<PAGE>
PROSPECTUS
NOVEMBER 1, 1995
MERRILL LYNCH NORTH CAROLINA MUNICIPAL BOND FUND
MERRILL LYNCH MULTI-STATE MUNICIPAL SERIES TRUST
P.O. BOX 9011, PRINCETON, NEW JERSEY 08543-9011 . PHONE NO. (609) 282-2800
Merrill Lynch North Carolina Municipal Bond Fund (the "Fund") is a mutual
fund seeking to provide shareholders with as high a level of income exempt
from Federal and North Carolina income taxes as is consistent with prudent
investment management. The Fund invests primarily in a portfolio of long-term,
investment grade obligations of the State of North Carolina, its political
subdivisions, agencies and instrumentalities, and obligations of other
qualifying issuers, such as issuers located in Puerto Rico, the Virgin Islands
and Guam, which pay interest exempt, in the opinion of bond counsel to the
issuer, from Federal and North Carolina income taxes. The Fund may invest in
certain tax-exempt securities classified as "private activity bonds" that may
subject certain investors in the Fund to an alternative minimum tax. At times,
the Fund may seek to hedge its portfolio through the use of futures
transactions and options. There can be no assurance that the investment
objective of the Fund will be realized. For more information on the Fund's
investment objective and policies, see "Investment Objective and Policies" on
page 9.
----------------
Pursuant to the Merrill Lynch Select Pricing SM System, the Fund offers four
classes of shares each with a different combination of sales charges, ongoing
fees and other features. The Merrill Lynch Select Pricing System permits an
investor to choose the method of purchasing shares that the investor believes
is most beneficial given the amount of the purchase, the length of time the
investor expects to hold the shares and other relevant circumstances. See
"Merrill Lynch Select Pricing SM System" on page 4.
Shares may be purchased directly from Merrill Lynch Funds Distributor, Inc.
(the "Distributor"), P.O. Box 9081, Princeton, New Jersey 08543-9081 ((609)
282-2800), and other securities dealers which have entered into selected
dealer agreements with the Distributor, including Merrill Lynch, Pierce,
Fenner & Smith Incorporated ("Merrill Lynch"). The minimum initial purchase is
$1,000 and the minimum subsequent purchase is $50. Merrill Lynch may charge
its customers a processing fee (presently $4.85) for confirming purchases and
repurchases. Purchases and redemptions directly through the Fund's Transfer
Agent are not subject to the processing fee. See "Purchase of Shares" and
"Redemption of Shares".
----------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
----------------
This Prospectus is a concise statement of information about the Fund that is
relevant to making an investment in the Fund. This Prospectus should be
retained for future reference. A statement containing additional information
about the Fund, dated November 1, 1995 (the "Statement of Additional
Information"), has been filed with the Securities and Exchange Commission and
is available, without charge, by calling or by writing Merrill Lynch Multi-
State Municipal Series Trust (the "Trust") at the above telephone number or
address. The Statement of Additional Information is hereby incorporated by
reference into this Prospectus. The Fund is a separate series of the Trust, an
open-end management investment company organized as a Massachusetts business
trust.
----------------
FUND ASSET MANAGEMENT -- MANAGER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
<PAGE>
FEE TABLE
A general comparison of the sales arrangements and other nonrecurring and
recurring expenses applicable to shares of the Fund follows:
<TABLE>
<CAPTION>
CLASS A(A) CLASS B(B) CLASS C CLASS D
---------- ---------- --------------- -------
<S> <C> <C> <C> <C>
SHAREHOLDER
TRANSACTION EX-
PENSES:
Maximum Sales
Charge Imposed
on Purchases
(as a percent-
age of offer-
ing price).... 4.00%(c) None None 4.00%(c)
Sales Charge
Imposed on
Dividend
Reinvestments. None None None None
Deferred Sales
Charge (as a
percentage of
original pur-
chase price or
redemption
proceeds,
whichever is
lower)........ None(d) 4.0% during the first year, 1% for one year None(d)
decreasing 1% annually
thereafter to 0.0% after
the fourth year
Exchange Fee... None None None None
ANNUAL FUND
OPERATING
EXPENSES (AS A
PERCENTAGE OF
AVERAGE NET
ASSETS)(E):
Management
Fees(f)....... 0.55% 0.55% 0.55% 0.55%
12b-1 Fees(g):
Account Mainte-
nance Fees.... None 0.25% 0.25% 0.10%
Distribution
Fees.......... None 0.25% 0.35% None
(Class B shares convert to
Class D shares automatically
after approximately ten years, cease
being subject to distribution fees
and become subject to
reduced account
maintenance fees)
Other Expenses:
Custodial
Fees......... 0.01% 0.01% 0.01% 0.01%
Shareholder
Servicing
Costs(h)..... 0.06% 0.07% 0.07% 0.06%
Miscellaneous. 0.31% 0.31% 0.31% 0.31%
----- ----- ----- -----
Total Other 0.38% 0.39% 0.39% 0.38%
Expenses.... ----- ----- ----- -----
Total Fund Op-
erating Ex-
penses+....... 0.93% 1.44% 1.54% 1.03%
===== ===== ===== =====
</TABLE>
- --------
(a) Class A shares are sold to a limited group of investors including existing
Class A shareholders and certain investment programs. See "Purchase of
Shares--Initial Sales Charge Alternatives--Class A and Class D Shares"--
page 23.
(b) Class B shares convert to Class D shares automatically approximately 10
years after initial purchase. See "Purchase of Shares--Deferred Sales
Charge Alternatives--Class B and Class C Shares"--page 25.
(c) Reduced for purchases of $25,000 and over. Class A and Class D purchases
of $1,000,000 or more may not be subject to an initial sales charge. See
"Purchase of Shares--Initial Sales Charge Alternatives--Class A and Class
D Shares"--page 23.
(d) Class A and Class D shares are not subject to a contingent deferred sales
charge ("CDSC"), except that certain purchases of $1,000,000 or more which
are not subject to an initial sales charge may instead be subject to a
CDSC of 1.0% if redeemed within the first year after purchase.
(e) Information for Class A and Class B shares is stated for the fiscal year
ended July 31, 1995. Information under "Other Expenses" for Class C and
Class D shares is estimated for the fiscal year ending July 31, 1996.
(f) See "Management of the Trust--Management and Advisory Arrangements"--page
19.
2
<PAGE>
(g) See "Purchase of Shares--Distribution Plans"--page 28.
(h) See "Management of the Trust--Transfer Agency Services"--page 21.
+ As of July 31, 1995, Fund Asset Management, L.P. ("FAM" or the "Manager")
has voluntarily waived a portion of the management fees due from the Fund.
The fee table has been restated to assume the absence of any waiver because
the Manager may discontinue or reduce such waiver of fees at any time
without notice. During the fiscal year ended July 31, 1995, the Manager
waived management fees totaling .22% for Class A shares and .22% for Class B
shares after which the Fund's total expense ratio was .71% for Class A
shares and 1.22% for Class B shares. During the period October 21, 1994
(commencement of operations of Class C and Class D shares) to July 31, 1995
(fiscal year end), the Manager waived management fees totaling .20% for
Class C shares and .20% for Class D shares after which the Fund's total
expense ratio was 1.37% for Class C shares and .85% for Class D shares.
EXAMPLE:
<TABLE>
<CAPTION>
CUMULATIVE EXPENSES PAID FOR THE PERIOD OF:
--------------------------------------------------
1 YEAR 3 YEARS 5 YEARS 10 YEARS
---------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
An investor would pay the
following expenses on a
$1,000 investment
including, the maximum
$40 initial sales charge
(Class A and Class D
shares only) and assuming
(1) the Total Fund
Operating Expenses for
each class set forth
above, (2) a 5% annual
return throughout the
periods and (3)
redemption at the end of
the period:
Class A................. $49 $68 $89 $150
Class B................. $55 $66 $79 $172
Class C................. $26 $49 $84 $183
Class D................. $50 $71 $95 $161
An investor would pay the
following expenses on the
same $1,000 investment
assuming no redemption at
the end of the period:
Class A................. $49 $68 $89 $150
Class B................. $15 $46 $79 $172
Class C................. $16 $49 $84 $183
Class D................. $50 $71 $95 $161
</TABLE>
The foregoing Fee Table is intended to assist investors in understanding the
costs and expenses that a shareholder in the Fund will bear directly or
indirectly. The Example set forth above assumes reinvestment of all dividends
and distributions and utilizes a 5% annual rate of return as mandated by
Securities and Exchange Commission regulations. THE EXAMPLE SHOULD NOT BE
CONSIDERED A REPRESENTATION OF PAST OR FUTURE EXPENSES OR ANNUAL RATE OF RETURN
AND ACTUAL EXPENSES OR ANNUAL RATE OF RETURN MAY BE MORE OR LESS THAN THOSE
ASSUMED FOR PURPOSES OF THE EXAMPLE. Class B and Class C shareholders who hold
their shares for an extended period of time may pay more in Rule 12b-1
distribution fees than the economic equivalent of the maximum front-end sales
charge permitted under the Rules of Fair Practice of the National Association
of Securities Dealers, Inc. ("NASD"). Merrill Lynch may charge its customers a
processing fee (presently $4.85) for confirming purchases and repurchases.
Purchases and redemptions directly through the Fund's Transfer Agent are not
subject to the processing fee. See "Purchase of Shares" and "Redemption of
Shares".
3
<PAGE>
MERRILL LYNCH SELECT PRICING SM SYSTEM
The Fund offers four classes of shares under the Merrill Lynch Select
Pricing SM System. The shares of each class may be purchased at a price equal
to the next determined net asset value per share subject to the sales charges
and ongoing fee arrangements described below. Shares of Class A and Class D
are sold to investors choosing the initial sales charge alternatives, and
shares of Class B and Class C are sold to investors choosing the deferred
sales charge alternatives. The Merrill Lynch Select Pricing SM System is used
by more than 50 mutual funds advised by Merrill Lynch Asset Management, L.P.
("MLAM") or its affiliate FAM. Funds advised by MLAM or FAM are referred to
herein as "MLAM-advised mutual funds".
Each Class A, Class B, Class C or Class D share of the Fund represents an
identical interest in the investment portfolio of the Fund and has the same
rights, except that Class B, Class C and Class D shares bear the expenses of
the ongoing account maintenance fees and Class B and Class C shares bear the
expenses of the ongoing distribution fees and the additional incremental
transfer agency costs resulting from the deferred sales charge arrangements.
The deferred sales charges and account maintenance fees that are imposed on
Class B and Class C shares, as well as the account maintenance fees that are
imposed on the Class D shares, are imposed directly against those classes and
not against all assets of the Fund and, accordingly, such charges will not
affect the net asset value of any other class or have any impact on investors
choosing another sales charge option. Dividends paid by the Fund for each
class of shares will be calculated in the same manner at the same time and
will differ only to the extent that account maintenance and distribution fees
and any incremental transfer agency costs relating to a particular class are
borne exclusively by that class. Each class has different exchange privileges.
See "Shareholder Services--Exchange Privilege".
Investors should understand that the purpose and function of the initial
sales charges with respect to the Class A and Class D shares are the same as
those of the deferred sales charges with respect to the Class B and Class C
shares in that the sales charges applicable to each class provide for the
financing of the distribution of the shares of the Fund. The distribution-
related revenues paid with respect to a class will not be used to finance the
distribution expenditures of another class. Sales personnel may receive
different compensation for selling different classes of shares.
The following table sets forth a summary of the distribution arrangements
for each class of shares under the Merrill Lynch Select Pricing SM System,
followed by a more detailed description of each class and a discussion of the
factors that investors should consider in determining the method of purchasing
shares under the Merrill Lynch Select Pricing SM System that the investor
believes is most beneficial under his particular circumstances. More detailed
information as to each class of shares is set forth under "Purchase of
Shares".
4
<PAGE>
<TABLE>
<CAPTION>
ACCOUNT
MAINTENANCE DISTRIBUTION
CLASS SALES CHARGE(/1/) FEE FEE CONVERSION FEATURE
- ------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
A Maximum 4.00% initial No No No
sales charge(/2/),(/3/)
- ------------------------------------------------------------------------------------
B CDSC for a period of 4 years, 0.25% 0.25% B shares convert to
at a rate of 4.0% during the D shares automatically
first year, decreasing 1.0% after approximately
annually to 0.0% ten years(/4/)
- ------------------------------------------------------------------------------------
C 1.0% CDSC for one year 0.25% 0.35% No
- ------------------------------------------------------------------------------------
D Maximum 4.00% initial 0.10% No No
sales charge(/3/)
</TABLE>
- --------
(1) Initial sales charges are imposed at the time of purchase as a percentage
of the offering price. Contingent deferred sales charges ("CDSCs") are
imposed if the redemption occurs within the applicable CDSC time period.
The charge will be assessed on an amount equal to the lesser of the
proceeds of redemption or the cost of the shares being redeemed.
(2) Offered only to eligible investors. See "Purchase of Shares--Initial Sales
Charge Alternatives--Class A and Class D Shares--Eligible Class A
Investors".
(3) Reduced for purchases of $25,000 or more. Class A and Class D share
purchases of $1,000,000 or more may not be subject to an initial sales
charge but instead will be subject to a CDSC if redeemed within one year.
See "Class A" and "Class D" below.
(4) The conversion period for dividend reinvestment shares is modified. Also,
Class B shares of certain other MLAM-advised mutual funds into which
exchanges may be made have an eight year conversion period. If Class B
shares of the Fund are exchanged for Class B shares of another MLAM-
advised mutual fund, the conversion period applicable to the Class B
shares acquired in the exchange will apply, and the holding period for the
shares exchanged will be tacked onto the holding period for the shares
acquired.
Class A: Class A shares incur an initial sales charge when they are purchased
and bear no ongoing distribution or account maintenance fees. Class A
shares are offered to a limited group of investors and also will be
issued upon reinvestment of dividends on outstanding Class A shares.
Investors that currently own Class A shares in a shareholder account
are entitled to purchase additional Class A shares in that account.
In addition, Class A shares will be offered to Merrill Lynch & Co.,
Inc. ("ML & Co.") and its subsidiaries (the term "subsidiaries", when
used herein with respect to ML & Co., includes MLAM, the Manager and
certain other entities directly or indirectly wholly-owned and
controlled by ML & Co.), and their directors and employees, and to
members of the Boards of MLAM-advised mutual funds. The maximum
initial sales charge is 4.00%, which is reduced for purchases of
$25,000 and over. Purchases of $1,000,000 or more may not be subject
to an initial sales charge but if the initial sales charge is waived
such purchases may be subject to a CDSC of 1.0% if the shares are
redeemed within one year after purchase. Sales charges also are
reduced under a right of accumulation which takes into account the
investor's holdings of all classes of all MLAM-advised mutual funds.
See "Purchase of Shares--Initial Sales Charge Alternatives--Class A
and Class D Shares".
Class B: Class B shares do not incur a sales charge when they are purchased,
but they are subject to an ongoing account maintenance fee of 0.25%
and an ongoing distribution fee of 0.25% of the Fund's average net
assets attributable to Class B shares, as well as a CDSC if they are
redeemed within four years of purchase. Approximately ten years after
issuance, Class B shares will convert
5
<PAGE>
automatically into Class D shares of the Fund, which are subject to a
lower account maintenance fee of 0.10% and no distribution fee; Class
B shares of certain other MLAM-advised mutual funds into which
exchanges may be made convert into Class D shares automatically after
approximately eight years. If Class B shares of the Fund are exchanged
for Class B shares of another MLAM-advised mutual fund, the conversion
period applicable to the Class B shares acquired in the exchange will
apply, as will the Class D account maintenance fee of the acquired
fund upon the conversion, and the holding period for the shares
exchanged will be tacked onto the holding period for the shares
acquired. Automatic conversion of Class B shares into Class D shares
will occur at least once a month on the basis of the relative net
asset values of the shares of the two classes on the conversion date,
without the imposition of any sales load, fee or other charge.
Conversion of Class B shares to Class D shares will not be deemed a
purchase or sale of the shares for Federal income tax purposes. Shares
purchased through reinvestment of dividends on Class B shares also
will convert automatically to Class D shares. The conversion period
for dividend reinvestment shares is modified as described under
"Purchase of Shares--Deferred Sales Charge Alternatives--Class B and
Class C Shares--Conversion of Class B Shares to Class D Shares".
Class C: Class C shares do not incur a sales charge when they are purchased,
but they are subject to an ongoing account maintenance fee of 0.25%
and an ongoing distribution fee of 0.35% of the Fund's average net
assets attributable to Class C shares. Class C shares are also subject
to a CDSC if they are redeemed within one year of purchase. Although
Class C shares are subject to a 1.0% CDSC for only one year (as
compared to four years for Class B), Class C shares have no conversion
feature and, accordingly, an investor that purchases Class C shares
will be subject to distribution fees that will be imposed on Class C
shares for an indefinite period subject to annual approval by the
Fund's Board of Trustees and regulatory limitations.
Class D: Class D shares incur an initial sales charge when they are purchased
and are subject to an ongoing account maintenance fee of 0.10% of
average net assets attributable to Class D shares. Class D shares are
not subject to an ongoing distribution fee or any CDSC when they are
redeemed. Purchases of $1,000,000 or more may not be subject to an
initial sales charge, but if the initial sales charge is waived such
purchases may be subject to a CDSC of 1.0% if the shares are redeemed
within one year after purchase. The schedule of initial sales charges
and reductions for Class D shares is the same as the schedule for
Class A shares. Class D shares also will be issued upon conversion of
Class B shares as described above under "Class B". See "Purchase of
Shares--Initial Sales Charge Alternatives--Class A and Class D
Shares".
The following is a discussion of the factors that investors should consider
in determining the method of purchasing shares under the Merrill Lynch Select
Pricing SM System that the investor believes is most beneficial under his
particular circumstances.
Initial Sales Charge Alternatives. Investors who prefer an initial sales
charge alternative may elect to purchase Class D shares or, if an eligible
investor, Class A shares. Investors choosing the initial sales charge
alternative who are eligible to purchase Class A shares should purchase Class A
shares rather than Class D shares because there is an account maintenance fee
imposed on Class D shares. Investors qualifying for significantly reduced
initial sales charges may find the initial sales charge alternative
particularly attractive because similar sales charge reductions are not
available with respect to the deferred sales charges imposed in
6
<PAGE>
connection with purchases of Class B or Class C shares. Investors not
qualifying for reduced initial sales charges who expect to maintain their
investment for an extended period of time also may elect to purchase Class A or
Class D shares, because over time the accumulated ongoing account maintenance
and distribution fees on Class B or Class C shares may exceed the initial sales
charge and, in the case of Class D shares, the account maintenance fee.
Although some investors that previously purchased Class A shares may no longer
be eligible to purchase Class A shares of other MLAM-advised mutual funds,
those previously purchased Class A shares, together with Class B, Class C and
Class D share holdings, will count toward a right of accumulation which may
qualify the investor for reduced initial sales charges on new initial sales
charge purchases. In addition, the ongoing Class B and Class C account
maintenance and distribution fees will cause Class B and Class C shares to have
higher expense ratios, pay lower dividends and have lower total returns than
the initial sales charge shares. The ongoing Class D account maintenance fees
will cause Class D shares to have a higher expense ratio, pay lower dividends
and have a lower total return than Class A Shares.
Deferred Sales Charge Alternatives. Because no initial sales charges are
deducted at the time of purchase, Class B and Class C shares provide the
benefit of putting all of the investor's dollars to work from the time the
investment is made. The deferred sales charge alternatives may be particularly
appealing to investors who do not qualify for a reduction in initial sales
charges. Both Class B and Class C shares are subject to ongoing account
maintenance fees and distribution fees; however, the ongoing account
maintenance and distribution fees potentially may be offset to the extent any
return is realized on the additional funds initially invested in Class B or
Class C shares. In addition, Class B shares will be converted into Class D
shares of the Fund after a conversion period of approximately ten years, and
thereafter investors will be subject to lower ongoing fees.
Certain investors may elect to purchase Class B shares if they determine it
to be most advantageous to have all their funds invested initially and intend
to hold their shares for an extended period of time. Investors in Class B
shares should take into account whether they intend to redeem their shares
within the CDSC period and, if not, whether they intend to remain invested
until the end of the conversion period and thereby take advantage of the
reduction in ongoing fees resulting from the conversion into Class D shares.
Other investors, however, may elect to purchase Class C shares if they
determine that it is advantageous to have all their assets invested initially
and they are uncertain as to the length of time they intend to hold their
assets in MLAM-advised mutual funds. Although Class C shareholders are subject
to a shorter CDSC period at a lower rate, they are subject to higher
distribution fees and forego the Class B conversion feature, making their
investment subject to account maintenance and distribution fees for an
indefinite period of time. In addition, while both Class B and Class C
distribution fees are subject to the limitations on asset-based sales charges
imposed by the NASD, the Class B distribution fees are further limited under a
voluntary waiver of asset-based sales charges. See "Purchase of Shares--
Limitations on the Payment of Deferred Sales Charges".
7
<PAGE>
FINANCIAL HIGHLIGHTS
The financial information in the table below has been audited in conjunction
with the annual audits of the financial statements of the Fund by Deloitte &
Touche LLP, independent auditors. Financial statements for the year ended July
31, 1995 and the independent auditors' report thereon are included in the
Statement of Additional Information. The following per share data and ratios
have been derived from information provided in the Fund's audited financial
statements. Financial information is presented for Class C or Class D shares
only for the period October 21, 1994 (commencement of operations of Class C and
Class D shares) to July 31, 1995. Further information about the performance of
the Fund is contained in the Fund's most recent annual report to shareholders
which may be obtained, without charge, by calling or by writing the Trust at
the telephone number or address on the front cover of this Prospectus.
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C CLASS D
------------------------------------ ------------------------------------- ------- -------
FOR THE PERIOD
OCTOBER 21,
FOR THE YEAR FOR THE YEAR 1994+
ENDED JULY 31, FOR THE PERIOD ENDED JULY 31, FOR THE PERIOD TO JULY 31,
--------------- SEPTEMBER 25, 1992+ ---------------- SEPTEMBER 25, 1992+ -----------------
1995 1994 TO JULY 31, 1993 1995 1994 TO JULY 31, 1993 1995 1995
------ ------- ------------------- ------- ------- ------------------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
INCREASE (DECREASE) IN
NET ASSET VALUE:
PER SHARE OPERATING
PERFORMANCE:
Net asset value,
beginning of period..... $10.19 $ 10.67 $10.00 $10.19 $ 10.67 $ 10.00 $9.80 $9.80
------ ------- ------ ------- ------- ------- ------ ------
Investment income--net.. .54 .54 .46 .49 .49 .41 .37 .41
Realized and unrealized
gain (loss) on
investments--net........ .10 (.42) .67 .10 (.42) .67 .48 .49
------ ------- ------ ------- ------- ------- ------ ------
Total from investment
operations.............. .64 .12 1.13 .59 .07 1.08 .85 .90
------ ------- ------ ------- ------- ------- ------ ------
Less dividends and
distributions:
Investment income--net.. (.54) (.54) (.46) (.49) (.49) (.41) (.37) (.41)
In excess of realized
gain on investments--
net..................... -- (.06) -- -- (.06) -- -- --
------ ------- ------ ------- ------- ------- ------ ------
Total dividends and
distributions........... (.54) (.60) (.46) (.49) (.55) (.41) (.37) (.41)
------ ------- ------ ------- ------- ------- ------ ------
Net asset value, end of
period.................. $10.29 $ 10.19 $10.67 $10.29 $ 10.19 $ 10.67 $10.28 $10.29
====== ======= ====== ======= ======= ======= ====== ======
Total Investment
Return:**
Based on net asset value
per share............... 6.60% 1.11% 11.52%# 6.06% .60% 11.06%# 8.87%# 9.39%#
====== ======= ====== ======= ======= ======= ====== ======
RATIOS TO AVERAGE NET
ASSETS:
Expenses, excluding
account maintenance and
distribution fees and
net of reimbursement.... .71% .50% .20%* .72% .51% .20%* .77%* .75%*
====== ======= ====== ======= ======= ======= ====== ======
Expenses, net of
reimbursement........... .71% .50% .20%* 1.22% 1.01% .70%* 1.37%* .85%*
====== ======= ====== ======= ======= ======= ====== ======
Expenses................ .93% .96% 1.15%* 1.44% 1.46% 1.67%* 1.57%* 1.05%*
====== ======= ====== ======= ======= ======= ====== ======
Investment income--net.. 5.43% 5.14% 5.26%* 4.91% 4.64% 4.77%* 4.67%* 5.28%*
====== ======= ====== ======= ======= ======= ====== ======
SUPPLEMENTAL DATA:
Net Assets, end of pe-
riod (in thousands)..... $9,256 $11,071 $9,311 $49,978 $50,664 $39,970 $713 $1,377
====== ======= ====== ======= ======= ======= ====== ======
Portfolio Turnover...... 52.33% 74.35% 27.98% 52.33% 74.35% 27.98% 52.33% 52.33%
====== ======= ====== ======= ======= ======= ====== ======
</TABLE>
- ----
+ Commencement of operations.
# Aggregate total investment return.
* Annualized.
** Total investment returns exclude the effects of sales loads.
8
<PAGE>
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to provide shareholders with as high
a level of income exempt from Federal and North Carolina income taxes as is
consistent with prudent investment management. The Fund seeks to achieve its
objective while providing investors with the opportunity to invest in a
portfolio of securities consisting primarily of long-term obligations issued by
or on behalf of the State of North Carolina, its political subdivisions,
agencies and instrumentalities, and obligations of other qualifying issuers,
such as issuers located in Puerto Rico, the Virgin Islands and Guam, which pay
interest exempt, in the opinion of bond counsel to the issuer, from Federal and
North Carolina income taxes. Obligations exempt from Federal income taxes are
referred to herein as "Municipal Bonds" and obligations exempt from both
Federal and North Carolina income taxes are referred to as "North Carolina
Municipal Bonds." Unless otherwise indicated, references to Municipal Bonds
shall be deemed to include North Carolina Municipal Bonds. The Fund at all
times, except during temporary defensive periods, will maintain at least 65% of
its total assets invested in North Carolina Municipal Bonds. The investment
objective of the Fund as set forth in the first sentence of this paragraph is a
fundamental policy and may not be changed without shareholder approval. At
times, the Fund will seek to hedge its portfolio through the use of futures
transactions to reduce volatility in the net asset value of Fund shares.
Municipal Bonds may include several types of bonds. The Fund may also invest
in variable rate demand obligations ("VRDOs"). The interest on Municipal Bonds
may bear a fixed rate or be payable at a variable or floating rate. At least
80% of the Municipal Bonds purchased by the Fund primarily will be what are
commonly referred to as "investment grade" securities, which are obligations
rated at the time of purchase within the four highest quality ratings as
determined by either Moody's Investors Service, Inc. ("Moody's") (currently
Aaa, Aa, A and Baa), Standard & Poor's Ratings Group ("Standard & Poor's")
(currently AAA, AA, A and BBB) or Fitch Investors Service, Inc. ("Fitch")
(currently AAA, AA, A and BBB). If Municipal Bonds are unrated, such securities
will possess creditworthiness comparable, in the opinion of the Manager to
obligations in which the Fund may invest. Municipal Bonds rated in the fourth
highest rating category, while considered "investment grade", have certain
speculative characteristics and are more likely to be downgraded to non-
investment grade than obligations rated in one of the top three rating
categories. See Appendix II--"Ratings of Municipal Bonds"--in the Statement of
Additional Information for more information regarding ratings of debt
securities. An issue of rated Municipal Bonds may cease to be rated or its
rating may be reduced below "investment grade" subsequent to its purchase by
the Fund. If an obligation is downgraded below investment grade, the Manager
will consider factors such as price, credit risk, market conditions, financial
condition of the issuer and interest rates to determine whether to continue to
hold the obligation in the Fund's portfolio.
The Fund may invest up to 20% of its total assets in Municipal Bonds that are
rated below Baa by Moody's or below BBB by Standard & Poor's or Fitch or which,
in the Manager's judgment, possess similar credit characteristics. Such
securities, sometimes referred to as "high-yield" or "junk" bonds, are
predominantly speculative with respect to the capacity to pay interest and
repay principal in accordance with the terms of the security and generally
involve a greater volatility of price than securities in higher rating
categories. The market prices of high-yielding, lower-rated securities may
fluctuate more than higher-rated securities and may decline significantly in
periods of general economic difficulty, which may follow periods of rising
interest rates. In purchasing such securities, the Fund will rely on the
Manager's judgment, analysis
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and experience in evaluating the creditworthiness of the issuer of such
securities. The Manager will take into consideration, among other things, the
issuer's financial resources, its sensitivity to economic conditions and
trends, its operating history, the quality of its management and regulatory
matters. See "Investment Objective and Policies" in the Statement of Additional
Information for a more detailed discussion of the pertinent risk factors
involved in investing in "high yield" or "junk" bonds and Appendix II--"Ratings
of Municipal Bonds"--in the Statement of Additional Information for additional
information regarding ratings of debt securities. The Fund does not intend to
purchase debt securities that are in default or which the Manager believes will
be in default.
Certain Municipal Bonds may be entitled to the benefits of letters of credit
or similar credit enhancements issued by financial institutions. In such
instances, the Trustees and the Manager will take into account in assessing the
quality of such bonds not only the creditworthiness of the issuer of such bonds
but also the creditworthiness of the financial institution.
The Fund's investments may also include VRDOs and VRDOs in the form of
participation interests ("Participating VRDOs") in variable rate tax-exempt
obligations held by a financial institution. The VRDOs in which the Fund will
invest are tax-exempt obligations which contain a floating or variable interest
rate adjustment formula and an unconditional right of demand on the part of the
holder thereof to receive payment of the unpaid principal balance plus accrued
interest on a short notice period not to exceed seven days. Participating VRDOs
provide the Fund with a specified undivided interest (up to 100%) of the
underlying obligation and the right to demand payment of the unpaid principal
balance plus accrued interest on the Participating VRDOs from the financial
institution on a specified number of days' notice, not to exceed seven days.
There is, however, the possibility that because of default or insolvency, the
demand feature of VRDOs or Participating VRDOs may not be honored. The Fund has
been advised by its counsel that the Fund should be entitled to treat the
income received on Participating VRDOs as interest from tax-exempt obligations.
VRDOs that contain an unconditional right of demand to receive payment of the
unpaid principal balance plus accrued interest on a notice period exceeding
seven days may be deemed illiquid securities. A VRDO with a demand notice
period exceeding seven days will therefore be subject to the Fund's restriction
on illiquid investments unless, in the judgment of the Trustees, such VRDO is
liquid. The Trustees may adopt guidelines and delegate to the Manager the daily
function of determining and monitoring liquidity of such VRDOs. The Trustees,
however, will retain sufficient oversight and be ultimately responsible for
such determinations.
The Fund ordinarily does not intend to realize investment income not exempt
from Federal and North Carolina income taxes. However, to the extent that
suitable North Carolina Municipal Bonds are not available for investment by the
Fund, the Fund may purchase Municipal Bonds issued by other states, their
agencies and instrumentalities, the interest income on which is exempt, in the
opinion of bond counsel, from Federal, but not North Carolina, taxation. The
Fund also may invest in securities not issued by or on behalf of a state or
territory or by an agency or instrumentality thereof, if the Fund nevertheless
believes such securities to be exempt from Federal income taxation ("Non-
Municipal Tax-Exempt Securities"). Non-Municipal Tax-Exempt Securities could
include trust certificates or other instruments evidencing interests in one or
more long-term municipal securities. Non-Municipal Tax-Exempt Securities may
also include securities issued by other investment companies that invest in
municipal bonds, to the extent such investments
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are permitted by the Investment Company Act of 1940, as amended (the "1940
Act") and North Carolina law.
Under normal circumstances, except when acceptable securities are unavailable
as determined by the Manager, the Fund will invest at least 65% of its total
assets in North Carolina Municipal Bonds. For temporary defensive periods or to
provide liquidity, the Fund has the authority to invest as much as 35% of its
total assets in tax-exempt or taxable money market obligations with a maturity
of one year or less (such short-term obligations being referred to herein as
"Temporary Investments"), except that taxable Temporary Investments shall not
exceed 20% of the Fund's net assets. The Temporary Investments, VRDOs and
Participating VRDOs in which the Fund may invest also will be in the following
rating categories at the time of purchase: MIG-1/VMIG-1 through MIG-4/VMIG-4
for notes and VRDOs and Prime-1 through Prime-3 for commercial paper (as
determined by Moody's), SP-1+ through SP-2 for notes and A-1+ through A-3 for
VRDOs and commercial paper (as determined by Standard & Poor's), or F-1+
through F-3 for notes, VRDOs and commercial paper (as determined by Fitch) or,
if unrated, of comparable quality in the opinion of the Manager. The Fund at
all times will have at least 80% of its net assets invested in securities the
interest on which is exempt from Federal taxation. However, interest received
on certain otherwise tax-exempt securities which are classified as "private
activity bonds" (in general, bonds that benefit non-governmental entities) may
be subject to Federal alternative minimum tax. The percentage of the Fund's net
assets invested in "private activity bonds" will vary during the year. See
"Distributions and Taxes". In addition, the Fund reserves the right to invest
temporarily a greater portion of its assets in Temporary Investments for
defensive purposes, when, in the judgment of the Manager, market conditions
warrant. The investment objective of the Fund is a fundamental policy of the
Fund which may not be changed without a vote of a majority of the outstanding
shares of the Fund. The Fund's hedging strategies, which are described in more
detail under "Financial Futures Transactions and Options", are not fundamental
policies and may be modified by the Trustees of the Trust without the approval
of the Fund's shareholders.
POTENTIAL BENEFITS
Investment in shares of the Fund offers several benefits. The Fund offers
investors the opportunity to receive income exempt from Federal and North
Carolina income taxes by investing in a professionally managed portfolio
consisting primarily of long-term North Carolina Municipal Bonds. The Fund also
provides liquidity because of its redemption features and relieves the investor
of the burdensome administrative details involved in managing a portfolio of
tax-exempt securities. The benefits of investing in the Fund are at least
partially offset by the expenses involved in operating an investment company.
Such expenses primarily consist of the management fee and operational costs,
and, in the case of certain classes of shares, the account maintenance and
distribution costs.
SPECIAL AND RISK CONSIDERATIONS RELATING TO MUNICIPAL BONDS
The risks and special considerations involved in investment in Municipal
Bonds vary with the types of instruments being acquired. Investments in Non-
Municipal Tax-Exempt Securities may present similar risks, depending on the
particular product. Certain instruments in which the Fund may invest may be
characterized as derivative instruments. See "Description of Municipal Bonds"
and "Financial Futures Transactions and Options".
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Moreover, the Fund ordinarily will invest at least 65% of its total assets in
North Carolina Municipal Bonds and, therefore, it is more susceptible to
factors adversely affecting issuers of North Carolina Municipal Bonds than is a
tax-exempt mutual fund that is not concentrated in issuers of North Carolina
Municipal Bonds to this degree.
Growth of North Carolina tax revenues slowed considerably during fiscal 1990-
92, requiring tax increases and budget adjustments, including hiring freezes
and restrictions, spending constraints, changes in timing of certain
collections and payments, and other short-term budget adjustments, that were
needed to comply with the State's constitutional mandate for a balanced budget.
Fiscal years 1993, 1994 and 1995, however, ended with a positive General Fund
balance each year. By law, 25% of such positive fund balance was required to be
reserved in the General Fund as part of a "Savings Reserve" (subject to a
maximum reserve of 5% of the preceding fiscal year's operating appropriation).
An additional portion of such positive fund balance was reserved in the General
Fund as part of a "Reserve for Repair and Renovation of State Facilities,"
leaving the remaining unrestricted fund balance at the end of each such year
available for future appropriations. The Manager does not believe that the
current economic conditions in North Carolina will have a significant adverse
effect on the Fund's ability to invest in high quality North Carolina Municipal
Bonds. See Appendix I, "Economic and Financial Conditions in North Carolina" in
the Statement of Additional Information.
DESCRIPTION OF MUNICIPAL BONDS
Municipal Bonds include debt obligations issued to obtain funds for various
public purposes, including construction and equipping of a wide range of public
facilities (including water, sewer, gas, electricity, solid waste, health care,
transportation, education and housing facilities), refunding outstanding
obligations and obtaining funds for general operating expenses and loans to
other public institutions and facilities. In addition, certain types of bonds
are issued by or on behalf of public authorities to finance various privately
operated facilities, including pollution control facilities or other
specialized facilities. For purposes of this Prospectus, such obligations are
referred to as Municipal Bonds if the interest paid thereon is excludable, in
the opinion of bond counsel, from gross income for purposes of Federal income
tax and as North Carolina Municipal Bonds if the interest thereon is
excludable, in the opinion of bond counsel, from gross income for Federal
income tax and from taxable net income of individuals, corporations, estates
and trusts for North Carolina income tax purposes, even though such bonds may
be "private activity bonds" as discussed below.
The two principal classifications of Municipal Bonds are "general obligation"
and "revenue" bonds, which latter category includes industrial development
bonds ("IDBs") and, for bonds issued after August 15, 1986, private activity
bonds. General obligation bonds are secured by the issuer's pledge of its
faith, credit and taxing power for the payment of principal and interest. The
taxing power of any governmental entity may be limited, however, by provisions
of the state constitution or laws, and an entity's creditworthiness will depend
on many factors, including potential erosion of its tax base due to population
declines, natural disasters, declines in the state's industrial or commercial
base or inability to attract new industries, economic limits on the ability to
tax without eroding the tax base, state legislative proposals or voter
initiatives to limit ad valorem real property taxes, and the extent to which
the entity relies on Federal or state aid, access to capital markets or other
factors beyond the state or entity's control. Accordingly, the capacity of the
issuer
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of a general obligation bond as to the timely payment of interest and the
repayment of principal when due is affected by the issuer's maintenance of its
tax base.
Revenue bonds are payable only from the revenues derived from a particular
facility or class of facilities or, in some cases, from the proceeds of a
special excise tax or other specific revenue source such as from the user of
the facility being financed; accordingly, the timely payment of interest and
the repayment of principal in accordance with the terms of the revenue or
special obligation bond is a function of the economic viability of such
facility or such revenue source. The Fund will not invest in IDBs where the
entity supplying the revenues from which the issuer is paid, including
predecessors, has a record of less than three years of continuous business
operations if such investments, together with investments in other unseasoned
issuers, would exceed 5% of the Fund's total assets. Investments involving
entities with less than three years of continuous business operations may pose
somewhat greater risks due to the lack of a substantial operating history for
such entities. The Manager believes, however, that the potential benefits of
such investments outweigh the potential risks, particularly given the Fund's
limitations on such investments.
The Fund may purchase IDBs and private activity bonds. IDBs and private
activity bonds are tax-exempt securities issued by states, municipalities or
public authorities to provide funds, usually through a loan or lease
arrangement, to a private corporation for the purpose of financing construction
or improvement of a facility to be used by the corporation. Such bonds are
secured primarily by revenues derived from loan repayments or lease payments
due from the entity which may or may not be guaranteed by a parent company or
otherwise secured. Neither IDBs nor private activity bonds are secured by a
pledge of the taxing power of the issuer of such bonds. Therefore, an investor
should be aware that repayment of such bonds depends on the revenues of a
private corporation and be aware of the risks that such an investment may
entail. Continued ability of a corporation to generate sufficient revenues for
the payment of principal of and interest on such bonds will be affected by many
factors including the size of the corporation, its capital structure, demand
for its products or services, competition, general economic conditions,
government regulation and the corporation's dependence on revenues from the
operation of the particular facility being financed. The Fund may invest more
than 25% of its total assets in IDBs and private activity bonds. The Fund also
may invest in Municipal Bonds that are so-called "moral obligation" bonds,
which are normally issued by special purpose public authorities. If an issuer
of moral obligation bonds is unable to meet its obligations, the repayment of
such bonds becomes a moral commitment, but not a legal obligation of the state
or municipality in question.
The Fund may invest in Municipal Bonds (and Non-Municipal Tax-Exempt
Securities) the return on which is based on a particular index of value or
interest rates. For example, the Fund may invest in Municipal Bonds that pay
interest based on an index of Municipal Bond interest rates or based on the
value of gold or some other commodity. The principal amount payable upon
maturity of certain Municipal Bonds also may be based on the value of an index.
To the extent the Fund invests in these types of Municipal Bonds, the Fund's
return on such Municipal Bonds will be subject to the risk with respect to the
value of the particular index. Interest and principal payable on the Municipal
Bonds may also be based on relative changes among particular indices. Also, the
Fund may invest in so-called "inverse floating obligations" or "residual
interest bonds" on which the interest rates typically decline as market rates
increase and increase as market rates decline. The Fund's return on such types
of Municipal Bonds (and Non-Municipal Tax-Exempt Securities) will be subject to
risk with respect to the value of the particular index, which may include
reduced or eliminated interest payments and losses of invested principal. Such
securities have the effect of providing a degree of investment leverage, since
they may increase or decrease in value in response to changes, as an
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illustration, in market interest rates at a rate which is a multiple (typically
two) of the rate at which fixed-rate long term tax exempt securities increase
or decrease in response to such changes. As a result, the market values of such
securities will generally be more volatile than the market values of fixed-rate
tax exempt securities. To seek to limit the volatility of these securities, the
Fund may purchase inverse floating obligations with shorter term maturities or
which contain limitations on the extent to which the interest rate may vary.
Certain investments in such obligations may be illiquid. The Fund may not
invest in such illiquid obligations if such investments, together with other
illiquid investments, would exceed 15% of the Fund's total assets (however, in
accordance with the provisions of certain state laws, the Fund currently will
not invest in excess of 10% of its total assets in illiquid securities). The
Manager believes, however, that indexed and inverse floating obligations
represent flexible portfolio management instruments for the Fund which allow
the Fund to seek potential investment rewards, hedge other portfolio positions
or vary the degree of investment leverage relatively efficiently under
different market conditions.
Also included within the general category of Municipal Bonds are
participation certificates issued by government authorities or entities to
finance the acquisition or construction of equipment, land and/or facilities.
The certificates represent participations in a lease, an installment purchase
contract or a conditional sales contract (hereinafter collectively called
"lease obligations") relating to such equipment, land or facilities. Although
lease obligations do not constitute general obligations of the issuer for which
the issuer's unlimited taxing power is pledged, a lease obligation is
frequently backed by the issuer's covenant to budget for, appropriate and make
the payments due under the lease obligation. However, certain lease obligations
contain "non-appropriation" clauses which provide that the issuer has no
obligation to make lease or installment purchase payments in future years
unless money is appropriated for such purpose on a yearly basis. Although "non-
appropriation" lease obligations are secured by the leased property,
disposition of the property in the event of foreclosure might prove difficult.
These securities represent a relatively new type of financing that has not yet
developed the depth of marketability associated with more conventional
securities. Certain investments in lease obligations may be illiquid. The Fund
may not invest in illiquid lease obligations if such investments, together with
all other illiquid investments, would exceed 15% (10% to the extent required by
certain state laws) of the Fund's total assets. The Fund may, however, invest
without regard to such limitation in lease obligations which the Manager,
pursuant to guidelines which have been adopted by the Board of Trustees and
subject to the supervision of the Board, determines to be liquid. The Manager
will deem lease obligations to be liquid if they are publicly offered and have
received an investment grade rating of Baa or better by Moody's, or BBB or
better by Standard & Poor's or Fitch. Unrated lease obligations, or those rated
below investment grade, will be considered liquid if the obligations come to
the market through an underwritten public offering and at least two dealers are
willing to give competitive bids. In reference to the obligations rated below
investment grade, the Manager must, among other things, also review the
creditworthiness of the state or political subdivisions obligated to make
payment under the lease obligation and make certain specified determinations
based on such factors as the existence of a rating or credit enhancement such
as insurance, the frequency of trades or quotes for the obligations and the
willingness of dealers to make a market in the obligation.
Federal tax legislation has limited the types and volume of bonds the
interest on which qualifies for a Federal income tax exemption. As a result,
this legislation and legislation which may be enacted in the future may affect
the availability of Municipal Bonds for investment by the Fund.
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WHEN-ISSUED SECURITIES AND DELAYED DELIVERY TRANSACTIONS
The Fund may purchase or sell Municipal Bonds on a delayed delivery basis or
a when-issued basis at fixed purchase terms. These transactions arise when
securities are purchased or sold by the Fund with payment and delivery taking
place in the future. The purchase will be recorded on the date the Fund enters
into the commitment, and the value of the obligation will thereafter be
reflected in the calculation of the Fund's net asset value. The value of the
obligation on the delivery date may be more or less than its purchase price. A
separate account of the Fund will be established with its custodian consisting
of cash, cash equivalents or high grade, liquid Municipal Bonds having a market
value at all times at least equal to the amount of the forward commitment.
CALL RIGHTS
The Fund may purchase a Municipal Bond issuer's right to call all or a
portion of such Municipal Bond for mandatory tender for purchase (a "Call
Right"). A holder of a Call Right may exercise such right to require a
mandatory tender for the purchase of related Municipal Bonds, subject to
certain conditions. A Call Right that is not exercised prior to the maturity of
the related Municipal Bond will expire without value. The economic effect of
holding both the Call Right and the related Municipal Bond is identical to that
of holding a Municipal Bond as a non-callable security. Certain investments in
such obligations may be illiquid. The Fund may not invest in such illiquid
obligations if such investments, together with other illiquid investments,
would exceed 15% (10% to the extent required by certain state laws) of the
Fund's total assets.
FINANCIAL FUTURES TRANSACTIONS AND OPTIONS
The Fund is authorized to purchase and sell certain exchange traded financial
futures contracts ("financial futures contracts") solely for the purpose of
hedging its investments in Municipal Bonds against declines in value and to
hedge against increases in the cost of securities it intends to purchase.
However, any transactions involving financial futures or options (including
puts and calls associated therewith) will be in accordance with the Fund's
investment policies and limitations. A financial futures contract obligates the
seller of a contract to deliver and the purchaser of a contract to take
delivery of the type of financial instrument covered by the contract or in the
case of an index-based futures contract, to make and accept a cash settlement,
at a specific future time for a specified price. A sale of financial futures
contracts may provide a hedge against a decline in the value of portfolio
securities because such depreciation may be offset, in whole or in part, by an
increase in the value of the position in the financial futures contracts. A
purchase of financial futures contracts may provide a hedge against an increase
in the cost of securities intended to be purchased because such appreciation
may be offset, in whole or in part, by an increase in the value of the position
in the futures contracts. Distributions, if any, of net long-term capital gains
from certain transactions in futures or options are taxable at long-term
capital gains rates for Federal income tax purposes, regardless of the length
of time the shareholder has owned Fund shares. See "Distributions and Taxes--
Taxes".
The Fund deals in financial futures contracts traded on the Chicago Board of
Trade based on The Bond Buyer Municipal Bond Index, a price-weighted measure of
the market value of 40 large, recently issued tax-exempt bonds. There can be no
assurance, however, that a liquid secondary market will exist to terminate any
particular financial futures contract at any specific time. If it is not
possible to close a financial futures position entered into by the Fund, the
Fund would continue to be required to make daily cash payments of
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<PAGE>
variation margin in the event of adverse price movements. In such a situation,
if the Fund has insufficient cash, it may have to sell portfolio securities to
meet daily variation margin requirements at a time when it may be
disadvantageous to do so. The inability to close financial futures positions
also could have an adverse impact on the Fund's ability to hedge effectively.
There is also the risk of loss by the Fund of margin deposits in the event of
bankruptcy of a broker with whom the Fund has an open position in a financial
futures contract.
The Fund may purchase and sell financial futures contracts on U.S. Government
securities and write and purchase put and call options on such futures
contracts as a hedge against adverse changes in interest rates as described
more fully in the Statement of Additional Information. With respect to U.S.
Government securities, currently there are financial futures contracts based on
long-term U.S. Treasury bonds, Treasury notes, Government National Mortgage
Association ("GNMA") Certificates and three-month U.S. Treasury bills.
Subject to policies adopted by the Trustees, the Fund also may engage in
other financial futures contracts transactions and options thereon, such as
financial futures contracts or options on other municipal bond indexes which
may become available if the Manager and the Trustees of the Trust should
determine that there is normally a sufficient correlation between the prices of
such futures contracts and the Municipal Bonds in which the Fund invests to
make such hedging appropriate.
Utilization of futures transactions and options thereon involves the risk of
imperfect correlation in movements in the price of futures contracts and
movements in the price of the security which is the subject of the hedge. If
the price of the futures contract moves more or less than the price of the
security that is the subject of the hedge, the Fund will experience a gain or
loss which will not be completely offset by movements in the price of such
security. There is a risk of imperfect correlation where the securities
underlying futures contracts have different maturities, ratings or geographic
mixes than the security being hedged. In addition, the correlation may be
affected by additions to or deletions from the index which serves as a basis
for a financial futures contract. Finally, in the case of futures contracts on
U.S. Government securities and options on such futures contracts, the
anticipated correlation of price movements between the U.S. Government
securities underlying the futures or options and Municipal Bonds may be
adversely affected by economic, political, legislative or other developments
which have a disparate impact on the respective markets for such securities.
Under regulations of the Commodity Futures Trading Commission ("CFTC"), the
futures trading activities described herein will not result in the Fund being
deemed to be a "commodity pool", as defined under such regulations, provided
that the Fund adheres to certain restrictions. In particular, the Fund may
purchase and sell futures contracts and options thereon (i) only for bona fide
hedging purposes, and (ii) for non-hedging purposes, if the aggregate initial
margins and premiums required to establish positions in such contracts and
options does not exceed 5% of the liquidation value of the Fund's portfolio
assets after taking into account unrealized profits and unrealized losses on
any such contracts and options. (However, as stated above, the Fund intends to
engage in options and futures transactions only for hedging purposes.) Margin
deposits may consist of cash or securities acceptable to the broker and the
relevant contract market.
When the Fund purchases a futures contract or writes a put option or
purchases a call option thereon, it will maintain an amount of cash, cash
equivalents (e.g., high grade commercial paper and daily tender
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<PAGE>
adjustable notes) or short-term, high-grade, fixed-income securities in a
segregated account with the Fund's custodian so that the amount so segregated
plus the amount of initial and variation margin held in the account of its
broker equals the market value of the futures contracts, thereby ensuring that
the use of such futures contract is unleveraged. It is not anticipated that
transactions in futures contracts will have the effect of increasing portfolio
turnover.
Although certain risks are involved in options and futures transactions, the
Manager believes that, because the Fund will engage in futures transactions
only for hedging purposes, the futures portfolio strategies of the Fund will
not subject the Fund to certain risks frequently associated with speculation in
futures transactions. The Fund must meet certain Federal income tax
requirements under the Internal Revenue Code of 1986, as amended (the "Code"),
in order to qualify for the special tax treatment afforded regulated investment
companies, including a requirement that less than 30% of its gross income be
derived from the sale or other disposition of securities held for less than
three months. Additionally, the Fund is required to meet certain
diversification requirements under the Code.
The liquidity of a secondary market in a futures contract may be adversely
affected by "daily price fluctuation limits" established by commodity exchanges
which limit the amount of fluctuation in a futures contract price during a
single trading day. Once the daily limit has been reached in the contract, no
trades may be entered into at a price beyond the limit, thus preventing the
liquidation of open futures positions. Prices have in the past moved beyond the
daily limit on a number of consecutive trading days.
The successful use of transactions in futures also depends on the ability of
the Manager to forecast correctly the direction and extent of interest rate
movements within a given time frame. To the extent these rates remain stable
during the period in which a futures contract is held by the Fund or moves in a
direction opposite to that anticipated, the Fund may realize a loss on the
hedging transaction which is not fully or partially offset by an increase in
the value of portfolio securities. As a result, the Fund's total return for
such period may be less than if it had not engaged in the hedging transaction.
Furthermore, the Fund will only engage in hedging transactions from time to
time and may not necessarily be engaging in hedging transactions when movements
in interest rates occur.
Reference is made to the Statement of Additional Information for further
information on financial futures contracts and certain options thereon.
REPURCHASE AGREEMENTS
As Temporary Investments, the Fund may invest in securities pursuant to
repurchase agreements. Repurchase agreements may be entered into only with a
member bank of the Federal Reserve System or a primary dealer or an affiliate
thereof in U.S. Government securities. Under such agreements, the seller
agrees, upon entering into the contract, to repurchase the security at a
mutually agreed upon time and price, thereby determining the yield during the
term of the agreement. This results in a fixed rate of return insulated from
market fluctuations during such period. The Fund may not invest in repurchase
agreements maturing in more than seven days if such investments, together with
the Fund's other illiquid investments, would exceed 15% (10% to the extent
required by certain state laws) of the Fund's total assets. In the event of
default by the seller under a repurchase agreement, the Fund may suffer time
delays and incur costs or possible losses in connection with the disposition of
the underlying securities.
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INVESTMENT RESTRICTIONS
The Fund's investment activities are subject to further restrictions that are
described in the Statement of Additional Information. Investment restrictions
and policies which are fundamental policies of the Fund may not be changed
without the approval of the holders of a majority of the Fund's outstanding
voting securities, as defined in the 1940 Act. Among its fundamental policies,
the Fund may not: (i) invest more than 25% of its total assets, taken at market
value at the time of each investment, in securities of issuers in any
particular industry (excluding the U.S. Government and its agencies and
instrumentalities) (For purposes of this restriction, states, municipalities
and their political subdivisions are not considered to be part of any
industry); and (ii) borrow money, except that (a) the Fund may borrow from
banks (as defined in the 1940 Act) in amounts up to 33 1/3% of its total assets
(including the amount borrowed), (b) the Fund may borrow up to an additional 5%
of its total assets for temporary purposes, (c) the Fund may obtain such short-
term credit as may be necessary for the clearance of purchases and sales of
portfolio securities and (d) the Fund may purchase securities on margin to the
extent permitted by applicable law. The Fund may not pledge its assets other
than to secure such borrowings or, to the extent permitted by the Fund's
investment policies as set forth in the Prospectus and Statement of Additional
Information, as they may be amended from time to time, in connection with
hedging transactions, short sales, when-issued and forward commitment
transactions and similar investment strategies.
Among its non-fundamental policies, the Fund may not (i) purchase securities
of other investment companies, except to the extent such purchases are
permitted by applicable law; (ii) invest in securities which cannot be readily
resold because of legal or contractual restrictions or which cannot otherwise
be marketed, redeemed or put to the issuer or a third party, if at the time of
acquisition more than 15% of its total assets would be invested in such
securities [This restriction (ii) shall not apply to securities which mature
within seven days or securities which the Board of Trustees of the Trust has
otherwise determined to be liquid pursuant to applicable law]; and (iii) invest
in securities or companies having a record, together with predecessors, of less
than three years of continuous operation, if more than 5% of the Fund's total
assets would be invested in such securities. This restriction (iii) shall not
apply to mortgaged-backed securities, asset-backed securities or obligations
issued or guaranteed by the U.S. Government, its agencies or instrumentalities.
The Fund's investments will be limited so as to qualify as a "regulated
investment company" for purposes of the Internal Revenue Code of 1986, as
amended (the "Code"). See "Distributions and Taxes--Taxes". To qualify, among
other requirements, the Trust will limit the Fund's investments so that, at the
close of each quarter of the taxable year, (i) not more than 25% of the market
value of the Fund's total assets will be invested in the securities of a single
issuer, and (ii) with respect to 50% of the market value of its total assets,
not more than 5% of the market value of its total assets will be invested in
the securities of a single issuer, and the Fund will not own more than 10% of
the outstanding voting securities of a single issuer. For purposes of this
restriction, the Fund will regard each state and each political subdivision,
agency or instrumentality of such state and each multi-state agency of which
such state is a member and each public authority which issues securities on
behalf of a private entity, as a separate issuer, except that if the security
is backed only by the assets and revenues of a non-government entity, then the
entity with the ultimate responsibility for the payment of interest and
principal may be regarded as the sole issuer. These tax-related limitations may
be changed by the Trustees of the Trust to the extent necessary to comply with
changes to
18
<PAGE>
the Federal tax requirements. A fund which elects to be classified as
"diversified" under the 1940 Act must satisfy the foregoing 5% and 10%
requirements with respect to 75% of its total assets. To the extent that the
Fund assumes large positions in the obligations of a small number of issuers,
the Fund's total return may fluctuate to a greater extent than that of a
diversified company as a result of changes in the financial condition or in the
market's assessment of the issuers.
Investors are referred to the Statement of Additional Information for a
complete description of the Fund's investment restrictions.
MANAGEMENT OF THE TRUST
TRUSTEES
The Trustees of the Trust consist of six individuals, five of whom are not
"interested persons" of the Trust as defined in the 1940 Act. The Trustees are
responsible for the overall supervision of the operations of the Trust and the
Fund and perform the various duties imposed on the directors or trustees of
investment companies by the 1940 Act.
The Trustees are:
Arthur Zeikel*--President of the Manager and MLAM; President and Director of
Princeton Services, Inc.; Executive Vice President of ML&Co.; Executive Vice
President of Merrill Lynch; Director of the Distributor.
James H. Bodurtha--Chairman and Chief Executive Officer, China Enterprise
Management Corporation.
Herbert I. London--John M. Olin Professor of Humanities, New York University.
Robert R. Martin--Director, WTC Industries, Inc.
Joseph L. May--Attorney in private practice.
Andre F. Perold--Professor, Harvard Business School.
- --------
* Interested person, as defined in the 1940 Act, of the Trust.
MANAGEMENT AND ADVISORY ARRANGEMENTS
Fund Asset Management, L.P. (the "Manager"), which is an affiliate of MLAM
and is owned and controlled by ML&Co., a financial services holding company,
acts as the manager for the Fund and provides the Fund with management
services. The Manager or MLAM acts as the investment adviser for more than 130
other registered investment companies. MLAM also provides investment advisory
services to individuals and institutions. As of September 30, 1995, the Manager
and MLAM had a total of approximately $189.4 billion in investment company and
other portfolio assets under management, including accounts of certain
affiliates of the Manager.
19
<PAGE>
Subject to the direction of the Trustees, the Manager is responsible for the
actual management of the Fund's portfolio and constantly reviews the Fund's
holdings in light of its own research analysis and that from other relevant
sources. The responsibility for making decisions to buy, sell or hold a
particular security rests with the Manager. The Manager performs certain of the
other administrative services and provides all the office space, facilities,
equipment and necessary personnel for management of the Fund.
Fred Stuebe became the Portfolio Manager of the Fund in 1995. He has been a
Vice President of MLAM since 1989.
Pursuant to the management agreement between the Manager and the Trust on
behalf of the Fund (the "Management Agreement"), the Manager is entitled to
receive from the Fund a monthly fee based upon the average daily net assets of
the Fund at the following annual rates: 0.55% of the average daily net assets
not exceeding $500 million; 0.525% of the average daily net assets exceeding
$500 million but not exceeding $1.0 billion; and 0.50% of the average daily net
assets exceeding $1.0 billion. For the year ended July 31, 1995, the total fee
paid by the Fund to the Manager was $331,791 (based on average net assets of
approximately $60.6 million), of which $133,074 was voluntarily waived.
The Management Agreement obligates the Trust on behalf of the Fund to pay
certain expenses incurred in the Fund's operations, including, among other
things, the management fee, legal and audit fees, unaffiliated Trustees' fees
and expenses, registration fees, custodian and transfer agency fees, accounting
and pricing costs, and certain of the costs of printing proxies, shareholder
reports, prospectuses and statements of additional information. Accounting
services are provided to the Fund by the Manager, and the Fund reimburses the
Manager for its costs in connection with such services. The Manager may waive
all or a portion of its management fee and may voluntarily assume all or a
portion of the Fund's expenses during the initial period of the Fund's
operations. For the year ended July 31, 1995, the Fund reimbursed the Manager
$34,887 for accounting services. For the year ended July 31, 1995, the ratio of
total expenses, net of account maintenance and distribution fees and net of
reimbursement, to average net assets was .71% for the Class A shares and .72%
for the Class B shares. For the period October 21, 1994 (commencement of
operations of Class C and Class D shares) to July 31, 1995 (fiscal year end),
the annualized ratio of total expenses, net of account maintenance and
distribution fees and net of reimbursement, to average net assets was .77% for
Class C shares and .75% for Class D shares.
CODE OF ETHICS
The Board of Trustees of the Trust has adopted a Code of Ethics under Rule
17j-1 of the 1940 Act which incorporates the Code of Ethics of the Manager
(together, the "Codes"). The Codes significantly restrict the personal
investing activities of all employees of the Manager and, as described below,
impose additional, more onerous, restrictions on fund investment personnel.
The Codes require that all employees of the Manager preclear any personal
securities investment (with limited exceptions, such as government securities).
The preclearance requirement and associated procedures are designed to identify
any substantive prohibition or limitation applicable to the proposed
investment. The substantive restrictions applicable to all employees of the
Manager include a ban on acquiring any securities in a "hot" initial public
offering and a prohibition from profiting on short-term trading in securities.
In addition, no employee may purchase or sell any security which at the time is
being purchased or sold (as the case may be), or to the knowledge of the
employee is being considered for purchase or sale, by any fund
20
<PAGE>
advised by the Manager. Furthermore, the Codes provide for trading "blackout
periods" which prohibit trading by investment personnel of the Fund within
periods of trading by the Fund in the same (or equivalent) security (15 or 30
days depending upon the transaction).
TRANSFER AGENCY SERVICES
Merrill Lynch Financial Data Services, Inc. (the "Transfer Agent"), which is
a wholly-owned subsidiary of ML&Co., acts as the Trust's transfer agent
pursuant to a transfer agency, dividend disbursing agency and shareholder
servicing agency agreement (the "Transfer Agency Agreement"). Pursuant to the
Transfer Agency Agreement, the Transfer Agent is responsible for the issuance,
transfer and redemption of shares and the opening and maintenance of
shareholder accounts. Pursuant to the Transfer Agency Agreement, the Fund pays
the Transfer Agent an annual fee of $11.00 per Class A or Class D shareholder
account and $14.00 per Class B or Class C shareholder account, and the Transfer
Agent is entitled to reimbursement from the Fund for out-of-pocket expenses
incurred by the Transfer Agent under the Transfer Agency Agreement. For the
year ended July 31, 1995, the Fund paid the Transfer Agent a total fee of
$42,065 pursuant to the Transfer Agency Agreement for providing transfer agency
services. At September 30, 1995, the Fund had 270 Class A shareholder accounts,
1,803 Class B shareholder accounts, 31 Class C shareholder accounts and 30
Class D shareholder accounts. At this level of accounts, the annual fee payable
to the Transfer Agent would aggregate approximately $28,976, plus out-of-pocket
expenses.
PURCHASE OF SHARES
Merrill Lynch Funds Distributor, Inc. (the "Distributor"), an affiliate of
the Manager, MLAM and Merrill Lynch, acts as the distributor of the shares of
the Fund. Shares of the Fund are offered continuously for sale by the
Distributor and other eligible securities dealers (including Merrill Lynch).
Shares of the Fund may be purchased from securities dealers or by mailing a
purchase order directly to the Transfer Agent. The minimum initial purchase is
$1,000, and the minimum subsequent purchase is $50.
The Fund is offering its shares in four classes at a public offering price
equal to the next determined net asset value per share plus sales charges
imposed either at the time of purchase or on a deferred basis depending upon
the class of shares selected by the investor under the Merrill Lynch Select
PricingSM System, as described below. The applicable offering price for
purchase orders is based upon the net asset value of the Fund next determined
after receipt of the purchase orders by the Distributor. As to purchase orders
received by securities dealers prior to the close of business on the New York
Stock Exchange (generally, 4:00 P.M., New York time, which includes orders
received after the close of business on the previous day, the applicable
offering price will be based on the net asset value as of 15 minutes after the
close of business on the New York Stock Exchange on that day, provided the
Distributor in turn receives the order from the securities dealer prior to 30
minutes after the close of business on the New York Stock Exchange on that day.
If the purchase orders are not received by the Distributor prior to 30 minutes
after the close of business on the New York Stock Exchange, such orders shall
be deemed received on the next business day. The Trust or the Distributor may
suspend the continuous offering of the Fund's shares of any class at any time
in response to conditions in the securities markets or otherwise and may
thereafter resume such offering from time to time. Any order may be rejected by
the Distributor or the Trust. Neither the Distributor nor the dealers are
permitted to withhold placing orders to benefit themselves by a price change.
Merrill Lynch may charge its
21
<PAGE>
customers a processing fee (presently $4.85) to confirm a sale of shares to
such customers. Purchases directly through the Fund's Transfer Agent are not
subject to the processing fee.
The Fund issues four classes of shares under the Merrill Lynch Select
PricingSM System, which permits each investor to choose the method of
purchasing shares that the investor believes is most beneficial given the
amount of the purchase, the length of time the investor expects to hold the
shares and other relevant circumstances. Shares of Class A and Class D are
sold to investors choosing the initial sales charge alternatives and shares of
Class B and Class C are sold to investors choosing the deferred sales charge
alternatives. Investors should determine whether under their particular
circumstances it is more advantageous to incur an initial sales charge or to
have the entire initial purchase price invested in the Fund with the
investment thereafter being subject to a CDSC and ongoing distribution fees
and higher account maintenance fees. A discussion of the factors that
investors should consider in determining the method of purchasing shares under
the Merrill Lynch Select PricingSM System is set forth under "Merrill Lynch
Select PricingSM System" on page 4.
Each Class A, Class B, Class C and Class D share of the Fund represents an
identical interest in the investment portfolio of the Fund and has the same
rights, except that Class B, Class C and Class D shares bear the expenses of
the ongoing account maintenance fees, and Class B and Class C shares bear the
expenses of the ongoing distribution fees and the additional incremental
transfer agency costs resulting from the deferred sales charge arrangements.
The deferred sales charges and account maintenance fees that are imposed on
Class B and Class C shares, as well as the account maintenance fees that are
imposed on Class D shares, will be imposed directly against those classes and
not against all assets of the Fund and, accordingly, such charges will not
affect the net asset value of any other class or have any impact on investors
choosing another sales charge option. Dividends paid by the Fund for each
class of shares will be calculated in the same manner at the same time and
will differ only to the extent that account maintenance and distribution fees
and any incremental transfer agency costs relating to a particular class are
borne exclusively by that class. Class B, Class C and Class D shares each have
exclusive voting rights with respect to the Rule 12b-1 distribution plan
adopted with respect to such class pursuant to which account maintenance
and/or distribution fees are paid. See "Distribution Plans" below. Each class
has different exchange privileges. See "Shareholder Services--Exchange
Privilege".
Investors should understand that the purpose and function of the initial
sales charges with respect to Class A and Class D shares are the same as those
of the deferred sales charges with respect to Class B and Class C shares in
that the sales charges applicable to each class provide for the financing of
the distribution of the shares of the Fund. The distribution-related revenues
paid with respect to a class will not be used to finance the distribution
expenditures of another class. Sales personnel may receive different
compensation for selling different classes of shares. Investors are advised
that only Class A and Class D shares may be available for purchase through
securities dealers, other than Merrill Lynch, which are eligible to sell
shares.
22
<PAGE>
The following table sets forth a summary of the distribution arrangements
for each class of shares under the Merrill Lynch Select PricingSM System.
<TABLE>
<CAPTION>
ACCOUNT
MAINTENANCE DISTRIBUTION CONVERSION
CLASS SALES CHARGE(/1/) FEE FEE FEATURE
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
A Maximum 4.00% initial sales No No No
charge(/2/)(/3/)
- ---------------------------------------------------------------------------------------
B CDSC for a period of 4 years, 0.25% 0.25% B shares convert to
at a rate of 4.0% during the D shares automatically
first year, decreasing 1.0% after approximately
annually to 0.0% ten years(/4/)
- ---------------------------------------------------------------------------------------
C 1.0% CDSC for one year 0.25% 0.35% No
- ---------------------------------------------------------------------------------------
D Maximum 4.00% initial 0.10% No No
sales charge(/3/)
</TABLE>
- --------
(1) Initial sales charges are imposed at the time of purchase as a percentage
of the offering price. CDSCs may be imposed if the redemption occurs
within the applicable CDSC time period. The charge will be assessed on an
amount equal to the lesser of the proceeds of redemption or the cost of
the shares being redeemed.
(2) Offered only to eligible investors. See "Initial Sales Charge
Alternative--Class A and Class D Shares--Eligible Class A Investors".
(3) Reduced for purchases of $25,000 or more. Class A and Class D share
purchases of $1,000,000 or more may not be subject to an initial sales
charge but instead will be subject to a 1.0% CDSC if redeemed within one
year.
(4) The conversion period for dividend reinvestment shares is modified. Also,
Class B shares of certain other MLAM-advised mutual funds into which
exchanges may be made have an eight year conversion period. If Class B
shares of the Fund are exchanged for Class B shares of another MLAM-
advised mutual fund, the conversion period applicable to the Class B
shares acquired in the exchange will apply, and the holding period for the
shares exchanged will be tacked onto the holding period for the shares
acquired.
INITIAL SALES CHARGE ALTERNATIVES--CLASS A AND CLASS D SHARES
Investors choosing the initial sales charge alternatives who are eligible to
purchase Class A shares should purchase Class A shares rather than Class D
shares because there is an account maintenance fee imposed on Class D shares.
23
<PAGE>
The public offering price of Class A and Class D shares for purchasers
choosing the initial sales charge alternative is the next determined net asset
value plus varying sales charges (i.e., sales loads), as set forth below.
<TABLE>
<CAPTION>
SALES CHARGE SALES CHARGE DISCOUNT TO
AND PERCENTAGE AS PERCENTAGE* SELECTED DEALERS
OF OFFERING OF THE NET AS PERCENTAGE OF THE
AMOUNT OF PURCHASE PRICE AMOUNT INVESTED OFFERING PRICE
- ------------------ -------------- --------------- --------------------
<S> <C> <C> <C>
Less than $25,000.......... 4.00% 4.17% 3.75%
$25,000 but less than
$50,000................... 3.75 3.90 3.50
$50,000 but less than
$100,000.................. 3.25 3.36 3.00
$100,000 but less than
$250,000.................. 2.50 2.56 2.25
$250,000 but less than
$1,000,000................ 1.50 1.52 1.25
$1,000,000 and over**...... 0.00 0.00 0.00
</TABLE>
- --------
* Rounded to the nearest one-hundredth percent.
** The initial sales charge may be waived on Class A and Class D purchases of
$1,000,000 or more made on or after October 21, 1994 (the date Class D
shares were initially offered to the public). If the sales charge is waived
in connection with a purchase of $1,000,000 or more, such purchases will be
subject to a CDSC of 1% if the shares are redeemed within one year after
purchase. Class A purchases made prior to October 21, 1994 may be subject
to a CDSC if the shares are redeemed within one year of purchase at the
following rates: 0.75% on purchases of $1,000,000 to $2,500,000; 0.40% on
purchases of $2,500,001 to $3,500,000; 0.25% on purchases of $3,500,001 to
$5,000,000; and 0.20% on purchases of more than $5,000,000. The charge will
be assessed on an amount equal to the lesser of the proceeds of redemption
or the cost of the shares being redeemed.
The Distributor may reallow discounts to selected dealers and retain the
balance over such discounts. At times the Distributor may reallow the entire
sales charge to such dealers. Since securities dealers selling Class A and
Class D shares of the Fund will receive a concession equal to most of the
sales charge, they may be deemed to be underwriters under the Securities Act
of 1933, as amended. During the fiscal year ended July 31, 1995, the Fund sold
84,037 Class A shares for aggregate net proceeds of $841,960. The gross sales
charges for the sale of Class A shares of the Fund for that year were $12,051,
of which $1,108 and $10,943 were received by the Distributor and Merrill
Lynch, respectively. For the fiscal year ended July 31, 1995, the Distributor
received no CDSCs with respect to redemption within one year after purchase of
Class A shares purchased subject to front-end sales charge waivers. For the
period October 21, 1994 (commencement of operations of Class D shares) to July
31, 1995 (fiscal year end), the Fund sold 136,785 Class D shares for aggregate
net proceeds of $1,320,711. The gross sales charges for the sale of Class D
shares of the Fund for the period were $5,112 of which $431 and $4,681 were
received by the Distributor and Merrill Lynch, respectively. For the period
October 21, 1994 (commencement of operations of Class D shares) to July 31,
1995 (fiscal year end), the Distributor received no CDSCs with respect to
redemption within one year after purchase of Class D shares purchased subject
to a front-end sales charge waiver.
Eligible Class A Investors. Class A shares are offered to a limited group of
investors and also will be issued upon reinvestment of dividends on
outstanding Class A shares. Investors that currently own Class A shares of the
Fund in a shareholder account are entitled to purchase additional Class A
shares of the Fund in that account. Class A shares are available at net asset
value to corporate warranty insurance reserve fund programs provided that the
program has $3 million or more initially invested in MLAM-advised mutual
funds. Also eligible to purchase Class A shares at net asset value are
participants in certain investment programs including TMA SM Managed Trusts to
which Merrill Lynch Trust Company provides
24
<PAGE>
discretionary trustee services and certain purchases made in connection with
the Merrill Lynch Mutual Fund Adviser ("MFA") program. In addition, Class A
shares are offered at net asset value to ML&Co. and its subsidiaries and their
directors and employees and to members of the Boards of MLAM-advised investment
companies, including the Trust. Certain persons who acquire shares of MLAM-
advised closed-end funds who wish to reinvest the net proceeds from a sale of
their closed-end fund shares of common stock in shares of the Fund also may
purchase Class A shares of the Fund if certain conditions set forth in the
Statement of Additional Information are met. For example, Class A shares of the
Fund and certain other MLAM-advised mutual funds are offered at net asset value
to shareholders of Merrill Lynch Senior Floating Rate Fund, Inc. who wish to
reinvest the net proceeds from a sale of certain of their shares of common
stock of Merrill Lynch Senior Floating Rate Fund, Inc. in shares of such funds.
Reduced Initial Sales Charges. No initial sales charges are imposed upon
Class A and Class D shares issued as a result of the automatic reinvestment of
dividends or capital gains distributions. Class A and Class D sales charges
also may be reduced under a Right of Accumulation and a Letter of Intention.
Class A shares are offered at net asset value to certain eligible Class A
investors as set forth above under "Eligible Class A Investors".
Class D shares are offered at net asset value without sales charge to an
investor who has a business relationship with a financial consultant, if
certain conditions set forth in the Statement of Additional Information are
met. Class D shares may be offered at net asset value in connection with the
acquisition of assets of other investment companies.
Additional information concerning these reduced initial sales charges is set
forth in the Statement of Additional Information.
DEFERRED SALES CHARGE ALTERNATIVES--CLASS B AND CLASS C SHARES
Investors choosing the deferred sales charge alternatives should consider
Class B shares if they intend to hold their shares for an extended period of
time and Class C shares if they are uncertain as to the length of time they
intend to hold their assets in MLAM-advised mutual funds.
The public offering price of Class B and Class C shares for investors
choosing the deferred sales charge alternatives is the next determined net
asset value per share without the imposition of a sales charge at the time of
purchase. As discussed below, Class B shares are subject to a four year CDSC,
while Class C shares are subject only to a one year 1.0% CDSC. On the other
hand, approximately ten years after Class B shares are issued, such Class B
shares, together with shares issued upon dividend reinvestment with respect to
those shares, are automatically converted into Class D shares of the Fund and
thereafter will be subject to lower continuing fees. See "Conversion of Class B
Shares to Class D Shares" below. Both Class B and Class C shares are subject to
an account maintenance fee of 0.25% of net assets and Class B and Class C
shares are subject to distribution fees of 0.25% and 0.35%, respectively, of
net assets as discussed below under "Distribution Plans". The proceeds from the
account maintenance fees are used to compensate Merrill Lynch for providing
continuing account maintenance activities.
25
<PAGE>
Class B and Class C shares are sold without an initial sales charge so that
the Fund will receive the full amount of the investor's purchase payment.
Merrill Lynch compensates its financial consultants for selling Class B and
Class C shares at the time of purchase from its own funds. See "Distribution
Plans" below.
Proceeds from the CDSC and the distribution fee are paid to the Distributor
and are used in whole or in part by the Distributor to defray the expenses of
dealers (including Merrill Lynch) related to providing distribution-related
services to the Fund in connection with the sale of the Class B and Class C
shares, such as the payment of compensation to financial consultants for
selling Class B and Class C shares, from the dealers' own funds. The
combination of the CDSC and the ongoing distribution fee facilitates the
ability of the Fund to sell the Class B and Class C shares without a sales
charge being deducted at the time of purchase. Approximately ten years after
issuance, Class B shares will convert automatically into Class D shares of the
Fund, which are subject to a lower account maintenance fee and no distribution
fee; Class B shares of certain other MLAM-advised mutual funds into which
exchanges may be made convert into Class D shares automatically after
approximately eight years. If Class B shares of the Fund are exchanged for
Class B shares of another MLAM-advised mutual fund, the conversion period
applicable to the Class B shares acquired in the exchange will apply, and the
holding period for the shares exchanged will be tacked onto the holding period
for the shares acquired.
Imposition of the CDSC and the distribution fee on Class B and Class C shares
is limited by the NASD asset-based sales charge rule. See "Limitations on the
Payment of Deferred Sales Charges" below. The proceeds from the ongoing account
maintenance fees are used to compensate Merrill Lynch for providing continuing
account maintenance activities. Class B shareholders of the Fund exercising the
exchange privilege described under "Shareholder Services--Exchange Privilege"
will continue to be subject to the Fund's CDSC schedule if such schedule is
higher than the CDSC schedule relating to the Class B shares acquired as a
result of the exchange.
Contingent Deferred Sales Charge--Class B Shares. Class B shares which are
redeemed within four years of purchase may be subject to a CDSC at the rates
set forth below charged as a percentage of the dollar amount subject thereto.
The charge will be assessed on an amount equal to the lesser of the proceeds of
redemption or the cost of the shares being redeemed. Accordingly, no CDSC will
be imposed on increases in net asset value above the initial purchase price. In
addition, no CDSC will be assessed on shares derived from reinvestment of
dividends or capital gains distributions.
The following table sets forth the Class B CDSC:
<TABLE>
<CAPTION>
CDSC AS A
PERCENTAGE OF
DOLLAR AMOUNT
SUBJECT TO
YEAR SINCE PURCHASE PAYMENT MADE CHARGE
-------------------------------- -------------
<S> <C>
0-1.......................................................... 4.0%
1-2.......................................................... 3.0%
2-3.......................................................... 2.0%
3-4.......................................................... 1.0%
4 and thereafter............................................. None
</TABLE>
26
<PAGE>
For the fiscal year ended July 31, 1995, the Distributor received CDSCs of
$153,402 with respect to redemptions of Class B shares, all of which were paid
to Merrill Lynch.
In determining whether a CDSC is applicable to a redemption, the calculation
will be determined in the manner that results in the lowest applicable rate
being charged. Therefore, it will be assumed that the redemption is first of
shares held for over four years or shares acquired pursuant to reinvestment of
dividends or distributions and then of shares held longest during the four-year
period. The charge will not be applied to dollar amounts representing an
increase in the net asset value since the time of purchase. A transfer of
shares from a shareholder's account to another account will be assumed to be
made in the same order as a redemption.
To provide an example, assume an investor purchased 100 shares at $10 per
share (at a cost of $1,000) and in the third year after purchase, the net asset
value per share is $12 and, during such time, the investor has acquired 10
additional shares upon dividend reinvestment. If at such time the investor
makes his first redemption of 50 shares (proceeds of $600), 10 shares will not
be subject to a CDSC because of dividend reinvestment. With respect to the
remaining 40 shares, the CDSC is applied only to the original cost of $10 per
share and not to the increase in net asset value of $2 per share. Therefore,
$400 of the $600 redemption proceeds will be charged at a rate of 2.0% (the
applicable rate in the third year after purchase).
In the event that Class B shares are exchanged by certain retirement plans
for Class A shares in connection with a transfer to the MFA program, the time
period that such Class A shares are held in the MFA program will be included in
determining the holding period of Class B shares reacquired upon termination of
participation in the MFA program (see "Shareholder Services--Exchange
Privilege").
The Class B CDSC is waived on redemptions of shares following the death or
disability (as defined in the Internal Revenue Code of 1986, as amended) of a
shareholder. Additional information concerning the waiver of the Class B CDSC
is set forth in the Statement of Additional Information.
Contingent Deferred Sales Charges--Class C Shares. Class C shares which are
redeemed within one year of purchase may be subject to a 1.0% CDSC charged as a
percentage of the dollar amount subject thereto. The charge will be assessed on
an equal to the lesser of the proceeds of redemption or the cost of the shares
being redeemed. Accordingly, no Class C CDSC will be imposed on increases in
net asset value above the initial purchase price. In addition, no Class C CDSC
will be assessed on shares derived from reinvestment of dividends or capital
gains distributions. For the period October 21, 1994 (commencement of
operations of Class C shares) to July 31, 1995 (fiscal year end), the
Distributor received no CDSCs with respect to redemptions of Class C shares.
In determining whether a Class C CDSC is applicable to a redemption, the
calculation will be determined in the manner that results in the lowest
possible rate being charged. Therefore, it will be assumed that the redemption
is first of shares held for over one year or shares acquired pursuant to
reinvestment of dividends or distributions and then of shares held longest
during the one-year period. The charge will not be applicable to dollar amounts
representing an increase in the net asset value since the time of purchase. At
transfer of shares from a shareholder's account to another account will be
assumed to be made in the same order as a redemption.
27
<PAGE>
Conversion of Class B Shares to Class D Shares. After approximately ten years
(the "Conversion Period"), Class B shares will be converted automatically into
Class D shares of the Fund. Class D shares are subject to an ongoing account
maintenance fee of 0.10% of net assets but are not subject to the distribution
fee that is borne by Class B shares. Automatic conversion of Class B shares
into Class D shares will occur at least once each month (on the "Conversion
Date") on the basis of the relative net asset values of the shares of the two
classes on the Conversion Date, without the imposition of any sales load, fee
or other charge. Conversion of Class B shares to Class D shares will not be
deemed a purchaser or sale of the shares for Federal income tax purposes.
In addition, shares purchased through reinvestment of dividends on Class B
shares also will convert automatically to Class D shares. The Conversion Date
for dividend reinvestment shares will be calculated taking into account the
length of time the shares underlying such dividend reinvestment shares were
outstanding. If at a Conversion Date the conversion of Class B shares to Class
D shares of the Fund in a single account will result in less than $50 worth of
Class B shares being left in the account, all of the Class B shares of the Fund
held in the account on the Conversion Date will be converted to Class D shares
of the Fund.
Share certificates for Class B shares of the Fund to be converted must be
delivered to the Transfer Agent at least one week prior to the Conversion Date
applicable to those shares. In the event such certificates are not received by
the Transfer Agent at least one week prior to the Conversion Date, the related
Class B shares will convert to Class D shares on the next scheduled Conversion
Date after such certificates are delivered.
In general, Class B shares of equity MLAM-advised mutual funds will convert
approximately eight years after initial purchase, and Class B shares of taxable
and tax-exempt fixed income MLAM-advised mutual funds will convert
approximately ten years after initial purchase. If, during the Conversion
Period, a shareholder exchanges Class B shares with an eight-year Conversion
Period for Class B shares with a ten-year Conversion Period, or vice versa, the
Conversion Period applicable to the Class B shares acquired in the exchange
will apply, and the holding period for the shares exchanged will be tacked onto
the holding period for the shares acquired.
DISTRIBUTION PLANS
The Fund has adopted separate distribution plans for Class B, Class C and
Class D shares pursuant to Rule 12b-1 under the Investment Company Act (each a
"Distribution Plan") with respect to the account maintenance and/or
distribution fees paid by the Fund to the Distributor with respect to such
classes. The Class B and Class C Distribution Plans provide for the payment of
account maintenance fees and distribution fees, and the Class D Distribution
Plan provides for the payment of account maintenance fees.
The Distribution Plans for Class B, Class C and Class D shares each provide
that the Fund pays the Distributor an account maintenance fee relating to the
shares of the relevant class, accrued daily and paid monthly, at the annual
rates of 0.25%, 0.25% and 0.10%, respectively, of the average daily net assets
of the Fund attributable to shares of the relevant class in order to compensate
the Distributor and Merrill Lynch (pursuant to a sub-agreement) in connection
with account maintenance activities.
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The Distribution Plans for Class B and Class C shares each provide that the
Fund also pays the Distributor a distribution fee relating to the shares of the
relevant class, accrued daily and paid monthly, at the annual rate of 0.25% and
0.35%, respectively, of the average daily net assets of the Fund attributable
to the shares of the relevant class in order to compensate the Distributor and
Merrill Lynch (pursuant to a sub-agreement) for providing shareholder and
distribution services, and bearing certain distribution-related expenses of the
Fund, including payments to financial consultants for selling Class B and Class
C shares of the Fund. The Distribution Plans relating to Class B and Class C
shares are designed to permit an investor to purchase Class B and Class C
shares through dealers without the assessment of an initial sales charge and at
the same time permit the dealer to compensate its financial consultants in
connection with the sale of the Class B and Class C shares. In this regard, the
purpose and function of the ongoing distribution fees and the CDSC are the same
as those of the initial sales charge with respect to the Class A and Class D
shares of the Fund in that the deferred sales charges provide for the financing
of the distribution of the Fund's Class B and Class C shares.
For the year ended July 31, 1995, the Fund paid the Distributor $247,176
pursuant to the Class B Distribution Plan (based on average net assets subject
to such Distribution Plan of approximately $49.4 million), all of which were
paid to Merrill Lynch for providing account maintenance and distribution-
related activities and services in connection with Class B shares. During the
period October 21, 1994 (commencement of operations of Class C shares) to July
31, 1995 (fiscal year end), the Fund paid the Distributor $1,413 pursuant to
the Distribution Plan relating to Class C shares (based on average net assets
subject to such Distribution Plan of approximately $305,955), all of which were
paid to Merrill Lynch for providing account maintenance and distribution-
related activities and services in connection with Class C shares. During the
period October 21, 1994 (commencement of operations of Class D shares) to July
31, 1995 (fiscal year end), the Fund paid the Distributor $691 pursuant to the
Distribution Plan relating to Class D shares (based on average net assets
subject to such Distribution Plan of approximately $897,660), all of which were
paid to Merrill Lynch for providing account maintenance services in connection
with Class D shares. At September 30, 1995, the net assets of the Fund subject
to the Class B Distribution Plan aggregated approximately $49.7 million. At
this asset level, the annual fee payable pursuant to the Class B Distribution
Plan would aggregate approximately $248,589. At September 30, 1995, the net
assets of the Fund subject to the Class C Distribution Plan aggregated
approximately $1.0 million. At this asset level, the annual fee payable
pursuant to the Class C Distribution Plan would aggregate approximately $6,071.
At September 30, 1995, the net assets of the Fund subject to the Class D
Distribution Plan aggregated approximately $1.4 million. At this asset level,
the annual fee payable pursuant to the Class D Distribution Plan would
aggregate approximately $1,422.
The payments under the Distribution Plan are based on a percentage of average
daily net assets attributable to the shares regardless of the amount of
expenses incurred and, accordingly, distribution-related revenues from the
Distribution Plans may be more or less than distribution-related expenses.
Information with respect to the distribution-related revenues and expenses is
presented to the Trustees for their consideration in connection with their
deliberations as to the continuance of the Class B and Class C Distribution
Plan. This information is presented annually as of December 31 of each year on
a "fully allocated accrual" basis and quarterly on a "direct expense and
revenue/cash" basis. On the fully allocated accrual basis, revenues consist of
the account maintenance fees, distribution fees, the CDSC and certain other
related revenues, and expenses consist of financial consultant compensation,
branch office and regional operation center selling and transaction processing
expenses, advertising, sales promotion and marketing expenses,
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corporate overhead and interest expense. On the direct expense and revenue/cash
basis, revenues consist of the account maintenance fees, distribution fees and
CDSCs, and the expenses consist of financial consultant compensation. As of
December 31, 1994, the fully allocated accrual revenues incurred by the
Distributor and Merrill Lynch exceeded fully allocated accrual expenses for
such period by approximately $1,065,000 (2.28% of Class B net assets at that
date). As of July 31, 1995, direct cash revenues for the period since the
commencement of operations exceeded direct cash expenses by $17,507 (.04% of
Class B net assets at that date). As of July 31, 1995, direct cash expenses for
the period since October 21, 1994 (commencement of operations of Class C
shares) exceeded direct cash revenues by $1,771 (1.74% of Class C net assets at
that date).
Limitations on the Payment of Deferred Sales Charges. The maximum sales
charge rule in the Rules of Fair Practice of the NASD imposes a limitation on
certain asset-based sales charges such as the distribution fee and the CDSC
borne by the Class B and Class C shares but not the account maintenance fee.
The maximum sales charge rule is applied separately to each class. As
applicable to the Fund, the maximum sales charge rule limits the aggregate of
distribution fee payments and CDSCs payable by the Fund to (1) 6.25% of
eligible gross sales of Class B shares and Class C shares computed separately
(defined to exclude shares issued pursuant to dividend reinvestments and
exchanges) plus (2) interest on the unpaid balance for the respective class,
computed separately, at the prime rate plus 1% (the unpaid balance being the
maximum amount payable minus amounts received from the payment of the
distribution fee and the CDSC). In connection with the Class B shares, the
Distributor has voluntarily agreed to waive interest charges on the unpaid
balance in excess of 0.50% of eligible gross sales. Consequently, the maximum
amount payable to the Distributor (referred to as the "voluntary maximum") in
connection with the Class B shares is 6.75% of eligible gross sales. The
Distributor retains the right to stop waiving the interest charges at any time.
To the extent payments would exceed the voluntary maximum, the Fund will not
make further payments of the distribution fee with respect to the Class B
shares and any CDSCs will be paid to the Fund rather than to the Distributor;
however, the Fund will continue to make payments of the account maintenance
fee. In certain circumstances the amount payable pursuant to the voluntary
maximum may exceed the amount payable under the NASD formula. In such
circumstances payments in excess of the amount payable under the NASD formula
will not be made.
The Fund has no obligation with respect to distribution and/or account
maintenance-related expenses incurred by the Distributor and Merrill Lynch in
connection with Class B, Class C and Class D shares, and there is no assurance
that the Trustees of the Trust will approve the continuance of the Distribution
Plans from year to year. However, the Distributor intends to seek annual
continuation of the Distribution Plans. In their review of the Distribution
Plans, the Trustees will be asked to take into consideration expenses incurred
in connection with the account maintenance and/or distribution of each class of
shares separately. The initial sales charges, the account maintenance fee, the
distribution fee and/or the CDSCs received with respect to one class will not
be used to subsidize the sale of shares of another class. Payments of the
distribution fee on Class B shares will terminate upon conversion of those
Class B shares into Class D shares as set forth under "Deferred Sales Charge
Alternatives--Class B and Class C Shares--Conversion of Class B Shares to Class
D Shares".
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REDEMPTION OF SHARES
The Trust is required to redeem for cash all shares of the Fund upon receipt
of a written request in proper form. The redemption price is the net asset
value per share next determined after the initial receipt of proper notice of
redemption. Except for any CDSC which may be applicable, there will be no
charge for redemption if the redemption request is sent directly to the
Transfer Agent. Shareholders liquidating their holdings will receive upon
redemption all dividends reinvested through the date of redemption. The value
of shares at the time of redemption may be more or less than the shareholder's
cost, depending on the market value of the securities held by the Fund at such
time.
REDEMPTION
A shareholder wishing to redeem shares may do so without charge by tendering
the shares directly to the Transfer Agent, Merrill Lynch Financial Data
Services, Inc., P.O. Box 45289, Jacksonville, Florida 32232-5289. Redemption
requests delivered other than by mail should be delivered to Merrill Lynch
Financial Data Services, Inc., 4800 Deer Lake Drive East, Jacksonville, Florida
32246-6484. Proper notice of redemption in the case of shares deposited with
the Transfer Agent may be accomplished by a written letter requesting
redemption. Proper notice of redemption in the case of shares for which
certificates have been issued may be accomplished by a written letter as noted
above accompanied by certificates for the shares to be redeemed. Redemption
requests should not be sent to the Trust. The notice in either event requires
the signature(s) of all persons in whose name(s) the shares are registered,
signed exactly as such name(s) appear(s) on the Transfer Agent's register. The
signature(s) on the redemption request must be guaranteed by an "eligible
guarantor institution" as such term is defined in Rule 17Ad-15 under the
Securities Exchange Act of 1934, as amended, the existence and validity of
which may be verified by the Transfer Agent through the use of industry
publications. Notarized signatures are not sufficient. In certain instances,
the Transfer Agent may require additional documents such as, but not limited
to, trust instruments, death certificates, appointments as executor or
administrator, or certificates of corporate authority. For shareholders
redeeming directly with the Transfer Agent, payments will be mailed within
seven days of receipt of a proper notice of redemption.
At various times the Trust may be requested to redeem Fund shares for which
it has not yet received good payment (e.g., cash, Federal funds or certified
check drawn on a United States bank). The Trust may delay or cause to be
delayed the mailing of a redemption check until such time as it has assured
itself that good payment has been collected for the purchase of such Fund
shares, which will not exceed 10 days.
REPURCHASE
The Trust also will repurchase Fund shares through a shareholder's listed
securities dealer. The Trust normally will accept orders to repurchase Fund
shares by wire or telephone from dealers for their customers at the net asset
value next computed after receipt of the order by the dealer, provided that the
request for repurchase is received by the dealer prior to the close of business
on the New York Stock Exchange (generally, 4:00 P.M., New York time) on the day
received and such request is received by the Trust from such dealer not later
than 30 minutes after the close of business on the New York Stock Exchange, on
the same day. Dealers have the responsibility to submit such repurchase
requests to the Fund not later than 30 minutes after the close of business on
the New York Stock Exchange, in order to obtain that day's closing price.
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The foregoing repurchase arrangements are for the convenience of shareholders
and do not involve a charge by the Trust (other than any applicable CDSC);
Securities firms which do not have selected dealer agreements with the
Distributor, however, may impose a transaction charge on the shareholder for
transmitting the notice of repurchase to the Trust. Merrill Lynch may charge
its customers a processing fee (presently $4.85) to confirm a repurchase of
shares of such customers. Redemptions directly through the Fund's Transfer
Agent are not subject to the processing fee. The Trust reserves the right to
reject any order for repurchase, which right of rejection might adversely
affect shareholders seeking redemption through the repurchase procedure.
However, a shareholder whose order for repurchase is rejected by the Trust may
redeem Fund shares as set forth above.
REINSTATEMENT PRIVILEGE--CLASS A AND CLASS D SHARES
Shareholders who have redeemed their Class A or Class D shares have a one-
time privilege to reinstate their accounts by purchasing Class A or Class D
shares, as the case may be, of the Fund at net asset value without a sales
charge up to the dollar amount redeemed. The reinstatement privilege may be
exercised by sending a notice of exercise along with a check for the amount to
be reinstated to the Transfer Agent within 30 days after the date the request
for redemption was accepted by the Transfer Agent or the Distributor. The
reinstatement will be made at the net asset value per share next determined
after the notice of reinstatement is received and cannot exceed the amount of
the redemption proceeds. The reinstatement privilege is a one-time privilege
and may be exercised by the Class A or Class D shareholder only the first time
such shareholder makes a redemption.
SHAREHOLDER SERVICES
The Trust offers a number of shareholder services and investment plans
designed to facilitate investment in shares of the Fund. Full details as to
each of such services, copies of the various plans described below and
instructions as to how to participate in the various services or plans, or to
change options with respect thereto, can be obtained from the Trust by calling
the telephone number on the cover page hereof or from the Distributor or
Merrill Lynch.
Investment Account. Each shareholder whose account is maintained at the
Transfer Agent has an Investment Account and will receive statements from the
Transfer Agent at least quarterly. These statements will serve as transaction
confirmations for automatic investment purchases and the reinvestment of
ordinary dividends and long-term capital gains distributions. These statements
will also show any other activity in the account since the preceding statement.
Shareholders also will receive separate confirmations for each purchase or sale
transaction other than reinvestments of ordinary income dividends and long-term
capital gains distributions. A shareholder may make additions to his Investment
Account at any time by mailing a check directly to the Transfer Agent.
Shareholders may also maintain their accounts through Merrill Lynch. Upon the
transfer of shares out of a Merrill Lynch brokerage account, an Investment
Account in the transferring shareholder's name will be opened automatically at
the Transfer Agent. Shareholders considering transferring their Class A or
Class D shares (paying any applicable CDSC) from Merrill Lynch to another
brokerage firm or financial institution should be aware that, if the firm to
which the Class A or Class D shares are to be transferred will not take
delivery of shares of the Fund, a shareholder either must redeem the Class A or
Class D shares (paying any applicable CDSC) so that the cash proceeds can be
transferred to the account at
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the new firm or such shareholder must continue to maintain an Investment
Account at the Transfer Agent for those Class A or Class D shares. Shareholders
interested in transferring their Class B or Class C shares from Merrill Lynch
and who do not wish to have an Investment Account maintained for such shares at
the Transfer Agent may request their new brokerage firm to maintain such shares
in an account registered in the name of the brokerage firm for the benefit of
the shareholder.
Exchange Privilege. Shareholders of each class of shares of the Fund have an
exchange privilege with certain other MLAM-advised mutual funds. There is
currently no limitation on the number of times a shareholder may exercise the
exchange privilege. The exchange privilege may be modified or terminated at any
time in accordance with the rules of the Commission.
Under the Merrill Lynch Select Pricing SM System, Class A shareholders may
exchange Class A shares of the Fund for Class A shares of a second MLAM-advised
mutual fund if the shareholder holds any Class A shares of the second fund in
his account in which the exchange is made at the time of the exchange or is
otherwise eligible to purchase Class A shares of the second fund. If the Class
A shareholder wants to exchange Class A shares for shares of a second MLAM-
advised mutual fund, and the shareholder does not hold Class A shares of the
second fund in his account at the time of the exchange and is not otherwise
eligible to acquire Class A shares of the second fund, the shareholder will
receive Class D shares of the second fund as a result of the exchange. Class D
shares also may be exchanged for Class A shares of a second MLAM-advised mutual
fund at any time as long as, at the time of the exchange, the shareholder holds
Class A shares of the second fund in the account in which the exchange is made
or is otherwise eligible to purchase Class A shares of the second fund.
Exchanges of Class A and Class D shares are made on the basis of the relative
net asset values per Class A or Class D share, respectively, plus an amount
equal to the difference, if any, between the sales charge previously paid on
the Class A or Class D shares being exchanged and the sales charge payable at
the time of the exchange on the shares being acquired.
Class B, Class C and Class D shares are exchangeable with shares of the same
class of other MLAM-advised mutual funds.
Shares of the Fund which are subject to a CDSC are exchangeable on the basis
of relative net asset value per share without the payment of any CDSC that
might otherwise be due upon redemption of the shares of the Fund. For purposes
of computing the CDSC that may be payable upon a disposition of the shares
acquired in the exchange, the holding period for the previously owned shares of
the Fund is "tacked" to the holding period of the newly acquired shares of the
other Fund.
Class A, Class B, Class C and Class D shares also are exchangeable for shares
of certain MLAM-advised money market funds specifically designated as available
for exchange by holders of Class A, Class B, Class C or Class D shares. The
period of time that Class A, Class B, Class C or Class D shares are held in a
money market fund, however, will not count toward satisfaction of the holding
period requirement for reduction of any CDSC imposed on such shares, if any,
and, with respect to Class B shares, toward satisfaction of the Conversion
Period.
Class B shareholders of the Fund exercising the exchange privilege will
continue to be subject to the Fund's CDSC schedule if such schedule is higher
than the CDSC schedule relating to the new Class B shares.
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In addition, Class B shares of the Fund acquired through use of the exchange
privilege will be subject to the Fund's CDSC schedule if such schedule is
higher than the CDSC schedule relating to the Class B shares of the MLAM-
advised mutual fund from which the exchange has been made.
Exercise of the exchange privilege is treated as a sale for Federal income
tax purposes. For further information, see "Shareholder Services--Exchange
Privilege" in the Statement of Additional Information.
The Fund's exchange privilege is modified with respect to purchases of Class
A and Class D shares by non-retirement plan investors under the MFA program.
First, the initial allocation of assets is made under the MFA program. Then,
any subsequent exchange under the MFA program of Class A or Class D shares of a
MLAM-advised mutual fund for Class A or Class D shares of the Fund will be made
solely on the basis of the relative net asset values of the shares being
exchanged. Therefore, there will not be a charge for any difference between the
sales charge previously paid on the shares of the other MLAM-advised mutual
fund and the sales charge payable on the shares of the Fund being acquired in
the exchange under the MFA program.
AUTOMATIC REINVESTMENT OF DIVIDENDS AND CAPITAL GAINS DISTRIBUTIONS
All dividends and capital gains distributions are reinvested automatically in
full and fractional shares of the Fund, without a sales charge, at the net
asset value per share at the close of business on the monthly payment date for
such dividends and distributions. A shareholder may at any time, by written
notification or by telephone (1-800-MER-FUND) to the Transfer Agent, elect to
have subsequent dividends or both dividends and capital gains distributions
paid in cash, rather than reinvested, in which event payment will be mailed
monthly. Cash payments can also be directly deposited to the shareholders bank
account. No CDSC will be imposed upon redemption of shares issued as a result
of the automatic reinvestment of dividends or capital gains distributions.
SYSTEMATIC WITHDRAWAL PLANS
A Class A or Class D shareholder may elect to receive systematic withdrawal
payments from his Investment Account through automatic payment by check or
through automatic payment by direct deposit to his bank account on either a
monthly or quarterly basis. Alternatively, a Class A or Class D shareholder
whose shares are held within a CMA (R) or CBA (R) account may elect to have
shares redeemed on a monthly, bimonthly, quarterly, semiannual or annual basis
through the CMA (R)/CBA (R) Systematic Redemption Program, subject to certain
conditions.
AUTOMATIC INVESTMENT PLANS
Regular additions of Class A, Class B, Class C and Class D shares may be made
to an investor's Investment Account by prearranged charges of $50 or more to
his or her regular bank account. The Fund's Automatic Investment Program is not
available to shareholders whose shares are held in a brokerage account with
Merrill Lynch. Alternatively, investors who maintain CMA (R) or CBA (R)
accounts may arrange to have periodic investments made in the Fund in their
CMA (R) or CBA (R) account or in certain related accounts in amounts of $100 or
more through the CMA (R)/CBA (R) Automatic Investment Program.
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PORTFOLIO TRANSACTIONS
The Trust has no obligation to deal with any dealer or group of dealers in
the execution of transactions in portfolio securities of the Fund. Municipal
Bonds and other securities in which the Fund invests are traded primarily in
the over-the-counter market. Where possible, the Trust deals directly with the
dealers who make a market in the securities involved except in those
circumstances where better prices and execution are available elsewhere. It is
the policy of the Trust to obtain the best net results in conducting portfolio
transactions for the Fund, taking into account such factors as price (including
the applicable dealer spread), the size, type and difficulty of the
transactions involved, the firm's general execution and operations facilities,
and the firm's risk in positioning the securities involved and the provision of
supplemental investment research by the firm. While reasonably competitive
spreads or commissions are sought, the Fund will not necessarily be paying the
lowest spread or commission available. The sale of shares of the Fund may be
taken into consideration as a factor in the selection of brokers or dealers to
execute portfolio transactions for the Fund. The portfolio securities of the
Fund generally are traded on a net basis and normally do not involve either
brokerage commissions or transfer taxes. The cost of portfolio securities
transactions of the Fund primarily consists of dealer or underwriter spreads.
Under the 1940 Act, persons affiliated with the Trust, including Merrill Lynch,
are prohibited from dealing with the Trust as a principal in the purchase and
sale of securities unless such trading is permitted by an exemptive order
issued by the Commission. The Trust has obtained an exemptive order permitting
it to engage in certain principal transactions with Merrill Lynch involving
high quality short-term municipal bonds subject to certain conditions. In
addition, the Trust may not purchase securities, including Municipal Bonds, for
the Fund during the existence of any underwriting syndicate of which Merrill
Lynch is a member except pursuant to procedures approved by the Trustees of the
Trust which comply with rules adopted by the Commission. The Trust has applied
for an exemptive order permitting it to, among other things, (i) purchase high
quality tax-exempt securities from Merrill Lynch when Merrill Lynch is a member
of an underwriting syndicate and (ii) purchase tax-exempt securities from and
sell tax-exempt securities to Merrill Lynch in secondary market transactions.
Affiliated persons of the Trust may serve as its broker in over-the-counter
transactions conducted for the Fund on an agency basis only.
DISTRIBUTIONS AND TAXES
DISTRIBUTIONS
The net investment income of the Fund is declared as dividends daily prior to
the determination of the net asset value which is calculated 15 minutes after
the close of business on the New York Stock Exchange (generally, 4:00 P.M., New
York time) on that day. The net investment income of the Fund for dividend
purposes consists of interest earned on portfolio securities, less expenses, in
each case computed since the most recent determination of the net asset value.
Expenses of the Fund, including the management fees and the account maintenance
and distribution fees, are accrued daily. Dividends of net investment income
are declared daily and reinvested monthly in the form of additional full and
fractional shares of the Fund at net asset value as of the close of business on
the "payment date" unless the shareholder elects to receive such dividends in
cash. Shares will accrue dividends as long as they are issued and outstanding.
Shares are issued and outstanding from the settlement date of a purchase order
to the day prior to the settlement date of a redemption order.
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All net realized long- or short-term capital gains, if any, are declared and
distributed to the Fund's shareholders at least annually. Capital gains
distributions will be reinvested automatically in shares unless the shareholder
elects to receive such distributions in cash.
The per share dividends and distributions on each class of shares will be
reduced as a result of any account maintenance, distribution and transfer
agency fees applicable to that class. See "Additional Information--
Determination of Net Asset Value".
See "Shareholder Services" for information as to how to elect either dividend
reinvestment or cash payments. Portions of dividends and distributions which
are taxable to shareholders as described below are subject to income tax
whether they are reinvested in shares of the Fund or received in cash.
TAXES
The Trust intends to continue to qualify the Fund for the special tax
treatment afforded regulated investment companies ("RICs") under the Internal
Revenue Code of 1986, as amended (the "Code"). If it so qualifies, in any
taxable year in which it distributes at least 90% of its taxable net income and
90% of its tax-exempt net income, the Fund (but not its shareholders) will not
be subject to Federal income tax to the extent that it distributes its net
investment income and net realized capital gains. The Trust intends to cause
the Fund to distribute substantially all of such income.
To the extent that the dividends distributed to the Fund's Class A, Class B,
Class C and Class D shareholders (together, the "shareholders") are derived
from interest income exempt from Federal tax under Code Section 103(a) and are
properly designated as "exempt-interest dividends" by the Trust, they will be
excludable from a shareholder's gross income for Federal income tax purposes.
Exempt-interest dividends are included, however, in determining the portion, if
any, of a person's social security benefits and railroad retirement benefits
subject to Federal income taxes. The portion of such exempt-interest dividends
paid from interest received by the Fund from North Carolina Municipal Bonds or
from direct obligations of the U.S. Government is excluded from the North
Carolina taxable net income of individuals, corporations, estates and trusts.
Shareholders subject to income taxation by states other than North Carolina
will realize a lower after-tax rate of return than North Carolina shareholders
since the dividends distributed by the Fund generally will not be exempt, to
any significant degree, from income taxation by such other states. The Trust
will inform shareholders annually as to the portion of the Fund's distributions
which constitutes exempt-interest dividends and the portion which is exempt
from North Carolina income taxes. Interest on indebtedness incurred or
continued to purchase or carry Fund shares is not deductible for Federal or
North Carolina income tax purposes to the extent attributable to exempt-
interest dividends. Persons who may be "substantial users" (or "related
persons" of substantial users) of facilities financed by industrial development
bonds or private activity bonds held by the Fund should consult their tax
advisers before purchasing Fund shares.
An investment in the Fund by a corporate shareholder would be included in the
capital stock, surplus and undivided profits base in computing the North
Carolina franchise tax.
To the extent that the Fund's distributions are derived from interest on its
taxable investments (including, for North Carolina income tax purposes,
interest on Municipal Bonds of other states) or from an
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excess of net short-term capital gains over net long-term capital losses
("ordinary income dividends"), such distributions are considered ordinary
income for Federal and North Carolina income tax purposes, except, in the case
of North Carolina income tax, for dividends that are directly attributable to
interest on obligations of the U.S. Government or to gains from certain
obligations of the State of North Carolina and its political subdivisions that
were issued before July 1, 1995. Distributions, if any, from an excess of net
long-term capital gains over net short-term capital losses derived from the
sale of securities or from certain transactions in futures or options ("capital
gain dividends") are taxable as long-term capital gains for Federal income tax
purposes, regardless of the length of time the shareholder has owned Fund
shares. Such capital gain dividends are also subject to North Carolina income
taxes, except to the extent attributable to gains from certain obligations of
the State of North Carolina and its political subdivisions that were issued
before July 1, 1995. Distributions by the Fund, whether from exempt-interest
income, ordinary income or capital gains, will not be eligible for the
dividends received deduction allowed to corporations under the Code.
All or a portion of the Fund's gain from the sale or redemption of tax-exempt
obligations purchased at a market discount will be treated as ordinary income
rather than capital gain. This rule may increase the amount of ordinary income
dividends received by shareholders. Distributions in excess of the Fund's
earnings and profits will first reduce the adjusted tax basis of a holder's
shares and, after such adjusted tax basis is reduced to zero, will constitute
capital gains (assuming such shares are held as a capital asset). Any loss upon
the sale or exchange of Fund shares held for six months or less will be treated
as long-term capital loss to the extent of any capital gain dividends received
by the shareholder. In addition, such loss will be disallowed for both Federal
and North Carolina income tax purposes to the extent of any exempt-interest
dividends received by the shareholder, even, in the case of North Carolina,
where all or a portion of such dividends is not excluded from North Carolina
taxable income. If the Fund pays a dividend in January which was declared in
the previous October, November or December to shareholders of record on a
specified date in one of such months, then such dividend will be treated for
tax purposes as being paid by the Fund and received by its shareholders on
December 31 of the year in which such dividend was declared.
The Code subjects interest received on certain otherwise tax-exempt
securities to an alternative minimum tax. The alternative minimum tax applies
to interest received on certain "private activity bonds" issued after August 7,
1986. Private activity bonds are bonds which, although tax-exempt, are used for
purposes other than those generally performed by governmental units and which
benefit non-governmental entities (e.g., bonds used for industrial development
or housing purposes). Income received on such bonds is classified as an item of
"tax preference," which could subject investors in such bonds, including
shareholders of the Fund, to an alternative minimum tax. The Fund will purchase
such "private activity bonds," and the Trust will report to shareholders within
60 days after the Fund's taxable year-end the portion of its dividends declared
during the year which constitutes an item of tax preference for alternative
minimum tax purposes. The Code further provides that corporations are subject
to an alternative minimum tax based, in part, on certain differences between
taxable income as adjusted for other tax preferences and the corporation's
"adjusted current earnings," which more closely reflect a corporation's
economic income. Because an exempt-interest dividend paid by the Fund will be
included in adjusted current earnings, a corporate shareholder may be required
to pay alternative minimum tax on exempt-interest dividends paid by the Fund.
No gain or loss will be recognized by Class B shareholders on the conversion
of their Class B shares into Class D shares. A shareholder's basis in the Class
D shares acquired will be the same as such shareholder's basis in the Class B
shares converted, and the holding period of the acquired Class D shares will
include the holding period for the converted Class B shares.
37
<PAGE>
If a shareholder exercises an exchange privilege within 90 days of acquiring
the shares, then the loss the shareholder can recognize on the exchange will be
reduced (or the gain increased) to the extent any sales charge paid to the Fund
on the exchanged shares reduces any sales charge such shareholder would have
owed upon purchase of the new shares in the absence of the exchange privilege.
Instead, such sales charge will be treated as an amount paid for the new
shares.
A loss realized on a sale or exchange of shares of the Fund will be
disallowed if other Fund shares are acquired (whether through the automatic
reinvestment of dividends or otherwise) within a 61-day period beginning 30
days before and ending 30 days after the date that the shares are disposed of.
In such a case, the basis of the shares acquired will be adjusted to reflect
the disallowed loss.
Under certain Code provisions, some shareholders may be subject to a 31%
withholding tax on certain ordinary income dividends and on capital gain
dividends and redemption payments ("backup withholding"). Generally,
shareholders subject to backup withholding will be those for whom no certified
taxpayer identification number is on file with the Trust or who, to the Trust's
knowledge, have furnished an incorrect number. When establishing an account, an
investor must certify under penalty of perjury that such number is correct and
that such investor is not otherwise subject to backup withholding.
The Code provides that every person required to file a tax return must
include for information purposes on such return the amount of exempt-interest
dividends received from all sources (including the Fund) during the taxable
year.
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code, Treasury regulations and North Carolina tax laws
presently in effect. For the complete provisions, reference should be made to
the pertinent Code sections, the Treasury regulations promulgated thereunder
and the applicable North Carolina income tax laws. The Code and the Treasury
regulations, as well as the North Carolina income tax laws, are subject to
change by legislative, judicial or administrative action either prospectively
or retroactively.
Shareholders are urged to consult their tax advisers regarding the
availability of any exemptions from state or local taxes (other than those
imposed by North Carolina) and with specific questions as to Federal, foreign,
state or local taxes.
PERFORMANCE DATA
From time to time the Fund may include its average annual total return, yield
and tax-equivalent yield for various specified time periods in advertisements
or information furnished to present or prospective shareholders. Average annual
total return, yield and tax equivalent yield are computed separately for Class
A, Class B, Class C and Class D shares in accordance with formulas specified by
the Commission.
Average annual total return quotations for the specified periods will be
computed by finding the average annual compounded rates of return (based on net
investment income and any realized and unrealized capital gains or losses on
portfolio investments over such periods) that would equate the initial amount
invested to the redeemable value of such investment at the end of each period.
Average annual total return will be
38
<PAGE>
computed assuming all dividends and distributions are reinvested and taking
into account all applicable recurring and nonrecurring expenses, including any
CDSC that would be applicable to a complete redemption of the investment at the
end of the specified period such as in the case of Class B and Class C shares
and the maximum sales charge in the case of Class A and Class D shares.
Dividends paid by the Fund with respect to all shares, to the extent any
dividends are paid, will be calculated in the same manner at the same time on
the same day and will be in the same amount, except that account maintenance
fees and distribution charges and any incremental transfer agency costs
relating to each class of shares will be borne exclusively by that class. The
Fund will include performance data for all classes of shares of the Fund in any
advertisement or information including performance data of the Fund.
The Fund also may quote total return and aggregate total return performance
data for various specified time periods. Such data will be calculated
substantially as described above, except that (1) the rates of return
calculated will not be average annual rates, but rather, actual annual,
annualized or aggregate rates of return, and (2) the maximum applicable sales
charges will not be included with respect to annual or annualized rates of
return calculations. Aside from the impact on the performance data calculations
of including or excluding the maximum applicable sales charges, actual annual
or annualized total return data generally will be lower than average annual
total return data since the average annual rates of return reflect compounding;
aggregate total return data generally will be higher than average annual total
return data since the aggregate rates of return reflect compounding over a
longer period of time. In advertisements distributed to investors whose
purchases are subject to waiver of the CDSC in the case of Class B and Class C
shares or reduced sales charges in the case of Class A and Class D shares the
performance data may take into account the reduced, and not the maximum, sales
charge or may not take into account the CDSC and therefore may reflect greater
total return since, due to the reduced sales charges or waiver of the CDSC, a
lower amount of expenses is deducted. See "Purchase of Shares". The Fund's
total return may be expressed either as a percentage or as a dollar amount in
order to illustrate such total return on a hypothetical $1,000 investment in
the Fund at the beginning of each specified period.
Yield quotations will be computed based on a 30-day period by dividing (a)
the net income based on the yield of each security earned during the period by
(b) the average daily number of shares outstanding during the period that were
entitled to receive dividends multiplied by the maximum offering price per
share on the last day of the period. Tax equivalent yield quotations will be
computed by dividing (a) the part of the Fund's yield that is tax-exempt by (b)
one minus a stated tax rate and (c) adding the result to that part, if any, of
the Fund's yield that is not tax-exempt. The yield for the 30-day period ended
July 31, 1995 was 5.02% for Class A shares, 4.72% for Class B shares, 4.62% for
Class C shares and 4.93% for Class D shares and the tax equivalent yield for
the same period (based on a Federal income tax rate of 28%) was 6.97% for Class
A shares, 6.56% for Class B shares, 6.42% for Class C shares and 6.85% for
Class D shares. The yield without voluntary reimbursement or waiver of Fund
expenses for the 30-day period would have been 4.83% for Class A shares, 4.51%
for Class B shares, 4.42% for Class C shares and 4.73% for Class D shares with
a tax equivalent yield of 6.71% for Class A shares, 6.26% for Class B shares,
6.14% for Class C shares and 6.57% for Class D shares.
Total return, yield and tax-equivalent yield figures are based on the Fund's
historical performance and are not intended to indicate future performance. The
Fund's total return, yield and tax-equivalent yield will vary depending on
market conditions, the securities comprising the Fund's portfolio, the Fund's
operating
39
<PAGE>
expenses and the amount of realized and unrealized net capital gains or losses
during the period. The value of an investment in the Fund will fluctuate and an
investor's shares, when redeemed, may be worth more or less than their original
cost.
On occasion, the Fund may compare its performance to performance data
prepared by Lipper Analytical Services, Inc., Morningstar Publications, Inc.
("Morningstar"), and CDA Investment Technology, Inc. or to data contained in
publications such as Money Magazine, U.S. News & World Report, Business Week,
Forbes Magazine and Fortune Magazine. From time to time, the Fund may include
the Fund's Morningstar risk-adjusted performance ratings in advertisements or
supplemental sales literature. As with other performance data, performance
comparisons should not be considered indicative of the Fund's relative
performance for any future period.
ADDITIONAL INFORMATION
DETERMINATION OF NET ASSET VALUE
The net asset value of the shares of all classes of the Fund is determined by
the Manager once daily 15 minutes after the close of business on the New York
Stock Exchange (generally, 4:00 P.M., New York time), on each day during which
the New York Stock Exchange is open for trading. The net asset value per share
is computed by dividing the sum of the value of the securities held by the Fund
plus any cash or other assets minus all liabilities by the total number of
shares outstanding at such time, rounded to the nearest cent. Expenses,
including the fees payable to the Manager and the Distributor, are accrued
daily.
The per share net asset value of the Class A shares generally will be higher
than the per share net asset value of shares of the other classes, reflecting
the daily expense accruals of the account maintenance, distribution and higher
transfer agency fees applicable with respect to Class B and Class C shares and
the daily expense accruals of the account maintenance fees applicable with
respect to Class D shares; moreover, the per share net asset value of Class D
shares generally will be higher than the per share net asset value of Class B
and Class C shares, reflecting the daily expense accruals of the distribution
and higher transfer agency fees applicable with respect to Class B and Class C
shares. It is expected, however, that the per share net asset value of the
classes will tend to converge (although not necessarily meet) immediately after
the payment of dividends or distributions which will differ by approximately
the amount of the expense accrual differentials between the classes.
ORGANIZATION OF THE TRUST
The Trust is an unincorporated business trust organized on August 2, 1985
under the laws of Massachusetts. On October 1, 1987, the Trust changed its name
from "Merrill Lynch Multi-State Tax-Exempt Series Trust" to "Merrill Lynch
Multi-State Municipal Bond Series Trust", and on December 22, 1987, the Trust
changed its name to "Merrill Lynch Multi-State Municipal Series Trust". The
Trust is an open-end management investment company comprised of separate series
("Series"), each of which is a separate portfolio offering shares to selected
groups of purchasers. Each of the Series is to be managed independently in
order to provide to shareholders who are residents of the state to which such
Series relates as high a level of income exempt from Federal, and, in certain
cases, state and local income taxes as is
40
<PAGE>
consistent with prudent investment management. The Trustees are authorized to
create an unlimited number of Series and, with respect to each Series, to issue
an unlimited number of full and fractional shares of beneficial interest of
$.10 par value of different classes. Shareholder approval is not required for
the authorization of additional Series or classes of a Series of the Trust. At
the date of this Prospectus, the shares of the Fund are divided into Class A,
Class B, Class C and Class D shares. Class A, Class B, Class C and Class D
shares represent an interest in the same assets of the Fund and are identical
in all respects except that Class B, Class C and Class D shares bear certain
expenses related to the account maintenance associated with such shares, and
Class B and Class C shares bear certain expenses related to the distribution of
such shares. Each class has exclusive voting rights with respect to matters
relating to account maintenance and distribution expenditures as applicable.
See "Purchase of Shares". The Trust has received an order (the "Order") from
the Commission permitting the issuance and sale of multiple classes of
beneficial interest. The Trustees of the Trust may classify and reclassify the
shares of any Series into additional classes of beneficial interest at a future
date. The Order permits the Fund to issue additional classes of shares of any
Series if the Board of Trustees deems such issuance to be in the best interest
of the Trust.
Shareholders are entitled to one vote for each full share and to fractional
votes for fractional shares held in the election of Trustees (to the extent
hereinafter provided) and on other matters submitted to the vote of
shareholders. There normally will be no meeting of shareholders for the purpose
of electing Trustees unless and until such time as less than a majority of the
Trustees holding office have been elected by shareholders, at which time the
Trustees then in office will call a shareholders' meeting for the election of
Trustees. Shareholders may, in accordance with the terms of the Declaration of
Trust, cause a meeting of shareholders to be held for the purpose of voting on
the removal of Trustees. Also, the Trust will be required to call a special
meeting of shareholders of a Series in accordance with the requirements of the
1940 Act to seek approval of new management and advisory arrangements, of a
material increase in distribution fees or of a change in the fundamental
policies, objective or restrictions of a Series. Except as set forth above, the
Trustees shall continue to hold office and appoint successor Trustees. Each
issued and outstanding share is entitled to participate equally in dividends
and distributions declared by the respective Series and in net assets of such
Series upon liquidation or dissolution remaining after satisfaction of
outstanding liabilities except that, as noted above, the Class B, Class C and
Class D shares bear certain additional expenses. The obligations and
liabilities of a particular Series are restricted to the assets of that Series
and do not extend to the assets of the Trust generally. The shares of each
Series, when issued, will be fully-paid and non-assessable by the Trust.
SHAREHOLDER REPORTS
Only one copy of each shareholder report and certain shareholder
communications will be mailed to each identified shareholder regardless of the
number of accounts such shareholder has. If a shareholder wishes to receive
separate copies of each report and communication for each of the shareholder's
related accounts, the shareholder should notify in writing:
Merrill Lynch Financial Data Services, Inc.
P.O. Box 45289
Jacksonville, Florida 32232-5289
The written notification should include the shareholder's name, address, tax
identification number and Merrill Lynch, Pierce, Fenner & Smith Incorporated
and/or mutual fund account numbers. If you have any questions regarding this
matter, please call your Merrill Lynch financial consultant or Merrill Lynch
Financial Data Services, Inc. at 800-637-3863.
41
<PAGE>
SHAREHOLDER INQUIRIES
Shareholder inquiries may be addressed to the Trust at the address or
telephone number set forth on the cover page of this Prospectus.
----------------
The Declaration of Trust establishing the Trust, dated August 2, 1985, a copy
of which together with all amendments thereto (the "Declaration"), is on file
in the office of the Secretary of the Commonwealth of Massachusetts, provides
that the name "Merrill Lynch Multi-State Municipal Series Trust" refers to the
Trustees under the Declaration collectively as Trustees, but not as individuals
or personally; and no Trustee, shareholder, officer, employee or agent of the
Trust shall be held to any personal liability, nor shall resort be had to such
person's private property for the satisfaction of any obligation or claim of
the Trust, but the "Trust Property" only shall be liable.
42
<PAGE>
MERRILL LYNCH NORTH CAROLINA MUNICIPAL BOND FUND -- AUTHORIZATION FORM (PART
1)
- -------------------------------------------------------------------------------
1. SHARE PURCHASE APPLICATION
I, being of legal age, wish to purchase: (choose one)
[_] Class A shares [_] Class B shares [_] Class C shares [_] Class D shares
of Merrill Lynch North Carolina Municipal Bond Fund and establish an
Investment Account as described in the Prospectus. In the event that I am not
eligible to purchase Class A shares, I understand that Class D shares will be
purchased.
Basis for establishing an Investment Account:
A. I enclose a check for $............ payable to Merrill Lynch Financial
Data Services, Inc., as an initial investment (minimum $1,000). I understand
that this purchase will be executed at the applicable offering price next to
be determined after this Application is received by you.
B. I already own shares of the following Merrill Lynch mutual funds that
would qualify for the right of accumulation as outlined in the Statement of
Additional Information: (Please list all funds. Use a separate sheet of
paper if necessary.)
1. .................................. 4. ..................................
2. .................................. 5. ..................................
3. .................................. 6. ..................................
Name...........................................................................
First Name Initial Last Name
Name of Co-Owner (if any)......................................................
First Name Initial Last Name
Address..............................
..................................... Date......................, 19......
(Zip Code)
Occupation........................... Name and Address of Employer.........
..................................... .....................................
Signature of Owner Signature of Co-Owner (if any)
(In the case of co-owners, a joint tenancy with right of survivorship will be
presumed unless otherwise specified.)
- -------------------------------------------------------------------------------
2. DIVIDEND AND CAPITAL GAIN DISTRIBUTION OPTIONS
Ordinary Income Dividends Long-Term Capital Gains
SELECT [_] Reinvest SELECT [_] Reinvest
ONE: [_] Cash ONE: [_] Cash
If no election is made, dividends and capital gains will be automatically
reinvested at net asset value without a sales charge.
IF CASH, SPECIFY HOW YOU WOULD LIKE YOUR DISTRIBUTIONS PAID TO YOU: [_] Check
or [_] Direct Deposit to bank account
IF DIRECT DEPOSIT TO BANK ACCOUNT IS SELECTED, PLEASE COMPLETE BELOW:
I hereby authorize payment of dividend and capital gain distributions by
direct deposit to my bank account and, if necessary, debit entries and
adjustments for any credit entries made to my account in accordance with the
terms I have selected on the Merrill Lynch North Carolina Municipal Bond Fund
Authorization Form.
SPECIFY TYPE OF ACCOUNT (CHECK ONE): [_] checking [_] savings
Name on your account ..........................................................
Bank Name .....................................................................
Bank Number ...................... Account Number ............................
Bank Address ..................................................................
I AGREE THAT THIS AUTHORIZATION WILL REMAIN IN EFFECT UNTIL I PROVIDE WRITTEN
NOTIFICATION TO MERRILL LYNCH FINANCIAL DATA SERVICES, INC. AMENDING OR
TERMINATING THIS SERVICE.
Signature of Depositor ........................................................
Signature of Depositor ............................... Date...................
(if joint account, both must sign)
NOTE: IF DIRECT DEPOSIT TO BANK ACCOUNT IS SELECTED, YOUR BLANK, UNSIGNED
CHECK MARKED "VOID" OR A DEPOSIT SLIP FROM YOUR SAVINGS ACCOUNT SHOULD
ACCOMPANY THIS APPLICATION.
43
<PAGE>
MERRILL LYNCH NORTH CAROLINA MUNICIPAL BOND FUND -- AUTHORIZATION FORM (PART
1) -- (CONTINUED)
- -------------------------------------------------------------------------------
3. SOCIAL SECURITY NUMBER OR TAXPAYER IDENTIFICATION NUMBER
Social Security Number or Taxpayer Identification Number
Under penalty of perjury, I certify (1) that the number set forth above is
my correct Social Security Number or Taxpayer Identification Number and (2)
that I am not subject to backup withholding (as discussed in the Prospectus
under "Distributions and Taxes--Taxes") either because I have not been
notified that I am subject thereto as a result of a failure to report all
interest or dividends, or the Internal Revenue Service ("IRS") has notified me
that I am no longer subject thereto.
INSTRUCTION: YOU MUST STRIKE OUT THE LANGUAGE IN (2) ABOVE IF YOU HAVE BEEN
NOTIFIED THAT YOU ARE SUBJECT TO BACKUP WITHHOLDING DUE TO UNDERREPORTING AND
IF YOU HAVE NOT RECEIVED A NOTICE FROM THE IRS THAT BACKUP WITHHOLDING HAS
BEEN TERMINATED. THE UNDERSIGNED AUTHORIZES THE FURNISHING OF THIS
CERTIFICATION TO OTHER MERRILL LYNCH SPONSORED MUTUAL FUNDS.
..................................... .....................................
Signature of Owner Signature of Co-Owner (if any)
(In the case of co-owners, a joint tenancy with right of survivorship will be
presumed unless otherwise specified.)
- -------------------------------------------------------------------------------
4. LETTER OF INTENTION--CLASS A AND CLASS D SHARES ONLY (SEE TERMS AND
CONDITIONS IN THE STATEMENT OF ADDITIONAL INFORMATION)
..................., 19......
Dear Sir/Madam: Date of Initial Purchase
Although I am not obligated to do so, I intend to purchase shares of Merrill
Lynch North Carolina Municipal Bond Fund or any other investment company with
an initial sales charge or deferred sales charge for which Merrill Lynch Funds
Distributor, Inc. acts as distributor over the next 13-month period which will
equal or exceed:
[_] $25,000 [_] $50,000 [_] $100,000 [_] $250,000 [_] $1,000,000
Each purchase will be made at the then reduced offering price applicable to
the amount checked above, as described in the Merrill Lynch North Carolina
Municipal Bond Fund Prospectus.
I agree to the terms and conditions of the Letter of Intention. I hereby
irrevocably constitute and appoint Merrill Lynch Funds Distributor, Inc., my
attorney, with full power of substitution, to surrender for redemption any or
all shares of Merrill Lynch North Carolina Municipal Bond Fund held as
security.
By: ................................. .....................................
Signature of Owner Signature of Co-Owner
(If registered in joint names,
both must sign)
In making purchases under this letter, the following are the related
accounts on which reduced offering prices are to apply:
(1) Name............................. (2) Name.............................
Account Number.......................
Account Number.......................
- -------------------------------------------------------------------------------
5. FOR DEALER ONLY
Branch Office, Address, Stamp We hereby authorize Merrill Lynch
Funds Distributor, Inc. to act as
- - - our agent in connection with
transactions under this
authorization form and agree to
notify the Distributor of any
purchases made under a Letter of
Intention or Systematic Withdrawal
Plan. We guarantee the shareholder's
signature.
- - -
This form, when completed, should .....................................
be mailed to: Dealer Name and Address
By: .................................
Merrill Lynch North Carolina Authorized Signature of Dealer
Municipal Bond Fund
c/o Merrill Lynch Financial
Data Services, Inc.
P.O. Box 45289 [_][_][_] [_][_][_][_] .............
Jacksonville, FL 32232-5289 Branch Code F/C No. F/C Last Name
[_][_][_] [_][_][_][_]
Dealer's Customer Account No.
44
<PAGE>
MERRILL LYNCH NORTH CAROLINA MUNICIPAL BOND FUND -- AUTHORIZATION FORM (PART
2)
- -------------------------------------------------------------------------------
1. ACCOUNT REGISTRATION
Name of Owner......................
[ ][ ][ ] [ ][ ] [ ][ ][ ][ ]
Social Security Number or
Name of Co-Owner (if any).......... Taxpayer Identification
Number
Address............................ Account Number ....................
(if existing account)
...................................
- -------------------------------------------------------------------------------
2. SYSTEMATIC WITHDRAWAL PLAN--CLASS A AND D SHARES ONLY (SEE TERMS AND
CONDITIONS IN THE STATEMENT OF ADDITIONAL INFORMATION)
MINIMUM REQUIREMENTS: $10,000 for monthly disbursements, $5,000 for quarterly,
of [_] Class A or [_] Class D shares in Merrill Lynch North Carolina Municipal
Bond Fund at cost or current offering price. Withdrawals to be made either
(check one) [_] Monthly on the 24th day of each month, or [_] Quarterly on the
24th day of March, June, September and December. If the 24th falls on a
weekend or holiday, the next succeeding business day will be utilized. Begin
systematic withdrawal on or as soon as possible thereafter.
(month)
SPECIFY HOW YOU WOULD LIKE YOUR WITHDRAWAL PAID TO YOU (CHECK ONE): [_] $
or [_] % of the current value of [_] Class A or [_] Class D shares in the
account.
SPECIFY WITHDRAWAL METHOD: [_] check or [_] direct deposit to bank account
(check one and complete part (a) or (b) below):
DRAW CHECKS PAYABLE (CHECK ONE)
(a)I hereby authorize payment by check
[_] as indicated in Item 1.
[_] to the order of..........................................................
Mail to (check one)
[_] the address indicated in Item 1.
[_] Name (please print)......................................................
Address .......................................................................
..........................................................................
Signature of Owner.............................................................
Date..................
Signature of Co-Owner (if any).................................................
(B) I HEREBY AUTHORIZE PAYMENT BY DIRECT DEPOSIT TO MY BANK ACCOUNT AND, IF
NECESSARY, DEBIT ENTRIES AND ADJUSTMENTS FOR ANY CREDIT ENTRIES MADE TO MY
ACCOUNT. I AGREE THAT THIS AUTHORIZATION WILL REMAIN IN EFFECT UNTIL I PROVIDE
WRITTEN NOTIFICATION TO MERRILL LYNCH FINANCIAL DATA SERVICES, INC. AMENDING
OR TERMINATING THIS SERVICE.
Specify type of account (check one): [_] checking [_] savings
Name on your account...........................................................
Bank Name......................................................................
Bank Number........................ Account Number............................
Bank Address...................................................................
........................................................................
Signature of Depositor................................. Date..................
Signature of Depositor.........................................................
(If joint account, both must sign)
NOTE: IF DIRECT DEPOSIT IS ELECTED, YOUR BLANK, UNSIGNED CHECK MARKED "VOID"
OR A DEPOSIT SLIP FROM YOUR SAVINGS ACCOUNT SHOULD ACCOMPANY THIS APPLICATION.
45
<PAGE>
MERRILL LYNCH NORTH CAROLINA MUNICIPAL BOND FUND -- AUTHORIZATION FORM (PART
2) -- (CONTINUED)
- -------------------------------------------------------------------------------
3. APPLICATION FOR AUTOMATIC INVESTMENT PLAN
I hereby request that Merrill Lynch Financial Data Services, Inc. draw an
automated clearing house ("ACH") debit on my checking account as described
below each month to purchase: (choose one)
[_] Class A shares [_] Class B shares [_] Class C shares [_] Class D shares
of Merrill Lynch North Carolina Municipal Bond Fund subject to the terms set
forth below. In the event that I am not eligible to purchase Class A shares, I
understand that Class D shares will be purchased.
AUTHORIZATION TO HONOR ACH DEBITS
MERRILL LYNCH FINANCIAL DATA
SERVICES, INC.
DRAWN BY MERRILL LYNCH FINANCIAL
You are hereby authorized to draw an DATA SERVICES, INC.
ACH debit each month on my bank
account for investment in Merrill
Lynch North Carolina Municipal Bond
Fund as indicated below:
Amount of each ACH debit $........ To...............................Bank
(Investor's Bank)
Account number ...................
Bank Address.........................
Please date and invest ACH debits on
the 20th of each month beginning City...... State...... Zip Code......
(Month) or as soon
thereafter as possible. As a convenience to me, I hereby
request and authorize you to pay and
I agree that you are drawing these charge to my account ACH debits
ACH debits voluntarily at my request drawn on my account by and payable
and that you shall not be liable for to Merrill Lynch Financial Data
any loss arising from any delay in Services, Inc. I agree that your
preparing or failure to prepare any rights in respect to each such debit
such debit. If I change banks or shall be the same as if it were a
desire to terminate or suspend this check drawn on you and signed
program, I agree to notify you personally by me. This authority is
promptly in writing. I hereby to remain in effect until revoked
authorize you to take any action to personally by me in writing. Until
correct erroneous ACH debits of my you receive such notice, you shall
bank account or purchases of Fund be fully protected in honoring any
shares including liquidating shares such debit. I further agree that if
of the Fund and credit my bank any such debit be dishonored,
account. I further agree that if a whether with or without cause and
check or debit is not honored upon whether intentionally or
presentation, Merrill Lynch Financial inadvertently, you shall be under no
Data Services, Inc. is authorized to liability.
discontinue immediately the Automatic
Investment Plan and to liquidate ............ .....................
sufficient shares held in my account Date Signature of
to offset the purchase made with the Depositor
dishonored debit.
............ .....................
............ ..................... Bank Signature of Depositor
Date Signature of Account (If joint account,
Depositor Number both must sign)
......................
Signature of
Depositor
(If joint account,
both must sign)
NOTE: IF AUTOMATIC INVESTMENT PLAN IS ELECTED, YOUR BLANK, UNSIGNED CHECK
MARKED "VOID" SHOULD ACCOMPANY THIS APPLICATION.
46
<PAGE>
MANAGER
Fund Asset Management
Administrative Offices:
800 Scudders Mill Road
Plainsboro, New Jersey
Mailing Address:
P.O. Box 9011
Princeton, New Jersey 08543-9011
DISTRIBUTOR
Merrill Lynch Funds Distributor, Inc.
Administrative Offices:
800 Scudders Mill Road
Plainsboro, New Jersey
Mailing Address:
P.O. Box 9081
Princeton, New Jersey 08543-9081
CUSTODIAN
State Street Bank and Trust Company,
P.O. Box 351
Boston, Massachusetts 02101
TRANSFER AGENT
Merrill Lynch Financial Data Services, Inc.
Administrative Offices:
4800 Deer Lake Drive East
Jacksonville, Florida 32246-6484
Mailing Address:
P.O. Box 45289
Jacksonville, Florida 32232-5289
INDEPENDENT AUDITORS
Deloitte & Touche LLP
117 Campus Drive
Princeton, New Jersey 08540-6400
COUNSEL
Brown & Wood
One World Trade Center
New York, New York 10048-0557
<PAGE>
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, IN CONNECTION
WITH THE OFFER CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER
INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED BY THE TRUST, THE MANAGER OR THE DISTRIBUTOR. THIS PROSPECTUS DOES
NOT CONSTITUTE AN OFFERING IN ANY STATE IN WHICH SUCH OFFERING MAY NOT LAWFULLY
BE MADE.
-------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Fee Table.................................................................. 2
Merrill Lynch Select Pricing SM System..................................... 4
Financial Highlights....................................................... 8
Investment Objective and Policies.......................................... 9
Potential Benefits........................................................ 11
Special and Risk Considertions Relating to Municipal Bonds................ 11
Description of Municipal Bonds............................................ 12
When-Issued Securities and Delayed Delivery Transactions.................. 15
Call Rights............................................................... 15
Financial Futures Transactions and Options................................ 15
Repurchase Agreements..................................................... 17
Investment Restrictions................................................... 18
Management of the Trust.................................................... 19
Trustees.................................................................. 19
Management and Advisory Arrangements...................................... 19
Code of Ethics............................................................ 20
Transfer Agency Services.................................................. 21
Purchase of Shares......................................................... 21
Initial Sales Charge Alternatives--Class A and Class D Shares............. 23
Deferred Sales Charge Alternatives--Class B and Class C Shares............ 25
Distribution Plans........................................................ 28
Redemption of Shares....................................................... 31
Redemption................................................................ 31
Repurchase................................................................ 31
Reinstatement Privilege--Class A and Class D Shares....................... 32
Shareholder Services....................................................... 32
Automatic Reinvestment of Dividends and Capital Gains Distributions....... 34
Systematic Withdrawal Plans............................................... 34
Automatic Investment Plans................................................ 34
Portfolio Transactions..................................................... 35
Distributions and Taxes.................................................... 35
Distributions............................................................. 35
Taxes..................................................................... 36
Performance Data........................................................... 38
Additional Information..................................................... 40
Determination of Net Asset Value.......................................... 40
Organization of the Trust................................................. 40
Shareholder Reports....................................................... 41
Shareholder Inquiries..................................................... 42
Authorization Form......................................................... 43
</TABLE>
Code #16400-1195
LOGO MERRILL LYNCH
Merrill Lynch North Carolina
Municipal Bond Fund
Merrill Lynch Multi-State
Municipal Series Trust
[ART]
PROSPECTUS
November 1, 1995
Distributor:
Merrill Lynch
Funds Distributor, Inc.
This prospectus should be retained for future reference.
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
MERRILL LYNCH NORTH CAROLINA MUNICIPAL BOND FUND
MERRILL LYNCH MULTI-STATE MUNICIPAL SERIES TRUST
P.O. BOX 9011, PRINCETON, NEW JERSEY 08543-9011 . PHONE NO. (609) 282-2800
----------------
Merrill Lynch North Carolina Municipal Bond Fund (the "Fund") is a series of
Merrill Lynch Multi-State Municipal Series Trust (the "Trust"), an open-end
management investment company organized as a Massachusetts business trust. The
investment objective of the Fund is to provide shareholders with as high a
level of income exempt from Federal and North Carolina income taxes as is
consistent with prudent investment management. The Fund invests primarily in a
portfolio of long-term investment grade obligations issued by or on behalf of
the State of North Carolina, its political subdivisions, agencies and
instrumentalities and obligations of other qualifying issuers, such as issuers
located in Puerto Rico, the Virgin Islands and Guam, which pay interest exempt,
in the opinion of bond counsel to the issuer, from Federal and North Carolina
income taxes. There can be no assurance that the investment objective of the
Fund will be realized.
Pursuant to the Merrill Lynch Select PricingSM System, the Fund offers four
classes of shares, each with a different combination of sales charges, ongoing
fees and other features. The Merrill Lynch Select PricingSM System permits an
investor to choose the method of purchasing shares that the investor believes
is most beneficial given the amount of the purchase, the length of time the
investor expects to hold the shares and other relevant circumstances.
----------------
The Statement of Additional Information of the Fund is not a prospectus and
should be read in conjunction with the prospectus of the Fund, dated November
1, 1995 (the "Prospectus"), which has been filed with the Securities and
Exchange Commission and can be obtained, without charge, by calling or by
writing the Fund at the above telephone number or address. This Statement of
Additional Information has been incorporated by reference into the Prospectus.
----------------
FUND ASSET MANAGEMENT -- MANAGER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
----------------
The date of this Statement of Additional Information is November 1, 1995.
<PAGE>
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to provide shareholders with as high
a level of income exempt from Federal and North Carolina income taxes as is
consistent with prudent investment management. The Fund seeks to achieve its
objective by investing primarily in a portfolio of long-term obligations issued
by or on behalf of the State of North Carolina, its political subdivisions,
agencies and instrumentalities and obligations of other qualifying issuers,
such as issuers located in Puerto Rico, the Virgin Islands and Guam, which pay
interest exempt, in the opinion of bond counsel to the issuer, from Federal and
North Carolina income taxes. Obligations exempt from Federal income taxes are
referred to herein as "Municipal Bonds" and obligations exempt from both
Federal and North Carolina income taxes are referred to as "North Carolina
Municipal Bonds." Unless otherwise indicated, references to Municipal Bonds
shall be deemed to include North Carolina Municipal Bonds. The Fund anticipates
that at all times, except during temporary defensive periods, it will maintain
at least 65% of its total assets invested in North Carolina Municipal Bonds. At
times, the Fund may seek to hedge its portfolio through the use of futures
transactions to reduce volatility in the net asset value of Fund shares.
Reference is made to "Investment Objective and Policies" in the Prospectus for
a discussion of the investment objective and policies of the Fund.
Municipal Bonds may include general obligation bonds of the state and its
political subdivisions, revenue bonds of utility systems, highways, bridges,
port and airport facilities, colleges, hospitals, housing facilities, etc., and
industrial development bonds or private activity bonds. The interest on such
obligations may bear a fixed rate or be payable at a variable or floating rate.
The Municipal Bonds purchased by the Fund will be primarily what are commonly
referred to as "investment grade" securities, which are obligations rated at
the time of purchase within the four highest quality ratings as determined by
either Moody's Investors Service, Inc. ("Moody's") (currently Aaa, Aa, A and
Baa), Standard & Poor's Ratings Group ("Standard & Poor's") (currently AAA, AA,
A and BBB) or Fitch Investors Service, Inc. ("Fitch") (currently AAA, AA, A and
BBB). If unrated, such securities will possess creditworthiness comparable, in
the opinion of the manager of the Fund, Fund Asset Management, L.P. (the
"Manager"), to other obligations in which the Fund may invest.
The Fund ordinarily does not intend to realize investment income not exempt
from Federal and North Carolina income taxes. However, to the extent that
suitable North Carolina Municipal Bonds are not available for investment by the
Fund, the Fund may purchase Municipal Bonds issued by other states, their
agencies and instrumentalities, the interest income on which is exempt, in the
opinion of bond counsel, from Federal but not North Carolina taxation. The Fund
also may invest in securities not issued by or on behalf of a state or
territory or by an agency or instrumentality thereof if the Fund nevertheless
believes such securities to be exempt from Federal income taxation ("Non-
Municipal Tax-Exempt Securities"). Non-Municipal Tax-Exempt Securities may
include securities issued by other investment companies that invest in
municipal bonds to the extent permitted by the Investment Company Act of 1940,
as amended (the "1940 Act"). Non-Municipal Tax-Exempt Securities also could
include trust certificates or other instruments evidencing interests in one or
more long-term municipal securities.
Except when acceptable securities are unavailable as determined by the
Manager, the Fund, under normal circumstances, will invest at least 65% of its
total assets in North Carolina Municipal Bonds. For temporary periods or to
provide liquidity, the Fund has the authority to invest as much as 35% of its
total
2
<PAGE>
assets in tax-exempt or taxable money market obligations with a maturity of one
year or less (such short-term obligations being referred to herein as
"Temporary Investments"), except that taxable Temporary Investments shall not
exceed 20% of the Fund's net assets. The Fund at all times will have at least
80% of its net assets invested in securities exempt from Federal income
taxation. However, interest received on certain otherwise tax-exempt securities
which are classified as "private activity bonds" (in general, bonds that
benefit non-governmental entities) may be subject to an alternative minimum
tax. The Fund may purchase such private activity bonds. See "Distributions and
Taxes". In addition, the Fund reserves the right to invest temporarily a
greater portion of its assets in Temporary Investments for defensive purposes,
when, in the judgment of the Manager, market conditions warrant. The investment
objective of the Fund set forth in this paragraph is a fundamental policy of
the Fund which may not be changed without a vote of a majority of the
outstanding shares of the Fund. The Fund's hedging strategies are not
fundamental policies and may be modified by the Trustees of the Trust without
the approval of the Fund's shareholders.
Municipal Bonds may at times be purchased or sold on a delayed delivery basis
or a when-issued basis. These transactions arise when securities are purchased
or sold by the Fund with payment and delivery taking place in the future, often
a month or more after the purchase. The payment obligation and the interest
rate are each fixed at the time the buyer enters into the commitment. The Fund
will make only commitments to purchase such securities with the intention of
actually acquiring the securities, but the Fund may sell these securities prior
to the settlement date if it is deemed advisable. Purchasing Municipal Bonds on
a when-issued basis involves the risk that the yields available in the market
when the delivery takes place may actually be higher than those obtained in the
transaction itself; if yields so increase, the value of the when-issued
obligations generally will decrease. The Fund will maintain a separate account
at its custodian bank consisting of cash, cash equivalents or high-grade,
liquid Municipal Bonds or Temporary Investments (valued on a daily basis) equal
at all times to the amount of the when-issued commitment.
The Fund may invest in Municipal Bonds (and Non-Municipal Tax-Exempt
Securities) the return on which is based on a particular index of value or
interest rates. For example, the Fund may invest in Municipal Bonds that pay
interest based on an index of Municipal Bond interest rates or based on the
value of gold or some other commodity. The principal amount payable upon
maturity of certain Municipal Bonds also may be based on the value of an index.
Also, the Fund may invest in so-called "inverse floating obligations" or
"residual interest bonds" on which the interest rates typically decline as
market rates increase and increase as market rates decline. For example, to the
extent the Fund invests in these types of Municipal Bonds, the Fund's return on
such Municipal Bonds will be subject to risk with respect to the value of the
particular index, which may include reduced or eliminated interest payments and
losses of invested principal. Such securities have the effect of providing a
degree of investment leverage, since they may increase or decrease in value in
response to changes, as an illustration, in market interest rates at a rate
which is a multiple (typically two) of the rate of at which fixed-rate long-
term tax exempt securities increase or decrease in response to such changes. As
a result, the market values of such securities will generally be more volatile
than the market values of fixed-rate tax exempt securities. To seek to limit
the volatility of these securities, the Fund may purchase inverse floating
obligations with shorter term maturities or which contain limitations on the
extent to which the interest rate may vary. Certain investments in such
obligations may be illiquid. The Fund may not invest in such illiquid
obligations if such investments, together with other illiquid investments,
would exceed 15% (10% to the extent required by certain state laws) of the
Fund's total assets. The Manager, however, believes that indexed and inverse
floating obligations represent flexible portfolio management
3
<PAGE>
instruments for the Fund which allow the Fund to seek potential investment
rewards, hedge other portfolio positions or to vary the degree of investment
leverage relatively efficiently under different market conditions.
The Fund may purchase a Municipal Bond issuer's right to call all or a
portion of such Municipal Bond for mandatory tender for purchase (a "Call
Right"). A holder of a Call Right may exercise such right to require a
mandatory tender for the purchase of related Municipal Bonds, subject to
certain conditions. A Call Right that is not exercised prior to the maturity of
the related Municipal Bond will expire without value. The economic effect to
holding both the Call Right and the related Municipal Bond is identical to
holding a Municipal Bond as a non-callable security. Certain investments in
such obligations may be illiquid. The Fund may not invest in such illiquid
obligations if such investments, together with other illiquid investments,
would exceed 15% (10% to the extent required by certain state laws) of the
Fund's total assets.
The Fund may invest up to 20% of its total assets in Municipal Bonds which
are rated below Baa by Moody's or below BBB by Standard & Poor's or Fitch or
which, in the Manager's judgment, possess similar credit characteristics ("high
yield securities"). See Appendix II--"Ratings of Municipal Bonds"--for
additional information regarding ratings of debt securities. The Manager
considers the ratings assigned by Standard & Poor's, Moody's or Fitch as one of
several factors in its independent credit analysis of issuers.
High yield securities are considered by Standard & Poor's, Moody's and Fitch
to have varying degrees of speculative characteristics. Consequently, although
high yield securities can be expected to provide higher yields, such securities
may be subject to greater market price fluctuations and risk of loss of
principal than lower yielding, higher rated debt securities. Investments in
high yield securities will be made only when, in the judgment of the Manager,
such securities provide attractive total return potential relative to the risk
of such securities, as compared to higher quality debt securities. The Fund
will not invest in debt securities in the lowest rating categories (those rated
CC or lower by Standard & Poor's or Fitch or Ca or lower by Moody's) unless the
Manager believes that the financial condition of the issuer or the protection
afforded the particular securities is stronger than would otherwise be
indicated by such low ratings. The Fund does not intend to purchase debt
securities that are in default or which the Manager believes will be in
default.
Issuers of high yield securities may be highly leveraged and may not have
available to them more traditional methods of financing. Therefore, the risks
associated with acquiring the securities of such issuers generally are greater
than is the case with higher rated securities. For example, during an economic
downturn or a sustained period of rising interest rates, issuers of high yield
securities may be more likely to experience financial stress, especially if
such issuers or obligors are highly leveraged. During such periods, such
issuers may not have sufficient revenues to meet their interest payment
obligations. The issuer's ability to service its debt obligations also may be
adversely affected by specific issuer developments or the issuer's inability to
meet specific projected business forecasts or the unavailability of additional
financing. The risk of loss due to default by the issuer is significantly
greater for the holders of high yield securities because such securities may be
unsecured and may be subordinated to other creditors of the issuer.
High yield securities frequently have call or redemption features that would
permit an issuer to repurchase the security from the Fund. If a call were
exercised by the issuer during a period of declining interest rates, the Fund
would likely have to replace such called security with a lower yielding
security, thus decreasing the net investment income to the Fund and dividends
to shareholders.
4
<PAGE>
The Fund may have difficulty disposing of certain high yield securities
because there may be a thin trading market for such securities. Because not all
dealers maintain markets in all high yield securities, there is no established
secondary market for many of these securities, and the Fund anticipates that
such securities could be sold only to a limited number of dealers or
institutional investors. To the extent that a secondary trading market for high
yield securities does exist, it generally is not as liquid as the secondary
market for higher rated securities. Reduced secondary market liquidity may have
an adverse impact on market price and the Fund's ability to dispose of
particular issues when necessary to meet the Fund's liquidity needs or in
response to a specific economic event such as a deterioration in the
creditworthiness of the issuer. Reduced secondary market liquidity for certain
securities also may make it more difficult for the Fund to obtain accurate
market quotations for purposes of valuing the Fund's portfolio. Market
quotations are generally available on many high yield securities only from a
limited number of dealers and may not necessarily represent firm bids of such
dealers or prices for actual sales.
It is expected that a significant portion of the high yield securities
acquired by the Fund will be purchased upon issuance, which may involve special
risks because the securities so acquired are new issues. In such instances, the
Fund may be a substantial purchaser of the issue and therefore have the
opportunity to participate in structuring the terms of the offering. Although
this may enable the Fund to seek to protect itself against certain of such
risks, the considerations discussed herein would nevertheless remain
applicable.
Adverse publicity and investor perceptions, which may not be based on
fundamental analysis, also may decrease the value and liquidity of high yield
securities, particularly in a thinly traded market. Factors adversely affecting
the market value of high yield securities are likely to adversely affect the
Fund's net asset value. In addition, the Fund may incur additional expenses to
the extent that it is required to seek recovery upon a default on a portfolio
holding or participate in the restructuring of the obligation.
DESCRIPTION OF MUNICIPAL BONDS AND TEMPORARY INVESTMENTS
Set forth below is a description of the Municipal Bonds and Temporary
Investments in which the Fund may invest. A more complete discussion concerning
futures and options transactions is set forth under "Investment Objective and
Policies" in the Prospectus. Information with respect to ratings assigned to
tax-exempt obligations which the Fund may purchase is set forth in Appendix II
to this Statement of Additional Information.
DESCRIPTION OF MUNICIPAL BONDS
Municipal Bonds include debt obligations issued to obtain funds for various
public purposes, including construction of a wide range of public facilities,
refunding outstanding obligations and obtaining funds for general operating
expenses and loans to other public institutions and facilities. In addition,
certain types of industrial development bonds or private activity bonds are
issued by or on behalf of public authorities to finance or refinance various
privately owned or operated facilities, including pollution control facilities.
Such obligations are included within the term Municipal Bonds if the interest
paid thereon is, in the opinion of bond counsel, excluded from gross income for
Federal income tax purposes and, in the case of North Carolina Municipal Bonds,
exempt from taxable net income of individuals, corporations, estates and trusts
for North Carolina income tax purposes. Other types of industrial development
bonds or private activity bonds, the proceeds of which are used for the
construction, equipment or improvement of privately operated industrial
5
<PAGE>
facilities, may constitute Municipal Bonds, although the current Federal tax
laws place substantial limitations on the size of such issues.
The two principal classifications of Municipal Bonds are "general obligation"
and "revenue" bonds, which latter category includes industrial development
bonds ("IDBs") and, for bonds issued after August 15, 1986, private activity
bonds. General obligation bonds are secured by the issuer's pledge of its
faith, credit and taxing power for the payment of principal and interest.
Revenue bonds are payable only from the revenues derived from a particular
facility or class of facilities or, in some cases, from the proceeds of a
special or limited tax or other specific revenue source such as payments from
the user of the facility being financed. IDBs and, in the case of bonds issued
after August 15, 1986, private activity bonds are in most cases revenue bonds
and generally do not constitute the pledge of the credit or taxing power of the
issuer of such bonds. Generally, the payment of the principal of and interest
on such industrial development bonds depends solely on the ability of the user
of the facility financed by the bonds to meet its financial obligations and the
pledge, if any, of real and personal property so financed as security for such
payment, unless a letter of credit, bond insurance or other security is
furnished. The Fund also may invest in "moral obligation" bonds, which are
normally issued by special purpose public authorities. If an issuer of moral
obligation bonds is unable to meet its obligations, the repayment of such bonds
becomes a moral commitment, but not a legal obligation, of the state or
municipality in question.
Also included within the general category of Municipal Bonds are
participation certificates issued by government authorities or entities to
finance the acquisition or construction of equipment, land and/or facilities.
The certificates represent participations in a lease, an installment purchase
contract or a conditional sales contract (hereinafter collectively called
"lease obligations") relating to such equipment, land or facilities. Although
lease obligations do not constitute general obligations of the issuer for which
the issuer's unlimited taxing power is pledged, a lease obligation is
frequently backed by the issuer's covenant to budget for, appropriate and make
the payments due under the lease obligation. However, certain lease obligations
contain "non-appropriation" clauses, which provide that the issuer has no
obligation to make lease or installment purchase payments in future years
unless money is appropriated for such purpose on a yearly basis. Although "non-
appropriation" lease obligations are secured by the leased property,
disposition of the property in the event of foreclosure might prove difficult.
These securities represent a relatively new type of financing that has not yet
developed the depth of marketability associated with more conventional
securities. Certain investments in lease obligations may be illiquid. The Fund
may not invest in illiquid lease obligations if such investments, together with
all other illiquid investments, would exceed 15% (10% to the extent required by
certain state laws) of the Fund's total assets. The Fund may, however, invest
without regard to such limitation in lease obligations which the Manager,
pursuant to the guidelines which have been adopted by the Board of Trustees and
subject to the supervision of the Board of Trustees, determines to be liquid.
The Manager will deem lease obligations liquid if they are publicly offered and
have received an investment grade rating of Baa or better by Moody's, or BBB or
better by Standard & Poor's, or Fitch. Unrated lease obligations, or those
rated below investment grade, will be considered liquid if the obligations come
to the market through an underwritten public offering and at least two dealers
are willing to give competitive bids. In reference to the latter, the Manager
must, among other things, also review the creditworthiness of the municipality
obligated to make payment under the lease obligation and make certain specified
determinations based on such factors as the existence of a rating or credit
enhancement (such as insurance), the frequency of trades or quotes for the
obligations and the willingness of dealers to make a market in the obligations.
6
<PAGE>
Yields on Municipal Bonds are dependent on a variety of factors, including
the general condition of the money market and of the municipal bond market, the
size of a particular offering, the financial condition of the issuer, the
general conditions of the Municipal Bond market, the maturity of the obligation
and the rating of the issue. The ability of the Fund to achieve its investment
objective is also dependent on the continuing ability of the issuers of the
bonds in which the Fund invests to meet their obligations for the payment of
interest and principal when due. There are variations in the risks involved in
holding Municipal Bonds, both within a particular classification and between
classifications, depending on numerous factors. Furthermore, the rights of
owners of Municipal Bonds and the obligations of the issuer of such Municipal
Bonds may be subject to applicable bankruptcy, insolvency and similar laws and
court decisions affecting the rights of creditors generally and to general
equitable principles, which may limit the enforcement of certain remedies.
DESCRIPTION OF TEMPORARY INVESTMENTS
The Fund may invest in short-term tax-free and taxable securities subject to
the limitations set forth under "Investment Objective and Policies". The tax-
exempt money market securities may include municipal notes, municipal
commercial paper, municipal bonds with a remaining maturity of less than one
year, variable rate demand notes and participations therein. Municipal notes
include tax anticipation notes, bond anticipation notes and grant anticipation
notes. Anticipation notes are sold as interim financing in anticipation of tax
collection, bond sales, government grants or revenue receipts. Municipal
commercial paper refers to short-term unsecured promissory notes generally
issued to finance short-term credit needs. The taxable money market securities
in which the Fund may invest as Temporary Investments consist of U.S.
Government securities, U.S. Government agency securities, domestic bank or
savings institution certificates of deposit and bankers' acceptances, short-
term corporate debt securities such as commercial paper, and repurchase
agreements. These Temporary Investments must have a stated maturity not in
excess of one year from the date of purchase.
Variable rate demand obligations ("VRDOs") are tax-exempt obligations which
contain a floating or variable interest rate adjustment formula and an
unconditional right of demand on the part of the holder thereof to receive
payment of the unpaid principal balance plus accrued interest upon a short
notice period not to exceed seven days. There is, however, the possibility that
because of default or insolvency the demand feature of VRDOs and Participating
VRDOs, described below, may not be honored. The interest rates are adjustable
at intervals (ranging from daily to up to one year) to some prevailing market
rate for similar investments, such adjustment formula being calculated to
maintain the market value of the VRDO at approximately the par value of the
VRDOs on the adjustment date. The adjustments typically are based upon the
prime rate of a bank or some other appropriate interest rate adjustment index.
The Fund may invest in all types of tax-exempt instruments currently
outstanding or to be issued in the future which satisfy the short-term maturity
and quality standards of the Fund.
The Fund also may invest in VRDOs in the form of participation interests
("Participating VRDOs") in variable rate tax-exempt obligations held by a
financial institution, typically a commercial bank. Participating VRDOs provide
the Fund with a specified undivided interest (up to 100%) of the underlying
obligation and the right to demand payment of the unpaid principal balance plus
accrued interest on the Participating VRDOs from the financial institution upon
a specified number of days' notice, not to exceed seven days. In addition, a
Participating VRDO is backed by an irrevocable letter of credit or guaranty of
the financial
7
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institution. The Fund would have an undivided interest in the underlying
obligation and thus participate on the same basis as the financial institution
in such obligation except that the financial institution typically retains fees
out of the interest paid on the obligation for servicing the obligation,
providing the letter of credit and issuing the repurchase commitment. The Fund
has been advised by its counsel that the Fund should be entitled to treat the
income received on Participating VRDOs as interest from tax-exempt obligations.
VRDOs that contain an unconditional right of demand to receive payment of the
unpaid principal balance plus accrued interest on a notice period exceeding
seven days may be deemed to be illiquid securities. A VRDO with a demand notice
period exceeding seven days will therefore be subject to the Fund's restriction
on illiquid investments unless, in the judgment of the Trustees, such VRDO is
liquid. The Trustees may adopt guidelines and delegate to the Manager the daily
function of determining and monitoring liquidity of such VRDOs. The Trustees,
however, will retain sufficient oversight and will be ultimately responsible
for such determination.
The Trust has established the following standards with respect to money
market securities and VRDOs in which the Fund invests. Commercial paper
investments at the time of purchase must be rated A-1+ through A-3 by Standard
& Poor's, Prime-1 through Prime-3 by Moody's, or F-1+ through F-3 by Fitch or,
if not rated, issued by companies having an outstanding debt issue rated at
least A by Standard & Poor's, Fitch or Moody's. Investments in corporate bonds
and debentures (which must have maturities at the date of purchase of one year
or less) must be rated at the time of purchase at least A by Standard & Poor's,
Moody's or Fitch. Notes and VRDOs at the time of purchase must be rated SP-
1+/A-1+ through SP-2/A-3 by Standard & Poor's, MIG-l/VMIG-1 through MIG-4/VMIG-
4 by Moody's or F-1+ through F-3 by Fitch. Temporary Investments, if not rated,
must be of comparable quality to securities rated in the above rating
categories in the opinion of the Manager. The Fund may not invest in any
security issued by a commercial bank or a savings institution unless the bank
or institution is organized and operating in the United States, has total
assets of at least one billion dollars and is a member of the Federal Deposit
Insurance Corporation ("FDIC"), except that up to 10% of total assets may be
invested in certificates of deposit of small institutions if such certificates
are fully insured by the FDIC.
REPURCHASE AGREEMENTS
The Fund may invest in securities pursuant to repurchase agreements.
Repurchase agreements may be entered into only with a member bank of the
Federal Reserve System or a primary dealer in U.S. Government securities or an
affiliate thereof. Under such agreements, the seller agrees, upon entering into
the contract, to repurchase the security at a mutually agreed upon time and
price, thereby determining the yield during the term of the agreement. This
results in a fixed rate of return insulated from market fluctuations during
such period. In repurchase agreements, the prices at which the trades are
conducted do not reflect accrued interest on the underlying obligations. Such
agreements usually cover short periods, such as under one week. Repurchase
agreements may be construed to be collateralized loans by the purchaser to the
seller secured by the securities transferred to the purchaser. In a repurchase
agreement, the Fund will require the seller to provide additional collateral if
the market value of the securities falls below the repurchase price at any time
during the term of the repurchase agreement. In the event of default by the
seller under a repurchase agreement construed to be a collateralized loan, the
underlying securities are not owned by the Fund but only constitute collateral
for the seller's obligation to pay the repurchase price. Therefore, the Fund
may
8
<PAGE>
suffer time delays and incur costs or possible losses in connection with the
disposition of the collateral. In the event of a default under such a
repurchase agreement, instead of the contractual fixed rate of return, the rate
of return to the Fund will depend on intervening fluctuations of the market
value of such security and the accrued interest on the security. In such event,
the Fund would have rights against the seller for breach of contract with
respect to any losses arising from market fluctuations following the failure of
the seller to perform. The Fund may not invest in repurchase agreements
maturing in more than seven days if such investments, together with all other
illiquid investments, would exceed 15% (10% to the extent required by certain
state laws) of the Fund's total assets.
In general, for Federal income tax purposes, repurchase agreements are
treated as collateralized loans secured by the securities "sold". Therefore,
amounts earned under such agreements will not be considered tax-exempt
interest. However, it is likely that income from such arrangements also will
not be considered tax-exempt interest.
FINANCIAL FUTURES TRANSACTIONS AND OPTIONS
Reference is made to the discussion concerning futures transactions under
"Investment Objective and Policies" in the Prospectus. Set forth below is
additional information concerning these transactions.
As described in the Prospectus, the Fund may purchase and sell exchange
traded financial futures contracts ("financial futures contracts") to hedge its
portfolio of Municipal Bonds against declines in the value of such securities
and to hedge against increases in the cost of securities the Fund intends to
purchase. However, any transactions involving financial futures or options (or
puts and calls associated therewith) will be in accordance with the Fund's
investment policies and limitations. See "Investment Objective and Policies--
Investment Restrictions" in the Prospectus. To hedge its portfolio, the Fund
may take an investment position in a futures contract which will move in the
opposite direction from the portfolio position being hedged. While the Fund's
use of hedging strategies is intended to moderate capital changes in portfolio
holdings and thereby reduce the volatility of the net asset value of Fund
shares, the Fund anticipates that its net asset value will fluctuate. Set forth
below is information concerning futures transactions.
Description of Futures Contracts. A futures contract is an agreement between
two parties to buy and sell a security or, in the case of an index-based
futures contract, to make and accept a cash settlement for a set price on a
future date. A majority of transactions in futures contracts, however, do not
result in the actual delivery of the underlying instrument or cash settlement,
but are settled through liquidation, i.e., by entering into an offsetting
transaction. Futures contracts have been designed by boards of trade which have
been designated "contracts markets" by the Commodity Futures Trading Commission
("CFTC").
The purchase or sale of a futures contract differs from the purchase or sale
of a security in that no price or premium is paid or received. Instead, an
amount of cash or securities acceptable to the broker and the relevant contract
market, which varies, but is generally about 5% of the contract amount, must be
deposited with the broker. This amount is known as "initial margin" and
represents a "good faith" deposit assuring the performance of both the
purchaser and seller under the futures contract. Subsequent payments to and
from the broker, called "variation margin", are required to be made on a daily
basis as the price of the futures contract fluctuates making the long and short
positions in the futures contract more or less valuable, a process known as
"mark to the market". At any time prior to the settlement date of the futures
contract, the position
9
<PAGE>
may be closed out by taking an opposite position which will operate to
terminate the position in the futures contract. A final determination of
variation margin is then made, additional cash is required to be paid to or
released by the broker, and the purchaser realizes a loss or gain. In addition,
a nominal commission is paid on each completed sale transaction.
The Fund may deal in financial futures contracts based on a long-term
municipal bond index developed by the Chicago Board of Trade ("CBT") and The
Bond Buyer (the "Municipal Bond Index"). The Municipal Bond Index is comprised
of 40 tax-exempt municipal revenue and general obligations bonds. Each bond
included in the Municipal Bond Index must be rated A or higher by Moody's or
Standard & Poor's and must have a remaining maturity of 19 years or more. Twice
a month new issues satisfying the eligibility requirements are added to, and an
equal number of old issues are deleted from, the Municipal Bond Index. The
value of the Municipal Bond Index is computed daily according to a formula
based on the price of each bond in the Municipal Bond Index, as evaluated by
six dealer-to-dealer brokers.
The Municipal Bond Index futures contract is traded only on the CBT. Like
other contract markets, the CBT assures performance under futures contracts
through a clearing corporation, a nonprofit organization managed by the
exchange membership which is also responsible for handling daily accounting of
deposits or withdrawals of margin.
As described in the Prospectus, the Fund may purchase and sell financial
futures contracts on U.S. Government securities as a hedge against adverse
changes in interest rates as described below. With respect to U.S. Government
securities, currently there are financial futures contracts based on long-term
U.S. Treasury bonds, Treasury notes, Government National Mortgage Association
("GNMA") Certificates and three-month U.S. Treasury bills. The Fund may
purchase and write call and put options on futures contracts on U.S. Government
securities in connection with its hedging strategies.
Subject to policies adopted by the Trustees, the Fund also may engage in
other futures contracts transactions such as futures contracts on other
municipal bond indices which may become available if the Manager and the
Trustees should determine that there is normally a sufficient correlation
between the prices of such futures contracts and the Municipal Bonds in which
the Fund invests to make such hedging appropriate.
Futures Strategies. The Fund may sell a financial futures contract (i.e.,
assume a short position) in anticipation of a decline in the value of its
investments in Municipal Bonds resulting from an increase in interest rates or
otherwise. The risk of decline could be reduced without employing futures as a
hedge by selling such Municipal Bonds and either reinvesting the proceeds in
securities with shorter maturities or by holding assets in cash. This strategy,
however, entails increased transaction costs in the form of dealer spreads and
typically would reduce the average yield of the Fund's portfolio securities as
a result of the shortening of maturities. The sale of futures contracts
provides an alternative means of hedging against declines in the value of its
investments in Municipal Bonds. As such values decline, the value of the Fund's
positions in the futures contracts will tend to increase, thus offsetting all
or a portion of the depreciation in the market value of the Fund's Municipal
Bond investments which are being hedged. While the Fund will incur commission
expenses in selling and closing out futures positions, commissions on futures
transactions are lower than transaction costs incurred in the purchase and sale
of Municipal Bonds. In addition, the ability of the Fund to trade in
10
<PAGE>
the standardized contracts available in the futures markets may offer a more
effective defensive position than a program to reduce the average maturity of
the portfolio securities due to the unique and varied credit and technical
characteristics of the municipal debt instruments available to the Fund.
Employing futures as a hedge also may permit the Fund to assume a defensive
posture without reducing the yield on its investments beyond any amounts
required to engage in futures trading.
When the Fund intends to purchase Municipal Bonds, the Fund may purchase
futures contracts as a hedge against any increase in the cost of such North
Carolina Municipal Bonds or Municipal Bonds, resulting from an increase in
interest rates or otherwise, that may occur before such purchases can be
effected. Subject to the degree of correlation between the Municipal Bonds and
the futures contracts, subsequent increases in the cost of Municipal Bonds
should be reflected in the value of the futures held by the Fund. As such
purchases are made, an equivalent amount of futures contracts will be closed
out. Due to changing market conditions and interest rate forecasts, however, a
futures position may be terminated without a corresponding purchase of
portfolio securities.
Call Options on Futures Contracts. The Fund also may purchase and sell
exchange traded call and put options on financial futures contracts on U.S.
Government securities. The purchase of a call option on a futures contract is
analogous to the purchase of a call option on an individual security. Depending
on the pricing of the option compared to either the futures contract on which
it is based or on the price of the underlying debt securities, it may or may
not be less risky than ownership of the futures contract or underlying debt
securities. Like the purchase of a futures contract, the Fund will purchase a
call option on a futures contract to hedge against a market advance when the
Fund is not fully invested.
The writing of a call option on a futures contract constitutes a partial
hedge against declining prices of the securities which are deliverable upon
exercise of the futures contract. If the futures price at expiration is below
the exercise price, the Fund will retain the full amount of the option premium
which provides a partial hedge against any decline that may have occurred in
the Fund's portfolio holdings.
Put Options on Futures Contracts. The purchase of options on a futures
contract is analogous to the purchase of protective put options on portfolio
securities. The Fund will purchase put options on futures contracts to hedge
the Fund's portfolio against the risk of rising interest rates.
The writing of a put option on a futures contract constitutes a partial hedge
against increasing prices of the securities which are deliverable upon exercise
of the futures contract. If the futures price at expiration is higher than the
exercise price, the Fund will retain the full amount of the option premium
which provides a partial hedge against any increase in the price of Municipal
Bonds which the Fund intends to purchase.
The writer of an option on a futures contract is required to deposit initial
and variation margin pursuant to requirements similar to those applicable to
futures contracts. Premiums received from the writing of an option will be
included in initial margin. The writing of an option on a futures contract
involves risks similar to those relating to futures contracts.
----------------
The Trust has received an order from the Securities and Exchange Commission
(the "Commission") exempting it from the provisions of Section 17(f) and
Section 18(f) of the 1940 Act in connection with its
11
<PAGE>
strategy of investing in futures contracts. Section 17(f) relates to the
custody of securities and other assets of an investment company and may be
deemed to prohibit certain arrangements between the Trust and commodities
brokers with respect to initial and variation margin. Section 18(f) of the 1940
Act prohibits an open-end investment company such as the Trust from issuing a
"senior security" other than a borrowing from a bank. The staff of the
Commission has in the past indicated that a futures contract may be a "senior
security" under the 1940 Act.
Restrictions on Use of Futures Transactions. Regulations of the CFTC
applicable to the Fund require that all of the Fund's futures transactions
constitute bona fide hedging transactions and that the Fund purchase and sell
futures contracts and options thereon (i) for bona fide hedging purposes, and
(ii) for non-hedging purposes, if the aggregate initial margin and premiums
required to establish positions in such contracts and options does not exceed
5% of the liquidation value of the Fund's portfolio assets after taking into
account unrealized profits and unrealized losses on any such contracts and
options. (However, the Fund intends to engage in options and futures
transactions only for hedging purposes). Margin deposits may consist of cash or
securities acceptable to the broker and the relevant contract market.
When the Fund purchases futures contracts or a call option with respect
thereto or writes a put option on a futures contract, an amount of cash, cash
equivalents or short-term, high-grade, fixed income securities will be
deposited in a segregated account with the Fund's custodian so that the amount
so segregated, plus the amount of initial and variation margin held in the
account of its broker, equals the market value of the futures contract, thereby
ensuring that the use of such futures is unleveraged.
Risk Factors in Futures Transactions and Options. Investment in futures
contracts involves the risk of imperfect correlation between movements in the
price of the futures contract and the price of the security being hedged. The
hedge will not be fully effective when there is imperfect correlation between
the movements in the prices of two financial instruments. For example, if the
price of the futures contract moves more than the price of the hedged security,
the Fund will experience either a loss or gain on the futures contract which is
not completely offset by movements in the price of the hedged securities. To
compensate for imperfect correlations, the Fund may purchase or sell futures
contracts in a greater dollar amount than the hedged securities if the
volatility of the hedged securities is historically greater than the volatility
of the futures contracts. Conversely, the Fund may purchase or sell fewer
futures contracts if the volatility of the price of the hedged securities is
historically less than that of the futures contracts.
The particular municipal bonds comprising the index underlying the Municipal
Bond Index financial futures contracts may vary from the bonds held by the
Fund. As a result, the Fund's ability to hedge effectively all or a portion of
the value of its Municipal Bonds through the use of such financial futures
contracts will depend in part on the degree to which price movements in the
index underlying the financial futures contract correlate with the price
movements of the Municipal Bonds held by the Fund. The correlation may be
affected by disparities in the average maturity, ratings, geographical mix or
structure of the Fund's investments as compared to those comprising the
Municipal Bond Index and general economic or political factors. In addition,
the correlation between movements in the value of the Municipal Bond Index may
be subject to change over time as additions to and deletions from the Municipal
Bond Index alter its structure. The correlation between futures contracts on
U.S. Government securities and the Municipal Bonds held by the Fund may be
adversely affected by similar factors, and the risk of imperfect correlation
between
12
<PAGE>
movements in the prices of such futures contracts and the prices of the
Municipal Bonds held by the Fund may be greater.
The Fund expects to liquidate a majority of the futures contracts it enters
into through offsetting transactions on the applicable contract market. There
can be no assurance, however, that a liquid secondary market will exist for any
particular futures contract at any specific time. Thus, it may not be possible
to close out a futures position. In the event of adverse price movements, the
Fund would continue to be required to make daily cash payments of variation
margin. In such situations, if the Fund has insufficient cash, it may be
required to sell portfolio securities to meet daily variation margin
requirements at a time when it may be disadvantageous to do so. The inability
to close out futures positions also could have an adverse impact on the Fund's
ability to hedge effectively its investments in Municipal Bonds. The Fund will
enter into a futures position only if, in the judgment of the Manager, there
appears to be an actively traded secondary market for such futures contracts.
The successful use of transactions in futures and related options also
depends on the ability of the Manager to forecast correctly the direction and
extent of interest rate movements within a given time frame. To the extent
interest rates remain stable during the period in which a futures contract or
option is held by the Fund or such rates move in a direction opposite to that
anticipated, the Fund may realize a loss on the hedging transaction which is
not fully or partially offset by an increase in the value of portfolio
securities. As a result, the Fund's total return for such period may be less
than if it had not engaged in the hedging transaction.
Because of low initial margin deposits made on the opening of a futures
position, futures transactions involve substantial leverage. As a result,
relatively small movements in the price of the futures contracts can result in
substantial unrealized gains or losses. Because the Fund will engage in the
purchase and sale of futures contracts solely for hedging purposes, however,
any losses incurred in connection therewith should, if the hedging strategy is
successful, be offset in whole or in part by increases in the value of
securities held by the Fund or decreases in the price of securities the Fund
intends to acquire.
The amount of risk the Fund assumes when it purchases an option on a futures
contract is the premium paid for the option plus related transaction costs. In
addition to the correlation risks discussed above, the purchase of an option on
a futures contract also entails the risk that changes in the value of the
underlying futures contract will not be fully reflected in the value of the
option purchased.
Municipal Bond Index futures contracts were approved for trading in 1986.
Trading in such futures contracts may tend to be less liquid than that in other
futures contracts. The trading of futures contracts also is subject to certain
market risks, such as inadequate trading activity, which could at times make it
difficult or impossible to liquidate existing positions.
INVESTMENT RESTRICTIONS
The Fund has adopted a number of fundamental and non-fundamental restrictions
and policies relating to the investment of its assets and its activities. The
fundamental policies set forth below may not be changed without the approval of
the holders of a majority of the Fund's outstanding voting securities (which
for this
13
<PAGE>
purpose and under the 1940 Act means the lesser of (i) 67% of the Fund's shares
present at a meeting at which more than 50% of the outstanding shares of the
Fund are represented or (ii) more than 50% of the Fund's outstanding shares).
The Fund may not:
1. Invest more than 25% of its assets, taken at market value at the time
of each investment, in the securities of issuers in any particular industry
(excluding the U.S. Government and its agencies and instrumentalities). For
purposes of this restriction, states, municipalities and their political
subdivisions are not considered part of any industry.
2. Make investments for the purpose of exercising control or management.
3. Purchase or sell real estate, except that to the extent permitted by
applicable law, the Fund may invest in securities directly or indirectly
secured by real estate or interests therein or issued by companies which
invest in real estate or interests therein.
4. Make loans to other persons, except that the acquisition of bonds,
debentures or other corporate debt securities and investment in government
obligations, commercial paper, pass-through instruments, certificates of
deposit, bankers' acceptances, repurchase agreements or any similar
instruments shall not be deemed to be the making of a loan, and except
further that the Fund may lend its portfolio securities, provided that the
lending of portfolio securities may be made only in accordance with
applicable law and the guidelines set forth in the Fund's Prospectus and
Statement of Additional Information, as they may be amended from time to
time.
5. Issue senior securities to the extent such issuance would violate
applicable law.
6. Borrow money, except that (i) the Fund may borrow from banks (as
defined in the 1940 Act) in amounts up to 33 1/3% of its total assets
(including the amount borrowed), (ii) the Fund may borrow up to an
additional 5% of its total assets for temporary purposes, (iii) the Fund
may obtain such short-term credit as may be necessary for the clearance of
purchases and sales of portfolio securities and (iv) the fund may purchase
securities on margin to the extent permitted by applicable law. The Fund
may not pledge its assets other than to secure such borrowings or, to the
extent permitted by the Fund's investment policies as set forth in its
Prospectus and Statement of Additional Information, as they may be amended
from time to time, in connection with hedging transactions, short sales,
when-issued and forward commitment transactions and similar investment
strategies.
7. Underwrite securities of other issuers, except insofar as the Fund
technically may be deemed an underwriter under the Securities Act of 1933,
as amended (the "Securities Act"), in selling portfolio securities.
8. Purchase or sell commodities or contracts on commodities, except to
the extent that the Fund may do so in accordance with applicable law and
the Fund's Prospectus and Statement of Additional Information, as they may
be amended from time to time, and without registering as a commodity pool
operator under the Commodity Exchange Act.
Under the non-fundamental investment restrictions, the Fund may not:
a. Purchase securities of other investment companies, except to the
extent such purchases are permitted by applicable law.
b. Make short sales of securities or maintain a short position, except to
the extent permitted by applicable law. The Fund currently does not intend
to engage in short sales, except short sales "against the box".
14
<PAGE>
c. Invest in securities which cannot be readily resold because of legal
or contractual restrictions or which cannot otherwise be marketed, redeemed
or put to the issuer or a third party, if at the time of acquisition more
than 15% of its total assets would be invested in such securities. This
restriction shall not apply to securities which mature within seven days or
securities which the Board of Trustees of the Trust has otherwise
determined to be liquid pursuant to applicable law. Notwithstanding the 15%
limitation herein, to the extent the laws of any state in which the Fund's
shares are registered or qualified for sale require a lower limitation, the
Fund will observe such limitation. As of the date hereof, therefore, the
Fund will not invest more than 10% of its total assets in securities which
are subject to this investment restriction (c).
d. Invest in warrants if, at the time of acquisition, its investments in
warrants, valued at the lower of cost or market value, would exceed 5% of
the Fund's total assets; included within such limitation, but not to exceed
2% of the Fund's total assets, are warrants which are not listed on the New
York Stock Exchange or American Stock Exchange or a major foreign exchange.
For purposes of this restriction, warrants acquired by the Fund in units or
attached to securities may be deemed to be without value.
e. Invest in securities of companies having a record, together with
predecessors, of less than three years of continuous operation, if more
than 5% of the Fund's total assets would be invested in such securities.
This restriction shall not apply to mortgage-backed securities, asset-
backed securities or obligations issued or guaranteed by the U.S.
Government, its agencies or instrumentalities.
f. Purchase or retain the securities of any issuer, if those individual
officers and Trustees of the Fund, the officers and general partner of the
Manager, the directors of such general partner or the officers and
directors of any subsidiary thereof each owning beneficially more than one-
half of one percent of the securities of such issuer own in the aggregate
more than 5% of the securities of such issuer.
g. Invest in real estate limited partnership interests or interests in
oil, gas or other mineral leases, or exploration or development programs,
except that the Fund may invest in securities issued by companies that
engage in oil, gas or other mineral exploration or development activities.
h. Write, purchase or sell puts, calls, straddles, spreads or
combinations thereof, except to the extent permitted in the Fund's
Prospectus and Statement of Additional Information, as they may be amended
from time to time.
i. Notwithstanding non-fundamental investment restriction (6) above,
borrow amounts in excess of 20% of its total assets, taken at market value
(including the amount borrowed), and then only from banks as a temporary
measure for extraordinary or emergency purposes. In addition, the Fund will
not purchase securities while borrowings are outstanding.
In addition, to comply with Federal income tax requirements for qualification
as a "regulated investment company", the Fund's investments will be limited in
a manner such that, at the close of each quarter of each fiscal year, (a) no
more than 25% of the Fund's total assets are invested in the securities of a
single issuer, and (b) with regard to at least 50% of the Fund's total assets,
no more than 5% of its total assets are invested in the securities of a single
issuer. For purposes of this restriction, the Fund will regard each state and
each political subdivision, agency or instrumentality of such state and each
multi-state agency of which such state is a member and each public authority
which issues securities on behalf of a private entity as a separate issuer,
except that if the security is backed only by the assets and revenues of a non-
governmental entity then the
15
<PAGE>
entity with the ultimate responsibility for the payment of interest and
principal may be regarded as the sole issuer. These tax-related limitations may
be changed by the Trustees of the Trust to the extent necessary to comply with
changes to the Federal income tax requirements.
----------------
Because of the affiliation of Merrill Lynch with the Fund, the Fund is
prohibited from engaging in certain transactions involving Merrill Lynch except
pursuant to a permissive order or otherwise in compliance with the provisions
of the Investment Company Act and the rules and regulations thereunder.
Included among such restricted transactions are purchases from or sales to
Merrill Lynch of securities in transactions in which it acts as principal. See
"Portfolio Transactions". An exemptive order has been obtained which permits
the Trust to effect principal transactions with Merrill Lynch in high quality,
short-term, tax-exempt securities subject to conditions set forth in such
order.
MANAGEMENT OF THE TRUST
TRUSTEES AND OFFICERS
Information about the Trustees, executive officers and portfolio manager of
the Trust, including their ages and principal occupations for at least the last
five years, is set forth below. Unless otherwise noted, the address of each
Trustee and executive officer is P.O. Box 9011, Princeton, New Jersey 08543-
9011.
Arthur Zeikel (63)--President and Trustee(1)(2)--President of the Manager
(which term as used herein includes the Manager's corporate predecessors) since
1977; President of MLAM (which term as used herein includes MLAM's corporate
predecessors) since 1977; President and Director of Princeton Services, Inc.
("Princeton Services") since 1993; Executive Vice President of Merrill Lynch &
Co., Inc. ("ML & Co.") since 1990; Executive Vice President of Merrill Lynch
since 1990 and a Senior Vice President thereof from 1985 to 1990; Director of
Merrill Lynch Funds Distributor, Inc. ("MLFD" or the "Distributor") since 1991.
James H. Bodurtha (51)--Trustee(2)--124 Long Pond Road, Plymouth,
Massachusetts 02360. Chairman and Chief Executive Officer, China Enterprise
Management Corporation since 1993; Chairman, Berkshire Corporation since 1980;
Partner, Squire, Sanders & Dempsey from 1980 to 1993.
Herbert I. London (56)--Trustee(2)--113-115 University Place, New York, New
York 10003. Dean, Gallatin Division of New York University from 1978 to 1993;
Professor, New York University since 1973; John M. Olin Professor of
Humanities, New York University, since 1993; Distinguished Fellow, Herman Kahn
Chair, Hudson Institute from 1984 to 1985; Trustee, Hudson Naval Institute
since 1980; Director, Damon Corporation since 1991; Overseer, Center for Naval
Analyses from 1983 to 1993.
Robert R. Martin (68)--Trustee(2)--513 Grand Hill, St. Paul, Minnesota 55102.
Director, WTC Industries, Inc., since 1995 and Chairman thereof from 1994 to
1995; Chairman and Chief Executive Officer, Kinnard Investments, Inc. from 1990
to 1993; Executive Vice President, Dain Bosworth from 1974 to 1989;
16
<PAGE>
Director, Carnegie Capital Management from 1977 to 1985 and Chairman thereof
in 1979; Director, Securities Industry Association from 1981 to 1982 and
Public Securities Association from 1979 to 1980; Trustee, Northland College
since 1992.
Joseph L. May (66)--Trustee(2)--424 Church Street, Suite 2000, Nashville,
Tennessee 37219. Attorney in private practice since 1984; President, May and
Athens Hosiery Mills Division, Wayne-Gossard Corporation from 1954 to 1983;
Vice President, Wayne-Gossard Corporation from 1972 to 1983; Chairman, The May
Corporation (personal holding company) from 1972 to 1983; Director, Signal
Apparel Co. from 1972 to 1989.
Andre F. Perold (43)--Trustee(2)--Morgan Hall, Soldiers Field, Boston,
Massachusetts 02163. Professor, Harvard Business School since 1989 and
Associate Professor from 1983 to 1989; Trustee, The Common Fund, since 1989;
Director, Quantec Limited since 1991 and Tenekron Software Systems since 1994.
Terry K. Glenn (55)--Executive Vice President(1)(2)--Executive Vice
President of the Manager and MLAM since 1983; Executive Vice President and
Director of Princeton Services since 1993; President of MLFD since 1986 and
Director thereof since 1991.
Vincent R. Giordano (51)--Vice President(1)(2)--Portfolio Manager of the
Manager and MLAM since 1977 and Senior Vice President of the Manager and MLAM
since 1984; Vice President of MLAM from 1980 to 1984; Senior Vice President of
Princeton Services since 1993.
Kenneth A. Jacob (44)--Vice President(1)(2)--Vice President of the Manager
and MLAM since 1984.
Fred Stuebe (44)--Portfolio Manager(1)(2)--Vice President of MLAM since
1989.
Donald C. Burke (35)--Vice President(1)(2)--Vice President and Director of
Taxation of MLAM since 1990; Employee of Deloitte & Touche LLP from 1982 to
1990.
Gerald M. Richard (46)--Treasurer(1)(2)--Senior Vice President and Treasurer
of the Manager and MLAM since 1984; Senior Vice President and Treasurer of
Princeton Services since 1993; Treasurer of MLFD since 1984 and Vice President
thereof since 1981.
Jerry Weiss (37)--Secretary(1)(2)--Vice President of MLAM since 1990;
Attorney in private practice from 1982 to 1990.
- --------
(1) Interested person, as defined in the 1940 Act, of the Trust.
(2) Such Trustee or officer is a director or officer of certain other
investment companies for which the Manager or MLAM acts as investment
adviser or manager.
At September 30, 1995, the Trustees and officers of the Trust as a group (12
persons) owned an aggregate of less than 1/4 of 1% of the outstanding shares
of Common Stock of ML & Co. and owned an aggregate of less than 1% of the
outstanding shares of the Fund.
17
<PAGE>
COMPENSATION OF TRUSTEES
The Trust pays each Trustee not affiliated with the Manager a fee of $10,000
per year plus $1,000 per meeting attended, together with such Trustee's actual
out-of-pocket expenses relating to attendance at meetings. The Trust also
compensates members of its Audit and Nominating Committee, which consists of
all the non-affiliated Trustees, an annual fee of $2,000 plus $500 per
committee meeting attended. The Trust reimburses each unaffiliated Trustee for
his out-of-pocket expenses relating to attendance at Board and committee
meetings. The fees and expenses of the Trustees are allocated to the
respective series of the Trust on the basis of asset size. For the fiscal year
ended July 31, 1995, fees and expenses paid to non-affiliated Trustees
aggregated $2,967.
The following table sets forth for the fiscal year ended July 31, 1995,
compensation paid by the Fund to the non-affiliated Trustees and, for the
calendar year ended December 31, 1994, the aggregate compensation paid by all
investment companies (including the Fund) advised by FAM and its affiliate,
MLAM ("FAM/MLAM Advised Funds") to the non-affiliated Trustees:
<TABLE>
<CAPTION>
AGGREGATE
PENSION OR COMPENSATION
RETIREMENT FROM FUND AND
BENEFITS FAM/MLAM
ACCRUED AS ADVISED FUNDS
COMPENSATION PART OF FUND PAID TO
NAME OF TRUSTEE FROM FUND EXPENSE TRUSTEES(1)
- --------------- ------------ ------------ -------------
<S> <C> <C> <C>
James H. Bodurtha....................... $126 None $168,250*
Herbert I. London....................... $594 None $168,250
Robert R. Martin........................ $594 None $168,250
Joseph L. May........................... $594 None $168,250
Andre F. Perold......................... $594 None $168,250
</TABLE>
- --------
(1) In addition to the Trust, the Trustees serve on the boards of other
FAM/MLAM Advised Funds as follows: Mr. Bodurtha (46 funds); Mr. London (46
funds); Mr. Martin (46 funds); Mr. May (46 funds); and Mr. Perold (46
funds).
* $168,250 represents the amount Mr. Bodurtha would have received if he had
been a Trustee for the entire calendar year ended December 31, 1994. Mr.
Bodurtha was elected to the Trust's Board of Trustees effective June 23,
1995.
MANAGEMENT AND ADVISORY ARRANGEMENTS
Reference is made to "Management of the Trust--Management and Advisory
Arrangements" in the Prospectus for certain information concerning the
management and advisory arrangements of the Fund.
Securities may be held by, or be appropriate investments for, the Fund as
well as other funds or investment advisory clients of the Manager or its
affiliates. Because of different objectives or other factors, a particular
security may be bought for one or more clients when one or more clients are
selling the same security. If purchases or sales of securities for the Fund or
other funds for which they act as manager or for their advisory clients arise
for consideration at or about the same time, transactions in such securities
will be made, insofar as feasible, for the respective funds and clients in a
manner deemed equitable to all. To the extent that transactions on behalf of
more than one client of the Manager or its affiliates during the same
18
<PAGE>
period may increase the demand for securities being purchased or the supply of
securities being sold, there may be an adverse effect on price.
Pursuant to a management agreement between the Trust on behalf of the Fund
and the Manager (the "Management Agreement"), the Manager receives for its
services to the Fund monthly compensation based upon the average daily net
assets of the Fund at the following annual rates: 0.55% of the average daily
net assets not exceeding $500 million; 0.525% of the average daily net assets
exceeding $500 million but not exceeding $1.0 billion; and 0.50% of the average
daily net assets exceeding $1.0 billion. For the year ended July 31, 1994, the
total advisory fees payable by the Fund to the Manager aggregated $323,712, of
which $264,567 was voluntarily waived. For the fiscal year ended July 31, 1995,
the total advisory fees paid by the Fund to the Manager was $331,791, of which
$133,074 was voluntarily waived.
The Management Agreement obligates the Manager to provide investment advisory
services and to pay all compensation of and furnish office space for officers
and employees of the Trust connected with investment and economic research,
trading and investment management of the Trust, as well as the fees of all
Trustees of the Trust who are affiliated persons of ML & Co. or any of its
affiliates. The Fund pays all other expenses incurred in its operation and, if
other Series shall be added ("Series"), a portion of the Trust's general
administrative expenses will be allocated on the basis of the asset size of the
respective Series. Expenses that will be borne directly by the Series include,
among other things, redemption expenses, expenses of portfolio transactions,
expenses of registering the shares under Federal and state securities laws,
pricing costs (including the daily calculation of net asset value), expenses of
printing shareholder reports, prospectuses and statements of additional
information (except to the extent paid by the Distributor as described below),
fees for legal and auditing services, Commission fees, interest, certain taxes
and other expenses attributable to a particular Series. Expenses which will be
allocated on the basis of asset size of the respective Series include fees and
expenses of unaffiliated Trustees, state franchise taxes, costs of printing
proxies and other expenses related to shareholder meetings and other expenses
properly payable by the Trust. The organizational expenses of the Trust were
paid by the Trust, and if additional Series are added to the Trust, the
organizational expenses are allocated among the Series (including the Fund) in
a manner deemed equitable by the Trustees. Depending upon the nature of a
lawsuit, litigation costs may be assessed to the specific Series to which the
lawsuit relates or allocated on the basis of the asset size of the respective
Series. The Trustees have determined that this is an appropriate method of
allocation of expenses. Accounting services are provided to the Fund by the
Manager, and the Fund reimburses the Manager for its costs in connection with
such services. For the year ended July 31, 1995, the Fund reimbursed the
Manager $34,887 for accounting services. As required by the Fund's distribution
agreements, the Distributor will pay the promotional expenses of the Fund
incurred in connection with the offering of shares of the Fund. Certain
expenses in connection with the account maintenance and distribution of Class B
shares will be financed by the Fund pursuant to the Distribution Plan in
compliance with Rule 12b-1 under the 1940 Act. See "Purchase of Shares--
Deferred Sales Charge Alternative--Class B Shares--Distribution Plan".
The Manager is a limited partnership, the partners of which are ML & Co. and
Princeton Services. ML & Co. and Princeton Services are "controlling persons"
of the Manager as defined under the 1940 Act because of their ownership of its
voting securities or their power to exercise a controlling influence over its
management or policies.
19
<PAGE>
Duration and Termination. Unless earlier terminated as described herein, the
Management Agreement will remain in effect from year to year if approved
annually (a) by the Trustees of the Trust or by a majority of the outstanding
shares of the Fund and (b) by a majority of the Trustees who are not parties to
such contract or interested persons (as defined in the 1940 Act) of any such
party. Such contracts are not assignable and may be terminated without penalty
on 60 days' written notice at the option of either party thereto or by vote of
the shareholders of the Fund.
PURCHASE OF SHARES
Reference is made to "Purchase of Shares" in the Prospectus for certain
information as to the purchase of Fund shares.
The Fund issues four classes of shares under the Merrill Lynch Select
Pricing(SM) System: shares of Class A and Class D are sold to investors choosing
the initial sales charge alternatives, and shares of Class B and Class C are
sold to investors choosing the deferred sales charge alternatives. Each Class
A, Class B, Class C and Class D share of the Fund represents identical
interests in the investment portfolio of the Fund and has the same rights,
except that Class B, Class C and Class D shares bear the expenses of the
ongoing account maintenance fees, and Class B and Class C shares bear the
expenses of the ongoing distribution fees and the additional incremental
transfer agency costs resulting from the deferred sales charge arrangements.
Class B, Class C and Class D shares each have exclusive voting rights with
respect to the Rule 12b-1 distribution plan adopted with respect to such class
pursuant to which account maintenance and/or distribution fees are paid. Each
class has different exchange privileges. See "Shareholder Services--Exchange
Privilege".
The Merrill Lynch Select Pricing(SM) System is used by more than 50 mutual
funds advised by MLAM or its affiliate, the Manager. Funds advised by MLAM or
the Manager are referred to herein as "MLAM-advised mutual funds".
The Fund has entered into four separate distribution agreements with the
Distributor in connection with the continuous offering of each class of shares
of the Fund (the "Distribution Agreements"). The Distribution Agreements
obligate the Distributor to pay certain expenses in connection with the
offering of each class of shares of the Fund. After the prospectuses,
statements of additional information and periodic reports have been prepared,
set in type and mailed to shareholders, the Distributor pays for the printing
and distribution of copies thereof used in connection with the offering to
dealers and prospective investors. The Distributor also pays for other
supplementary sales literature and advertising costs. The Distribution
Agreements are subject to the same renewal requirements and termination
provisions as the Management Agreement described above.
INITIAL SALES CHARGE ALTERNATIVES--CLASS A AND CLASS D SHARES
The gross sales charges for the sale of Class A shares for the period
September 25, 1992 (commencement of operations) to July 31, 1993 (fiscal year
end) were $189,726, of which the Distributor received $9,954 and Merrill Lynch
received $179,772. The gross sales charges for the sale of Class A shares for
the fiscal year ended July 31, 1994 were $56,194 of which the Distributor
received $6,609 and Merrill Lynch received
20
<PAGE>
$49,585. The gross sales charges for the sale of Class A shares for the fiscal
year ended July 31, 1995 were $12,051, of which the Distributor received $1,108
and Merrill Lynch received $10,943. The gross sales charges for the sale of
Class D shares for the period October 21, 1995 (commencement of operations of
Class D shares) to July 31, 1995 (fiscal year end) were $5,112, of which the
Distributor received $431 and Merrill Lynch received $4,681.
The term "purchase", as used in the Prospectus and this Statement of
Additional Information in connection with an investment in Class A and Class D
shares of the Fund, refers to a single purchase by an individual, or to
concurrent purchases, which in the aggregate are at least equal to the
prescribed amounts, by an individual, his spouse and their children under the
age of 21 years purchasing shares for his or their own account and to single
purchases by a trustee or other fiduciary purchasing shares for a single trust
estate or single fiduciary account although more than one beneficiary is
involved. The term "purchase" also includes purchases by any "company", as that
term is defined in the 1940 Act, but does not include purchases by any such
company which has not been in existence for at least six months or which has no
purpose other than the purchase of shares of the Fund or shares of other
registered investment companies at a discount; provided, however, that it shall
not include purchases by any group of individuals whose sole organizational
nexus is that the participants therein are credit cardholders of a company,
policyholders of an insurance company, customers of either a bank or broker-
dealer or clients of an investment adviser.
Closed-End Investment Option. Class A shares of the Fund and other MLAM-
advised mutual funds ("Eligible Class A Shares") are offered at net asset value
to shareholders of certain closed-end funds advised by the Manager or MLAM who
purchased such closed-end fund shares prior to October 21, 1994, the date the
Merrill Lynch Select PricingSM System commenced operations, and wish to
reinvest the net proceeds of a sale of their closed-end fund shares in Eligible
Class A Shares, if the conditions set forth below are satisfied. Alternatively,
closed-end fund shareholders who purchased such shares on or after October 21,
1994 and wish to reinvest the net proceeds from a sale of their closed-end fund
shares are offered Class A shares (if eligible to purchase Class A Shares) or
Class D shares of the Fund and other MLAM-advised mutual funds ("Eligible Class
D Shares"), if the following conditions are met. First, the sale of closed-end
fund shares must be made through Merrill Lynch, and the net proceeds therefrom
must be immediately reinvested in Eligible Class A or Class D Shares. Second,
the closed-end fund shares must either have been acquired in the initial public
offering or be shares representing dividends from shares acquired in such
offering. Third, the closed-end fund shares must have been continuously
maintained in a Merrill Lynch securities account. Fourth, there must be a
minimum purchase of $250 to be eligible for the investment option. Class A
shares of the Fund are offered at net asset value to shareholders of Merrill
Lynch Senior Floating Rate Fund, Inc. ("Senior Floating Rate Fund") who wish to
reinvest the net proceeds from a sale of certain of their shares of common
stock of Senior Floating Rate Fund in shares of the Fund. In order to exercise
this investment option, Senior Floating Rate Fund shareholders must sell their
Senior Floating Rate Fund shares to the Senior Floating Rate Fund in connection
with a tender offer conducted by the Senior Floating Rate Fund and reinvest the
proceeds immediately in the Fund. This investment option is available only with
respect to the proceeds of Senior Floating Rate Fund shares as to which no
Early Withdrawal Charge (as defined in the Senior Floating Rate Fund
prospectus) is applicable. Purchase orders from Senior Floating Rate Fund
shareholders wishing to exercise this investment option will be accepted only
on the day that the related Senior Floating Rate Fund tender offer terminates
and will be effected at the net asset value of the Fund on such day.
21
<PAGE>
REDUCED INITIAL SALES CHARGES
Right of Accumulation. Reduced sales charges are applicable through a right
of accumulation under which eligible investors are permitted to purchase shares
of the Fund subject to an initial sales charge at the offering price applicable
to the total of (a) the public offering price of the shares then being
purchased plus (b) an amount equal to the then current net asset value or cost,
whichever is higher, of the purchaser's combined holdings of all classes of
shares of the Fund and of any other MLAM-advised mutual fund. For any such
right of accumulation to be made available, the Distributor must be provided at
the time of purchase, by the purchaser or the purchaser's securities dealer,
with sufficient information to permit confirmation of qualification. Acceptance
of the purchase order is subject to such confirmation. The right of
accumulation may be amended or terminated at any time. Shares held in the name
of a nominee or custodian under pension, profit-sharing or other employee
benefit plans may not be combined with other shares to qualify for the right of
accumulation.
Letter of Intention. Reduced sales charges are applicable to purchases
aggregating $25,000 or more of the Class A or Class D shares of the Fund or any
other MLAM-advised mutual funds made within a 13-month period starting with the
first purchase pursuant to a Letter of Intention in the form provided in the
Prospectus. The Letter of Intention is available only to investors whose
accounts are maintained at the Fund's transfer agent. The Letter of Intention
is not available to employee benefit plans for which Merrill Lynch provides
plan participant record-keeping services. The Letter of Intention is not a
binding obligation to purchase any amount of Class A or Class D shares;
however, its execution will result in the purchaser paying a lower sales charge
at the appropriate quantity purchase level. A purchase not originally made
pursuant to a Letter of Intention may be included under a subsequent Letter of
Intention executed within 90 days of such purchase if the Distributor is
informed in writing of this intent within such 90-day period. The value of
Class A and Class D shares of the Fund and of other MLAM-advised mutual funds
presently held, at cost or maximum offering price (whichever is higher), on the
date of the first purchase under the Letter of Intention, may be included as a
credit toward the completion of such Letter, but the reduced sales charge
applicable to the amount covered by such Letter will be applied only to new
purchases. If the total amount of shares does not equal the amount stated in
the Letter of Intention (minimum of $25,000), the investor will be notified and
must pay, within 20 days of the expiration of such Letter, the difference
between the sales charge on the Class A or Class D shares purchased at the
reduced rate and the sales charge applicable to the shares actually purchased
through the Letter. Class A or Class D shares equal to at least five percent of
the intended amount will be held in escrow during the 13-month period (while
remaining registered in the name of the purchaser) for this purpose. The first
purchase under the Letter of Intention must be at least five percent of the
dollar amount of such Letter. If a purchase during the term of such Letter
would otherwise be subject to a further reduced sales charge based on the right
for accumulation, the purchaser will be entitled on that purchase and
subsequent purchases to that further reduced percentage sales charge but there
will be no retroactive reduction of the sales charges on any previous purchase.
The value of any shares redeemed or otherwise disposed of by the purchaser
prior to termination or completion of the Letter of Intention will be deducted
from the total purchases made under such Letter. An exchange from a MLAM-
advised money market fund into the Fund that creates a sales charge will count
toward completing a new or existing Letter of Intention from the Fund.
Employee Access AccountsSM. Class A or Class D shares are offered at net
asset value to Employee Access Accounts available through employers that
provide employer sponsored retirement or savings plans
22
<PAGE>
that are eligible to purchase such shares at net asset value. The initial
minimum for such accounts is $500, except that the initial minimum for shares
purchased for such accounts pursuant to the Automatic Investment Program is
$50.
TMA(SM) Managed Trusts. Class A shares are offered to TMASM Managed Trusts to
which Merrill Lynch Trust Company provides discretionary trustee services at
net asset value.
Purchase Privilege of Certain Persons. Trustees of the Trust, members of the
Boards of other MLAM-advised investment companies, ML & Co. and its
subsidiaries (the term "subsidiaries", when used herein with respect to ML &
Co., includes MLAM, the Manager and certain other entities directly or
indirectly wholly-owned and controlled by ML & Co.), and their directors and
employees and any trust, pension, profit-sharing or other benefit plan for such
persons, may purchase Class A shares of the Fund at net asset value. Under such
programs, the Fund realizes economies of scale and reduction of sales related
expenses by virtue of familiarity with the Fund.
Class D shares of the Fund are offered at net asset value, without sales
charge, to an investor who has a business relationship with a financial
consultant who joined Merrill Lynch from another investment firm within six
months prior to the date of purchase by such investor, if the following
conditions are satisfied: first, the investor must advise Merrill Lynch that it
will purchase Class D shares of the Fund with proceeds from a redemption of a
mutual fund that was sponsored by the financial consultant's previous firm and
was subject to a sales charge either at the time of purchase or on a deferred
basis; and second, the investor also must establish that such redemption had
been made within 60 days prior to the investment in the Fund, and the proceeds
from the redemption had been maintained in the interim in cash or a money
market fund.
Class D shares of the Fund are also offered at net asset value, without a
sales charge, to an investor who has a business relationship with a Merrill
Lynch financial consultant and who has invested in a mutual fund sponsored by a
non-Merrill Lynch company for which Merrill Lynch has served as a selected
dealer and where Merrill Lynch has either received or given notice that such
arrangement will be terminated ("notice"), if the following conditions are
satisfied: first, the investor must purchase Class D shares of the Fund with
proceeds from a redemption of shares of such other mutual fund and the shares
of such other fund were subject to a sales charge either at the time of
purchase or on a deferred basis; and second, such purchase of Class D shares
must be made within 90 days after such notice.
Class D shares of the Fund will be offered at net asset value, without a
sales charge, to an investor who has a business relationship with a Merrill
Lynch financial consultant and who has invested in a mutual fund for which
Merrill Lynch has not served as a selected dealer if the following conditions
are satisfied: first, the investor must advise Merrill Lynch that it will
purchase Class D shares of the Fund with proceeds from the redemption of shares
of such other mutual fund and that such shares have been outstanding for a
period of no less than six months; and second, such purchase of Class D shares
must be made within 60 days after the redemption and the proceeds from the
redemption must be maintained in the interim in cash or a money market fund.
Acquisition of Certain Investment Companies. The public offering price of
Class D shares may be reduced to the net asset value per Class D share in
connection with the acquisition of the assets of or merger or consolidation
with a personal holding company or a public or private investment company. The
value of
23
<PAGE>
the assets or company acquired in a tax-free transaction may be adjusted in
appropriate cases to reduce possible adverse tax consequences to the Fund
which might result from an acquisition of assets having net unrealized
appreciation which is disproportionately higher at the time of acquisition
than the realized or unrealized appreciation of the Fund. The issuance of
Class D shares for consideration other than cash is limited to bona fide
reorganizations, statutory mergers or other acquisitions of portfolio
securities which (i) meet the investment objectives and policies of the Fund;
(ii) are acquired for investment and not for resale (subject to the
understanding that the disposition of the Fund's portfolio securities shall at
all times remain within its control); and (iii) are liquid securities, the
value of which is readily ascertainable, which are not restricted as to
transfer either by law or liquidity of market (except that the Fund may
acquire through such transactions restricted or illiquid securities to the
extent the Fund does not exceed the applicable limits on acquisition of such
securities set forth under "Investment Objective and Policies" herein).
Reductions in or exemptions from the imposition of a sales load are due to
the nature of the investors and/or the reduced sales efforts that will be
needed in obtaining such investments.
DISTRIBUTION PLANS
Reference is made to "Purchase of Shares--Distribution Plans" in the
Prospectus for certain information with respect to the separate distribution
plans for Class B, Class C and Class D shares pursuant to Rule 12b-1 under the
1940 Act (each a "Distribution Plan") with respect to the account maintenance
and/or distribution fees paid by the Fund to the Distributor with respect to
such classes.
The payments of the account maintenance and/or distribution fees are subject
to the provisions of Rule 12b-1 under the 1940 Act. Among other things, each
Distribution Plan provides that the Distributor shall provide and the Trustees
shall review quarterly reports of the disbursement of the account maintenance
and/or distribution fees paid to the Distributor. In their consideration of
each Distribution Plan, the Trustees must consider all factors they deem
relevant, including information as to the benefits of the Distribution Plan to
the Fund and its related class of shareholders. Each Distribution Plan further
provides that, so long as the Distribution Plan remains in effect, the
selection and nomination of Trustees who are not "interested persons" of the
Trust, as defined in the 1940 Act (the "Independent Trustees"), shall be
committed to the discretion of the Independent Trustees then in office. In
approving each Distribution Plan in accordance with Rule 12b-1, the
Independent Trustees concluded that there is reasonable likelihood that each
Distribution Plan will benefit the Fund and its related class of shareholders.
Each Distribution Plan can be terminated at any time, without penalty, by the
vote of a majority of the Independent Trustees or by the vote of the holders
of a majority of the outstanding related class of voting securities of the
Fund. A Distribution Plan cannot be amended to increase materially the amount
to be spent by the Fund without approval of the related class of shareholders,
and all material amendments are required to be approved by the vote of
Trustees, including a majority of the Independent Trustees who have no direct
or indirect financial interest in such Distribution Plan, cast in person at a
meeting called for that purpose. Rule 12b-1 further requires that the Trust
preserve copies of each Distribution Plan and any report made pursuant to such
plan for a period of not less than six years from the date of such
Distribution Plan or such report, the first two years in an easily accessible
place.
LIMITATIONS ON THE PAYMENT OF DEFERRED SALES CHARGES
The maximum sales charge rule in the Rules of Fair Practice of the National
Association of Securities Dealers, Inc. ("NASD") imposes a limitation on
certain asset-based sales charges such as the distribution fee and the
contingent deferred sales charge ("CDSC") borne by the Class B and Class C
shares but not the
24
<PAGE>
account maintenance fee. The maximum sales charge rule is applied separately
to each class. As applicable to the Fund, the maximum sales charge rule limits
the aggregate of distribution fee payments and CDSCs payable by the Fund to
(1) 6.25% of eligible gross sales of Class B shares and Class C shares,
computed separately (defined to exclude shares issued pursuant to dividend
reinvestments and exchanges), plus (2) interest on the unpaid balance for the
respective class, computed separately, at the prime rate plus 1% (the unpaid
balance being the maximum amount payable minus amounts received from the
payment of the distribution fee and the CDSC). In connection with the Class B
shares, the Distributor has voluntarily agreed to waive interest charges on
the unpaid balance in excess of 0.50% of eligible gross sales. Consequently,
the maximum amount payable to the Distributor (referred to as the "voluntary
maximum") in connection with the Class B shares is 6.75% of eligible gross
sales. The Distributor retains the right to stop waiving the interest charges
at any time. To the extent payments would exceed the voluntary maximum, the
Fund will not make further payments of the distribution fee with respect to
Class B shares, and any CDSCs will be paid to the Fund rather than to the
Distributor; however, the Fund will continue to make payments of the account
maintenance fee. In certain circumstances the amount payable pursuant to the
voluntary maximum may exceed the amount payable under the NASD formula. In
such circumstances payment in excess of the amount payable under the NASD
formula will not be made.
The following table sets forth comparative information as of July 31, 1995,
with respect to the Class B and Class C shares of the Fund, indicating the
maximum allowable payments that can be made under the NASD maximum sales
charge rule and, with respect to the Class B shares, the Distributor's
voluntary maximum for the period September 25, 1992 (commencement of
operations of Class B shares) to July 31, 1995.
<TABLE>
<CAPTION>
DATA CALCULATED AS OF JULY 31, 1995
------------------------------------------------------------------------------
(IN THOUSANDS)
ANNUAL
DISTRIBUTION
ALLOWABLE ALLOWABLE AMOUNTS FEE AT
ELIGIBLE AGGREGATE INTEREST MAXIMUM PREVIOUSLY AGGREGATE CURRENT
GROSS SALES ON UNPAID AMOUNT PAID TO UNPAID NET ASSET
SALES (1) CHARGES BALANCE (2) PAYABLE DISTRIBUTOR (3) BALANCE LEVEL (4)
--------- --------- ----------- ------- --------------- --------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
CLASS B
Under NASD Rule as
Adopted................ $ 54,063 $ 3,379 $ 584 $ 3,963 $546 $ 3,417 $ 125
Under Distributor's
Voluntary Waiver....... $ 54,063 $ 3,379 $ 270 $ 3,649 $546 $ 3,103 $ 125
CLASS C (NOT IN THOUSANDS)
Under NASD Rule as
Adopted................ $820,248 $51,266 $1,367 $52,633 $825 $51,807 $2,495
</TABLE>
- --------
(1) Purchase price of all eligible Class B shares sold since September 25,
1992 (commencement of operations of Class B shares) other than shares
acquired through dividend reinvestment and the exchange privilege.
Purchase price of all eligible Class C shares sold since October 21, 1994
(commencement of operations of Class C shares) other than shares acquired
through dividend reinvestment and the exchange privilege.
(2) Interest is computed on a monthly basis based upon the prime rate, as
reported in The Wall Street Journal, plus 1.0%, as permitted under the
NASD Rule.
(3) Consists of CDSC payments, distribution fee payments and accruals.
(4) Provided to illustrate the extent to which the current level of
distribution fee payments (not including any CDSC payments) is amortizing
the unpaid balance. No assurance can be given that payments of the
distribution fee will reach either the voluntary maximum (with respect to
Class B shares) or the NASD maximum (with respect to Class B or Class C
shares).
25
<PAGE>
REDEMPTION OF SHARES
Reference is made to "Redemption of Shares" in the Prospectus for certain
information as to the redemption and repurchase of Fund shares.
The right to redeem shares or to receive payment with respect to any such
redemption may be suspended only for any period during which trading on the New
York Stock Exchange is restricted as determined by the Commission or such
Exchange is closed (other than customary weekend and holiday closings), for any
period during which an emergency exists as defined by the Commission as a
result of which disposal of portfolio securities or determination of the net
asset value of the Fund is not reasonably practicable, and for such other
periods as the Commission may by order permit for the protection of
shareholders of the Fund.
DEFERRED SALES CHARGE--CLASS B AND CLASS C SHARES
As discussed in the Prospectus under "Purchase of Shares--Deferred Sales
Charge Alternatives--Class B and Class C Shares", while Class B shares redeemed
within four years of purchase are subject to a CDSC under most circumstances,
the charge is waived on redemptions of Class B shares following the death or
disability of a Class B shareholder. Redemptions for which the waiver applies
are any partial or complete redemptions following the death or disability (as
defined in the Code) of a Class B shareholder (including one who owns the Class
B shares as joint tenant with his or her spouse), provided the redemption is
requested within one year of the death or initial determination of disability.
For the period September 25, 1992 (commencement of operations) to July 31, 1993
(fiscal year end), and the fiscal years ended 1994 and 1995, the Distributor
received CDSCs of $34,243, $58,588 and $153,402, respectively, with respect to
redemptions of Class B shares, all of which was paid to Merrill Lynch. For the
period October 21, 1994 (commencement of operations of Class C shares) to July
31, 1995 (fiscal year end), the Distributor received no CDSCs with respect to
redemptions of Class C shares.
The CDSC is also waived for any Class B shares that were acquired and held at
the time of redemption by Employee Access Accounts available through employers
that provide Eligible 401(k) Plans. The initial minimum for such accounts is
$500, except that the initial minimum for shares purchased for such accounts
pursuant to the Automatic Investment Program is $50.
PORTFOLIO TRANSACTIONS
Reference is made to "Investment Objective and Policies" and "Portfolio
Transactions" in the Prospectus.
Under the 1940 Act, persons affiliated with the Trust are prohibited from
dealing with the Fund as a principal in the purchase and sale of securities
unless such trading is permitted by an exemptive order issued by the
Commission. Since over-the-counter transactions are usually principal
transactions, affiliated persons of the Trust, including Merrill Lynch, may not
serve as dealer in connection with transactions with the Fund. The Trust has
obtained an exemptive order permitting it to engage in certain principal
transactions with Merrill Lynch involving high quality short-term municipal
bonds subject to certain conditions. For the period September 25, 1992
(commencement of operations) to July 31, 1993 (fiscal year end), the Fund
engaged in 19
26
<PAGE>
transactions pursuant to such order for an aggregate market value of
$9,100,885. For the fiscal year ended July 31, 1994, the Fund engaged in no
transactions pursuant to such order. For the fiscal year ended July 31, 1995,
the Fund engaged in two transactions pursuant to such order for an aggregate
market value of $800,000. The Trust has applied for an exemptive order
permitting it to, among other things, (i) purchase high quality tax-exempt
securities from Merrill Lynch when Merrill Lynch is a member of an underwriting
syndicate and (ii) purchase tax-exempt securities from and sell tax-exempt
securities to Merrill Lynch in secondary market transactions. Affiliated
persons of the Trust may serve as its broker in over-the-counter transactions
conducted for the Fund on an agency basis only. Affiliated persons of the Trust
may serve as broker for the Fund in over-the-counter transactions conducted on
an agency basis. Certain court decisions have raised questions as to the extent
to which investment companies should seek exemptions under the 1940 Act in
order to seek to recapture underwriting and dealer spreads from affiliated
entities. The Trustees have considered all factors deemed relevant and have
made a determination not to seek such recapture at this time. The Trustees will
reconsider this matter from time to time.
As a non-fundamental restriction, the Trust will prohibit the purchase or
retention by the Fund of the securities of any issuer if the officers and
trustees of the Trust, the officers and general partner of the Manager, the
directors of such general partner or the officers and directors of any
subsidiary thereof each owning beneficially more than one-half of one percent
of the securities of an issuer together own beneficially more than five percent
of the securities of that issuer. In addition, under the 1940 Act, the Fund may
not purchase securities from any underwriting syndicate of which Merrill Lynch
is a member except pursuant to an exemptive order or rules adopted by the
Commission. Rule 10f-3 under the 1940 Act sets forth conditions under which the
Fund may purchase municipal bonds in such transactions. The rule sets forth
requirements relating to, among other things, the terms of an issue of
municipal bonds purchased by the Fund, the amount of municipal bonds which may
be purchased in any one issue and the assets of the Fund which may be invested
in a particular issue.
The Fund does not expect to use any particular dealer in the execution of
transactions but, subject to obtaining the best net results, dealers who
provide supplemental investment research (such as information concerning tax-
exempt securities, economic data and market forecasts) to the Manager may
receive orders for transactions by the Fund. Information so received will be in
addition to and not in lieu of the services required to be performed by the
Manager under its Management Agreement, and the expenses of the Manager will
not necessarily be reduced as a result of the receipt of such supplemental
information.
The Trust has no obligation to deal with any broker in the execution of
transactions for the Fund's portfolio securities. In addition, consistent with
the Rules of Fair Practice of the NASD and policies established by the Trustees
of the Trust, the Manager may consider sales of shares of the Fund as a factor
in the selection of brokers or dealers to execute portfolio transactions for
the Fund.
Generally, the Fund does not purchase securities for short-term trading
profits. However, the Fund may dispose of securities without regard to the time
they have been held when such action, for defensive or other reasons, appears
advisable to its Manager. While it is not possible to predict turnover rates
with any certainty, at present it is anticipated that the Fund's annual
portfolio turnover rate, under normal circumstances after the Fund's portfolio
is invested in accordance with its investment objective, will be less than
100%. (The portfolio turnover rate is calculated by dividing the lesser of
purchases or sales of portfolio securities for the particular fiscal year by
the monthly average of the value of the portfolio securities owned by the Fund
during
27
<PAGE>
the particular fiscal year. For purposes of determining this rate, all
securities whose maturities at the time of acquisition are one year or less are
excluded.) The portfolio turnover rates for the period September 25, 1992
(commencement of operations) to July 31, 1993 (fiscal year end) and for the
fiscal years ended July 31, 1994 and 1995 were 27.98%, 74.35% and 52.33%,
respectively.
Section 11(a) of the Securities Exchange Act of 1934, as amended, generally
prohibits members of the U.S. national securities exchanges from executing
exchange transactions for their affiliates and institutional accounts which
they manage unless the member (i) has obtained prior express authorization from
the account to effect such transactions, (ii) at least annually furnishes the
account with a statement setting forth the aggregate compensation received by
the member in effecting such transactions, and (iii) complies with any rules
the Commission has prescribed with respect to the requirements of clauses (i)
and (ii). To the extent Section 11(a) would apply to Merrill Lynch acting as a
broker for the Fund in any of its portfolio transactions executed on any such
securities exchange of which it is a member, appropriate consents have been
obtained from the Fund and annual statements as to aggregate compensation will
be provided to the Fund.
DETERMINATION OF NET ASSET VALUE
The net asset value of shares of all classes of the Fund is determined by the
Manager once daily, Monday through Friday, as of 15 minutes after the close of
business on the New York Stock Exchange (generally, 4:00 P.M., New York time),
on each day during which the New York Stock Exchange is open for trading. The
New York Stock Exchange is not open on New Year's Day, Presidents' Day, Good
Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and
Christmas Day. Net asset value per share is computed by dividing the sum of the
value of the securities held by the Fund plus any cash or other assets minus
all liabilities by the total number of shares outstanding at such time, rounded
to the nearest cent. Expenses, including the fees payable to the Manager and
any account maintenance and/or distribution fees, are accrued daily. The per
share net asset value of Class B, Class C and Class D shares generally will be
lower than the per share net asset value of the Class A shares, reflecting the
daily expense accruals of the account maintenance, distribution and higher
transfer agency fees applicable with respect to Class B and Class C shares and
the daily expense accruals of the account maintenance fees applicable with
respect to Class D shares; moreover, the per share net asset value of Class B
and Class C shares generally will be lower than the per share net asset value
of Class D shares reflecting the daily expense accruals of the distribution
fees and higher transfer agency fees applicable with respect to Class B and
Class C shares of the Fund. It is expected, however, that the per share net
asset value of the four classes eventually will tend to converge (although not
necessarily meet) immediately after the payment of dividends, which will differ
by approximately the amount of the expense accrual differentials between the
classes.
The Municipal Bonds and other portfolio securities in which the Fund invests
are traded primarily in over-the-counter municipal bond and money markets and
are valued at the last available bid price in the over-the-counter market or on
the basis of yield equivalents as obtained from one or more dealers that make
markets in the securities. One bond is the "yield equivalent" of another bond
when, taking into account market price, maturity, coupon rate, credit rating
and ultimate return of principal, both bonds will theoretically produce an
equivalent return to the bondholder. Financial futures contracts and options
thereon, which are traded on exchanges, are valued at their settlement prices
as of the close of such exchanges. Short-
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<PAGE>
term investments with a remaining maturity of 60 days or less are valued on an
amortized cost basis, which approximates market value. Securities and assets
for which market quotations are not readily available are valued at fair value
as determined in good faith by or under the direction of the Trustees of the
Trust, including valuations furnished by a pricing service retained by the
Trust, which may utilize a matrix system for valuations. The procedures of the
pricing service and its valuations are reviewed by the officers of the Trust
under the general supervision of the Trustees.
SHAREHOLDER SERVICES
The Trust offers a number of shareholder services described below which are
designed to facilitate investment in shares of the Fund. Full details as to
each of such services and copies of the various plans described below can be
obtained from the Trust, the Distributor or Merrill Lynch.
INVESTMENT ACCOUNT
Each shareholder whose account is maintained at the Transfer Agent has an
Investment Account and will receive statements, at least quarterly, from the
Transfer Agent. These statements will serve as transaction confirmations for
automatic investment purchases and the reinvestment of ordinary income
dividends and long-term capital gains distributions. These statements will also
show any other activity in the account since the previous statement.
Shareholders also will receive separate confirmations for each purchase or sale
transaction other than automatic investment purchases and the reinvestment of
ordinary income dividends and long-term capital gains distributions. A
shareholder may make additions to his Investment Account at any time by mailing
a check directly to the Transfer Agent.
Share certificates are issued only for full shares and only upon the specific
request of a shareholder who has an Investment Account. Issuance of
certificates representing all or only part of the full shares in an Investment
Account may be requested by a shareholder directly from the Transfer Agent.
Shareholders considering transferring their Class A or Class D shares from
Merrill Lynch to another brokerage firm or financial institution should be
aware that, if the firm to which the Class A or Class D shares are to be
transferred will not take delivery of shares of the Fund, a shareholder either
must redeem the Class A or Class D shares so that the cash proceeds can be
transferred to the account at the new firm, or such shareholder must continue
to maintain an Investment Account at the Transfer Agent for those Class A or
Class D shares. Shareholders interested in transferring their Class B or Class
C shares from Merrill Lynch and who do not wish to have an Investment Account
maintained for such shares at the Transfer Agent may request their new
brokerage firm to maintain such shares in an account registered in the name of
the brokerage firm for the benefit of the shareholder. If the new brokerage
firm is willing to accommodate the shareholder in this manner, the shareholder
must request that he or she be issued certificates for his or her shares and
then must turn the certificates over to the new firm for re-registration as
described in the preceding sentence.
AUTOMATIC INVESTMENT PLANS
A shareholder may make additions to an Investment Account at any time by
purchasing Class A (if he or she is an eligible Class A investor as described
in the Prospectus), or Class B, Class C or Class D shares at the applicable
public offering price either through the shareholder's securities dealer or by
mail directly to the Transfer Agent, acting as agent for such securities
dealers. Voluntary accumulation also can be made
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<PAGE>
through a service known as the Automatic Investment Plan whereby the Fund is
authorized through pre-authorized checks or automated house clearing debits of
$50 or more to charge the regular bank account of the shareholder on a regular
basis to provide systematic additions to the Investment Account of such
shareholder. The Fund's Automatic Investment Plan is not available to
shareholders whose shares are held in brokerage accounts with Merrill Lynch.
Alternatively, investors who maintain CMA(R) or CBA(R) accounts may arrange to
have periodic investments made in the Fund, in their CMA(R) or CBA(R) accounts
or in certain related accounts in amounts of $100 or more through the
CMA(R)/CBA(R) Automated Investment Program.
AUTOMATIC REINVESTMENT OF DIVIDENDS AND CAPITAL GAINS DISTRIBUTIONS
Unless specific instructions are given as to the method of payment of
dividends and capital gains distributions, dividends and distributions will be
reinvested automatically in additional shares of the Fund. Such reinvestment
will be at the net asset value of shares of the Fund as of the close of
business on the monthly payment date for such dividends and distributions.
Shareholders may elect in writing to receive either their income dividends or
capital gains distributions, or both, in cash, in which event payment will be
mailed or direct deposited on or about the payment date. Cash payments can also
be directly deposited to the shareholder's bank account.
Shareholders may, at any time, notify the Transfer Agent in writing or by
telephone (1-800-MER-FUND) that they no longer wish to have their dividends
and/or capital gains distributions reinvested in shares of the Fund or vice
versa and, commencing ten days after the receipt by the Transfer Agent of such
notice, such instructions will be effected.
SYSTEMATIC WITHDRAWAL PLANS--CLASS A AND CLASS D SHARES
A Class A or Class D shareholder may elect to make systematic withdrawals
from an Investment Account on either a monthly or quarterly basis as provided
below. Quarterly withdrawals are available for shareholders who have acquired
Class A of Class D shares of the Fund having a value, based on cost or the
current offering price, of $5,000 or more and monthly withdrawals are available
for shareholders with Class A or Class D shares with such a value of $10,000 or
more.
At the time of each withdrawal payment, sufficient Class A or Class D shares
are redeemed from those on deposit in the shareholder's account to provide the
withdrawal payment specified by the shareholder. The shareholder may specify
either a dollar amount or a percentage of the value of his Class A or Class D
shares. Redemptions will be made at net asset value as determined 15 minutes
after the close of business on the New York Stock Exchange (generally, 4:00
P.M., New York time) on the 24th day of each month or the 24th day of the last
month of each quarter, whichever is applicable. If the Exchange is not open for
business on such date, the Class A or Class D shares will be redeemed at the
close of business on the following business day. The check for the withdrawal
payment will be mailed, or the direct deposit for the withdrawal payment will
be made, on the next business day following redemption. When a shareholder is
making systematic withdrawals, dividends and distributions on all Class A or
Class D shares in the Investment Account are reinvested automatically in the
Fund's Class A or Class D shares, respectively. A shareholder's Systematic
Withdrawal Plan may be terminated at any time, without charge or penalty, by
the shareholder, the Trust, the Transfer Agent or the Distributor. Withdrawal
payments should not be considered as dividends, yield or income. Each
withdrawal is a taxable event. If periodic withdrawals continuously exceed
reinvested
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<PAGE>
dividends, the shareholder's original investment may be reduced
correspondingly. Purchases of additional Class A or Class D shares concurrent
with withdrawals are ordinarily disadvantageous to the shareholder because of
sales charges and tax liabilities. The Trust will not knowingly accept
purchase orders for Class A or Class D shares of the Fund from investors who
maintain a Systematic Withdrawal Plan unless such purchase is equal to at
least one year's scheduled withdrawals or $1,200, whichever is greater.
Periodic investments may not be made into an Investment Account in which the
shareholder has elected to make systematic withdrawals.
Alternatively, a Class A or Class D shareholder whose shares are held within
a CMA (R) or CBA (R) account may elect to have shares redeemed on a monthly,
bimonthly, quarterly, semiannual or annual basis through the CMA (R)/CBA (R)
Systematic Redemption Program. The minimum fixed dollar amount redeemable is
$25. The proceeds of systematic redemptions will be posted to the
shareholder's account five business days after the date the shares are
redeemed. Monthly systematic redemptions will be made at net asset value on
the first Monday of each month, bimonthly systematic redemptions will be made
at net asset value on the first Monday of every other month, and quarterly,
semiannual or annual redemptions are made at net asset value on the first
Monday of months selected at the shareholder's option. If the first Monday of
the month is a holiday, the redemption will be processed at net asset value on
the next business day. The CMA (R)/CBA (R) Systematic Redemption Program is
not available if Fund shares are being purchased within the account pursuant
to the CMA (R)/CBA (R) Automated Investment Program. For more information on
the CMA (R)/CBA (R) Systematic Redemption Program, eligible shareholders
should contact their Financial Consultant.
EXCHANGE PRIVILEGE
Shareholders of each class of shares of the Fund have an exchange privilege
with certain other MLAM-advised mutual funds listed below. Under the Merrill
Lynch Select Pricing SM System, Class A shareholders may exchange Class A
shares of the Fund for Class A shares of a second MLAM-advised mutual funds if
the shareholder holds any Class A shares of the second fund in his account in
which the exchange is made at the time of the exchange or is otherwise
eligible to purchase Class A shares of the second fund. If the Class A
shareholder wants to exchange Class A shares for shares of a second MLAM-
advised mutual fund, and the shareholder does not hold Class A shares of the
second fund in his account at the time of the exchange and is not otherwise
eligible to acquire Class A shares of the second fund, the shareholder will
receive Class D shares of the second fund as a result of the exchange. Class D
shares also may be exchanged for Class A shares of a second MLAM-advised
mutual fund at any time as long as, at the time of the exchange, the
shareholder holds Class A shares of the second fund in the account in which
the exchange is made or is otherwise eligible to purchase Class A shares of
the second fund. Class B, Class C and Class D shares are exchangeable with
shares of the same class of other MLAM-advised mutual funds. For purposes of
computing the CDSC that may be payable upon a disposition of the shares
acquired in the exchange, the holding period for the previously owned shares
of the Fund is "tacked" to the holding period of the newly acquired shares of
the other Fund as more fully described below. Class A, Class B, Class C and
Class D shares also are exchangeable for shares of certain MLAM-advised money
market funds specifically designated below as available for exchange by
holders of Class A, Class B, Class C or Class D shares. Shares with a net
asset value of at least $100 are required to qualify for the exchange
privilege, and any shares utilized in an exchange must have been held by the
shareholder for 15 days. It is contemplated that the exchange privilege may be
applicable to other new mutual funds whose shares may be distributed by the
Distributor.
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<PAGE>
Exchanges of Class A or Class D shares outstanding ("outstanding Class A or
Class D shares") for Class A or Class D shares of other MLAM-advised mutual
fund ("new Class A or Class D shares") are transacted on the basis of relative
net asset value per Class A or Class D share, respectively, plus an amount
equal to the difference, if any, between the sales charge previously paid on
the outstanding Class A or Class D shares and the sales charge payable at the
time of the exchange on the new Class A or Class D shares. With respect to
outstanding Class A or Class D shares as to which previous exchanges have taken
place, the "sales charge previously paid" shall include the aggregate of the
sales charges paid with respect to such Class A or Class D shares in the
initial purchase and any subsequent exchange. Class A or Class D shares issued
pursuant to dividend reinvestment are sold on a no-load basis in each of the
funds offering Class A or Class D shares. For purposes of the exchange
privilege, Class A and Class D shares acquired through dividend reinvestment
shall be deemed to have been sold with a sales charge equal to the sales charge
previously paid on the Class A or Class D shares on which the dividend was
paid. Based on this formula, Class A and Class D shares generally may be
exchanged into the Class A or Class D shares of the other funds or into shares
of the Class A and Class D money market funds without a sales charge.
In addition, each of the funds with Class B and Class C shares outstanding
("outstanding Class B and Class C shares") offers to exchange its Class B or
Class C shares for Class B or Class C shares, respectively, of another MLAM-
advised mutual fund ("new Class B or Class C shares") on the basis of relative
net asset value per Class B or Class C share, without the payment of any CDSC
that might otherwise be due on redemption of the outstanding shares. Class B
shareholders of the Fund exercising the exchange privilege will continue to be
subject to the Fund's CDSC schedule if such schedule is higher than the CDSC
schedule relating to the new Class B shares acquired through use of the
exchange privilege. In addition, Class B shares of the Fund acquired through
use of the exchange privilege will be subject to the Fund's schedule if such
schedule is higher than the CDSC schedule relating to the Class B shares of the
fund from which the exchange has been made. For purposes of computing the sales
load that may be payable on a disposition of the new Class B or Class C shares,
the holding period for the outstanding Class B or Class C shares is "tacked" to
the holding period of the new Class B or Class C shares. For example, an
investor may exchange Class B shares of the Fund for those of Merrill Lynch
Special Value Fund ("Special Value Fund") after having held the Fund's Class B
shares for two and a half years. The 2% CDSC that generally would apply to a
redemption would not apply to the exchange. Three years later the investor may
decide to redeem the Class B shares of Special Value Fund and receive cash.
There will be no CDSC due on this redemption, since by "tacking" the two and a
half year holding period of the Fund's Class B shares to the three year holding
period for the Special Value Fund Class B shares, the investor will be deemed
to have held the new Class B shares for more than five years.
Shareholders also may exchange shares of the Fund into shares of the money
market funds advised by the Manager of its affiliates and Class B money market
funds, respectively, but the period of time that Class B or Class C shares are
held in a Class B money market fund will not count towards satisfaction of the
holding period requirement for purposes of reducing the CDSC or, with respect
to Class B shares, toward satisfaction of the conversion period. However,
shares of a money market fund which were acquired as a result of an exchange
for Class B or Class C shares of a fund may, in turn, be exchanged back into
Class B or Class C shares, respectively, of any fund offering such shares, in
which event the holding period for Class B or Class C shares of the fund will
be aggregated with previous holding periods for purposes of reducing the CDSC
or, with respect to Class B shares, towards satisfaction of the conversion
period. However, shares of a money
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<PAGE>
market fund which were acquired as a result of an exchange for Class B or Class
C shares of a fund may, in turn, be exchanged back into Class B or Class C
shares, respectively, of any fund offering such shares, in which event the
holding period for Class B or Class C shares of the Fund will be aggregated
with previous holding period for purposes of reducing the CDSC. Thus, for
example, an investor may exchange Class B shares of the Fund for shares of
Merrill Lynch Institutional Fund ("Institutional Fund") after having held the
Fund Class B shares for two and a half years and three years later decide to
redeem the shares of Merrill Lynch Institutional Fund for cash. At the time of
this redemption, the 2% CDSC that would have been due had the Class B shares of
the Fund been redeemed for cash rather than exchanged for shares of
Institutional Fund will be payable. If, instead of such redemption, the
shareholder exchanged such shares for Class B shares of a fund which the
shareholder continues to hold for an additional two and a half years, any
subsequent redemption will not incur a CDSC.
Set forth below is a description of the investment objectives of the other
funds into which exchanges can be made:
Funds Issuing Class A, Class B, Class C and Class D shares:
Merrill Lynch Adjustable Rate
Securities Fund, Inc. ............
High current income consistent with a
policy of limiting the degree of fluctu-
ation in net asset value of fund shares
resulting from movements in interest
rates through investment primarily in a
portfolio of adjustable rate securities
consisting principally of mortgage-
backed and asset-backed securities.
Merrill Lynch Americas Income
Fund, Inc. .......................
A high level of current income, consis-
tent with prudent investment risk, by
investing primarily in debt securities
denominated in a currency of a country
located in the Western Hemisphere (i.e.,
North and South America and the sur-
rounding waters).
Merrill Lynch Arizona Limited
Maturity Municipal Bond Fund......
A portfolio of Merrill Lynch Multi-State
Limited Maturity Municipal Series Trust,
a series fund, whose objective is to
provide as high a level of income exempt
from Federal and Arizona income taxes as
is consistent with prudent investment
management through investment in a port-
folio primarily of intermediate-term
investment grade Arizona Municipal
Bonds.
Merrill Lynch Arizona Municipal
Bond Fund ........................
A portfolio of Merrill Lynch Multi-State
Municipal Series Trust, a series fund,
whose objective is to provide as high a
level of income exempt from Federal and
Arizona income taxes as is consistent
with prudent investment management.
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<PAGE>
Merrill Lynch Arkansas Municipal
Bond Fund.........................
A portfolio of Merrill Lynch Multi-State
Municipal Series Trust, a series fund,
whose objective is to provide as high a
level of income exempt from Federal and
Arkansas income taxes as is consistent
with prudent investment management.
Merrill Lynch Asset Growth
Fund, Inc. .......................
High total investment return, consistent
with prudent risk, from investment in
United States and foreign equity, debt
and money market securities the combina-
tion of which will be varied both with
respect to types of securities and mar-
kets in response to changing market and
economic trends.
Merrill Lynch Asset Income Fund,
Inc. .............................
A high level of current income through
investment primarily in United States
fixed income securities.
Merrill Lynch Balanced Fund for
Investment and Retirement, Inc. ..
As high a level of total investment re-
turn as is consistent with a reasonable
and relatively low level of risk through
investment in common stocks and other
types of securities, including fixed in-
come securities and convertible securi-
ties.
Merrill Lynch Basic Value Fund, Capital appreciation and, secondarily,
Inc. ............................. income by investing in securities, pri-
marily equities, that are undervalued
and therefore represent basic investment
value.
Merrill Lynch California Insured
Municipal Bond Fund...............
A portfolio of Merrill Lynch California
Municipal Series Trust, a series fund,
whose objective is to provide as high a
level of income exempt from Federal and
California income taxes as is consistent
with prudent investment management
through investment in a portfolio pri-
marily of insured California Municipal
Bonds.
Merrill Lynch California Limited
Maturity Municipal Bond Fund......
A portfolio of Merrill Lynch Multi-State
Limited Maturity Municipal Series Trust,
a series fund, whose objective is to
provide as high a level of income exempt
from Federal and California income taxes
as is consistent with prudent investment
management through investment in a port-
folio primarily of intermediate-term in-
vestment grade California Municipal
Bonds.
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<PAGE>
Merrill Lynch California Municipal
Bond Fund.........................
A portfolio of Merrill Lynch California
Municipal Series Trust, a series fund,
whose objective is to provide as high a
level of income exempt from Federal and
California income taxes as is consistent
with prudent investment management.
Merrill Lynch Capital Fund, Inc. .. The highest total investment return con-
sistent with prudent risk through a
fully managed investment policy utiliz-
ing equity, debt, and convertible secu-
rities.
Merrill Lynch Colorado Municipal
Bond Fund.........................
A portfolio of Merrill Lynch Multi-State
Municipal Series Trust, a series fund,
whose objective is to provide as high a
level of income exempt from Federal and
Colorado income taxes as is consistent
with prudent investment management.
Merrill Lynch Connecticut
Municipal Bond Fund...............
A portfolio of Merrill Lynch Multi-State
Limited Municipal Series Trust, a series
fund, whose objective is to provide as
high a level of income exempt from Fed-
eral and Connecticut income taxes as is
consistent with prudent investment man-
agement.
Merrill Lynch Corporate Bond
Fund, Inc. .......................
Current income from three separate diver-
sified portfolios of fixed income secu-
rities.
Merrill Lynch Developing Capital
Markets Fund, Inc. ...............
Long-term capital appreciation through
investment in securities, principally
equities, of issuers in countries having
smaller capital markets.
Merrill Lynch Dragon Fund, Inc. ... Capital appreciation by investing primar-
ily in equity and debt securities of is-
suers domiciled in developing countries
located in Asia and the Pacific Basin.
Merrill Lynch Eurofund............. Capital appreciation primarily through
investment in equity securities of cor-
porations domiciled in Europe.
Merrill Lynch Federal Securities
Trust.............................
High current return through investments
in U.S. Government and Government agency
securities, including GNMA mortgage-
backed certificates and other mortgage-
backed Government securities.
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<PAGE>
Merrill Lynch Florida Limited
Maturity Municipal Bond Fund......
A portfolio of Merrill Lynch Multi-State
Limited Maturity Municipal Series Trust,
a series fund, whose objective is to
provide as high a level of income exempt
from Federal income taxes as is consis-
tent with prudent investment management
while serving to offer shareholders the
opportunity to own securities exempt
from Florida intangible personal prop-
erty taxes through investment in a port-
folio primarily of intermediate-term in-
vestment grade Florida Municipal Bonds.
Merrill Lynch Florida Municipal
Bond Fund.........................
A portfolio of Merrill Lynch Multi-State
Municipal Series Trust, a series fund,
whose objective is to provide as high a
level of income exempt from Federal in-
come taxes as is consistent with prudent
investment management while seeking to
offer shareholders the opportunity to
own securities exempt from Florida in-
tangible personal property taxes.
Merrill Lynch Fund For
Tomorrow, Inc. ...................
Long-term growth through investment in a
portfolio of good quality securities,
primarily common stock, potentially po-
sitioned to benefit from demographic and
cultural changes as they affect consumer
markets.
Merrill Lynch Fundamental Growth
Fund, Inc. .......................
Long-term growth of capital through in-
vestment in a diversified portfolio of
equity securities placing particular em-
phasis on companies that have exhibited
an above-average growth rate in earn-
ings.
Merrill Lynch Fundamental Value
Portfolio (available only for
exchanges by certain individual
retirement accounts for which
Merrill Lynch acts as custodian)..
A portfolio of Merrill Lynch Asset
Builder Program, Inc., a series fund,
whose objective is to provide capital
appreciation and income by investing in
securities, with at least 65% of the
portfolio's assets being invested in eq-
uities.
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<PAGE>
Merrill Lynch Global Allocation
Fund, Inc. .......................
High total return, consistent with
prudent risk, through a fully managed
investment policy utilizing United
States and foreign equity, debt and
money market securities, the combination
of which will be varied from time to
time both with respect to the types of
securities and markets in response to
changing market and economic trends.
Merrill Lynch Global Bond Fund for
Investment and Retirement.........
High total investment return from invest-
ment in a global portfolio of debt in-
struments denominated in various
currencies and multinational currency
units.
Merrill Lynch Global Convertible
Fund, Inc. .......................
High total return from investment
primarily in an international
diversified portfolio of convertible
debt securities, convertible preferred
stock and "synthetic" convertible
securities consisting of a combination
of debt securities or preferred stock
and warrants or options.
Merrill Lynch Global Holdings,
Inc. (residents of Arizona must
meet investor suitability
standards)........................
The highest total investment return con-
sistent with prudent risk through world-
wide investment in an internationally
diversified portfolio of securities.
Merrill Lynch Global Opportunity
Portfolio (available only for
exchanges by certain individual
retirement accounts for which
Merrill Lynch acts as custodian)..
A portfolio of Merrill Lynch Asset
Builder Program, Inc., a series fund,
whose objective is to provide a high to-
tal investment return through an invest-
ment policy utilizing United States and
foreign equity, debt and money market
securities, the combination of which
will vary depending upon changing market
and economic trends.
Merrill Lynch Global Resources
Trust.............................
Long-term growth and protection of capi-
tal from investment in securities of do-
mestic and foreign companies that pos-
sess substantial natural resource as-
sets.
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<PAGE>
Merrill Lynch Global SmallCap
Fund, Inc. .......................
Long-term growth of capital by investing
primarily in equity securities of compa-
nies with relatively small market capi-
talizations located in various foreign
countries and in the United States.
Merrill Lynch Global Utility
Fund, Inc. .......................
Capital appreciation and current income
through investment of at least 65% of
its total assets in equity and debt se-
curities issued by domestic and foreign
companies which are primarily engaged in
the ownership or operation of facilities
used to generate, transmit or distribute
electricity, telecommunications, gas or
water.
Merrill Lynch Growth Fund for
Investment and Retirement.........
Growth of capital and, secondarily, in-
come from investment in a diversified
portfolio of equity securities placing
principal emphasis on those securities
which management of the fund believes to
be undervalued.
Merrill Lynch Healthcare Fund,
Inc. (residents of Wisconsin must
meet investor suitability
standards)........................
Capital appreciation from worldwide in-
vestment in equity securities of compa-
nies that derive or are expected to de-
rive a substantial portion of their
sales from products and services in
healthcare.
Merrill Lynch International Equity
Fund..............................
Capital appreciation and, secondarily,
income by investing in a diversified
portfolio of equity securities of
issuers located in countries other than
the United States.
Merrill Lynch Latin America
Fund, Inc. .......................
Capital appreciation by investing primar-
ily in Latin American equity and debt
securities.
Merrill Lynch Maryland Municipal
Bond Fund.........................
A portfolio of Merrill Lynch Multi-State
Municipal Series Trust, a series fund,
whose objective is to provide as high a
level of income exempt from Federal and
Maryland income taxes as is consistent
with prudent investment management.
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<PAGE>
Merrill Lynch Massachusetts
Limited Maturity Municipal Bond
Fund.............................. A portfolio of Merrill Lynch Multi-State
Limited Maturity Municipal Series Trust,
a series fund, whose objective is to
provide as high a level of income exempt
from Federal and Massachusetts income
taxes as is consistent with prudent in-
vestment management through investment
in a portfolio primarily of intermedi-
ate-term investment grade Massachusetts
Municipal Bonds.
Merrill Lynch Massachusetts
Municipal Bond Fund...............
A portfolio of Merrill Lynch Multi-State
Municipal Series Trust, a series fund,
whose objective is to provide as high a
level of income exempt from Federal and
Massachusetts income taxes as is consis-
tent with prudent investment management.
Merrill Lynch Michigan Limited
Maturity Municipal Bond Fund......
A portfolio of Merrill Lynch Multi-State
Limited Maturity Municipal Series Trust,
a series fund, whose objective is to
provide as high a level of income exempt
from Federal and Michigan income taxes
as is consistent with prudent investment
management through investment in a port-
folio primarily of intermediate-term in-
vestment grade Michigan Municipal Bonds.
Merrill Lynch Michigan Municipal
Bond Fund.........................
A portfolio of Merrill Lynch Multi-State
Municipal Series Trust, a series fund,
whose objective is to provide as high a
level of income exempt from Federal and
Michigan income taxes as is consistent
with prudent investment management.
Merrill Lynch Minnesota Municipal
Bond Fund.........................
A portfolio of Merrill Lynch Multi-State
Municipal Series Trust, a series fund,
whose objective is to provide as high a
level of income exempt from Federal and
Minnesota personal income taxes as is
consistent with prudent investment man-
agement.
Merrill Lynch Municipal Bond
Fund, Inc. .......................
Tax-exempt income from three separate di-
versified portfolios of municipal bonds.
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<PAGE>
Merrill Lynch Municipal
Intermediate Term Fund............
Currently the only portfolio of Merrill
Lynch Municipal Series Trust, a series
fund, whose objective is to provide as
high a level as possible of income ex-
empt from Federal income taxes by in-
vesting in investment grade obligations
with a dollar weighted average maturity
of five to twelve years.
Merrill Lynch New Jersey Limited
Maturity Municipal Bond Fund......
A portfolio of Merrill Lynch Multi-State
Limited Maturity Municipal Series Trust,
a series fund, whose objective is to
provide as high a level of income exempt
from Federal and New Jersey income taxes
as is consistent with prudent investment
management through investment in a port-
folio primarily of intermediate-term in-
vestment grade New Jersey Municipal
Bonds.
Merrill Lynch New Jersey Municipal
Bond Fund.........................
A portfolio of Merrill Lynch Multi-State
Municipal Series Trust, a series fund,
whose objective is to provide as high a
level of income exempt from Federal and
New Jersey income taxes as is consistent
with prudent investment management.
Merrill Lynch New Mexico Municipal
Bond Fund.........................
A portfolio of Merrill Lynch Multi-State
Municipal Series Trust, a series fund,
whose objective is to provide as high a
level of income exempt from Federal and
New Mexico income taxes as is consistent
with prudent investment management.
Merrill Lynch New York Limited
Maturity Municipal Bond Fund......
A portfolio of Merrill Lynch Multi-State
Limited Maturity Municipal Series Trust,
a series fund, whose objective is to
provide as high a level of income exempt
from Federal, New York State and New
York City income taxes as is consistent
with prudent investment management
through investment in a portfolio pri-
marily of intermediate-term investment
grade New York Municipal Bonds.
Merrill Lynch New York Municipal
Bond Fund.........................
A portfolio of Merrill Lynch Multi-State
Municipal Series Trust, a series fund,
whose objective is to provide as high a
level of income exempt from Federal, New
York State and New York City income
taxes as is consistent with prudent in-
vestment management.
40
<PAGE>
Merrill Lynch Ohio Municipal
Bond Fund.........................
A portfolio of Merrill Lynch Multi-State
Municipal Series Trust, a series fund,
whose objective is to provide as high a
level of income exempt from Federal and
Ohio income taxes as is consistent with
prudent investment management.
Merrill Lynch Oregon Municipal
Bond Fund.........................
A portfolio of Merrill Lynch Multi-State
Municipal Series Trust, a series fund,
whose objective is to provide as high a
level of income exempt from Federal and
Oregon income taxes as is consistent
with prudent investment management.
Merrill Lynch Pacific Fund, Inc. .. Capital appreciation by investing in eq-
uity securities of corporations domi-
ciled in Far Eastern and Western Pacific
countries, including Japan, Australia,
Hong Kong and Singapore.
Merrill Lynch Pennsylvania Limited
Maturity Municipal Bond Fund......
A portfolio of Merrill Lynch Multi-State
Limited Maturity Municipal Series Trust,
a series fund, whose objective is to
provide as high a level of income exempt
from Federal and Pennsylvania income
taxes as is consistent with prudent in-
vestment management through investment
in a portfolio primarily of intermedi-
ate-term investment grade Pennsylvania
Municipal Bonds.
Merrill Lynch Pennsylvania
Municipal Bond Fund...............
A portfolio of Merrill Lynch Multi-State
Municipal Series Trust, a series fund,
whose objective is to provide as high a
level of income exempt from Federal and
Pennsylvania personal income taxes as is
consistent with prudent investment man-
agement.
Merrill Lynch Phoenix Fund, Inc. .. Long-term growth of capital by investing
in equity and fixed income securities,
including tax-exempt securities, of is-
suers in weak financial condition or ex-
periencing poor operating results be-
lieved to be undervalued relative to the
current or prospective condition of such
issuer.
41
<PAGE>
Merrill Lynch Quality Bond
Portfolio (available only for
exchanges by certain individual
retirement accounts for which
Merrill Lynch acts as custodian)..
A portfolio of Merrill Lynch Asset
Builder Program, Inc., a series fund,
whose objective is to provide a high
level of current income through invest-
ment in a diversified portfolio of debt
obligations, such as corporate bonds and
notes, convertible securities, preferred
stocks and governmental obligations.
Merrill Lynch Short-Term Global
Income Fund, Inc. ................
As high a level of current income as is
consistent with prudent investment man-
agement from a global portfolio of high
quality debt securities denominated in
various currencies and multinational
currency units and having remaining ma-
turities not exceeding three years.
Merrill Lynch Special Value
Fund, Inc. .......................
Long-term growth of capital from invest-
ments in securities, primarily common
stocks, of relatively small companies
believed to have special investment
value and emerging growth companies re-
gardless of size.
Merrill Lynch Strategic Dividend
Fund..............................
Long-term total return from investment in
dividend-paying common stocks which
yield more than Standard & Poor's 500
Composite Stock Price Index.
Merrill Lynch Technology Fund, Capital appreciation through worldwide
Inc. ............................. investment in equity securities of com-
panies that derive or are expected to
derive a substantial portion of their
sales from products and services in
technology.
Merrill Lynch Texas Municipal
Bond Fund.........................
A portfolio of Merrill Lynch Multi-State
Municipal Series Trust, a series fund,
whose objective is to provide as high a
level of income exempt from Federal in-
come taxes as is consistent with prudent
investment management by investing pri-
marily in a portfolio of long-term, in-
vestment grade municipal obligations is-
sued by the State of Texas, its politi-
cal subdivisions, agencies and instru-
mentalities.
42
<PAGE>
Merrill Lynch U.S. Government
Securities Portfolio (available
only for exchanges by certain
individual retirement accounts
for which Merrill Lynch acts as
custodian)........................
A portfolio of Merrill Lynch Asset
Builder Program, Inc., a series fund,
whose objective is to provide a high
current return through investments in
U.S. Government and government agency
securities, including GNMA mortgage-
backed certificates and other mortgage-
backed government securities.
Merrill Lynch Utility Income
Fund, Inc. .......................
High current income through investment in
equity and debt securities issued by
companies which are primarily engaged in
the ownership or operation of facilities
used to generate, transmit or distribute
electricity, telecommunications, gas or
water.
Merrill Lynch World Income
Fund, Inc. .......................
High current income by investing in a
global portfolio of fixed income securi-
ties denominated in various currencies,
including multinational currency units.
Class A Share Money Market Funds:
Merrill Lynch Ready Assets Trust... Preservation of capital, liquidity and
the highest possible current income con-
sistent with the foregoing objectives
from the short-term money market securi-
ties in which the fund invests.
Merrill Lynch Retirement Reserves
Money Fund (available only if the
exchange occurs within certain
retirement plans).................
Currently the only portfolio of Merrill
Lynch Retirement Series Trust, a series
fund, whose objectives are to provide
current income, preservation of capital
and liquidity available from investing
in a diversified portfolio of short-term
money market securities.
Merrill Lynch U.S.A. Government
Reserves..........................
Preservation of capital, current income
and liquidity available from investing
in direct obligations of the U.S. Gov-
ernment and repurchase agreements relat-
ing to such securities.
43
<PAGE>
Merrill Lynch U.S. Treasury Money
Fund..............................
Preservation of capital, liquidity and
current income through investment exclu-
sively in a diversified portfolio of
short-term marketable securities which
are direct obligations of the U.S. Trea-
sury.
Class B, Class C and Class D Share Money Market Funds:
Merrill Lynch Government Fund...... A portfolio of Merrill Lynch Funds for
Institutions Series, a series fund,
whose objective is to provide current
income consistent with liquidity and se-
curity of principal from investment in
securities issued or guaranteed by the
U.S. Government, its agencies and
instrumentalities and in repurchase
agreements secured by such obligations.
Merrill Lynch Institutional Fund... A portfolio of Merrill Lynch Funds for
Institutions Series, a series fund,
whose objective is to provide maximum
current income consistent with liquidity
and the maintenance of a high-quality
portfolio of money market securities.
Merrill Lynch Institutional Tax-
Exempt Fund.......................
A portfolio of Merrill Lynch Funds for
Institutions Series, a series fund,
whose objective is to provide current
income exempt from Federal income taxes,
preservation of capital and liquidity
available from investing in a diversi-
fied portfolio of short-term, high qual-
ity municipal bonds.
Merrill Lynch Treasury Fund........ A portfolio of Merrill Lynch Funds for
Institutions Series, a series fund,
whose objective is to provide current
income consistent with liquidity and se-
curity of principal from investment in
direct obligations of the U.S. Treasury
and up to 10% of its total assets in
repurchase agreements secured by such
obligations.
Before effecting an exchange, shareholders of the Fund should obtain a
currently effective prospectus of the fund into which the exchange is to be
made.
To exercise the exchange privilege, shareholders should contact their Merrill
Lynch financial consultant, who will advise the Fund of the exchange, or if the
exchange does not involve a money market fund, the shareholder may write to the
Transfer Agent requesting that the exchange be effected. Such letter must be
signed exactly as the account is registered with signatures guaranteed by an
"eligible guarantor institution"
44
<PAGE>
as such term is defined in Rule 17Ad-15 under the Securities Exchange Act of
1934, as amended, the existence and validity of which may be verified by the
Transfer Agent through the use of industry publications. Shareholders of the
Fund, and shareholders of the other funds described above with shares for which
certificates have not been issued, may exercise the exchange privilege by wire
through their securities dealers. The Fund reserves the right to require a
properly completed Exchange Application. This exchange privilege may be
modified or terminated at any time in accordance with the rules of the
Commission. The Fund reserves the right to limit the number of times an
investor may exercise the exchange privilege. Certain funds may suspend the
continuous offering of their shares to the general public at any time and may
thereafter resume such offering from time to time. The exchange privilege is
available only to U.S. shareholders in states where the exchange legally may be
made.
DISTRIBUTIONS AND TAXES
The Trust intends to continue to qualify the Fund for the special tax
treatment afforded regulated investment companies ("RICs") under the Internal
Revenue Code of 1986, as amended (the "Code"). If it so qualifies, in any
taxable year in which it distributes at least 90% of its taxable net income and
90% of its tax-exempt net income (see below), the Fund (but not its
shareholders) will not be subject to Federal income tax to the extent that it
distributes its net investment income and net realized capital gains. The Trust
intends to cause the Fund to distribute substantially all of such income.
As discussed in the Fund's Prospectus, the Trust has established other series
in addition to the Fund (together with the Fund, the "Series"). Each Series of
the Trust is treated as a separate corporation for Federal income tax purposes.
Each Series therefore is considered to be a separate entity in determining its
treatment under the rules for RICs described in the Prospectus. Losses in one
Series do not offset gains in another Series, and the requirements (other than
certain organizational requirements) for qualifying for RIC status are
determined at the Series level rather than at the Trust level.
The Code requires a RIC to pay a nondeductible 4% excise tax to the extent
the RIC does not distribute, during each calendar year, 98% of its ordinary
income, determined on a calendar year basis, and 98% of its capital gains,
determined, in general, on an October 31 year end, plus certain undistributed
amounts from previous years. The required distributions, however, are based
only on the taxable income of a RIC. The excise tax, therefore, generally will
not apply to the tax-exempt income of a RIC, such as the Fund, that pays
exempt-interest dividends.
The Trust intends to qualify the Fund to pay "exempt-interest dividends" as
defined in Section 852(b)(5) of the Code. Under such section if, at the close
of each quarter of the Fund's taxable year, at least 50% of the value of its
total assets consists of obligations exempt from Federal income tax ("tax-
exempt obligations") under Section 103(a) of the Code (relating generally to
obligations of a state or local governmental unit), the Fund shall be qualified
to pay exempt-interest dividends to its Class A, Class B, Class C and Class D
shareholders (together, the "shareholders"). Exempt-interest dividends are
dividends or any part thereof paid by the Fund which are attributable to
interest on tax-exempt obligations and designated by the Trust as exempt-
interest dividends in a written notice mailed to the Fund's shareholders within
60 days after the close of the Fund's taxable year. For this purpose, the Fund
will allocate interest from tax-exempt obligations (as
45
<PAGE>
well as ordinary income, capital gains and tax preference items, discussed
below) among the Class A, Class B, Class C and Class D shareholders according
to a method (which it believes is consistent with the Commission's exemptive
order permitting the issuance and sale of multiple classes of shares) that is
based on the gross income allocable to Class A, Class B, Class C and Class D
shareholders during the taxable year, or such other method as the Internal
Revenue Service may prescribe. To the extent that the dividends distributed to
the Fund's shareholders are derived from interest income exempt from Federal
income tax under Code Section 103(a) and are properly designated as exempt-
interest dividends, they will be excludable from a shareholder's gross income
for Federal income tax purposes. Exempt-interest dividends are included,
however, in determining the portion, if any, of a person's social security
benefits and railroad retirement benefits subject to Federal income taxes.
Interest on indebtedness incurred or continued to purchase or carry shares of a
RIC paying exempt-interest dividends, such as the Fund, will not be deductible
by the investor for Federal and North Carolina income tax purposes.
Shareholders are advised to consult their tax advisers with respect to whether
exempt-interest dividends retain the exclusion under Code Section 103(a) if a
shareholder would be treated as a "substantial user" or "related person" under
Code Section 147(a) with respect to property financed with the proceeds of an
issue of "industrial development bonds" or "private activity bonds," if any,
held by the Fund.
The portion of the Fund's exempt-interest dividends paid from interest
received by the Fund from North Carolina Municipal Bonds is not subject to
North Carolina individual and corporate income taxes. Additionally, the Fund's
dividends attributable to interest from direct obligations of the U.S.
Government are not subject to North Carolina individual or corporate income
tax. Distributions of gains attributable to the disposition of certain
obligations of the State of North Carolina and its political subdivisions that
were issued before July 1, 1995 also are not subject to North Carolina
individual or corporate income tax; however, for such obligations issued after
June 30, 1995, distributions of gains attributable to disposition will not be
exempt from North Carolina individual or corporate income tax. Shareholders
subject to income taxation by states other than North Carolina will realize a
lower after-tax rate of return than North Carolina shareholders since the
dividends distributed by the Fund generally will not be exempt, to any
significant degree, from income taxation by such other states. The Trust will
inform shareholders annually regarding the portion of the Fund's distributions
which constitutes exempt-interest dividends and the portion which is exempt
from North Carolina income taxes. The Fund will allocate exempt-interest
dividends among Class A, Class B, Class C and Class D shareholders for North
Carolina income tax purposes based on a method similar to that described above
for Federal income tax purposes.
An investment in the Fund prior to 1995 was potentially subject to the North
Carolina intangible personal property tax, subject to certain exemptions. This
tax, however, was repealed by the North Carolina General Assembly, effective
for taxable years beginning on or after January 1, 1995.
Distributions from investment income and capital gains of the Fund, including
exempt-interest dividends, will be included in the North Carolina capital
stock, surplus and undivided profits base in computing the North Carolina
franchise tax and may also be subject to state taxes in states other than North
Carolina and local taxes by municipalities in states other than North Carolina.
Accordingly, investors in the Fund, including, in particular, corporate
investors which may be subject to the North Carolina franchise tax, should
consult their tax advisers with respect to the application of such taxes to an
investment in the Fund and to the receipt of Fund dividends and as to their
North Carolina tax situation in general.
46
<PAGE>
To the extent that the Fund's distributions are derived from interest on its
taxable investments (including for North Carolina income tax purposes, interest
on Municipal Bonds of other states) or from an excess of net short-term capital
gains over net long-term capital losses ("ordinary income dividends"), such
distributions are considered ordinary income for Federal and North Carolina
income tax purposes, except, in the case of North Carolina income tax, for
dividends that are directly attributable to interest on obligations of the U.S.
Government or to gains from certain obligations of the State of North Carolina
and its political subdivisions that were issued before July 1, 1995.
Distributions, if any, from an excess of net long-term capital gains over net
short-term capital losses derived from the sale of securities or from certain
transactions in futures or options ("capital gain dividends") are taxable as
long-term capital gains for Federal income tax purposes, regardless of the
length of time the shareholder has owned Fund shares. Distributions by the
Fund, whether from exempt-interest income, ordinary income or capital gains,
will not be eligible for the dividends received deduction allowed to
corporations under the Code.
All or a portion of the Fund's gain from the sale or redemption of tax-exempt
obligations purchased at a market discount will be treated as ordinary income
rather than capital gain. This rule may increase the amount of ordinary income
dividends received by shareholders. Capital gain dividends and distributions of
market discount gain treated as ordinary income dividends also are subject to
North Carolina income taxes, except to the extent attributable to gains from
certain obligations of the State of North Carolina and its political
subdivisions that were issued before July 1, 1995. Any loss upon the sale or
exchange of Fund shares held for six months or less will be treated as long-
term capital loss to the extent of any capital gain dividends received by the
shareholder. In addition, such loss will be disallowed for both Federal and
North Carolina income tax purposes to the extent of any exempt-interest
dividends received by the shareholder, even, in the case of North Carolina,
where all or a portion of such dividends is not excluded from North Carolina
taxable income. Distributions in excess of the Fund's earnings and profits will
first reduce the adjusted tax basis of a holder's shares and, after such
adjusted tax basis is reduced to zero, will constitute capital gains (assuming
such shares are held as a capital asset). If the Fund pays a dividend in
January which was declared in the previous October, November or December to
shareholders of record on a specified date in one of such months, then such
dividend will be treated for tax purposes as being paid by the Fund and
received by its shareholders on December 31 of the year in which such dividend
was declared.
The Code subjects interest received on certain otherwise tax-exempt
securities to an alternative minimum tax. The alternative minimum tax applies
to interest received on certain "private activity bonds" issued after August 7,
1986. Private activity bonds are bonds which, although tax-exempt, are used for
purposes other than those generally performed by governmental units and which
benefit non-governmental entities (e.g., bonds used for industrial development
or housing purposes). Income received on such bonds is classified as an item of
"tax preference," which could subject investors in such bonds, including
shareholders of the Fund, to an alternative minimum tax. The Fund will purchase
such "private activity bonds," and the Trust will report to shareholders within
60 days after the Fund's taxable year-end the portion of the Fund's dividends
declared during the year which constitutes an item of tax preference for
alternative minimum tax purposes. The Code further provides that corporations
are subject to an alternative minimum tax based, in part, on certain
differences between taxable income as adjusted for other tax preferences and
the corporation's "adjusted current earnings," which more closely reflect a
corporation's economic income. Because an exempt-interest dividend paid by the
Fund will be included in adjusted current earnings, a corporate shareholder may
be required to pay alternative minimum tax on exempt-interest dividends paid by
the Fund.
47
<PAGE>
No gain or loss will be recognized by Class B shareholders on the conversion
of their Class B shares into Class D shares. A shareholder's basis in the Class
D shares acquired will be the same as such shareholder's basis in the Class B
shares converted, and the holding period of the acquired Class D shares will
include the holding period for the converted Class B shares.
If a shareholder exercises an exchange privilege within 90 days of acquiring
the shares, then the loss the shareholder can recognize on the exchange will be
reduced (or the gain increased) to the extent any sales charge paid to the Fund
on the exchanged shares reduces any sales charge such shareholder would have
owed upon purchase of the new shares in the absence of the exchange privilege.
Instead, such sales charge will be treated as an amount paid for the new
shares.
A loss realized on a sale or exchange of shares of the Fund will be
disallowed if other Fund shares are acquired (whether through the automatic
reinvestment of dividends or otherwise) within a 61-day period beginning 30
days before and ending 30 days after the date that the shares are disposed of.
In such a case, the basis of the shares acquired will be adjusted to reflect
the disallowed loss.
Ordinary income dividends paid to shareholders who are nonresident aliens or
foreign entities will be subject to a 30% United States withholding tax under
existing provisions of the Code applicable to foreign individuals and entities
unless a reduced rate of withholding or a withholding exemption is provided
under applicable treaty law. Nonresident shareholders are urged to consult
their own tax advisers concerning the applicability of the U.S. withholding
tax.
Under certain Code provisions, some shareholders may be subject to a 31%
withholding tax on certain ordinary income dividends and on capital gain
dividends and redemption payments ("backup withholding"). Generally,
shareholders subject to backup withholding will be those for whom no certified
taxpayer identification number is on file with the Trust or who, to the Trust's
knowledge, have furnished an incorrect number. When establishing an account, an
investor must certify under penalty of perjury that such number is correct and
that such investor is not otherwise subject to backup withholding.
The Code provides that every person required to file a tax return must
include for information purposes on such return the amount of exempt-interest
dividends received from all sources (including the Fund) during the taxable
year.
ENVIRONMENTAL TAX
The Code imposes a deductible tax (the "Environmental Tax") on a
corporation's modified alternative minimum taxable income (computed without
regard to the alternative tax net operating loss deduction and the deduction
for the Environmental Tax) at a rate of $12 per $10,000 (0.12%) of alternative
minimum taxable income in excess of $2,000,000. The Environmental Tax is
imposed for taxable years beginning after December 31, 1986, and before January
1, 1996. The Environmental Tax is imposed even if the corporation is not
required to pay an alternative minimum tax because the corporation's regular
income tax liability exceeds its minimum tax liability. The Code provides,
however, that a RIC, such as the Fund, is not subject to the Environmental Tax.
However, exempt-interest dividends paid by the Fund that create alternative
minimum taxable income for corporate shareholders (as described above) may
subject corporate shareholders of the Fund to the Environmental Tax.
48
<PAGE>
TAX TREATMENT OF OPTION AND FUTURES TRANSACTIONS
The Fund may purchase or sell municipal bond index futures contracts and
interest rate futures contracts on U.S. Government securities ("financial
futures contracts"). The Fund may also purchase and write call and put options
on such financial futures contracts. In general, unless an election is
available to the Fund or an exception applies, such options and financial
futures contracts that are "Section 1256 contracts" will be "marked to market"
for Federal income tax purposes at the end of each taxable year, i.e., each
such option or financial futures contract will be treated as sold for its fair
market value on the last day of the taxable year, and any gain or loss
attributable to Section 1256 contracts will be 60% long-term and 40% short-term
capital gain or loss. Application of these rules to Section 1256 contracts held
by the Fund may alter the timing and character of distributions to
shareholders. The mark-to-market rules outlined above, however, will not apply
to certain transactions entered into by the Fund solely to reduce the risk of
changes in price or interest rates with respect to its investments.
Code Section 1092, which applies to certain "straddles," may affect the
taxation of the Fund's transactions in financial futures contracts and related
options. Under Section 1092, the Fund may be required to postpone recognition
for tax purposes of losses incurred in certain closing transactions in options
and financial futures contracts or the related options.
One of the requirements for qualification as a RIC is that less than 30% of
the Fund's gross income be derived from gains from the sale or other
disposition of securities held for less than three months. Accordingly, the
Fund may be restricted in effecting closing transactions within three months
after entering into an option or financial futures contract.
NORTH CAROLINA INCOME AND FRANCHISE TAXES
Provided the Fund does not have a tax nexus to North Carolina, such as
through the location of the Fund's activities or those of its advisors within
the state, under present North Carolina law the Fund is not subject to any
North Carolina income taxation or other North Carolina taxation measured by the
capital assets of the Fund. In the event of a tax nexus to North Carolina, the
Fund, if it qualifies as a RIC and files the necessary election with the North
Carolina Department of Revenue, would be subject to North Carolina income tax
only to the extent that its net income is not distributed or declared for
distribution to shareholders, and the Fund would be subject to the North
Carolina franchise tax. If the Fund qualifies as a RIC and files the necessary
election with the North Carolina Department of Revenue, it would be allowed to
deduct the aggregate market value of certain of its investments in stocks,
bonds, debentures, other securities and other evidences of indebtedness in
determining its North Carolina franchise tax base.
----------------
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code, Treasury regulations and North Carolina tax laws
presently in effect. For the complete provisions, reference should be made to
the pertinent Code sections, the Treasury regulations promulgated thereunder
and the applicable North Carolina income tax laws. The Code and the Treasury
regulations, as well as the North Carolina tax laws, are subject to change by
legislative, judicial or administrative action either prospectively or
retroactively.
Shareholders are urged to consult their own tax advisers regarding the
availability of any exemptions from state or local taxes (other than those
imposed by North Carolina) and with specific questions as to Federal, foreign,
state or local taxes.
49
<PAGE>
PERFORMANCE DATA
From time to time the Fund may include its average annual total return and
other total return data, as well as yield and tax-equivalent yield, in
advertisements or information furnished to present or prospective shareholders.
From time to time, the Fund may include the Fund's Morningstar risk-adjusted
performance ratings in advertisements or supplemental sales literature. Total
return, yield and tax-equivalent yield figures are based on the Fund's
historical performance and are not intended to indicate future performance.
Average annual total return, yield and tax-equivalent yield are determined
separately for Class A, Class B, Class C and Class D shares in accordance with
formulas specified by the Commission.
Average annual total return quotations for the specified periods are computed
by finding the average annual compounded rates of return (based on net
investment income and any realized and unrealized capital gains or losses on
portfolio investments over such periods) that would equate the initial amount
invested to the redeemable value of such investment at the end of each period.
Average annual total return is computed assuming all dividends and
distributions are reinvested and taking into account all applicable recurring
and nonrecurring expenses, including the maximum sales charge in the case of
Class A and Class D shares and the CDSC that would be applicable to a complete
redemption of the investment at the end of the specified period in the case of
the Class B and Class C shares.
The Fund also may quote annual, average annual and annualized total return
and aggregate total return performance data, both as a percentage and as a
dollar amount based on a hypothetical $1,000 investment, for various periods
other than those noted below. Such data will be computed as described above,
except that (1) as required by the periods of the quotations, actual annual,
annualized or aggregate data, rather than average annual data, may be quoted
and (2) the maximum applicable sales charges will not be included with respect
to annual or annualized rates of return calculations. Aside from the impact on
the performance data calculations of including or excluding the maximum
applicable sales charges, actual annual or annualized total return data
generally will be lower than average annual total return data since the average
rates of return reflect compounding of return; aggregate total return data
generally will be higher than average annual total return data since the
aggregate rates of return reflect compounding over a longer period of time.
50
<PAGE>
Set forth below is the total return, yield and tax-equivalent yield
information for Class A, Class B, Class C and Class D shares of the Fund for
the periods indicated.
<TABLE>
<CAPTION>
Class A Shares Class B Shares
----------------------------------- -----------------------------------
Expressed as Redeemable Value Expressed as Redeemable Value
a percentage of a hypothetical a percentage of a hypothetical
based on a $1,000 investment based on a $1,000 investment
hypothetical at the end of hypothetical at the end of
$1,000 investment the period $1,000 investment the period
----------------- ----------------- ----------------- -----------------
<S> <C> <C> <C> <C>
AVERAGE ANNUAL TOTAL RETURN (INCLUDING MAXIMUM APPLICABLE SALES CHARGE)
One year ended
July 31, 1995 2.33% $ 1,023.30 2.06% $ 1,020.60
Inception (Sep-
tember 25, 1992)
to July 31,
1995............ 5.16% $ 1,153.90 5.51% $ 1,165.10
Inception (Octo-
ber 21, 1994) to
July 31, 1995...
ANNUAL TOTAL RETURN (EXCLUDING MAXIMUM APPLICABLE SALES CHARGE)
Year ended July
31, 1995........ 6.60% $ 1,066.00 6.06% $ 1,060.60
One Year ended
July 31, 1994... 1.11% $ 1,011.10 0.60% $ 1,006.00
Inception (Sep-
tember 25, 1992)
to July 31,
1993............ 11.52% $ 1,115.20 11.06% $ 1,110.60
Inception (Octo-
ber 21, 1994) to
July 31, 1995...
AGGREGATE TOTAL RETURN (INCLUDING MAXIMUM APPLICABLE SALES CHARGE)
Inception (Sep-
tember 25, 1992)
to July 31,
1995............ 15.39% $ 1,153.90 16.51% $ 1,165.10
Inception (Octo-
ber 21, 1994) to
July 31, 1995...
YIELD
30 days ended
July 31, 1995... 5.02% 4.72%
TAX EQUIVALENT YIELD**
30 days ended
July 31, 1995... 6.97% 6.56%
</TABLE>
<TABLE>
<CAPTION>
Class C Shares* Class D Shares*
----------------------------------- -----------------------------------
Expressed as Redeemable Value Expressed as Redeemable Value
a percentage of a hypothetical a percentage of a hypothetical
based on a $1,000 investment based on a $1,000 investment
hypothetical at the end of hypothetical at the end of
$1,000 investment the period $1,000 investment the period
----------------- ----------------- ----------------- -----------------
<S> <C> <C> <C> <C>
AVERAGE ANNUAL TOTAL RETURN (INCLUDING MAXIMUM APPLICABLE SALES CHARGE)
One year ended
July 31, 1995
Inception (Sep-
tember 25, 1992)
to July 31,
1995............
Inception (Octo-
ber 21, 1994) to
July 31, 1995... 10.27% $1,078.70 6.52% $1,050.20
ANNUAL TOTAL RETURN (EXCLUDING MAXIMUM APPLICABLE SALES CHARGE)
Year ended July
31, 1995........
One Year ended
July 31, 1994...
Inception (Sep-
tember 25, 1992)
to July 31,
1993............
Inception (Octo-
ber 21, 1994) to
July 31, 1995... 8.87% $1,088.70 9.39% $1,093.90
AGGREGATE TOTAL RETURN (INCLUDING MAXIMUM APPLICABLE SALES CHARGE)
Inception (Sep-
tember 25, 1992)
to July 31,
1995............
Inception (Octo-
ber 21, 1994) to
July 31, 1995... 7.87% $1,078.70 5.02% $1,050.20
YEILD
30 days ended
July 31, 1995... 4.62% 4.93%
TAX EQUIVALENT YIELD**
30 days ended
July 31, 1995... 6.42% 6.85%
</TABLE>
- ----
* Information as to Class C and Class D shares is presented only for the
period October 21, 1994 (commencement of operations of Class C and Class D
shares) to July 31, 1995. Prior to October 21, 1994, no Class C or Class D
shares had been publicly issued.
** Based on a Federal income tax rate of 28%.
51
<PAGE>
In order to reflect the reduced sales charges in the case of Class A or Class
D shares or the waiver of the CDSC in the case of Class B shares applicable to
certain investors, as described under "Purchase of Shares" and "Redemption of
Shares", respectively, the total return data quoted by the Fund in
advertisements directed to such investors may take into account the reduced,
and not the maximum, sales charge or may take into account the CDSC and
therefore may reflect greater total return since, due to the reduced sales
charges or the waiver of sales charges, a lower amount of expenses is deducted.
GENERAL INFORMATION
DESCRIPTION OF SHARES
The Declaration of Trust provides that the Trust shall be comprised of
separate Series each of which will consist of a separate portfolio which will
issue separate shares. The Trust is presently comprised of the Fund, Merrill
Lynch Arizona Municipal Bond Fund, Merrill Lynch Arkansas Municipal Bond Fund,
Merrill Lynch Colorado Municipal Bond Fund, Merrill Lynch Connecticut Municipal
Bond Fund, Merrill Lynch Florida Municipal Bond Fund, Merrill Lynch Maryland
Municipal Bond Fund, Merrill Lynch Massachusetts Municipal Bond Fund, Merrill
Lynch Michigan Municipal Bond Fund, Merrill Lynch Minnesota Municipal Bond
Fund, Merrill Lynch New Jersey Municipal Bond Fund, Merrill Lynch New Mexico
Municipal Bond Fund, Merrill Lynch New York Municipal Bond Fund, Merrill Lynch
Ohio Municipal Bond Fund, Merrill Lynch Oregon Municipal Bond Fund, Merrill
Lynch Pennsylvania Municipal Bond Fund and Merrill Lynch Texas Municipal Bond
Fund. The Trustees are authorized to create an unlimited number of Series and,
with respect to each Series, to issue an unlimited number of full and
fractional shares of beneficial interest, par value $.10 per share, of
different classes and to divide or combine the shares into a greater or lesser
number of shares without thereby changing the proportionate beneficial
interests in the Series. Shareholder approval is not necessary for the
authorization of additional Series or classes of a Series of the Trust. At the
date of this Statement of Additional Information, the shares of the Fund are
divided into Class A, Class B, Class C and Class D shares. Class A, Class B,
Class C and Class D shares represent an interest in the same assets of the Fund
and are identical in all respects except that the Class B, Class C and Class D
shares bear certain expenses related to the account maintenance and/or
distribution of such shares and have exclusive voting rights with respect to
matters relating to such account maintenance and/or distribution expenditures.
The Trust has received an order (the "Order") from the Commission permitting
the issuance and sale of multiple classes of shares. The Order permits the
Trust to issue additional classes of shares of any Series if the Board of
Trustees deems such issuance to be in the best interests of the Trust. The
Board of Trustees may classify and reclassify the shares of any Series into
additional classes at a future date.
All shares of the Trust have equal voting rights, except that only shares of
the respective Series are entitled to vote on matters concerning only that
Series and, as noted above, Class B, Class C and Class D shares will have
exclusive voting rights with respect to matters relating to the account
maintenance and/or distribution expenses being borne solely by such class. Each
issued and outstanding share is entitled to one vote and to participate equally
in dividends and distributions declared by the Fund and in the net assets of
such Series upon liquidation or dissolution remaining after satisfaction of
outstanding liabilities, except that, as noted above, expenses related to the
account maintenance and/or distribution of the Class B, Class C and Class D
shares are borne solely by such class. There normally will be no meetings of
shareholders for the purposes of electing Trustees unless and until such time
as less than a majority of the Trustees holding office
52
<PAGE>
have been elected by shareholders, at which time the Trustees then in office
will call a shareholders' meeting for the election of Trustees. Shareholders
may, in accordance with the terms of the Declaration of Trust, cause a meeting
of shareholders to be held for the purpose of voting on the removal of
Trustees. Also, the Trust will be required to call a special meeting of
shareholders in accordance with the requirements of the 1940 Act to seek
approval of new management and advisory arrangements, of a material increase
in distribution fees or of a change in the fundamental policies, objective or
restrictions of a Series.
The obligations and liabilities of a particular Series are restricted to the
assets of that Series and do not extend to the assets of the Trust generally.
The shares of each Series, when issued, will be fully paid and nonassessable,
have no preference, preemptive, conversion, exchange or similar rights and are
freely transferable. Holders of shares of any Series are entitled to redeem
their shares as set forth elsewhere herein and in the Prospectus. Shares do
not have cumulative voting rights, and the holders of more than 50% of the
shares of the Trust voting for the election of Trustees can elect all of the
Trustees if they choose to do so and in such event the holders of the
remaining shares would not be able to elect any Trustees. No amendments may be
made to the Declaration of Trust without the affirmative vote of a majority of
the outstanding shares of the Trust.
The Manager provided the initial capital for the Fund by purchasing 10,000
shares of the Fund for $100,000. Such shares were acquired for investment and
can only be disposed of by redemption. The organizational expenses of the Fund
(estimated at approximately $29,050) were paid by the Fund and are amortized
over a period not exceeding five years. The proceeds realized by the Manager
upon the redemption of any of the shares initially purchased by it will be
reduced by the proportionate amount of unamortized organizational expenses
which the number of shares redeemed bears to the number of shares initially
purchased. Such organizational expenses include certain of the initial
organizational expenses of the Trust which have been allocated to the Fund by
the Trustees. If additional Series are added to the Trust, the organizational
expenses will be allocated among the Series in a manner deemed equitable by
the Trustees.
COMPUTATION OF OFFERING PRICE PER SHARE
An illustration of the computation of the offering price for Class A, Class
B, Class C and Class D shares of the Fund based on the value of the Fund's net
assets and number of shares outstanding on July 31, 1995, is calculated as set
forth below.
TABLE
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C CLASS D
---------- ----------- -------- ----------
<S> <C> <C> <C> <C>
Net Assets.......................... $9,256,261 $49,977,593 $712,907 $1,376,526
========== =========== ======== ==========
Number of Shares Outstanding........ 899,900 4,858,115 69,316 133,759
========== =========== ======== ==========
Net Asset Value Per Share (net
assets divided by number of shares
outstanding)....................... $ 10.29 $ 10.29 $ 10.28 $ 10.29
Sales Charge (for Class A and Class
D shares: 4.00% of offering price
(4.17% of net asset value per
share))*........................... .43 ** ** .43
---------- ----------- -------- ----------
Offering Price...................... $ 10.72 $ 10.29 $ 10.28 $ 10.72
========== =========== ======== ==========
</TABLE>
- --------
* Rounded to the nearest one-hundredth percent; assumes maximum sales charge
is applicable.
** Class B and Class C shares are not subject to an initial sales charge but
may be subject to a CDSC on redemption of shares. See "Purchase of Shares--
Deferred Sales Charge Alternatives--Class B and Class C Shares" and in the
Prospectus.
53
<PAGE>
INDEPENDENT AUDITORS
Deloitte & Touche LLP, 117 Campus Drive, Princeton, New Jersey 08540-6400,
has been selected as the independent auditors of the Fund. The independent
auditors are responsible for auditing the annual financial statements of the
Fund.
CUSTODIAN
State Street Bank and Trust Company, P.O. Box 351, Boston, Massachusetts
02101, acts as the custodian of the Fund's assets. The custodian is responsible
for safeguarding and controlling the Fund's cash and securities, handling the
delivery of securities and collecting interest on the Fund's investments.
TRANSFER AGENT
Merrill Lynch Financial Data Services, Inc., 4800 Deer Lake Drive East,
Jacksonville, Florida 32246-6484, acts as the Trust's transfer agent. The
Transfer Agent is responsible for the issuance, transfer and redemption of
shares and the opening, maintenance and servicing of shareholder accounts. See
"Management of the Trust--Transfer Agency Services" in the Prospectus.
LEGAL COUNSEL
Brown & Wood, One World Trade Center, New York, New York 10048-0557, is
counsel for the Trust.
REPORTS TO SHAREHOLDERS
The fiscal year of the Fund ends on July 31 of each year. The Trust sends to
shareholders of the Fund at least semi-annually reports showing the Fund's
portfolio and other information. An annual report, containing financial
statements audited by independent auditors, is sent to shareholders each year.
After the end of each year, shareholders will receive Federal income tax
information regarding dividends and capital gains distributions.
ADDITIONAL INFORMATION
The Prospectus and this Statement of Additional Information do not contain
all the information set forth in the Registration Statement and the exhibits
relating thereto, which the Trust has filed with the Commission, Washington,
D.C., under the Securities Act of 1933 and the Investment Company Act of 1940,
to which reference is hereby made.
The Declaration of Trust establishing the Trust dated August 2, 1985, a copy
of which, together with all amendments thereto (the "Declaration") is on file
in the office of the Secretary of the Commonwealth of Massachusetts, provides
that the name "Merrill Lynch Multi-State Municipal Series Trust" refers to the
Trustees under the Declaration collectively as Trustees, but not as individuals
or personally; and no Trustee, shareholder, officer, employee or agent of the
Trust shall be held to any personal liability; nor shall resort be had to any
such person's private property for the satisfaction of any obligation or claim
of the Trust but the "Trust Property" only shall be liable.
To the knowledge of the Trust, no person or entity owned beneficially 5% or
more of the Fund's shares on October 16, 1995.
54
<PAGE>
APPENDIX I
ECONOMIC AND FINANCIAL CONDITIONS IN NORTH CAROLINA
The following information is a brief summary of factors affecting the economy
of the state and does not purport to be a complete description of such factors.
Other factors will affect issuers. The summary is based primarily upon one or
more publicly available offering statements relating to debt offerings of state
issuers, however, it has not been updated nor will it be updated during the
year. The Trust has not independently verified the information.
The State of North Carolina (the "State") has two major operating funds: the
General Fund and the Highway Fund. In addition, the 1989 General Assembly
created the Highway Trust Fund to provide funding for a major highway
construction program. The State derives most of its revenue from taxes,
including individual income tax, corporation income tax, sales and use taxes,
corporation franchise tax, alcoholic beverage tax, insurance tax, inheritance
tax, tobacco products tax and soft drink tax. The State receives other non-tax
revenues which are also deposited in the General Fund. The most important are
Federal funds collected by State agencies, university fees and tuitions,
interest earned by the State Treasurer on investments of General Fund moneys
and revenues from the judicial branch. The proceeds from the motor fuel tax,
highway use tax and motor vehicle license tax are deposited in the Highway Fund
and the Highway Trust Fund.
During 1989-92 budget years, growth of North Carolina tax revenues slowed
considerably, requiring tax increases and budget adjustments, including hiring
freezes and restrictions, spending constraints, changes in timing of certain
collections and payments, and other short-term budget adjustments necessary to
comply with the State's constitutional mandate for a balanced budget. Many
areas of State government were affected. Reductions in capital spending, local
government aid, and the use of the budget stabilization reserve, combined with
other budget adjustments, brought the budget into balance. Tax increases in the
fiscal 1992 budget included a $.01 increase in the State sales tax and
increases in the personal and corporate income tax rates, as well as increases
in the tax on cigarettes and alcohol, among other items.
Fiscal year 1992 ended with a positive fund balance of approximately $164.8
million. By law, $41.2 million of such positive fund balance was required to be
reserved in the General Fund of North Carolina as part of a "Savings Reserve,"
leaving an unrestricted General Fund balance at June 30, 1992 of $123.6
million. Fiscal year 1993 ended with a positive General Fund balance of
approximately $537.3 million. Of this amount, $134.3 million was reserved in
the Savings Reserve and $57.0 million was reserved in a Reserve for Repair and
Renovation of State Facilities, leaving an unrestricted General Fund balance at
June 30, 1993 of $346.0 million. Fiscal year 1994 ended with a positive General
Fund balance of approximately $444.7 million. An additional $178 million was
available from a reserved fund balance. Of this aggregate amount, $155.7
million was reserved in the Savings Reserve (bringing the total reserve to
$210.6 million after prior withdrawals) and $60 million was reserved in the
Reserve for Repair and Renovation of State Facilities (bringing the total
reserve to $60.0 million after prior withdrawals), leaving an unrestricted
General Fund balance at June 30, 1994 of $407 million. Fiscal year 1995 ended
with a positive General Fund balance of approximately $343.4 million. An
additional $269.9 million was available from a reserved fund balance. Of this
aggregate amount, $146.3 million was reserved in the Savings Reserve (bringing
the total reserve to $423.6 million after prior contributions) and $146.3
million was reserved in the Reserve for Repair and
55
<PAGE>
Renovation of State Facilities (bringing the total reserve to $146.3 million
after prior withdrawals), leaving an unrestricted General Fund balance at June
30, 1995 of $320.7 million.
The foregoing results are presented on a budgetary basis. Accounting
principles applied to develop data on a budgetary basis differ significantly
from those principles used to present financial statements in conformity with
generally accepted accounting principles (GAAP). Based on a modified accrual
basis, the General Fund balance at June 30, 1993 and 1994 was $681.5 million
and $1,240.9 million, respectively. The foregoing results for fiscal year 1995
are based upon unaudited financial information supplied by the Office of State
Budget and Management. Modified accrual basis results were not available as of
the date this Appendix was prepared.
Under the State's constitutional and statutory scheme, the Governor is
required to prepare and propose a biennial budget to the General Assembly. The
General Assembly is responsible for considering the budget proposed by the
Governor and enacting the final budget. In enacting the final budget, the
General Assembly may modify the budget proposed by the Governor as it deems
necessary. The Governor is responsible for administering the budget enacted by
the General Assembly.
The 1995-97 biennium budget adopted by the General Assembly authorized
continuation funding from the General Fund of $9,512 million for fiscal 1996
and $9,763 million for fiscal 1997. Expansion funds of $280 million for fiscal
1996 were approved, along with capital improvements of $114 million for such
fiscal year. For fiscal 1997, $267 million of expansion funds were approved,
along with $157 million of capital improvements. Tax reductions of
approximately $363 million for fiscal 1996 and $400 million for fiscal 1997
were authorized, principally through the repeal of the State's intangible
personal property tax and reductions in the State's unemployment and personal
income taxes. The General Assembly also took several measures that benefitted
the State's Department of Corrections, including a reservation of $33 million
to build new prison beds. State workers generally received a 2% pay increase.
The General Assembly also passed a package of tort reform bills that included a
cap on punitive damage awards.
The State budget is based upon a number of existing and assumed State and
non-State factors, including State and national economic conditions,
international activity, Federal government policies and legislation and the
activities of the State's General Assembly. Such factors are subject to change
which may be material and affect the budget. The Congress of the United States
is considering a number of matters affecting the Federal government's
relationship with state governments that, if enacted into law, could affect
fiscal and economic policies of the states, including the State.
During recent years, the State has moved from an agricultural to a service
and goods-producing economy. According to the North Carolina Employment
Security Commission (the "Commission"), in November, 1994, the State ranked
ninth among the states in non-agricultural employment and eighth in
manufacturing employment. The Commission estimated the State's seasonally
adjusted unemployment rate in August, 1995 to be 4.5% of the labor force, as
compared with an unemployment rate of 5.6% nationwide.
The following are certain cases pending in which the State faces the risk of
either a loss of revenue or an unanticipated expenditure which, in the opinion
of the Department of State Treasurer, would not materially adversely affect the
State's ability to meet its financial obligations:
56
<PAGE>
1. Swanson v. State of North Carolina--State Tax Refunds--Federal
Retirees. In Davis v. Michigan (1989), the United States Supreme Court
ruled that a Michigan income tax statute which taxed federal retirement
benefits while exempting those paid by state and local governments violated
the constitutional doctrine of intergovernmental tax immunity. At the time
of the Davis decision, North Carolina law contained similar exemptions in
favor of state and local retirees. Those exemptions were repealed
prospectively, beginning with the 1989 tax year. All public pension and
retirement benefits are now entitled to a $4,000 annual exclusion.
Following Davis, federal retirees filed a class action suit in federal
court in 1989 seeking damages equal to the North Carolina income tax paid
on federal retirement income by the class members. A companion suit was
filed in state court in 1990. The complaints alleged that the amount in
controversy exceeded $140 million. The North Carolina Department of Revenue
estimate of refunds and interest liability is $280.89 million as of June
30, 1994. In 1991, the North Carolina Supreme Court ruled in favor of the
State in the state court action, concluding that Davis could only be
applied prospectively and that the taxes collected from the federal
retirees were thus not improperly collected. In 1993, the United State
Supreme Court vacated that decision and remanded the case back to the North
Carolina Supreme Court. The North Carolina Supreme Court then ruled in
favor of the State on the grounds that the federal retirees had failed to
comply with state procedures for challenging unconstitutional taxes.
Plaintiffs have petitioned the United States Supreme Court for review of
that decision. The United States District Court ruled in favor of the
defendants in the companion federal case, and a petition for
reconsideration was denied. Plaintiffs appealed to the United States Court
of Appeals, which concurred with the lower court's ruling.
An additional lawsuit was recently filed in State court by Federal
pensioners to recover State income taxes paid on Federal retirement
benefits. This case grew out of a claim by Federal pensioners in the
original Federal court case in Swanson. In the new lawsuit, the plaintiffs
allege that when the State granted an increase in retirement benefits to
State retirees in the same legislation that equalized tax treatment between
state and Federal retirees, the increased benefits to State retirees
constituted an indirect violation of Davis. The lawsuit seeks a refund of
taxes paid by Federal retirees on Federal retirement benefits received in
the years 1989 through 1993 and refunds or monetary relief sufficient to
equalize the alleged on-going discriminatory treatment for those years. An
extension of time to answer the complaint has been filed by the North
Carolina Attorney General, who believes that sound legal authority and
arguments support the denial of this claim.
2. Bailey v. State of North Carolina--State Tax Refunds--State
Retirees. State and local governmental retirees filed a class action suit
in 1990 as a result of the repeal of the income tax exemptions for state
and local government retirement benefits. The original suit was dismissed
after the North Carolina Supreme Court ruled in 1991 that the plaintiffs
had failed to comply with state law requirements for challenging
unconstitutional taxes and the United States Supreme Court denied review.
In 1992, many of the same plaintiffs filed a new lawsuit alleging
essentially the same claims, including breach of contract, unconstitutional
impairment of contract rights by the State in taxing benefits that were
allegedly promised to be tax-exempt and violation of several state
constitutional provisions.
On May 31, 1995 the Superior Court issued an order ruling in favor of the
plaintiffs. Under the terms of the order, the Superior Court found that the
act of the General Assembly that repealed the tax exemption on State and
local government retirement benefits is null, void, and unenforceable and
that
57
<PAGE>
retirement benefits which were vested before August 1989 are exempt from
taxation. The North Carolina Attorney General intends to pursue an appeal
from this order.
The North Carolina Attorney General's Office estimates that the amount in
controversy is approximately $40-$45 million annually for the tax years
1989 through 1991. In addition, it is anticipated that the decision reached
in this case will govern the resolution of tax refund claims made by
retired state and local government employees for taxes paid on retirement
benefit income for tax years after 1991. Furthermore, if the order of the
Superior Court is upheld, its provisions would apply prospectively to
prevent future taxation of State and local government retirement benefits
that were vested before August 1989.
3. Fulton v. Justus. The State's intangible personal property tax levied
on certain shares of stock has been challenged by the plaintiff on grounds
that it violates the United States Constitution Commerce Clause by
discriminating against stock issued by corporations that do all or part of
their business outside the State. The plaintiff in the action is a North
Carolina corporation that does all or part of its business outside the
State. The plaintiff seeks to invalidate the tax in its entirety and to
recover tax paid on the value of its shares in other corporations. The
North Carolina Court of Appeals invalidated the taxable percentage
deduction and excised it from the statute beginning with the 1994 tax year.
The effect of this ruling is to increase collections by rendering all stock
taxable on 100% of its value. The North Carolina Supreme Court reversed the
Court of Appeals and held that the tax is valid and constitutional. The
plaintiff's petition for review by the United States Supreme Court was
granted. Oral argument is expected in Fall 1995 and a decision expected by
mid-1996. Net collections from the tax for the fiscal year ended June 30,
1993 amounted to $120.6 million. The North Carolina Attorney General's
Office believes that sound legal arguments support the State's position. In
April 1995, the North Carolina General Assembly repealed, effective for
taxable years beginning on or after January 1, 1995, the State's intangible
personal property tax.
In October 1993, the State issued a total of $194.7 million in general
obligation bonds (consisting of $87.5 million in Prison and Youth Services
Facilities Bonds, $61 million in Public Improvement Refunding Bonds, $30.2
million in Highway Refunding Bonds, and $16 million in Clean Water Refunding
Bonds). An additional $67.5 million in general obligation bonds (Prison and
Youth Services Facilities Bonds) were issued in November 1993. On November 2,
1993, a total of $740 million in general obligation bonds (consisting of $310
million in University Improvement Bonds, $250 million in Community College
Bonds, $145 million in Clean Water Bonds, and $35 million in State Parks Bonds)
were approved by the voters of the State. Pursuant to this authorization, the
State issued $400 million in general obligation bonds (Capital Improvement
Bonds) in January 1994. The proceeds of these Capital Improvement Bonds may be
used for any purpose for which the proceeds of the University Improvement
Bonds, Community College Bonds, and State Parks Bonds may be used (none of such
proceeds may be used for Clean Water purposes). An additional $60 million in
general obligation bonds (Clean Water Bonds) were issued in September and
October 1994. The remaining $85 million in general obligation bonds (Clean
Water Bonds) were issued in June and July 1995. The offering of the remaining
$195 million of these authorized bonds is anticipated to occur over the next
two years.
Currently, Moody's, Standard & Poor's, and Fitch rate North Carolina general
obligation bonds Aaa, AAA, and AAA, respectively.
58
<PAGE>
APPENDIX II
RATINGS OF MUNICIPAL BONDS
DESCRIPTION OF MOODY'S INVESTORS SERVICE, INC.'S ("MOODY'S") MUNICIPAL BOND
RATINGS
Aaa Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally
referred to as "gilt edge". Interest payments are protected by a large
or by an exceptionally stable margin and principal is secure. While
the various protective elements are likely to change, such changes as
can be visualized are most unlikely to impair the fundamentally strong
position of such issues.
Aa Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are
generally known as high grade bonds. They are rated lower than the
best bonds because margins of protection may not be as large as in Aaa
securities or fluctuation of protective elements may be of greater
amplitude or there may be other elements present which make the long-
term risks appear somewhat larger than in Aaa securities.
A Bonds which are rated A possess many favorable investment attributes
and are to be considered as upper medium grade obligations. Factors
giving security to principal and interest are considered adequate, but
elements may be present which suggest a susceptibility to impairment
sometime in the future.
Baa Bonds which are rated Baa are considered as medium grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest
payment and principal security appear adequate for the present but
certain protective elements may be lacking or may be
characteristically unreliable over any great length of time. Such
bonds lack outstanding investment characteristics and in fact have
speculative characteristics as well.
Ba Bonds which are rated Ba are judged to have speculative elements;
their future cannot be considered as well assured. Often the
protection of interest and principal payments may be very moderate and
thereby not well safeguarded during both good and bad times over the
future. Uncertainty of position characterizes bonds in this class.
B Bonds which are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or
of maintenance of other terms of the contract over any long period of
time may be small.
Caa Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to
principal or interest.
Ca Bonds which are rated Ca represent obligations which are speculative
in a high degree. Such issues are often in default or have other
marked shortcomings.
C Bonds which are rated C are the lowest rated class of bonds, and
issues so rated can be regarded as having extremely poor prospects of
ever attaining any real investment standing.
59
<PAGE>
Note: Those bonds in the Aa, A, Baa, Ba and B groups which Moody's believes
possess the strongest investment attributes are designated by the symbols Aa1,
A1, Baa1, Ba1 and B1.
Short-term Notes: The four ratings of Moody's for short-term notes are MIG
1/VMIG1, MIG 2/VMIG2, MIG 3/VMIG3 and MIG 4/VMIG4; MIG 1/VMIG1 denotes "best
quality . . . strong protection by established cash flows"; MIG 2/VMIG2 denotes
"high quality" with ample margins of protection; MIG 3/VMIG3 notes are of
"favorable quality . . . but . . . lacking the undeniable strength of the
preceding grades"; MIG 4/VMIG4 notes are of "adequate quality . . .
[p]rotection commonly regarded as required of an investment security is present
. . . there is specific risk."
DESCRIPTION OF MOODY'S CORPORATE BOND RATINGS
Excerpts from Moody's description of its corporate bond ratings: Aaa--judged
to be the best quality, carry the smallest degree of investment risk; Aa--
judged to be of high quality by all standards; A--possess many favorable
investment attributes and are to be considered as upper medium grade
obligations; Baa--considered as medium grade obligations, i.e., they are
neither highly protected nor poorly secured.
DESCRIPTION OF MOODY'S COMMERCIAL PAPER RATINGS
Moody's Commercial Paper ratings are opinions of the ability of issuers to
repay punctually promissory obligations not having an original maturity in
excess of nine months. Moody's employs the following three designations, all
judged to be investment grade, to indicate the relative repayment capacity of
rated issuers:
Issuers rated Prime-1 (or related supporting institutions) have a superior
capacity for repayment of short-term promissory obligations. Prime-1 repayment
capacity will normally be evidenced by the following characteristics: leading
market positions in well established industries; high rates of return on funds
employed; conservative capitalization structures with moderate reliance on debt
and ample asset protection; broad margins in earning coverage of fixed
financial charges and high internal cash generation; and well established
access to a range of financial markets and assured sources of alternate
liquidity.
Issuers rated Prime-2 (or related supporting institutions) have a strong
capacity for repayment of short-term promissory obligations. This will normally
be evidenced by many of the characteristics cited above but to a lesser degree.
Earnings trends and coverage ratios, while sound, will be more subject to
variation. Capitalization characteristics, while still appropriate, may be more
affected by external conditions. Ample alternate liquidity is maintained.
Issuers rated Prime-3 (or related supporting institutions) have an acceptable
capacity for repayment of short-term promissory obligations. The effects of
industry characteristics and market composition may be more pronounced.
Variability in earnings and profitability may result in changes in the level of
debt protection measurements and the requirement for relatively high financial
leverage. Adequate alternate liquidity is maintained.
Issuers rated Not Prime do not fall within any of the Prime rating
categories.
60
<PAGE>
DESCRIPTION OF STANDARD & POOR'S RATINGS GROUP ("STANDARD & POOR'S") MUNICIPAL
DEBT RATINGS
A Standard & Poor's municipal debt rating is a current assessment of the
creditworthiness of an obligor with respect to a specific obligation. This
assessment may take into consideration obligors such as guarantors, insurers,
or lessees.
The debt rating is not a recommendation to purchase, sell or hold a security,
inasmuch as it does not comment as to market price or suitability for a
particular investor.
The ratings are based on current information furnished by the issuer or
obtained by Standard & Poor's from other sources Standard & Poor's considers
reliable. Standard & Poor's does not perform an audit in connection with any
rating and may, on occasion, rely on unaudited financial information. The
ratings may be changed, suspended or withdrawn as a result of changes in, or
unavailability of, such information, or for other reasons.
The ratings are based, in varying degrees, on the following considerations:
I. Likelihood of default--capacity and willingness of the obligor as to
the timely payment of interest and repayment of principal in accordance
with the terms of the obligation;
II. Nature of and provisions of the obligation;
III. Protection afforded by, and relative position of, the obligation in
the event of bankruptcy, reorganization or other arrangement under the laws
of bankruptcy and other laws affecting creditors' rights.
AAA Debt rated "AAA" has the highest rating assigned by Standard & Poor's.
Capacity to pay interest and repay principal is extremely strong.
AA Debt rated "AA" has a very strong capacity to pay interest and repay
principal and differs from the highest rated issues only in small
degree.
A Debt rated "A" has a strong capacity to pay interest and repay
principal although it is somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than debt
in higher-rated categories.
BBB Debt rated "BBB" is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate
protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to pay
interest and repay principal for debt in this category than for debt
in higher rated categories.
BB B CCC CC C
Debt rated "BB", "B", "CCC", "CC" and "C" is regarded, on balance, as
predominately speculative with respect to capacity to pay interest and
repay principal in accordance with the terms of the obligations. "BB"
indicates the lowest degree of speculation and "C" the highest degree
of speculation. While such bonds will likely have some quality and
protective characteristics, these are outweighed by large
uncertainties or major exposures to adverse conditions.
61
<PAGE>
CI The rating "CI" is reserved for income bonds on which no interest is
being paid.
D Debt rated "D" is in payment default. The "D" rating category is used
when interest payments or principal payments are not made on the date
due even if the applicable grace period has not expired, unless
Standard & Poor's believes that such payments will be made during such
grace period. The "D" rating also will be used upon the filing of a
bankruptcy petition if debt service payments are jeopardized.
Plus (+) or Minus (-): The ratings from "AA" to "CCC" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
DESCRIPTION OF STANDARD & POOR'S CORPORATE BOND RATINGS
A Standard & Poor's corporate debt rating is a current assessment of the
creditworthiness of an obligor with respect to a specific obligation. Debt
rated "AAA" has the highest rating assigned by Standard & Poor's. Capacity to
pay interest and repay principal is extremely strong. Debt rated "AA" has a
very strong capacity to pay interest and to repay principal and differs from
the highest rated issues only in small degree. Debt rated "A" has a strong
capacity to pay interest and repay principal although it is somewhat more
susceptible to the adverse effects of changes in circumstances and economic
conditions than debt of a higher rated category. Debt rated "BBB" is regarded
as having an adequate capacity to pay interest and repay principal. Whereas it
normally exhibits adequate protection parameters, adverse economic conditions
or changing circumstances are more likely to lead to a weakened capacity to pay
interest and repay principal for debt in this category than in higher rated
categories.
The ratings from "AA" to "BBB" may be modified by the addition of a plus or
minus sign to show relative standing within the major rating categories.
DESCRIPTION OF STANDARD & POOR'S COMMERCIAL PAPER RATINGS
A Standard & Poor's Commercial Paper Rating is a current assessment of the
likelihood of timely payment of debt having an original maturity of no more
than 365 days. Ratings are graded into four categories, ranging from "A" for
the highest quality obligations to "D" for the lowest. These categories are as
follows:
A-1 This highest category indicates that the degree of safety regarding
timely payment is strong. Those issues determined to possess extremely
strong safety characteristics are denoted with a plus sign (+)
designation.
A-2 Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as
for issues designated "A-1".
A-3 Issues carrying this designation have adequate capacity for timely
payment. They are, however, somewhat more vulnerable to the adverse
effects of changes in circumstances than obligations carrying the
higher designations.
B Issues rated "B" are regarded as having only speculative capacity for
timely payment.
C This rating is assigned to short-term debt obligations with a doubtful
capacity for payment.
62
<PAGE>
D Debt rated "D" is in payment default. The "D" rating category is used
when interest payments or principal payments are not made on the date
due, even if the applicable grace period has not expired, unless S&P
believes that such payments will be made during such grace period.
A Commercial Paper Rating is not a recommendation to purchase or sell a
security. The ratings are based on current information furnished to Standard &
Poor's by the issuer and obtained by Standard & Poor's from other sources it
considers reliable. The ratings may be changed, suspended, or withdrawn as a
result of changes in, or unavailability of, such information.
A Standard & Poor's municipal note rating reflects the liquidity concerns and
market access risks unique to such notes. Notes due in three years or less will
likely receive a note rating. Notes maturing beyond three years will most
likely receive a long-term debt rating. The following criteria will be used in
making that assessment.
--Amortization schedule (the larger the final maturity relative to other
maturities, the more likely it will be treated as a note).
--Source of payment (the more dependent the issue is on the market for its
refinancing, the more likely it will be treated as a note).
Note rating symbols are as follows:
SP-1 A very strong or strong capacity to pay principal and interest. Those
issues determined to possess overwhelming safety characteristics will be
given a "+" designation.
SP-2 A satisfactory capacity to pay principal and interest.
SP-3 A speculative capacity to pay principal and interest.
Unrated: Where no rating has been assigned or where a rating has been
suspended or withdrawn, it may be for reasons unrelated to the quality of the
issue.
Should no rating be assigned, the reason may be one of the following:
1. An application for rating was not received or accepted.
2. The issue or issuer belongs to a group of securities that are not rated as
a matter of policy.
3. There is a lack of essential data pertaining to the issue or issuer.
4. The issue was privately placed, in which case the rating is not published
in Standard & Poor's publications.
Suspension or withdrawal may occur if new and material circumstances arise,
the effects of which preclude satisfactory analysis; if there is no longer
available reasonable up-to-date information to permit a judgment to be formed;
if a bond is called for redemption; or for other reasons.
63
<PAGE>
DESCRIPTION OF FITCH INVESTORS SERVICE, INC.'S ("FITCH") INVESTMENT GRADE BOND
RATINGS
Fitch investment grade bond ratings provide a guide to investors in
determining the credit risk associated with a particular security. The ratings
represent Fitch's assessment of the issuer's ability to meet the obligations of
a specific debt issue or class of debt in a timely manner.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the current and prospective
financial condition and operating performance of the issuer and of any
guarantor, as well as the economic and political environment that might affect
the issuer's future financial strength and credit quality.
Fitch ratings do not reflect any credit enhancement that may be provided by
insurance policies or financial guaranties unless otherwise indicated.
Bonds that have the same rating are of similar but not necessarily identical
credit quality since the rating categories do not fully reflect small
differences in the degrees of credit risk.
Fitch ratings are not recommendations to buy, sell, or hold any security.
Ratings do not comment on the adequacy of market price, the suitability of any
security for a particular investor, or the tax-exempt nature or taxability of
payments made in respect of any security.
Fitch ratings are based on information obtained from issuers, other obligors,
underwriters, their experts, and other sources Fitch believes to be reliable.
Fitch does not audit or verify the truth or accuracy of such information.
Ratings may be changed, suspended, or withdrawn as a result of changes in, or
the unavailability of, information or for other reasons.
AAA Bonds considered to be investment grade and of the highest credit
quality. The obligor has an exceptionally strong ability to pay
interest and repay principal, which is unlikely to be affected by
reasonably foreseeable events.
AA Bonds considered to be investment grade and of very high credit
quality. The obligor's ability to pay interest and repay principal is
very strong, although not quite as strong as bonds rated "AAA".
Because bonds rated in the "AAA" and "AA" categories are not
significantly vulnerable to foreseeable future developments, short-
term debt of these issuers is generally rated "F-1+".
A Bonds considered to be investment grade and of high credit quality.
The obligor's ability to pay interest and repay principal is
considered to be strong, but may be more vulnerable to adverse changes
in economic conditions and circumstances than bonds with higher
ratings.
BBB Bonds considered to be investment grade and of satisfactory credit
quality. The obligor's ability to pay interest and repay principal is
considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have adverse impact on
these bonds, and therefore, impair timely payment. The likelihood that
the ratings of these bonds will fall below investment grade is higher
than for bonds with higher ratings.
64
<PAGE>
Plus (+) or Minus (-): Plus and minus signs are used with a rating symbol to
indicate the relative position of a credit within the rating category. Plus and
minus signs, however, are not used in the "AAA" category.
Credit Trend Indicator: Credit trend indicators show whether credit
fundamentals are improving, stable, declining, or uncertain, as follows:
Improving [UP ARROW]
Stable [LEFT/RIGHT ARROW]
Declining [DOWN ARROW]
Uncertain [UP/DOWN ARROW]
Credit trend indicators are not predictions that any rating change will
occur, and have a longer-term time frame than issues placed on FitchAlert.
NR indicates that Fitch does not rate the specific issue.
Conditional A conditional rating is premised on the successful completion of a
project or the occurrence of a specific event.
Suspended A rating is suspended when Fitch deems the amount of information
available from the issuer to be inadequate for rating purposes.
Withdrawn A rating will be withdrawn when an issue matures or is called or
refinanced and, at Fitch's discretion, when an issuer fails to
furnish proper and timely information.
FitchAlert Ratings are placed on FitchAlert to notify investors of an
occurrence that is likely to result in a rating change and the
likely direction of such change. These are designated as
"Positive," indicating a potential upgrade, "Negative," for
potential downgrade, or "Evolving," where ratings may be raised or
lowered. FitchAlert is relatively short-term, and should be
resolved within 12 months.
DESCRIPTION OF FITCH SPECULATIVE GRADE BOND RATINGS
Fitch speculative grade bond ratings provide a guide to investors in
determining the credit risk associated with a security. The ratings ("BB" to
"C") represent Fitch's assessment of the likelihood of timely payment of
principal and interest in accordance with the terms of obligation for bond
issues not in default. For defaulted bonds, the rating ("DDD" to "D") is an
assessment of the ultimate recovery value through reorganization or
liquidation.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the current and prospective
financial condition and operating performance of the issuer and any guarantor,
as well as the economic and political environment that might affect the
issuer's future financial strength.
65
<PAGE>
Bonds that have the same rating are of similar but not necessarily identical
credit quality since rating categories cannot fully reflect the differences in
degrees of credit risk.
BB Bonds are considered speculative. The obligor's ability to pay
interest and repay principal may be affected over time by
adverse economic changes. However, business and financial
alternatives can be identified which could assist the obligor
in satisfying its debt service requirements.
B Bonds are considered highly speculative. While bonds in this
class are currently meeting debt service requirements, the
probability of continued timely payment of principal and
interest reflects the obligor's limited margin of safety and
the need for reasonable business and economic activity
throughout the life of the issue.
CCC Bonds have certain identifiable characteristics which, if not
remedied, may lead to default. The ability to meet obligations
requires an advantageous business and economic environment.
CC Bonds are minimally protected. Default in payment of interest
and/or principal seems probable over time.
C Bonds are in imminent default in payment of interest or
principal.
DDD, DD and D Bonds are in default on interest and/or principal payments.
Such bonds are extremely speculative and should be valued on
the basis of their ultimate recovery value in liquidation or
reorganization of the obligor. "DDD" represents the highest
potential for recovery on these bonds, and "D" represents the
lowest potential for recovery.
Plus (+) or Minus (-): Plus and minus signs are used with a rating symbol to
indicate the relative position of a credit within the rating category. Plus and
minus signs, however, are not used in the "DDD", "DD", or "D" categories.
DESCRIPTION OF FITCH INVESTMENT GRADE SHORT-TERM RATINGS
Fitch's short-term ratings apply to debt obligations that are payable on
demand or have original maturities of generally up to three years, including
commercial paper, certificates of deposit, medium-term notes, and municipal and
investment notes.
The short-term rating places greater emphasis than a long-term rating on the
existence of liquidity necessary to meet the issuer's obligations in a timely
manner.
Fitch short-term ratings are as follows:
F-1+ Exceptionally Strong Credit Quality. Issues assigned this rating
are regarded as having the strongest degree of assurance for
timely payment.
F-1 Very Strong Credit Quality. Issues assigned this rating reflect an
assurance of timely payment only slightly less in degree than
issues rated "F-1+".
66
<PAGE>
F-2 Good Credit Quality. Issues assigned this rating have a
satisfactory degree of assurance for timely payment, but the
margin of safety is not as great as for issues assigned "F-1+" and
"F-1" ratings.
F-3 Fair Credit Quality. Issues assigned this rating have
characteristics suggesting that the degree of assurance for timely
payment is adequate, however, near-term adverse changes could
cause these securities to be rated below investment grade.
F-S Weak Credit Quality. Issues assigned this rating have
characteristics suggesting a minimal degree of assurance for
timely payment and are vulnerable to near-term adverse changes in
financial and economic conditions.
D Default. Issues assigned this rating are in actual or imminent
payment default.
LOC The symbol "LOC" indicates that the rating is based on a letter of
credit issued by a commercial bank.
67
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Trustees and Shareholders,
Merrill Lynch North Carolina Municipal Bond Fund of
Merrill Lynch Multi-State Municipal Series Trust:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of Merrill Lynch North Carolina Municipal Bond
Fund of Merrill Lynch Multi-State Municipal Series Trust as of July 31, 1995,
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 years in the two-year period then ended
and for the period September 25, 1992 (commencement of operations) to July 31,
1993. 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 July
31, 1995 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 North
Carolina Municipal Bond Fund of Merrill Lynch Multi-State Municipal Series
Trust as of July 31, 1995, 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
September 5, 1995
68
<PAGE>
<TABLE>
<CAPTION>
SCHEDULE OF INVESTMENTS (in Thousands)
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note 1a)
North Carolina--91.1%
<C> <C> <C> <S> <C>
Charlotte, North Carolina, COP:
AA NR* $ 1,500 (Law Enforcement Facilities Project), Series A, 6.10% due 12/01/2015 $ 1,501
AAA Aaa 3,500 Refunding (Convention Facility Project), Series C, 5.25% due 12/01/2020 (b) 3,181
AA Aa 3,000 Charlotte, North Carolina, Health Care System, Revenue Refunding Bonds
(Charlotte-Mecklenberg Hospital Authority), 6.25% due 1/01/2020 3,045
AAA Aaa 500 Charlotte, North Carolina, Refunding, GO, UT, 5% due 2/01/2012 473
A A2 500 Chatham County, North Carolina, Industrial Facilities and Pollution Control
Financing Authority, Pollution Revenue Bonds (Carolina Power and Light
Company), 6.30% due 6/15/2014 509
AAA Aaa 500 Cleveland County, North Carolina, GO, UT, 7.20% due 6/01/2000 (b)(g) 569
AAA Aaa 1,500 Concord, North Carolina, Utilities System Revenue Bonds, 5.75% due 12/01/2017 (c) 1,480
AAA Aaa 2,000 Craven, North Carolina, Regional Medical Authority, Health Care Facilities
Revenue Refunding Bonds, 5.625% due 10/01/2017 (c) 1,916
AAA Aaa 1,000 Cumberland County, North Carolina, COP (Civic Center Project), Series A, 6.40%
due 12/01/2024 (b) 1,035
AAA Aaa 2,000 Fayetteville, North Carolina, Public Works Commission Revenue Bonds, Series A,
6% due 3/01/2016 (d) 2,001
AAA Aaa 1,000 Gastonia, North Carolina, Combined Utilities System Revenue Bonds, 6%
due 5/01/2014 (c) 1,001
AAA Aa1 1,000 Greensboro, North Carolina, Public Improvement Bonds, UT, 6.30% due 3/01/2010 1,061
BBB Baa1 2,500 Haywood County, North Carolina, Industrial Facilities and Pollution Control
Financing Authority, Solid Waste Disposal Revenue Bonds (Champion International
Corporation Project), AMT, 5.50% due 10/01/2018 2,178
A A2 3,500 Martin County, North Carolina, Industrial Facilities and Pollution Control
Financing Authority Revenue Bonds (Solid Waste Disposal-Weyerhaeuser Company),
AMT, 6.80% due 5/01/2024 3,657
A A 2,225 Monroe, North Carolina, Combined Enterprise Systems Revenue Bonds,
6% due 3/01/2019 2,219
</TABLE>
PORTFOLIO ABBREVIATIONS
- --------------------------------------------------------------------------------
To simplify the listings of Merrill Lynch North Carolina Municipal Bond Fund's
portfolio holdings in the Schedule of Investments, we have abbreviated the names
of many of the securities according to the lists below and at right.
ACES/(SM)/ Adjustable Convertible Extendable Securities
AMT Alternative Minimum Tax (subject to)
COP Certificates of Participation
DATES Daily Adjustable Tax-Exempt Securities
GO General Obligation Bonds
HFA Housing Finance Agency
LEVRRS Leveraged Reverse Rate Securities
S/F Single-Family
UT Unlimited Tax
YCN Yield Curve Notes
69
<PAGE>
<TABLE>
<CAPTION>
SCHEDULE OF INVESTMENTS (continued) (in Thousands)
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note 1a)
North Carolina (concluded)
<C> <C> <C> <S> <C>
A A2 $ 300 New Hanover County, North Carolina, Industrial Facilities and Pollution
Control Financing Authority Revenue Bonds (Carolina Power and Light
Company), 6.30% due 6/15/2014 $ 305
A- Aaa 3,055 North Carolina Eastern Municipal Power Agency, Power System Revenue
Refunding Bonds, Series A, 6.50% due 1/01/2018 (i) 3,301
North Carolina Educational Facilities, Finance Agency Revenue Bonds:
AA Aa1 2,000 (Duke University Project), Series C, 6.75% due 10/01/2021 2,115
AAA NR* 900 Refunding (Elon College Project), 6.375% due 1/01/2007 (e) 948
North Carolina HFA, Revenue Bonds, GO:
A+ Aa 2,750 AMT, Series V, 6.80% due 9/01/2025 2,809
AA Aa 1,340 Refunding, Series F, 6.60% due 7/01/2017 (h) 1,380
A+ Aa 665 Series U, 6.70% due 3/01/2018 691
North Carolina HFA, S/F Revenue Bonds, GO:
A+ Aa 1,805 AMT, Series X, 6.70% due 9/01/2026 1,835
A+ Aa 2,000 Series W, 6.50% due 3/01/2018 2,041
North Carolina Medical Care Community, Hospital Revenue Bonds:
AAA Aaa 2,000 (Moore Regional Hospital Project), 5% due 10/01/2018 (b) 1,751
NR* VMIG1++ 2,500 (Pooled Financing Project), ACES, Series B, 3.90% due 10/01/2013 (a) 2,500
AA Aa 1,000 Refunding (Presbyterian Health Services Project), 5.50% due 10/01/2020 940
A+ A1 1,500 (Rex Hospital Project), 6.25% due 6/01/2017 1,543
AAA Aaa 1,620 (Wilson Memorial Hospital Project), 6.50% due 11/01/2020 (b) 1,698
AAA Aaa 1,000 North Carolina Municipal Power Agency, Revenue Refunding Bonds (Catawba
Electric Project Number 1), 5% due 1/01/2015 (c) 888
Onslow County, North Carolina, GO, UT (c):
AAA Aaa 1,000 5.70% due 3/01/2012 1,013
AAA Aaa 1,000 5.70% due 3/01/2013 1,013
AA Aa 1,000 Orange County, North Carolina, Water and Sewer Authority, Revenue Refunding
Bonds, 5.20% due 7/01/2016 919
NR* VMIG1++ 800 Person County, North Carolina, Industrial Facilities and Pollution Control
Financing Authority, Solid Waste Disposal Revenue Bonds (Carolina Power and
Light Company), AMT, DATES, 4.50% due 11/01/2016 (a) 800
A- A 700 Shelby, North Carolina, Combined Producing Facilities System Revenue Bonds
(Capital Improvement), 6.625% due 6/01/2017 732
AA- A1 800 University of North Carolina, Chapel Hill, Hospital Revenue Bonds (Board of
Governors), 6.375% due 2/15/2017 823
</TABLE>
70
<PAGE>
<TABLE>
<CAPTION>
SCHEDULE OF INVESTMENTS (concluded) (in Thousands)
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note 1a)
Puerto Rico--8.5%
<C> <C> <C> <S> <C>
A Baa1 $ 700 Puerto Rico Commonwealth, GO, UT, 6.45% due 7/01/2017 $ 718
AAA NR* 700 Puerto Rico Commonwealth, Public Improvement Bonds, UT, Series A,
6.50% due 7/01/1999 (g) 757
AAA Aaa 1,250 Puerto Rico Commonwealth, YCN, 7.682% due 7/01/2020 (d)(f) 1,189
AAA Aaa 400 Puerto Rico Electric Power Authority, Power Revenue Bonds, LEVRRS, 8.018%
due 7/01/2023 (d)(f) 391
AA Aa3 2,000 Puerto Rico Industrial, Medical and Environmental Pollution Control
Facilities Financing Authority Revenue Bonds (Motorola Inc. Project),
Series A, 6.75% due 1/01/2014 2,163
Total Investments (Cost--$59,735)--99.6% 61,089
Other Assets Less Liabilities--0.4% 234
-------
Net Assets--100.0% $61,323
=======
<FN>
(a)The interest rate is subject to change periodically based upon
prevailing market rates. The interest rate shown is the rate
in effect at July 31, 1995.
(b)AMBAC Insured.
(c)MBIA Insured.
(d)FSA Insured.
(e)Insured by Connie Lee.
(f)The interest rate is subject to change periodically and inversely
based upon prevailing market rates. The interest rate shown is the
rate in effect at July 31, 1995.
(g)Prerefunded.
(h)FHA Insured.
(i)Escrowed to maturity.
*Not Rated.
++Highest short-term rating by Moody's Investors Service, Inc.
Ratings of issues shown have not been audited by Deloitte &Touche
LLP.
See Notes to Financial Statements.
</TABLE>
71
<PAGE>
FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Statement of Assets and Liabilities as of July 31, 1995
<C> <S> <C> <C>
Assets: Investments, at value (identified cost--$59,735,499) (Note 1a) $ 61,088,805
Cash 42,774
Receivables:
Interest $ 884,077
Beneficial interest sold 29,716 913,793
------------
Deferred organization expenses (Note 1e) 22,149
Prepaid registration fees and other assets (Note 1e) 26,528
------------
Total assets 62,094,049
------------
Liabilities: Payables:
Securities purchased 572,075
Beneficial interest redeemed 56,653
Dividends to shareholders (Note 1f) 54,760
Distributor (Note 2) 20,464
Investment adviser (Note 2) 17,182 721,134
------------
Accrued expenses and other liabilities 49,628
------------
Total liabilities 770,762
------------
Net Assets: Net assets $ 61,323,287
============
Net Assets Class A Shares of beneficial interest, $.10 par value,
Consist of: unlimited number of shares authorized $ 89,990
Class B Shares of beneficial interest, $.10 par value,
unlimited number of shares authorized 485,811
Class C Shares of beneficial interest, $.10 par value,
unlimited number of shares authorized 6,932
Class D Shares of beneficial interest, $.10 par value,
unlimited number of shares authorized 13,376
Paid-in capital in excess of par 61,319,049
Accumulated realized capital losses on investments--net (Note 5) (1,587,732)
Accumulated distributions in excess of realized capital gains--net (357,445)
Unrealized appreciation on investments--net 1,353,306
------------
Net assets $ 61,323,287
============
Net Asset Value: Class A--Based on net assets of $9,256,261 and 899,900 shares
of beneficial interest outstanding $ 10.29
============
Class B--Based on net assets of $49,977,593 and 4,858,115 shares
of beneficial interest outstanding $ 10.29
============
Class C--Based on net assets of $712,907 and 69,316 shares
of beneficial interest outstanding $ 10.28
============
Class D--Based on net assets of $1,376,526 and 133,759 shares
of beneficial interest outstanding $ 10.29
============
See Notes to Financial Statements.
</TABLE>
72
<PAGE>
FINANCIAL INFORMATION (continued)
<TABLE>
<CAPTION>
Statement of Operations
For the Year Ended
July 31, 1995
<C> <S> <C> <C>
Investment Income Interest and amortization of premium and discount earned $ 3,700,624
(Note 1d):
Expenses: Investment advisory fees (Note 2) $ 331,791
Account maintenance and distribution fees--Class B (Note 2) 247,176
Professional fees 66,371
Printing and shareholder reports 59,913
Transfer agent fees--Class B (Note 2) 35,428
Accounting services (Note 2) 34,887
Amortization of organization expenses (Note 1e) 10,285
Pricing fees 6,797
Transfer agent fees--Class A (Note 2) 6,014
Custodian fees 4,134
Registration fees (Note 1e) 3,846
Trustees' fees and expenses 2,967
Account maintenance and distribution fees--Class C (Note 2) 1,413
Account maintenance fees--Class D (Note 2) 691
Transfer agent fees--Class D (Note 2) 444
Transfer agent fees--Class C (Note 2) 179
Other 4,369
------------
Total expenses before reimbursement 816,705
Reimbursement of expenses (Note 2) (133,074)
------------
Total expenses after reimbursement 683,631
------------
Investment income--net 3,016,993
------------
Realized & Realized loss on investments--net (919,952)
Unrealized Change in unrealized appreciation/depreciation on investments--net 1,391,157
Gain (Loss) on ------------
Investments Net Increase in Net Assets Resulting from Operations $ 3,488,198
- --Net (Notes 1b, ============
1d & 3):
See Notes to Financial Statements.
</TABLE>
73
<PAGE>
FINANCIAL INFORMATION (continued)
<TABLE>
<CAPTION>
Statements of Changes in Net Assets
For the Year Ended July 31,
Increase (Decrease) in Net Assets: 1995 1994
<C> <S> <C> <C>
Operations: Investment income--net $ 3,016,993 $ 2,783,373
Realized loss on investments--net (919,952) (685,668)
Change in unrealized appreciation/depreciation on
investments--net 1,391,157 (2,097,393)
------------ ------------
Net increase in net assets resulting from operations 3,488,198 312
------------ ------------
Dividends & Investment income--net:
Distributions to Class A (541,099) (564,183)
Shareholders Class B (2,428,396) (2,219,190)
(Note 1f): Class C (11,006) --
Class D (36,492) --
In excess of realized gain on investments--net:
Class A -- (70,229)
Class B -- (287,216)
------------ ------------
Net decrease in net assets resulting from dividends and
distributions to shareholders (3,016,993) (3,140,818)
------------ ------------
Beneficial Net increase (decrease) in net assets derived from beneficial
Interest interest transactions (883,695) 15,594,348
Transactions ------------ ------------
(Note 4):
Net Assets: Total increase (decrease) in net assets (412,490) 12,453,842
Beginning of year 61,735,777 49,281,935
------------ ------------
End of year $ 61,323,287 $ 61,735,777
============ ============
See Notes to Financial Statements.
</TABLE>
74
<PAGE>
FINANCIAL INFORMATION (continued)
<TABLE>
<CAPTION>
Financial Highlights
Class A
For the
Period
The following per share data and ratios have been derived Sept. 25,
from information provided in the financial statements. For the Year 1992++ to
Ended July 31, July 31,
Increase (Decrease) in Net Asset Value: 1995 1994 1993
<C> <S> <C> <C> <C>
Per Share Net asset value, beginning of period $ 10.19 $ 10.67 $ 10.00
Operating -------- -------- --------
Performance: Investment income--net .54 .54 .46
Realized and unrealized gain (loss) on
investments--net .10 (.42) .67
-------- -------- --------
Total from investment operations .64 .12 1.13
-------- -------- --------
Less dividends and distributions:
Investment income--net (.54) (.54) (.46)
In excess of realized gain on investments--net -- (.06) --
-------- -------- --------
Total dividends and distributions (.54) (.60) (.46)
-------- -------- --------
Net asset value, end of period $ 10.29 $ 10.19 $ 10.67
======== ======== ========
Total Investment Based on net asset value per share 6.60% 1.11% 11.52%+++
Return:** ======== ======== ========
Ratios to Expenses, net of reimbursement .71% .50% .20%*
Average ======== ======== ========
Net Assets: Expenses .93% .96% 1.15%*
======== ======== ========
Investment income--net 5.43% 5.14% 5.26%*
======== ======== ========
Supplemental Net assets, end of period (in thousands) $ 9,256 $ 11,071 $ 9,311
Data: ======== ======== ========
Portfolio turnover 52.33% 74.35% 27.98%
======== ======== ========
<FN>
*Annualized.
**Total investment returns exclude the effects of sales loads.
++Commencement of Operations.
+++Aggregate total investment return.
See Notes to Financial Statements.
</TABLE>
75
<PAGE>
FINANCIAL INFORMATION (continued)
<TABLE>
<CAPTION>
Financial Highlights (continued)
Class B
For the
Period
The following per share data and ratios have been derived Sept. 25,
from information provided in the financial statements. For the Year 1992++ to
Ended July 31, July 31,
Increase (Decrease) in Net Asset Value: 1995 1994 1993
<C> <S> <C> <C> <C>
Per Share Net asset value, beginning of period $ 10.19 $ 10.67 $ 10.00
Operating -------- -------- --------
Performance: Investment income--net .49 .49 .41
Realized and unrealized gain (loss) on
investments--net .10 (.42) .67
-------- -------- --------
Total from investment operations .59 .07 1.08
-------- -------- --------
Less dividends and distributions:
Investment income--net (.49) (.49) (.41)
In excess of realized gain on investments--net -- (.06) --
-------- -------- --------
Total dividends and distributions (.49) (.55) (.41)
-------- -------- --------
Net asset value, end of period $ 10.29 $ 10.19 $ 10.67
======== ======== ========
Total Investment Based on net asset value per share 6.06% .60% 11.06%+++
Return:** ======== ======== ========
Ratios to Expenses, excluding account maintenance and
Average distribution fees and net of reimbursement .72% .51% .20%*
Net Assets: ======== ======== ========
Expenses, net of reimbursement 1.22% 1.01% .70%*
======== ======== ========
Expenses 1.44% 1.46% 1.67%*
======== ======== ========
Investment income--net 4.91% 4.64% 4.77%*
======== ======== ========
Supplemental Net assets, end of period (in thousands) $ 49,978 $ 50,664 $ 39,970
Data: ======== ======== ========
Portfolio turnover 52.33% 74.35% 27.98%
======== ======== ========
<FN>
*Annualized.
**Total investment returns exclude the effects of sales loads.
++Commencement of Operations.
+++Aggregate total investment return.
See Notes to Financial Statements.
</TABLE>
76
<PAGE>
FINANCIAL INFORMATION (concluded)
<TABLE>
<CAPTION>
Financial Highlights (concluded)
The following per share data and ratios have been derived For the Period
from information provided in the financial statements. October 21, 1994++ to
July 31, 1995
Increase (Decrease) in Net Asset Value: Class C Class D
<C> <S> <C> <C>
Per Share Net asset value, beginning of period $ 9.80 $ 9.80
Operating -------- --------
Performance: Investment income--net .37 .41
Realized and unrealized gain on investments--net .48 .49
-------- --------
Total from investment operations .85 .90
-------- --------
Less dividends from investment income--net (.37) (.41)
-------- --------
Net asset value, end of period $ 10.28 $ 10.29
-------- --------
Total Investment Based on net asset value per share 8.87%+++ 9.39%+++
Return:** ======== ========
Ratios to Expenses, excluding account maintenance and distribution
Average fees and net of reimbursement .77%* .75%*
Net Assets: ======== ========
Expenses, net of reimbursement 1.37%* .85%*
======== ========
Expenses 1.57%* 1.05%*
======== ========
Investment income--net 4.67%* 5.28%*
======== ========
Supplemental Net assets, end of period (in thousands) $ 713 $ 1,377
Data: ======== ========
Portfolio turnover 52.33% 52.33%
======== ========
<FN>
*Annualized.
**Total investment returns exclude the effects of sales loads.
++Commencement of Operations.
+++Aggregate total investment return.
See Notes to Financial Statements.
</TABLE>
77
<PAGE>
NOTES TO FINANCIAL STATEMENTS
1. Significant Accounting Policies:
Merrill Lynch North Carolina Municipal Bond Fund (the "Fund") is
part of Merrill Lynch Multi-State Municipal Series Trust (the
"Trust"). 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.
(a) Valuation of investments--Municipal bonds and other portfolio
securities in which the Fund invests are traded primarily in the
over-the-counter municipal bond and money markets and are valued at
the last available bid price in the over-the-counter market or on
the basis of yield equivalents as obtained from one or more dealers
that make markets in the securities. Financial futures contracts and
options thereon, which are traded on exchanges, are valued at their
settlement prices as of the close of such exchanges. Short-term
investments with remaining maturities of sixty days or less are
valued at amortized cost, which approximates market value.
Securities and assets for which market quotations are not readily
available are valued at fair value as determined in good faith by or
under the direction of the Board of Trustees of the Trust, including
valuations furnished by a pricing service retained by the Trust,
which may utilize a matrix system for valuations. The procedures of
the pricing service and its valuations are reviewed by the officers
of the Trust under the general supervision of the Trustees.
(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 debt markets. Losses may
arise due to changes in the value of the contract or if the
counterparty does not perform under the contract.
* Financial futures contracts--The Fund may purchase or sell interest
rate futures contracts and options on such futures contracts for the
purpose of hedging the market risk on existing securities or the
intended purchase of securities. Futures contracts are contracts for
delayed delivery of securities at a specific future date and at a
specific price or yield. 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) 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.
(d) Security transactions and investment income--Security
transactions are recorded on the dates the transactions are entered
into (the trade dates). Interest income is recognized on the accrual
basis. Discounts and market premiums are amortized into interest
income. Realized gains and losses on security transactions are
determined on the identified cost basis.
(e) 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.
(f) Dividends and distributions--Dividends from net investment
income are declared daily and paid monthly. Distributions of capital
gains are recorded on the ex-dividend dates. Distributions in excess
of
78
<PAGE>
realized capital gains are due primarily to differing tax treatments for futures
transactions and post-October losses.
NOTES TO FINANCIAL STATEMENTS (concluded)
2. Investment Advisory Agreement and
Transactions with Affiliates:
The Fund has entered into an Investment Advisory Agreement with Fund
Asset Management, L.P. ("FAM"). The general partner of FAM 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.
FAM 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 based upon the average daily
value of the Fund's net assets at the following annual rates: 0.55%
of the Fund's average daily net assets not exceeding $500 million;
0.525% of average daily net assets in excess of $500 million but not
exceeding $1 billion; and 0.50% of average daily net assets in
excess of $1 billion. For the year ended July 31, 1995, FAM earned
fees of $331,791, of which $133,074 was voluntarily waived.
Pursuant to the distribution plans ("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% 0.25%
Class C 0.25% 0.35%
Class D 0.10% --
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 July 31, 1995, MLFD earned underwriting discounts
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 $1,108 $10,943
Class D $ 431 $ 4,681
For the year ended July 31, 1995, MLPF&S received contingent
deferred sales charges of $153,402 relating to transactions in Class
B Shares.
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 FAM at cost.
Certain officers and/or trustees of the Fund are officers and/or
directors of FAM, PSI, MLPF&S, MLFDS, MLFD, and/or ML & Co.
3. Investments:
Purchases and sales of investments, excluding short-term securities,
for the year ended July 31, 1995 were $29,710,738 and $33,845,186,
respectively.
Net realized and unrealized gains (losses) as of July 31, 1995 were
as follows:
Realized Unrealized
Losses Gains
Long-term investments $ (431,704) $ 1,353,306
Financial futures contracts (488,248) --
----------- ------------
Total $ (919,952) $ 1,353,306
=========== ============
As of July 31, 1995, net unrealized appreciation for Federal income
tax purposes aggregated $1,353,306, of which $1,882,182 related to
appreciated securities and $528,876 related to depreciated
securities. The aggregate cost of investments at July 31, 1995 for
Federal income tax purposes was $59,735,499.
79
<PAGE>
4. Beneficial Interest Transactions:
Net increase (decrease) in net assets derived from beneficial
interest transactions was $(883,695) and $15,594,348 for the years
ended July 31, 1995 and July 31, 1994, respectively.
Transactions in shares of beneficial interest for each class were as
follows:
Class A Shares for the Year Dollar
Ended July 31, 1995 Shares Amount
Shares sold 84,037 $ 841,960
Shares issued to share-
holders in reinvestment
of dividends 28,877 288,342
----------- ------------
Total issued 112,914 1,130,302
Shares redeemed (299,936) (2,960,930)
----------- ------------
Net decrease (187,022) $ (1,830,628)
=========== ============
Class A Shares for the Year Dollar
Ended July 31, 1994 Shares Amount
Shares sold 461,410 $ 4,928,197
Shares issued to share-
holders in reinvestment
of dividends and
distributions 29,035 307,049
----------- ------------
Total issued 490,445 5,235,246
Shares redeemed (276,285) (2,887,349)
----------- ------------
Net increase 214,160 $ 2,347,897
=========== ============
Class B Shares for the Year Dollar
Ended July 31, 1995 Shares Amount
Shares sold 881,166 $ 8,833,126
Shares issued to share-
holders in reinvestment
of dividends , 120,152 1,200,171
----------- ------------
Total issued 1,001,318 10,033,297
Automatic conversion
of shares (102) (1,063)
Shares redeemed (1,116,312) (11,088,915)
----------- ------------
Net decrease (115,096) $ (1,056,681)
=========== ============
Class B Shares for the Year Dollar
Ended July 31, 1994 Shares Amount
Shares sold 1,596,885 $ 17,101,455
Shares issued to share-
holders in reinvestment
of dividends and
distributions 119,538 1,266,444
----------- ------------
Total issued 1,716,423 18,367,899
Shares redeemed (489,131) (5,121,448)
----------- ------------
Net increase 1,227,292 $ 13,246,451
=========== ============
Class C Shares for the Period
October 21, 1994++ to Dollar
July 31, 1995 Shares Amount
Shares sold 80,718 $ 831,926
Shares issued to share-
holders in reinvestment
of dividends 590 6,034
----------- ------------
Total issued 81,308 837,960
Shares redeemed (11,992) (123,319)
----------- ------------
Net increase 69,316 $ 714,641
=========== ============
[FN]
++Commencement of Operations.
Class D Shares for the Period
October 21, 1994++ to Dollar
July 31, 1995 Shares Amount
Shares sold 136,785 $ 1,320,711
Shares issued to share-
holders in reinvestment
of dividends 3,016 30,556
Automatic conversion
of shares 102 1,063
----------- ------------
Total issued 139,903 1,352,330
Shares redeemed (6,144) (63,357)
----------- ------------
Net increase 133,759 $ 1,288,973
=========== ============
[FN]
++Commencement of Operations.
5. Capital Loss Carryforward:
At July 31, 1995, the Fund had a net capital loss carryforward of
approximately $981,000, all of which expires in 2003. This amount
will be available to offset like amounts of any future taxable
gains.
80
<PAGE>
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81
<PAGE>
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82
<PAGE>
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83
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objective and Policies.......................................... 2
Description of Municipal Bonds and Temporary Investments................... 5
Description of Municipal Bonds............................................ 5
Description of Temporary Investments...................................... 7
Repurchase Agreements..................................................... 8
Financial Futures Transactions and Options................................ 9
Investment Restrictions.................................................... 13
Management of the Trust.................................................... 16
Trustees and Officers..................................................... 16
Compensation of Trustees.................................................. 18
Management and Advisory Arrangements...................................... 18
Purchase of Shares......................................................... 20
Initial Sales Charge Alternative--Class A and Class D Shares.............. 20
Reduced Initial Sales Charges............................................. 22
Distribution Plans........................................................ 24
Limitations on the Payment of Deferred Sales Charges...................... 24
Redemption of Shares....................................................... 26
Deferred Sales Charge--Class B and Class C Shares......................... 26
Portfolio Transactions..................................................... 26
Determination of Net Asset Value........................................... 28
Shareholder Services....................................................... 29
Investment Account........................................................ 29
Automatic Investment Plans................................................ 29
Automatic Reinvestment of Dividends and Capital Gains Distributions....... 30
Systematic Withdrawal Plans--Class A and Class D Shares................... 30
Exchange Privilege........................................................ 31
Distributions and Taxes.................................................... 45
Environmental Tax......................................................... 48
Tax Treatment of Option and Futures Transactions.......................... 49
North Carolina Income and Franchise Taxes................................. 49
Performance Data........................................................... 50
General Information........................................................ 52
Description of Shares..................................................... 52
Computation of Offering Price Per Share................................... 53
Independent Auditors...................................................... 54
Custodian................................................................. 54
Transfer Agent............................................................ 54
Legal Counsel............................................................. 54
Reports to Shareholders................................................... 54
Additional Information.................................................... 54
Appendix I--Economic and Financial Conditions in North Carolina............ 55
Appendix II--Ratings of Municipal Bonds.................................... 59
Independent Auditors' Report............................................... 68
Financial Statements....................................................... 69
</TABLE>
Code # 16411-1195
LOGO MERRILL LYNCH
Merrill Lynch North Carolina
Municipal Bond Fund
Merrill Lynch Multi-State
Municipal Series Trust
[ART]
STATEMENT OF
ADDITIONAL
INFORMATION
November 1, 1995
Distributor:
Merrill Lynch
Funds Distributor, Inc.
[C/R/C]
<PAGE>
APPENDIX FOR GRAPHIC AND IMAGE MATERIAL
Pursuant to Rule 304 of Regulation S-T, the following table presents
fair and accurate narrative descriptions of graphic and image material omitted
from this EDGAR Submission file due to ASCII-incompatibility and cross-
references this material to the location of each occurrence in the text.
DESCRIPTION OF OMITTED LOCATION OF GRAPHIC
GRAPHIC OR IMAGE OR IMAGE IN TEXT
- ---------------------- -------------------
Compass plate, circular Back cover of Prospectus and
graph paper and Merrill Lynch back cover of Statement of
logo including stylized market Additional Information
bull
