MERRILL LYNCH
DRAGON FUND, INC.
FUND LOGO
Annual Report
December 31, 1997
Officers and Directors
Arthur Zeikel, President and Director
Donald Cecil, Director
Edward H. Meyer, Director
Charles C. Reilly, Director
Richard R. West, Director
Edward D. Zinbarg, Director
Terry K. Glenn, Executive Vice President
Norman R. Harvey, Senior Vice President
Kara W.Y. Tan Bhala, Senior Vice President and
Portfolio Manager
Donald C. Burke, Vice President
Gerald M. Richard, Treasurer
James W. Harshaw, Secretary
Custodian
Brown Brothers Harriman & Co.
40 Water Street
Boston, MA 02109
Transfer Agent
Merrill Lynch Financial Data Services, Inc.
4800 Deer Lake Drive East
Jacksonville, FL 32246-6484
(800) 637-3863
<PAGE>
Investing in emerging market securities involves a number of risk
factors and special considerations, including restrictions on
foreign investments and on repatriation of capital invested in
emerging markets, currency fluctuations, and potential price
volatility and less liquidity of securities traded in emerging
markets. In addition, there may be less publicly available
information about the issuers of securities, and such issuers may
not be subject to accounting, auditing and financial reporting
standards and requirements comparable to those to which US companies
are subject. Therefore, the Fund is designed as a long-term
investment for investors capable of assuming the risks of investing
in emerging markets. The Fund should be considered as a vehicle for
diversification and not as a complete investment program. Please
refer to the prospectus for details.
This report is not authorized for use as an offer of sale or a
solicitation of an offer to buy shares of the Fund unless
accompanied or preceded by the Fund's current prospectus. Past
performance results shown in this report should not be considered a
representation of future performance. Investment return and
principal value of shares will fluctuate so that shares, when
redeemed, may be worth more or less than their original cost.
Statements and other information herein are as dated and are subject
to change.
Merrill Lynch
Dragon Fund, Inc.
Box 9011
Princeton, NJ
08543-9011
Printed on post-consumer recycled paper
MERRILL LYNCH DRAGON FUND, INC.
Asset Allocation
As a Percentage* of
Net Assets as of
December 31, 1997
<PAGE>
Map Depicting the Fund's Asset Allocation As a Percentage*
of Net Assets as of December 31, 1997
India 1.0%
Indonesia 2.5%
Singapore 8.3%
Malaysia 4.1%
Thailand 2.8%
China 7.8%
Hong Kong 57.4%
Philippines 4.9%
[FN]
*Total may not equal 100%.
Merrill Lynch Dragon Fund, Inc., December 31, 1997
DEAR SHAREHOLDER
Fiscal Year in Review
The fiscal year ended December 31, 1997 proved to be an extremely
difficult one for the "dragon" stock markets and Merrill Lynch
Dragon Fund, Inc. The problems began in Thailand during the summer
months. Economic fundamentals in that country deteriorated as banks
began to experience an increasing number of loan defaults, property
prices declined, and the level of exports continued to drop, hurting
the current account deficit. As a result, foreign investors began to
pull their money out of Thailand. The Thai baht came under attack by
speculators and hedgers alike. Finally, after spending a large
portion of its foreign exchange reserves in an attempt to maintain
the currency's peg to the US dollar, the central bank allowed the
baht to float on July 2, 1997. Since that time, the baht has fallen
by 50% relative to the US dollar through December month-end.
Developments in Thailand had a domino effect throughout the dragon
stock markets. As investor confidence rapidly deteriorated, the
currency crisis spread from one country to the next in a series of
"rolling devaluations." The Indonesian rupiah, the Philippine peso,
the Malaysian ringgit and the Korean won all declined sharply in
foreign exchange markets. The devaluations in foreign currency
markets led to dramatic declines in stock markets throughout the
region. Hong Kong, whose currency is pegged to the US dollar,
initially avoided the "Asian contagion," but its stock market
finally sustained a steep decline. Hong Kong operates a currency
board that ensured that the Hong Kong dollar would hold its value,
at the expense of higher interest rates and falling asset prices. We
believe that the Hong Kong dollar peg to the US dollar is likely to
hold because there is strong political will from both Hong Kong and
China to maintain the peg. In addition, to release the peg in these
chaotic times would be extremely detrimental to Hong Kong.
<PAGE>
As discussed in our September 30, 1997 report to shareholders, the
negative effects of currency devaluations have and will continue to
reverberate throughout the dragon economies. Higher interest rates
are needed to support currencies until stability returns to foreign
exchange markets. These higher interest rates lead to lower
corporate earnings. These factors, along with the negative wealth
effect of declining stock markets, will likely result in lower gross
domestic product growth.
Liquidity in the dragon countries is greatly diminished, and the
number of non-performing loans at banks is increasing. To help bring
some liquidity back into their financial systems, Thailand, South
Korea and Indonesia are receiving assistance from the International
Monetary Fund (IMF), which brings with it stringent economic targets
and conditions. While investors were initially positive about the
IMF aid, the optimism gave way to widespread skepticism about the
ability and willingness of these governments to carry out IMF-
mandated reforms.
Currently, we are in the final stage of the economic downturn. We
expect to see corporations shrinking and retrenching through
layoffs. As a result, unemployment will increase. We expect each
country to reach the bottom of its economic cycle at a different
time, depending upon political and social factors. However, it is
clear that the deleveraging process is occurring much more quickly
in dragon countries than is the case in a more developed economy
like Japan. After reaching bottom, recovery in the dragon countries
is likely to evolve slowly.
Government policy will be critical in the restructuring process for
the financial systems in the dragon countries. Of primary importance
are the steps taken to liquidate insolvent banks and recapitalize
viable ones. At the same time, governments must free up their
economies and liberalize financial systems. Bankruptcy laws must
also be put in place, since such legislation is nonexistent in most
dragon countries. The faster that governments are able to implement
such measures, the sooner their economies will recover and investor
confidence will be restored.
As disruptive as recent events have been, it is important to
remember that such developments are not unusual in emerging
economies. Periods of exceptionally rapid economic expansion are
often followed by financial crises. In turn, these crises actually
serve to create a firmer foundation for economic growth in the
future. Therefore, we believe that this is not the end of economic
growth in the dragon countries. Those countries that develop
credible policy responses to the crisis will actually emerge out of
it in stronger positions and better able to function in a global
economy.
<PAGE>
The two dragon countries that have remained largely unscathed by the
Asian currency turmoil are The People's Republic of China and India.
Both have closed capital accounts, which makes their currencies less
vulnerable to speculative attacks. However, they are not
invulnerable, since even the rupee has depreciated in sympathy with
other Asian currencies. There is now some expectation of a
devaluation of the Chinese renminbi. In the short term, such a
devaluation may not occur. However, if competitive pressures from
other Asian countries result in falling exports for China, a
currency devaluation cannot be ruled out. China cut interest rates
in October to reflate its slowing economy. We expect more interest
rate cuts to occur there, and hope that they are enacted soon.
As the currency crisis gathered momentum during the latter part of
the Fund's fiscal year, our strategy was to increase cash reserves
by selling positions in Southeast Asian markets and trimming
holdings in the People's Republic of China and Hong Kong. Cash and
cash reserves made up approximately 14% of the portfolio as of
December 31. As of that date, the portfolio was substantially
underweighted in the Thai, Singapore, Malaysian and Indonesian stock
markets, and had no holdings in South Korea. Our only overweighted
positions were in Hong Kong, the Philippines and the People's
Republic of China.
Despite these actions, we could not avoid the negative effects of
sharply declining dragon stock markets. However, the Fund
outperformed the unmanaged index of the dragon stock markets. For
the fiscal year ended December 31, 1997, Merrill Lynch Dragon Fund,
Inc.'s Class A, Class B, Class C and Class D Shares had total
investment returns of -40.77%, -41.40, -41.38% and -40.89%,
respectively. For the same period, the unmanaged Morgan Stanley
Combined Far East Free (Ex-Japan and Ex-Taiwan) Index had a total
investment return of -49.10%. (Fund results shown do not reflect
sales charges, and would be lower if sales charges were included.
Complete performance information, including average annual total
returns, can be found on pages 4--7 of this report to shareholders.)
Investment Outlook & Strategy
Looking ahead, we expect to employ the Fund's cash reserves over the
course of 1998 to purchase shares of undervalued, well-managed
companies with good balance sheets that will emerge from this crisis
in strong positions. However, we are not in a hurry to reinvest cash
reserves, since the dragon countries must pass through further
difficult stages.
<PAGE>
We eliminated all the Fund's positions in South Korea in October
before the currency and stock market plunged. Our outlook for South
Korea is negative because of the country's huge public and private
debts. Historically, Korean companies have not been concerned with
return on equity, but have been driven to capture market share at
whatever the cost. Korean corporate management culture will have to
change, but we believe that the change will take place very slowly
and at great cost to the country.
On the currency front, as of December 31, 1997, two-thirds of the
Fund's Malaysian ringgit and Singapore dollar positions were hedged
back into US dollars. Our Hong Kong dollar position was
approximately 11% hedged as of December month-end. We expect to
maintain these hedges until there is greater stability in the
foreign exchange markets.
In Conclusion
We expect that our investment strategy will remain defensive in the
months ahead, with a larger-than-usual cash position. At the same
time, we will take a selective, "bottom up" approach when we commit
cash reserves to stocks. We thank you for your investment in Merrill
Lynch Dragon Fund, Inc., and we look forward to reviewing our
outlook and strategy with you again in our next report to
shareholders.
Sincerely,
(Arthur Zeikel)
Arthur Zeikel
President
(Kara Tan Bhala)
Kara Tan Bhala
Senior Vice President and
Portfolio Manager
February 12, 1998
Merrill Lynch Dragon Fund, Inc., December 31, 1997
<PAGE>
PERFORMANCE DATA
About Fund
Performance
Investors are able to purchase shares of the Fund through the
Merrill Lynch Select Pricing SM System, which offers four pricing
alternatives:
* Class A Shares incur a maximum initial sales charge (front-end
load) of 5.25% and bear no ongoing distribution or account
maintenance fees. Class A Shares are available only to eligible
investors, as detailed in the Fund's prospectus. If you were a Class
A shareholder prior to October 21, 1994, your Class A Shares were
redesignated to Class D Shares on October 21, 1994. However, in the
case of certain eligible investors, the shares were simultaneously
exchanged for Class A Shares.
* Class B Shares are subject to a maximum contingent deferred sales
charge of 4% if redeemed during the first year, decreasing 1% each
year thereafter to 0% after the fourth year. In addition, Class B
Shares are subject to a distribution fee of 0.75% and an account
maintenance fee of 0.25%. These shares automatically convert to
Class D Shares after approximately 8 years. (There is no initial
sales charge for automatic share conversions.)
* Class C Shares are subject to a distribution fee of 0.75% and an
account maintenance fee of 0.25%. In addition, Class C Shares are
subject to a 1% contingent deferred sales charge if redeemed within
one year of purchase.
* Class D Shares incur a maximum initial sales charge of 5.25% and
an account maintenance fee of 0.25% (but no distribution fee).
None of the past results shown should be considered a representation
of future performance. Figures shown in the "Average Annual Total
Return" tables as well as the total returns and cumulative total
returns in the "Performance Summary" tables assume reinvestment of
all dividends and capital gains distributions at net asset value on
the ex-dividend date. Investment return and principal value of
shares will fluctuate so that shares, when redeemed, may be worth
more or less than their original cost. Dividends paid to each class
of shares will vary because of the different levels of account
maintenance, distribution and transfer agency fees applicable to
each class, which are deducted from the income available to be paid
to shareholders.
<PAGE>
Total Return
Based on a
$10,000
Investment
A line graph depicting the growth of an investment in the Fund's Class
A Shares and Class C Shares compared to growth of an investment in the
Morgan Stanley Combined Far East (Ex-Japan & Ex-Taiwan) Free Index.
Beginning and ending values are:
10/21/94** 12/97
ML Dragon Fund, Inc.++--
Class A Shares* $ 9,475 $ 6,108
ML Dragon Fund, Inc.++--
Class C Shares* $10,000 $ 6,246
Morgan Stanley Combined Far
East (Ex-Japan & Ex-Taiwan)
Free Index $10,000 $ 5,436
A line graph depicting the growth of an investment in the Fund's Class
B Shares and Class D Shares compared to growth of an investment in the
Morgan Stanley Combined Far East (Ex-Japan & Ex-Taiwan) Free Index.
Beginning and ending values are:
5/29/92** 12/97
ML Dragon Fund, Inc.++--
Class B Shares* $10,000 $10,888
ML Dragon Fund, Inc.++--
Class D Shares* $ 9,475 $10,781
Morgan Stanley Combined Far
East (Ex-Japan & Ex-Taiwan)
Free Index $10,000 $10,327
[FN]
*Assuming maximum sales charge, transaction costs and other
operating expenses, including advisory fees.
**Commencement of operations.
++ML Dragon Fund, Inc. invests primarily (at least 65% of the Fund's
net assets) in developing Asia-Pacific equity and debt securities.
++++This unmanaged capitalization-weighted Index is comprised of a
representative sampling of stocks of large-, medium-, and small-
capitalization companies in Hong Kong, Indonesia, Korea, Malaysia,
the Philippines, Singapore and Thailand that are freely purchasable
by foreign investors. Performance data is from May 31, 1992 for
Class B and Class D Shares and from October 31, 1994 for Class A and
Class C Shares.
<PAGE>
Average Annual
Total Return
% Return Without % Return With
Sales Charge Sales Charge**
Class A Shares*
Year Ended 12/31/97 -40.77% -43.88%
Inception (10/21/94) through 12/31/97 -12.84 -14.30
[FN]
*Maximum sales charge is 5.25%.
**Assuming maximum sales charge.
% Return % Return
Without CDSC With CDSC**
Class B Shares*
Year Ended 12/31/97 -41.40% -43.32%
Five Years Ended 12/31/97 + 1.41 + 1.41
Inception (5/29/92) through 12/31/97 + 1.53 + 1.53
[FN]
*Maximum contingent deferred sales charge is 4% and is reduced to 0%
after 4 years.
**Assuming payment of applicable contingent deferred sales charge.
% Return % Return
Without CDSC With CDSC**
Class C Shares*
Year Ended 12/31/97 -41.38% -41.86%
Inception (10/21/94) through 12/31/97 -13.70 -13.70
[FN]
*Maximum contingent deferred sales charge is 1% and is reduced to 0%
after 1 year.
**Assuming payment of applicable contingent deferred sales charge.
<PAGE>
% Return Without % Return With
Sales Charge Sales Charge**
Class D Shares*
Year Ended 12/31/97 -40.89% -43.99%
Five Years Ended 12/31/97 + 2.21 + 1.11
Inception (5/29/92) through 12/31/97 + 2.34 + 1.36
[FN]
*Maximum sales charge is 5.25%.
**Assuming maximum sales charge.
Merrill Lynch Dragon Fund, Inc., December 31, 1997
PERFORMANCE DATA (concluded)
<TABLE>
Performance
Summary--
Class A Shares
<CAPTION>
Net Asset Value Capital Gains
Period Covered Beginning Ending Distributed Dividends Paid* % Change**
<C> <C> <C> <C> <C> <C>
10/21/94--12/31/94 $17.43 $15.05 $0.241 $0.251 -10.82%
1995 15.05 15.99 -- 0.176 + 7.44
1996 15.99 18.09 0.071 -- +13.59
1997 18.09 8.81 1.886 -- -40.77
------ ------
Total $2.198 Total $0.427
Cumulative total return as of 12/31/97: -35.53%**
<FN>
*Figures may include short-term capital gains distributions.
**Figures do not include sales charges; results would be lower if
sales charge was included.
</TABLE>
<PAGE>
<TABLE>
Performance
Summary--
Class B Shares
<CAPTION>
Net Asset Value Capital Gains
Period Covered Beginning Ending Distributed Dividends Paid* % Change**
<C> <C> <C> <C> <C> <C>
5/29/92--12/31/92 $10.00 $10.13 -- $0.020 + 1.50%
1993 10.13 18.74 $0.006 0.103 +86.15
1994 18.74 15.03 0.241 0.122 -17.86
1995 15.03 15.98 -- 0.025 + 6.49
1996 15.98 17.89 0.071 -- +12.41
1997 17.89 8.58 1.886 -- -41.40
------ ------
Total $2.204 Total $0.270
Cumulative total return as of 12/31/97: +8.88%**
<FN>
*Figures may include short-term capital gains distributions.
**Figures do not reflect deduction of any sales charge; results
would be lower if sales charge was deducted.
</TABLE>
<TABLE>
Performance
Summary--
Class C Shares
<CAPTION>
Net Asset Value Capital Gains
Period Covered Beginning Ending Distributed Dividends Paid* % Change**
<C> <C> <C> <C> <C> <C>
10/21/94--12/31/94 $17.29 $14.92 $0.241 $0.229 -10.98%
1995 14.92 15.79 -- 0.091 + 6.46
1996 15.79 17.68 0.071 -- +12.43
1997 17.68 8.46 1.886 -- -41.38
------ ------
Total $2.198 Total $0.320
Cumulative total return as of 12/31/97: -37.54%**
<FN>
*Figures may include short-term capital gains distributions.
**Figures do not reflect deduction of any sales charge; results
would be lower if sales charge was deducted.
</TABLE>
<PAGE>
<TABLE>
Performance
Summary--
Class D Shares
<CAPTION>
Net Asset Value Capital Gains
Period Covered Beginning Ending Distributed Dividends Paid* % Change**
<C> <C> <C> <C> <C> <C>
5/29/92--12/31/92 $10.00 $10.12 -- $0.080 + 2.02%
1993 10.12 18.77 $0.006 0.182 +87.46
1994 18.77 15.08 0.241 0.211 -17.24
1995 15.08 16.05 -- 0.136 + 7.35
1996 16.05 18.11 0.071 -- +13.29
1997 18.11 8.80 1.886 -- -40.89
------ ------
Total $2.204 Total $0.609
Cumulative total return as of 12/31/97: +13.79%**
<FN>
*Figures may include short-term capital gains distributions.
**Figures do not include sales charges; results would be lower if
sales charge was included.
</TABLE>
<TABLE>
Recent
Performance
Results*
<CAPTION>
12 Month 3 Month
12/31/97 9/30/97 12/31/96 % Change % Change
<S> <C> <C> <C> <C> <C>
ML Dragon Fund, Inc.--Class A Shares $8.81 $15.30 $18.09 -40.77%(1) -29.96%(1)
ML Dragon Fund, Inc.--Class B Shares 8.58 15.02 17.89 -41.40(1) -30.20(1)
ML Dragon Fund, Inc.--Class C Shares 8.46 14.84 17.68 -41.38(1) -30.16(1)
ML Dragon Fund, Inc.--Class D Shares 8.80 15.29 18.11 -40.89(1) -29.98(1)
ML Dragon Fund, Inc.--Class A Shares--Total Return -40.77(1) -29.96(1)
ML Dragon Fund, Inc.--Class B Shares--Total Return -41.40(1) -30.20(1)
ML Dragon Fund, Inc.--Class C Shares--Total Return -41.38(1) -30.16(1)
ML Dragon Fund, Inc.--Class D Shares--Total Return -40.89(1) -29.98(1)
<FN>
*Investment results shown do not reflect sales charges; results
shown would be lower if a sales charge was included.
(1)Percent change includes reinvestment of $1.886 per share capital
gains distributions.
</TABLE>
<PAGE>
Merrill Lynch Dragon Fund, Inc., December 31, 1997
<TABLE>
SCHEDULE OF INVESTMENTS (in US dollars)
<CAPTION>
Shares Held/ Value Percent of
COUNTRIES Industries Face Amount Long-Term Investments Cost (Note 1a) Net Assets
<S> <S> <C> <S> <C> <C> <C>
China Conglomerates 688,000 ++Beijing Enterprises
Holdings Limited $ 2,046,009 $ 1,767,177 0.3%
1,284,000 China Resources Enterprise Ltd. 2,501,703 2,867,144 0.6
8,622,014 Guangdong Investments, Ltd. 6,212,643 5,731,316 1.1
2,182,000 Shanghai Industrial Holdings Ltd. 10,619,733 8,111,210 1.5
-------------- -------------- ------
21,380,088 18,476,847 3.5
Infrastructure 441,800 ++New World Infrastructure, Ltd. 1,230,149 995,084 0.2
US$ 8,797,000 New World Infrastructure, Ltd.,
5% due 7/15/2001 (b) 11,209,632 8,665,045 1.6
-------------- -------------- ------
12,439,781 9,660,129 1.8
Telecommuni- 7,793,000 ++China Telecom (Hong Kong) 11,370,496 13,378,109 2.5
cations Limited
Total Long-Term Investments
in China 45,190,365 41,515,085 7.8
Hong Kong Banking 2,230,600 Dah Sing Financial Holdings Ltd. 13,255,654 5,369,563 1.0
7,183,000 Guoco Group, Ltd. 32,731,159 17,569,261 3.3
2,001,626 HSBC Holdings, Ltd. 31,739,250 49,346,314 9.4
-------------- -------------- ------
77,726,063 72,285,138 13.7
Conglomerates 6,351,000 Citic Pacific Ltd. 24,208,936 25,248,248 4.8
21,950,015 First Pacific Company Ltd. 24,909,838 10,624,402 2.0
6,751,000 Hutchison Whampoa, Ltd. 42,235,549 42,348,964 8.0
1,043,000 Swire Pacific Ltd. 'A' 8,028,851 5,721,523 1.1
4,679,000 Swire Pacific Ltd. 'B' 6,489,889 4,740,904 0.9
-------------- -------------- ------
105,873,063 88,684,041 16.8
<PAGE>
Insurance 24,157,000 National Mutual Asia, Ltd. 12,624,588 24,008,893 4.6
Publishing & 8,188,000 South China Morning Post
Broadcasting Holdings Ltd. 4,992,818 5,759,871 1.1
4,802,000 Television Broadcasts Ltd. 19,125,113 13,697,864 2.6
-------------- -------------- ------
24,117,931 19,457,735 3.7
Real Estate 3,344,000 Cheung Kong Holdings Ltd. 22,430,705 21,904,873 4.2
3,816,514 New World Development Co., Ltd. 20,317,666 13,202,010 2.5
US$ 5,150,000 New World Development Co., Ltd.,
4.375% due 12/11/2000 (b) 5,822,455 4,738,000 0.9
2,326,100 Sun Hung Kai Properties, Ltd. 22,237,009 16,212,894 3.1
-------------- -------------- ------
70,807,835 56,057,777 10.7
Utilities-- 21,470,198 Hong Kong and China Gas Company Ltd. 24,807,446 41,568,631 7.9
Electric & Gas
Total Long-Term Investments
in Hong Kong 315,956,926 302,062,215 57.4
India Finance 522 Housing Development Finance
Corp., Ltd. 51,177 41,086 0.0
Telecommuni- 348,000 ++Mahanagar Telephone Nigam 4,161,384 5,376,600 1.0
cations Ltd. (GDR)**
Total Long-Term Investments
in India 4,212,561 5,417,686 1.0
Indonesia Infrastructure 23,565,000 P.T. Citra Marga Nusaphala
Persada (Foreign) 10,821,062 2,618,333 0.5
Oil & Gas 289,000 ++Gulf Indonesia Resources, Ltd. 6,206,334 6,358,000 1.2
Telecommuni- 240,500 P.T. Telekomunikasi Indonesia 6,793,351 2,660,531 0.5
cations (Series B) (ADR)*
Tobacco 1,835,500 P.T. Hanjaya Mandala Sampoerna
(Foreign) 1,227,022 1,410,616 0.3
Total Long-Term Investments
in Indonesia 25,047,769 13,047,480 2.5
Malaysia Banking 146,000 Malayan Banking BHD 1,381,684 424,659 0.1
6,042,400 Public Bank BHD (Foreign) 9,688,116 2,084,122 0.4
1,007,066 Public Bank BHD (Rights) (c) 0 51,844 0.0
-------------- -------------- ------
11,069,800 2,560,625 0.5
Construction 4,219,000 I.J.M. Corp. BHD 5,372,002 1,400,903 0.3
Food 1,409,700 Nestle Malaysia BHD 6,139,518 6,531,429 1.2
Leisure 3,609,000 Berjaya Sports ToTo BHD 9,179,761 9,243,127 1.7
Publishing & 1,793,000 Star Publications Malaysia BHD 6,160,202 2,049,143 0.4
Broadcasting
Total Long-Term Investments
in Malaysia 37,921,283 21,785,227 4.1
<PAGE>
Philippines Conglomerates 1,421,816 ++Benpres Holdings Corp.
(GDR)** (a) 9,020,683 4,276,254 0.8
Infrastructure 30,070,732 ++International Container Terminal
Services, Inc. (ICTSI) 7,713,352 3,758,842 0.7
Real Estate 12,810,987 Ayala Land, Inc. 'B' 10,878,228 5,124,395 1.0
Retail 53,264,170 SM Prime Holdings, Inc. 9,921,185 7,989,626 1.5
Utilities-- 1,351,993 Manila Electric Co. (MERALCO) 'B' 6,517,356 4,529,177 0.9
Electric & Gas
Total Long-Term Investments
in the Philippines 44,050,804 25,678,294 4.9
Singapore Airlines 1,373,000 Singapore Airlines Ltd. (Foreign) 11,529,043 8,979,191 1.7
Banking 860,000 Development Bank of Singapore
Ltd. (Foreign) 12,098,200 7,362,663 1.4
1,981,704 United Overseas Bank (Foreign) 14,572,348 11,016,012 2.1
-------------- -------------- ------
26,670,548 18,378,675 3.5
Publishing & 685,400 Singapore Press Holdings Ltd. 8,187,700 8,598,062 1.6
Broadcasting (Foreign)
Real Estate 647,000 City Development Ltd. 5,521,951 3,000,357 0.6
3,053,000 DBS Land Ltd. 9,818,745 4,682,961 0.9
-------------- -------------- ------
15,340,696 7,683,318 1.5
Total Long-Term Investments
in Singapore 61,727,987 43,639,246 8.3
Thailand Industrial US$ 3,040,000 Banpu Public Co. Ltd., 2.75%
due 4/10/2003 1,973,230 1,945,600 0.4
Oil & Gas 846,400 PTT Exploration and Production
Public Co. Ltd. (Foreign) 8,436,155 9,861,317 1.8
Telecommuni- 299,000 Advanced Info Service Public 1,468,243 1,458,843 0.3
cations Co., Ltd.
Television 354,100 BEC World Public Company Limited 1,562,941 1,429,804 0.3
Total Long-Term Investments
in Thailand 13,440,569 14,695,564 2.8
Total Long-Term Investments 547,548,264 467,840,797 88.8
</TABLE>
<PAGE>
Merrill Lynch Dragon Fund, Inc., December 31, 1997
<TABLE>
SCHEDULE OF INVESTMENTS (concluded) (in US dollars)
<CAPTION>
Face Value Percent of
COUNTRIES Amount Short-Term Securities Cost (Note 1a) Net Assets
<S> <S> <C> <S> <C> <C> <C>
United States Commercial US$ 20,000,000 Atlantic Asset Securitization
Paper*** Corp., 5.95% due 1/15/1998 $ 19,953,722 $ 19,953,722 3.8%
7,548,000 General Motors Acceptance Corp.,
6.75% due 1/02/1998 7,546,585 7,546,585 1.5
Lexington Parker LLC:
8,088,000 5.95% due 1/14/1998 8,070,622 8,070,622 1.5
17,000,000 6.05% due 1/14/1998 16,962,860 16,962,860 3.2
20,166,000 Park Avenue Receivables Corp.,
5.75% due 1/16/1998 20,117,685 20,117,685 3.8
Total Investments in
Short-Term Securities 72,651,474 72,651,474 13.8
Total Investments $ 620,199,738 540,492,271 102.6
==============
Unrealized Appreciation on Forward Foreign Exchange Contracts++++ 4,949,077 0.9
Liabilities in Excess of Other Assets (18,667,118) (3.5)
-------------- ------
Net Assets $ 526,774,230 100.0%
============== ======
<FN>
*American Depositary Receipts (ADR).
**Global Depositary Receipts (GDR).
***Commercial Paper is traded on a discount basis; the interest
rates shown are the discount rates paid at the time of purchase by
the Fund.
(a)The security may be offered and sold to "qualified institutional
buyers" under Rule 144A of the Securities Act of 1933.
(b)Convertible security.
(c)The rights may be exercised until 2/23/1998.
See Notes to Financial Statements.
<PAGE>
++Non-income producing security.
++++Forward foreign exchange contracts as of December 31, 1997 were
as follows:
Unrealized
Expiration Appreciation
Foreign Currency Sold Date (Note 1b)
HK$ 373,901,000 September 1998 $ 1,074,378
MYR 70,933,400 May 1998 1,848,057
SG$ 51,584,000 November 1998 2,026,642
Total Unrealized Appreciation on
Forward Foreign Exchange Contracts--
Net (US$ Commitment--$99,500,000) $ 4,949,077
============
</TABLE>
EQUITY PORTFOLIO CHANGES
For the Quarter Ended December 31, 1997
Additions
Advanced Info Service Public Co., Ltd.
BEC World Public Company Limited
China Telecom (Hong Kong) Limited
Mahanagar Telephone Nigam Ltd. (GDR)
Deletions
China Merchants Holdings International Co., Ltd.
China Overseas Land & Investment Co.
Cycle & Carriage, Ltd.
DMCI Holdings Inc.
Korean Electric & Power Corp.
P.T. Astra International (Foreign)
P.T. Fiskar Agung Perkasa
Renong BHD
SK Telecom
<PAGE>
PORTFOLIO INFORMATION
Investments
As of 12/31/97
Ten Largest Equity Holdings Percent of
Represented in the Portfolio Net Assets
HSBC Holdings, Ltd. 9.4%
Hutchison Whampoa, Ltd. 8.0
Hong Kong and China Gas Company Ltd. 7.9
Citic Pacific Ltd. 4.8
National Mutual Asia, Ltd. 4.6
Cheung Kong Holdings Ltd. 4.2
Guoco Group, Ltd. 3.3
Sun Hung Kai Properties, Ltd. 3.1
Television Broadcasts Ltd. 2.6
China Telecom (Hong Kong) Limited 2.5
Ten Largest Industries Percent of
Represented in the Portfolio Net Assets
Conglomerates 21.1%
Banking 17.7
Real Estate 13.2
Utilities--Electric & Gas 8.8
Publishing & Broadcasting 5.7
Insurance 4.6
Telecommunications 4.3
Oil & Gas 3.0
Infrastructure 3.0
Leisure 1.7
Merrill Lynch Dragon Fund, Inc., December 31, 1997
<PAGE>
<TABLE>
STATEMENT OF ASSETS AND LIABILITIES
<CAPTION>
As of December 31, 1997
<S> <S> <C> <C>
Assets: Investments, at value (identified cost--$620,199,738)(Note 1a) $ 540,492,271
Unrealized appreciation on forward foreign exchange
contracts (Note 1b) 4,949,077
Cash 854
Foreign cash (Note 1c) 2,953,213
Receivables:
Securities sold $ 2,281,741
Capital shares sold 1,513,673
Dividends 634,361
Interest 339,968 4,769,743
--------------
Prepaid registration fees and other assets (Note 1f) 75,021
--------------
Total assets 553,240,179
--------------
Liabilities: Payables:
Capital shares redeemed 23,084,740
Securities purchased 1,374,181
Investment adviser (Note 2) 520,428
Distributor (Note 2) 421,868 25,401,217
--------------
Accrued expenses and other liabilities 1,064,732
--------------
Total liabilities 26,465,949
--------------
Net Assets: Net assets $ 526,774,230
==============
Net Assets Class A Shares of Common Stock, $0.10 par value,
Consist of: 100,000,000 shares authorized $ 163,807
Class B Shares of Common Stock, $0.10 par value,
200,000,000 shares authorized 4,368,788
Class C Shares of Common Stock, $0.10 par value,
100,000,000 shares authorized 261,378
Class D Shares of Common Stock, $0.10 par value,
100,000,000 shares authorized 1,311,146
Paid-in capital in excess of par 616,794,664
Accumulated distributions in excess of investment income--net (1,843,664)
Accumulated realized capital losses on investments and
foreign currency transactions--net (8,078,571)
Accumulated distributions in excess of realized capital gains
on investments and foreign currency transactions--net (11,169,131)
Unrealized depreciation on investments and foreign currency
transactions--net (75,034,187)
--------------
Net assets $ 526,774,230
==============
<PAGE>
Net Asset Class A--Based on net assets of $14,431,036 and 1,638,069
Value: shares outstanding $ 8.81
==============
Class B--Based on net assets of $374,914,011 and 43,687,879
shares outstanding $ 8.58
==============
Class C--Based on net assets of $22,111,273 and 2,613,783
shares outstanding $ 8.46
==============
Class D--Based on net assets of $115,317,910 and 13,111,456
shares outstanding $ 8.80
==============
See Notes to Financial Statements.
</TABLE>
<TABLE>
STATEMENT OF OPERATIONS
<CAPTION>
For the Year Ended December 31, 1997
<S> <S> <C> <C>
Investment Dividends (net of $371,768 foreign withholding tax) $ 20,403,804
Income Interest and discount earned 4,318,005
(Notes 1d & 1e): --------------
Total income 24,721,809
--------------
Expenses: Investment advisory fees (Note 2) $ 11,592,896
Account maintenance and distribution fees--Class B (Note 2) 8,547,588
Transfer agent fees--Class B (Note 2) 1,728,921
Custodian fees 1,452,106
Account maintenance fees--Class D (Note 2) 574,161
Account maintenance and distribution fees--Class C (Note 2) 454,624
Transfer agent fees--Class D (Note 2) 386,542
Printing and shareholder reports 214,765
Registration fees (Note 1f) 169,715
Accounting services (Note 2) 160,150
Transfer agent fees--Class C (Note 2) 99,049
Professional fees 65,039
Transfer agent fees--Class A (Note 2) 49,172
Directors' fees and expenses 37,384
Pricing fees 10,424
Amortization of organization expenses (Note 1f) 7,194
Other 63,926
--------------
Total expenses 25,613,656
--------------
Investment loss--net (891,847)
--------------
<PAGE>
Realized & Realized gain (loss) from:
Unrealized Gain Investments--net 63,719,007
(Loss) on Foreign currency transactions--net (1,081,326) 62,637,681
Investments & --------------
Foreign Currency Change in unrealized appreciation/depreciation on:
Transactions--Net Investments--net (523,418,480)
(Notes 1b, 1c, Foreign currency transactions--net 4,687,497 (518,730,983)
1e & 3): -------------- --------------
Net realized and unrealized loss on investments and
foreign currency transactions (456,093,302)
--------------
Net Decrease in Net Assets Resulting from Operations $ (456,985,149)
==============
See Notes to Financial Statements.
</TABLE>
Merrill Lynch Dragon Fund, Inc., December 31, 1997
<TABLE>
STATEMENTS OF CHANGES IN NET ASSETS
<CAPTION>
For the Year
Ended December 31,
Increase (Decrease) in Net Assets: 1997 1996
<S> <S> <C> <C>
Operations: Investment loss--net $ (891,847) $ (982,484)
Realized gain on investments and foreign currency
transactions--net 62,637,681 49,205,560
Change in unrealized appreciation/depreciation on investments
and foreign currency transactions--net (518,730,983) 128,903,659
-------------- --------------
Net increase (decrease) in net assets resulting from operations (456,985,149) 177,126,735
-------------- --------------
Dividends & Realized gain on investments--net:
Distributions to Class A (2,185,017) (191,338)
Shareholders Class B (64,077,324) (4,598,194)
(Note 1g): Class C (3,632,309) (250,735)
Class D (19,118,895) (1,140,627)
In excess of realized gain on investments--net:
Class A (274,169) --
Class B (8,040,215) --
Class C (455,770) --
Class D (2,398,977) --
-------------- --------------
Net decrease in net assets resulting from distributions
to shareholders (100,182,676) (6,180,894)
-------------- --------------
<PAGE>
Capital Share Net increase (decrease) in net assets derived from capital
Transactions share transactions (483,237,127) 58,833,959
(Note 4): -------------- --------------
Net Assets: Total increase (decrease) in net assets (1,040,404,952) 229,779,800
Beginning of year 1,567,179,182 1,337,399,382
-------------- --------------
End of year $ 526,774,230 $1,567,179,182
============== ==============
See Notes to Financial Statements.
</TABLE>
<TABLE>
FINANCIAL HIGHLIGHTS
<CAPTION>
Class A++++
For the
Period
The following per share data and ratios have been derived Oct. 21,
from information provided in the financial statements. For the Year 1994++ to
Ended December 31, Dec. 31,
Increase (Decrease) in Net Asset Value: 1997 1996 1995 1994
<S> <S> <C> <C> <C> <C>
Per Share Net asset value, beginning of period $ 18.09 $ 15.99 $ 15.05 $ 17.43
Operating -------- -------- -------- --------
Performance: Investment income--net .12 .14 .12 .02
Realized and unrealized gain (loss) on investments
and foreign currency transactions--net (7.51) 2.03 1.00 (1.91)
-------- -------- -------- --------
Total from investment operations (7.39) 2.17 1.12 (1.89)
-------- -------- -------- --------
Less dividends and distributions:
In excess of investment income--net -- -- (.18) (.13)
Realized gain on investments--net (1.68) (.07) -- (.27)
In excess of realized gain on investments--net (.21) -- -- (.09)
-------- -------- -------- --------
Total dividends and distributions (1.89) (.07) (.18) (.49)
-------- -------- -------- --------
Net asset value, end of period $ 8.81 $ 18.09 $ 15.99 $ 15.05
======== ======== ======== ========
Total Investment Based on net asset value per share (40.77%) 13.59% 7.44% (10.82%)+++
Return:** ======== ======== ======== ========
Ratios to Average Expenses 1.35% 1.33% 1.37% 1.54%*
Net Assets: ======== ======== ======== ========
Investment income--net .73% .78% .74% .84%*
======== ======== ======== ========
<PAGE>
Supplemental Net assets, end of period (in thousands) $ 14,431 $ 49,943 $ 31,591 $ 3,383
Data: ======== ======== ======== ========
Portfolio turnover 21.11% 30.63% 24.52% 16.45%
======== ======== ======== ========
Average commission rate paid++++++ $ .0101 $ .0130 -- --
======== ======== ======== ========
<FN>
*Annualized.
**Total investment returns exclude the effects of sales loads.
++Commencement of operations.
++++Based on average shares outstanding.
++++++For fiscal years beginning on or after September 1, 1995, the
Fund is required to disclose its average commission rate per share
for purchases and sales of equity securities. The "Average
Commission Rate Paid" includes commissions paid in foreign
currencies, which have been converted into US dollars using the
prevailing exchange rate on the date of the transaction. Such
conversions may significantly affect the rate shown.
+++Aggregate total investment return.
See Notes to Financial Statements.
</TABLE>
Merrill Lynch Dragon Fund, Inc., December 31, 1997
<TABLE>
FINANCIAL HIGHLIGHTS (continued)
<CAPTION>
Class B++++
The following per share data
and ratios have been derived For the
from information provided For the Period
in the financial statements. Ten Months May 29,
Ended 1992++ to
Increase (Decrease) in For the Year Ended December 31, Dec. 31, Feb. 28,
Net Asset Value: 1997 1996 1995 1994 1993 1993
<S> <S> <C> <C> <C> <C> <C> <C>
Per Share Net asset value,
Operating beginning of period $ 17.89 $ 15.98 $ 15.03 $ 18.74 $ 11.01 $ 10.00
Performance: ---------- ---------- ---------- ---------- ---------- ----------
Investment loss--net (.04) (.04) (.03) (.07) (.02) (.02)
Realized and unrealized
gain (loss) on investments
and foreign currency
<PAGE> transactions--net (7.38) 2.02 1.00 (3.28) 7.86 1.05
---------- ---------- ---------- ---------- ---------- ----------
Total from investment
operations (7.42) 1.98 .97 (3.35) 7.84 1.03
---------- ---------- ---------- ---------- ---------- ----------
Less dividends and
distributions:
Investment income--net -- -- -- -- --+++++ --
In excess of investment
income--net -- -- (.02) -- --+++++ (.02)
Realized gain on
investments--net (1.68) (.07) -- (.27) (.11) --+++++
In excess of realized
gain on investments--net (.21) -- -- (.09) -- --
---------- ---------- ---------- ---------- ---------- ----------
Total dividends and
distributions (1.89) (.07) (.02) (.36) (.11) (.02)
---------- ---------- ---------- ---------- ---------- ----------
Net asset value,
end of period $ 8.58 $ 17.89 $ 15.98 $ 15.03 $ 18.74 $ 11.01
========== =========== ========== ========== ========== ==========
Total Investment Based on net asset value
Return:** per share (41.40%) 12.41% 6.49% (17.86%) 71.27%+++ 10.32%+++
========== =========== ========== ========== ========== ==========
Ratios to Average Expenses 2.39% 2.36% 2.41% 2.40% 2.35%* 2.49%*
Net Assets: ========== =========== ========== ========== ========== ==========
Investment loss--net (.26%) (.24%) (.20%) (.42%) (.15%)* (.08%)*
========== =========== ========== ========== ========== ==========
Supplemental Net assets, end of period
Data: (in thousands) $ 374,914 $ 1,157,944 $ 991,281 $ 917,384 $ 990,843 $ 365,430
========== =========== ========== ========== ========== ==========
Portfolio turnover 21.11% 30.63% 24.52% 16.45% 16.62% 4.65%
========== =========== ========== ========== ========== ==========
Average commission
rate paid++++++ $ .0101 $ .0130 -- -- -- --
========== =========== ========== ========== ========== ==========
<CAPTION>
Class C++++
For the
Period
The following per share data and ratios have been derived Oct. 21,
from information provided in the financial statements. For the Year 1994++ to
<PAGE> Ended December 31, Dec. 31,
Increase (Decrease) in Net Asset Value: 1997 1996 1995 1994
<S> <S> <C> <C> <C> <C>
Per Share Net asset value, beginning of period $ 17.68 $ 15.79 $ 14.92 $ 17.29
Operating -------- -------- -------- --------
Performance: Investment loss--net (.04) (.04) (.04) (.01)
Realized and unrealized gain (loss) on
investments and foreign currency
transactions--net (7.29) 2.00 1.00 (1.89)
-------- -------- -------- --------
Total from investment operations (7.33) 1.96 .96 (1.90)
-------- -------- -------- --------
Less dividends and distributions:
In excess of investment income--net -- -- (.09) (.11)
Realized gain on investments--net (1.68) (.07) -- (.27)
In excess of realized gain on investments--net (.21) -- -- (.09)
-------- -------- -------- --------
Total dividends and distributions (1.89) (.07) (.09) (.47)
-------- -------- -------- --------
Net asset value, end of period $ 8.46 $ 17.68 $ 15.79 $ 14.92
======== ======== ======== ========
Total Investment Based on net asset value per share (41.38%) 12.43% 6.46% (10.98%)+++
Return:** ======== ======== ======== ========
Ratios to Average Expenses 2.41% 2.37% 2.42% 2.57%*
Net Assets: ======== ======== ======== ========
Investment loss--net (.28%) (.23%) (.28%) (.17%)*
======== ======== ======== ========
Supplemental Net assets, end of period (in thousands) $ 22,111 $ 62,113 $ 29,042 $ 5,329
Data: ======== ======== ======== ========
Portfolio turnover 21.11% 30.63% 24.52% 16.45%
======== ======== ======== ========
Average commission rate paid++++++ $ .0101 $ .0130 -- --
======== ======== ======== ========
<FN>
*Annualized.
**Total investment returns exclude the effects of sales loads.
++Commencement of operations.
++++Based on average shares outstanding.
++++++For fiscal years beginning on or after September 1, 1995, the
Fund is required to disclose its average commission rate per share
for purchases and sales of equity securities. The "Average
Commission Rate Paid" includes commissions paid in foreign
currencies, which have been converted into US dollars using the
prevailing exchange rate on the date of the transaction. Such
conversions may significantly affect the rate shown.
+++Aggregate total investment return.
+++++Amount was less than $.01 per share.
See Notes to Financial Statements.
</TABLE>
<PAGE>
Merrill Lynch Dragon Fund, Inc., December 31, 1997
<TABLE>
FINANCIAL HIGHLIGHTS (concluded)
<CAPTION>
Class D++++
The following per share data
and ratios have been derived For the
from information provided For the Period
in the financial statements. Ten Months May 29,
Ended 1992++ to
Increase (Decrease) in For the Year Ended December 31, Dec. 31, Feb. 28,
Net Asset Value: 1997 1996 1995 1994 1993 1993
<S> <S> <C> <C> <C> <C> <C> <C>
Per Share Net asset value,
Operating beginning of period $ 18.11 $ 16.05 $ 15.08 $ 18.77 $ 11.01 $ 10.00
Performance: -------- -------- -------- -------- -------- --------
Investment income--net .09 .09 .09 .06 .07 .05
Realized and unrealized
gain (loss) on investments
and foreign currency
transactions--net (7.51) 2.04 1.02 (3.30) 7.88 1.04
-------- -------- -------- -------- -------- --------
Total from investment
operations (7.42) 2.13 1.11 (3.24) 7.95 1.09
-------- -------- -------- -------- -------- --------
Less dividends and
distributions:
Investment income--net -- -- -- -- (.01) --+++++
In excess of investment
income--net -- -- (.14) (.09) (.07) (.08)
Realized gain on
investments--net (1.68) (.07) -- (.27) (.11) --
In excess of realized gain
on investments--net (.21) -- -- (.09) -- --
-------- -------- -------- -------- -------- --------
Total dividends and
distributions (1.89) (.07) (.14) (.45) (.19) (.08)
-------- -------- -------- -------- -------- --------
Net asset value,
end of period $ 8.80 $ 18.11 $ 16.05 $ 15.08 $ 18.77 $ 11.01
======== ======== ======== ======== ======== ========
Total Investment Based on net asset value
Return:** per share (40.89%) 13.29% 7.35% (17.24%) 72.31%+++ 10.99%+++
======== ======== ======== ======== ======== ========
<PAGE>
Ratios to Average Expenses 1.61% 1.58% 1.63% 1.63% 1.59%* 1.73%*
Net Assets: ======== ======== ======== ======== ======== ========
Investment income--net .53% .53% .59% .34% .61%* .61%*
======== ======== ======== ======== ======== ========
Supplemental Net assets, end of period
Data: (in thousands) $115,318 $297,179 $285,485 $249,903 $311,848 $111,180
======== ======== ======== ======== ======== ========
Portfolio turnover 21.11% 30.63% 24.52% 16.45% 16.62% 4.65%
======== ======== ======== ======== ======== ========
Average commission
rate paid++++++ $ .0101 $ .0130 -- -- -- --
======== ======== ======== ======== ======== ========
<FN>
*Annualized.
**Total investment returns exclude the effects of sales loads.
++Commencement of operations.
++++Based on average shares outstanding.
++++++For fiscal years beginning on or after September 1, 1995, the
Fund is required to disclose its average commission rate per share
for purchases and sales of equity securities. The "Average
Commission Rate Paid" includes commissions paid in foreign
currencies, which have been converted into US dollars using the
prevailing exchange rate on the date of the transaction. Such
conversions may significantly affect the rate shown.
+++Aggregate total investment return.
+++++Amount was less than $.01 per share.
See Notes to Financial Statements.
</TABLE>
NOTES TO FINANCIAL STATEMENTS
1. Significant Accounting Policies:
Merrill Lynch Dragon Fund, Inc. (the "Fund") is registered under the
Investment Company Act of 1940 as a non-diversified, open-end
management investment company. The Fund offers four classes of
shares under the Merrill Lynch Select Pricing SM System. Shares of
Class A and Class D are sold with a front-end sales charge. Shares
of Class B and Class C may be subject to a contingent deferred sales
charge. All classes of shares have identical voting, dividend,
liquidation and other rights and the same terms and conditions,
except that Class B, Class C and Class D Shares bear certain
expenses related to the account maintenance of such shares, and
Class B and Class C Shares also bear certain expenses related to the
distribution of such shares. Each class has exclusive voting rights
with respect to matters relating to its account maintenance and
distribution expenditures. The following is a summary of significant
accounting policies followed by the Fund.
<PAGE>
(a) Valuation of investments--Portfolio securities which are traded
on stock exchanges are valued at the last sale price on the exchange
on which such securities are traded, as of the close of business on
the day the securities are being valued or, lacking any sales, at
the last available bid price. Securities traded in the over-the-
counter market are valued at the last available bid price prior to
the time of valuation. In cases where securities are traded on more
than one exchange, the securities are valued on the exchange
designated by or under the authority of the Board of Directors as
the primary market. 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. Options written are valued
at the last sale price in the case of exchange-traded options or, in
the case of options traded in the over-the-counter market, the last
asked price. Options purchased are valued at the last sale price in
the case of exchange-traded options or, in the case of options
traded in the over-the-counter market, the last bid price. Short-
term securities are valued at amortized cost, which approximates
market value. Other investments, including futures contracts and
related options, are stated at market value. Securities and other
assets for which market value quotations are not available are
valued at their fair value as determined in good faith by or under
the direction of the Fund's Board of Directors.
(b) Derivative financial instruments--The Fund may engage in various
portfolio strategies to seek to increase its return by hedging its
portfolio against adverse movements in the equity, debt and currency
markets. Losses may arise due to changes in the value of the
contract or if the counterparty does not perform under the contract.
* Forward foreign exchange contracts--The Fund is authorized to
enter into forward foreign exchange contracts as a hedge against
either specific transactions or portfolio positions. Such contracts
are not entered on the Fund's records. However, the effect on
operations is recorded from the date the Fund enters into such
contracts. Premium or discount is amortized over the life of the
contracts.
* Foreign currency options and futures--The Fund may also purchase
or sell listed or over-the-counter foreign currency options, foreign
currency futures and related options on foreign currency futures as
a short or long hedge against possible variations in foreign
exchange rates. Such transactions may be effected with respect to
hedges on non-US dollar denominated securities owned by the Fund,
sold by the Fund but not yet delivered, or committed or anticipated
to be purchased by the Fund.
* Options--The Fund is authorized to write covered call options and
purchase put options. When the Fund sells an option, an amount equal
to the premium received by the Fund is reflected as an asset and an
equivalent liability. The amount of the liability is subsequently
marked to market to reflect the current market value of the option
written.
<PAGE>
When a security is purchased or sold through an exercise of an
option, the related premium paid (or received) is added to (or
deducted from) the basis of the security acquired or deducted from
(or added to) the proceeds of the security sold. When an option
expires (or the Fund enters into a closing transaction), the Fund
realizes a gain or loss on the option to the extent of the premiums
received or paid (or gain or loss to the extent the cost of the
closing transaction exceeds the premium paid or received).
Written and purchased options are non-income producing investments.
Merrill Lynch Dragon Fund, Inc., June 30, 1996
NOTES TO FINANCIAL STATEMENTS (continued)
(c) Foreign currency transactions--Transactions denominated in
foreign currencies are recorded at the exchange rate prevailing when
recognized. Assets and liabilities denominated in foreign currencies
are valued at the exchange rate at the end of the period. Foreign
currency transactions are the result of settling (realized) or
valuing (unrealized) assets or liabilities expressed in foreign
currencies into US dollars. Realized and unrealized gains or losses
from investments include the effects of foreign exchange rates on
investments.
(d) Income taxes--It is the Fund's policy to comply with the
requirements of the Internal Revenue Code applicable to regulated
investment companies and to distribute substantially all of its
taxable income to its shareholders. Therefore, no Federal income tax
provision is required. Under the applicable foreign tax law, a
withholding tax may be imposed on interest, dividends, and capital
gains at various rates.
(e) Security transactions and investment income--Security
transactions are recorded on the dates the transactions are entered
into (the trade dates). Dividend income is recorded on the ex-
dividend dates. Dividends from foreign securities where the ex-
dividend date may have passed are subsequently recorded when the
Fund has determined the ex-dividend date. Interest income (including
amortization of discount) is recognized on the accrual basis.
Realized gains and losses on security transactions are determined on
the identified cost basis.
<PAGE>
(f) Deferred organization expenses and prepaid registration fees--
Deferred organization expenses are charged to expense on a straight-
line basis over a five-year period. Prepaid registration fees are
charged to expense as the related shares are issued.
(g) Dividends and distributions--Dividends and distributions paid by
the Fund are recorded on the ex-dividend dates. Distributions in
excess of realized capital gains are due primarily to differing tax
treatments for futures transactions and post-October losses.
(h) Reclassification--Generally accepted accounting principles
require that certain components of net assets be adjusted to reflect
permanent differences between financial and tax reporting.
Accordingly, current year's permanent book/tax differences of
$8,078,571 have been reclassified between accumulated net realized
capital losses and accumulated distributions in excess of net
investment income and differences of $354,306 have been reclassified
between paid-in capital in excess of par and accumulated
distributions in excess of net investment income. These
reclassifications have no effect on net assets or net asset values
per share.
2. Investment Advisory Agreement and Transactions
with Affiliates:
The Fund has entered into an Investment Advisory Agreement with
Merrill Lynch Asset Management, L.P. ("MLAM"). The general partner
of MLAM is Princeton Services, Inc. ("PSI"), an indirect wholly-
owned subsidiary of Merrill Lynch & Co., Inc. ("ML & Co.") which is
the limited partner. The Fund has also entered into a Distribution
Agreement and Distribution Plans with Merrill Lynch Funds
Distributor, Inc. ("MLFD" or "Distributor"), a wholly-owned
subsidiary of Merrill Lynch Group, Inc.
MLAM is responsible for the management of the Fund's portfolio and
provides the necessary personnel, facilities, equipment and certain
other services necessary to the operations of the Fund. For such
services, the Fund pays a monthly fee of 1.00%, on an annual basis,
of the average daily value of the Fund's net assets.
Pursuant to the Distribution Plans adopted by the Fund in accordance
with Rule 12b-1 under the Investment Company Act of 1940, the Fund
pays the Distributor ongoing account maintenance and distribution
fees. The fees are accrued daily and paid monthly at annual rates
based upon the average daily net assets of the shares as follows:
Account Distribution
Maintenance Fee Fee
Class B 0.25% 0.75%
Class C 0.25% 0.75%
Class D 0.25% --
<PAGE>
Pursuant to a sub-agreement with the Distributor, Merrill Lynch,
Pierce, Fenner & Smith Inc. ("MLPF&S"), a subsidiary of ML & Co.,
also provides account maintenance and distribution services to the
Fund. The ongoing account maintenance fee compensates the
Distributor and MLPF&S for providing account maintenance services to
Class B, Class C and Class D shareholders. The ongoing distribution
fee compensates the Distributor and MLPF&S for providing shareholder
and distribution-related services to Class B and Class C
shareholders.
For the year ended December 31, 1997, MLFD earned underwriting
discounts and direct commissions and MLPF&S earned dealer
concessions on sales of the Fund's Class A and Class D Shares as
follows:
MLFD MLPF&S
Class A $ 146 $ 2,037
Class D $14,111 $193,973
For the year ended December 31, 1997, MLPF&S received contingent
deferred sales charges of $3,327,007 and $64,200 relating to
transactions in Class B and Class C Shares, respectively, and where
the initial sales charge was waived, $10,000 relating to
transactions in Class D Shares.
In addition, MLPF&S received $198,625 in commissions on the
execution of portfolio security transactions for the Fund for the
year ended December 31, 1997.
Merrill Lynch Financial Data Services, Inc. ("MLFDS"), a wholly-
owned subsidiary of ML & Co., is the Fund's transfer agent.
Accounting services are provided to the Fund by MLAM at cost.
Certain officers and/or directors of the Fund are officers and/or
directors of MLAM, PSI, MLFDS, MLFD, and/or ML & Co.
3. Investments:
Purchases and sales of investments, excluding short-term securities,
for year ended December 31, 1997 were $232,885,879 and $793,557,852,
respectively.
Net realized and unrealized gains (losses) as of December 31, 1997
were as follows:
<PAGE>
Realized Unrealized
Gains Gains
(Losses) (Losses)
Long-term investments $ 63,719,015 $(79,707,467)
Short-term investments (8) --
Foreign currency transactions (2,118,776) (275,797)
Forward foreign exchange contracts 1,037,450 4,949,077
------------ ------------
Total $ 62,637,681 $(75,034,187)
============ ============
As of December 31, 1997, net unrealized depreciation for Federal
income tax purposes aggregated $80,096,022, of which $53,938,509
related to appreciated securities and $134,034,531 related to
depreciated securities. At December 31, 1997, the aggregate cost of
investments for Federal income tax purposes was $620,588,293.
4. Capital Share Transactions:
Net increase (decrease) in net assets derived from capital share
transactions was $(483,237,127) and $58,833,959 for the years ended
December 31, 1997 and December 31, 1996, respectively.
Transactions in capital shares for each class were as follows:
Class A Shares for the Year Dollar
Ended December 31, 1997 Shares Amount
Shares sold 6,015,713 $ 88,275,915
Shares issued to shareholders
in reinvestment of distributions 236,924 2,065,973
------------ -------------
Total issued 6,252,637 90,341,888
Shares redeemed (7,375,072) (115,587,006)
------------ -------------
Net decrease (1,122,435) $ (25,245,118)
============ =============
Class A Shares for the Year Dollar
Ended December 31, 1996 Shares Amount
Shares sold 12,899,901 $ 220,044,411
Shares issued to shareholders
in reinvestment of dividends 9,549 166,434
------------ -------------
Total issued 12,909,450 220,210,845
Shares redeemed (12,124,370) (208,148,463)
------------ -------------
Net increase 785,080 $ 12,062,382
============ =============
<PAGE>
Class B Shares for the Year Dollar
Ended December 31, 1997 Shares Amount
Shares sold 14,731,989 $ 221,129,612
Shares issued to shareholders
in reinvestment of distributions 7,005,794 59,549,243
------------ -------------
Total issued 21,737,783 280,678,855
Shares redeemed (42,518,325) (642,737,859)
Automatic conversion of shares (250,913) (3,997,661)
------------ -------------
Net decrease (21,031,455) $(366,056,665)
============ =============
Class B Shares for the Year Dollar
Ended December 31, 1996 Shares Amount
Shares sold 25,325,787 $ 434,357,379
Shares issued to shareholders
in reinvestment of dividends 228,431 3,938,163
------------ -------------
Total issued 25,554,218 438,295,542
Shares redeemed (22,696,021) (388,041,441)
Automatic conversion of shares (190,734) (3,243,492)
------------ -------------
Net increase 2,667,463 $ 47,010,609
============ =============
Class C Shares for the Year Dollar
Ended December 31, 1997 Shares Amount
Shares sold 16,303,336 $ 241,289,351
Shares issued to shareholders
in reinvestment of distributions 411,551 3,448,796
------------ -------------
Total issued 16,714,887 244,738,147
Shares redeemed (17,613,299) (265,825,401)
------------ -------------
Net decrease (898,412) $ (21,087,254)
============ =============
Merrill Lynch Dragon Fund, Inc., December 31, 1997
<PAGE>
NOTES TO FINANCIAL STATEMENTS (concluded)
Class C Shares for the Year Dollar
Ended December 31, 1996 Shares Amount
Shares sold 10,211,909 $ 171,725,625
Shares issued to shareholders
in reinvestment of dividends 13,170 224,411
------------ -------------
Total issued 10,225,079 171,950,036
Shares redeemed (8,552,384) (144,423,321)
------------ -------------
Net increase 1,672,695 $ 27,526,715
============ =============
Class D Shares for the Year Dollar
Ended December 31, 1997 Shares Amount
Shares sold 22,513,372 $ 330,483,403
Automatic conversion of shares 246,834 3,997,661
Shares issued to shareholders
in reinvestment of distributions 2,016,701 17,565,462
------------ -------------
Total issued 24,776,907 352,046,526
Shares redeemed (28,070,639) (422,894,616)
------------ -------------
Net decrease (3,293,732) $ (70,848,090)
============ =============
Class D Shares for the Year Dollar
Ended December 31, 1996 Shares Amount
Shares sold 25,641,811 $ 438,051,376
Automatic conversion of shares 189,401 3,243,492
Shares issued to shareholders
in reinvestment of dividends 55,362 966,068
------------ -------------
Total issued 25,886,574 442,260,936
Shares redeemed (27,271,316) (470,026,683)
------------ -------------
Net decrease (1,384,742) $ (27,765,747)
============ =============
5. Commitments:
On December 31, 1997, the Fund had entered into foreign exchange
contracts, in addition to the contracts listed on the Schedule of
Investments, under which it had agreed to purchase and sell foreign
currency with the approximate value of $261,000 and $2,282,000,
respectively.
<PAGE>
<AUDIT-REPORT>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders,
Merrill Lynch Dragon Fund, Inc.:
We have audited the accompanying statement of assets and
liabilities, including the schedule of investments, of Merrill Lynch
Dragon Fund, Inc. as of December 31, 1997, the related statements of
operations for the year then ended and changes in net assets for
each of the years in the two-year period then ended, and the
financial highlights for each of the periods presented. These
financial statements and the financial highlights are the
responsibility of the Fund's management. Our responsibility is to
express an opinion on these financial statements and the 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 the 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 at December
31, 1997 by correspondence with the custodian and brokers. An audit
also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, such financial statements and financial highlights
present fairly, in all material respects, the financial position
of Merrill Lynch Dragon Fund, Inc. as of December 31, 1997, the
results of its operations, the changes in its net assets,
and the financial highlights for the respective stated periods
in conformity with generally accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
February 12, 1998
</AUDIT-REPORT>
<PAGE>
IMPORTANT TAX INFORMATION (unaudited)
During the taxable year ended December 31, 1997, Merrill Lynch
Dragon Fund, Inc. paid a long-term capital gain distribution of
$1.886076 per share to shareholders of record on December 18, 1997.
Of this amount, 97.88% is subject to a 20% tax rate and 2.12% is
subject to a 28% tax rate.
Please retain this information for your records.
