MERRILL LYNCH
DRAGON FUND, INC.
FUND LOGO
Annual Report
December 31, 1998
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.
Map Depicting the Fund's Asset Allocation As a Percentage* of Net
Assets as of December 31, 1998
INDIA 1.2%
INDONESIA 0.8%
SINGAPORE 14.1%
MALAYSIA 4.7%
THAILAND 8.3%
CHINA 4.8%
HONG KONG 33.7%
TAIWAN 8.5%
SOUTH KOREA 13.9%
PHILIPPINES 5.2%
[FN]
*Total may not equal 100%.
Merrill Lynch Dragon Fund, Inc., December 31, 1998
DEAR SHAREHOLDER
Fiscal Year in Review
Monetary policy makers cut interest rates in the last quarter of
Merrill Lynch Dragon Fund, Inc.'s fiscal year. These easings
appeared to calm investors, at least through December month-end.
During the last three months of 1998, equity markets rallied, bond
spreads narrowed slightly, and the credit squeeze was apparently
diminished. In light of the problems that assailed the world
throughout most of the Fund's fiscal year, financial markets reached
a remarkable level of calm during the December quarter.
Non-Japan Asia was the best-performing region among global stock
markets in the last quarter of the Fund's fiscal year. Some dragon
stock markets rose over 30% during the three-month period. The main
driver of these rallies was the substantial fall in interest rates
across the region. The other factor that kept these markets buoyant
was the stability of their currencies.
Falling interest rates with stable currencies may be the first signs
of recovery in Asia. With these two positive factors in place,
investors started paying attention to other favorable data such as
current account surpluses, higher foreign reserves and improvement
in consumer spending. Local investor sentiment improved, and retail
investors were a large component of the buying that took place in
the region. Although 1998 ended on a high note, the prospects for
emerging markets economies dimmed once again in January with
Brazil's devaluation of its currency. Of particular concern as well
was the failure of Guangdong International Trust and Investment
Corporation (GITIC) in the People's Republic of China. As a result,
the dragon stock markets began to give back some of their recent
gains.
During the fiscal year ended December 31, 1998, Taiwan eased long-
standing investment restrictions, making it easier for foreigners to
invest there. As a result, we changed the Fund's performance
benchmark as of October 31, 1998 to reflect Taiwan's inclusion in
our universe of stock markets. For the fiscal year ended December
31, 1998, the unmanaged blended index--which consists of the Morgan
Stanley Capital International All Country Far East (Ex-Japan and Ex-
Taiwan) Free Index from January 1, 1998 through October 31, 1998 and
the Morgan Stanley Capital International All Country Far East (Ex-
Japan) Free Index from November 1, 1998 though December 31, 1998--
had a total return of -4.36%. This compares to total returns for the
Fund's Class A, Class B, Class C and Class D Shares of -16.22%,
- -17.06%, -17.05% and -16.38%, respectively, for the same 12-month
period. We followed a cautious investment strategy throughout most
of the Fund's fiscal year, which benefited performance relative to
the unmanaged benchmark index through the end of September. However,
the dragon stock markets rose rapidly during the last two months of
the year, supported by greater liquidity and falling interest rates.
Although we decreased the Fund's cash position during the final
quarter of the fiscal year to 4.7% of net assets as of December 31,
1998, the Fund did not keep up with the performance of its
benchmark, in part because the benchmark includes higher risk issues
that we believed were not appropriate for the Fund. (Fund results 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 6--8 of this report to
shareholders.)
Investment Outlook and Strategy
The South Korean stock market was the best performer among dragon
stock markets during the quarter ended December 31, 1998. The
country's current account balance has continued to improve, and the
South Korean government repaid US $1 billion of its International
Monetary Fund (IMF) loan. However, there is a considerable amount of
debt that the private sector has to service in the next six months.
So far, there has not been significant restructuring among the large
conglomerates or chaebols, with few closures of plants and
manufacturing facilities. Perhaps the latest government pressure on
the chaebols will elicit some substantive reforms. As with the other
Asian stock markets, liquidity was very high in South Korea during
the December quarter and local investors were very active. We
increased the Fund's South Korean investments during the December
quarter, although our position is still underweighted relative to
the Morgan Stanley Capital International All Country Far East (Ex-
Japan) Free Index.
The main question on the minds of most China watchers is the fate of
the renminbi. Chinese authorities have reiterated their commitment
to a stable currency, which has been made easier by the current
strength of the Japanese yen and the nascent recovery of non-Japan
Asia. China's own economy is obviously slowing. The government has
now accepted that the economy is suffering from deflation, and has
instituted a policy of reflation. Interest rates were cut in
November, and we believe that more cuts are likely. The bankruptcy
of GITIC, a large enterprise owned by Guangdong Province, has caused
some investor nervousness. Banks in China and Hong Kong with
exposures to GITIC will have to write down their loans, which may
result in lower earnings in the near term. However, the move by the
Chinese central government to shut GITIC down bodes well for the
long-term restructuring prospects for the Chinese economy, in our
view. In effect, the Chinese government has stated that no company
is too large to fail and that it will not bail out inefficient
entities. As of December 31, 1998, the Fund had an overweighted
position in China, largely through an investment in China Telecom
(Hong Kong) Limited.
The Hong Kong stock market moved up very strongly during the
December quarter despite market intervention by the Hong Kong
Monetary Authority (HKMA) during the prior quarter. In addition, the
seven new measures introduced by the HKMA to reduce the
vulnerability of the financial markets to short-term manipulation
appear to be working. In order to support the property market, the
government has loosened lending restrictions for real estate
purchases. It would appear that there has been some improvement in
property prices. However, it is difficult to believe that asset
prices will not fall more in view of the declining competitive
position of Hong Kong relative to its neighbors, with their devalued
currencies. The Fund was underweighted in Hong Kong as of December
31, 1998. Our investments there focused on conglomerates and banks
in relatively strong financial positions.
Taiwan has been experiencing some financial problems with the
announced bankruptcy of a few finance companies. However, the
central bank has been loosening monetary policy aggressively, while
the government has created a sizeable stabilization fund to help
support the stock market. Although earnings prospects appear poor
for 1999, liquidity and technical factors supported the Taiwanese
stock market in the December quarter. We were underweighted in
Taiwan as of December 31, 1998, since we believe that the banking
system may come under pressure because of non-performing loans. Our
Taiwanese investments are largely in electronics companies with
export-oriented businesses.
The Thai stock market was an especially strong performer during the
December quarter, with its currency strengthening despite falling
interest rates. With some recovery in recent car sales, consumer
spending may have bottomed in Thailand. The government is moving
toward important and needed bankruptcy legislation. However, the
results of the latest auction of collateral of bankrupt finance
companies proved to be very disappointing, since only 20% of the
items were sold. As of December 31, 1998, the Fund was overweighted
in Thailand.
Falling interest rates set the stage for higher share prices in
Indonesia during the December quarter. The stock market's recovery
was aided by some actions by the government to deal with the
country's banking problems. However, political uncertainties are
still high in Indonesia, and we continue to underweight this market.
Nominal interest rates moved down steeply in Singapore, where the
government has decided to make the country more competitive.
Merrill Lynch Dragon Fund, Inc., December 31, 1998
Cost-cutting measures were announced, which included wage and
utility tariff cuts, as well as tax abatements. These measures
should create savings for corporations next year, and earnings
growth estimates have been revised up for this reason. The Fund had
a neutral weighting in Singapore as of December month-end, and our
investments focused on export-oriented electronics companies and
banks, which we expect to benefit from financial deregulation.
The Philippines has delivered a series of good economic reports,
such as strong exports, a current account surplus and increasing
foreign reserves. The economy was not badly damaged by the Asian
financial crisis, primarily because corporations had not accumulated
large levels of debt. In addition, the country has benefited from
falling interest rates and a stable currency. Although we sold some
of our Philippine investments during the December quarter, the
Fund's position in this stock market remains overweighted.
As discussed in our last report to shareholders, capital controls
continue in Malaysia, although they were eased somewhat in February
1999. These modified controls limit the Fund's ability to repatriate
proceeds of its Malaysian investments without penalty. However, our
Malaysian investments focus on companies whose shares have
relatively high dividend yields. As of December 31, 1998,
approximately 4.7% of the Fund's net assets was invested in
Malaysia. As opportunities arise, we plan to selectively pursue
opportunities to decrease the Fund's exposure to the Malaysian
ringgit.
In Conclusion
The December quarter gave investors hope that the dragon countries
have probably seen the worst in their economies and financial
markets. However, as reflected in the declines experienced in
January, there are still deep problems that will take time to
resolve. The biggest problem remains the recapitalization of the
banking systems in the region. Non-performing loan levels of banks
are very high, and governments have only begun to deal with them.
Until banks are recapitalized and healthy again, loan growth and
hence economic activity is likely to be low. However, it is
heartening to see that countries like South Korea, Thailand and even
Indonesia are now grappling with the problems.
We believe that investors in the dragon stock markets are beginning
to anticipate economic recovery, since economic fundamentals have
improved. The recovery process will be slow, but it should move the
region forward. There may be a small shrinkage in some Asian
economies in 1999, but earnings growth is expected to be better in
many countries as the base of comparison will be low. However, the
relative economic stability that we witnessed in late 1998 must be
maintained if Asia is to continue its recovery. The stability has
been somewhat shaken early in 1999 by the devaluation of the
Brazilian real. As the year unfolds, the dragon economies may be
susceptible to other possible external shocks, such as further
deterioration of the Japanese economy or recessions in the United
States and some European countries. If these events do not unfold,
Asia has a good chance of returning to a modicum of economic health,
in our view.
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 10, 1999
EQUITY PORTFOLIO CHANGES
For the Quarter Ended December 31, 1998
Additions
Cathay Life Insurance Co., Ltd.
HSBC Holdings PLC (GBP)
Hana Microelectronics Public Company Limited 'Foreign'
Jiangsu Expressway Company Ltd., Series H
Metropolitan Bank & Trust Company
Nien Hsing Textile Corporation Ltd.
Oversea-Chinese Banking Corporation Ltd. 'Foreign'
Overseas Union Bank Ltd. 'Foreign'
Pohang Iron & Steel Company, Ltd. (ADR)
Pou Chen Corporation
President Chain Store Corp.
Rothmans of Pall Mall (Malaysia) BHD
Samsung Fire & Marine Insurance
VTech Holdings Limited
Deletions
Berjaya Sports ToTo BHD
Kookmin Bank
Shanghai Industrial Holdings Limited
PORTFOLIO INFORMATION
Investments
As of 12/31/98
Ten Largest Equity Holdings Percent of
Represented in the Portfolio Net Assets
Hutchison Whampoa Limited 8.1%
HSBC Holdings PLC 5.9
Korea Electric Power Corporation 4.4
Cheung Kong Holdings Ltd. 4.3
Hong Kong Telecommunications Ltd. (ADR) 4.1
CLP Holdings Limited 3.1
Samsung Display Devices Co., Ltd. 3.1
Singapore Airlines Ltd. 'Foreign' 3.0
Samsung Electronics Co., Ltd. 2.9
Samsung Fire & Marine Insurance 2.5
Ten Largest Industries Percent of
Represented in the Portfolio Net Assets
Electronics 15.4%
Banking 13.2
Utilities--Electric & Gas 12.6
Conglomerates 10.2
Telecommunications 9.9
Publishing & Broadcasting 6.6
Real Estate 6.2
Airlines 3.0
Property & Casualty Insurance 2.5
Oil & Gas 2.4
Merrill Lynch Dragon Fund, Inc., December 31, 1998
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 "Recent Performance
Results" and "Average Annual Total Return" 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.
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 Capital International All Country
Far East (Ex-Japan) Free Index and the Morgan Stanley Capital
International All Country Far East Composite (Ex-Japan) Free Index.
Beginning and ending values are:
10/21/94** 12/98
ML Dragon Fund, Inc.++--
Class A Shares* $ 9,475 $ 5,117
ML Dragon Fund, Inc.++--
Class C Shares* $10,000 $ 5,181
Morgan Stanley Capital International
All Country Far East (Ex-Japan)
Free Index++++ $10,000 $ 5,658
Morgan Stanley Capital International
All Country Far East Composite
(Ex-Japan) Free Index++++++ $10,000 $ 5,199
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 Capital International All Country
Far East (Ex-Japan) Free Index and the Morgan Stanley Capital
International All Country Far East Composite (Ex-Japan) Free Index.
Beginning and ending values are:
5/29/92** 12/98
ML Dragon Fund, Inc.++--
Class B Shares* $10,000 $ 9,030
ML Dragon Fund, Inc.++--
Class D Shares* $ 9,475 $ 9,015
Morgan Stanley Capital International
All Country Far East (Ex-Japan)
Free Index++++ $10,000 $10,750
Morgan Stanley Capital International
All Country Far East Composite
(Ex-Japan) Free Index++++++ $10,000 $ 9,877
[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, South Korea, the
Philippines, Singapore, China, Taiwan, Malaysia and Thailand that
are freely purchasable by foreign investors. Effective 10/30/98,
Malaysia was removed from the Index. The starting date for the Index
in the Class A & Class C Shares graph is from 10/31/94 and in the
Class B & Class D Shares graph is from 5/31/92.
++++++This unmanaged capitalization-weighted Index is comprised of a
representative sampling of stocks of large-, medium- and small-
capitalization companies in Hong Kong, Indonesia, South Korea, the
Philippines, Singapore, China, Taiwan, Malaysia and Thailand that
are freely purchasable by foreign investors. This Index excluded
Taiwan from September 1996 to October 1998. Effective 10/30/98,
Malaysia was removed from the Index. The starting date for the Index
in the Class A & Class C Shares graph is from 10/31/94 and in the
Class B & Class D Shares graph is from 5/31/92.
Average Annual
Total Return
% Return Without % Return With
Sales Charge Sales Charge**
Class A Shares*
Year Ended 12/31/98 -16.22% -20.62%
Inception (10/21/94) through 12/31/98 -13.66 -14.76
[FN]
*Maximum sales charge is 5.25%.
**Assuming maximum sales charge.
% Return % Return
Without CDSC With CDSC**
Class B Shares*
Year Ended 12/31/98 -17.06% -20.36%
Five Years Ended 12/31/98 -13.73 -13.73
Inception (5/29/92) through 12/31/98 - 1.54 - 1.54
[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 12/31/98 -17.05% -17.87%
Inception (10/21/94) through 12/31/98 -14.51 -14.51
[FN]
*Maximum contingent deferred sales charge is 1% and is reduced to 0%
after 1 year.
**Assuming payment of applicable contingent deferred sales charge.
% Return Without % Return With
Sales Charge Sales Charge**
Class D Shares*
Year Ended 12/31/98 -16.38% -20.77%
Five Years Ended 12/31/98 -13.03 -13.96
Inception (5/29/92) through 12/31/98 - 0.75 - 1.56
[FN]
*Maximum sales charge is 5.25%.
**Assuming maximum sales charge.
Merrill Lynch Dragon Fund, Inc., December 31, 1998
PERFORMANCE DATA (concluded)
<TABLE>
Recent
Performance
Results*
<CAPTION>
12 Month 3 Month Since Inception
Total Return Total Return Total Return
<S> <C> <C> <C>
ML Dragon Fund, Inc. Class A Shares -16.22% +23.02% -45.98%
ML Dragon Fund, Inc. Class B Shares -17.06 +22.69 - 9.70
ML Dragon Fund, Inc. Class C Shares -17.05 +22.69 -48.19
ML Dragon Fund, Inc. Class D Shares -16.38 +22.85 - 4.85
<FN>
*Investment results shown do not reflect sales charges; results
shown would be lower if a sales charge was included. Total
investment returns are based on changes in net asset values for the
periods shown, and assume reinvestment of all dividends and capital
gains distributions at net asset value on the ex-dividend date. The
Fund's since inception periods are Class A & Class C Shares, from
10/21/94 to 12/31/98 and Class B & Class D Shares, from 5/29/92 to
12/31/98.
</TABLE>
<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> <S> <C> <S> <C> <C> <C>
China Appliances 1,207,000 Guangdong Kelon Electrical Holdings
Company Limited $ 1,239,261 $ 1,075,049 0.4%
Infrastructure 4,130,000 Jiangsu Expressway Company Ltd.
(Series H) 1,025,327 906,298 0.3
US$ 1,302,000 New World Infrastructure Limited,
5% due 7/15/2001 (a) 1,684,567 1,132,740 0.4
4,867,000 Zhejiang Expressway Co. Ltd.
(Series H) 861,134 986,354 0.3
-------------- -------------- ------
3,571,028 3,025,392 1.0
Mining 107,520 Yanzhou Coal Mining Co., Ltd.
(ADR)* 1,693,440 813,120 0.3
Telecommunications 200,450 ++China Telecom (Hong Kong)
Limited (Class H) (ADR)* 7,549,126 6,965,637 2.3
Utilities-- 4,152,000 Beijing Datang Power Generation
Electric & Gas Company Limited 2,010,079 1,246,098 0.4
88,800 Huaneng Power International,
Inc. (ADR)* 1,372,562 1,287,600 0.4
-------------- -------------- ------
3,382,641 2,533,698 0.8
Total Long-Term Investments in China 17,435,496 14,412,896 4.8
Hong Kong Banking 83,200 HSBC Holdings PLC (GBP) 2,235,921 2,255,430 0.8
710,067 HSBC Holdings PLC 14,660,081 17,690,035 5.9
-------------- -------------- ------
16,896,002 19,945,465 6.7
Conglomerates 3,448,000 Hutchison Whampoa Limited 24,965,652 24,368,199 8.1
4,645,000 Swire Pacific Ltd. 'B' 3,084,355 3,087,913 1.0
-------------- -------------- ------
28,050,007 27,456,112 9.1
Consumer Products 149,900 VTech Holdings Limited 616,950 654,019 0.2
Electronics 1,083,000 Johnson Electric Holdings Limited 2,189,419 2,781,977 0.9
Infrastructure 647,000 Cheung Kong Infrastructure
Holdings Limited 1,931,148 1,444,849 0.5
Insurance 2,316,000 National Mutual Asia Limited 2,180,743 1,719,010 0.6
Publishing & 3,806,000 South China Morning Post
Broadcasting Holdings Ltd. 2,428,772 1,952,891 0.7
868,000 Television Broadcasts Ltd. 3,208,050 2,240,896 0.7
-------------- -------------- ------
5,636,822 4,193,787 1.4
Real Estate 1,800,000 Cheung Kong Holdings Ltd. 8,426,284 12,953,569 4.3
405,588 Sun Hung Kai Properties, Ltd. 3,067,040 2,958,051 1.0
-------------- -------------- ------
11,493,324 15,911,620 5.3
Telecommunications 700,500 Hong Kong Telecommunications
Ltd. (ADR)* 12,985,863 12,302,531 4.1
Utilities-- 1,889,000 CLP Holdings Limited 8,012,971 9,412,204 3.1
Electric & Gas 4,142,817 Hong Kong and China Gas Company Ltd. 6,442,987 5,267,494 1.8
-------------- -------------- ------
14,455,958 14,679,698 4.9
Total Long-Term Investments
in Hong Kong 96,436,236 101,089,068 33.7
India Finance 10 Housing Development Finance
Corporation Ltd. (HDFC) 980 514 0.0
Telecommunications 287,000 Mahanagar Telephone Nigam Ltd. (GDR)** 3,431,946 3,551,625 1.2
Total Long-Term Investments
in India 3,432,926 3,552,139 1.2
Indonesia Oil & Gas 359,300 ++Gulf Indonesia Resources Ltd.
Producers (ADR)* 7,456,619 2,335,450 0.8
Total Long-Term Investments
in Indonesia 7,456,619 2,335,450 0.8
Malaysia+++ Consumer Products 1,230,000 Amway (Malaysia) Holdings BHD 1,994,644 2,310,015 0.8
Food 1,296,700 Nestle (Malaysia) BHD 5,698,096 4,745,677 1.6
Publishing & 2,643,000 Star Publications (Malaysia) 7,556,692 3,436,418 1.1
Broadcasting
Tobacco 319,000 Rothmans of Pall Mall (Malaysia) BHD 1,348,609 1,720,496 0.6
Utilities-- 2,444,000 YTL Power Internationl BHD 2,233,583 1,759,493 0.6
Electric & Gas
Total Long-Term Investments in
Malaysia 18,831,624 13,972,099 4.7
Philippines Banking 240,000 Metropolitan Bank & Trust Company 1,591,117 1,734,194 0.6
Conglomerates 20,209,320 ++Benpres Holdings Corporation 6,024,823 3,285,644 1.1
Infrastructure 1,853,650 ++International Container Terminal
Services, Inc. (ICTSI) 160,362 155,467 0.1
Real Estate 9,974,184 Ayala Land, Inc. 7,988,637 2,831,381 0.9
Retail 23,982,170 SM Prime Holdings, Inc. 4,875,759 4,579,821 1.5
Utilities-- 952,893 Manila Electric Co. (MERALCO) 'B' 5,319,342 3,073,848 1.0
Electric & Gas
Total Long-Term Investments in
the Philippines 25,960,040 15,660,355 5.2
</TABLE>
Merrill Lynch Dragon Fund, Inc., December 31, 1998
<TABLE>
SCHEDULE OF INVESTMENTS (concluded) (in US dollars)
<CAPTION>
Shares Held/ Value Percent of
COUNTRIES Industries Face Amount Long-Term Investments Cost (Note 1a) Net Assets
<S> <S> <S> <C> <S> <C> <C> <C>
Singapore Airlines 1,214,000 Singapore Airlines Ltd. 'Foreign' $ 10,644,242 $ 8,910,767 3.0%
Banking 762,000 Development Bank of Singapore
Ltd. 'Foreign' 8,585,372 6,887,352 2.3
426,000 Oversea-Chinese Banking Corporation
Ltd. 'Foreign' 2,757,834 2,894,267 1.0
636,000 Overseas Union Bank Ltd. 'Foreign' 2,765,313 2,777,798 0.9
-------------- -------------- ------
14,108,519 12,559,417 4.2
Electronics 1,011,000 Elec & Eltek International
Company Ltd. 5,916,473 5,459,400 1.8
2,108,000 Natsteel Electronics Ltd. 4,044,964 5,370,701 1.8
-------------- -------------- ------
9,961,437 10,830,101 3.6
Publishing & 595,837 Singapore Press Holdings Ltd. 7,361,511 6,505,954 2.2
Broadcasting
Telecommunications 2,267,000 Singapore Telecommunications Limited 3,462,746 3,465,478 1.1
Total Long-Term Investments
in Singapore 45,538,455 42,271,717 14.1
South Electronics 187,708 Samsung Display Devices Co., Ltd. 7,377,388 9,275,904 3.1
Korea 129,999 Samsung Electronics Co., Ltd. 6,849,909 8,742,433 2.9
-------------- -------------- ------
14,227,297 18,018,337 6.0
Property & Casualty 20,159 Samsung Fire & Marine Insurance 5,329,666 7,559,625 2.5
Insurance
Steel 171,930 Pohang Iron & Steel Company, Ltd.
(ADR)* 2,851,900 2,901,319 1.0
Utilities-- 535,890 Korea Electric Power Corporation 7,706,087 13,307,935 4.4
Electric & Gas
Total Long-Term Investments in
South Korea 30,114,950 41,787,216 13.9
Taiwan Electronics 1,520,000 Advanced Semiconductor Engineering
Inc. (GDR)** 2,919,845 2,551,445 0.8
668,000 Compeq Manufacturing Co., Ltd. 4,588,984 4,381,349 1.4
853,000 Hon Hai Precision Industry 4,403,365 4,719,739 1.6
1,474,000 ++Taiwan Semiconductor Manufacturing
Company Ltd. (TSMC) (ADR)* 3,011,997 3,253,155 1.1
-------------- -------------- ------
14,924,191 14,905,688 4.9
Footwear 1,085,000 Pou Chen Corporation 2,859,658 2,613,848 0.9
Insurance 817,000 Cathay Life Insurance Co., Ltd. 2,805,135 2,641,219 0.9
148,200 Fubon Insurance Co., Ltd. (GDR)** 2,124,553 1,633,905 0.5
-------------- -------------- ------
4,929,688 4,275,124 1.4
Retail 756,000 President Chain Store Corp. 2,404,656 2,385,266 0.8
Textiles 624,000 Nien Hsing Textile Corporation Ltd. 1,425,713 1,483,867 0.5
Total Long-Term Investments in
Taiwan 26,543,906 25,663,793 8.5
Thailand Banking US$ 3,689,000 Bangkok Bank Public Company Limited,
3.25% due 3/03/2004 (a) 1,496,880 1,457,155 0.5
765,400 ++Bangkok Bank Public Company Limited
'Foreign' 1,852,939 1,583,586 0.5
1,202,000 ++Thai Farmers Bank Public Company
Limited 'Foreign' 1,694,499 2,122,152 0.7
-------------- -------------- ------
5,044,318 5,162,893 1.7
Manufacturing 229,600 ++Hana Microelectronics Public Company
Limited 'Foreign' 571,042 557,374 0.2
Oil & Gas 1,001,500 ++PTT Exploration and Production Public
Co. Ltd. 'Foreign' 10,315,952 7,072,662 2.4
Publishing & 1,013,900 BEC World Public Company Limited
Broadcasting 'Foreign' 4,725,098 5,593,931 1.9
Telecommunications 622,600 Advanced Info Service Public Company
Limited 'Foreign' 3,323,449 3,709,837 1.2
Utilities-- 1,032,800 Electricity Generating Public
Electric & Gas Company Limited 'Foreign' 1,608,064 2,806,367 0.9
Total Long-Term Investments
in Thailand 25,587,923 24,903,064 8.3
Total Long-Term Investments 297,338,175 285,647,797 95.2
Face
COUNTRIES Amount Short-Term Investments
United Commercial US$ 1,511,000 General Motors Acceptance Corp.,
States Paper*** 5.13% due 1/04/1999 1,510,354 1,510,354 0.5
13,000,000 Lexington Parker Capital Company,
LLC, 5.40% due 1/15/1999 12,972,700 12,972,700 4.3
Total Short-Term Investments 14,483,054 14,483,054 4.8
Total Investments $ 311,821,229 300,130,851 100.0
==============
Unrealized Depreciation on Forward Foreign Exchange Contracts++++ (32,684) (0.0)
Other Assets Less Liabilities 133,528 0.0
-------------- ------
Net Assets $ 300,231,695 100.0%
============== ======
<FN>
*American Depositary Receipts (ADR).
**Global Depositary Receipts (GDR).
***Commercial Paper is traded on a discount basis; the interest rates
shown reflect the discount rates paid at the time of purchase
by the Fund.
(a)Convertible security.
++Non-income producing security.
++++Forward foreign exchange contracts as of December 31, 1998 were as
follows:
Unrealized
Appreciation
Expiration (Depreciation)
Foreign Currency Sold Date (Note 1b)
THB 296,000,000 May 1999 $ (87,984)
THB 174,000,000 June 1999 55,300
-----------
Total Unrealized Depreciation on Forward
Foreign Exchange Contracts--Net
(US$ Commitment--$12,800,000) $ (32,684)
===========
+++On October 21, 1998, the Fund's Board of Directors decided to discount
the current Malaysian exchange rate of 3.80 by 12%. This is due to the
capital controls implemented by the Malaysian government, which froze the
Malaysian ringgit at 3.80 until September 1, 1999. The discount will be
amortized on a daily basis from 12% to zero through September 1, 1999.
See Notes to Financial Statements.
</TABLE>
Merrill Lynch Dragon Fund, Inc., December 31, 1998
<TABLE>
STATEMENT OF ASSETS AND LIABILITIES
<CAPTION>
As of December 31, 1998
<S> <S> <C> <C>
Assets: Investments, at value (identified cost--$311,821,229)(Note 1a) $ 300,130,851
Cash 542
Foreign cash (Note 1c) 1,309,838
Receivables:
Securities sold $ 3,209,120
Dividends 474,381
Capital shares sold 191,873
Interest 129,651 4,005,025
--------------
Prepaid registration fees and other assets (Note 1f) 81,300
--------------
Total assets 305,527,556
--------------
Liabilities: Unrealized depreciation on forward foreign exchange
contracts (Note 1b) 32,684
Payables:
Capital shares redeemed 3,612,990
Securities purchased 709,095
Investment adviser (Note 2) 260,172
Distributor (Note 2) 206,136 4,788,393
--------------
Accrued expenses and other liabilities 474,784
--------------
Total liabilities 5,295,861
--------------
Net Assets: Net assets $ 300,231,695
==============
Net Assets Class A Shares of Common Stock, $0.10 par value, 100,000,000
Consist of: shares authorized $ 192,720
Class B Shares of Common Stock, $0.10 par value, 200,000,000
shares authorized 2,923,476
Class C Shares of Common Stock, $0.10 par value, 100,000,000
shares authorized 221,462
Class D Shares of Common Stock, $0.10 par value, 100,000,000
shares authorized 884,338
Paid-in capital in excess of par 484,809,799
Accumulated distributions in excess of investment income--net (563,969)
Accumulated realized capital losses on investments and foreign
currency transactions--net (165,333,793)
Accumulated distributions in excess of realized capital gains on
investments and foreign currency transactions--net (Note 1g) (11,169,131)
Unrealized depreciation on investments and foreign currency
transactions--net (11,733,207)
--------------
Net assets $ 300,231,695
==============
Net Asset Class A--Based on net assets of $13,960,355 and 1,927,202
Value: shares outstanding $ 7.24
==============
Class B--Based on net assets of $206,809,296 and 29,234,757
shares outstanding $ 7.07
==============
Class C--Based on net assets of $15,431,017 and 2,214,622
shares outstanding $ 6.97
==============
Class D--Based on net assets of $64,031,027 and 8,843,381
shares outstanding $ 7.24
==============
See Notes to Financial Statements.
</TABLE>
<TABLE>
STATEMENT OF OPERATIONS
<CAPTION>
For the Year Ended December 31, 1998
<S> <S> <C> <C>
Investment Dividends (net of $150,885 foreign withholding tax) $ 9,242,112
Income Interest and discount earned 3,504,727
(Notes 1d & 1e): --------------
Total income 12,746,839
--------------
Expenses: Investment advisory fees (Note 2) $ 3,804,347
Account maintenance and distribution fees--Class B (Note 2) 2,630,765
Transfer agent fees--Class B (Note 2) 914,774
Custodian fees 262,664
Transfer agent fees--Class D (Note 2) 226,033
Account maintenance fees--Class D (Note 2) 202,327
Account maintenance and distribution fees--Class C (Note 2) 194,054
Printing and shareholder reports 112,711
Professional fees 111,660
Registration fees (Note 1f) 91,190
Accounting services (Note 2) 69,836
Transfer agent fees--Class C (Note 2) 68,522
Transfer agent fees--Class A (Note 2) 46,778
Directors' fees and expenses 38,133
Pricing fees 4,079
Other 21,207
--------------
Total expenses 8,799,080
--------------
Investment income--net 3,947,759
--------------
Realized & Realized loss from:
Unrealized Gain Investments--net (157,110,732)
(Loss) on Foreign currency transactions--net (21,531) (157,132,263)
Investments & --------------
Foreign Currency Change in unrealized appreciation/depreciation on:
Transactions--Net Investments--net 68,017,089
(Notes 1b, 1c, Foreign currency transactions--net (4,716,109) 63,300,980
1e & 3): -------------- --------------
Net realized and unrealized loss on investments and foreign
currency transactions (93,831,283)
--------------
Net Decrease in Net Assets Resulting from Operations $ (89,883,524)
==============
See Notes to Financial Statements.
</TABLE>
Merrill Lynch Dragon Fund, Inc., December 31, 1998
<TABLE>
STATEMENTS OF CHANGES IN NET ASSETS
<CAPTION>
For the Year
Ended December 31,
Increase (Decrease) in Net Assets: 1998 1997
<S> <S> <C> <C>
Operations: Investment income (loss)--net $ 3,947,759 $ (891,847)
Realized gain (loss) on investments and foreign currency
transactions--net (157,132,263) 62,637,681
Change in unrealized appreciation/depreciation on investments
and foreign currency transactions--net 63,300,980 (518,730,983)
-------------- --------------
Net decrease in net assets resulting from operations (89,883,524) (456,985,149)
-------------- --------------
Dividends & Investment income--net:
Distributions to Class A (216,933) --
Shareholders Class B (1,017,103) --
(Note 1g): Class C (80,142) --
Class D (789,917) --
In excess of investment income--net:
Class A (70,818) --
Class B (332,036) --
Class C (26,163) --
Class D (257,870) --
Realized gain on investments--net:
Class A -- (2,185,017)
Class B -- (64,077,324)
Class C -- (3,632,309)
Class D -- (19,118,895)
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 dividends and
distributions to shareholders (2,790,982) (100,182,676)
-------------- --------------
Capital Share Net decrease in net assets derived from capital share
Transactions transactions (133,868,029) (483,237,127)
(Note 4): -------------- --------------
Net Assets: Total decrease in net assets (226,542,535) (1,040,404,952)
Beginning of year 526,774,230 1,567,179,182
-------------- --------------
End of year $ 300,231,695 $ 526,774,230
============== ==============
See Notes to Financial Statements.
</TABLE>
<TABLE>
FINANCIAL HIGHLIGHTS
<CAPTION>
Class A++++
For the
The following per share data and ratios Period
have been derived from information provided Oct. 21,
in the financial statements. For the Year 1994++ to
Ended December 31, Dec. 31,
Increase (Decrease) in Net Asset Value: 1998 1997 1996 1995 1994
<S> <S> <C> <C> <C> <C> <C>
Per Share Net asset value, beginning of period $ 8.81 $ 18.09 $ 15.99 $ 15.05 $ 17.43
Operating -------- -------- -------- -------- --------
Performance: Investment income--net .14 .12 .14 .12 .02
Realized and unrealized gain (loss) on
investments and foreign currency
transactions--net (1.57) (7.51) 2.03 1.00 (1.91)
-------- -------- -------- -------- --------
Total from investment operations (1.43) (7.39) 2.17 1.12 (1.89)
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net (.11) -- -- -- --
In excess of investment income--net (.03) -- -- (.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 (.14) (1.89) (.07) (.18) (.49)
-------- -------- -------- -------- --------
Net asset value, end of period $ 7.24 $ 8.81 $ 18.09 $ 15.99 $ 15.05
======== ======== ======== ======== ========
Total Investment Based on net asset value per share (16.22%) (40.77%) 13.59% 7.44% (10.82%)+++
Return:** ======== ======== ======== ======== ========
Ratios to Average Expenses 1.46% 1.35% 1.33% 1.37% 1.54%*
Net Assets: ======== ======== ======== ======== ========
Investment income--net 1.78% .73% .78% .74% .84%*
======== ======== ======== ======== ========
Supplemental Net assets, end of period (in thousands) $ 13,961 $ 14,431 $ 49,943 $ 31,591 $ 3,383
Data: ======== ======== ======== ======== ========
Portfolio turnover 99.85% 21.11% 30.63% 24.52% 16.45%
======== ======== ======== ======== ========
<FN>
*Annualized.
**Total investment returns exclude the effects of sales loads.
++Commencement of operations.
++++Based on average shares outstanding.
+++Aggregate total investment return.
See Notes to Financial Statements.
</TABLE>
Merrill Lynch Dragon Fund, Inc., December 31, 1998
<TABLE>
FINANCIAL HIGHLIGHTS (concluded)
<CAPTION>
Class B++++
The following per share data and ratios
have been derived from information provided
in the financial statements. For the Year
Ended December 31,
Increase (Decrease) in Net Asset Value: 1998 1997 1996 1995 1994
<S> <S> <C> <C> <C> <C> <C>
Per Share Net asset value, beginning of year $ 8.58 $ 17.89 $ 15.98 $ 15.03 $ 18.74
Operating -------- -------- ---------- -------- --------
Performance: Investment income (loss)--net .06 (.04) (.04) (.03) (.07)
Realized and unrealized gain (loss) on invest-
ments and foreign currency transactions--net (1.52) (7.38) 2.02 1.00 (3.28)
-------- -------- ---------- -------- --------
Total from investment operations (1.46) (7.42) 1.98 .97 (3.35)
-------- -------- ---------- -------- --------
Less dividends and distributions:
Investment income--net (.04) -- -- -- --
In excess of investment income--net (.01) -- -- (.02) --
Realized gain on investments--net -- (1.68) (.07) -- (.27)
In excess of realized gain on invest-
ments--net -- (.21) -- -- (.09)
-------- -------- ---------- -------- --------
Total dividends and distributions (.05) (1.89) (.07) (.02) (.36)
-------- -------- ---------- -------- --------
Net asset value, end of year $ 7.07 $ 8.58 $ 17.89 $ 15.98 $ 15.03
======== ======== ========== ======== ========
Total Investment Based on net asset value per share (17.06%) (41.40%) 12.41% 6.49% (17.86%)
Return:** ======== ======== ========== ======== ========
Ratios to Average Expenses 2.54% 2.39% 2.36% 2.41% 2.40%
Net Assets: ======== ======== ========== ======== ========
Investment income (loss)--net .73% (.26%) (.24%) (.20%) (.42%)
======== ======== ========== ======== ========
Supplemental Net assets, end of year (in thousands) $206,809 $374,914 $1,157,944 $991,281 $917,384
Data: ======== ======== ========== ======== ========
Portfolio turnover 99.85% 21.11% 30.63% 24.52% 16.45%
======== ======== ========== ======== ========
<CAPTION>
Class C++++
For the
The following per share data and ratios have Period
been derived from information provided in the Oct. 21,
financial statements. For the Year 1994++ to
Ended December 31, Dec. 31,
Increase (Decrease) in Net Asset Value: 1998 1997 1996 1995 1994
<S> <S> <C> <C> <C> <C> <C>
Per Share Net asset value, beginning of period $ 8.46 $ 17.68 $ 15.79 $ 14.92 $ 17.29
Operating -------- -------- -------- -------- --------
Performance: Investment income (loss)--net .06 (.04) (.04) (.04) (.01)
Realized and unrealized gain (loss) on invest-
ments and foreign currency transactions--net (1.50) (7.29) 2.00 1.00 (1.89)
-------- -------- -------- -------- --------
Total from investment operations (1.44) (7.33) 1.96 .96 (1.90)
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net (.04) -- -- -- --
In excess of investment income--net (.01) -- -- (.09) (.11)
Realized gain on investments--net -- (1.68) (.07) -- (.27)
-------- -------- -------- -------- --------
In excess of realized gain on invest-
ments--net -- (.21) -- -- (.09)
-------- -------- -------- -------- --------
Total dividends and distributions (.05) (1.89) (.07) (.09) (.47)
-------- -------- -------- -------- --------
Net asset value, end of period $ 6.97 $ 8.46 $ 17.68 $ 15.79 $ 14.92
======== ======== ======== ======== ========
Total Investment Based on net asset value per share (17.05%) (41.38%) 12.43% 6.46% (10.98%)+++
Return:** ======== ======== ======== ======== ========
Ratios to Average Expenses 2.54% 2.41% 2.37% 2.42% 2.57%*
Net Assets: ======== ======== ======== ======== ========
Investment income (loss)--net .75% (.28%) (.23%) (.28%) (.17%)*
======== ======== ======== ======== ========
Supplemental Net assets, end of period (in thousands) $ 15,431 $ 22,111 $ 62,113 $ 29,042 $ 5,329
Data: ======== ======== ======== ======== ========
Portfolio turnover 99.85% 21.11% 30.63% 24.52% 16.45%
======== ======== ======== ======== ========
<CAPTION>
Class D++++
The following per share data and ratios have
been derived from information provided in the
financial statements. For the Year
Ended December 31,
Increase (Decrease) in Net Asset Value: 1998 1997 1996 1995 1994
<S> <S> <C> <C> <C> <C> <C>
Per Share Net asset value, beginning of year $ 8.80 $ 18.11 $ 16.05 $ 15.08 $ 18.77
Operating -------- -------- -------- -------- --------
Performance: Investment income--net .11 .09 .09 .09 .06
Realized and unrealized gain (loss) on invest-
ments and foreign currency transactions--net (1.55) (7.51) 2.04 1.02 (3.30)
-------- -------- -------- -------- --------
Total from investment operations (1.44) (7.42) 2.13 1.11 (3.24)
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net (.09) -- -- -- --
In excess of investment income--net (.03) -- -- (.14) (.09)
Realized gain on investments--net -- (1.68) (.07) -- (.27)
In excess of realized gain on invest-
ments--net -- (.21) -- -- (.09)
-------- -------- -------- -------- --------
Total dividends and distributions (.12) (1.89) (.07) (.14) (.45)
-------- -------- -------- -------- --------
Net asset value, end of year $ 7.24 $ 8.80 $ 18.11 $ 16.05 $ 15.08
======== ======== ======== ======== ========
Total Investment Based on net asset value per share (16.38%) (40.89%) 13.29% 7.35% (17.24%)
Return:** ======== ======== ======== ======== ========
Ratios to Average Expenses 1.72% 1.61% 1.58% 1.63% 1.63%
Net Assets: ======== ======== ======== ======== ========
Investment income--net 1.48% .53% .53% .59% .34%
======== ======== ======== ======== ========
Supplemental Net assets, end of year (in thousands) $ 64,031 $115,318 $297,179 $285,485 $249,903
Data: ======== ======== ======== ======== ========
Portfolio turnover 99.85% 21.11% 30.63% 24.52% 16.45%
======== ======== ======== ======== ========
<FN>
*Annualized.
**Total investment returns exclude the effects of sales loads.
++Commencement of operations.
++++Based on average shares outstanding.
+++Aggregate total investment return.
See Notes to Financial Statements.
</TABLE>
Merrill Lynch Dragon Fund, Inc., December 31, 1998
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's financial statements are
prepared in accordance with generally accepted accounting principles
which may require the use of management accruals and estimates. 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.
(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 or
purchased are valued at the last sale price in the case of exchange-
traded options. In the case of options traded in the over-the-
counter market, valuation is the last asked price (options written)
or the last bid price (options purchased). 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.
* 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 put and covered call
options and purchase put and call 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.
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.
* Financial futures contracts--The Fund may purchase or sell
financial futures contracts and options on such futures contracts as
a hedge against adverse changes in the interest rate. A futures
contract is an agreement between two parties to buy and sell a
security, respectively, for a set price at a future date. Upon
entering into a contract, the Fund deposits and maintains as
collateral such initial margin as required by the exchange on which
the transaction is effected. Pursuant to the contract, the Fund
agrees to receive from or pay to the broker an amount of cash equal
to the daily fluctuation in value of the contract. Such receipts or
payments are known as variation margin and are recorded by the Fund
as unrealized gains or losses. When the contract is closed, the Fund
records a realized gain or loss 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.
(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.
(f) Prepaid registration fees--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 net investment income are due primarily to differing tax
treatments for foreign currency transactions. 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
$122,918 have been reclassified between accumulated net realized
capital losses and accumulated distributions in excess of net
investment income and $41 has been reclassified between accumulated
net realized capital losses and paid-in capital in excess of par.
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 ("MLFD" or "Distributor"), a division of Princeton Funds
Distributor, Inc. ("PFD"), which is 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% --
Pursuant to a sub-agreement with the Distributor, Merrill Lynch,
Pierce, Fenner & Smith Incorporated ("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, 1998, 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 $ 37 $ 749
Class D $16,437 $210,105
Merrill Lynch Dragon Fund, Inc., December 31, 1998
NOTES TO FINANCIAL STATEMENTS (concluded)
For the year ended December 31, 1998, MLPF&S received contingent
deferred sales charges of $690,536 and $54,453 relating to
transactions in Class B and Class C Shares, respectively.
Furthermore, MLPF&S received contingent deferred sales charges of
$58,953 relating to transactions subject to front-end sales charges
waivers in Class D Shares.
In addition, MLPF&S received $264,171 in commissions on the
execution of portfolio security transactions for the Fund for the
year ended December 31, 1998.
Financial Data Services, Inc. ("FDS"), 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, FDS, PFD, and/or ML & Co.
3. Investments:
Purchases and sales of investments, excluding short-term securities,
for the year ended December 31, 1998 were $338,461,016 and
$434,697,307, respectively.
Net realized gains (losses) for the year ended December 31, 1998 and
net unrealized losses as of December 31, 1998 were as follows:
Realized
Gains Unrealized
(Losses) Losses
Long-term investments $(157,111,785) $(11,690,378)
Short-term investments 1,053 --
Foreign currency transactions (1,958,417) (10,145)
Forward foreign exchange contracts 1,936,886 (32,684)
------------- ------------
Total $(157,132,263) $(11,733,207)
============= ============
As of December 31, 1998, net unrealized depreciation for Federal
income tax purposes aggregated $19,054,003, of which $23,717,884
related to appreciated securities and $42,771,887 related to
depreciated securities. At December 31, 1998, the aggregate cost of
investments for Federal income tax purposes was $319,184,854.
4. Capital Share Transactions:
Net decrease in net assets derived from capital share transactions
for the years ended December 31, 1998 and December 31, 1997 was
$133,868,029 and $483,237,127, respectively.
Transactions in capital shares for each class were as follows:
Class A Shares for the Year Dollar
Ended December 31, 1998 Shares Amount
Shares sold 15,653,403 $ 111,046,956
Shares issued to shareholders
in reinvestment of dividends 36,394 258,759
------------ -------------
Total issued 15,689,797 111,305,715
Shares redeemed (15,400,664) (110,364,777)
------------ -------------
Net increase 289,133 $ 940,938
============ =============
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 B Shares for the Year Dollar
Ended December 31, 1998 Shares Amount
Shares sold 14,667,045 $ 105,916,021
Shares issued to shareholders
in reinvestment of dividends 159,633 1,107,854
------------ -------------
Total issued 14,826,678 107,023,875
Shares redeemed (28,838,811) (201,760,153)
Automatic conversion of shares (440,989) (2,950,502)
------------ -------------
Net decrease (14,453,122) $ (97,686,780)
============ =============
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 C Shares for the Year Dollar
Ended December 31, 1998 Shares Amount
Shares sold 8,974,966 $ 64,145,196
Shares issued to shareholders
in reinvestment of dividends 13,504 92,366
------------ -------------
Total issued 8,988,470 64,237,562
Shares redeemed (9,387,631) (67,722,350)
------------ -------------
Net decrease (399,161) $ (3,484,788)
============ =============
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)
============ =============
Class D Shares for the Year Dollar
Ended December 31, 1998 Shares Amount
Shares sold 15,696,281 $ 115,286,453
Automatic conversion of shares 428,711 2,950,502
Shares issued to shareholders
in reinvestment of dividends 110,723 787,239
------------ -------------
Total issued 16,235,715 119,024,194
Shares redeemed (20,503,790) (152,661,593)
------------ -------------
Net decrease (4,268,075) $ (33,637,399)
============ =============
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)
============ =============
5. Commitments:
At December 31, 1998, 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 sell foreign currency with
the approximate value of $3,130,000.
6. Capital Loss Carryforward:
On December 31, 1998, the Fund had a net capital loss carryforward
of approximately $167,519,000, all of which expires in 2006. This
amount will be available to offset like amounts of any future
taxable gains.
Merrill Lynch Dragon Fund, Inc., December 31, 1998
<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, 1998, 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, 1998 by correspondence with the custodian and broker. 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, 1998, 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, 1999
</AUDIT-REPORT>
IMPORTANT TAX INFORMATION (unaudited)
The following information summarizes all per share distributions
paid by Merrill Lynch Dragon Fund, Inc. during the year ended
December 31, 1998:
<TABLE>
<CAPTION>
Non-Qualifying Foreign Total Foreign Taxes
Record Payable Domestic Source Ordinary Paid or
Date Date Ordinary Income Income Income Withheld
<S> <C> <C> <C> <C> <C> <C>
Class A Shares 12/17/98 12/28/98 $.013986 $.124812 $.138798 $.003304
Class B Shares 12/17/98 12/28/98 $.004537 $.040488 $.045025 $.003304
Class C Shares 12/17/98 12/28/98 $.004720 $.042123 $.046843 $.003304
Class D Shares 12/17/98 12/28/98 $.011722 $.104603 $.116325 $.003304
</TABLE>
The foreign taxes paid or withheld represent taxes incurred by the
Fund on dividends received by the Fund from foreign sources. Foreign
taxes paid or withheld should be included in taxable income with an
offsetting deduction from gross income or as a credit for taxes paid
to foreign governments. You should consult your tax adviser
regarding the appropriate treatment of foreign taxes paid.
Please retain this information for your records.
OFFICERS AND DIRECTORS
Arthur Zeikel, President and Director
Donald Cecil, Director
Roland M. Machold, 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
Phillip Gillespie, Secretary
Custodian
Brown Brothers Harriman & Co.
40 Water Street
Boston, MA 02109
Transfer Agent
Financial Data Services, Inc.
4800 Deer Lake Drive East
Jacksonville, FL 32246-6484
(800) 637-3863
