certification to provide the Fund with a certified
TIN within 60 days after opening the account.
PORTFOLIO OPERATIONS
The following persons are primarily responsible for the day-to-day management
of the Funds# portfolios.
Sheila Amoroso, Portfolio Manager, has been responsible for portfolio
recommendations and decisions of the Arkansas, Hawaii, Tennessee and Washington
Funds since their inception. She joined Franklin in 1986. She holds a bachelor
of science degree from San Francisco State University and is a member of
municipal securities industry associations.
Greg Harrington, Senior Vice President and Managing Director, has been
responsible for portfolio recommendations and decisions since inception of the
Arkansas, Hawaii, Tennessee and Washington Funds. He is a graduate of Mount
Saint Mary's College in Maryland and has studied at the New York School of
Finance. His experience in the municipal securities industry dates back to
1946. He joined Advisers in 1983.
Andrew Jennings, Sr., Vice President and Portfolio Manager, has been
responsible for portfolio recommendations and decisions since inception of the
Arkansas, Hawaii, Tennessee and Washington Funds. He joined Advisers in 1990.
He attended Villanova University in Philadelphia, has been in the securities
industry for over 33 years, and is a member of several municipal securities
industry associations. From 1985 to 1990, Mr. Jennings was First Vice President
and Manager of the Municipal Institutional Bond Department at Dean Witter
Reynolds Inc.
SPECIAL FACTORS AFFECTING EACH STATE FUND
The following information is a brief summary of factors affecting each of the
individual state Funds and does not purport to be a complete description of
such factors. The information is based primarily upon information derived from
public documents relating to securities offerings of issuers of such states,
from independent municipal credit reports and historically reliable sources,
but has not been independently verified by the Trust. The market value of the
shares of any Fund may fluctuate due to factors such as changes in interest
rates, matters affecting a particular state or for other reasons. Additional
information regarding each state is included in the Statement of Additional
Information.
34
<PAGE>
FACTORS AFFECTING ARKANSAS
During the past two decades, Arkansas' economic base has shifted from
agriculture to light manufacturing. The state is now moving toward a heavier
manufacturing base involving more sophisticated processes and products such as
electrical machinery, transportation equipment, fabricated metals and
electronics. Arkansas now has a higher percentage of workers involved in
manufacturing than the national average. The diversification of economic
interests has lessened the state's cyclical sensitivity to the impact of any
single sector.
Arkansas' diversified economic base is also reflected in the distribution of
the state's employment among the manufacturing, trade, service and governmental
sectors. During the past decade, there have been gains in the services and
wholesale and retail trade sectors. However, the civilian unemployment rate in
Arkansas has exceeded the national average during each year since 1978.
Manufacturing continues to be a leading component of Arkansas' economy.
Manufacturing contributes over 25% of the total wage and salary component of
personal income. There is an almost equal division between durable and
nondurable goods. Non-manufacturing and non-agricultural goods provide a
balanced proportion of the overall economy and tend to insulate the state's
economy from any adverse economic conditions which affect manufacturing.
Agriculture is a significant and historical component of Arkansas' economy.
Over 40% of the land in Arkansas is devoted to agriculture. Arkansas ranks
first in the nation in rice production, first in commercial broilers and fourth
in cotton.
Arkansas ranks first in the nation in the production of bauxite and bromine.
The state has significant natural gas and oil production in its west, central
and southern regions. There is also increased activity in the coal mining
fields of western Arkansas.
FACTORS AFFECTING HAWAII
The state's historically strong tourism industry, which dominates its economy
and which began declining in 1991 and continued declining in 1992 and 1993, has
now begun to rebound. The number of visitors for the first four months of
1994 is up 3.4% from the same period in 1993. The number of visitors from the
continental U.S. was up 4.3% and from Japan and Asia, 1.7%.
Hawaii's population has grown about 0.7% faster than that of the nation for the
last 20 years. It's employment growth is usually faster and unemployment rate
lower than the rest of the U.S. However, unemployment is up, although the
state's rate remains well below the national average. The state's employment
growth has been weak during the last two years; in-migration and the growth of
the labor force has also slowed, which held down the rise in the unemployment
rate.
Hawaii's economy is linked to the economies of California and Japan, which are
the origins of many Hawaiian visitors and which are slowly recovering from
economic recessions in recent years.
FACTORS AFFECTING TENNESSEE
The Tennessee economy has outpaced the nation for the last four years, due
to the expansion of its services sector, improved financial operations and low
debt. Historically, the Tennessee economy has been characterized by a greater
concentration in manufacturing employment than the United States as a whole.
Although the rate of growth in manufacturing jobs has leveled off since the
early 1980s, the growth that has occurred has been primarily in the
transportation equipment sector. The new manufacturing jobs have tended to be
well paying and have led to improved wealth and per capita income levels.
Diversification within the manufac-
35
<PAGE>
turing sector into durable products, as well as the overall diversification of
the state's economy into the service sector, contributed to a measure of
insulation of the state's economy from the most recent national recession. Per
capita personal income ranks 35th in the nation. From the second quarter of
1990 through 1992 the state led the nation in wage rate growth. Currently,
services, trade and manufacturing each account for approximately 23% of the
state's nonagricultural employment.
The unemployment rate has been rising steadily (from 5.1% in 1989 to 6.4% in
1993). Manufacturing employment growth is expected to continue to decline, but
the transportation equipment industry should continue to add new jobs, and the
number of automobile suppliers should grow as well. It is anticipated that the
unemployment rate should decline to approximately 5% by 1998.
FACTORS AFFECTING WASHINGTON
The recession hit the state of Washington later than the rest of the nation.
Strong personal income and employment growth experienced by the state during
the 1980s (characterized by a 26% increase in the civilian labor force)
continued through 1990. Some economic softening emerged in the first quarter of
1991 as the trade and construction areas turned downward. Employment growth
subsequently resumed and employment levels surpassed their pre-recession peak
by the end of 1992.
Employment grew modestly during the first quarter of 1994. The seasonally
adjusted unemployment rate improved from 6.2% to 5.9% of the labor force. Real
personal income rose by 2.0% in 1993, substantially slower than the 5.5% gain
recorded in 1992.
Looking ahead, however, a much slower pattern of growth is projected for the
next few years with announced reductions in operations at Boeing, whose 100,000
employees represent about 5% of the state's employment. Boeing has reduced its
Washington workforce by 15,000 and it is expected there will be 5,000
additional reductions. Other sectors of the economy are strong and are adding
jobs at rates that are offsetting aerospace contraction.
36
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MUN S
AMENDMENT DATED FEBRUARY 1, 1995
TO THE STATEMENT OF ADDITIONAL INFORMATION OF
FRANKLIN MUNICIPAL SECURITIES TRUST
DATED OCTOBER 1, 1994
The following substitutes subsection "Purchases at Net Asset Value" under
"Additional Information Regarding Fund Shares":
ADDITIONAL INFORMATION REGARDING PURCHASES
Special Net Asset Value Purchases. As discussed in the Prospectuses, certain
categories of investors may purchase shares of the Funds without a front-end
sales charge ("net asset value") or a contingent deferred sales charge.
Distributors or one of its affiliates may make payments, out of its own
resources, to securities dealers who initiate and are responsible for such
purchases, as indicated below. As a condition for these payments, Distributors
or its affiliates may require reimbursement from the securities dealers with
respect to certain redemptions made within 12 months of the calendar month
following purchase, as well as other conditions, all of which may be imposed
by an agreement between Distributors, or its affiliates, and the securities
dealer.
The following amounts may be paid by Distributors or one of its affiliates,
out of its own resources, to securities dealers who initiate and are
responsible for (i) purchases of most equity and taxable-income Franklin
Templeton Funds made at net asset value by certain designated retirement plans
(excluding IRA and IRA rollovers): 1.00% on sales of $1 million but less than
$2 million, plus 0.80% on sales of $2 million but less than $3 million, plus
0.50% on sales of $3 million but less than $50 million, plus 0.25% on sales of
$50 million but less than $100 million, plus 0.15% on sales of $100 million or
more; and (ii) purchases of most taxable income Franklin Templeton Funds made
at net asset value by non-designated retirement plans: 0.75% on sales of $1
million but less than $2 million, plus 0.60% on sales of $2 million but less
than $3 million, plus 0.50% on sales of $3 million but less than $50 million,
plus 0.25% on sales of $50 million but less than $100 million, plus 0.15% on
sales of $100 million or more. These payment breakpoints are reset every 12
months for purposes of additional purchases. With respect to purchases made at
net asset value by certain trust companies and trust departments of banks and
certain retirement plans of organizations with collective retirement plan
assets of $10 million or more, Distributors, or one of its affiliates, out of
its own resources, may pay up to 1% of the amount invested.
Letter of Intent. An investor may qualify for a reduced sales charge on the
purchase of shares of each Fund, as described in the prospectuses. At any time
within 90 days after the first investment which the investor wants to qualify
for the reduced sales charge, a signed Shareholder Application, with the
Letter of Intent section completed, may be filed with the Fund. After the
Letter of Intent is filed, each additional investment will be entitled to the
sales charge applicable to the level of investment indicated on the Letter.
Sales charge reductions based upon purchases in more than one of the Franklin
Templeton Funds will be effective only after notification to Distributors that
the investment qualifies for a discount. The shareholder's holdings in the
Franklin Templeton Funds acquired more than 90 days before the Letter of
Intent is filed will be counted towards completion of the Letter of Intent but
will not be entitled to a retroactive downward adjustment in the sales charge.
Any redemptions made by the shareholder, other than by a designated benefit
plan during the 13-month period will be subtracted from the amount of the
purchases for purposes of determining whether the terms of the Letter of
Intent have been completed. If the Letter of Intent is not completed within
the 13-month period, there will be an upward adjustment of the sales charge,
depending upon the amount actually purchased (less redemptions) during the
period. The upward adjustment does not apply to designated benefit plans. An
investor who executes a Letter of Intent prior to a change in the sales charge
structure for the Fund will be entitled to complete the Letter of Intent at
the lower of (i) the new sales charge structure; or (ii) the sales charge
structure in effect at the time the Letter of Intent was filed with the Fund.
Five percent (5%) of the amount of the total intended purchase will be
reserved in shares of the Fund registered in the investor's name. If the total
purchases, less redemptions, equal the amount specified under the Letter, the
reserved shares will be deposited to an account in the name of the investor or
delivered to the investor or the investor's order. If the total purchases,
less redemptions, exceed the amount specified under the Letter of Intent and
is an amount which would qualify for a further quantity discount, a
retroactive price adjustment will be made by Distributors and the securities
dealer through whom purchases were made pursuant to the Letter of Intent (to
reflect such further quantity discount) on purchases made within 90 days
before and on those made after filing the Letter. The resulting difference in
offering price will be applied to the purchase of additional shares at the
offering price applicable to a single purchase or the dollar amount of the
total purchases. If the total purchases, less redemptions, are less than the
amount specified under the Letter, the investor will remit to Distributors an
amount equal to the difference in the dollar amount of sales charge actually
paid and the amount of sales charge which would have applied to the aggregate
purchases if the total of such purchases had been made at a single time. Upon
such remittance the reserved shares held for the investor's account will be
deposited
<PAGE>
to an account in the name of the investor or delivered to the investor or to
the investor's order. If within 20 days after written request such difference
in sales charge is not paid, the redemption of an appropriate number of
reserved shares to realize such difference will be made. In the event of a
total redemption of the account prior to fulfillment of the Letter of Intent,
the additional sales charge due will be deducted from the proceeds of the
redemption, and the balance will be forwarded to the investor.
<PAGE>
FRANKLIN
MUNICIPAL
SECURITIES TRUST [LOGO]
Franklin Arkansas Municipal Bond Fund
Franklin California High Yield Municipal Fund
Franklin Hawaii Municipal Bond Fund
Franklin Tennessee Municipal Bond Fund
Franklin Washington Municipal Bond Fund
STATEMENT OF
ADDITIONAL INFORMATION 777 MARINERS ISLAND BLVD., P.O. BOX 7777
OCTOBER 1, 1994 SAN MATEO, CA 94403-7777 1-800/DIAL BEN
<TABLE>
<CAPTION>
CONTENTS PAGE
<S> <C>
About the Trust.................................. 2
Each Fund's Investment Objective
and Policies.................................... 2
Description of Municipal and
Other Securities................................ 2
Investment Restrictions.......................... 4
Trustees and Officers............................ 5
Investment Advisory and Other Services........... 8
The Trust's Policies Regarding
Brokers Used on Portfolio Transactions.......... 9
Additional Information
Regarding Fund Shares........................... 10
The Trust's Underwriter.......................... 12
Additional Information Regarding Taxation........ 14
General Information.............................. 14
Miscellaneous Information........................ 18
Appendix A - Further Information on Special
Factors Affecting Each State Fund............... 19
Appendix B - Description of Municipal
Securities Ratings.............................. 23
Financial Statements............................. 26
</TABLE>
Franklin Municipal Securities Trust (the "Trust") is an open-end management
investment company consisting of five separate, non-diversified series:
Franklin Arkansas Municipal Bond Fund, Franklin California High Yield Municipal
Fund, Franklin Hawaii Municipal Bond Fund, Franklin Tennessee Municipal Bond
Fund and Franklin Washington Municipal Bond Fund (collectively referred to as
the "Funds," or individually by the state included as part of its name). Each
Fund seeks to provide investors with as high a level of income exempt from
regular federal income taxes and the personal income taxes for resident
shareholders of the named state, where such named state imposes such taxes, as
is consistent with prudent investment management, while seeking preservation of
shareholders' capital. Washington currently imposes no state income tax. As a
secondary objective the California Fund will seek capital appreciation to the
extent this is possible and is consistent with its principal investment
objective.
Each Fund seeks to accomplish its objective by investing primarily in municipal
securities issued by its respective state and the state's political
subdivisions, agencies and instrumentalities, and in any municipal obligations
of non-state issuers which pay interest exempt from regular federal income
taxes.
Each Fund's (except the Franklin California High Yield Municipal Fund (the
"California High Yield Fund")) investments in municipal securities will be
limited to such investments rated in one of the four highest ratings categories
by a recognized ratings agency or in securities which are not rated, but deemed
to be comparable in quality. In addition to its ability to invest in higher
rated municipal securities, the California High Yield Fund may invest, without
percentage limitation, in lower rated or unrated municipal securities.
Prospectuses for the Funds dated October 1, 1994, and as may be further amended
from time to time, provide the basic information a prospective investor should
know before investing in a Fund and may be obtained without charge from the
Trust at the address listed above or from the Trust's principal underwriter,
Franklin/Templeton Distributors, Inc. ("Distributors"), at the above address.
THIS STATEMENT OF ADDITIONAL INFORMATION IS NOT A PROSPECTUS. IT CONTAINS
INFORMATION IN ADDITION TO AND IN MORE DETAIL THAN SET FORTH IN THE
PROSPECTUSES. THIS STATEMENT IS INTENDED TO PROVIDE AN INVESTOR WITH ADDITIONAL
INFORMATION REGARDING THE ACTIVITIES AND OPERATIONS OF THE tRUST AND EACH fUND,
AND SHOULD BE READ IN CONJUNCTION WITH THE PROSPECTUS.
<PAGE>
ABOUT THE TRUST
The Trust is an open-end management investment company, commonly called a
"mutual fund." The Trust was organized as a Delaware business trust as of
November 19, 1991. The Trust issues shares of beneficial interest with a par
value of $0.01 per share. Currently, the Trust has five series, but may in the
future issue additional series, each to be known as a "Fund" and to maintain a
totally separate investment portfolio.
EACH FUND'S INVESTMENT
OBJECTIVE AND POLICIES
As noted in the Prospectus, each Fund attempts to invest 100% and, as a matter
of fundamental policy, invests at least 80% of the value of its net assets in
municipal securities, the interest on which is exempt from regular federal
income taxes, but which may be deemed to be a preference item under the federal
alternative minimum tax. It is also the policy of each Fund to invest at least
65% of its total assets in bonds which pay interest that is exempt from
personal income tax in its respective state, where such state imposes an income
tax. Interest paid on certain types of municipal obligations, such as "private
activity bonds," and the dividends to be paid by each Fund therefrom, although
exempt from regular federal income tax, may be deemed to be a preference item
under the federal alternative minimum tax, and thus subject to the federal
alternative minimum tax.
Thus, it is possible, although not anticipated, that up to 20% of each Fund's
net assets could be in obligations subject to regular federal taxation and/or
up to 35% of each Fund's total assets could be in municipal securities from
other states. In addition, it is possible that each Fund's investments could
consist entirely of bonds, the interest on which is subject to the federal
alternative minimum tax.
The Arkansas, Hawaii, Tennessee and Washington Funds may invest, without
percentage limitation, in securities having at the time of purchase one of the
four highest ratings of Moody's Investors Service ("Moody's") (Aaa, Aa, A,
Baa), Standard & Poor's Corporation ("S&P") (AAA, AA, A, BBB), Fitch Investors
Service, Inc. ("Fitch") (AAA, AA, A, BBB), or in securities which are not
rated, provided that, in the opinion of the Fund's investment manager, Franklin
Advisers, Inc. ("Advisers" or "Manager"), such securities are comparable in
quality to those within the four highest ratings. These are considered to be
"investment grade" securities, although bonds rated in the fourth highest
rating category by the foregoing rating services are regarded as having an
adequate capacity to pay principal and interest but with greater vulnerability
to adverse economic conditions and to have some speculative characteristics. In
addition, the California High Yield Fund may invest, without percentage
limitation, in lower rated securities. The California Fund may invest up to 5%
of its assets (at the time of purchase) in defaulted securities.
Although each Fund seeks to invest all its assets in a manner designed to
accomplish its objectives, there may be times where market conditions limit the
availability of appropriate municipal securities or, in the investment
manager's opinion, there exist uncertain economic, market, political, or legal
conditions which may jeopardize the value of municipal securities. Accordingly,
for temporary defensive purposes, each Fund may invest more than 20% and up to
100% of its total assets in taxable, fixed-income obligations, and each Fund
may invest more than 35% and up to 100% of the value of its total assets in
instruments, the interest on which is exempt from regular federal income taxes,
but not the respective state's personal income tax, where such state imposes an
income tax.
It is the policy of each Fund that illiquid securities (a term which means
securities that cannot be disposed of within seven days in the normal course of
business at approximately the amount at which the Fund has valued the
securities) may not constitute, at the time of purchase or at any time, more
than 10% of the value of the total net assets of the Fund.
DESCRIPTION OF MUNICIPAL
AND OTHER SECURITIES
The Prospectus describes the general categories and nature of municipal
securities. Discussed below are the major attributes of the various municipal
and other securities in which each Fund may invest.
Tax Anticipation Notes are used to finance working capital needs of
municipalities and are issued in anticipation of various seasonal tax revenues
to be payable from these specific future taxes. They are usually general
obligations of the issuer, secured by the taxing power for the payment of
principal and interest.
Revenue Anticipation Notes are issued in expectation of receipt of other kinds
of revenue, such as federal revenues available under the Federal Revenue
Sharing Program. They are usually general obligations of the issuer. Bond
Anticipation Notes are normally issued to provide interim financing until
long-term financing can be arranged. The
<PAGE>
long-term bonds then provide the money for the repayment of the notes.
Construction Loan Notes are sold to provide construction financing for specific
projects. After successful completion and acceptance, many projects receive
permanent financing through the Federal Housing Administration under the
Federal National Mortgage Association or the Government National Mortgage
Association.
Municipal Bonds, which meet longer-term capital needs and generally have
maturities of more than one year when issued, have two principal
classifications: general obligation bonds and revenue bonds.
1. General Obligation Bonds. Issuers of general obligation bonds include
states, counties, cities, towns and regional districts. The proceeds of these
obligations are used to fund a wide range of public projects, including
construction or improvement of schools, highways and roads, and water and sewer
systems. The basic security behind general obligation bonds is the issuer's
pledge of its full faith, credit and taxing power for the payment of principal
and interest. The taxes that can be levied for the payment of debt service may
be limited or unlimited as to the rate or amount of special assessments.
2. Revenue Bonds. A revenue bond is not secured by the full faith, credit and
taxing power of an issuer. Rather, the principal security for a revenue bond is
generally the net revenue derived from a particular facility, group of
facilities or, in some cases, the proceeds of a special excise tax or other
specific revenue source. Revenue bonds are issued to finance a wide variety of
capital projects including: electric, gas, water, and sewer systems; highways,
bridges, and tunnels; port and airport facilities; colleges and universities;
and hospitals. Although the principal security behind these bonds may vary,
many provide additional security in the form of a debt service reserve fund,
from which money may be used to make principal and interest payments on the
issuer's obligations. Housing finance authorities have a wide range of
security, including partially or fully insured mortgages, rent subsidized
and/or collateralized mortgages, and/or the net revenues from housing or other
public projects. Some authorities are provided with further security in the
form of state assurance (although without obligation) to make up deficiencies
in the debt service reserve fund.
Industrial Development Bonds. These are, in most cases, revenue bonds and are
issued by or on behalf of public authorities to raise money for the financing
of various privately-operated facilities for business manufacturing, housing,
sports, and pollution control. These bonds are also used to finance public
facilities such as airports, mass transit systems, ports, and parking. The
payment of the principal and interest on such bonds is solely dependent on the
ability of the facilities user to meet its financial obligations and the
pledge, if any, of the real and personal property so financed as security for
such payment.
Variable or Floating Rate Demand Notes ("VRDNs"). These are tax-exempt
obligations which contain a floating or variable interest rate and a right of
demand which may be unconditional, to receive payment of the unpaid principal
balance plus accrued interest upon a short notice period (generally up to 30
days) prior to specified dates, either from the issuer or by drawing on a bank
letter of credit, a guarantee or insurance issued with respect to such
instrument. The interest rates are adjustable at intervals ranging from daily
up to monthly, and are calculated to maintain the market value of the VRDN at
approximately its par value upon the adjustment date.
When-Issued Purchases. New issues of municipal securities are offered on a
when-issued basis; that is, payment for and delivery of the securities (the
"settlement date") normally takes place after the date that the offer is
accepted. The purchase price and the yield that will be received on the
securities are each fixed at the time the buyer enters into the commitment.
While the Trust will always make commitments to purchase such securities with
the intention of actually acquiring the securities, it may nevertheless sell
these securities before the settlement date if it is deemed advisable as a
matter of investment strategy. To the extent that assets of a Fund are held in
cash pending the settlement of a purchase of securities, the Fund would earn no
income; however, it is each Fund's intention to be fully invested to the extent
practicable and subject to the policies stated in the Prospectus. At the time
the Trust makes the commitment to purchase a municipal bond on a when-issued
basis, it will record the transaction and reflect the value of the security in
determining each Fund's net asset value. The Trust does not believe that each
Fund's net asset value or income will be adversely affected by the purchase of
municipal bonds on a when-issued basis. Each Fund will establish a segregated
account, in which it will maintain cash and mar ketable securities equal in
value to commitments for when-issued securities.
Escrow secured bonds or defeased bonds are created when an issuer refunds in
advance of maturity (or pre-refunds) an outstanding bond issue which is
<PAGE>
not immediately callable, and it becomes necessary or desirable to set
aside funds for redemption of the bonds at a future date. In an advance
refunding, the issuer will use the proceeds of a new bond issue to purchase
high grade interest bearing debt securities which are then deposited in an
irrevocable escrow account held by a trustee bank to secure all future payments
of principal and interest of the advance refunded bond. Escrow secured bonds
will often receive a AAA rating from S&P and Moody's.
U.S. government obligations which may be owned by each Fund are issued by the
U.S. Treasury and include bills, certificates of indebtedness, notes and bonds,
or are issued by agencies and instrumentalities of the U.S. government and
backed by the full faith and credit of the U.S. government.
Commercial Paper refers to promissory notes issued by corporations in order to
finance their short-term credit needs.
There may, of course, be other types of municipal securities that become
available which are similar to the foregoing described municipal securities and
in which each Fund may invest so long as they are consistent with the Fund's
investment objective and policies.
INVESTMENT RESTRICTIONS
The Trust has adopted the following restrictions as additional fundamental
policies of each Fund. These policies may not be changed with respect to any
Fund without the approval of a majority of the outstanding voting securities of
such Fund. Under the Investment Company Act of 1940 (the "1940 Act"), a "vote
of a majority of the outstanding voting securities" of the Trust or of a
particular Fund means the affirmative vote of the lesser of (1) more than 50%
of the outstanding shares of the Trust or of such Fund or (2) 67% or more of
the shares of the Trust or of such Fund present at a shareholders meeting if
more than 50% of the outstanding shares of the Trust or of such Fund are
represented at the meeting in person or by proxy. A Fund may not:
1. Borrow money or mortgage or pledge any of its assets, except that borrowing
(and a pledge of assets therefore) for temporary or emergency purposes may be
made from banks in any amount up to 5% of the total asset value.
2. Buy any securities on "margin" or sell any securities "short," except that
it may use such short-term credits as are necessary for the clearance of
transactions.
3. Make loans, except by engaging in repurchase transactions and except through
the purchase of readily marketable debt securities which are either publicly
distributed or customarily purchased by institutional investors. Although such
loans are not presently intended, this prohibition will not preclude a Fund
from loaning portfolio securities to broker-dealers or other institutional
investors if at least 102% cash collateral is pledged and maintained by the
borrower, provided such portfolio security loans may not be made if, as a
result, the aggregate of such loans exceeds 10% of the value of the Fund's
total assets at the time of the most recent loan.
4. Act as underwriter of securities issued by other persons, except insofar as
the Fund may be technically deemed an underwriter under the federal securities
laws in connection with the disposition of portfolio securities, except that,
in the case of the Arkansas and Tennessee Funds, all or substantially all of
the assets of either Fund may be invested in another registered investment
company having the same investment objective and policies as the Fund.
5. Purchase securities from or sell to the Trust's officers and trustees, or
any firm of which any officer or trustee is a member, as principal, or retain
securities of any issuer if, to the knowledge of the Trust, one or more of the
Trust's officers, trustees, or investment adviser own beneficially more than
1/2 of 1% of the securities of such issuer and all such officers and trustees
together own beneficially more than 5% of such securities, except that, in the
case of the Arkansas and Tennessee Funds, to the extent this restriction is
applicable, all or substantially all of the assets of the Fund may be invested
in another registered investment company having the same investment objective
and policies as the Fund, or except as permitted under investment restriction
Number 9 regarding the purchase of shares of money market funds managed by
Advisers or its affiliates.
6. Acquire, lease or hold real estate, except such as may be necessary or
advisable for the maintenance of its offices and provided that this limitation
shall not prohibit the purchase of municipal and other debt securities secured
by real estate or interests therein.
7. Invest in commodities and commodity contracts, puts, calls, straddles,
spreads, or any combination thereof, or interests in oil, gas, or other mineral
exploration or development programs, except that it may purchase, hold, and
dispose of obligations with puts attached in accordance with its investment
policies.
8. Invest in companies for the purpose of exercising control or management,
except that, in the case
<PAGE>
of the Arkansas and Tennessee Funds, to the extent this restriction is
applicable, all or substantially all of the assets of either Fund may be
invested in another registered investment company having the same investment
objective and policies as the Fund.
9. Purchase securities of other investment companies, except in connection with
a merger, consolidation, acquisition, or reorganization, provided that, in the
case of the Arkansas and Tennessee Funds, all or substantially all of the
assets of either Fund may be invested in another registered investment company
having the same investment objective and policies as the Fund. To the extent
permitted by exemptions which may be granted under the 1940 Act, each Fund may
invest in shares of one or more money market funds managed by Advisers or its
affiliates.
10. Invest more than 25% of its assets in securities of any industry, except
that, in the case of the Arkansas and Tennessee Funds, to the extent this
restriction is applicable, all or substantially all of the assets of either
Fund may be invested in another registered investment company having the same
investment objective and policies as the Fund. For purposes of this limitation,
municipal securities and U.S. government obligations are not considered to be
part of any industry.
So long as the percentage restrictions above are observed by each Fund at the
time it purchases any security, changes in values of particular Fund assets or
the assets of a Fund as a whole will not cause a violation of any of the
foregoing restrictions.
To the extent municipal securities constitute securities issued to finance
non-governmental business activities, they are generally not deemed to be
exempt from taxation under federal law. As such, these securities, if purchased
by a Fund, will be subject to the prohibition in investment restriction number
10 against concentrating in an industry.
In addition, the Funds may not invest in real estate limited partnerships or in
interests in oil, gas or other mineral leases.
TRUSTEES AND OFFICERS
The Board of Trustees have the responsibility for the overall management of the
Trust and each Fund, including general supervision and review of each Fund's
investment activities. The trustees, in turn, elect the officers of the Trust
who are responsible for administering day-to-day operations of the Trust and
each Fund. The affiliations of the officers and trustees and their principal
occupations for the past five years are listed below. Trustees who are deemed
to be "interested persons" of the Trust, as defined in the 1940 Act, are
indicated by an asterisk (*).
<TABLE>
<CAPTION>
POSITIONS AND OFFICES
NAME AND ADDRESS WITH THE TRUST PRINCIPAL OCCUPATIONS DURING PAST FIVE YEARS
---------------- --------------------- --------------------------------------------
<S> <C> <C>
Frank H. Abbott, III Trustee President and Director, Abbott Corporation (an investment
1045 Sansome St. company); Director, Mother Lode Gold Mines Consolidated; and
San Francisco, CA 94111 director, trustee or managing general partner, as the case may
be, of most of the investment companies in the Franklin Group
of Funds.
Harris J. Ashton Trustee President Chief Executive Officer and Chairman of the Board,
General Host Corporation General Host Corporation (nursery and craft centers);
Metro Center, 1 Station Place Director, RBC Holdings, Inc. (a bank holding company), Bar-S
Stamford, CT 06904-2045 Foods and Sunbelt Nursery Group, Inc.; director of certain of
the investment companies in the Templeton Group of Funds; and
director, trustee or managing general partner, as the case
may be, of most of the investment companies in the Franklin
Group of Funds.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
POSITIONS AND OFFICES
NAME AND ADDRESS WITH THE TRUST PRINCIPAL OCCUPATIONS DURING PAST FIVE YEARS
---------------- --------------------- --------------------------------------------
<S> <C> <C>
*Harmon E. Burns Vice President Executive Vice President, Secretary and Director, Franklin
777 Mariners Island Blvd. and Trustee Resources, Inc.; Executive Vice President and Director,
San Mateo, CA 94404 Franklin/Templeton Distributors, Inc.; Executive Vice
President, Franklin Advisers, Inc.; Director,
Franklin/Templeton Investor Services, Inc.; director of
certain of the investment companies in the Templeton Group of
Funds; officer and/or direc tor, as the case may be, of other
subsidiaries of Franklin Resources, Inc.; and officer and/or
director or trustee of all the investment companies in the
Franklin Group of Funds.
S. Joseph Fortunato Trustee Member of the law firm of Pitney, Hardin, Kipp & Szuch;
Park Avenue at Morris County Director of General Host Corporation; director of certain of
P. O. Box 1945 the investment companies in the Templeton Group of Funds; and
Morristown, NJ 07962-1945 director, trustee or managing general partner, as the case
may be, of most of the investment companies in the Franklin
Group of Funds.
David W. Garbellano Trustee Private Investor; Assistant Secretary/Treasurer and Director,
111 New Montgomery St., #402 Berkeley Science Corporation (a venture capital company); and
San Francisco, CA 94105 director, trustee or managing general partner, as the case
may be, of most of the investment companies in the Franklin
Group of Funds.
*Charles B. Johnson Chairman of the President and Director, Franklin Resources, Inc. and Franklin/
777 Mariners Island Blvd. Board and Trustee Templeton Distributors, Inc.; Chairman of the Board and
San Mateo, CA 94404 Director, Franklin Advisers, Inc.; Director, Franklin/
Templeton Investor Services, Inc. and General Host
Corporation; director of certain of the investment companies
in the Templeton Group of Funds; and officer and/or director,
trustee or managing general partner, as the case may be, of
most other subsidiaries of Franklin Resources, Inc. and of
most of the investment companies in the Franklin Group of Funds.
*Rupert H. Johnson, Jr. President Executive Vice President and Director, Franklin Resources, Inc.
777 Mariners Island Blvd. and Trustee and Franklin/Templeton Distributors, Inc.; President and
San Mateo, CA 94404 Director, Franklin Advisers, Inc.; Director, Franklin/Templeton
Investor Services, Inc.; director of certain of the investment
companies in the Templeton Group of Funds; and officer and/or
director, trustee or managing general partner, as the case
may be, of most other subsidiaries of Franklin Resources, Inc.
and of most of the investment companies in the Franklin Group
of Funds.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
POSITIONS AND OFFICES
NAME AND ADDRESS WITH THE TRUST PRINCIPAL OCCUPATIONS DURING PAST FIVE YEARS
---------------- --------------------- --------------------------------------------
<S> <C> <C>
Frank W. T. LaHaye Trustee General Partner, Peregrine Associates and Miller & LaHaye,
20833 Stevens Creek Blvd. which are General Partners of Peregrine Ventures and Peregrine
Suite 102 Ventures II (venture capital firms); Chairman of the Board and
Cupertino, CA 95014 Director, Quarter deck Office Systems, Inc.; Director,
FischerImaging Corporation; and director or trustee, as the
case may be, of most of the investment companies in the
Franklin Group of Funds.
Gordon S. Macklin Trustee Chairman, White River Corporation (information services);
8212 Burning Tree Road Director, Fundamerican Enterprises Holdings, Inc., Martin
Bethesda, MD 20817 Marietta Corporation, MCI Communications Corporation,
Medimmune, Inc. (biotechnology), and Infovest Corporation
(information services); director of certain of the investment
companies in the Templeton Group of Funds; and director,
trustee or managing general partner, as the case may be, of
most of the investment companies in the Franklin Group of
formerly, Chairman, Hambrecht and Quist Group; Director,
H & Q Healthcare Investors; and President, National
Association of Securities Dealers, Inc.
Hayato Tanaka Trustee Retired former owner of The Jewel Box Orchids; Director of
277 Haihai Street Franklin Premier Return Fund.
Hilo, HI 96720
Edward V. McVey Vice President Senior Vice President/National Sales Manager, Franklin/
777 Mariners Island Blvd. Templeton Distributors, Inc.; and officer of many of the
San Mateo, CA 94404 investment companies in the Franklin Group of Funds.
Charles E. Johnson Vice President Senior Vice President and Director, Franklin Resources, Inc.;
777 Mariners Island Blvd. Senior Vice President, Franklin/Templeton Distributors, Inc.;
San Mateo CA 94404 President, Franklin Institutional Services Corporation;
President and Director, Templeton Worldwide, Inc.; Vice
President, Franklin Advisers, Inc.; director of certain of
the investment companies in the Templeton Group of Funds;
officer and/or director, as the case may be, of some of the
subsidiaries of Franklin Resources, Inc. and Templeton
Worldwide, Inc.; and officer and/or director or trustee, as
the case may be, of some of the investment companies in the
Franklin Group of Funds.
Thomas J. Kenny Vice President Senior Vice President, Franklin Advisers, Inc. and officer of
777 Mariners Island Blvd. some of the investment companies in the Franklin Group of Funds.
San Mateo, CA 94404
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Positions and Offices
Name and Address with the Trust Principal Occupations During Past Five Years
---------------- --------------------- --------------------------------------------
<S> <C> <C>
Kenneth V. Domingues Vice President Senior Vice President, Franklin Resources, Inc., Franklin
777 Mariners Island Blvd. and Treasurer Advisers, Inc., and Franklin/Templeton Distributors, Inc.;
San Mateo, CA 94404 officer and/or director, as the case may be, of other
subsidiaries of Franklin Resources, Inc.; and officer and/or
managing general partner, as the case may be, of all the
investment companies in the Franklin Group of Funds.
Deborah R. Gatzek Vice President Senior Vice President - Legal, Franklin Resources, Inc. and
777 Mariners Island Blvd. and Secretary Franklin/Templeton Distributors, Inc.; Vice President,
San Mateo, CA 94404 Franklin Advisers, Inc.; and officer of all the investment
companies in the Franklin Group of Funds.
</TABLE>
As indicated above, certain of the trustees and officers hold positions with
other companies in the Franklin Group of Funds(R). Trustees not affiliated with
the investment manager may in the future be, but are not currently, paid fees
or reimbursed for expenses incurred in connection with attending meetings. As
of July 5, 1994, the trustees and officers, as a group, did not own of record
or beneficially any of the outstanding shares of the Funds. Certain officers or
trustees who are shareholders of Franklin Resources, Inc. may be deemed to
receive indirect remuneration by virtue of their participation, if any, in the
fees paid to its subsidiaries. Charles E. Johnson is the son and nephew,
respectively, of Charles B. Johnson and Rupert H. Johnson, Jr., who are
brothers.
INVESTMENT ADVISORY AND OTHER SERVICES
The investment manager of each Fund in the Trust is Advisers. Advisers is a
wholly-owned subsidiary of Franklin Resources, Inc. ("Resources"), a
publicly-owned holding company whose shares are listed on the New York Stock
Exchange ("Exchange"). Resources owns several other subsidiaries which are
involved in investment management and shareholder services. The Manager and
other subsidiary companies of Resources currently manage over $112 billion in
assets for over 3.6 million shareholders. The preceding table indicates those
officers and trustees who are also affiliated persons of Distributors and
Advisers.
Pursuant to the management agreement, the Manager provides investment research
and portfolio management services, including the selection of securities for
the Funds to purchase, hold or sell and the selection of brokers through whom
each Fund's portfolio transactions are executed. The Manager's activities are
subject to the review and supervision of the trustees to whom the Manager
renders periodic reports of each Fund's investment activities. The Manager, at
its own expense, furnishes the Trust with office space and office furnishings,
facilities and equipment required for managing the business affairs of the
Trust; maintains all internal bookkeeping, clerical, secretarial and
administrative personnel and services; and provides certain telephone and other
mechanical services. The Manager is covered by fidelity insurance on its
officers, directors, and employees for the protection of the Trust. Each Fund
bears all of its expenses not assumed by the Manager. See the Statement of
Operations in the financial statements at the end of this Statement of
Additional Information for additional details of these expenses.
Pursuant to the management agreement, each Fund is obligated to pay the Manager
a fee equal to a monthly rate of 5/96 of 1% (approximately 5/8 of 1% per year)
for the first $100 million of net assets of the Fund; 1/24 of 1% (approximately
1/2 of 1% per year) on net assets of the Fund in excess of $100 million up to
$250 million; and 9/240 of 1% (approximately 45/100 of 1% per year) of net
assets of the Fund in excess of $250 million. The fee is computed and paid
monthly based on the average daily net assets of each Fund during the month.
The Manager has not imposed its management fees and has assumed responsibility
for making payments, if necessary, to offset certain operating expenses
otherwise payable by such Fund(s). This action by the Manager to limit its
management fees and to assume responsibility for payment of the expenses
related to the operations of the Funds may be terminated by the Manager at any
time. The management agreement specifies that the management fee will be
reduced to the extent neces-
<PAGE>
sary to comply with the most stringent limits on the expenses which may
be borne by each Fund as prescribed by any state in which such Fund's shares
are offered for sale. The most stringent current limit requires the Manager to
reduce or eliminate its fee to the extent that aggregate operating expenses of
each Fund (excluding interest, taxes, brokerage commissions and extraordinary
expenses such as litigation costs) would otherwise exceed in any fiscal year
2.5% of the first $30 million of average net assets of the Fund, 2% of the next
$70 million of average net assets of the Fund and 1.5% of average net assets of
the Fund in excess of $100 million. Expense reductions have not been necessary
based on state limitation requirements.
The table below sets forth on a per Fund basis the management fees which each
Fund was obligated to pay Advisers and the management fees actually paid by
each Fund for the fiscal years ended May 31, 1992, 1993, and 1994.
<TABLE>
<CAPTION>
1994 CONTRACTUAL MANAGEMENT
MANAGEMENT FEES PAID
FEES BY THE FUND
----------- -----------
<S> <C> <C>
Arkansas Fund............ $ 1,175 $0
California Fund.......... $111,730 $0
Hawaii Fund.............. $152,252 $0
Tennessee Fund........... $ 1,181 $0
Washington Fund.......... $ 22,669 $0
</TABLE>
<TABLE>
<CAPTION>
1993 CONTRACTUAL MANAGEMENT
MANAGEMENT FEES PAID
FEES BY THE FUND
----------- -----------
<S> <C> <C>
Arkansas Fund............ n/a n/a
California Fund.......... $ 1,175 $0
Hawaii Fund.............. $61,202 $0
Tennessee Fund........... n/a n/a
Washington Fund.......... $ 1,167 $0
</TABLE>
<TABLE>
<CAPTION>
1992 CONTRACTUAL MANAGEMENT
MANAGEMENT FEES PAID
FEES BY THE FUND
----------- -----------
<S> <C> <C>
Arkansas Fund............ n/a n/a
California Fund.......... n/a n/a
Hawaii Fund.............. $3,426 $0
Tennessee Fund........... n/a n/a
Washington Fund.......... n/a n/a
</TABLE>
The management agreement is in effect until March 31, 1995. Thereafter, it may
continue in effect for successive annual periods providing such continuance is
specifically approved at least annually by a vote of the Trust's Board of
Trustees or by a vote of the holders of a majority of each Fund's outstanding
voting securities, and in either event by a majority vote of the trustees who
are not parties to the management agreement or interested persons of any such
party (other than as trustees), cast in person at a meeting called for that
purpose. The management agreement may be terminated without penalty at any time
by the Trust or by the Manager on 30 days' written notice and will
automatically terminate in the event of its assignment, as defined in the 1940
Act.
OTHER SERVICES
Franklin/Templeton Investor Services, Inc. ("Investor Services" or "Shareholder
Services Agent"), a wholly-owned subsidiary of Resources, is the shareholder
servicing agent for the Funds and acts as the Funds' transfer agent and
dividend-paying agent. Investor Services is compensated on the basis of a fixed
fee per account.
Bank of America NT & SA, 555 California Street, 4th Floor, San Francisco,
California 94104, acts as custodian of the securities and other assets of the
Trust. Citibank Delaware, One Penn's Way, New Castle, Delaware 19720, acts as
custodian in connection with transfer services through bank automated clearing
houses. The custodians do not participate in decisions relating to the purchase
and sale of portfolio securities.
Coopers & Lybrand, 333 Market Street, San Francisco, California 94105, are the
Trust's independent auditors. During the fiscal year ended May 31, 1994, their
auditing services consisted of rendering an opinion on the financial statements
of the Trust included in the Trust's Annual Report and this Statement of
Additional Information.
THE TRUST'S POLICIES REGARDING
BROKERS USED ON PORTFOLIO TRANSACTIONS
Since most purchases made by the Trust are principal transactions at net
prices, the Trust incurs little or no brokerage costs. Each Fund deals directly
with the selling or purchasing principal or market maker without incurring
charges for the services of a broker on its behalf, unless it is determined
that a better price or execution may be obtained by utilizing the services of a
broker. Purchases of portfolio securities from underwriters include a
commission or concession paid by the issuer to the underwriter, and purchases
from dealers include a spread between the bid and ask price. As a general rule,
the Funds do not purchase bonds in underwritings where they are not given any
choice, or only limited choice, in the designation of dealers to receive the
commission. Each Fund seeks to obtain prompt execution of orders at the most
favorable net price. Transactions
<PAGE>
may be directed to dealers in return for research and statistical information,
as well as for special services rendered by such dealers in the execution of
orders. It is not possible to place a dollar value on the special executions or
on the research services received by Advisers from dealers effecting
transactions in portfolio securities. The allocations of transactions in order
to obtain additional research services permits Advisers to supplement its own
research and analysis activities and to receive the views and information of
individuals and research staff of other securities firms which the Manager or
its affiliates may lawfully and appropriately use in their investment advisory
capacities with other clients. Provided that best execution is obtained, the
sale of Fund shares may also be considered as a factor in the selection of
broker-dealers to execute each Fund's portfolio transactions.
If purchases or sales of securities of a Fund and one or more other investment
companies or clients supervised by the Manager are considered at or about the
same time, transactions in such securities will be allocated among the several
investment companies and clients in a manner deemed equitable to all by the
Manager, taking into account the respective sizes of each Fund and the amount
of securities to be purchased or sold. It is recognized that in some cases this
procedure could possibly have a detrimental effect on the price or volume of
the security so far as any Fund is concerned. In other cases, it is possible
that the ability to participate in volume transactions and to negotiate lower
brokerage commissions will be beneficial to a Fund.
During the past year ended May 31, 1994, the Funds paid no brokerage
commissions. As of May 31, 1994, the Funds did not own securities of their
regular broker-dealers.
ADDITIONAL INFORMATION
REGARDING FUND SHARES
All checks, drafts, wires and other payment mediums used for purchasing or
redeeming shares of the Funds must be denominated in U.S. dollars. Each Fund
reserves the right, in its sole discretion, to either (a) reject any order for
the purchase or sale of shares denominated in any other currency or (b) to
honor the transaction or make adjustments to a shareholder's account for the
transaction as of a date and with a foreign currency exchange factor determined
by the drawee bank.
Shares are eligible to receive dividends beginning on the first business day
following settlement of the purchase transaction through the date on which the
Fund writes a check or sends a wire on redemption transactions.
Dividend checks which are returned to the Funds marked "unable to forward" by
the postal service will be deemed to be a request by the shareholder to change
the dividend option and the proceeds will be reinvested in additional shares at
the net asset value until new instructions are received.
Each Fund may deduct from a shareholder's account the costs of its efforts to
locate a shareholder if mail is returned as undeliverable or the Fund is
otherwise unable to locate the shareholder or verify the current mailing
address. These costs may include a percentage of the account when a search
company charges a percentage fee in exchange for their location services.
Under agreements with certain banks in Taiwan, Republic of China, the Funds'
shares are available to such banks' discretionary trust funds at net asset
value. The banks may charge service fees to their customers who participate in
the discretionary trusts. Pursuant to agreements, a portion of such service
fees may be paid to Distributors, or an affiliate of Distributors, to help
defray expenses of maintaining a service office in Taiwan, including expenses
related to local literature fulfillment and communication facilities.
Shares of the Funds may be offered to investors in Taiwan through securities
firms known locally as Securities Investment Consulting Enterprises. In
conformity with local business practices in Taiwan, shares of each Fund will be
offered with the following schedule of sales charges:
<TABLE>
<CAPTION>
SALES
SIZE OF PURCHASE (IN U.S. DOLLARS) CHARGE
- ---------------------------------- ------
<S> <C>
Up to $100,000................................ 3%
$100,000 to $1,000,000........................ 2%
Over $1,000,000............................... 1%
</TABLE>
PURCHASES AND REDEMPTIONS
THROUGH SECURITIES DEALERS
Orders for the purchase of shares of each Fund received in proper form prior to
1:00 p.m. Pacific time any business day that the Exchange is open for trading
and promptly transmitted to the Fund will be based upon the public offering
price determined that day. Purchase orders received by securities dealers or
other financial institutions after 1:00 p.m. Pacific time will be effected at
the Fund's public offering price on the day it is next calculated. The use of
the term "securities dealer" herein shall include other financial institutions
which, pursuant to an agreement with Distributors (directly or through
affiliates), handle customer orders and accounts
<PAGE>
with the Fund. Such reference however is for convenience only and does not
indicate a legal conclusion of capacity.
Orders for the redemption of shares are effected at net asset value subject to
the same conditions concerning time of receipt in proper form. It is the
securities dealer's responsibility to transmit the order in a timely fashion
and any loss to the customer resulting from failure to do so must be settled
between the customer and the securities dealer.
PURCHASES AT NET ASSET VALUE
As discussed in the Prospectus, certain categories of investors may purchase
shares of the Funds at net asset value (without a sales charge) or at a reduced
sales charge. The reason for this is that there is minimal or no sales effort
required with respect to these investors. If certain investments at net asset
value are made through a dealer who has executed a dealer or similar agreement
with Distributors, Distributors or its affiliates may make a payment, out of
their own resources, to such dealer in an amount not to exceed 0.25% of the
amount invested, paid pro rata on a quarterly basis on average quarterly
balances for a period of one year.
REDEMPTIONS IN KIND
Each Fund has committed itself to pay in cash (by check) all requests for
redemption by any shareholder of record, limited in amount, however, during any
90-day period to the lesser of $250,000 or 1% of the value of a Fund's net
assets at the beginning of such period. Such commitment is irrevocable without
the prior approval of the SEC. In the case of requests for redemption in excess
of such amounts, the trustees reserve the right to make payments in whole or in
part in securities or other assets of the Fund from which the shareholder is
redeeming, in case of an emergency, or if the payment of such a redemption in
cash would be detrimental to the existing shareholders of such Fund. In such
circumstances, the securities distributed would be valued at the price used to
compute a Fund's net assets. Should a Fund do so, a shareholder may incur
brokerage fees in converting the securities to cash. The Funds do not intend to
redeem illiquid securities in kind; however, should it happen, shareholders may
not be able to timely recover their investment and may also incur brokerage
costs in selling such securities.
REDEMPTIONS BY EACH FUND
Due to the relatively high cost of handling small investments, each Fund
reserves the right to redeem, involuntarily, at net asset value, the shares of
any shareholder whose account has a value of less than one-half of the initial
minimum investment required for that shareholder, but only where the value of
such account has been reduced by the shareholder's prior voluntary redemption
of shares. Until further notice, it is the present policy of each Fund not to
exercise this right with respect to any shareholder whose account has a value
of $50 or more. In any event, before the Fund redeems such shares and sends the
proceeds to the shareholder, it will notify the shareholder that the value of
the shares in the account is less than the minimum amount and allow the
shareholder 30 days to make an additional investment in an amount which will
increase the value of the account to at least $100.
CALCULATION OF NET ASSET VALUE
As noted in the Prospectus, each Fund generally calculates net asset value as
of 1:00 p.m. Pacific time each day that the Exchange is open for trading. As of
the date of this Statement of Additional Information, the Trust is informed
that the Exchange observes the following holidays: New Year's Day, Presidents'
Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day
and Christmas Day.
The Fund's portfolio securities are valued as stated in the Prospectus.
Generally, trading in corporate bonds, U.S. government securities and money
market instruments is substantially completed each day at various times prior
to the close of the Exchange. The values of such securities used in computing
the net asset value of the Fund's shares are determined as of such times.
Occasionally, events affecting the values of such securities may occur between
the times at which they are determined and 1:00 p.m. Pacific time which will
not be reflected in the computation of the Fund's net asset value. If events
materially affecting the value of such securities occur during such period,
then these securities will be valued at their fair value as determined in good
faith by the Board of Trustees.
REINVESTMENT DATE
The dividend reinvestment date is the date on which additional shares are
purchased for the investor who has elected to have dividends reinvested. This
date will vary from month to month, based on operational considerations, and is
not necessarily the same date as the payable date for cash dividends.
SPECIAL SERVICES
The Trust and Institutional Services Division of Distributors provides
specialized services, including
<PAGE>
recordkeeping, for institutional investors of the Funds. The cost of these
services is not borne by the Funds.
Investor Services may pay certain financial institutions, which maintain
omnibus accounts with the Funds on behalf of numerous beneficial owners, for
recordkeeping operations performed with respect to such beneficial owners. For
each beneficial owner in the omnibus account, the Funds may reimburse Investor
Services an amount not to exceed the per account fee which the Funds normally
pay Investor Services. Such financial institutions may also charge a fee for
their services directly to their clients.
THE TRUST'S UNDERWRITER
Pursuant to an underwriting agreement in effect until March 31, 1995,
Distributors acts as principal underwriter in a continuous public offering for
shares of each Fund.
Distributors pays the expenses of distribution of each Fund's shares, including
advertising expenses and the costs of printing sales material and prospectuses
used to offer shares to the public. Each Fund pays the expenses of preparing
and printing amendments to its registration statements and prospectuses (other
than those necessitated by the activities of Distributors) and of sending
prospectuses to existing shareholders.
The underwriting agreement will continue in effect for successive annual
periods provided that its continuance is specifically approved at least
annually by a vote of the Trust's Board of Trustees or by a vote of the holders
of a majority of the outstanding voting securities of each Fund, and in either
event by a majority vote of the Trust's trustees who are not parties to the
underwriting agreement or interested persons of any such party (other than as
trustees of the Trust), cast in person at a meeting called for that purpose.
The underwriting agreement terminates automatically in the event of its
assignment and may be terminated by either party on 90 days' written notice.
Underwriting commissions received by Distributors and the amounts which were
subsequently paid by Distributors for each of the last three fiscal years
ending on May 31, 1994, 1993 and 1992 were as follows:
<TABLE>
<CAPTION>
1994 TOTAL PAID TO
COMMISSIONS OTHER
RECEIVED DEALERS
----------- --------
<S> <C> <C>
Arkansas Fund.............. $0 $0
California Fund............ $847,492 $781,267
Hawaii Fund................ $420,455 $369,296
Tennessee Fund............. $0 $0
Washington Fund............ $ 81,291 $ 77,955
</TABLE>
<TABLE>
<CAPTION>
1993 TOTAL PAID TO
COMMISSIONS OTHER
RECEIVED DEALERS
----------- --------
<S> <C> <C>
Arkansas Fund.............. n/a n/a
California Fund............ $1,801 $0
Hawaii Fund................ $538,200 $483,833
Tennessee Fund............. n/a n/a
Washington Fund............ $0 $0
</TABLE>
<TABLE>
<CAPTION>
1992 TOTAL PAID TO
COMMISSIONS OTHER
RECEIVED DEALERS
----------- --------
<S> <C> <C>
Arkansas Fund.............. n/a n/a
California Fund............ n/a n/a
Hawaii Fund................ $27,465 $26,794
Tennessee Fund............. n/a n/a
Washington Fund............ n/a n/a
</TABLE>
DISTRIBUTION PLANS
The Funds have adopted Distribution Plans pursuant to Rule 12b-1 under the 1940
Act (the "Plans"), whereby the Hawaii Fund may pay up to a maximum of 0.10% per
annum (1/10 of 1%) of its average daily net assets for expenses incurred in the
promotion and distribution of its shares, and the Arkansas, California,
Tennessee and Washington Funds may pay up to a maximum of 0.15% per annum (1/15
of 1%) of their average daily net assets for expenses incurred in the promotion
and distribution of their shares.
Pursuant to these Plans, Distributors or others will be entitled to be
reimbursed each quarter (up to the maximum as stated above) for actual expenses
incurred in the distribution and promotion of a Fund's shares, including, but
not limited to, the printing of prospectuses and reports used for sales
purposes, expenses of preparing and distributing sales literature and related
expenses, advertisements, and other distribution-related expenses including a
prorated portion of Distributors' overhead expenses attributable to the
distribution of Fund shares, as well as any distribution or service fees paid
to securities dealers or their firms or others who have executed a servicing
agreement with a Fund, Distributors or its affiliates.
<PAGE>
In addition to the payments to which Distributors or others are entitled under
the Plans, the Plans also provide that to the extent a Fund, the Manager or
Distributors or other parties on behalf of a Fund, the Manager or Distributors,
make payments that are deemed to be payments for the financing of any activity
primarily intended to result in the sale of shares of a Fund within the context
of Rule 12b-1 under the 1940 Act, then such payments shall be deemed to have
been made pursuant to the Plan.
In no event shall the aggregate asset-based sales charges which include
payments made under the Plans, plus any other payments deemed to be made
pursuant to the Plans, exceed the amount permitted to be paid pursuant to the
Rules of Fair Practice of the National Association of Securities Dealers, Inc.,
Article III, Section 26(d)4.
The terms and provisions of the Plans relating to required reports, term, and
approval are consistent with Rule 12b-1. The Plans do not permit unreimbursed
expenses incurred in a particular year to be carried over to or reimbursed in
subsequent years.
To the extent fees are for distribution or marketing functions, as
distinguished from administrative servicing or agency transactions, certain
banks will not be entitled to participate in the Plans as a result of
applicable federal law prohibiting certain banks from engaging in the
distribution of mutual fund shares. Such banking institutions, however, are
permitted to receive fees under the Plans for administrative servicing or for
agency transactions. If a bank were prohibited from providing such services,
its customers who are shareholders would be permitted to remain shareholders of
a Fund and alternate means for continuing the servicing of such shareholders
would be sought. In such an event, changes in the services provided might occur
and such shareholders might no longer be able to avail themselves of any
automatic investment or other services then being provided by the bank. It is
not expected that shareholders would suffer any adverse financial consequences
as a result of any of these changes. Securities laws of states in which a
Fund's shares are offered for sale may differ from the interpretations of
federal law expressed herein, and banks and financial institutions selling
shares of a Fund may be required to register as dealers pursuant to state law.
The Board of Trustees has determined that a consistent cash flow resulting from
the sale of new shares is necessary and appropriate to meet redemptions and to
take advantage of buying opportunities of portfolio securities without having
to make unwarranted liquidations of other portfolio securities. The Board of
Trustees, therefore, felt that it would benefit each Fund to have monies
available for the direct distribution activities of Distributors or others in
promoting the sale of its shares. The Board of Trustees, including the
non-interested trustees, concluded that, in the exercise of their reasonable
business judgment and in light of their fiduciary duties, there is a reasonable
likelihood that the Plans will benefit each Fund and its shareholders.
Each Plan has been approved by Resources, each Fund's initial shareholder, and
by the trustees, including those trustees who are not interested persons, as
defined in the 1940 Act. The Plans for the Hawaii, California and Washington
Funds are effective through March 31, 1995. The Plans for the Arkansas and
Tennessee Funds are initially effective through May 9, 1995. Each plan is
renewable annually by a vote of the Trust's Board of Trustees, including a
majority vote of the trustees who are non-interested persons of the Trust and
who have no direct or indirect financial interest in the operation of the
Plans, cast in person at a meeting called for that purpose. It is also required
that the selection and nomination of such trustees be done by the
non-interested trustees. Each Plan and any related agreement may be terminated
at any time, without any penalty, by vote of a majority of the non-interested
trustees on not more than 60 days' written notice, by Distributors on not more
than 60 days' written notice, by any act that constitutes an assignment of the
Management Agreement with the Manager or the Underwriting Agreement with
Distributors, or, as to each Fund, by vote of a majority of that Fund's
outstanding shares. Distributors or any dealer or other firm may also terminate
their respective distribution or service agreement at any time upon written
notice.
Each Plan and any related agreements may not be amended to increase materially
the amount to be spent for distribution expenses without approval by a majority
of each Fund's outstanding shares, and all such material amendments to the Plan
or any related agreements shall be approved by a vote of the non-interested
trustees, cast in person at a meeting called for the purpose of voting on any
such amendment.
Distributors is required to report in writing to the Board of Trustees at least
quarterly on the amounts and purpose of any payment made under the Plans and
any related agreements, as well as to furnish the Board of Trustees with such
other information as may reasonably be requested in order to enable the Board
of Trustees to make an informed determination of whether the Plans should be
continued.
<PAGE>
ADDITIONAL INFORMATION REGARDING TAXATION
As stated in the Prospectus, each fund has elected and/or intends to elect to
be treated as a regulated investment company under Subchapter M of the Internal
Revenue Code of 1986, as amended (the "Code"). The trustees reserve the right
not to maintain the qualification of any Fund as a regulated investment company
if they determine such course of action to be beneficial to the shareholders.
In such case, a Fund will be subject to federal and possibly state corporate
taxes on its taxable income and gains, to the alternative minimum tax on a
portion of its tax-exempt income, and distributions (including tax-exempt
interest dividends to shareholders) will be taxable to the extent of such
Fund's available earnings and profits.
The Code requires all funds to distribute at least 98% of their taxable
ordinary income earned during the calendar year and at least 98% of their
capital gain net income earned during the twelve-month period ending October 31
of each year (in addition to amounts from the prior year that were neither
distributed nor taxed to the Fund) to shareholders by December 31 of each year
in order to avoid the imposition of a federal excise tax. Under these rules,
certain distributions which are declared in October, November or December but
which, for operational reasons, may not be paid to the shareholder until the
following January, will be treated for tax purposes as if paid by the Funds and
received by the shareholder on December 31 of the calendar year in which they
are declared. Each Fund intends as a matter of policy to declare and pay such
dividends, if any, in December to avoid the imposition of this tax, but does
not guarantee that its distributions will be sufficient to avoid any or all
federal excise taxes.
Redemptions and exchanges of Fund shares are taxable transactions for federal
and state income tax purposes. For most shareholders, gain or loss will be
recognized in an amount equal to the difference between the shareholder's basis
in the shares and the amount received, subject to the rules described below. If
such shares are a capital asset in the hands of the shareholder, gain or loss
will be capital gain or loss and will be long-term for federal income tax
purposes if the shares have been held for more than one year.
Since the Funds' income is derived from interest income and gain on the sale of
portfolio securities rather than dividend income, no portion of the Funds'
distributions will generally be eligible for the corporate dividends-received
deduction. None of the distributions paid by the Funds for the fiscal year
ended May 31, 1994, qualified for this deduction and it is not anticipated that
any of the current year dividends for any of the Funds will so qualify.
All or a portion of a loss realized upon a redemption of shares will be
disallowed to the extent other shares of such Fund are purchased (through
reinvestment of dividends or otherwise) within 30 days before or after such
redemption. Any loss disallowed under these rules will be added to the tax
basis of the shares purchased.
Many states grant tax-free status to dividends paid to shareholders of mutual
funds from interest income earned by a Fund from direct obligations of the U.S.
Government, subject in some states to minimum investment requirements that must
be met by a fund. Investments in GNMA/FNMA securities and repurchase agreements
collateralized by U.S. Government securities do not generally qualify for
tax-free treatment. While it is not the primary investment objective of any
Fund of the Trust to invest in such obligations, the Funds are authorized to so
invest for temporary or defensive purposes. To the extent that such investments
are made, any affected Fund will provide shareholders with the percentage of
any dividends paid which may qualify for such tax-free treatment at the end of
each calendar year. Shareholders should then consult with their own tax
advisers with respect to the application of their state and local laws to these
distributions and on the application of other state and local laws on
distributions and redemption proceeds received from the Fund.
Persons who are defined in the Code as "substantial users" (or related persons)
of facilities financed by private activity bonds should consult with their tax
advisors before purchasing shares of any Fund.
GENERAL INFORMATION
PERFORMANCE
As noted in the Prospectus, a Fund may from time to time quote various
performance figures to illustrate its past performance. It may occasionally
cite statistics to reflect its volatility or risk.
Performance quotations by investment companies are subject to rules adopted by
the SEC. These rules require the use of standardized performance quotations or,
alternatively, that every non-standardized performance quotation furnished by a
Fund be accompanied by certain standardized performance information computed as
required by the SEC. Current yield and average annual com-
<PAGE>
pounded total return quotations used by the Funds are based on the
standardized methods of computing performance mandated by the Securities and
Exchange Commission. An explanation of those and other methods used by the
Funds to compute or express performance follows.
TOTAL RETURN
The average annual total return is determined by finding the average annual
compounded rates of return over one-, five-, and ten-year periods, or
fractional portion thereof, that would equate an initial hypothetical $1,000
investment to its ending redeemable value. The calculation assumes the maximum
sales charge is deducted from the initial $1,000 purchase order, income
dividends and capital gains are reinvested at net asset value on the
reinvestment dates during the period. The quotation assumes the account was
completely redeemed at the end of each one-, five-, and ten-year period and the
deduction of all applicable charges and fees.
In considering the quotations of total return by a Fund, investors should
remember that the sales charge reflected in each quotation is the maximum one
time fee (charged on all direct purchases) which will have its greatest impact
during the early stages of an investor's investment in one of the Funds. The
actual performance of an investment will be affected less by this charge the
longer an investor retains the investment in such Fund.
<TABLE>
<CAPTION>
AVERAGE ANNUAL
TOTAL RETURN
--------------------
INCEPTION ONE- FROM
OF THE fUND YEAR INCEPTION
----------- ----- ---------
<S> <C> <C> <C>
Arkansas Fund.......... 05/10/94 n/a n/a
California Fund........ 05/03/93 3.94% -2.21%
Hawaii Fund............ 02/26/92 -5.52% 4.65%
Tennessee Fund......... 05/10/94 n/a n/a
Washington Fund........ 05/03/93 -6.98% -4.42%
</TABLE>
These figures were calculated according to the following SEC formula:
P(1+T)n = ERV
where:
P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $1,000 payment made at the
beginning of the one-, five-, or ten-year periods at the end of the one-,
five-, or ten-year periods (or fractional portion thereof)
As discussed in the Prospectus, a Fund may quote total rates of return in
addition to its average annual total return. Such quotations are computed in
the same manner as a Fund's average annual compounded rate, except that such
quotations will be based on a Fund's actual return for a specified period
rather than on its average return over one-, five-, and ten-year periods.
<TABLE>
<CAPTION>
AGGREGATE
TOTAL RETURN
--------------------
INCEPTION ONE- FROM
OF THE fUND YEAR INCEPTION
----------- ----- ---------
<S> <C> <C> <C>
Arkansas Fund.......... 05/10/94 n/a n/a
California Fund........ 05/03/93 -1.29% -1.57%
Hawaii Fund............ 02/26/92 -3.00% 12.02%
Tennessee Fund......... 05/10/94 n/a n/a
Washington Fund........ 05/03/93 -4.07% -4.16%
</TABLE>
In considering the quotations of total return by a Fund, investors should
remember that the sales charge reflected in each quotation is the maximum one
time fee (charged on all direct purchases) which will have its greatest impact
during the early stages of an investor's investment in one of the Funds. The
actual performance of an investment will be affected less by this charge the
longer an investor retains the investment in such Fund.
Yield
Current yield reflects the income per share earned by a Fund's portfolio
investments.
Current yield is determined by dividing the net investment income per share
earned during a 30-day base period by the maximum offering price per share on
the last day of the period and annualizing the result. Expenses accrued for the
period include any fees charged to all shareholders during the base period. The
yield for each of the Funds for the 30-day period ended on the date of the
financial statements included herein were as follows:
<TABLE>
<S> <C>
Arkansas Fund................................ n/a
Hawaii Fund.................................. 5.81%
California Fund.............................. 6.61%
Tennessee Fund............................... n/a
Washington Fund.............................. 5.91%
</TABLE>
These figures were obtained using the following SEC formula:
Yield = 2[(a-b + 1)6 -1]
---
cd
<PAGE>
where:
a = interest earned during the period
b = expenses accrued for the period (net of reimbursements)
c = the average daily number of shares outstanding during the period that
were entitled to receive dividends
d = the maximum offering price per share on the last day of the period
Tax Equivalent Yield
A Fund may also quote a tax equivalent yield which demonstrates the taxable
yield necessary to produce an after-tax yield equivalent to that of a fund
which invests in tax-exempt obligations. Such yield is computed by dividing
that portion of the yield of a Fund (computed as indicated above) which is
tax-exempt by one minus the highest applicable combined federal and state
income tax rate (and adding the product to that portion of the yield of a Fund
that is not tax-exempt, if any). The tax equivalent yield for each of the Funds
for the 30-day period ended on the date of the financial statements included
herein were as follows:
<TABLE>
<S> <C>
Arkansas Fund................................ n/a
California Fund.............................. 12.30%
Hawaii Fund.................................. 10.69%
Tennessee Fund............................... n/a
Washington Fund.............................. 9.78%
</TABLE>
As of the date of this Statement of Additional Information, the state and the
combined state and federal income tax rates upon which tax equivalent yield
quotations are based are 10% and 45.64% for the Hawaii Fund, 11% and 46.24% for
the California High Yield Fund, 7% and 43.83% for the Arkansas Fund, and 6% and
39.6% for the Tennessee Fund. For the Washington Fund, which currently has no
state income tax, the maximum federal tax rate of 39.6% will be used. The tax
equivalent yield quotations by the Funds will be based upon a 39.6% federal
income tax rate.
From time to time, as any changes to such rates become effective, tax
equivalent yield quotations advertised by the Funds will be updated to reflect
such changes. The Funds expect updates may be necessary as tax rates are
frequently changed by federal, state and local governments. The advantage of
tax-free investments, such as in the Funds of the Trust, will be enhanced by
any tax rate increases. Therefore, the details of specific tax increases may be
used in sales material for each Fund.
CURRENT DISTRIBUTION RATE
Current yield and tax equivalent yield, which are calculated according to
a formula prescribed by the SEC, are not indicative of the amounts which were
or will be paid to a Fund's shareholders. Amounts paid to shareholders are
reflected in the quoted current distribution rate or taxable equivalent
distribution rate. The current distribution rate is computed by dividing the
total amount of dividends per share paid by the Fund during the past 12 months
by a current maximum offering price. A taxable equivalent distribution rate
demonstrates the taxable distribution rate equivalent to a Fund's current
distribution rate (calculated as indicated above). The advertised taxable
equivalent distribution rate will reflect the most current federal and state
tax rates available to a Fund.
Under certain circumstances, such as when there has been a change in the amount
of dividend payout or a fundamental change in investment policies, it might be
appropriate to annualize the dividends paid over the period such policies were
in effect, rather than using the dividends during the past 12 months. The
current distribution rate differs from the current yield computation because it
may include distributions to shareholders from sources other than dividends and
interest, such as short-term capital gains, and is calculated over a different
period of time.
VOLATILITY
Occasionally, statistics may be used to specify Fund volatility or risk.
Measures of volatility or risk are generally used to compare Fund net asset
value or performance relative to a market index. One measure of volatility or
risk is standard deviation. Standard deviation is used to measure variability
of net asset value or total return around an average, over a specified period
of time. The premise is that greater volatility connotes greater risk
undertaken in achieving performance.
OTHER PERFORMANCE QUOTATIONS
With respect to those categories of investors who are permitted to purchase
shares of a Fund at net asset value, sales literature pertaining to a Fund may
quote a "Current Distribution Rate for Net Asset Value Investments." This rate
is computed by adding the income dividends paid by a Fund during the last 12
months and dividing that sum by a current net asset value. Figures for yield,
total return and other measures of performance for Net Asset Value Investments
may also be quoted. These will be derived as described elsewhere in this State-
<PAGE>
ment of Additional Information with the substitution of net asset value
for public offering price.
Regardless of the method used, past performance is not necessarily indicative
of future results, but is an indication of the return to shareholders only for
the limited historical period used.
The Funds may include in their advertising or sales material information
relating to investment objectives and performance results of funds belonging to
the Templeton Group of Funds. Resources is the parent company of the advisers
and underwriter of both the Franklin Group of Funds(R) and Templeton Group of
Funds.
COMPARISONS
To help investors better evaluate how an investment in a Fund might satisfy
their investment objective, advertisements and other materials regarding the
Funds may discuss various measures of Fund performance as reported by various
financial publications. Materials may also compare performance (as calculated
above) to performance as reported by other investments, indices, and averages.
Such comparisons may include, but are not limited to, the following examples:
a) Salomon Brothers Broad Bond Index or its component indices - The Broad Index
measures yield, price, and total return for Treasury, Agency, Corporate, and
Mortgage bonds.
b) Lehman Brothers Aggregate Bond Index or its component indices - The
Aggregate Bond Index measures yield, price and total return for Treasury,
Agency, Corporate, Mortgage, and Yankee bonds.
c) Lehman Brothers Municipal Bond Index (LBMBI) or its component indices -
LBMBI measures yield, price and total return for the municipal bond market.
d) Bond Buyer's 20-Bond Index - an index of municipal bond yields based upon
yields of 20 general obligation bonds maturing in 20 years.
e) Bond Buyer's 30-Bond Index - an index of municipal bond yields based upon
yields of 20 revenue bonds maturing in 30 years.
f) Bond Buyers 40 Bond Index - an index based on the yields of 40 long-term
tax-exempt municipal bonds. Designed to be the basis for the Municipal Bond
Index in futures contracts.
g) Financial publications: The Wall Street Journal and Business Week, Financial
World, Forbes, Fortune, and Money magazines - provide performance statistics
over specified time periods.
h) Salomon Brothers Composite High Yield Index or its component indices - The
High Yield Index measures yield, price and total return for Long-Term
High-Yield Index, Intermediate-Term High-Yield Index, Long-Term Utility
High-Yield Index.
i) Historical data supplied by the research departments of First Boston
Corporation, the J. P. Morgan companies, Salomon Brothers, Merrill Lynch,
Pierce, Fenner & Smith, Lehman Brothers and Bloomberg, L.P.
j) Merrill Lynch California Municipal Bond Index - based upon yields from
revenue and general obligation bonds weighted in accordance with their
respective importance to the California municipal market. The index is
published weekly in the Los Angeles Times and the San Francisco Chronicle.
k) Lipper - Mutual Fund Performance Analysis and Lipper - Fixed Income Fund
Performance Analysis - measure total return and average current yield for the
mutual fund industry and rank individual mutual fund performance over specified
time periods, assuming reinvestment of all distributions, exclusive of any
applicable sales charges.
l) Savings & Loan Historical Interest Rates as published by the U.S. Savings &
Loan League Fact Book.
m) Inflation as measured by the Consumer Price Index, published by the U.S.
Bureau of Labor Statistics.
From time to time, advertisements or information for the Funds may include a
discussion of certain attributes or benefits to be derived by an investment in
the Funds. Such advertisements or information may include symbols, headlines,
or other material which highlight or summarize the information discussed in
more detail in the communiciation.
Advertisements or information may also compare the Funds' performance to the
return on certificates of deposit or other investments. Investors should be
aware, however, that an investment in the Funds involve the risk of fluctuation
of principal value, a risk generally not present in an investment in a
certificate of deposit issued by a bank. For example, as the general level of
interest rates rise, the value of the Funds' fixed-income investments, as well
as the value of their shares which are based upon the value of such portfolio
investments, can be expected to decrease. Conversely, when interest rates
decrease, the value of the Funds' shares can be expected to increase.
Certificates of deposit are frequently insured by an agency of the U.S.
government. An investment in the Funds is not insured by any federal, state or
private entity.
In assessing such comparisons of performance, an investor should keep in mind
that the composition
<PAGE>
of the investments in the reported indices and averages is not identical to the
Funds' portfolio, that the indices and averages are generally unmanaged, and
that the items included in the calculations of such averages may not be
identical to the formula used by the Funds to calculate their figures. In
addition there can be no assurance that the Funds will continue this
performance as compared to such other averages.
OTHER FEATURES AND BENEFITS
Each of the Funds may help investors achieve various investment goals such as
accumulating money for retirement, saving for a down payment on a home, college
cost and/or other long-term goals. The Franklin College Costs Planner may
assist an investor in determining how much money must be invested on a monthly
basis in order to have a projected amount available in the future to fund a
child's college education. (Projected college cost estimates are based upon
current costs published by the College Board.) The Franklin Retirement Planning
Guide leads an investor through the steps to start a retirement savings
program. Of course, an investment in a Fund cannot guarantee that such goals
will be met.
The Dalbar Surveys, Inc. broker/dealer has ranked Franklin number one of 36
mutual fund groups in service quality for five out of the past six years.
MISCELLANEOUS INFORMATION
The Funds of the Trust are members of the Franklin/Templeton Group, one of the
largest mutual fund organizations in the United States and may be considered in
a program for diversification of assets. Founded in 1947, Franklin, one of the
oldest mutual fund organizations, has managed mutual funds for over 45 years
and now services more than 2.4 million shareholder accounts. In 1992, Franklin,
a leader in managing fixed-income mutual funds and an innovator in creating
domestic equity funds, joined forces with Templeton Worldwide, Inc., a pioneer
in international investing. Together, the Franklin/Templeton Group has over
$112 billion in assets under management for more than 3.6 million shareholder
accounts and offers 101 U.S.-based mutual funds. Each Fund may identify itself
by its NASDAQ or CUSIP number.
The Dalbar Surveys, Inc. broker/dealer survey has ranked Franklin number one of
36 mutual fund groups in service quality for 1993. One other fund group
was also ranked number one. Franklin has been ranked number one in service
quality by Dalbar for five of the past six years.
From time to time advertisements or sales material issued by the Fund may
discuss or be based upon information in a recent issue of the Special
Report on Tax Freedom Day published by the Tax Foundation, a Washington, D.C.
based nonprofit, research and public education organization. The report
illustrates, among other things, the amount of time, on an annual basis, the
average taxpayer works to satisfy his or her tax obligations to the federal,
state and local taxing authorities.
Franklin is one of the largest and oldest managers of municipal bond funds in
the country. Franklin currently offers 40 tax-free and municipal bond funds
(funds whose dividends may be subject to the alternative minimum tax system),
including 31 funds free from both federal and state personal income taxes, and
manages over $43.1 billion in municipal securities for more than half a million
investors.
Under current tax laws, municipal securities remain one of the few investments
offering the potential for tax-free income. In 1994, taxes could cost as much
as $47 on every $100 earned from a fully taxable investment (based on the
combined 39.6% federal tax rate and the highest state tax rate of 12% for 1994.
In addition, investors subject to the federal or state alternative minimum tax
may find a small portion of their income distribution subject to such tax.)
Franklin municipal securities funds, however, offer tax relief through a
professionally managed portfolio of municipal securities selected based on
their yield, quality and maturity. An investment in a Franklin municipal
securities fund can provide an investor with the potential to earn income
exempt from regular federal income taxes, and depending on the fund, state and
local taxes as well, while supporting state and local public projects. Franklin
municipal funds may also provide potential tax-free compounding, when dividends
are reinvested. An investment in Franklin's municipal securities funds can grow
more rapidly than a similar taxable investment.
GENERAL
The Trust will amortize the organizational expenses attributable to each Fund
over a period of five years from the effective date of the registration
statement covering each Fund. New investors purchasing shares of a Fund after
the effective date of such Fund's registration statement under the Securities
Act of 1933 will be bearing such expenses during the amortization period.
The shareholders of a Delaware business trust could, under certain
circumstances, be held personally liable as partners for its obligations.
However, the Trust's Declaration of Trust contains an
<PAGE>
express disclaimer of shareholder liability for acts or obligations of the
Trust. The Declaration of Trust also provides for indemnification and
reimbursement of expenses out of Trust assets for any shareholder held
personally liable for obligations of the Trust. The Declaration of Trust
provides that the Trust shall, upon request, assume the defense of any claim
made against any shareholder for any act or obligation of the Trust and satisfy
any judgement thereon. All such rights are limited to the assets of the Fund(s)
of which a shareholder holds shares. The Declaration of Trust further provides
that the Trust may maintain appropriate insurance (for example, fidelity
bonding, and errors and omissions insurance) for the protection of the Trust,
its shareholders, trustees, officers, employees and agents to cover possible
tort and other liabilities. Thus, the risk of a shareholder incurring financial
loss on account of shareholder liability is limited to circumstances in which
both inadequate insurance exists and the Trust itself is unable to meet its
obligations.
From time to time, the number of shares of each Fund held in the "street name"
accounts of various securities dealers for the benefit of their clients or in
centralized securities depositories may exceed 5% of the total shares
outstanding. To the best knowledge of the Trust, as of July 5, 1994, the
principal shareholders of the Funds, beneficial or of record, their addresses
and the amount of their share ownership were as follows:
<TABLE>
<CAPTION>
NUMBER
OF SHARES PERCENTAGE
----------- ----------
<S> <C> <C>
ARKANSAS FUND
Franklin Resources, Inc. 220,000.000 87.9%
777 Mariners Island Blvd.
San Mateo, CA 94404
California Fund
Franklin Resources, Inc. 233,615.511 6.61%
777 Mariners Island Blvd.
San Mateo, CA 94404
The Foreman Family Trust 213,436.068 6.04%
4304 Valley Meadow Rd.
Encino, CA 91436-3441
Hawaii Fund
Franklin Resources, Inc. 226,910.102 8.65%
777 Mariners Island Blvd.
San Mateo, CA 94404
Tennessee Fund
Franklin Resources, Inc. 220,000.000 97.71%
777 Mariners Island Blvd.
San Mateo, CA 94404
</TABLE>
<TABLE>
<CAPTION>
NUMBER
OF SHARES PERCENTAGE
----------- ----------
<S> <C> <C>
WASHINGTON MUNICIPAL
BOND FUND
Franklin Resources, Inc. 231,605.795 50.81%
777 Mariners Island Blvd.
San Mateo, CA 94404
</TABLE>
OWNERSHIP AND AUTHORITY DISPUTES
In the event of disputes involving multiple claims of ownership or authority to
control a shareholder's account, the Trust has the right (but has no
obligation) to: (a) freeze the account and require the written agreement of all
persons deemed by the Trust to have a potential property interest in the
account, prior to executing instructions regarding the account; (b) interplead
disputed funds or accounts with a court of competent jurisdiction; or (c)
surrender ownership of all or a portion of the account to the Internal Revenue
Service in response to a Notice of Levy.
APPENDIX A-
FURTHER INFORMATION ON SPECIAL
FACTORS AFFECTING EACH STATE FUND
The following information is a summary of special factors affecting each of the
individual state Funds. It does not purport to be a complete description of
such factors and is based primarily upon information derived from public
documents relating to securities offerings of issuers of such states and other
historically reliable sources. The Trust has not independently verified any of
this data. The market value of the shares of any Fund may fluctuate due to
factors such as changes in interest rates, matters affecting a particular
state, or for other reasons.
ARKANSAS
From 1980-1990, Arkansas has had a 3.0% increase in population. Little
Rock -- North Little Rock, which has a population of over a half million, is
centrally located in Arkansas and serves as a major transportation,
governmental and industrial center of the state. Little Rock is home to the
largest regional airport in the state and also home to the University of
Arkansas for Medical Sciences, a comprehensive health center with five colleges
- -- Medicine, Nursing, Pharmacy, Health Related Professions and a Graduate
School.
Arkansas has shifted to a more diversified economic level, with less
emphasis on agriculture and a stronger emphasis on manufacturing, a leading
component of the state's economy, contributing
<PAGE>
approximately 25% of the total wage and salary component of personal income.
Employment distribution is fairly balanced between the state's four largest
non-agricultural industries: Manufacturing (25%), Wholesale and Retail Trade
(21.7%), Services (21.3%) and Government (18.0%), therefore reducing economic
risk to the state as a whole. The state's manufacturing expanded considerably
in the 1960's and 1970's, contributing to a reversal of population losses
experienced in earlier decades. Resource related industries dominate and the
largest employers are the food product, lumber and paper goods industries. The
agricultural sector, though much diminished in importance, remains a
significant contributor to state income. Chief products are poultry, rice and
soybeans.
The state unemployment rate had been declining from its peak of more than 10%
in 1983 to 6.9% in 1990 and has been increasing since that year as a result of
national recessionary pressures; 1992 average unemployment was 7.2%, but the
rate is expected to remain below 7% for the rest of the decade. Most of the
state's economic data such as personal income, wages and salaries, total
employment, population and housing starts have reflected growth trends in
general and are expected to continue to do so going forward. Income per capita,
at $15,439, is 78% of the national average and has maintained its relative
position despite economic growth trends.
The Constitution of the state does not limit the amount of general obligation
bonds which may be issued by the state; however, no such bonds may be issued
unless approved by the voters of the state at a general election or a special
election held for that purpose.
There is no constitutional limitation on the aggregate principal amount of
revenue bonds that may be issued by the state and its agencies. All revenue
bonds and notes are secured only by specific revenue streams and neither the
general revenues of the state nor its full faith and credit are pledged to
repayment.
In 1973, the state established the Revenue Stabilization Law (the "Act") which
governs the administration and distribution of state Revenues. The General
Assembly must enact legislation pursuant to this Act to provide for an
allotment process of funding appropriations in order to comply with state law
prohibiting deficit spending whereby spending is limited to actual revenues
received by the state. The governor may restrict spending to a level below the
level of appropriations.
Pursuant to the Stabilization Act, the General Assembly establishes three
levels of priority for general revenue spending, levels "A," "B," and "C."
Successive levels of appropriation are funded only in the event sufficient
revenues have been generated to fully fund any prior level. Accordingly,
appropriations made to programs and agencies are only maximum authorization to
spend. Actual expenditures are limited to the lesser of (i) moneys flowing into
a program or agencies' fund maintained by the Treasurer or (ii) the maximum
appropriation by the General Assembly.
Audited results show that Arkansas' revenues slightly exceeded expenditures
during fiscal years 1987 through 1992. Revenues exceeded distributions by $413
million for fiscal year 1993. Principal revenue sources are sales and use taxes
(36% of revenues), individual income taxes (34%), motor fuels tax (10%) and
corporate income taxes (5.4%). The state prepares financial plans on a biennial
basis and has adopted a $2.3 billion budget for fiscal year 1994.
Since state revenues are not collected throughout the year in a pattern
consistent with the program and agency expenditures, the Budget Stabilization
Trust, which receives one-half of the interest earnings from state fund
investments, has been established and is utilized to assure proper cash flow
during any period. Other interest earnings are pledged to special revenue
obligations or used to supplement the state's capital construction program.
A settlement reached in 1989 in a desegregation case involving the Little Rock
School District is projected to cost the state $131 million over a ten-year
period, with the bulk of the outlays expected in the first five years. These
additional outlays coincide with settlement of an earlier court case involving
a magnet school program in three central Arkansas school districts, projected
to cost $98 million over ten years. Fiscal year 1990 marked the peak year of
increased state outlays for these programs, with expenditures of $33.4 million;
another $24.7 million was spent in fiscal 1991. For the last biennium, the
state budgeted $31.6 million and $26.8 million.
CALIFORNIA
On June 6, 1978, California voters approved Proposition 13, which added Article
XIIIA to the California Constitution. The principal thrust of Article XIIIA is
to limit the amount of ad valorem taxes on real property to one percent of the
full cash value as determined by the county assessor. The assessed valuation of
all real property may be increased, but not in excess of two percent per year,
or decreased
<PAGE>
to reflect the rate of inflation or deflation as shown by the consumer price
index. Article XIIIA requires a vote of two thirds of the qualified electorate
to impose special taxes, and completely prohibits the imposition of any
additional ad valorem, sales or transaction tax on real property (other than ad
valorem taxes to repay general obligation bonds issued to acquire or improve
real property), and requires the approval of two-thirds of all members of the
State Legislature to change any state tax laws resulting in increased tax
revenues.
On November 6, 1979, California voters approved the initiative seeking to amend
the California Constitution entitled "Limitation of Government Appropriations"
which added Article XIIIB to the California Constitution. Under Article XIIIB
state and local governmental entities have an annual appropriations limit and
may not spend certain monies which are called appropriations subject to
limitations (consisting of tax revenues, state subventions and certain other
funds) in an amount higher than the appropriations limit. Generally, the
appropriations limit is to be based on certain 1978-79 expenditures, and is to
be adjusted annually to reflect changes in consumer prices, population and
services provided by these entities.
Decreases in state and local revenues in future fiscal years as a consequence
of these initiatives may continue to result in reductions in allocations of
state revenues to California municipal issuers or reduce the ability of such
California issuers to pay their obligations.
With the apparent onset of recovery in California's economy, revenue growth
over the next few years could recommence at levels that would enable California
to restore fiscal stability. The political environment, however, combined with
pressures on the state's financial flexibility, may frustrate its ability to
reach this goal. Strong interests in long-established state programs ranging
from low-cost public higher education access to lofty welfare and health
benefits join with the more recently emerging pressure for expanded prison
construction and a heightened awareness and concern over the state's business
climate.
Adopted on July 8, 1994, the fiscal 1995 budget is designed to address
California's accumulated deficit over a 22-month period. In order to balance
the budget and generate sufficient cash to retire the $4 billion deficit
Revenue Anticipation Warrant and a $3 billion Revenue Anticipation Note to be
issued in July 1995, the state's fiscal plan relies upon aggressive assumptions
of federal aid, projected at about $760 million in fiscal year 1995 and $2.8
billion in fiscal year 1996, to compensate the state for its costs of providing
services to illegal immigrants. These assumptions, combined with fiscal year
1996 constitutionally mandated increases in spending for K-14 education, and
continued growth in social services and corrections expenditures, are risky. To
offset this risk, the state has enacted a Budget Adjustment Law, known as the
"trigger" legislation, which establishes a set of backup budget adjustment
mechanisms to address potential shortfalls in cash. The trigger mechanism will
be in effect for both fiscal years 1995 and 1996.
In July of 1994, S&P and Moody's lowered the state's general obligation bond
rating. The rating agencies explained their actions by citing the state's
continuing deferral of substantial portions of its estimated $3.8 billion
accumulated deficit; continuing structural budgetary constraints including a
funding guarantee for K-14 education; overly optimistic expectation of federal
aid to balance fiscal year 1995's budget and fiscal year 1996's cash flow
projections; and reliance upon a trigger mechanism to reduce spending if the
plan's federal aid assumptions prove to be inflated.
HAWAII
Until recently, revenue growth outpaced expenditures, averaging 11% annually.
Increased spending pressures have caused this number to drop to 3% during the
state's 1989-90 fiscal year. Hawaii's general excise taxes and license fees
account for 42% of its total revenues, followed by individual and corporate
income taxes (27.4% and 3%, respectively). Until 1981, real property taxes were
collected by the state, but are now under each county's jurisdiction, averaging
between 15% and 17% of total revenues annually. A 1978 constitutional revision
provided that when the general fund balance exceeds 5% of revenues for two
consecutive years, tax credits are to be given to qualified residents. Pursuant
to this revision, $54 million was appropriated for the taxable year 1990.
Hawaii's debt levels are high relative to other states, due in large part to
high development and strong centralized government. Although gross debt has
risen rapidly, debt ratios other than per capita income, have declined,
reflecting the state's growth.
The economy of Hawaii is different from the rest of the U.S. Tourism and its
related business activities dominate the state's economy and therefore,
transportation, retailing and lodging, as well as the food industry, are more
important to Hawaii than in the U.S. Construction is also important because of
the state's growing population. In the 1980s construc-
<PAGE>
tion activity increased upon the insurgence of Japanese investment in Hawaii and
after experiencing many years of lower vacancy rates than the rest of the
nation, the economy began declining and vacancy rates increased sharply.
Although Hawaii's economy has been in recession for most of the last two years,
housing activity is rebounding. The median existing home price rose from
approximately $130,000 in 1980 to $370,000 in 1990. In the last few years,
however, prices have stabilized. This, along with the mortgage rate decline,
has improved affordability dramatically.
TENNESSEE
In 1978, the voters of the state of Tennessee approved an amendment to the
state Constitution requiring that (1) the total expenditures of the state for
any fiscal year shall not exceed the state's revenues and reserves, including
the proceeds of debt obligations issued to finance capital expenditures and (2)
in no year shall the rate of growth of appropriations from state tax revenues
exceed the estimated rate of growth of the state's economy. In the past the
governor and the General Assembly have had to restrict expenditures to comply
with the state Constitution.
Tennessee has historically had a sound financial position, though as in many
states, the recession has had a negative impact on revenues. Although the
recession produced shortfalls in fiscal years 1991 and 1992, renewed economic
growth, increased taxes, and cost controls in fiscal 1993 generated a $132
million general fund surplus and the rainy day revenue fluctuation fund was
restored to $150 million from $75 million in 1992. For fiscal 1994, general
fund revenues are expected to exceed estimates of about 4% nominal growth and
lead to another year of surplus.
In January 1994, TennCare, the state's comprehensive health care program, was
implemented. The program is designed to restructure the health care delivery
system and extends benefits to the uninsured. It is anticipated that the state
should be able to produce sizable savings and limit the growth of Medicaid
spending. The state has received a waiver from the federal government to be
free of the requirements of the Medicaid program. Also included in the state's
budget initiatives for fiscal 1994-1995 is continued implementation of the
Education Improvement Act of 1992, which guarantees a basic level of service
for all primary and secondary school students in the state under a Basic
Education Program formula.
Tennessee's financial operations are considerably different than most other
states because there is no state payroll income tax. This factor, together with
the state's reliance on the sales tax for approximately 60% of general fund
receipts, exposes total state tax collections to considerably more volatility
than would otherwise be the case and, in the event of an economic downswing,
could affect the state's ability to pay principal and interest in a timely
manner.
Although major programs in the capital budget are near completion, particularly
for state universities and correctional facilities, the state has limited debt
issuance through the use of operating funds. Tennessee's outstanding G.O.
indebtedness is $790 million. Overall debt remains low at $648 per capita,
while direct debt is extremely low at $157. Future capital needs are small and
include funds for a bicentennial mall and highway improvements. The state is in
a surplus position in funding its pension liabilities.
The Tennessee economy is largely based on manufacturing. The expansion of the
Saturn and Nissan automotive facilities and related suppliers is believed to
demonstrate the continuing vitality of manufacturing in the state. Other
important segments of the state economy include the wholesale and retail trade,
service industries and the government sector. Within the service sector, health
care and product distribution services are taking a leading role. There can be
no assurance that Tennessee's relatively favorable economic performance will
continue.
WASHINGTON
In response to Boeing's announcement regarding reductions in its Washington
operations, the state is faced with economic and fiscal challenges. Boeing
employs approximately 100,000 people in Washington, representing about 5% of
employment in the state. The company has reduced its workforce by 15,000 with
5,000 in additional reductions expected.
Although the state's fiscal management procedures performed well in response to
the recent national recession, it will be tested more seriously as the impact
of the Boeing contraction is felt. The state, in response to the Boeing
announcements, promptly lowered its revenue forecasts and enacted a 1993-95
biennial budget aimed to enhance reserve levels and bring spending and revenue
back into balance.
During 1991, in response to economic softening, the state made downward
revisions in its economic and revenue forecasts for the 1991-93 biennium, and
enacted corresponding adjustments on the expenditure side of the budget. As a
result of the adjustments, the 1991-93 biennium closed with an
<PAGE>
ending unreserved general fund balance of approximately $234 million, in
addition to a $100 million balance in the budget stabilization fund (or "rainy
day fund"). These balances have decreased from the beginning of the biennium,
when the unreserved fund balance and the rainy day fund stood at $468 million
and $260 million, respectively.
The total 1993-95 biennial general fund budget is $16.3 billion, up 6% over the
1991-1993 biennium. The budget successfully closed a gap reflecting new
expenditures of approximately $2 billion necessary to keep up with growth in
education enrollment, prison populations, debt service and health care costs.
The state addressed the $2 billion imbalance through a combination of
expenditure reductions, program restructurings, and increases in federal
revenue, which includes an expansion of the sales tax base to include selected
business services and an increase in the business and occupation tax rate. On
April 6, 1994, the governor signed a supplemental budget, which includes $168
million of additional spending for various one-time items, including grants to
local school districts. The state now expects to end the biennium with $289
million in the general fund and budget stabilization fund. Presently,
Washington does not have an income tax and although from time to time one has
been proposed, it was not seriously considered during the 1993-95 biennial
budget debate.
In November 1993, voters approved Initiative 601, which will limit state
spending increases to the rate of inflation and population growth beginning
with the 1995-1997 biennium. Estimates indicate a spending cap of $17.7 billion
for the next biennium, an increase of 8.2% from the current budget.
APPENDIX B -
DESCRIPTION OF MUNICIPAL SECURITIES RATINGS
MUNICIPAL BONDS
Moody's Investors Services ("Moody's")
Aaa: Municipal bonds which are rated Aaa are judged to be of the best quality.
They carry the smallest degree of investment risk and are generally referred to
as "gilt-edged." Interest payments are protected by a large or by an
exceptionally stable margin, and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized are
most unlikely to impair the fundamentally strong position of such issues.
Aa: Municipal bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group, they comprise what are generally known
as high-grade bonds. They are rated lower than the best bonds because margins
of protection may not be as large as in Aaa securities, fluctuation of
protective elements may be of greater amplitude, or there may be other elements
present which make the long-term risks appear somewhat larger than in Aaa
securities.
A: Municipal bonds which are rated A possess many favorable investment
attributes and are to be considered as upper medium-grade obligations. Factors
giving security to principal and interest are considered adequate, but elements
may be present which suggest a susceptibility to impairment sometime in the
future.
Baa: Bonds which are rated Baa are considered as medium-grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and, in
fact, have speculative characteristics as well.
Ba: Bonds which are rated Ba are judged to have predominantly speculative
elements; their future cannot be considered as well assured. Often the
protection of interest and principal payments may be very moderate and,
thereby, not well safeguarded during both good and bad times over the future.
Uncertainty of position characterizes bonds in this class.
B: Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
Caa: Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal or
interest.
Ca: Bonds which are rated Ca represent obligations which are speculative to a
high degree. Such issues are often in default or have other marked
shortcomings.
C: Bonds which are rated C are the lowest-rated class of bonds, and issues so
rated can be regarded as having extremely poor prospects of ever attaining any
real investment standing.
Con. (-): Bonds for which the security depends upon the completion of some act
or the fulfillment of some condition are rated conditionally. These are bonds
secured by (a) earnings of projects under construction, (b) earnings of
projects unsea-
<PAGE>
soned in operation experience, (c) rentals which begin when facilities are
completed, or (d) payments to which some other limiting condition attaches.
Parenthetical rating denotes probable credit stature upon completion of
construction or elimination of basis condition.
Note: Moody's applies numerical modifiers 1, 2 and 3 in each generic rating
classification from Aa through B in its corporate bond ratings. The modifier 1
indicates that the security ranks in the higher end of its generic rating
category; modifier 2 indicates a mid-range ranking; and modifier 3 indicates
that the issue ranks in the lower end of its generic rating category.
Standard & Poor's ("S&P")
AAA: Municipal bonds rated AAA are highest-grade obligations. They possess the
ultimate degree of protection as to principal and interest. In the market they
move with interest rates and, hence, provide the maximum safety on all counts.
AA: Municipal bonds rated AA also qualify as high-grade obligations, and in the
majority of instances differ from AAA issues only in a small degree. Here, too,
prices move with the long-term money market.
A: Municipal bonds rated A are regarded as upper medium-grade. They have
considerable investment strength but are not entirely free from adverse effects
of changes in economic and trade conditions. Interest and principal are
regarded as safe. They predominantly reflect money rates in their market
behavior, but also, to some extent, economic conditions.
BBB: Bonds rated BBB are regarded as having an adequate capacity to pay
principal and interest. Whereas they normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay principal and interest for bonds
in this category than for bonds in the A category.
BB, B, CCC, CC: Bonds rated BB, B, CCC and CC are regarded, on balance, as
predominantly speculative with respect to the issuer's capacity to pay interest
and repay principal in accordance with the terms of the obligations. BB
indicates the lowest degree of speculation and CC the highest degree of
speculation. While such bonds will likely have some quality and protective
characteristics, these are outweighed by large uncertainties or major risk
exposures to adverse conditions.
C: This rating is reserved for income bonds on which no interest is being paid.
D: Debt rated "D" is in default, and payment of interest and/or repayment of
principal is in arrears.
Note: The S&P ratings may be modified by the addition of a plus (+) or minus
(-) sign to show relative standing within the major rating categories.
Fitch's Investor Services, Inc. ("Fitch")
AAA bonds: (highest quality) "the obligor has an extraordinary ability to pay
interest and repay principal which is unlikely to be affected by reasonably
foreseeable events."
AA bonds: (high quality) "the obligor's ability to pay interest and repay
principal, while very strong, is somewhat less than for AAA rated securities or
more subject to possible change over the term of the issue."
A bonds: (good quality) "the obligor's ability to pay interest and repay
principal is strong, but may be more vulnerable to adverse changes in economic
conditions and circumstances than bonds with higher ratings."
BBB bonds: (satisfactory bonds) "the obligor's ability to pay interest and
repay principal is considered to be adequate. Adverse changes in economic
conditions and circumstances, however, are more likely to weaken this ability
than bonds with higher ratings."
Municipal Notes
Moody's
Moody's ratings for state, municipal and other short-term obligations will be
designated Moody's Investment Grade ("MIG"). This distinction is in recognition
of the differences between short-term credit risk and long-term risk. Factors
affecting the liquidity of the borrower are uppermost in importance in
short-term borrowing; factors of the first importance in long-term borrowing
risk are of lesser importance in the short run. Symbols used will be as
follows:
MIG 1: Notes are of the best quality enjoying strong protection from
established cash flows of funds for their servicing or from established and
broad-based access to the market for refinancing, or both.
MIG 2: Notes are of high quality, with margins of protection ample, although
not so large as in the preceding group.
MIG 3: Notes are of favorable quality, with all security elements accounted
for, but lacking the undeniable strength of the preceding grades. Market access
for refinancing, in particular, is likely to be less well established.
MIG 4: Notes are of adequate quality, carrying specific risk but having
protection and not distinctly or predominantly speculative.
<PAGE>
S&P
Until June 29, 1984, S&P used the same rating symbols for notes and bonds.
After June 29, 1984, for new municipal note issues due in three years or less,
the ratings below will usually be assigned. Notes maturing beyond three years
will most likely receive a bond rating of the type recited above.
SP-1: Issues carrying this designation have a very strong or strong capacity to
pay principal and interest. Issues determined to possess overwhelming safety
characteristics will be given a "plus" (+) designation.
SP-2: Issues carrying this designation have a satisfactory capacity to pay
principal and interest.
COMMERCIAL PAPER
Moody's
Moody's Commercial Paper ratings, which are also applicable to municipal paper
investments permitted to be made by the Trust, are opinions of the ability of
issuers to repay punctually their promissory obligations not having an original
maturity in excess of nine months. Moody's employs the following designations,
all judged to be investment grade, to indicate the relative repayment capacity
of rated issuers:
P-1 (Prime-1): Superior capacity for repayment.
P-2 (Prime-2): Strong capacity for repayment.
S&P
S&P's ratings are a current assessment of the likelihood of timely payment of
debt having an original maturity of no more than 365 days. Ratings are graded
into four categories, ranging from "A" for the highest quality obligations to
"D" for the lowest. Issues within the "A" category are delineated with the
numbers 1, 2 and 3 to indicate the relative degree of safety, as follows:
A-1: This designation indicates the degree of safety regarding timely payment
is very strong. A "plus" (+) designation indicates an even stronger likelihood
of timely payment.
A-2: Capacity for timely payment on issues with this designation is strong.
However, the relative degree of safety is not as overwhelming as for issues
designated A-1.
A-3: Issues carrying this designation have a satisfactory capacity for timely
payment. They are, however, somewhat more vulnerable to the adverse effects of
changes in circumstances than obligations carrying the higher designations.
Fitch's
Fitch's short-term ratings apply to debt obligations that are payable on demand
or have original maturities of generally up to three years, including
commercial paper, certificates of deposit, medium-term notes, and municipal and
investment notes. The short-term rating places greater emphasis than a
long-term rating on the existence of liquidity necessary to meet the issuer's
obligations in a timely manner.
F-1+: Exceptionally strong credit quality. Regarded as having the strongest
degree of assurance for timely payment.
F-1: Very strong credit quality. Reflect on assurance of timely payment only
slightly less in degree than issues rated F-1+.
F-2: Good credit quality. A satisfactory degree of assurance for timely
payment, but the margin of safety is not as great as for issues assigned F-1+
and F-1 ratings.
F-3: Fair credit quality. Have characteristics suggesting that the degree of
assurance for timely payment is adequate; however, near-term adverse changes
could cause these securities to be rated below investment grade.
F-S: Weak credit quality. Have characteristics suggesting a minimal degree of
assurance for timely payment and are vulnerable to near-term adverse changes in
financial and economic conditions.
D: Default. Actual or imminent payment default.
LOC: The symbol LOC indicates that the rating is based on a letter of credit
issued by a commercial bank.
<PAGE>
FRANKLIN MUNICIPAL SECURITIES TRUST
REPORT OF INDEPENDENT AUDITORS
To the Shareholders and Board of Trustees
of Franklin Municipal Securities Trust:
We have audited the accompanying statements of assets and liabilities of the
Funds comprising the Franklin Municipal Securities Trust, including each Fund's
statements of investments in securities and net assets, as of May 31, 1994, and
the related statements of operations and changes in net assets for the periods
indicated thereon, and the financial highlights included under the caption
"Financial Highlights" for the periods indicated thereon. These financial
statements and financial highlights are the responsibility of the Trust'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 May
31, 1994 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
Funds comprising the Franklin Municipal Securities Trust as of May 31, 1994,
the results of their operations and the changes in their net assets for the
periods indicated thereon, and the financial highlights for the periods
indicated thereon, in conformity with generally accepted accounting principles.
COOPERS & LYBRAND
San Francisco, California
June 27, 1994
66
<PAGE>
FRANKLIN MUNICIPAL SECURITIES TRUST
STATEMENT OF INVESTMENTS IN SECURITIES AND NET ASSETS, MAY 31, 1994
<TABLE>
<CAPTION>
FACE FRANKLIN ARKANSAS MUNICIPAL BOND FUND VALUE
AMOUNT BONDS 51.4% (NOTE 1)
------- ------------------------------------- ---------
<S> <C> <C>
$365,000 Independence County PCR, Refunding, Arkansas Power & Light Co. Project,
FSA Insured, 6.25%, 01/01/21 ........................................................ $ 369,924
100,000 Little Rock, Hotel & Restaurant Gross Receipts Tax, Refunding, 5.00%, 08/01/03......... 97,482
400,000 Puerto Rico PBA, Public Education & Health Facilities, Refunding, Series M,
5.75%, 07/01/15 ..................................................................... 375,396
100,000 Puerto Rico Commonwealth GO, 6.50%, 07/01/23 .......................................... 101,582
100,000 Puerto Rico Commonwealth, Highway & Transportation Authority, Highway Revenue,
Refunding, Series V, 5.75%, 07/01/18 ................................................ 93,226
100,000 Puerto Rico Electric Power Authority Revenue, Series R, 6.25%, 07/01/17 99,873
----------
TOTAL INVESTMENTS (COST $1,126,825) 51.4% 1,137,483
OTHER ASSETS AND LIABILITIES, NET 48.6% 1,075,718
----------
NET ASSETS 100.0% $2,213,201
==========
At May 31, 1994, the net unrealized appreciation based on the cost
of investments for income tax purposes of $1,126,825 was as
follows: Aggregate gross unrealized appreciation for all
investments in which there was an excess of value over tax cost...................... $ 10,658
Aggregate gross unrealized depreciation for all investments in
which there was an excess of tax cost over value..................................... -
----------
Net unrealized appreciation........................................................... 10,658
==========
</TABLE>
PORTFOLIO ABBREVIATIONS:
FSA - Financial Security Assistance
GO - General Obligation
PBA - Public Building Authority
PCR - Pollution Control Revenue
The accompanying notes are an integral part of these financial statements.
67
<PAGE>
FRANKLIN MUNICIPAL SECURITIES TRUST
STATEMENT OF INVESTMENTS IN SECURITIES AND NET ASSETS, MAY 31, 1994
<TABLE>
<CAPTION>
FACE VALUE
AMOUNT FRANKLIN CALIFORNIA HIGH YIELD MUNICIPAL FUND (NOTE 1)
- ------------ --------------------------------------------- -----------
<S> <C>
BONDS 97.0%
$1,160,000 Adelanto Improvement Agency, Tax Allocation, Refunding & Improvement Project,
Series C, 7.75%, 12/01/29......................................................... $ 1,128,610
500,000 Antioch Improvement Board, 1915 ACT, AD No. 27, Series D, 7.30%, 09/02/13........... 499,965
1,400,000 Azusa RDA, Refunding, Tax Allocation, Merged Project Area, Series A, 6.75%, 08/01/23 1,358,238
425,000 Beaumont Public Financing Authority Revenue, Sewer Enterprise Project,
Series A, 6.90%, 09/01/23......................................................... 408,965
Benicia, 1915 ACT, Refunding,
200,000 Fleetside Industrial Park Assessment, 6.80%, 09/02/12............................. 191,526
540,000 Fleetside Industrial Park Assessment, 6.90%, 09/02/13............................. 516,704
575,000 Fleetside Industrial Park Assessment, 7.00%, 09/02/14............................. 549,809
100,000 Burbank RDA, Refunding, Tax Allocation, Series A, 6.25%, 12/01/24................... 92,963
175,000 California Educational Facilities Authority Revenue, Refunding,
Pooled College & University Financing, Series B, 6.25%, 06/01/18.................. 164,869
90,000 California Special District Association Finance Corp., COP, Series V, 7.50%,
05/01/13.......................................................................... 89,362
California State Public Works Board, Lease Revenue,
750,000 Community College Projects, Series A, 6.00%, 10/01/14............................. 732,720
350,000 Southern California, Veterans Home, Series A, 6.50%, 10/01/14..................... 347,617
1,000,000 Capistrano USD, CFD, Special Tax No. 92-1, 7.00%, 09/01/18.......................... 974,830
750,000 Chico Parking Revenue, Refunding, Downtown Parking Project, 6.20%, 02/01/18......... 673,883
100,000 Contra Costa County Public Financing Authority Revenue, Refunding,
6.875%, 09/02/16.................................................................. 95,873
Daily City, 1915 ACT,
145,000 Carter-Martin Reassessment District No. 1, 6.00%, 09/02/03........................ 141,477
415,000 Carter-Martin Reassessment District No. 1, 6.05%, 09/02/04........................ 404,164
440,000 Carter-Martin Reassessment District No. 1, 6.10%, 09/02/05........................ 427,768
425,000 Escondido Union School District, COP, Refunding, Series A, 5.90%, 07/01/11.......... 389,342
1,000,000 Fontana Public Financing Authority Revenue, Tax Allocation, North Fontana,
Series B, 6.30%, 01/15/24......................................................... 908,340
100,000 Fort Bragg RDAR, Tax Allocation, Fort Bragg Redevelopment Project, Series A,
6.875%, 05/01/18.................................................................. 98,663
1,000,000 Gardena COP, Refunding, Civic Center Improvement Projects, 6.30%, 08/01/23.......... 932,050
800,000 Hawaiian Gardens RDA, Refunding, Tax Allocation, Project No. 1, 6.35%, 12/01/33..... 738,576
2,600,000 Hesperia Public Financing Authority, Improvement Revenue, Series B, 7.375%, 10/01/23 2,561,546
800,000 La Palma Community Development Commission, Refunding, Tax Allocation,
La Palma Community Development Project No. 1, 6.10%, 06/01/22..................... 722,944
1,265,000 Lake Elsinore, 1915 ACT, AD No. 93-1, Series A, 7.90%, 09/02/24..................... 1,270,123
1,200,000 Lancaster RDA, Refunding, Tax Allocation, Fox Field Redevelopment
Project Area, 6.125%, 08/01/22.................................................... 1,068,804
Long Beach Special Tax,
140,000 Community Facilities District No. 2, Long Beach, 7.50%, 09/01/11.................. 144,543
550,000 Community Facilities District No. 3, Pine Avenue, 6.25%, 09/01/07................. 527,549
</TABLE>
The accompanying notes are an integral part of these financial statements.
68
<PAGE>
FRANKLIN MUNICIPAL SECURITIES TRUST
STATEMENT OF INVESTMENTS IN SECURITIES AND NET ASSETS, MAY 31, 1994 (CONT.)
<TABLE>
<CAPTION>
FACE VALUE
AMOUNT FRANKLIN CALIFORNIA HIGH YIELD MUNICIPAL FUND (NOTE 1)
- ------------ --------------------------------------------- -----------
<S> <C>
BONDS (CONT.)
Los Angeles County COP,
$ 500,000 Disney Parking Project, 6.50%, 03/01/23......................................... $ 495,435
100,000 Marina del Rey, Series A, 6.50%, 07/01/08....................................... 97,216
1,150,000 Los Angeles MFR, Refunding, Series J-2, 8.50%, 01/01/24........................... 1,088,452
100,000 M-S-R Public Power Agency Revenue, San Juan Project, Series A, 6.00%, 07/01/22.... 94,686
100,000 Merced Irrigation District, COP, Water Facilities Project, 6.40%, 11/01/10........ 94,285
250,000 Millbrae RDA, Tax Allocation, Millbrae Redevelopment Project, Series A,
6.00%, 09/01/18................................................................. 223,390
1,000,000 Novato, 1915 ACT, Golden Gate Plaza Project No. 93-1, 6.50%, 09/02/19............. 959,260
500,000 Perris Public Financing Authority, Local Agency Revenue, Series B, 7.25%, 08/15/23 505,975
350,000 Rialto RDA, Refunding, Tax Allocation, Industrial Redevelopment,
Sub-Areas A & B, Series A, 6.00%, 09/01/23...................................... 316,652
500,000 Rialto RDA, Tax Allocation, Agua Mansa Redevelopment Project, 6.75%, 03/01/24..... 474,830
1,125,000 Richmond Joint Powers Financing Authority, 1915 ACT, ID Nos. 851 & 853,
Series B, 8.50%, 09/02/19....................................................... 1,123,583
600,000 Roseville COP, Golf Course Project, 6.00%, 08/01/23............................... 529,788
100,000 Sacramento County, 1915 ACT, Refunding, Sunrise/U.S. Corridor Assessment,
7.00%, 09/02/09................................................................. 99,237
800,000 San Francisco City & County Revenue, Irwin Memorial Blood Centers, Series A,
6.80%, 12/01/21................................................................. 802,248
San Joaquin Hills, Transportation Corridor Agency, Toll Road Revenue,
400,000 Senior Lien, 7.00%, 01/01/30.................................................... 395,832
350,000 Senior Lien, 6.75%, 01/01/32.................................................... 337,075
485,000 Senior Lien, 5.00%, 01/01/33.................................................... 358,657
325,000 San Ramon, 1915 ACT, Fostoria Parkway Reassessment District 93-1, 6.80%, 09/02/15. 323,830
1,500,000 aSan Ramon Public Financing Authority, Refunding, Tax Allocation, 6.90%, 02/01/24 1,503,480
670,000 Scotts Valley Water District Revenue, Refunding, Water Works, 5.70%, 01/01/20..... 602,806
250,000 Shasta Joint Powers Financing Authority Lease Revenue, Refunding,
Justice Center Project, Series A, 5.90%, 09/01/07............................... 232,825
1,000,000 Temple City Financing Authority Revenue, Refunding, Rosemead Boulevard
Redevelopment Project, 6.50%, 09/01/23.......................................... 905,950
750,000 Visalia Public Finance Authority Revenue, Tax Allocation, Central Visalia-Mooney
Boulevard Projects, 6.125%, 08/01/23............................................ 669,630
700,000 Westminster COP, Water System, Improvement Project, 5.75% 06/01/24................ 599,865
-----------
TOTAL BONDS (COST $32,358,627).............................................. $30,996,810
===========
</TABLE>
69
The accompanying notes are an integral part of these
financial statements.
<PAGE>
FRANKLIN MUNICIPAL SECURITIES TRUST
STATEMENT OF INVESTMENTS IN SECURITIES AND NET ASSETS, MAY 31, 1994 (CONT.)
<TABLE>
<CAPTION>
FACE VALUE
AMOUNT FRANKLIN CALIFORNIA HIGH YIELD MUNICIPAL FUND (NOTE 1)
---------- --------------------------------------------- -----------
<S> <C> <C>
bSHORT TERM INVESTMENTS 1.9%
$ 100,000 Irvine, 1915 Act, AD No. 89-10, Daily VRDN and Put, 2.80%, 09/02/15 ................ $ 100,000
500,000 Irvine Ranch Water District Nos. 105, 250 & 290, Daily VRDN and Put,
2.95%, 08/01/16 .................................................................. 500,000
-----------
TOTAL SHORT TERM INVESTMENTS (COST $600,000) ................................ 600,000
----------
TOTAL INVESTMENTS (COST $32,958,627) 98.9% .............................. 31,596,810
OTHER ASSETS AND LIABILITIES, NET 1.1% .................................. 341,493
----------
NET ASSETS 100.0% ....................................................... $31,938,303
===========
At May 31, 1994, the net unrealized depreciation based on the cost of investments
for income tax purposes of $32,958,627 was as follows:
Aggregate gross unrealized appreciation for all investments in which there
was an excess of value over tax cost......................................... $ 43,155
Aggregate gross unrealized depreciation for all investments in which
there was an excess of tax cost over value .................................. (1,404,972)
-----------
Net unrealized depreciation ................................................... $(1,361,817)
===========
</TABLE>
PORTFOLIO ABBREVIATIONS:
1915 ACT - Improvement Bond Act of 1915
AD - Assessment District
CFD - Community Facilities District
COP - Certificate of Participation
MFR - Multi Family Revenue
RDA - Redevelopment Agency
RDAR - Redevelopment Agency Revenue
USD - Unified School District
aSee Note 1 regarding securities purchased on a when-issued basis.
bVariable rate demand notes (VRDN's) are tax-exempt obligations which contain a
floating or variable interest rate adjustment formula and an unconditional
right of demand to receive payment of the principal balance plus accrued
interest upon short notice prior to specified dates. The interest rate may
change on specified dates in relationship with changes in a designated rate
(such as the prime interest rate or U.S. Treasury bills rate).
The accompanying notes are an integral part of these financial statements.
<PAGE>
FRANKLIN MUNICIPAL SECURITIES TRUST
STATEMENT OF INVESTMENTS IN SECURITIES AND NET ASSETS, MAY 31, 1994
<TABLE>
<CAPTION>
FACE VALUE
AMOUNT FRANKLIN HAWAII MUNICIPAL BOND FUND (NOTE 1)
- ---------- ----------------------------------- ----------
<S> <C> <C>
BONDS 98.7%
Guam Airport Authority Revenue,
$ 200,000 Series B, 6.60%, 10/01/10 ...................................................... $ 201,242
1,000,000 Series B, 6.70%, 10/01/23 ...................................................... 1,006,170
280,000 Guam Government Limited Obligation Highway, Refunding, Series A, CGIC Insured
6.30%, 05/01/12 ................................................................. 285,970
Guam Power Authority Revenue,
200,000 Series A, 5.25%, 10/01/13 ...................................................... 173,092
300,000 Series A, 6.30%, 10/01/22 ...................................................... 293,001
Hawaii County GO, Refunding & Improvement,
250,000 Series A, FGIC Insured, 5.60%, 05/01/12 ........................................ 241,492
500,000 Series A, FGIC Insured, 5.60%, 05/01/13 ........................................ 482,460
Hawaii State Airport System Revenue,
300,000 Refunding, Third Series 1994, AMBAC Insured, 5.75%, 07/01/09 ................... 291,456
60,000 Second Series 1990, FGIC Insured, 7.50%, 07/01/20 .............................. 66,031
1,520,000 Second Series 1991, 7.00%, 07/01/18 ............................................ 1,584,022
200,000 Second Series 1991, MBIA Insured, 6.75%, 07/01/21 .............................. 208,092
400,000 Second Series 1992, MBIA Insured, 6.90%, 07/01/12 .............................. 437,492
Hawaii State Department Budget & Finance, Special Purpose Mortgage Revenue,
100,000 Hawaii Electric Light Co., 7.20%, 12/01/14 ..................................... 106,767
600,000 Hawaii Electric Light Co. & Subsidiaries, MBIA Insured, 6.55%, 12/01/22......... 609,528
4,100,000 Hawaii Electric Light Co. & Subsidiaries, MBIA Insured, 5.45%, 11/01/23......... 3,615,995
105,000 Pali Momi Medical Center Project, Pre-Refunded, 7.65%, 07/01/19 ................ 121,169
500,000 Queens Medical Center Project, FGIC Insured, 6.20%, 07/01/22 ................... 500,710
25,000 Refunding, Hawaii Electric Co., Inc., 6.875%, 04/01/12 ......................... 25,894
100,000 Refunding, Kaiser Permanente, Series A, 6.25%, 03/01/21 ........................ 100,455
600,000 Refunding, Kapiolani Health Care System, 6.40%, 07/01/13........................ 602,322
1,075,000 Refunding, Kapiolani Health Care System, 6.00%, 07/01/19 ....................... 1,021,594
725,000 Refunding, Queens Medical Center Project, FGIC Insured, 6.50%, 07/01/12......... 738,391
1,100,000 Refunding, Wahiawa General Hospital Project, 7.50%, 07/01/12 ................... 1,166,913
1,100,000 St. Francis Medical Centers, CGIC Insured, 6.50%, 07/01/22 ..................... 1,126,026
875,000 Hawaii State Department Transport, Special Facilities Revenue, Refunding,
Matson Terminals, Inc., 5.75%, 03/01/13 ......................................... 816,042
Hawaii State GO,
100,000 Series BT, Pre-Refunded, 6.125%, 02/01/11....................................... 105,271
100,000 Series BW, 6.375%, 03/01/11 .................................................... 105,543
100,000 Series CA, 6.00%, 01/01/09...................................................... 101,943
Hawaii State Harbor Capital Improvement Revenue,
350,000 Refunding, Series 1992, 6.20%, 07/01/08 ........................................ 351,278
70,000 Series 1990, MBIA Insured, 7.25%, 07/01/10 ..................................... 75,442
80,000 Series 1990, MBIA Insured, 7.00%, 07/01/17 ..................................... 84,633
200,000 Series 1992, FGIC Insured, 6.50%, 07/01/19 ..................................... 204,732
</TABLE>
The accompanying notes are an integral part of these financial statements.
71
<PAGE>
FRANKLIN MUNICIPAL SECURITIES TRUST
STATEMENT OF INVESTMENTS IN SECURITIES AND NET ASSETS, MAY 31, 1994 (CONT.)
<TABLE>
<CAPTION>
FACE VALUE
AMOUNT FRANKLIN HAWAII MUNICIPAL BOND FUND (NOTE 1)
- ---------- ------------------------------------ -----------
<S> <C> <C>
BONDS (CONT.)
$1,100,000 Hawaii State Highway Revenue, 5.00%, 07/01/12 ...................................... $ 978,505
2,000,000 Hawaii State Housing Finance & Development Corp., Rental Housing System Revenue,
Refunding, Series A, 5.60%, 07/01/12 ............................................. 1,866,460
Hawaii State Housing Finance & Development Corp., SFM Purchase Revenue,
25,000 Series A, 7.10%, 07/01/24 ........................................................ 25,229
2,000,000 Series B, 5.85%, 07/01/17 ........................................................ 1,881,940
Honolulu, Hawaii, City & County,
150,000 Refunding, Series 1992, 6.00%, 12/01/14 .......................................... 149,122
85,000 Series A, 6.30%, 03/01/08 ........................................................ 87,038
100,000 Series A, 6.30%, 03/01/11 ........................................................ 101,807
75,000 Series A, Pre-Refunded, 6.70%, 08/01/07 .......................................... 81,925
100,000 Series A, Pre-Refunded, 6.70%, 08/01/11 .......................................... 109,233
1,000,000 aSeries B, 6.125%, 06/01/14 ....................................................... 1,002,080
150,000 Honolulu, Hawaii, City & County, MFHR, Hale Pauahi Project, Series A,
FHA Mortgage Insured, MBIA Insured, 8.70%, 12/01/28 .............................. 154,076
220,000 Kauai County, GO, Refunding, Series C, AMBAC Insured, 5.95%, 08/01/10 .............. 222,028
100,000 Maui County Board, Water Supply Revenue, Series A, FGIC Insured, Pre-Refunded,
6.70%, 12/01/11 .................................................................. 109,555
Maui County GO, Refunding,
50,000 Series 1992, 6.05%, 09/01/07 ................................................... 50,869
300,000 Series 1992, 6.10%, 09/01/08 ................................................... 306,186
425,000 Series B, C, D & E, FGIC Insured, 5.00%, 09/01/08 .............................. 393,873
350,000 Series B, C, D & E, FGIC Insured, 5.25%, 09/01/06 .............................. 337,421
145,000 Puerto Rico Commonwealth, Aqueduct & Sewer Authority Revenue, Series A,
7.00%, 07/01/19 .................................................................. 153,081
115,000 Puerto Rico Commonwealth, Electric Power Authority Revenue, Refunding,
Water Resources, Series 1989-O, 7.125%, 07/01/14 ................................. 122,319
Puerto Rico Commonwealth, Highway & Transportation Authority Revenue,
315,000 Series T, 6.625%, 07/01/18 ..................................................... 322,525
85,000 Series T, Pre-Refunded, 6.625%, 07/01/18 ....................................... 94,033
250,000 Puerto Rico Commonwealth, Public Improvement, Series A, 6.25%, 07/01/10 ............ 253,150
350,000 Puerto Rico Industrial Medical & Environmental Pollution Control Facilities,
Financing Authority Revenue, PepsiCo., Inc. Project, 6.25%, 11/15/13 ............. 359,377
215,000 Puerto Rico PBA, Guaranteed, Public Education & Health Facilities, Series L,
Pre-Refunded, 6.875%, 07/01/21 ................................................... 241,359
325,000 University of Hawaii System Revenue, Series G, AMBAC Insured, 5.70%, 10/01/17 ...... 308,519
-----------
TOTAL BONDS (COST $27,242,866) ............................................. 26,562,878
===========
</TABLE>
The accompanying notes are an integral part of these
financial statements.
<PAGE>
FRANKLIN MUNICIPAL SECURITIES TRUST
STATEMENT OF INVESTMENTS IN SECURITIES AND NET ASSETS, MAY 31, 1994 (CONT.)
<TABLE>
<CAPTION>
FACE VALUE
AMOUNT FRANKLIN HAWAII MUNICIPAL BOND FUND (NOTE 1)
- ----------- ------------------------------------ -----------
<S> <C> <C>
bSHORT TERM INVESTMENTS .8%
$ 200,000 Puerto Rico Commonwealth Government Development Bank, Refunding,
Weekly VRDN and Put, 2.60%, 12/01/15 (COST $200,000) ............................ $ 200,000
-----------
TOTAL INVESTMENTS (COST $27,442,866) 99.5% ........................... 26,762,878
OTHER ASSETS AND LIABILITIES, NET .5% ................................ 141,182
-----------
NET ASSETS 100.0% .................................................... $26,904,060
===========
At May 31, 1994, the net unrealized depreciation based on the cost of investments
for income tax purposes of $27,442,866 was as follows:
Aggregate gross unrealized appreciation for all investments in which there was
an excess of value over tax cost ............................................ $ 310,586
Aggregate gross unrealized depreciation for all investments in which there was
an excess of tax cost over value ............................................ (990,574)
-----------
Net unrealized depreciation ................................................... $ (679,988)
===========
</TABLE>
PORTFOLIO ABBREVIATIONS:
AMBAC - American Municipal Bond Assurance Corp.
CGIC - Capital Guaranty Insurance Co.
FGIC - Financial Guaranty Insurance Corp.
FHA - Federal Housing Agency/Authority
GO - General Obligation
MBIA - Municipal Bond Investors Assurance Corp.
MFHR - Multi-Family Housing Revenue
PBA - Public Building Authority
SFM - Single Family Mortgage
(a) See Note 1 regarding securities purchased on a when-issued basis.
(b) Variable rate demand notes (VRDN's) are tax-exempt obligations which
contain a floating or variable interest rate adjustment formula and an
unconditional right of demand to receive payment of the principal balance
plus accrued interest upon short notice prior to specified dates. The
interest rate may change on specified dates in relationship with changes
in a designated rate (such as the prime interest rate or U.S. Treasury
bills rate).
The accompanying notes are an integral part of these
financial statements.
<PAGE>
FRANKLIN MUNICIPAL SECURITIES TRUST
STATEMENT OF INVESTMENTS IN SECURITIES AND NET ASSETS, MAY 31, 1994
<TABLE>
<CAPTION>
FACE VALUE
AMOUNT FRANKLIN TENNESSEE MUNICIPAL BOND FUND (NOTE 1)
- -------- ----------------------------------- -----------
<S> <C> <C>
BONDS 76.0%
$100,000 Chattanooga-Hamilton County Hospital Authority Revenue, Refunding,
Erlanger Medical Center, FSA Insured, 5.60%, 10/01/08 ............................. $ 97,023
500,000 Humphreys County IDB, Solid Waste Disposal Revenue, E.I. Dupont Denemours & Co.
Project, 6.70%, 05/01/24 .......................................................... 507,325
100,000 aJohnson City Solid Waste, AMBAC Insured, 5.80%, 05/01/09 ......................... 99,402
100,000 Puerto Rico Electric Power Authority Revenue, Water Resources, Series R,
6.25%, 07/01/17 ................................................................... 99,873
100,000 Puerto Rico Commonwealth GO, 6.50%, 07/01/23 ........................................ 101,582
100,000 Puerto Rico Commonwealth Highway & Transportation Authority Revenue, Refunding,
Series V, 5.75%, 07/01/18 ......................................................... 93,226
300,000 Shelby County GO, Series A, 5.90%, 03/01/15 ......................................... 292,959
100,000 Sullivan County Health Educational & Housing Facilities Board Revenue,
Holston Valley Health, MBIA Insured, 5.75%, 02/15/13 .............................. 95,369
100,000 aTennessee HDA, Mortgage Finance, Series A, 6.90%, 07/01/25 ...................... 100,399
200,000 Tullahoma IDB Revenue, Refunding, 1st. mtg., 6.875%, 06/15/06 ....................... 203,470
----------
TOTAL BONDS (COST $1,668,971) ............................................... 1,690,628
----------
SHORT TERM INVESTMENTS 4.5%
100,000 bTennessee State School Board Authority, Higher Educational, BAN, Series A,
Weekly VRDN and Put, 2.20%, 03/01/98 (COST $100,000) .............................. 100,000
----------
TOTAL INVESTMENTS (COST $1,768,971) 80.5% ................................ 1,790,628
OTHER ASSETS AND LIABILITIES, NET 19.5% .................................. 433,441
----------
NET ASSETS 100.0% ........................................................ $2,224,069
==========
At May 31, 1994, the net unrealized appreciation based on the cost of investments
for income tax purposes of $1,768,971 was as follows:
Aggregate gross unrealized appreciation for all investments in which there was an
excess of value over tax cost ................................................. $ 22,103
Aggregate gross unrealized depreciation for all investments in which there was an
excess of tax cost over value ................................................. (446)
----------
Net unrealized appreciation ..................................................... $ 21,657
==========
</TABLE>
PORTFOLIO ABBREVIATIONS:
AMBAC - American Municipal Bond Assurance Corp.
BAN - Bond Anticipation Notes
FSA - Financial Security Assistance
GO - General Obligation
HDA - Housing Development Authority/Agency
IDB - Industrial Development Board
MBIA - Municipal Bond Investors Assurance Corp.
(a) See Note 1 regarding securities purchased on a when-issued basis.
(b) Variable rate demand notes (VRDN's) are tax-exempt obligations which
contain a floating or variable interest rate adjustment formula and an
unconditional right of demand to receive payment of the principal balance
plus accrued interest upon short notice prior to specified dates. The
interest rate may change on specified dates in relationship with changes
in a designated rate (such as the prime interest rate or U.S. Treasury
bills rate).
The accompanying notes are an integral part of these
financial statements.
<PAGE>
FRANKLIN MUNICIPAL SECURITIES TRUST
STATEMENT OF INVESTMENTS IN SECURITIES AND NET ASSETS, MAY 31, 1994
<TABLE>
<CAPTION>
FACE VALUE
AMOUNT FRANKLIN WASHINGTON MUNICIPAL BOND FUND (NOTE 1)
- -------- --------------------------------------- ----------
<S> <C> <C>
BONDS 97.4%
$100,000 Aberdeen GO, Series A, MBIA Insured, 5.80%, 12/01/12 ................................. $ 96,592
100,000 Federal Way Washington GO, Refunding, 5.85%, 12/01/21 ................................ 95,280
100,000 Kent GO, Refunding, AMBAC Insured, 5.60%, 12/01/09 ................................... 96,390
40,000 Kent Sewer Revenue, Refunding & Improvement, AMBAC Insured, 5.50%, 11/01/13 .......... 36,820
100,000 King County Public Hospital District No. 001, Hospital Facilities Revenue, Refunding,
Valley Medical Center, AMBAC Insured, 5.50% 09/01/17 ............................... 90,408
150,000 Kirkland GO, 5.70%, 12/01/14 ......................................................... 141,198
125,000 Kitsap County School District No. 400, North Kitsap, FGIC Insured, 5.50%, 06/01/13 ... 115,839
175,000 Pierce County EDC Revenue, Solid Waste, Occidental Petroleum, 5.80%, 09/01/29 ........ 152,098
650,000 Pilchuck Development Public Corp., Special Facilities Revenue, Airport Tramco, Inc.
Project, 6.00%, 08/01/23 ............................................................. 580,593
200,000 Port of Seattle Revenue, Series B, 6.00%, 11/01/17 ................................... 189,190
100,000 Richland Water & Sewer Improvement Revenue, MBIA Insured, 5.625%, 04/01/12 ........... 93,943
450,000 Seatac GO, MBIA Insured, 6.50%, 12/01/13 ............................................. 455,801
100,000 Seattle Municipal Light & Power Revenue, Series A, 5.75%, 08/01/17 ................... 93,915
Seattle Municipality Metropolitan Sewer Revenue, Refunding,
100,000 Series Y, FGIC Insured, 5.70%, 01/01/15 ............................................ 93,348
75,000 Series Z, AMBAC Insured, 5.50%, 01/01/33 ........................................... 65,665
100,000 Spokane County Water District No. 3 Revenue, Refunding, 5.90%, 01/01/14 .............. 96,183
300,000 Stevens County Public Corp., PCR, Refunding, Water Power Co. Project, 6.00%,
12/01/23 ........................................................................... 274,572
250,000 University of Washington, Aluminum Association, Lease Revenue, Roosevelt University,
Medical Center, CGIC Insured, 6.30%, 08/15/14 ...................................... 251,165
100,000 Washington State COP, Office Building Project, Series A, MBIA Insured, 6.00%,
04/01/12 ........................................................................... 96,596
100,000 Washington State GO, Series 1993-A, 5.75%, 10/01/17 .................................. 95,070
Washington State Health Care Facilities Authority Revenue,
100,000 Harrison Memorial Hospital, AMBAC Insured, 5.40%, 08/15/23 ......................... 87,323
150,000 Refunding, Dominican Health Services, Connie Lee Insured, 5.75%, 06/01/13 .......... 138,596
125,000 Refunding, Franciscan Health, St. Joseph Hospital, MBIA Insured, 5.625%, 01/01/13 .. 115,705
150,000 Refunding, Northwest Hospital, AMBAC Insured, 5.75%, 11/15/23 ...................... 137,883
100,000 Washington State Health Care Facilities Authority Revenue, Multicare Medical Center,
FGIC Insured, 5.75%, 08/15/22 ...................................................... 92,040
400,000 Washington State Public Power, Supply Systems Revenue, Refunding, Nuclear Project
No.1, Series A, 6.00%, 07/01/17 .................................................... 377,152
----------
TOTAL INVESTMENTS (COST $4,409,290) 97.4% ................................... 4,159,365
OTHER ASSETS AND LIABILITIES, NET 2.6% ...................................... 112,903
----------
NET ASSETS 100.0% ........................................................... $4,272,268
==========
</TABLE>
The accompanying notes are an integral part of these
financial statements.
<PAGE>
FRANKLIN MUNICIPAL SECURITIES TRUST
STATEMENT OF INVESTMENTS IN SECURITIES AND NET ASSETS, MAY 31,1994 (CONT.)
<TABLE>
<CAPTION>
VALUE
FRANKLIN WASHINGTON MUNICIPAL BOND FUND (NOTE 1)
- ----------------------------------------------------------------------------------------------------------------
<S> <C>
At May 31, 1994, the net unrealized depreciation based on the cost of investments
for income tax purposes of $4,409,290 was as follows:
Aggregate gross unrealized appreciation for all investments in which there was an
excess of value over tax cost .................................................. $ 9,809
Aggregate gross unrealized depreciation for all investments in which there was an
excess of tax cost over value .................................................. (259,734)
---------
Net unrealized depreciation ...................................................... $(249,925)
=========
</TABLE>
PORTFOLIO ABBREVIATIONS:
AMBAC - American Municipal Bond Assurance Corp.
COP - Certificate of Participation
CGIC - Capital Guaranty Insurance Co.
EDC - Economic Development Corp.
FGIC - Financial Guaranty Insurance Co.
GO - General Obligation
MBIA - Municipal Bond Investors Assurance Corp.
PCR - Pollution Control Revenue
The accompanying notes are an integral part of these financial statements.
76
<PAGE>
FRANKLIN MUNICIPAL SECURITIES TRUST
FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
STATEMENTS OF ASSETS AND LIABILITIES
MAY 31, 1994
FRANKLIN FRANKLIN FRANKLIN FRANKLIN FRANKLIN
ARKANSAS CALIFORNIA HAWAII TENNESSEE WASHINGTON
MUNICIPAL HIGH YIELD MUNICIPAL MUNICIPAL MUNICIPAL
BOND FUND MUNICIPAL FUND BOND FUND BOND FUND BOND FUND
---------- -------------- ----------- --------- ----------
<S> <C> <C> <C> <C> <C>
Assets:
Investments in securities:
At identified cost............................ $1,126,825 $32,958,627 $27,442,866 $1,768,971 $4,409,290
========== =========== =========== ========== ==========
At value...................................... 1,137,483 31,596,810 26,762,878 1,790,628 4,159,365
Cash............................................ 1,532,249 98,428 1,032 620,039 37,356
Receivables:
Interest...................................... 26,425 653,113 487,600 13,156 82,772
Investment securities sold.................... - 988,227 667,065 - -
Capital shares sold........................... - 161,492 20,171 - -
Unamortized organization costs (Note 2)......... - - 3,998 - -
---------- ----------- ----------- ---------- ----------
Total assets 2,696,157 33,498,070 27,942,744 2,423,823 4,279,493
---------- ----------- ----------- ---------- ----------
Liabilities:
Payables:
Investment securities purchased:
Regular delivery............................ 482,920 - - - -
When-issued basis (Note 1)................... - 1,501,725 988,810 199,717 -
Distributions payable to shareholders......... - 46,003 34,676 - 5,491
Distribution fees............................. 36 12,039 11,200 37 1,734
Payable to advisor for organization costs - - 3,998 - -
---------- ----------- ----------- ---------- ----------
Total liabilities 482,956 1,559,767 1,038,684 199,754 7,225
---------- ----------- ----------- ---------- ----------
Net assets, at value............................. $2,213,201 $31,938,303 $26,904,060 $2,224,069 $4,272,268
========== =========== =========== ========== ==========
Net assets consist of:
Undistributed net investment income............. $ 2,543 $ (337) $ 78,519 $ 2,413 $ 31,109
Unrealized appreciation (depreciation)
on investments................................ 10,658 (1,361,817) (679,988) 21,657 (249,925)
Accumulated net realized loss................... - (366,593) (170,615) (1) (31,073)
Capital shares 2,200,000 33,667,050 27,676,144 2,200,000 4,522,157
---------- ----------- ----------- ---------- ----------
Net assets, at value............................. $2,213,201 $31,938,303 $26,904,060 $2,224,069 $4,272,268
========== =========== =========== ========== ==========
Shares outstanding............................... 220,000 3,283,367 2,597,599 220,000 447,362
========== =========== =========== ========== ==========
Net asset value per share........................ $10.06 $9.73 $10.36 $10.11 $9.55
========== =========== =========== ========== ==========
Representative computation (Franklin Arkansas
Municipal Bond Fund) of net asset value and
offering price per share:
Net asset value and redemption price
per share ($2,213,201 / 220,000)............ $10.06
==========
Maximum offering price+ (100/95.75 of $10.06)*... $10.51
==========
</TABLE>
+ The maximum offering price for each of the other funds of the Trust is
calculated as follows: Franklin California High Yield Municipal Fund--100/95.5
of $9.73; Franklin Hawaii Municipal Bond fund--100/95.5 of $10.36; Franklin
Tennessee Municipal Bond Fund--100/95.75 of $10.11; Franklin Washington
Municipal Bond Fund--100/95.5 of $9.55.
* On sales of $100,000 or more the offering price is reduced as stated in the
section of the Prospectus entitled "How to Buy Shares of the Fund."
The accompanying notes are an integral part of these
financial statements.
77
<PAGE>
FRANKLIN MUNICIPAL SECURITIES TRUST
FINANCIAL STATEMENTS (CONT.)
<TABLE>
<CAPTION>
STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED MAY 31, 1994
(EXCEPT AS NOTED BELOW)
FRANKLIN FRANKLIN FRANKLIN FRANKLIN FRANKLIN
ARKANSAS CALIFORNIA HAWAII TENNESSEE WASHINGTON
MUNICIPAL HIGH YIELD MUNICIPAL MUNICIPAL MUNICIPAL
BOND FUND+ MUNICIPAL FUND BOND FUND BOND FUND+ BOND FUND
---------- -------------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Investment income:
Interest (Note 1).......................... $ 2,579 $ 1,106,892 $ 1,412,668 $ 2,450 $ 204,153
------- ----------- ----------- ------- ---------
Expenses
Distribution fees (Note 6)................. 36 12,039 11,200 37 1,734
------- ----------- ----------- ------- ---------
Net investment income................... 2,543 1,094,853 1,401,468 2,413 202,419
------- ----------- ----------- ------- ---------
Realized and unrealized gain (loss) on
investments:
Net realized loss........................ - (339,852) (159,863) (1) (26,074)
Net unrealized appreciation
(depreciation) during the period........ 10,658 (1,350,386) (1,254,988) 21,657 (241,899)
------- ----------- ----------- ------- ---------
Net realized and unrealized gain (loss)
on investments............................. 10,658 (1,690,238) (1,414,851) 21,656 (267,973)
------- ----------- ----------- ------- ---------
Net increase (decrease) in net assets
resulting from operations.................. $13,201 $ (595,385) $ (13,383) $24,069 $ (65,554)
======= ========== =========== ======= =========
</TABLE>
+For the period May 10, 1994 (effective date of registration) to May 31, 1994.
The accompanying notes are an integral part of these financial statements.
<PAGE>
FRANKLIN MUNICIPAL SECURITIES TRUST
FINANCIAL STATEMENTS (CONT.)
STATEMENTS OF CHANGES IN NET ASSETS
FOR THE PERIODS ENDED MAY 31, 1994 AND 1993
(EXCEPT AS NOTED IN THE COLUMN HEADINGS)
<TABLE>
<CAPTION>
FRANKLIN ARKANSAS FRANKLIN CALIFORNIA FRANKLIN HAWAII
MUNICIPAL BOND FUND HIGH YIELD MUNICIPAL FUND MUNICIPAL BOND FUND
------------------ --------------------------- ----------------------------
5/10/94 5/3/93
(EFFECTIVE DATE) YEAR ENDED (EFFECTIVE DATE) YEAR ENDED YEAR ENDED
TO 5/31/94 5/31/94 TO 5/31/93 5/31/94 5/31/93
-------------- ------------ ----------- ------------- -----------
<S> <C> <C> <C> <C> <C>
Increase (decrease) in net assets:
Operations:...................
Net investment income....... $ 2,543 $ 1,094,853 $ 6,869 $ 1,401,468 $ 581,674
Net realized loss from
security transactions...... - (339,852) (1,120) (159,863) (10,752)
Net unrealized appreciation
(depreciation) during
the period................. 10,658 (1,350,386) (11,431) (1,254,988) 539,467
---------- ----------- ---------- ----------- -----------
Net increase (decrease)
in net assets resulting
from operations.......... 13,201 (595,385) (5,682) (13,383) 1,110,389
Distributions to shareholders:
From undistributed net
investment income............ - (1,102,059) - (1,334,899) (576,489)
From net realized capital gains - (25,621) - - -
Increase in net assets from
capital share transactions
(Note 3)...................... 2,200,000 31,416,649 2,250,401 9,595,395 15,145,001
---------- ----------- ---------- ----------- -----------
Net increase in
net assets............... 2,213,201 29,693,584 2,244,719 8,247,113 15,678,901
Net assets:
Beginning of period........... - 2,244,719 - 18,656,947 2,978,046
---------- ----------- ---------- ----------- -----------
End of period................. $2,213,201 $31,938,303 $2,244,719 $26,904,060 $18,656,947
========== =========== ========== =========== ===========
Undistributed net investment
income included in net assets:
Beginning of period......... $ - $ 6,869 $ - $ 11,950 $ 6,765
========== =========== ========== =========== ===========
End of period.............. $ 2,543 $ (337) $ 6,869 $ 78,519 $ 11,950
========== =========== ========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these
financial statements.
<PAGE>
FRANKLIN MUNICIPAL SECURITIES TRUST
FINANCIAL STATEMENTS (CONT.)
<TABLE>
<CAPTION>
STATEMENTS OF CHANGES IN NET ASSETS (CONT.)
FOR THE PERIODS ENDED MAY 31, 1994 AND 1993
(EXCEPT AS NOTED IN THE COLUMN HEADINGS)
FRANKLIN TENNESSEE FRANKLIN WASHINGTON
MUNICIPAL BOND FUND MUNICIPAL BOND FUND
------------------- ------------------------------
5/10/94 5/3/93
(EFFECTIVE DATE) YEAR ENDED (EFFECTIVE DATE)
TO 5/31/94 5/31/94 TO 5/31/93
---------------- ---------- ----------------
<S> <C> <C> <C>
Increase (decrease) in net assets:
Operations:
Net investment income......................................... $ 2,413 $ 202,419 $ 6,085
Net realized loss from security transactions.................. (1) (26,074) -
Net unrealized appreciation (depreciation) during the period.. 21,657 (241,899) (8,026)
---------- ---------- ----------
Net increase (decrease) in net assets resulting
from operations............................................ 24,069 (65,554) (1,941)
Distributions to shareholders:
From undistributed net investment income....................... - (177,395) -
From net realized capital gains................................ - (4,999) -
Increase in net assets from capital share transactions (Note 3) 2,200,000 2,322,157 2,200,000
---------- ---------- ----------
Net increase in net assets.................................. 2,224,069 2,074,209 2,198,059
Net assets:
Beginning of period............................................ - 2,198,059 -
---------- ---------- ----------
End of period.................................................. 2,224,069 $4,272,268 $2,198,059
========== ========== ==========
Undistributed net investment income included in net assets:
Beginning of period............................................ $ - $ 6,085 $ -
========== ========== ==========
End of period.................................................. $ 2,413 $ 31,109 $ 6,085
========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
FRANKLIN MUNICIPAL SECURITIES TRUST
NOTES TO FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
Franklin Municipal Securities Trust (the Trust) is an open-end management
investment company (mutual fund) registered under the Investment Company Act of
1940 as amended. The Trust currently operates five separate non-diversified
funds (the Funds), consisting of the Franklin Arkansas Municipal Bond Fund (the
Arkansas Fund), Franklin California High Yield Municipal Fund (the California
High Yield Fund), Franklin Hawaii Municipal Bond Fund (the Hawaii Fund),
Franklin Tennessee Municipal Bond Fund (the Tennessee Fund), and Franklin
Washington Municipal Bond Fund (the Washington Fund). Each of the Funds issues
a separate series of the Trust's shares and maintains a totally separate
investment portfolio.
The following is a summary of significant accounting policies consistently
followed by the Funds in the preparation of their financial statements. The
policies are in conformity with generally accepted accounting principles for
investment companies.
A. SECURITY VALUATION: Municipal securities generally trade in the
over-the-counter market rather than on a national securities exchange. Often
there are no transactions in a particular security on any given day. In the
absence of a recorded sale or reported bid and asked prices, information with
respect to bond and note transactions, quotations from bond dealers, market
transactions in comparable securities, and various relationships between
securities are used to determine the value of the security. The Trust may also
utilize a pricing service, bank or broker/dealer experienced in such matters to
perform any of the pricing functions, under procedures approved by the Board of
Trustees. Short-term securities and similar investments with remaining
maturities of 60 days or less are valued at amortized cost, which approximates
value.
B. INCOME TAXES: The Trust intends to continue to qualify for the tax treatment
applicable to regulated investment companies under the Internal Revenue Code
and make the requisite distributions to its shareholders which will be
sufficient to relieve it from income and excise taxes. Therefore, no income tax
provision is required.
Each Fund is treated as a separate entity in the determination of compliance
with the Internal Revenue Code.
C. SECURITY TRANSACTIONS: Security transactions are accounted for on the date
the securities are purchased or sold (trade date). Realized gains and losses on
security transactions are determined on the basis of specific identification
for both financial statement and income tax purposes.
D. INVESTMENT INCOME, EXPENSES AND DISTRIBUTIONS: Distributions to shareholders
are recorded on the ex-dividend date. Interest income and estimated expenses
are accrued daily. Bond discount and premium, if any, are amortized as required
by the Internal Revenue Code. The Fund normally declares dividends from its net
investment income daily and distributes monthly. Daily allocations of net
investment income will commence on the date of receipt of an investor's funds.
Dividends are normally declared each day the New York Stock Exchange is open
for business equal to an amount per day set from time to time by the Board of
Trustees, and are payable to shareholders of record at the beginning of
business on the ex-date. The Arkansas and Tennessee Funds have not yet begun
distributing dividends. Once each month, dividends are reinvested in additional
shares of the Funds, or paid in cash as requested by the shareholders.
E. SECURITIES PURCHASED ON A WHEN-ISSUED BASIS: The Trust may trade securities
on a when-issued or delayed delivery basis, with payment and delivery scheduled
for a future date. These are subject to market fluctuations and are subject to
the risk that the value at delivery may be more or less than the trade date
purchase price transactions. Although the Trust will generally purchase these
securities with the intention of acquiring such securities, they may sell such
securities before the settlement date. These securities are identified on the
accompanying statement of investments in securities and net assets. The Trust
has set aside sufficient investment securities as collateral for these purchase
commitments.
F. EXPENSE ALLOCATION: Common expenses incurred by the Trust are allocated among
the Funds based on the ratio of net assets of each Fund to the combined net
assets. In all other respects, expenses are charged to each Fund as incurred on
a specific identification basis.
81
<PAGE>
FRANKLIN MUNICIPAL SECURITIES TRUST
NOTES TO FINANCIAL STATEMENTS (CONT.)
2. UNAMORTIZED ORGANIZATION COSTS
The organization costs of the Hawaii Fund are amortized on a straight-line
basis over a period of five years from February 26, 1992 (the effective date of
registration under the Securities Act of 1933). In the event Franklin
Resources, Inc. (which was the sole shareholder prior to February 26, 1992)
redeems its shares within the five-year period, the pro rata share of the
then-unamortized deferred organization costs will be deducted from the
redemption price paid to Franklin Resources, Inc. New investors purchasing
shares of the Hawaii Fund subsequent to that date bear such costs during the
amortization period only as such charges are accrued daily against investment
income. Franklin Advisers, Inc. had advanced all of the organization costs of
the Hawaii Fund, which approximated $7,269. In an effort to reduce the Fund's
expenses, Franklin Advisers, Inc. waived repayment of the amount of the current
year's amortization of $1,454. The remaining unamortized balance of such costs
at May 31, 1994 was $3,998.
3. TRUST SHARES
At May 31, 1994, there were an unlimited number of no par value shares of
beneficial interest authorized. Transactions in Trust shares were as follows:
<TABLE>
<CAPTION>
FRANKLIN ARKANSAS FRANKLIN CALIFORNIA FRANKLIN HAWAII
MUNICIPAL BOND FUND+ HIGH YIELD MUNICIPAL FUND MUNICIPAL BOND FUND
--------------------- ------------------------- -----------------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
-------- ---------- --------- ----------- --------- -----------
<S> <C> <C> <C> <C> <C> <C>
Year Ended May 31, 1994
Shares sold.................... 220,000 $2,200,000 2,507,494 $25,732,228 943,538 $10,385,467
Shares issued in reinvestment
of distributions.............. - - 51,770 523,496 70,151 764,282
Shares redeemed................ - - (181,366) (1,829,597) (218,807) (2,362,214)
Changes from exercise of
exchange privilege:
Shares sold................. - - 897,709 9,167,457 127,875 1,386,820
Shares redeemed............. - - (217,294) (2,176,935) (53,402) (578,960)
------- ---------- --------- ----------- -------- -----------
Net increase................ 220,000 $2,200,000 3,058,313 $31,416,649 869,355 $ 9,595,395
======= ========== ========= =========== ======== ===========
Year Ended May 31, 1993++
Shares sold............................................ 224,063 $ 2,240,501 1,313,226 $13,858,900
Shares issued in reinvestment
of distributions...................................... - - 28,299 299,898
Shares redeemed........................................ - - (27,106) (291,378)
Changes from exercise of
exchange privilege:
Shares sold.......................................... 991 9,900 140,970 1,478,032
Shares redeemed...................................... - - (19,660) (200,451)
------- ----------- --------- -----------
Net increase........................................ 225,054 $ 2,250,401 1,435,729 $15,145,001
======= =========== ========= ===========
</TABLE>
<PAGE>
FRANKLIN MUNICIPAL SECURITIES TRUST
NOTES TO FINANCIAL STATEMENTS (CONT.)
3. TRUST SHARES (CONT.)
<TABLE>
<CAPTION>
FRANKLIN TENNESSEE FRANKLIN WASHINGTON
MUNICIPAL BOND FUND+ MUNICIPAL BOND FUND
--------------------- ---------------------
SHARES AMOUNT SHARES AMOUNT
------- ---------- ------- ----------
<S> <C> <C> <C> <C>
Year Ended May 31, 1994
Shares sold.................................................. 220,000 $2,200,000 183,326 $1,875,000
Shares issued in reinvestment of distributions............... - - 13,870 140,305
Shares redeemed.............................................. - - (1,102) (10,931)
Changes from exercise of exchange privilege:
Shares sold.................................................. - - 32,417 329,194
Shares redeemed.............................................. - - (1,149) (11,411)
------- ---------- ------- ----------
Net increase.............................................. 220,000 $2,200,000 227,362 $2,322,157
======= ========== ======= ==========
Year Ended May 31, 1993++
Shares sold........................................................................... 220,000 $2,200,000
Shares issued in reinvestment of distributions........................................ - -
Shares redeemed....................................................................... - -
Changes from exercise of exchange privilege:.......................................... - -
Shares sold........................................................................... - -
Shares redeemed....................................................................... - -
------- ----------
Net increase....................................................................... 220,000 $2,200,000
======= ==========
</TABLE>
+For the period May 10, 1994 (effective date of registration) to May 31, 1994.
++For the California High Yield Fund and the Washington Fund, period from May
3, 1993 (effective date of registration) to May 31, 1993.
4. DISTRIBUTIONS AND CAPITAL LOSS CARRYOVERS
At May 31, 1994, for tax purposes, the Trust had capital loss carryovers as
follows:
<TABLE>
<CAPTION>
FRANKLIN FRANKLIN FRANKLIN FRANKLIN FRANKLIN
ARKANSAS CALIFORNIA HAWAII TENNESSEE WASHINGTON
MUNICIPAL HIGH YIELD MUNICIPAL MUNICIPAL MUNICIPAL
BOND FUND MUNICIPAL FUND* BOND FUND BOND FUND BOND FUND**
--------- --------------- --------- --------- -----------
<S> <C> <C> <C> <C> <C>
Capital loss carryover expiring:
2001..................................... $ - $ - $ 10,752 $ - $ -
2002..................................... - - 159,863 1 -
--- --- -------- --- ---
$ - $ - $170,615 $ 1 $ -
=== === ======== === ===
</TABLE>
*The California High Yield Fund has a deferred capital loss of $366,593, deemed
to be incurred on the first day of the following fiscal year.
**The Washington Fund has a deferred capital loss of $31,073, deemed to be
incurred on the first day of the following fiscal year.
For income tax purposes, the aggregate cost of securities and unrealized
appreciation (depreciation) of the Trust are the same as for financial
reporting purposes at May 31, 1994.
83
<PAGE>
FRANKLIN MUNICIPAL SECURITIES TRUST
NOTES TO FINANCIAL STATEMENTS (CONT.)
5. PURCHASES AND SALES OF SECURITIES
Aggregate purchases and sales of securities (excluding purchases and sales of
short-term securities) for the period ended May 31, 1994 were as follows:
<TABLE>
<CAPTION>
FRANKLIN FRANKLIN FRANKLIN FRANKLIN FRANKLIN
ARKANSAS CALIFORNIA HAWAII TENNESSEE WASHINGTON
MUNICIPAL HIGH YIELD MUNICIPAL MUNICIPAL MUNICIPAL
BOND FUND MUNICIPAL FUND BOND FUND BOND FUND BOND FUND
---------- -------------- ----------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Purchases.............................. $1,126,815 $37,619,625 $17,377,745 $1,860,345 $3,626,514
========== =========== =========== ========== ==========
Sales.................................. $ - $ 7,104,516 $ 7,466,143 $ 191,390 $1,370,771
========== =========== =========== ========== ==========
</TABLE>
6. TRANSACTIONS WITH AFFILIATES AND RELATED PARTIES
Franklin Advisers, Inc. ("Manager"), under the terms of a management agreement,
provides investment advice, office space and facilities to each Fund, and
receives fees computed monthly based on the average daily net assets of each
Fund at an annual rate of 5/8 of 1% of the first $100 million of net assets,
1/2 of 1% on net assets in excess of $100 million up to and including $250
million, and 45/100 of 1% of net assets in excess of $250 million. Fees which
would have been incurred by the Arkansas Fund, California High Yield Fund,
Hawaii Fund, Tennessee Fund and Washington Fund under the agreement aggregated
$1,175, $111,730, $152,252, $1,181 and $22,669, respectively, for the period
ended May 31, 1994. The terms of the management agreement provide that annual
aggregate expenses of the Funds be limited to the extent necessary to comply
with the limitations set forth in the laws, regulations, and administrative
interpretations of the states in which the Funds' shares are registered. The
Funds' expenses did not exceed these limitations; however, for the period ended
May 31, 1994, Franklin Advisers, Inc. did not impose management fees. In
addition, Franklin Advisers, Inc. bore other expenses of $10,614, $31,828,
$60,618, $7,413 and $1,172, for the Arkansas Fund, California High Yield Fund,
Hawaii Fund, Tennessee Fund and Washington Fund, respectively, which are not
reflected in the Statement of Operations.
In its capacity as underwriter for the shares of the Funds, Franklin/Templeton
Distributors, Inc. received commissions on sales of the Trust's shares.
Commissions received by Franklin/Templeton Distributors, Inc. and the amounts
which were subsequently paid to other dealers for the period ended May 31, 1994
were as follows:
<TABLE>
<CAPTION>
FRANKLIN FRANKLIN FRANKLIN FRANKLIN FRANKLIN
ARKANSAS CALIFORNIA HAWAII TENNESSEE WASHINGTON
MUNICIPAL HIGH YIELD MUNICIPAL MUNICIPAL MUNICIPAL
BOND FUND MUNICIPAL FUND BOND FUND BOND FUND BOND FUND
---------- -------------- ----------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Total commissions received................ $ - $847,492 $420,455 $ - $81,291
=== ======== ======== === =======
Paid to other dealers..................... $ - $781,267 $369,296 $ - $77,955
=== ======== ======== === =======
</TABLE>
Commissions are deducted from the gross proceeds received from the sale of the
Trust's shares, and as such are not expenses of the Funds.
Under the terms of a Distribution Agreement pursuant to Rule 12b-1 of the
Investment Company Act of 1940, the Hawaii Fund will reimburse
Franklin/Templeton Distributors, Inc., in an amount up to 0.10% per annum of
its average daily net assets while the Arkansas Fund, California High Yield
Fund, Tennessee Fund and Washington Fund will reimburse up to 0.15% per annum
of the Funds' average daily net assets for costs incurred in the promotion,
offering and marketing of the Funds' shares.
84
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FRANKLIN MUNICIPAL SECURITIES TRUST
NOTES TO FINANCIAL STATEMENTS (CONT.)
6. TRANSACTIONS WITH AFFILIATES AND RELATED PARTIES (CONT.)
Distribution fees incurred by the Arkansas Fund, California High Yield Fund,
Hawaii Fund, Tennessee Fund and Washington Fund under the agreements aggregated
$36, $12,039, $11,200, $37 and $1,734, respectively, for the period ended May
31, 1994.
Under the terms of a shareholder services agreement with Franklin/Templeton
Investor Services, Inc., the Trust pays costs on a per shareholder account
basis. Shareholder servicing costs incurred by the Funds for the period ended
May 31, 1994 aggregated $8,296, all of which was paid by Franklin Advisers,
Inc.
Certain officers and trustees of the Trust are also officers and/or directors
of Franklin/Templeton Distributors, Inc., Franklin Advisers, Inc. and
Franklin/Templeton Investor Services, Inc., all wholly-owned subsidiaries of
Franklin Resources, Inc.
At May 31, 1994, Franklin Resources, Inc. owned 100%, 100% and 52% of the
Arkansas Fund, Tennessee Fund and Washington Fund, respectively.
7. CREDIT RISKS
Although each of the Funds has a diversified investment portfolio, all of its
investments are in the securities of issuers within its respective state, Guam
and Puerto Rico. Such manner of investments may subject the Funds to economic
and fiscal changes occurring within those states, Guam and Puerto Rico.
8. FINANCIAL HIGHLIGHTS
Selected data for each share of beneficial interest outstanding throughout each
period are set forth in the Prospectus under the caption "Financial
Highlights."
During this fiscal year, the California High Yield Fund, Hawaii Fund and
Washington Fund paid distributions from undistributed net investment income in
the amounts shown in the Statement of Changes in Net Assets. The California
High Yield Fund, Hawaii Fund and Washington Fund hereby designate the total
amount of these distributions as exempt-interest dividends under Section 852
(b) (5) of the Internal Revenue Code.
85
<PAGE>
