SMITH BREEDEN TRUST, N-30D, 1998-11-30

SMITH BREEDEN TRUST
N-30D, 1998-11-30

Previous: SMITH BREEDEN TRUST, NSAR-A, 1998-11-30

Next: NUVEEN TAX EXEMPT UNIT TRUST SERIES 656, 497J, 1998-11-30

SMITH BREEDEN EQUITY MARKET PLUS FUND
- --------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS (UNAUDITED) SEPTEMBER 30, 1998

<TABLE>
<CAPTION>
MARKET
FACE AMOUNT SECURITY VALUE
- ------------- ----------------------------------------------------- --------------
<S> <C> <C>
U.S. GOVERNMENT & AGENCY OBLIGATIONS -- 109.6%
FREDDIE MAC -- 28.6% (1)
FH
$ 2,928,576 6.00%, due 4/1/13 ................................... $ 2,961,322
8,000,000 6.00%, due date to be announced ..................... 8,140,312
26,300,000 6.50%, due 11/1/13 .................................. 26,852,711
50,817 9.50%, due 7/1/02 ................................... 52,485
-----------
38,006,830
-----------
FANNIE MAE -- 15.8% (1)
FN
9,950,100 6.50%, due 7/1/28 to 8/1/28 ......................... 10,122,392
10,000,000 7.00%, due date to be announced ..................... 10,271,094
75,688 12.50%, due 9/1/12 .................................. 86,047
62,275 13.50%, due 1/1/15 .................................. 74,102
FN ARM
372,855 7.515%, due 9/1/18 .................................. 384,856
-----------
20,938,491
-----------
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION -- 58.4% (1)
GNMA
4,933,642 7.00%, due 9/15/27 to 12/15/27 ...................... 5,091,678
4,290,059 7.50%, due 3/15/28 .................................. 4,445,680
GNMA ARM
2,926,111 4.50%, due 10/20/27 ................................. 2,926,106
43,236,507 5.00%, due 1/20/28 to 6/20/28 ....................... 43,383,858
18,252,055 5.50%, due 10/20/27 to 3/20/28 ...................... 18,382,376
2,947,041 6.875%, due 2/20/16 to 5/20/22 ...................... 3,005,251
158,511 7.00%, due 9/20/21 to 5/20/22 ....................... 161,267
-----------
77,396,216
-----------
U.S. TREASURY OBLIGATIONS -- 6.8%
800,000 5.14% Bill, due 10/15/98 (2),(3) .................... 798,659
1,000,000 5.50% Note, due 11/15/98 (3) ........................ 1,001,563
900,000 5.875% Note, due 7/31/99 (3) ........................ 909,141
6,250,000 6.375% Note, due 5/15/99 (3) ........................ 6,314,453
-----------
9,023,816
-----------
TOTAL U.S. GOVERNMENT & AGENCY OBLIGATIONS
(COST $144,072,686)................................. 145,365,353
-----------
</TABLE>

20
<PAGE>

SMITH BREEDEN EQUITY MARKET PLUS FUND
- --------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS (UNAUDITED) (CONTINUED) SEPTEMBER 30, 1998

<TABLE>
<CAPTION>
MARKET
CONTRACTS SECURITY VALUE
- -------------- ------------------------------------------------------------------------ ----------------
<S> <C> <C>
OPTIONS CONTRACTS -- 0.2%
100 Call on Ten-Year US Treasury Note Futures, expires 11/98, strike price
$130.................................................................... $ 264,063
110 Put on Ten-Year US Treasury Note Futures, expires 11/98, strike price
$110.................................................................... 1,719
85 Put on Five-Year US Treasury Note Futures, expires 11/98, strike price
$113.................................................................... 1,328
130 Put on Five-Year US Treasury Note Futures, expires 2/99, strike price
$114.................................................................... 26,406
-------------
293,516
-------------
FACE AMOUNT OPTION CONTRACTS ON THREE-MONTH LIBOR INTEREST-RATE SWAP
- -------------- AGREEMENTS -- 0.7%
$30,000,000 Option to enter a pay-fixed 6.5% interest-rate swap with Deutsche Bank
AG beginning 9/29/03 and expiring 9/29/08 .............................. 322,090
30,000,000 Option to enter a receive-fixed 5.25% interest-rate swap with Deutsche
Bank AG beginning 9/29/03 and expiring 9/29/08 ......................... 551,532
-------------
873,622
COMMERCIAL MORTGAGE-BACKED SECURITIES -- 7.1% (1)
5,000,000 First Union-Lehman Brothers-Bank of America Commercial Mortage Trust
6.56%, due 11/18/08 .................................................... 5,246,925
4,000,000 Nomura Asset Securities Corporation Commercial Mortgage Trust 6.59%,
due 3/15/30 ............................................................ 4,195,529
-------------
9,442,454
-------------
TOTAL INVESTMENTS (COST $154,267,487)--117.6%........................... 155,974,945
-------------
REPURCHASE AGREEMENTS -- 15.1%
20,000,000 Morgan Stanley Dean Witter, 5.27%, due 10/6/98 dated 9/29/98 ........... 20,000,000
-------------
20,000,000
-------------
LIABILITIES LESS CASH AND OTHER ASSETS -- (32.7%) ...................... (43,354,104)
-------------
NET ASSETS -- 100.00% .................................................. $ 132,620,841
=============
</TABLE>

- ---------
(1) Mortgage-backed obligations are subject to principal paydowns as a result
of prepayments or refinancings of the underlying mortgage instruments. As a
result, the average life may be substantially less than the original
maturity. ARMs have coupon rates that adjust periodically. The interest rate
shown is the rate in effect at September 30, 1998. The adjusted rate is
determined by adding a spread to a specified index.

(2) The interest rate shown for U.S. Treasury Bills is the discount rate paid
at the time of purchase by the Fund.

(3) Security is held as collateral by Carr Futures, Inc.

Portfolio Abbreviations:
ARM -- Adjustable-Rate Mortgage
FH -- Freddie Mac
FN -- Fannie Mae
GNMA -- Government National Mortgage Association

- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
21
<PAGE>

SMITH BREEDEN EQUITY MARKET PLUS FUND
- --------------------------------------------------------------------------------
STATEMENT OF ASSETS AND LIABILITIES (UNAUDITED)

SEPTEMBER 30, 1998

<TABLE>
<S> <C>
ASSETS:
Investments at market value (identified cost $154,267,487) (Note 1)...................... $ 155,974,945
Cash .................................................................................... 2,678,793
Repurchase Agreements (Cost $20,000,000) (Note 1)........................................ 20,000,000
Receivables:
Subscriptions ......................................................................... 2,875,619
Interest and maturities ............................................................... 765,461
Securities sold ....................................................................... 45,028,273
Other Assets ............................................................................ 60,706
--------------
TOTAL ASSETS .......................................................................... 227,383,797
--------------
LIABILITIES:
Payables:
Variation margin on futures contracts (Note 2) ........................................ 4,303,107
Redemptions ........................................................................... 375,776
Securities purchased .................................................................. 89,947,786
Due to advisor (Note 3) ................................................................. 77,567
Accrued expenses ........................................................................ 58,720
--------------
TOTAL LIABILITIES ..................................................................... 94,762,956
--------------
NET ASSETS:
(Applicable to outstanding shares of 9,920,988; unlimited number of shares of beneficial
interest authorized; no stated par) ................................................... $ 132,620,841
==============
Net asset value, offering price and redemption price per share
($132,620,841 / 9,920,988)............................................................. $ 13.37
==============
SOURCE OF NET ASSETS:
Paid in capital ......................................................................... $ 150,099,179
Undistributed net investment income ..................................................... 538,659
Accumulated net realized gain (loss) on investments ..................................... (6,359,329)
Net unrealized appreciation (depreciation) of investments ............................... (11,657,668)
--------------
NET ASSETS ............................................................................ $ 132,620,841
==============
</TABLE>

- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
22
<PAGE>

SMITH BREEDEN EQUITY MARKET PLUS FUND
- --------------------------------------------------------------------------------
STATEMENT OF OPERATIONS (UNAUDITED)

FOR THE SIX MONTHS ENDED SEPTEMBER 30, 1998

<TABLE>
<S> <C>
INVESTMENT INCOME:
Interest and discount earned, net of premium amortization (Note 1) ...... $ 4,143,518
EXPENSES:
Advisory fees (Note 3) .................................................. 519,439
Accounting and pricing services fees .................................... 30,398
Custodian fees .......................................................... 21,232
Audit and tax preparation fees .......................................... 24,190
Legal fees .............................................................. 20,385
Transfer agent fees ..................................................... 72,493
Registration fees ....................................................... 17,350
Trustees fees and expenses .............................................. 60,831
Insurance expense ....................................................... 6,381
Other ................................................................... 14,774
-------------
TOTAL EXPENSES BEFORE REIMBURSEMENT ................................... 787,473
Expenses reimbursed by advisor (Note 3) ............................... (134,464)
-------------
NET EXPENSES .......................................................... 653,009
-------------
NET INVESTMENT INCOME ................................................. 3,490,509
-------------
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:
Net realized gain on investments ........................................ 2,956,732
Change in unrealized appreciation (depreciation) of investments ......... (20,742,950)
-------------
Net realized and unrealized gain (loss) on investments .................. (17,786,218)
-------------
Net decrease in net assets resulting from operations .................... $ (14,295,709)
=============
</TABLE>

- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
23
<PAGE>

SMITH BREEDEN EQUITY MARKET PLUS FUND
- --------------------------------------------------------------------------------
STATEMENTS OF CHANGES IN NET ASSETS

<TABLE>
<CAPTION>
SIX MONTHS ENDED
SEPTEMBER 30, 1998 YEAR ENDED
(UNAUDITED) MARCH 31, 1998
-------------------- ---------------
<S> <C> <C>
OPERATIONS:
Net investment income .................................................... $ 3,490,509 $ 2,908,437
Net realized gain on investments ......................................... 2,956,732 9,514,596
Change in unrealized appreciation (depreciation) of investments .......... (20,742,950) 9,573,592
------------- -------------
Net increase (decrease) in net assets resulting from operations .......... (14,295,709) 21,996,625
------------- -------------
DISTRIBUTIONS TO SHAREHOLDERS:
Dividends from net investment income ..................................... (3,264,248) (2,632,273)
Distributions from net realized gains on investments ..................... (17,138,874) (2,556,880)
------------- -------------
Total distributions ...................................................... (20,403,122) (5,189,153)
------------- -------------
CAPITAL SHARE TRANSACTIONS:
Shares sold .............................................................. 67,376,805 123,373,056
Shares issued on reinvestment of distributions ........................... 19,812,770 4,918,950
Shares redeemed .......................................................... (56,537,342) (21,939,416)
------------- -------------
Increase in net assets resulting from capital share transactions (a) ..... 30,652,233 106,352,590
------------- -------------
TOTAL INCREASE (DECREASE) IN NET ASSETS ................................ (4,046,598) 123,160,062
NET ASSETS:
Beginning of period ...................................................... 136,667,439 13,507,377
------------- -------------
End of period ............................................................ $ 132,620,841 $136,667,439
============= =============
(a) Transactions in capital shares were as follows: .......................
Shares sold .............................................................. 4,307,101 8,130,007
Shares issued on reinvestment of distributions ........................... 1,359,398 330,714
Shares redeemed .......................................................... (3,853,145) (1,428,596)
------------- -------------
Net increase ............................................................. 1,813,354 7,032,125
Beginning balance ........................................................ 8,107,634 1,075,509
------------- -------------
Ending balance ........................................................... 9,920,988 8,107,634
============= =============
</TABLE>

- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
24
<PAGE>

SMITH BREEDEN EQUITY MARKET PLUS FUND
- --------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS

The following average per share data, ratios and supplemental information
has been derived from information provided in the financial statements.

<TABLE>
<CAPTION>
SIX MONTHS
ENDED YEAR YEAR
SEPTEMBER 30, ENDED ENDED
1998 MARCH 31, MARCH 31,
(UNAUDITED) 1998 1997
----------------- ---------------- ---------------
<S> <C> <C> <C>
NET ASSET VALUE,
BEGINNING OF PERIOD ............. $ 16.86 $ 12.56 $ 12.27
---------- ----------- ----------
INCOME FROM INVESTMENT
OPERATIONS
Net investment income ........... 0.349 0.591 0.592
Net realized and
unrealized gain (loss)
on investments ................. (1.603) 4.940 1.813
----------- ------------ -----------
Total from investment
operations ..................... (1.254) 5.531 2.405
----------- ------------ -----------
LESS DISTRIBUTIONS
Dividends from net
investment income .............. (0.334) (0.586) (0.590)
Dividends in excess of
net investment
income ......................... -- -- --
Distributions from net
realized gains on
investments .................... (1.905) (0.645) (1.525)
Distributions in excess of
net realized gains on
investments .................... -- -- --
----------- ------------ -----------
Total distributions ............ (2.239) (1.231) (2.115)
----------- ------------ -----------
NET ASSET VALUE, END OF
PERIOD .......................... $ 13.37 $ 16.86 $ 12.56
----------- ------------ -----------
TOTAL RETURN ..................... (8.30%) 45.71% 21.41%
RATIOS/SUPPLEMENTAL DATA
Net assets, end of
period ......................... $132,620,841 $136,667,439 $13,507,377
Ratio of expenses to
average net assets ............. 0.88%* 0.88% 0.88%
Ratio of net investment
income to average net
assets ......................... 4.89%* 4.79% 5.30%
Portfolio turnover rate ......... 133% 424% 182%
Ratio of expenses to
average net assets
before reimbursement
of expenses by the
Advisor ........................ 1.09%* 1.23% 2.60%
Ratio of net investment
income to average net
assets before
reimbursement of
expenses by the
Advisor ........................ 4.68%* 4.44% 3.58%

<CAPTION>
YEAR YEAR YEAR PERIOD
ENDED ENDED ENDED ENDED
MARCH 31, MARCH 31, MARCH 31, MARCH 31,
1996 1995 1994 1993 (1)
-------------- -------------- -------------- ---------------
<S> <C> <C> <C> <C>
NET ASSET VALUE,
BEGINNING OF PERIOD ............. $ 10.84 $ 9.88 $ 10.85 $ 10.00
--------- --------- --------- ----------
INCOME FROM INVESTMENT
OPERATIONS
Net investment income ........... 0.615 0.568 0.476 0.355
Net realized and
unrealized gain (loss)
on investments ................. 2.768 1.081 (0.216) 1.281
---------- ---------- ---------- -----------
Total from investment
operations ..................... 3.383 1.649 0.260 1.636
---------- ---------- ---------- -----------
LESS DISTRIBUTIONS
Dividends from net
investment income .............. (0.583) (0.568) (0.472) (0.311)
Dividends in excess of
net investment
income ......................... -- (0.001) -- --
Distributions from net
realized gains on
investments .................... (1.370) (0.047) (0.701) (0.420)
Distributions in excess of
net realized gains on
investments .................... -- (0.073) (0.057) (0.055)
---------- ---------- ---------- -----------
Total distributions ............ (1.953) (0.689) (1.230) (0.786)
---------- ---------- ---------- -----------
NET ASSET VALUE, END OF
PERIOD .......................... $ 12.27 $ 10.84 $ 9.88 $ 10.85
---------- ---------- ---------- -----------
TOTAL RETURN ..................... 32.30% 17.18% 2.19% 16.52%
RATIOS/SUPPLEMENTAL DATA
Net assets, end of
period ......................... $4,766,534 $2,107,346 $1,760,519 $ 903,846
Ratio of expenses to
average net assets ............. 0.90% 0.90% 0.90% 0.57%*
Ratio of net investment
income to average net
assets ......................... 5.53% 7.44% 8.02% 5.28%*
Portfolio turnover rate ......... 107% 120% 119% 271%
Ratio of expenses to
average net assets
before reimbursement
of expenses by the
Advisor ........................ 4.58% 7.75% 7.08% 28.48%*
Ratio of net investment
income to average net
assets before
reimbursement of
expenses by the
Advisor ........................ 1.85% 0.59% 1.84% (22.63%)*
</TABLE>

- ---------
(1) Commenced operations June 30, 1992.
* Annualized

- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
25
<PAGE>

SMITH BREEDEN EQUITY MARKET PLUS FUND
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)

1. SIGNIFICANT ACCOUNTING POLICIES

The Smith Breeden Trust (the "Trust") is an open-end, diversified management
investment company registered under the Investment Company Act of 1940, as
amended. The Fund offers shares in two series: the Smith Breeden Equity Market
Plus Fund ( the "Fund", formerly the Smith Breeden Equity Plus Fund) and the
Smith Breeden Financial Services Fund. The following is a summary of accounting
policies consistently followed by the Fund.

A. SECURITY VALUATION: Portfolio securities are valued at the current market
value provided by a pricing service, or by a bank or broker/dealer experienced
in such matters when over-the-counter market quotations are readily available.
Securities and other assets for which market prices are not readily available
are valued at fair market value as determined in accordance with procedures
approved by the Board of Trustees.

B. REPURCHASE AGREEMENTS: Repurchase agreements may be entered into with member
banks of the Federal Reserve System with total assets in excess of $500
million, and securities dealers, provided that such banks or dealers meet the
credit guidelines of the Fund's Board of Trustees. In a repurchase agreement,
the Fund acquires securities from a third party, with the commitment that they
will be repurchased by the seller at a fixed price on an agreed upon date. The
Fund's custodian maintains control or custody of the securities collateralizing
the repurchase agreement until maturity. The value of the collateral is
monitored daily, and, if necessary, additional collateral is received to ensure
that the market value of the collateral remains sufficient to protect the Fund
in the event of the seller's default. However, in the event of default or
bankruptcy of the seller, the Fund's right to the collateral may be subject to
legal proceedings.

C. REVERSE REPURCHASE AGREEMENTS: A reverse repurchase agreement involves the
sale of portfolio assets together with an agreement to repurchase the same
assets later at a fixed price. Additional assets are maintained in a segregated
account with the custodian, and are marked to market daily. The segregated
assets may consist of cash, U.S. Government securities, or other liquid
high-grade debt obligations equal in value to the obligations under the reverse
repurchase agreements. In the event the buyer of securities under a reverse
repurchase agreement files for bankruptcy or becomes insolvent, the Fund's use
of the proceeds under the agreement may be restricted pending a determination
by the other party, or its trustee or receiver, whether to enforce the
obligation to repurchase the securities.

D. DOLLAR ROLL AGREEMENTS: A dollar roll is an agreement to sell securities for
delivery in the current month and to repurchase substantially similar (same
type and coupon) securities on a specified future date. During the roll period,
principal and interest paid on these securities are not received. The Fund is
compensated by the difference between the current sales price and the forward
price for the future purchase (often referred to as the "drop") as well as by
earnings on the cash proceeds of the initial sale.

E. DISTRIBUTIONS AND TAXES: Dividends to shareholders are recorded on the
ex-dividend date. The Fund intends to continue to qualify for and elect the
special tax treatment afforded regulated investment companies under Subchapter
M of the Internal Revenue Code, thereby relieving the Fund of Federal income
taxes. To so qualify, the Fund intends to distribute substantially all of its
net investment income and net realized capital gains, if any, less any
available capital loss carryforward. As of March 31, 1998, the Fund had no net
capital loss carryforward.

F. SECURITIES TRANSACTIONS, INVESTMENT INCOME AND OPERATING EXPENSES: Interest
income is accrued daily, and includes net amortization from the purchase of
fixed-income securities. Discounts and premiums on securities purchased are
amortized over the life of the respective securities. Securities transactions
are recorded on the trade date. Gains or losses on the sale of securities are
calculated for accounting and tax purposes on the identified cost basis.

Expenses are accrued daily. Common expenses incurred by the Trust are generally
allocated among the funds comprising the Trust based on the ratio of net assets
of each fund to the combined net assets of the Trust. Other expenses are
charged to each fund on a specific identification basis.

G. ACCOUNTING ESTIMATES: The preparation of financial statements in accordance
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and the amounts of income
and expense during the reporting period. Actual results could differ from those
estimates.

26
<PAGE>

SMITH BREEDEN EQUITY MARKET PLUS FUND
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)

2. FINANCIAL INSTRUMENTS

A. DERIVATIVE FINANCIAL INSTRUMENTS HELD OR ISSUED FOR PURPOSES OTHER THAN
TRADING: The Fund uses interest rate futures contracts for risk management
purposes in order to reduce fluctuations in the Fund's net asset value relative
to its targeted option-adjusted duration. On entering into a futures contract,
either cash or securities in an amount equal to a certain percentage of the
contract value (initial margin) must be deposited with the futures broker.
Subsequent payments (variation margin) are made or received by the Fund each
day. The variation margin payments equal the daily changes in the contract
value and are recorded as unrealized gains or losses. The Fund recognizes a
realized gain or loss when the contract is closed or expires equal to the
difference between the value of the contract at the time it was opened and the
value at the time it was closed.

Futures transactions involve costs and may result in losses. The effective use
of futures depends on the Fund's ability to close futures positions at times
when the Fund's Advisor deems it desirable to do so. The use of futures also
involves the risk of imperfect correlation among movements in the values of the
securities underlying the futures purchased and sold by the Fund, of the
futures contract itself, and of the securities which are the subject of a
hedge.

The Fund had the following open futures contracts as of September 30, 1998:

<TABLE>
<CAPTION>
NUMBER OF EXPIRATION UNREALIZED
TYPE CONTRACTS POSITION MONTH GAIN/(LOSS)
- ---------------------------- ----------- ---------- ----------------- -----------------
<S> <C> <C> <C> <C>
3 Month Eurodollar ......... 154 Long December, 1998 $ 122,507
3 Month Eurodollar ......... 79 Short March, 1999 (215,681)
3 Month Eurodollar ......... 3 Short June, 1999 (8,225)
3 Month Eurodollar ......... 111 Short September, 1999 (448,037)
3 Month Eurodollar ......... 3 Short December, 1999 (8,789)
3 Month Eurodollar ......... 40 Short March, 2000 (128,930)
3 Month Eurodollar ......... 3 Short June, 2000 (8,600)
3 Month Eurodollar ......... 112 Short September, 2000 (426,454)
3 Month Eurodollar ......... 3 Short December, 2000 (7,513)
3 Month Eurodollar ......... 34 Short March, 2001 (89,778)
3 Month Eurodollar ......... 3 Short June, 2001 (6,800)
3 Month Eurodollar ......... 108 Short September, 2001 (370,911)
3 Month Eurodollar ......... 3 Short December, 2001 (5,979)
3 Month Eurodollar ......... 33 Short March, 2002 (71,360)
3 Month Eurodollar ......... 3 Short June, 2002 (5,338)
3 Month Eurodollar ......... 102 Short September, 2002 (222,059)
3 Month Eurodollar ......... 3 Short December, 2002 (4,776)
3 Month Eurodollar ......... 47 Short March, 2003 (94,036)
3 Month Eurodollar ......... 3 Short June, 2003 (4,438)
3 Month Eurodollar ......... 87 Short September, 2003 (121,242)
3 Month Eurodollar ......... 3 Short December, 2003 (4,213)
3 Month Eurodollar ......... 134 Short March, 2004 (241,653)
3 Month Eurodollar ......... 3 Short June, 2004 (4,138)
3 Month Eurodollar ......... 3 Short September, 2004 (4,138)
3 Month Eurodollar ......... 3 Short December, 2004 (3,989)
3 Month Eurodollar ......... 81 Short March, 2005 (141,515)
3 Month Eurodollar ......... 3 Short June, 2005 (3,914)
3 Month Eurodollar ......... 37 Short March, 2006 (63,992)
3 Month Eurodollar ......... 24 Short March, 2007 (39,708)
5 Year Treasury ............ 100 Short December, 1998 (342,638)
10 Year Treasury ........... 13 Short December, 1998 (95,629)
-------------
Total $ (3,071,966)
=============
</TABLE>

27
<PAGE>

SMITH BREEDEN EQUITY MARKET PLUS FUND
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)

2. FINANCIAL INSTRUMENTS -- CONTINUED
B. DERIVATIVE FINANCIAL INSTRUMENTS HELD OR ISSUED FOR TRADING PURPOSES: The
Fund invests in futures contracts on the S&P 500 Index whose returns are
expected to track movements in the S&P 500 Index.

The Fund had the following open futures contracts on the S&P 500 Index as of
September 30, 1998:

<TABLE>
<CAPTION>
NUMBER OF EXPIRATION UNREALIZED
TYPE CONTRACTS POSITION MONTH GAIN/(LOSS)
- ----------------- ----------- ---------- ---------------- -----------------
<S> <C> <C> <C> <C>
S&P 500 ......... 372 Long December, 1998 $ (6,620,210)
S&P 500 ......... 140 Long March, 1999 (3,672,950)
-------------
Total $ (10,293,160)
=============
</TABLE>

The aggregate market value of investments pledged to cover margin requirements
for the open positions at September 30, 1998 was $9,023,816.

C. OPTIONS ON INTEREST RATE SWAP CONTRACTS: The Fund may enter into
over-the-counter transactions swapping interest rates, or purchase options to
enter into such contracts. Interest rate swaps represent an agreement between
counterparties to exchange cash flows based on the difference between two
interest rates, applied to a notional principal amount for a specified period.
The most common type of interest rate swap involves the exchange of fixed-rate
cash flows for variable-rate cash flows. Interest rate swaps do not involve the
exchange of principal between the parties. Purchased options on interest rate
swap contracts ("swaptions") give the fund the right, but not the obligation,
to enter into a swap contract with the counterparty which has written the
option on a date, at an interest rate, and with a notional amount as specified
in the swaption agreement.

As of September 30, 1998, the Fund had two open options to enter into interest
rate swap contracts. In each of the contracts, the Fund has paid a sum of
money, called a premium, to the counterparty, in return for the swaptions.
These swaptions may be exercised by entering into a swap contract with the
counterparty only on the date specified in each contract. If the swaptions are
exercised, the Fund will enter a swap either to pay a specified fixed interest
rate in return for receiving a floating rate, or receive a fixed rate in return
for paying a floating rate, based on the respective contracts. The floating
rate on the swap contracts as specified in the swaption agreements resets
quarterly and is the three month London Inter-Bank Offered Rate ("LIBOR"). If
the counterparty to the swaption transaction defaults, the Fund will be limited
to contractual remedies pursuant to the agreements governing the transaction.
There is no assurance that the interest rate swap or swaption contract
counterparty will be able to meet its obligation under the contracts, or that,
in the event of default, the Fund will succeed in pursuing contractual
remedies. The Fund thus assumes the risk that it may be delayed in, or
prevented from, receiving payments owed to it under the swaption, or swap
contracts should the swaptions be exercised. Should interest rates move
unexpectedly, the Fund may not achieve the anticipated benefits of the
swaptions, and may realize a loss. The Fund records gains and losses under
swaptions as realized gains or losses on investments.

3. INVESTMENT ADVISORY FEES AND OTHER TRANSACTIONS WITH AFFILIATES

Smith Breeden Associates, Inc. (the "Advisor"), a registered Investment
Advisor, provides the Fund with investment management services. As compensation
for these services, the Fund pays the Advisor a fee computed daily and payable
monthly, at an annual rate equal to 0.70% of the Fund's average daily net
assets.

The Advisor has voluntarily agreed to reduce or otherwise limit the expenses of
the Fund to 0.88% of the Fund's average daily net assets. This voluntary
agreement may be terminated or modified at any time by the Advisor in its sole
discretion, except that the Advisor has agreed to limit expenses of the Fund to
0.88% through August 1, 1999. For the six months ended September 30, 1998, the
Advisor received fees of $519,439 and reimbursed the Fund $134,464.

28
<PAGE>

SMITH BREEDEN EQUITY MARKET PLUS FUND
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)

3. INVESTMENT ADVISORY FEES AND OTHER TRANSACTIONS WITH AFFILIATES -- CONTINUED

sale of shares of the Fund, reducing redemptions, or otherwise maintaining or
improving services provided to shareholders by such dealers or other persons.
The Plan provides for payments by the Advisor, out of the advisory fee to
dealers and other persons at the annual rate of up to 0.25% of the Fund's
average net assets, subject to the authority of the Trustees of the Fund, to
reduce the amount of payments permitted under the Plan or to suspend the Plan
for such periods as they may determine. Subject to these limitations, the
Advisor shall determine the amount of such payments and the purposes for which
they are made.

Certain officers and trustees of the Fund are also officers and directors of
the Advisor.

4. INVESTMENT TRANSACTIONS

During the six months ended September 30, 1998, purchases and proceeds from
sales of securities, other than short-term investments, aggregated $231,121,042
and $181,037,488, respectively. The cost of securities for federal income tax
purposes is $154,267,487. Net unrealized depreciation of investments and
futures contracts consists of:

<TABLE>
<S> <C>
Gross unrealized appreciation ........ $ 1,850,222
Gross unrealized depreciation ........ (13,507,890)
--------------
Net unrealized depreciation .......... $ (11,657,668)
==============
</TABLE>

29
<PAGE>

SMITH BREEDEN FINANCIAL SERVICES FUND
- --------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS (UNAUDITED) SEPTEMBER 30, 1998

<TABLE>
<CAPTION>
MARKET
SHARES SECURITY VALUE
- -------- ------------------------------------------------------------ ---------------
<S> <C> <C>
EQUITY HOLDINGS -- 124.7%
COMMERCIAL BANKING -- 37.9%
7,000 Bank One Corp. ............................................. $ 298,375
4,000 First Chicago NBD Corp. .................................... 274,000
5,700 First Union Corp. .......................................... 291,769
2,200 Fleet Financial Group, Inc. ................................ 161,563
5,000 KeyCorp .................................................... 144,375
6,000 Mercantile Bancorporation Inc. ............................. 290,250
5,500 Nationsbank Corp. .......................................... 294,250
18,000 Pacific Century Financial Corp. ............................ 300,375
6,400 PNC Bank Corp. ............................................. 288,000
------------
2,342,957
------------
INVESTMENT BANKING AND BROKERAGE -- 10.1%
6,000 Lehman Brothers, Inc. ...................................... 169,500
5,000 Merrill Lynch & Co. ........................................ 236,875
5,000 Morgan Stanley Dean Witter & Co. ........................... 215,313
------------
621,688
------------
MONEY CENTER BANKING -- 21.0%
5,000 BankAmerica Corp. .......................................... 300,625
3,500 Chase Manhattan Corp. ...................................... 432,500
2,400 Citicorp ................................................... 278,813
5,000 J.P. Morgan & Co. .......................................... 287,725
------------
1,299,663
------------
INVESTMENT MANAGEMENT AND ADVISORY -- 14.4%
10,000 Franklin Resources, Inc. ................................... 300,000
10,000 PIMCO Advisors Holdings LP (1) ............................. 293,750
10,000 Price (T. Rowe) Assoc., Inc. ............................... 293,750
------------
887,500
------------
CONSUMER FINANCE -- 3.6%
6,000 Household International, Inc. .............................. 225,000
------------
225,000
------------
SAVINGS & LOANS -- 37.7%
2,000 Community Bank Shares of Indiana, Inc. ..................... 34,750
35,000 FirstFed America Bancorp ................................... 498,750
3,500 Golden West Financial Corp. ................................ 286,344
4,200 HF Ahmanson & Co. .......................................... 233,100
20,000 HF Bancorp Inc. (2) ........................................ 320,000
12,000 Home Federal Bancorp ....................................... 276,000
12,000 Marion Capital Holdings, Inc. .............................. 282,000
9,700 Piedmont Bancorp, Inc. ..................................... 93,969
9,000 Washington Mutual Inc. ..................................... 303,750
------------
2,328,663
------------
TOTAL EQUITY HOLDINGS (COST $9,456,126)..................... 7,705,471
------------
LIABILITIES LESS CASH AND OTHER ASSETS -- (24.7%) .......... (1,523,575)
------------
NET ASSETS -- 100.0% ....................................... $ 6,181,896
============
</TABLE>

- ---------
(1) Limited partnership units

(2) Non-income producing security

- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
30
<PAGE>

SMITH BREEDEN FINANCIAL SERVICES FUND
- --------------------------------------------------------------------------------
STATEMENT OF ASSETS AND LIABILITIES (UNAUDITED)

SEPTEMBER 30, 1998

<TABLE>
<S> <C>
ASSETS
Investments at market value (identified cost $9,456,126) (Note 1)..................... $ 7,705,471
Receivables:
Variation margin on futures contracts (Note 2) ...................................... 141,400
Subscriptions ....................................................................... 3,000
Dividends ........................................................................... 18,940
Securities sold ..................................................................... 124,284
Deferred organization expenses (Note 1) .............................................. 6,069
Prepaid Expenses ..................................................................... 26,523
------------
TOTAL ASSETS ........................................................................ 8,025,687
------------
LIABILITIES
Bank loan ............................................................................ 1,685,604
Payables:
Securities purchased ................................................................ 125,990
Interest and loan fees .............................................................. 16,570
Due to advisor (Note 3) .............................................................. 9,257
Accrued expenses ..................................................................... 6,370
------------
TOTAL LIABILITIES ................................................................... 1,843,791
------------
NET ASSETS:
(Applicable to outstanding shares of 851,749; unlimited number of shares of beneficial
interest authorized; no stated par) ................................................. $ 6,181,896
============
Net asset value, offering price and redemption price per share ($6,181,896 / 851,749). $ 7.26
============
SOURCE OF NET ASSETS
Paid in capital ...................................................................... $ 7,767,590
Undistributed net investment income .................................................. 6,814
Accumulated net realized gain on investments ......................................... 105,602
Net unrealized depreciation of investments ........................................... (1,698,110)
------------
NET ASSETS ......................................................................... $ 6,181,896
============
</TABLE>

- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
31
<PAGE>

SMITH BREEDEN FINANCIAL SERVICES FUND
- --------------------------------------------------------------------------------
STATEMENT OF OPERATIONS (UNAUDITED)

FOR THE SIX MONTHS ENDED SEPTEMBER 30, 1998

<TABLE>
<S> <C>
INVESTMENT INCOME
Dividends and interest earned net of interest expense (Note 1) .......................... $ 66,861
EXPENSES
Advisory fees (Note 3) .................................................................. 57,023
Accounting and pricing services fees .................................................... 12,832
Custodian fees........................................................................... 3,248
Audit and tax preparation fees .......................................................... 1,259
Legal fees .............................................................................. 1,061
Amortization of organization expenses (Note 1) .......................................... 1,107
Transfer agent fees ..................................................................... 13,775
Registration fees ....................................................................... 10,000
Trustees fees and expenses .............................................................. 3,159
Insurance expense ....................................................................... 1,761
Other ................................................................................... 964
------------
TOTAL EXPENSES BEFORE REIMBURSEMENT 106,189
Expenses reimbursed by advisor (Note 3) ............................................... (49,607)
------------
NET EXPENSES .......................................................................... 56,582
------------
NET INVESTMENT INCOME ................................................................. 10,279
------------
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS
Net realized gain on investments ........................................................ 105,088
Change in unrealized appreciation (depreciation) of investments and futures contracts ... (2,376,904)
------------
Net realized and unrealized gain (loss) on investments .................................. (2,271,816)
------------
Net decrease in net assets resulting from operations .................................... $ (2,261,537)
============
</TABLE>

- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
32
<PAGE>

SMITH BREEDEN FINANCIAL SERVICES FUND
- --------------------------------------------------------------------------------
STATEMENTS OF CHANGES IN NET ASSETS

<TABLE>
<CAPTION>
SIX MONTHS ENDED
SEPTEMBER 30, 1998 PERIOD ENDED
(UNAUDITED) MARCH 31, 1998 (1)
-------------------- -------------------
<S> <C> <C>
OPERATIONS
Net investment income .................................................. $ 10,279 $ 12,415
Net realized gain on investments ....................................... 105,088 50,408
Net unrealized appreciation (depreciation) of investments .............. (2,376,904) 678,794
------------ ----------
Net increase (decrease) in net assets resulting from operations ........ (2,261,537) 741,617
------------ ----------
DISTRIBUTIONS TO SHAREHOLDERS
Dividends from net investment income ................................... (15,881) --
Distributions from net realized gains on investments ................... (49,894) --
------------ ----------
Total distributions .................................................... (65,775) --
------------ ----------
CAPITAL SHARE TRANSACTIONS
Shares sold ............................................................ 1,465,045 6,588,508
Shares issued on reinvestment of distributions ......................... 54,326 --
Shares redeemed ........................................................ (326,879) (13,409)
------------ ----------
Increase in net assets resulting from capital share transactions (a) ... 1,192,492 6,575,099
------------ ----------
TOTAL INCREASE (DECREASE) IN NET ASSETS (1,134,820) 7,316,716
NET ASSETS
Beginning of period .................................................... 7,316,716 --
------------ ----------
End of period .......................................................... $ 6,181,896 $7,316,716
============ ==========
(a) Transactions in capital shares were as follows:
Shares sold ............................................................ 153,162 729,112
Shares issued on reinvestment of distributions ......................... 5,482 --
Shares redeemed ........................................................ (34,503) (1,504)
------------ ----------
Net increase ........................................................... 124,141 727,608
Beginning balance ...................................................... 727,608 --
------------ ----------
Ending balance ......................................................... 851,749 727,608
============ ==========
</TABLE>

- ---------
(1) Commenced operations on December 22, 1997

- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
33
<PAGE>

SMITH BREEDEN FINANCIAL SERVICES FUND
- --------------------------------------------------------------------------------
STATEMENT OF CASH FLOWS

FOR THE SIX MONTHS ENDED SEPTEMBER 30, 1998 (UNAUDITED)

<TABLE>
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net decrease in net assets resulting from operations ................................ $ (2,261,537)
Net realized and unrealized loss on investments ..................................... 2,271,816
------------
Net investment income ............................................................... 10,279
ADJUSTMENTS TO RECONCILE NET INVESTMENT INCOME TO NET CASH PROVIDED BY OPERATING
ACTIVITIES:
Increase in interest receivable ..................................................... (5,789)
Limited partnership income accrual .................................................. (12,478)
Decrease in other assets ............................................................ 703
Decrease in other liabilities ....................................................... (415)
------------
Net cash used in operating activities ............................................... (7,700)
------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Payments for futures variation ...................................................... (26,218)
Proceeds from sales of long-term investments ........................................ 2,445,068
Purchases of long-term investments .................................................. (5,198,633)
------------
Net cash used in investing activities ............................................... (2,779,783)
------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in bank borrowings ......................................................... 1,685,604
Proceeds from shares tendered ....................................................... 1,422,718
Payments for shares redeemed ........................................................ (326,879)
Dividends from net investment income ................................................ (11,448)
------------
Net cash provided by financing activities ......................................... 2,769,995
------------
Net decrease in cash .............................................................. (17,488)
CASH AT BEGINNING OF YEAR ............................................................. 17,488
------------
CASH AT END OF YEAR ................................................................... $ 0
============
NONCASH FINANCING ACTIVITIES:
Market value of shares issued to stockholders through reinvestment of dividends ..... $ 54,326
============
SUPPLEMENTAL DISCLOSURE:
Interest and loan fees paid ......................................................... $ 28,031
============
</TABLE>

- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
34
<PAGE>

SMITH BREEDEN FINANCIAL SERVICES FUND
- --------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS

The following average per share data, ratios and supplemental information
has been derived from information provided in the financial statements.

<TABLE>
<CAPTION>
SIX MONTHS
ENDED PERIOD
SEPTEMBER 30, 1998 ENDED
(UNAUDITED) MARCH 31, 1998
-------------------- -----------------
<S> <C> <C>
NET ASSET VALUE, BEGINNING OF PERIOD ................................ $ 10.06 $ 9.00
---------- ---------
INCOME FROM INVESTMENT OPERATIONS
Net investment income ............................................. 0.029 0.017
Net realized and unrealized gain (loss) on investments ............ (2.748) 1.043
---------- ---------
Total from investment operations .................................. (2.719) 1.060
---------- ---------
LESS DISTRIBUTIONS
Dividends from net investment income .............................. (0.020) --
Dividends in excess of net investment income ...................... -- --
Distributions from net realized gains on investments .............. (0.063) --
Distributions in excess of net realized gains on investments ...... -- --
---------- ---------
Total distributions .............................................. (0.083) --
---------- ---------
NET ASSET VALUE, END OF PERIOD ...................................... $ 7.26 $ 10.06
---------- ---------
TOTAL RETURN ........................................................ (27.15%) 11.78%
RATIOS/SUPPLEMENTAL DATA
Net assets, end of period ......................................... $6,181,896 $7,316,716
Ratio of expenses to average net assets ........................... 1.49%* 1.48%*
Ratio of net investment income to average net assets .............. 0.27%* 0.79%*
Portfolio turnover rate ........................................... 30% 85%
Ratio of expenses to average net assets before reimbursement of
expenses by the Advisor .......................................... 2.80%* 3.20%*
Ratio of net investment income to average net assets before
reimbursement of expenses by the Advisor ......................... (1.04%)* (0.92%)*
Average commission paid per share ................................. $ 0.06 $ 0.09
</TABLE>

- ---------
(1) Commenced operations on December 22, 1997.

* Annualized

- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
35
<PAGE>

SMITH BREEDEN FINANCIAL SERVICES FUND
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)

1. SIGNIFICANT ACCOUNTING POLICIES

The Smith Breeden Trust (the "Trust") is an open-end, diversified management
investment company registered under the Investment Company Act of 1940, as
amended. The Fund offers shares in two series: the Smith Breeden Equity Market
Plus Fund (formerly the Smith Breeden Equity Plus Fund) and the Smith Breeden
Financial Services Fund (the "Fund"). The following is a summary of accounting
policies consistently followed by the Fund.

B. REPURCHASE AGREEMENTS: Repurchase agreements may be entered into with
member banks of the Federal Reserve System with total assets in excess of $500
million, and securities dealers, provided that such banks or dealers meet the
credit guidelines of the Fund's Board of Trustees. In a repurchase agreement,
the Fund acquires securities from a third party, with the commitment that they
will be repurchased by the seller at a fixed price on an agreed upon date. The
Fund's custodian maintains control or custody of the securities collateralizing
the repurchase agreement until maturity. The value of the collateral is
monitored daily, and, if necessary, additional collateral is received to ensure
that the market value of the collateral remains sufficient to protect the Fund
in the event of the seller's default. However, in the event of default or
bankruptcy of the seller, the Fund's right to the collateral may be subject to
legal proceedings.

D. DISTRIBUTIONS AND TAXES: Dividends to shareholders are recorded on the
ex-dividend date. The Fund intends to continue to qualify for and elect the
special tax treatment afforded regulated investment companies under Subchapter
M of the Internal Revenue Code, thereby relieving the Fund of Federal income
taxes. To so qualify, the Fund intends to distribute substantially all of its
net investment income and net realized capital gains, if any, less any
available capital loss carryforward. As of March 31, 1998, the Fund had no net
capital loss carryforward.

E. SECURITIES TRANSACTIONS, INVESTMENT INCOME AND OPERATING EXPENSES:
Securities transactions are recorded on the trade date. Interest income is
accrued daily, and includes net amortization from the purchase of fixed-income
securities. Discounts and premiums on securities purchased are amortized over
the life of the respective securities. Gains or losses on the sale of
securities are calculated for accounting and tax purposes on the identified
cost basis.

Expense are accrued daily. Common expenses incurred by the Trust are generally
allocated among the funds comprising the Trust based on the ratio of net assets
of each fund to the combined net assets of the Trust. Other expenses are
charged to each fund on a specific identification basis.

F. DEFERRED ORGANIZATION EXPENSES: Deferred organization expenses are being
amortized on a straight-line basis over five years.

36
<PAGE>

SMITH BREEDEN FINANCIAL SERVICES FUND
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)

2. FINANCIAL INSTRUMENTS

A. DERIVATIVE FINANCIAL INSTRUMENTS HELD OR ISSUED FOR PURPOSES OTHER THAN
TRADING: The Fund uses equity index futures contracts for risk management
purposes in order to manage the Fund's equity-market risk relative to its
benchmark. On entering into a futures contract, either cash or securities in an
amount equal to a certain percentage of the contract value (initial margin)
must be deposited with the futures broker. Subsequent payments (variation
margin) are made or received by the Fund each day. The variation margin
payments equal the daily changes in the contract value and are recorded as
unrealized gains or losses. The Fund recognizes a realized gain or loss when
the contract is closed or expires equal to the difference between the value of
the contract at the time it was opened and the value at the time it was closed.

The Fund had the following open futures contracts as of September 30, 1998:

<TABLE>
<CAPTION>
NUMBER OF EXPIRATION UNREALIZED
TYPE CONTRACTS POSITION MONTH GAIN/(LOSS)
- ----------------- ----------- ---------- ---------------- ------------
<S> <C> <C> <C> <C>
S&P 500 ......... 7 Short December, 1998 52,547
------
Total $52,547
=======
</TABLE>

The value of assets required to cover margin requirements for the open
positions at September 30, 1998 was $94,500.

3. INVESTMENT ADVISORY FEES AND OTHER TRANSACTIONS WITH AFFILIATES

The Advisor has voluntarily agreed to reduce or otherwise limit the expenses of
the Fund to 1.48% of the Fund's average daily net assets. This voluntary
agreement may be terminated or modified at any time by the Advisor in its sole
discretion, except that the Advisor has agreed to limit expenses of the Fund to
1.48% through August 1, 1999. For the six months ended September 30, 1999, the
Advisor received fees of $57,023 and reimbursed the Fund $49,607.

The Fund has adopted a Distribution and Services Plan (the "Plan") under Rule
12b-1 under the Investment Company Act of 1940. The purpose of the Plan is to
permit the Advisor to compensate investment dealers and other persons involved
in servicing shareholder accounts for services provided and expenses incurred
in promoting the sale of shares of the Fund, reducing redemptions, or otherwise
maintaining or improving services provided to shareholders by such dealers or
other persons. The Plan provides for payments by the Advisor, out of the
advisory fee to dealers and other persons at the annual rate of up to 0.25% of
the Fund's average net assets, subject to the authority of the Trustees of the
Fund, to reduce the amount of payments permitted under the Plan or to suspend
the Plan for such periods as they may determine. Subject to these limitations,
the Advisor shall determine the amount of such payments and the purposes for
which they are made.

Certain officers and trustees of the Fund are also officers and directors of
the Advisor.

37
<PAGE>

SMITH BREEDEN FINANCIAL SERVICES FUND
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)

4. INVESTMENT TRANSACTIONS

During the six months ended September 30, 1998, purchases and proceeds from
sales of securities, other than short-term investments, aggregated $5,324,623
and $2,448,356, respectively. The cost of securities for federal income tax
purposes is $9,456,126. Net unrealized depreciation of investments and futures
contracts consists of:

<TABLE>
<S> <C>
Gross unrealized appreciation ........ $ 52,547
Gross unrealized depreciation ........ (1,750,657)
------------
Net unrealized depreciation .......... $ (1,698,110)
============
</TABLE>

38
<PAGE>

(This Page Intentionally Left Blank)
<PAGE>

(This Page Intentionally Left Blank)