MERRILL LYNCH CALIFORNIA INSURED MUNICIPAL BOND FUND OF MERR, 497, 1994-10-26

MERRILL LYNCH CALIFORNIA INSURED MUNICIPAL BOND FUND OF MERR
497, 1994-10-26

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<PAGE>

PROSPECTUS
- ----------
OCTOBER 21, 1994
MERRILL LYNCH CALIFORNIA INSURED MUNICIPAL BOND FUND
MERRILL LYNCH CALIFORNIA MUNICIPAL SERIES TRUST
P.O. BOX 9011, PRINCETON, NEW JERSEY 08543-9011 . PHONE NO. (609) 282-2800

----------------
Merrill Lynch California Insured Municipal Bond Fund (the "Fund") is a non-
diversified mutual fund seeking to provide shareholders with as high a level
of income exempt from Federal and California income taxes as is consistent
with prudent investment management. The Fund invests primarily in a non-
diversified portfolio of long-term, investment grade obligations, the interest
on which, in the opinion of bond counsel to the issuer, is exempt from Federal
and California income taxes ("California Municipal Bonds"). Under normal
circumstances, at least 80% of the Fund's total assets will be invested in
municipal obligations with remaining maturities of one year or more which are
covered by insurance guaranteeing the timely payment of principal at maturity
and interest and at least 65% of the Fund's total assets will be invested in
insured California Municipal Bonds. THE FUND'S PORTFOLIO INSURANCE RELATES
ONLY TO PAYMENT ON THE MUNICIPAL BONDS (AS THAT TERM IS DEFINED IN THE
PROSPECTUS UNDER INVESTMENT OBJECTIVE AND POLICIES) HELD BY THE FUND AND NOT
TO THE VALUE OF FUND SHARES. For a full discussion of the nature and
limitations of insurance, see "Investment Objective and Policies--Portfolio
Insurance" on page 11. Dividends paid by the Fund are exempt from Federal and
California income taxes to the extent they are paid from interest on
California Municipal Bonds. 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.

----------------
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 SM 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 3.

Shares may be purchased directly from Merrill Lynch Funds Distributor, Inc.
(the "Distributor"), P.O. Box 9011, Princeton, New Jersey 08543-9011 [(609)
282-2800], or from securities dealers that have entered into 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 SECURI-
TIES 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 October 21, 1994 (the "Statement of Additional
Information"), has been filed with the Securities and Exchange Commission (the
"Commission") and is available, without charge, by calling or by writing
Merrill Lynch California 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 CLASS CLASS CLASS
A(a) B(b) C(c) D(c)
----- ----- ----- -----
<S> <C> <C> <C> <C>
SHAREHOLDER TRANSACTION
EXPENSES:
Maximum Sales Charge
Imposed on Purchases
(as a percentage of
offering price)....... 4.00%(d) None None 4.0%(d)
Sales Charge Imposed
on Dividend
Reinvestments......... None None None None
Deferred Sales Charge
(as a percentage of
original purchase
price or redemption
proceeds, whichever
is lower)............. None(e) 4.0% during the 1.0% for None(e)
first year, decreasing one year
1.0% annually to
0.0% after the
fourth year(b)
Exchange Fee........... None None None
ANNUAL FUND OPERATING
EXPENSES (AS A PERCENT-
AGE OF AVERAGE NET
ASSETS)(F):
Management Fees(g)..... 0.55% 0.55% 0.55% 0.55%
Rule 12b-1 Fees(h):
Account Maintenance
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 are subject
to reduced account
maintenance fees)
Other Expenses
Custodial Fees....... 0.02% 0.02% 0.02% 0.02%
Shareholder Servicing
Costs(i)............ 0.03% 0.03% 0.03% 0.03%
Miscellaneous........ 0.36% 0.36% 0.36% 0.36%
---- ---- ---- ----
TOTAL OTHER EXPENSES.... 0.41% 0.41% 0.41% 0.41%
---- ---- ---- ----
TOTAL FUND OPERATING
EXPENSES(j)............ 0.96% 1.46% 1.56% 1.06%
==== ==== ==== ====
</TABLE>
- --------
(a) Class A shares are sold to a limited group of investors including existing
Class A shareholders and participants in 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 ten
years after initial purchase. See "Purchase of Shares--Deferred Sales
Charge Alternatives--Class B and Class C Shares"--page 25.
(c) Prior to the date of this Prospectus, the Fund has not offered its Class C
or Class D shares to the public.
(d) Reduced for purchases of $25,000 and over. Class A or 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.
(e) Class A and Class D shares are not subject to a contingent deferred sales
charge ("CDSC"), except that purchases of $1,000,000 or more which may not
be subject to an initial sales charge will instead be subject to a CDSC of
up to 1.00% of amounts redeemed within the first year after purchase.
(f) Information for Class A and Class B shares is stated for the fiscal year
ended August 31, 1994. Information under "Other Expenses" for Class C and
Class D shares is estimated for the fiscal year ending August 31, 1995.
(g) See "Management of the Trust--Management and Advisory Arrangements"--page
20.
(h) See "Purchase of Shares--Distribution Plans"--page 28.
(i) See "Management of the Trust--Transfer Agency Services"--page 21.
(j) As of July 31, 1994, the Manager was voluntarily waiving all of its
management fee and voluntarily reimbursing the Fund for a portion of other
expenses (excluding 12b-1 fees). The Fee Table has been restated to assume
the absence of any waiver or reimbursement because the Manager may
discontinue or reduce such waiver and assumption of expenses at any time
without notice. During the fiscal year ended August 31, 1994, the Manager
waived management fees and reimbursed expenses totaling 0.63% for Class A
shares and 0.63% for Class B shares after which the Fund's total expense
ratio was .33% for Class A shares and .83% for Class B shares. Class C and
Class D shares were not offered during that year.

2
<PAGE>

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 front-end 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 $69 $91 $153
Class B..................................... $55 $66 $80 $175
Class C..................................... $26 $49 $85 $186
Class D..................................... $50 $72 $96 $164
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 $69 $91 $153
Class B..................................... $15 $46 $80 $175
Class C..................................... $16 $49 $85 $186
Class D..................................... $50 $72 $96 $164
</TABLE>

The manager of the Fund, Fund Asset Management, L.P. (the "Manager"), has
voluntarily agreed to assume a portion of the operating expenses of the Fund.
The Manager may discontinue or reduce such assumption of expenses at any time
without notice.

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
Commission regulations. THE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION
OF PAST OR FUTURE EXPENSES OR ANNUAL RATES OF RETURN, AND ACTUAL EXPENSES OR
ANNUAL RATES 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 charges permitted under the
Rules of Fair Practice of the National Association of Securities Dealers, Inc.
(the "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".

MERRILL LYNCH SELECT PRICINGSM 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, Fund Asset Management, L.P. (the "Manager"). Funds
advised by MLAM or the Manager 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

3
<PAGE>

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, 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. 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 or her particular circumstances. More
detailed information as to each class of shares is set forth under "Purchase
of Shares".

<TABLE>
<CAPTION>
ACCOUNT
SALES MAINTENANCE DISTRIBUTION CONVERSION
CLASS CHARGE(/1/) FEE FEE FEATURE
- -----------------------------------------------------------------------------------------
<C> <S> <C> <C> <C>
A Maximum 4.0% initial sales No No No
charge(/2/)(/3/)
- -----------------------------------------------------------------------------------------
B 0.25% 0.25% B shares convert to D
CDSC for a period of 4 years, at shares
a rate of 4.0% during the first automatically after
year, decreasing 1.0% annually approximately ten
to 0.0% years(/4/)
- -----------------------------------------------------------------------------------------
1.0% CDSC for one
C year 0.25% 0.35% No
- -----------------------------------------------------------------------------------------
Maximum 4.0% initial sales
D charge(/3/) 0.10% No No
</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 up to a 1.00% CDSC for 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.

4
<PAGE>

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 directors and
employees of 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
to members of the Boards of MLAM-advised mutual funds. The maximum
initial sales charge is 4.0%, 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 will be subject to a CDSC of up to 1.00% 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 the Class B shares and a CDSC if they are
redeemed within four years 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 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 and for certain retirement plans 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 Trust's Board of Trustees and regulatory limitations.

5
<PAGE>

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
the Fund's 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 will be subject to a CDSC of up to 1.00% 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 or
her 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 of the 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 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.

6
<PAGE>

Certain investors may elect to purchase Class B shares if they determine it
to be most advantageous to have all of 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 of 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 forgo 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
August 31, 1994 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 not presented for Class C or
Class D shares, since no shares of those classes are publicly issued as of the
date of this Prospectus. 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 Fund at the telephone
number or address on the front cover of this Prospectus.

<TABLE>
<CAPTION>
CLASS A CLASS B
---------------------------------- ----------------------------------
FOR THE FOR THE PERIOD FOR THE FOR THE PERIOD
YEAR ENDED FEBRUARY 26, 1993+ YEAR ENDED FEBRUARY 26, 1993+
AUGUST 31, 1994 TO AUGUST 31, 1993 AUGUST 31, 1994 TO AUGUST 31, 1993
--------------- ------------------ --------------- ------------------
<S> <C> <C> <C> <C>
INCREASE (DECREASE) IN
NET ASSET VALUE:
PER SHARE OPERATING PER-
FORMANCE:
Net asset value, begin-
ning of period......... $ 10.23 $ 10.00 $ 10.23 $ 10.00
------- ------- ------- -------
Investment income--
net.................. .51 .24 .46 .22
Realized and
unrealized gain
(loss) on
investments--net..... (.65) .23 (.65) .23
------- ------- ------- -------
Total from investment
operations............. (.14) .47 (.19) .45
------- ------- ------- -------
Less dividends:
Investment income--
net.................. (.51) (.24) (.46) (.22)
In excess of realized
gain on investments--
net.................. (.04) -- (.04) --
------- ------- ------- -------
Total dividends and dis-
tributions............. (.55) (.24) (.50) (.22)
------- ------- ------- -------
Net asset value, end of
period................. $ 9.54 $ 10.23 $ 9.54 $ 10.23
======= ======= ======= =======
TOTAL INVESTMENT RE-
TURN++:
Based on net asset value
per share.............. (1.44%) 4.81%** (1.93%) 4.56%**
======= ======= ======= =======
RATIOS TO AVERAGE NET
ASSETS:
Expenses, net of
reimbursement and
excluding distribution
fees................... .33% .14%* .33% .14%*
======= ======= ======= =======
Expenses, net of reim-
bursement.............. .33% .14%* .83% .64%*
======= ======= ======= =======
Expenses................ .96% 1.06%* 1.46% 1.56%*
======= ======= ======= =======
Investment income--net.. 5.16% 4.80%* 4.67% 4.31%*
======= ======= ======= =======
SUPPLEMENTAL DATA:
Net Assets, end of
period
(in thousands)......... $15,946 $17,105 $74,982 $72,861
======= ======= ======= =======
Portfolio Turnover...... 93.04% 74.26% 93.04% 74.26%
======= ======= ======= =======
</TABLE>
- --------
+ Commencement of operations.
++ Total investment returns exclude the effects of sales loads.
* Annualized.
**Aggregate total investment return.

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 California 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 non-
diversified portfolio of securities consisting primarily of long-term
obligations issued by or on behalf of the State of California, 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 California income taxes. Obligations exempt from
Federal income taxes are referred to herein as "Municipal Bonds" and
obligations exempt from both Federal and California income taxes are referred
to herein as "California Municipal Bonds". Unless otherwise indicated,
references to Municipal Bonds shall be deemed to include California Municipal
Bonds. Under normal circumstances, at least 80% of the Fund's total assets will
be invested in Municipal Bonds which are covered by insurance guaranteeing the
timely payment of principal at maturity and interest and at least 65% of the
Fund's total assets will be invested in insured California Municipal Bonds. The
investment objective of the Fund is a fundamental policy and may not be changed
without shareholder approval. 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.

Municipal Bonds may include several types of bonds. The risks and special
considerations involved in investments in Municipal Bonds vary with the types
of instruments being acquired. Investments in Non-Municipal Tax-Exempt
Securities, as defined herein, 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". The Fund also may invest in
variable rate demand obligations. The interest on Municipal Bonds may bear a
fixed rate or be payable at a variable or floating rate. At least 80% of the
California Municipal Bonds and Municipal Bonds purchased by the Fund 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 Corporation ("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

9
<PAGE>

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 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
Municipal Bonds but also the creditworthiness of the financial institution.

The Fund's investments may also include variable rate demand obligations
("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 a 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 judgement 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.

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<PAGE>

exempt from Federal income taxation. Non-municipal tax-exempt securities may
include securities issued by other investment companies that invest in
municipal bonds, to the extent such investments are permitted by the Investment
Company Act of 1940, as amended (the "1940 Act"). Other non-municipal tax-
exempt securities could include trust certificates or other derivative
instruments evidencing interests in one or more Municipal Bonds.

Under normal circumstances, except when acceptable securities are unavailable
as determined by the Manager, the Fund will invest at least 80% of its total
assets in Municipal Bonds which are covered by insurance and at least 65% of
the Fund's total assets will be invested in insured California Municipal Bonds.
For temporary defensive periods or to provide liquidity, the Fund has the
authority to invest as much as 20% 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 total assets.
The Temporary Investments, VRDOs and Participating VRDOs in which the Fund may
invest 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 or 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 total 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 a Federal alternative minimum tax. The
percentage of the Fund's total 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 Fund's outstanding voting securities, as defined in the 1940
Act. 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.

PORTFOLIO INSURANCE

Under normal circumstances, at least 80% of the Fund's total assets (and 65%
of its California Municipal Bonds) will be invested in Municipal Bonds and will
be comprised of Municipal Bonds which are either (i) insured under an insurance
policy purchased by the Fund or (ii) insured under an insurance policy obtained
by the issuer thereof or any other party. The insurance policies in either
instance will be issued by insurance carriers that have total admitted assets
(unaudited) of at least $75,000,000 and capital and surplus (unaudited) of at
least $50,000,000 and insurance claims-paying ability ratings of AAA from S&P
and Aaa from Moody's. See Appendix III to the Statement of Additional
Information for a description of S&P's and Moody's insurance claims-paying
ability ratings. Currently, it is anticipated that a majority of the insured
Municipal Bonds in the Fund's portfolio will be insured by the following
insurance companies which satisfy the foregoing requirements: AMBAC Indemnity
Corporation, Capital Guaranty Insurance Company, Capital Markets Assurance
Corporation, Financial Guaranty Insurance Company, Financial Security Assurance
and Municipal Bond Investors Assurance Corporation. The Fund also may purchase
Municipal Bonds covered by insurance issued by any other insurance company
which satisfies the foregoing requirements. It is

11
<PAGE>

anticipated that initially a majority of insured Municipal Bonds held by the
Fund will be insured under policies obtained by parties other than the Fund.

The Fund may purchase, but has no obligation to purchase, separate mutual
fund insurance policies (the "Policies") from insurance companies meeting the
requirements set forth above which guarantee the payment of principal and
interest on specified eligible Municipal Bonds purchased by the Fund. A
Municipal Bond will be eligible for coverage if it meets certain requirements
of the insurance company set forth in a Policy. In the event interest or
principal on an insured Municipal Bond is not paid when due, the insurer will
be obligated under its Policy to make such payment not later than 30 days after
it has been notified by, and provided with documentation from, the Fund that
such nonpayment has occurred.

The Policies will be effective only as to insured Municipal Bonds
beneficially owned by the Fund. In the event of a sale of any Municipal Bonds
held by the Fund, the issuer of the relevant Policy will be liable only for
those payments of interest and principal which are then due and owing. The
Policies will not guarantee the market value of the insured Municipal Bonds or
the value of the shares of the Fund.

The insurer will not have the right to withdraw coverage on securities
insured by their Policies and held by the Fund so long as such securities
remain in the Fund's portfolio. In addition, the insurer may not cancel its
Policies for any reason except failure to pay premiums when due. The Trustees
of the Trust will reserve the right to terminate any of the Policies if they
determine that the benefits to the Fund of having its portfolio insured under
such Policies are not justified by the expense involved.

The premiums for the Policies are paid by the Fund, and the yield on the
Fund's portfolio is reduced thereby. The Manager estimates that the cost of the
annual premiums for the Policies currently ranges from approximately .20 of 1%
to .25 of 1% of the principal amount of the Municipal Bonds covered by such
Policies. The estimate is based on the expected composition of the Fund's
portfolio of Municipal Bonds. Additional information regarding the Policies is
set forth in Appendix III to the Statement of Additional Information. In
instances in which the Fund purchases Municipal Bonds insured under policies
obtained by parties other than the Fund, the Fund does not pay the premiums for
such policies; rather, the cost of such policies may be reflected in the
purchase price of the Municipal Bonds.

It is the intention of the Manager to retain any insured securities which are
in default or in significant risk of default and to place a value on the
insurance which ordinarily will be the difference between the market value of
the defaulted security and the market value of similar securities which are not
in default. In certain circumstances, however, the Manager may determine that
an alternative value for the insurance, such as the difference between the
market value of the defaulted security and its par value, is more appropriate.
The Manager will be unable to manage the portfolio to the extent it holds
defaulted securities which may limit its ability in certain circumstances to
purchase other Municipal Bonds.

There can be no assurance that insurance of the kind described above will
continue to be available to the Fund. In the event the Trustees determine that
such insurance is unavailable or that the cost of such insurance outweighs the
benefits to the Fund, the Fund may discontinue its policy of maintaining
insurance for all or any of the Municipal Bonds held in the Fund's portfolio.
Although the Manager periodically reviews the financial condition of each
insurer, there can be no assurance that the insurers will honor their
obligations under all circumstances.

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<PAGE>

The portfolio insurance reduces financial or credit risk (i.e., the
possibility that the owners of the insured Municipal Bonds will not receive
timely scheduled payments of principal or interest). However, the insured
Municipal Bonds are subject to market risk (i.e., fluctuations in market value
as a result of changes in prevailing interest rates).

POTENTIAL BENEFITS

Investment in shares of the Fund offers several benefits. The Fund offers
investors the opportunity to receive income exempt from Federal and California
income taxes by investing in a professionally managed portfolio consisting
primarily of long-term California Municipal Bonds. Moreover, as noted above,
the existence of portfolio insurance reduces the financial or credit risk of
such investments. 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 (including insurance premiums), and in the
case of certain classes of shares, account maintenance and distribution fees.

SPECIAL AND RISK CONSIDERATIONS RELATING TO CALIFORNIA MUNICIPAL BONDS

The Fund ordinarily will invest at least 65% of its total assets in
California Municipal Bonds, and therefore it is more susceptible to factors
adversely affecting issuers of California Municipal Bonds than is a municipal
bond mutual fund that is not concentrated in issuers of California Municipal
Bonds to this degree. While at least 80% of the Municipal Bonds (and at least
65% of the California Municipal Bonds) held by the Fund will be insured, the
shares of the Fund are not insured by any government entity and the value of
the shares may fluctuate daily. California is experiencing its deepest
recession since the 1930s. The State of California's bond ratings have been
lowered from AAA to A by S&P, from AAA to AA by Fitch and from Aaa to Aa1 by
Moody's. The Manager does not believe that the current economic conditions in
California will have a significant adverse effect on the Fund's ability to
invest in high quality California Municipal Bonds. For a discussion of economic
and other conditions in the State of California, see Appendix I 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 of 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 certain facilities for the local furnishing of
electric energy or gas, sewage facilities, solid waste disposal facilities and
other specialized facilities. In the case of certain community facilities
district special tax ("Mello-Roos" in the case of California Municipal Bonds),
tax increment (or tax allocation) and assessment bonds, the payment of the
special tax, tax increment and assessments may be secured solely by remedies
against the land (such as by foreclosure) and not against the individual
property owner, which could be time-consuming and costly.

The two principal classifications of Municipal Bonds are "general obligation"
and "revenue" bonds which include industrial development bonds ("IDBs") and,
for bonds issued after August 15, 1986, private

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<PAGE>

activity bonds. General obligation bonds are secured by the issuer's pledge of
its faith, credit and taxing power for the repayment of principal and the
payment of interest. The taxing power of any governmental entity may be
limited, however, by provisions of state constitutions 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 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 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 payments 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 more than 10% of
its total assets (taken at market value at the time of each investment) in
industrial revenue bonds 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. 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 entity for the purpose of financing construction or
improvement of a facility to be used by the entity. 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. In view of this, an investor should
be aware that repayment of such bonds depends on the revenues of a private
entity and be aware of the risks that such an investment may entail. Continued
ability of an entity to generate sufficient revenues for the payment of
principal and interest on such bonds will be affected by many factors including
the size of the entity, capital structure, demand for its products or services,
competition, general economic conditions, governmental regulation and the
entity's dependence on revenues for the operation of the particular facility
being financed. The Fund may invest more than 25% of its total assets in IDBs
or private activity bonds. For purposes of this Prospectus, such debt
obligations are referred to as Municipal Bonds if the interest paid thereon is
exempt from Federal income tax, and, as California Municipal Bonds if the
interest thereon is exempt from Federal and California income taxes, even
though such bonds may be "private activity bonds" as discussed above. The Fund
may also invest in "moral obligation" bonds. If an issuer of such bonds is
unable to meet its obligations, the repayment of such bonds becomes a moral
commitment, but not a legal obligation, of the issuer.

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<PAGE>

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 risk with respect to the value of the
particular 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. 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 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.
The Manager believes that indexed and inverse floating obligations represent a
flexible portfolio management instrument for the Fund which allows the Manager
to vary the degree of investment leverage relatively efficiently under
different market conditions. 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.

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 type of financing that may not have the depth of
marketability associated with more conventional securities. Consequently,
certain investments in lease obligations may be illiquid. The Fund may not
invest in illiquid lease obligations if such investments, together with other
illiquid investments, would exceed 15% 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
Trustees and subject to the supervision of the Board, 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
obligation 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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<PAGE>

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 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% 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 purposes of
hedging its investments in Municipal Bonds against declines in value and
hedging 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 index-based financial futures contracts 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

16
<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 financial
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, U.S. 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 of the Fund 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 financial futures transactions and options thereon involves
the risk of imperfect correlation in movements in the price of financial
futures contracts and movements in the price of the security which is the
subject of the hedge. If the price of the financial 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 financial 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 financial futures contracts on U.S.
Government securities and options on such financial 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, 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 financial 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 financial futures contracts and options. (However, as stated above,
the Fund intends to engage in options and financial 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 financial 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

17
<PAGE>

tender 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 financial futures contract is unleveraged. It is
not anticipated that transactions in financial futures contracts will have the
effect of increasing portfolio turnover.

Although certain risks are involved in options and financial futures
transactions, the Manager believes that, because the Fund will engage in
financial 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 financial 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
reached and exceeded the daily limit on a number of consecutive trading days.

The successful use of transactions in financial 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 financial 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 in U.S.
Government securities, or an affiliate thereof. Under such agreements, the
seller agrees, upon entering into the contract, to repurchase the security from
the Fund 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% of the
Fund's net assets. In the event of default by the seller under a

18
<PAGE>

repurchase agreement, the Fund may suffer time delays and incur costs or
possible losses in connection with the disposition of the underlying
securities.

INVESTMENT RESTRICTIONS

Current Investment Restrictions. The Fund has adopted a number of
restrictions and policies relating to the investment of the Fund's assets and
its activities, which are fundamental policies of the Fund and 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 the more
significant restrictions, the Fund may not: (i) purchase any securities other
than securities referred to under "Investment Objective and Policies" herein;
(ii) invest more than 5% of its total assets (taken at market value at the
time of each investment) in the securities of any one issuer, except that such
restriction shall not apply to securities backed by the United States
Government or its agencies or instrumentalities [For purposes of this
restriction, the Trust 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]; (iii) 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 [Usually only "leveraged" investment companies may
borrow in excess of 5% of their assets; however, the Fund will not purchase
securities while borrowings are outstanding. Interest paid on such borrowings
will reduce net income.]; (iv) invest in securities with legal or contractual
restrictions on resale or for which no readily available market exists,
including repurchase agreements and purchase and sale contracts maturing in
more than seven days, if, regarding all such securities taken together, more
than 10% of its net assets (taken at market value) would be invested in such
securities; and (v) invest more than 5% of its total assets (taken at market
value at the time of each investment) in industrial revenue bonds where the
entity supplying the revenues from which the issue is to be paid, including
predecessors, has a record of less than three years' continuous business
operation.

Proposed Investment Restrictions. The Board of Trustees of the Trust, at a
meeting held on August 3, 1994, approved certain changes to the fundamental
and non-fundamental investment restrictions of the Fund. These changes were
proposed in connection with the creation of a set of standard fundamental and
non-fundamental investment restrictions that would be adopted, subject to
shareholder approval, by all of the non-money market mutual funds advised by
MLAM or the Manager. The proposed uniform investment restrictions are designed
to provide each of these funds, including the Fund, with as much investment
flexibility as possible under the 1940 Act and applicable state securities
regulations, help promote operational efficiencies and facilitate monitoring
of compliance. The investment objective and policies of the Fund will be
unaffected by the adoption of the proposed investment restrictions.

The full text of the proposed investment restrictions is set forth under
"Investment Objective and Policies--Proposed Uniform Investment Restrictions"
in the Statement of Additional Information. Shareholders of the Fund are
currently considering whether to approve the proposed revised investment
restrictions. If such shareholder approval is obtained, the Fund's current
investment restrictions will be replaced by the proposed restrictions, and the
Fund's Prospectus and Statement of Additional Information will be supplemented
to reflect such change.

19
<PAGE>

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.

Arthur Zeikel*--President and Chief Investment Officer of the Manager and of
MLAM; President and Director of Princeton Services, Inc.; Executive Vice
President of ML & Co.; Executive Vice President of Merrill Lynch; Director of
the Distributor.

Kenneth S. Axelson--Former Executive Vice President and Director, J.C. Penney
Company, Inc.

Herbert I. London--John M. Olin Professor of Humanities, of New York
University.

Robert R. Martin--Chairman, WTC Industries Inc.; former Chairman, Kinnard
Investments, 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 over 100 other
registered investment companies. MLAM also provides investment advisory
services to individual and institutional accounts. As of August 31, 1994, the
Manager and MLAM had a total of approximately $165.7 billion in investment
company and other portfolio assets under management, including accounts of
certain affiliates of the Manager.

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, subject to review by the Board of
Trustees. The Manager performs certain of the other administrative services and
provides all of the office space, facilities, equipment and necessary personnel
for management of the Fund.

20
<PAGE>

Vincent R. Giordano and Kenneth A. Jacob are the Portfolio Managers for the
Fund. Vincent R. Giordano has been a Portfolio Manager of the Manager and MLAM
since 1977 and a Senior Vice President of the Manager and MLAM since 1984.
Kenneth A. Jacob has been a Vice President of the Manager and MLAM since 1984.

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 portion of the average
daily net assets not exceeding $500 million; 0.525% of the portion of the
average daily net assets exceeding $500 million but not exceeding $1.0 billion;
and 0.50% of the portion of the average daily net assets exceeding $1.0
billion. For the fiscal year ended August 31, 1994, the total fee payable by
the Fund to the Manager was $509,552 (based on average net assets of
approximately $92.6 million), all of which was voluntarily waived, and the
effective fee rate was approximately 0.55%.

The Management Agreement obligates 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. For the fiscal year ended August 31, 1994, the Fund reimbursed the
Manager $39,696 for accounting services. For the fiscal year ended August 31,
1994, the ratio of total expenses, excluding distribution fees and net of
reimbursement, to average net assets was 0.33% for the Class A shares and 0.33%
for the Class B shares; no Class C shares or Class D shares had been issued
during that year.

TRANSFER AGENCY SERVICES

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 fiscal year ended August 31,
1994, the Fund paid the Transfer Agent a total fee of $33,871 pursuant to the
Transfer Agency Agreement for providing transfer agency services.

21
<PAGE>

PURCHASE OF SHARES

Merrill Lynch Funds Distributor, Inc. (the "Distributor"), an affiliate of
both the Manager 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 offers 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 4:15 P.M., New York time, which includes orders
received after the determination of the net asset value on the previous day,
the applicable offering price will be based on the net asset value determined
as of 4:15 P.M., New York time, on the day the orders are placed with the
Distributor, provided the orders are received by the Distributor prior to 4:30
P.M., New York time, on that day. If the purchase orders are not received by
the Distributor prior to 4:30 P.M., New York time, such orders shall be deemed
received on the next business day. Any order may be rejected by the Distributor
or the Trust. The Trust or the Distributor may suspend the continuous offering
of the Fund's shares at any time in response to conditions in the securities
markets or otherwise and may thereafter resume such offering from time to time.
Neither the Distributor nor the dealers are permitted to withhold placing
orders to benefit themselves by a price change. Merrill Lynch may charge its
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. 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 3.

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

22
<PAGE>

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.

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
SALES MAINTENANCE DISTRIBUTION CONVERSION
CLASS CHARGE(1) FEE FEE FEATURE
- -----------------------------------------------------------------------------------------
<C> <S> <C> <C> <C>
A Maximum 4.0% initial sales No No No
charge(/2/)(/3/)
- -----------------------------------------------------------------------------------------
B 0.25% 0.25% B shares convert to D
CDSC for a period of 4 years, at shares
a rate of 4.0% during the first automatically after
year, decreasing 1.0% annually approximately ten
to 0.0% years(/4/)
- -----------------------------------------------------------------------------------------
1.0% CDSC for one
C year 0.25% 0.35% No
- -----------------------------------------------------------------------------------------
Maximum 4.0% initial sales
D charge(/3/) 0.10% No No
</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
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 may be subject to up to a 1.00% CDSC for 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 alternatives is the next determined net
asset value plus varying sales charges (i.e., sales loads), as set forth
below.

<TABLE>
<CAPTION>
SALES LOAD AS DISCOUNT TO
SALES LOAD AS PERCENTAGE* OF SELECTED DEALERS
PERCENTAGE OF THE NET AMOUNT AS PERCENTAGE OF
AMOUNT OF PURCHASE OFFERING PRICE INVESTED THE 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. If the sales charge
is waived, such purchases will be subject to a CDSC of up to 1.00% 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 in lieu of paying an initial sales
charge. 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.
During the fiscal year ended August 31, 1994, the Fund sold 301,766 Class A
shares for aggregate net proceeds of $3,002,096. The gross sales charges for
the sale of Class A shares of the Fund for that year were $23,814, of which
$2,428 and $21,386 were received by the Distributor and Merrill Lynch,
respectively. For the fiscal year ended August 31, 1994, 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.

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 in a
shareholder account are entitled to purchase additional Class A shares in that
account. Class A shares are available at net asset value to corporate warranty
insurance reserve fund programs, provided that each 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 discretionary trustee services and certain purchases
made in connection with the Merrill Lynch Mutual Fund Adviser program. In
addition, Class A shares will be offered at net asset value to 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 investment companies,
including the Fund. Certain persons who acquired shares of certain 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

24
<PAGE>

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 Merrill Lynch 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.

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. "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

25
<PAGE>

as the payment of compensation to financial consultants for selling Class B and
Class C shares, from its 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 fee 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 Charges--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 rates of the Class B CDSC:

<TABLE>
<CAPTION>
CLASS B
CDSC AS A
PERCENTAGE OF
YEAR SINCE PURCHASE DOLLAR AMOUNT
PAYMENT MADE SUBJECT TO CHARGE
------------------- -----------------
<S> <C>
0-1....................................................... 4.00%
1-2....................................................... 3.00%
2-3....................................................... 2.00%
3-4....................................................... 1.00%
4 and thereafter.......................................... none
</TABLE>

For the fiscal year ended August 31, 1994, the Distributor received CDSCs of
$177,779 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 possible rate being
charged. Therefore, it will be assumed that the redemption is first of shares
held for over four years of 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

26
<PAGE>

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 purchases 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 through dividend reinvestment. If at such time the investor
makes his or her first redemption of 50 shares (proceeds of $600), 10 shares
will not be subject to the 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).

Contingent Deferred Sales Charges--Class C Shares. Class C shares which are
redeemed within one year after 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 amount 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.

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 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.

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 purchase 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

27
<PAGE>

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 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 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.

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 rates 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.

Prior to July 6, 1993, the Fund paid the Distributor an ongoing distribution
fee, accrued daily and paid monthly, at the annual rate of 0.50% of average
daily net assets of the Class B shares of the Fund under a distribution plan
previously adopted by the Fund (the "Prior Plan") to compensate the Distributor
and Merrill Lynch for providing account maintenance and distribution-related
activities and services to Class B shareholders. The fee rate payable and the
services provided under the Prior Plan are identical to the aggregate fee rate
payable and the services provided under the Class B Distribution Plan, the
difference being that the account maintenance and distribution services have
been unbundled.

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<PAGE>

For the year ended August 31, 1994, the Fund paid the Distributor account
maintenance fees of $189,306 and distribution fees of $189,306 under the Class
B Distribution Plan. The Fund did not begin to offer shares of Class C or Class
D publicly until the date of this Prospectus. Accordingly, no payments have
been made pursuant to the Class C or Class D Distribution Plans prior to the
date of this Prospectus.

The payments under the Distribution Plans 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 Directors for their consideration in connection with their
deliberations as to the continuance of the Class B and Class C Distribution
Plans. 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, 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 August 31,
1994, direct cash expenses for the period since commencement of the offering of
Class B shares exceeded direct cash revenues by $513,221 (.68% of Class B net
assets at that date). At December 31, 1993, the fully allocated accrual
expenses incurred by the Distributor and Merrill Lynch with respect to Class B
shares for the period February 26, 1993 (commencement of operations) through
December 31, 1993 exceeded fully allocated accrual revenues for such period by
approximately $1,841,000 (2.3% of Class B net assets at that date).

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".

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

29
<PAGE>

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.

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 by tendering the shares
directly to the Transfer Agent, Financial Data Services, Inc., Transfer Agency
Mutual Fund Operations, P.O. Box 45289, Jacksonville, Florida 32232-5289.
Redemption requests delivered other than by mail should be delivered to
Financial Data Services, Inc., Transfer Agency Mutual Fund Operations, 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 may take up to 10 days.

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<PAGE>

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 on the day received and is received by the Fund
from such dealer not later than 4:30 P.M., New York time, on the same day.

Dealers have the responsibility of submitting such repurchase requests to the
Trust not later than 4:30 P.M., New York time, in order to obtain that day's
closing price. The repurchase arrangements are for the convenience of
shareholders and do not involve a charge by the Trust (other than the applicable
CDSC). Securities firms that do not have selected dealer agreements with the
Distributor, however, may impose a 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 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 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 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. Included in such services are the following:

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 showing any reinvestments of dividends
and capital gains distributions. The statements will serve as transaction
confirmations for automatic investment purchases and the reinvestment of
taxable ordinary income, dividends, tax exempt income and long-term capital
gains distributions. These statements will show any other activity in the
account since the preceding statement. Shareholders will receive separate
transaction

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<PAGE>

confirmations for each purchase or sale transaction other than automatic
investment purchases and the reinvestments of ordinary income dividends and
long-term capital gains distributions. A shareholder may make additions to his
or her 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, without charge, at 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 (paying any applicable CDSC) 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 at the Transfer Agent.

Exchange Privilege. Shareholders of each class of shares of the Fund each
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 PricingSM 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 or her 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 or her 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 will be exchangeable with shares of the
same class of other MLAM-advised mutual funds.

Shares of the Fund which are subject to a CDSC will be 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.

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<PAGE>

Class A, Class B, Class C and Class D shares also will be 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. 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 under the Merrill Lynch Mutual Fund Adviser ("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 notifying the
Transfer Agent in writing or by telephone (1-800-MER-FUND), 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 also can be directly deposited to the shareholder's 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 and Automatic Investment Plans. A Class A or Class D
shareholder may elect to receive systematic withdrawal payments from his or her
Investment Account through automatic payment by check or through automatic
payment by direct deposit to his or her bank account on either a monthly or
quarterly basis. 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 Systematic
Redemption Program, subject to certain conditions.

Automatic Investment Plans. Regular additions of Class A, Class B, Class C or
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. Alternatively,
investors who maintain CMA(R) accounts may arrange to have periodic investments
made in the Fund in their CMA(R) account or in certain related accounts in
amounts of $100 or more through the CMA(R) Automated Investment Program.

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<PAGE>

PORTFOLIO TRANSACTIONS

Subject to the policies established by the Trustees of the Trust, the Manager
is primarily responsible for the execution of the Fund's 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 or commission), 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 principal
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. 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
following the normal close of trading on the New York Stock Exchange (currently
4:00 P.M.) prior to the determination of the net asset value 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 settlement date of a redemption order.

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.

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<PAGE>

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 (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.

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 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 and railroad retirement benefits subject to
Federal income taxes. The portion of such exempt-interest dividends paid from
interest received by the Fund from California Municipal Bonds also will be
exempt from California personal income taxes if, at the close of each quarter
of the Fund's taxable year, at least 50% of the value of the Fund's total
assets consists of California Municipal Bonds. Shareholders subject to income
taxation by states other than California will realize a lower after-tax rate of
return than California 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 California personal income taxes. Interest
on indebtedness incurred or continued to purchase or carry Fund shares is not
deductible for Federal or California personal 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.

Exempt-interest dividends paid to a corporate shareholder will be subject to
California franchise tax.

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<PAGE>

of 1993, 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 to such holder (assuming the 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 to the extent of any exempt-interest dividends received by the
shareholder. 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. This alternative minimum tax applies
to interest received on "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.

The Revenue Reconciliation Act of 1993 has added new marginal tax brackets of
36% and 39.6% for individuals and has created a graduated structure of 26% and
28% for the alternative minimum tax applicable to individual taxpayers. These
rate increases may affect an individual investor's after-tax return from an
investment in the Fund as compared with such investor's return from taxable
investments.

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 such shareholder can recognize on the exchange will
be reduced (or the gain increased) to the extent the sales charge paid to the
Fund 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.

36
<PAGE>

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 provisions of the Code, 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 California 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 California personal income and corporate franchise tax laws.
The Code and the Treasury regulations, as well as the California 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 California) 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 and
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 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 Class A and Class B 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.

37
<PAGE>

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 or to reduced sales charges in the case of Class A or
Class D shares, waiver of the CDSC in the case of Class B or Class C 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
August 31, 1994 was 5.61% for Class A shares and 5.32% for Class B shares and
the tax-equivalent yield for the same period (based on a Federal income tax
rate of 28%) was 7.79% for Class A shares and 7.39% for Class B shares; no
shares of Class C or Class D shares had been issued during that period. The
yield without voluntary reimbursement for the 30-day period would have been
5.06% for Class A shares and 4.75% for Class B shares with a tax equivalent
yield of 7.03% for Class A shares and 6.60% for Class B shares.

Total return and yield figures are based on the Fund's historical performance
and are not intended to indicate future performance. The Fund's total return
and yield will vary depending on market conditions, the securities comprising
the Fund's portfolio, the Fund's operating 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
published 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 representative of the Fund's relative
performance for any future period.

38
<PAGE>

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 as of 4:15 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 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 March 20, 1985
under the laws of Massachusetts. 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, state and local income taxes as is 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
interests 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 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.

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,

39
<PAGE>

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, objectives 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:

Financial Data Services, Inc.
Attn: TAMFO
P.O. Box 45289
Jacksonville, FL 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 Financial Data
Services, Inc. at 800-637-3863.

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 March 20, 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 California 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" (as defined in the Declaration) only shall
be liable.

40
<PAGE>

MERRILL LYNCH CALIFORNIA INSURED 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 California Insured 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 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........................
(Zip Code)
Occupation........................... Name and Address of Employer ........
..................................... .....................................
Signature of Owner Signature of Co-Owner (if any)
(In the case of co-owner, a joint tenancy with rights 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 California Insured 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 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.

41
<PAGE>

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 "Additional Information--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)

- -------------------------------------------------------------------------------
4. LETTER OF INTENTION--CLASS A AND CLASS D SHARES ONLY (SEE TERMS AND
CONDITIONS IN THE STATEMENT OF ADDITIONAL INFORMATION)
Dear Sir/Madam:

..................., 19......
Date of Initial Purchase

Although I am not obligated to do so, I intend to purchase shares of Merrill
Lynch California Insured 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 California Insured
Municipal Bond Fund Prospectus.

I agree to the terms and conditions of this 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 California Insured Municipal Bond Fund held as
security.

By .................................. .....................................
Signature of Owner Signature of Co-Owner
(If registered in joint parties,
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
Merrill Lynch California Insured
Municipal Bond Fund By ..................................
c/o Financial Data Services, Inc. Authorized Signature of Dealer
Transfer Agency Mutual Funds Operations
P.O. Box 45289 [_][_][_] [_][_][_][_].............
Jacksonville, Florida 32232-5289 Branch-Code F/C No. F/C Last Name

[_][_][_] [_][_][_][_][_]
Dealer's Customer A/C No.

42
<PAGE>

MERRILL LYNCH CALIFORNIA INSURED MUNICIPAL BOND FUND--AUTHORIZATION FORM
(PART 2)
- -------------------------------------------------------------------------------

NOTE: THIS FORM IS REQUIRED TO APPLY FOR THE SYSTEMATIC WITHDRAWAL OR
AUTOMATIC INVESTMENT PLANS ONLY.
- -------------------------------------------------------------------------------

1. ACCOUNT REGISTRATION

Name of Owner...................... [_][_][_] [_][_] [_][_][_][_]

Name of Co-Owner (if any).......... Social Security No. or
Taxpayer Identification
Number

Address............................ Account Number ....................
(if existing account)
...................................
- -------------------------------------------------------------------------------

2. SYSTEMATIC WITHDRAWAL PLAN--CLASS A AND CLASS 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 California
Insured 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 . . . . . . . . . .(month) or as soon
as possible thereafter.

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 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 FINANCIAL DATA SERVICES, INC. AMENDING OR TERMINATING
THIS SERVICE.

Specify type of account (check one): [_] checking [_] savings

Name of 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 SHALL ACCOMPANY THIS APPLICATION.

43
<PAGE>

- -------------------------------------------------------------------------------

3. APPLICATION FOR AUTOMATIC INVESTMENT PLAN

I hereby request that 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 California Insured 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.

FINANCIAL DATA SERVICES, INC. AUTHORIZATION TO HONOR ACH DEBITS
DRAWN BY FINANCIAL DATA SERVICES,
You are hereby authorized to draw an INC.
ACH debit each month on my bank
account for investment in Merrill To...............................Bank
Lynch California Insured Municipal (Investor's Bank)
Bond Fund as indicated below:
Bank Address.........................
Amount of each check or ACH debit
$.................................
City...... State...... Zip Code......

Account Number ................... As a convenience to me, I hereby
request and authorize you to pay and
Please date and invest ACH debits on charge to my account ACH debits
the 20th of each month beginning drawn on my account by and payable
to Financial Data Services, Inc., I
..................................... agree that your rights in respect to
each such debit shall be the same as
................(month) if it were a check drawn on you and
signed personally by me. This
or as soon thereafter as possible. authority is to remain in effect
I agree that you are preparing these until revoked by me in writing.
ACH debits voluntarily at my request Until you receive such notice, you
and that you shall not be liable for shall be fully protected in honoring
any loss arising from any delay in any such debit. I further agree that
preparing or failure to prepare any if any such debit be dishonored,
such check or debit. If I change whether with or without cause and
banks or desire to desire to whether intentionally or
terminate or suspend this program, I inadvertently, you shall be under no
agree to notify you promptly in liability.
writing. I hereby authorize you to
take any action to correct erroneous ............ .....................
ACH debits of my bank account or Date Signature of
purchases of fund shares including Depositor
liquidating shares of the Fund and
crediting my bank account. I further ............ .....................
agree that if a check or debit is not Bank Signature of Depositor
honored upon presentation, Financial Account (If joint account,
Data Services, Inc. is authorized to Number both must sign)
discontinue immediately the Automatic
Investment Plan and to liquidate
sufficient shares held in my account
to offset the purchase made with the
returned check or dishonored debit.

............ .....................
Date Signature of
Depositor

......................
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.

44
<PAGE>

[This page is intentionally left blank.]

45
<PAGE>

[This page is intentionally left blank.]

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 9011
Princeton, New Jersey 08543-9011

CUSTODIAN
The Bank of New York
90 Washington Street, 12th Floor
New York, New York 10286

TRANSFER AGENT
Financial Data Services, Inc.

Administrative Offices:
Transfer Agency Mutual Fund Operations
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

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 REPRE-
SENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, IN CONNECTION WITH
THE OFFER CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER IN-
FORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE TRUST, THE MANAGER, OR THE DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTI-
TUTE 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..................................... 3
Financial Highlights....................................................... 8
Investment Objective and Policies.......................................... 9
Portfolio Insurance....................................................... 11
Potential Benefits........................................................ 13
Special and Risk Considerations Relating to California Municipal Bonds.... 13
Description of Municipal Bonds............................................ 13
When-Issued Securities and Delayed Delivery Transactions.................. 16
Call Rights............................................................... 16
Financial Futures Transactions and Options................................ 16
Repurchase Agreements .................................................... 18
Investment Restrictions................................................... 19
Management of the Trust.................................................... 20
Trustees.................................................................. 20
Management and Advisory Arrangements...................................... 20
Transfer Agency Services.................................................. 21
Purchase of Shares......................................................... 22
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
Limitations on the Payment of Deferred Sales Charges....................... 29
Redemption of Shares....................................................... 30
Redemption................................................................ 30
Repurchase................................................................ 31
Reinstatement Privilege--
Class A and Class D Shares............................................... 31
Shareholder Services....................................................... 31
Portfolio Transactions..................................................... 34
Distributions and Taxes.................................................... 34
Distributions............................................................. 34
Taxes..................................................................... 35
Performance Data........................................................... 37
Additional Information..................................................... 39
Determination of Net Asset Value.......................................... 39
Organization of the Trust................................................. 39
Shareholder Reports....................................................... 40
Shareholder Inquiries..................................................... 40
Authorization Form......................................................... 41
</TABLE>
Code #16574-1094
Prospectus
(ART)
- --------------------------------------------------------------------------------
MERRILL LYNCHCALIFORNIA INSUREDMUNICIPAL BOND FUND

MERRILL LYNCH CALIFORNIA MUNICIPAL SERIES TRUST

October 21, 1994

Distributor:
Merrill Lynch
Funds Distributor, Inc.

This prospectus should be
retained for future reference.
<PAGE>

STATEMENT OF ADDITIONAL INFORMATION
- -----------------------------------

MERRILL LYNCH CALIFORNIA INSURED MUNICIPAL BOND FUND

MERRILL LYNCH CALIFORNIA MUNICIPAL SERIES TRUST
P.O. BOX 9011, PRINCETON, NEW JERSEY 08543-9011 . PHONE NO. (609) 282-2800

----------------

Merrill Lynch California Insured Municipal Bond Fund (the "Fund") is a
series of Merrill Lynch California 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 California personal income
taxes as is consistent with prudent investment management. The Fund invests
primarily in a non-diversified portfolio of long-term investment grade
obligations of the State of California, its political subdivisions, agencies
and instrumentalities, the interest on which is exempt from Federal and
California income taxes in the opinion of bond counsel to the issuer
("California Municipal Bonds"). Under normal circumstances, at least 80% of
the Fund's total assets will be invested in municipal obligations with
remaining maturities of one year or more which are covered by insurance
guaranteeing the timely payment of principal at maturity and interest and at
least 65% of the Fund's total assets will be invested in insured California
Municipal Bonds. There can be no assurance that the investment objective of
the Fund will be realized.

----------------

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 SM 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 October
21, 1994 (the "Prospectus"), which has been filed with the Securities and
Exchange Commission (the "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. Capitalized terms used but not defined herein have the same
meanings as in the Prospectus.

----------------

FUND ASSET MANAGEMENT--MANAGER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC.--DISTRIBUTOR

----------------

The date of this Statement of Additional Information is October 21, 1994.
<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 California personal 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 California, 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
California personal income taxes. Obligations exempt from Federal income taxes
are referred to herein as "Municipal Bonds" and obligations exempt from both
Federal and California income taxes are referred to as "California Municipal
Bonds". Unless otherwise indicated, references to Municipal Bonds shall be
deemed to include California Municipal Bonds. Under normal circumstances, at
least 80% of the Fund's total assets will be invested in Municipal Bonds which
are covered by insurance guaranteeing the timely payment of principal at
maturity and interest and at least 65% of the Fund's total assets will be
invested in insured California Municipal Bonds. 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. 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 Corporation ("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 California income taxes. However, to the extent that suitable
California 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 California 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 ("Non-Municipal Tax-Exempt Securities"),
if the Fund nevertheless believes such securities to be exempt from Federal
income taxation. 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 derivative instruments evidencing interests in one or
more Municipal Bonds.

Except when acceptable securities are unavailable as determined by the
Manager, the Fund, under normal circumstances, will invest at least 80% of its
total assets in Municipal Bonds which are covered by insurance and at least 65%
of its total assets in insured California Municipal Bonds. For temporary
periods or to provide liquidity, the Fund has the authority to invest as much
as 20% of its total assets in tax-exempt

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<PAGE>

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
total assets. Accordingly, the Fund at all times will have at least 80% of its
total 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 total 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 voting securities, as
defined in the 1940 Act, 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
on 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 actually may 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 California Municipal Bonds, 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.
To the extent the Fund invests in those 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. 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. 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 at which fixed-rate 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.
The Manager believes that indexed and inverse floating obligations represent a
flexible portfolio management instrument for the Fund which allows the Manager
to vary the degree of investment leverage relatively efficiently under
different market conditions. Certain investments in such obligations may be
illiquid. The Fund may not invest in such illiquid obligations of such
investments, together with other illiquid investments, would exceed 15% of the
Fund's total assets.

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<PAGE>

The Fund may invest up to 20% of its total assets in California Municipal
Bonds and 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
generally 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 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 affected adversely
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
likely would have to replace such called security with a lower yielding
security, thus decreasing the net investment income to the Fund and dividends
to shareholders.

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

4
<PAGE>

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 generally are 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 affect adversely 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.

PORTFOLIO INSURANCE

Under normal circumstances, at least 80% of the Fund's total assets (and 65%
of its California Municipal Bonds) will be comprised of Municipal Bonds which
are either (i) insured under an insurance policy purchased by the Fund or (ii)
insured under an insurance policy obtained by the issuer thereof or any other
party. The insurance policies in either instance will be issued by insurance
carriers that have total admitted assets (unaudited) of at least $75,000,000
and capital and surplus (unaudited) of at least $50,000,000 and insurance
claims-paying ability ratings of AAA from S&P and Aaa from Moody's. See
Appendix III to this Statement of Additional Information for a brief
description of S&P's and Moody's insurance claims-paying ability ratings.
Currently, it is anticipated that a majority of the insured Municipal Bonds in
the Fund's portfolio will be insured by the following insurance companies which
satisfy the foregoing requirements: AMBAC Indemnity Corporation, Capital
Guaranty Insurance Company, Capital Markets Assurance Corporation, Financial
Guaranty Insurance Company, Financial Security Assurance and Municipal Bond
Investors Assurance Corporation. The Fund also may purchase Municipal Bonds
covered by insurance issued by any other insurance company which satisfies the
foregoing requirements. It is anticipated that initially a majority of insured
Municipal Bonds held by the Fund will be insured under policies obtained by
parties other than the Fund.

5
<PAGE>

be obligated under its Policy to make such payment not later than 30 days after
it has been notified by, and provided with documentation from, the Fund that
such nonpayment has occurred.

The premiums for the Policies are paid by the Fund, and the yield on the
Fund's portfolio is reduced thereby. The Manager estimates that the cost of the
annual premiums for the Policies currently ranges from approximately 0.20 of 1%
to 0.25 of 1% of the principal amount of the Municipal Bonds covered by such
Policies. The estimate is based on the expected composition of the Fund's
portfolio of Municipal Bonds. Additional information regarding the Policies is
set forth in Appendix III to this Statement of Additional Information. In
instances in which the Fund purchases Municipal Bonds insured under policies
obtained by parties other than the Fund, the Fund does not pay the premiums for
such policies; rather, the cost of such policies may be reflected in the
purchase price of the Municipal Bonds.

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<PAGE>

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. 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 of 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 ("IDBs") or private activity
bonds are issued by or on behalf of public authorities to finance various
privately owned or operated facilities, including certain facilities for the
local furnishing of electric energy or gas, sewage facilities, solid waste
disposal facilities and other specialized facilities. Such obligations are
included within the term Municipal Bonds if the interest paid thereon is, in
the opinion of bond counsel to the issuer, excluded from gross income for
Federal income tax purposes and, in the case of California Municipal Bonds,
exempt from California personal income taxes. Other types of IDBs or private
activity bonds, the proceeds of which are used for the construction, equipment
or improvement of privately operated industrial or commercial facilities, may
constitute Municipal Bonds, although the current Federal tax laws place
substantial limitations on the size of such issues. In the case of certain
community facilities district special tax ("Mello-Roos" in the case of
California Municipal Bonds), tax increment (or tax allocation) and assessment
bonds, the payment of the special tax, tax increment and assessments may be
secured solely by remedies against the land (such as by foreclosure) and not
against the individual property owner, which could be time-consuming and
costly.

The two principal classifications of Municipal Bonds are "general obligation"
bonds and "revenue" bonds. General obligation bonds are secured by the issuer's
pledge of faith, credit and taxing power for the repayment of principal and the
payment of 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 repayment of the
principal of and the payment of the interest on such industrial development
bonds and private activity 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 line 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. Under a moral obligation
bond, if the issuer thereof is unable to meet its obligations, the repayment of
the bond becomes a moral commitment, but not a legal obligation, of the state
or municipality in question.

7
<PAGE>

appropriate and make the payments due under the lease obligation. 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% 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
Trustees and subject to the supervision of the 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 obligation and the willingness of dealers
to make a market in the obligation.

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 also is 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.

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 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

8
<PAGE>

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 set at a rate determined by the remarketing
agent or 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 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 therefore will 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-
1/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 (the "FDIC"), except that up to 10% of the Fund's
total assets may be invested in certificates of deposit of small institutions
if such certificates are insured fully 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

9
<PAGE>

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 the case of 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 the case of 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 suffer time delays and incur
costs or possible losses in connection with the disposition of the collateral.
The Fund would retain ownership of the securities in the event of a default
under a repurchase agreement that is construed not to be a collateralized loan.
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% 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.

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 financial 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 Financial Futures Contracts. A financial futures contract is
an agreement between two parties to buy and sell a security, or in the case of
an index-based financial futures contract, to make and accept a cash settlement
for a set price on a future date. A majority of transactions in financial
futures

10
<PAGE>

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. Financial futures contracts have been
designed by boards of trade which have been designated "contracts markets" by
the Commodity Futures Trading Commission (the "CFTC").

The purchase or sale of a financial 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 financial 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 financial futures
contract fluctuates making the long and short positions in the financial
futures contract more or less valuable, a process known as "mark to market". At
any time prior to the settlement date of the financial futures contract, the
position may be closed out by taking an opposite position which will operate to
terminate the position in the financial 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 (the "CBT") and
The Bond Buyer (the "Municipal Bond Index"). The Municipal Bond Index is
comprised of 40 tax-exempt municipal revenue bonds and general obligation
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 financial futures contract is traded only on the
CBT. Like other contract markets, the CBT assures performance under financial
futures contracts through a clearing corporation, a nonprofit organization
managed by the exchange membership which also is 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, U.S. 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 financial 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 financial futures contracts transactions such as financial 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.

11
<PAGE>

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 financial 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 financial 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 financial
futures positions, commissions on financial 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 the standardized contracts
available in the financial 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
financial futures contracts as a hedge against any increase in the cost of such
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 financial 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 financial 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 Financial 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 financial
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
financial 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 financial futures contract or underlying debt securities. Like the purchase
of a financial futures contract, the Fund will purchase a call option on a
financial futures contract to hedge against a market advance when the Fund is
not fully invested.

The writing of a call option on a financial futures contract constitutes a
partial hedge against declining prices of the securities which are deliverable
upon exercise of the financial 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 Financial Futures Contracts. The purchase of options on a
financial futures contract is analogous to the purchase of protective put
options on portfolio securities. The Fund will purchase put options on
financial futures contracts to hedge the Fund's portfolio against the risk of
rising interest rates.

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<PAGE>

The writing of a put option on a financial futures contract constitutes a
partial hedge against increasing prices of the securities which are deliverable
upon exercise of the financial 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 financial futures contract is required to
deposit initial and variation margin pursuant to requirements similar to those
applicable to financial futures contracts. Premiums received from the writing
of an option will be included in initial margin. The writing of an option on a
financial futures contract involves risks similar to those relating to
financial 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 strategy of investing in
financial 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 financial futures contract may be a "senior security" under
the 1940 Act.

Restrictions on Use of Financial 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
financial 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 financial futures contracts or a call option with
respect thereto or writes a put option on a financial 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 Financial Futures Transactions and Options. Investment in
financial futures contracts involves the risk of imperfect correlation between
movements in the price of the financial 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 financial futures contract moves
more than the price of the hedged security, the Fund will experience either a
loss or gain on the financial futures contract which is not offset completely
by movements in the price of the hedged securities. To compensate for imperfect
correlations, the Fund may purchase or sell financial 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 financial
futures contracts. Conversely, the Fund may purchase or sell fewer financial
futures contracts if the volatility of the price of the hedged securities is
historically less than that of the financial futures contracts.

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<PAGE>

The particular municipal bonds comprising the index underlying the Municipal
Bond Index financial futures contract 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 financial 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 movements in the prices of such financial 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 financial 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 financial 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 financial futures position only if, in the judgment of
the Manager, there appears to be an actively traded secondary market for such
financial 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 financial 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 financial futures contracts can
result in substantial unrealized gains or losses. Because the Fund will engage
in the purchase and sale of financial 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
financial 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 financial futures contract also entails the risk
that changes in the value of the underlying futures contract will not be
reflected fully in the value of the option purchased.

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<PAGE>

Municipal Bond Index financial futures contracts have only recently been
approved for trading and therefore have little trading history. It is possible
that trading in such financial futures contracts will be less liquid than that
in other financial futures contracts. The trading of financial 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

Current Investment Restrictions. The Trust has adopted a number of
restrictions and policies relating to the investment of its assets and its
activities, which are fundamental policies and may not be changed without the
approval of the holders of a majority of the Fund's outstanding voting
securities (which for this 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) purchase any securities other than securities referred to under
"Investment Objective and Policies" herein and in the Prospectus and under
"Description of Municipal Bonds and Temporary Investments" herein;

(2) invest more than 25% of its total assets (taken at market value at
the time of each investment) in securities of issuers in any single
industry provided that, for purposes of this restriction, the U.S.
Government, U.S. Government Agencies, states, municipalities and their
political subdivisions are not considered to be part of any industry;

(3) invest more than 10% of its total assets (taken at market value at
the time of each investment) in industrial revenue bonds where the entity
supplying the revenues from which the issuer is to be paid, and the
guarantor of the obligation, including predecessors, each have a record of
less than three years of continuous business operation;

(4) make investments for the purpose of exercising control or management;

(5) purchase securities of other investment companies, except in
connection with a merger, consolidation, acquisition or reorganization and
provided further that the Fund may purchase securities of closed-end
investment companies if immediately thereafter not more than (i) 3% of the
total outstanding voting stock of such company is owned by the Fund, (ii)
5% of the Fund's total assets, taken at market value, would be invested in
any one such company, or (iii) 10% of the Fund's total assets, taken at
market value, would be invested in such securities;

(6) purchase or sell real estate or real estate limited partnership
interests (provided that such restriction shall not apply to securities
secured by real estate or interests therein or issued by companies, other
than such partnerships, which invest in real estate or interests therein),
commodities or commodity contracts (except that the Fund may purchase and
sell financial futures contracts), interests in oil, gas or other mineral
leases or exploration or development programs;

(7) purchase any securities on margin, except for use of short-term
credit necessary for clearance of purchases and sales of portfolio
securities (the deposit or payment by the Fund of initial or variation
margin in connection with financial futures contracts is not considered the
purchase of a security on margin);

15
<PAGE>

(8) make short sales of securities or maintain a short position or invest
in put, call, straddle or spread options (this restriction does not apply
to options on financial futures contracts);

(9) make loans to other persons, provided that the Fund may purchase a
portion of an issue of tax-exempt securities (the acquisition of a portion
of an issue of tax-exempt securities or bonds, debentures or other debt
securities which are not publicly distributed is considered to be the
making of a loan under the 1940 Act) and provided further that investments
in repurchase agreements and purchase and sale contracts shall not be
deemed to be the making of a loan;

(10) 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 [Usually only
"leveraged" investment companies may borrow in excess of 5% of their
assets; however, the Fund will not borrow to increase income but only to
meet redemption requests which might otherwise require untimely disposition
of portfolio securities. The Fund will not purchase securities while
borrowings are outstanding. Interest paid on such borrowings will reduce
net income];

(11) mortgage, pledge, hypothecate or in any manner transfer as security
for indebtedness any securities owned or held by the Fund except as may be
necessary in connection with borrowings mentioned in (10) above, and then
such mortgaging, pledging or hypothecating may not exceed 10% of its total
assets, taken at market value, or except as may be necessary in connection
with transactions in financial futures contracts;

(12) invest in securities which cannot be readily resold because of legal
or contractual restrictions or which are not readily marketable, or in
individually negotiated loans that constitute illiquid investments and
illiquid lease obligations, or in repurchase agreements maturing in more
than seven days, if, regarding all such securities, more than 15% of its
total assets (taken at market value), would be invested in such securities;
and

(13) act as an underwriter of securities, except to the extent that the
Fund may technically be deemed an underwriter when engaged in the
activities described in (12) above or insofar as the Fund may be deemed an
underwriter under the Securities Act of 1933, as amended, in selling
portfolio securities.

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
California 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 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.

Proposed Uniform Investment Restrictions. As discussed in the Prospectus
under "Investment Objective and Policies--Investment Restrictions", the Board
of Trustees of the Trust has approved the replacement of the Fund's existing
investment restrictions with the fundamental and non-fundamental investment
restrictions

16
<PAGE>

set forth below. These uniform investment restrictions have been proposed for
adoption by all of the non-money market mutual funds advised by the Manager or
its affiliate, Merrill Lynch Asset Management, L.P. ("MLAM"). The investment
objective and policies of the Fund will be unaffected by the adoption of the
proposed investment restrictions.

Shareholders of the Fund are currently considering whether to approve the
proposed revised investment restrictions. If such shareholder approval is
obtained, the Fund's current investment restrictions will be replaced by the
proposed restrictions, and the Fund's Prospectus and Statement of Additional
Information will be supplemented to reflect such change.

Under the proposed fundamental investment restrictions, the Fund may not:

1. Invest more than 25% of its assets, taken at market value, in the
securities of issuers in any particular industry (excluding the U.S.
Government and its agencies and instrumentalities).

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 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.

17
<PAGE>

Under the proposed 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".

c. Invest in securities that cannot be readily resold because of legal or
contractual restrictions or that 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 net assets; included within such limitation, but not to exceed
2% of the Fund's net assets, are warrants which are not listed on the New
York Stock Exchange or the 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 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 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 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 such as the redemption of
Fund shares. In addition, the Fund will not purchase securities while
borrowings are outstanding.

18
<PAGE>

Because of the affiliation of Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("Merrill Lynch") with the Trust, the Fund is prohibited from
engaging in certain transactions involving such firm or its affiliates except
for brokerage transactions permitted under the 1940 Act involving only usual
and customary commissions or transactions pursuant to an exemptive order under
the 1940 Act. Included among such restricted transactions will be 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

The Trustees and executive officers of the Trust and their principal
occupations for at least the last five years are 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--President and Trustee(1)(2)--President (which term, as used
herein, includes the Manager's corporate predecessors) and Chief Investment
Officer the Manager since 1977; President of MLAM (which term, as used herein,
includes MLAM's corporate predecessors) since 1977 and Director and Chief
Investment Officer since 1976; 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. (the "Distributor").

Kenneth S. Axelson--Trustee(2)--75 Jameson Point Road, Rockland, Maine 04841.
Executive Vice President and Director, J.C. Penney Company, Inc. until 1982;
Director, UNUM Corporation, Protection Mutual Insurance Company, Zurn
Industries, Inc. and, until 1992, of Central Maine Power Company and Key Trust
Company of Maine and, until 1994 of Grumman Corporation; Trustee, The Chicago
Dock and Canal Trust.

Herbert I. London--Trustee(2)--New York University--113-115 University Place,
9th Floor, New York, New York 10003. Dean, Gallatin Division of New York
University from 1978 to 1993 and Director from 1975 to 1976; John M. Olin
Professor of Humanities, New York University since 1993 and Professor thereof
since 1973; Distinguished Fellow, Herman Kahn Chair, Hudson Institute from 1984
to 1985; Director, Damon Corporation since 1991; Overseer, Center for Naval
Analyses.

Robert R. Martin--Trustee(2)--513 Grand Hill, St. Paul, Minnesota 55102.
Chairman, WTC Industries, Inc. since 1994; Chairman and Chief Executive
Officer, Kinnard Investments, Inc. from 1990 to 1993; Executive Vice President,
Dain Bosworth from 1974 to 1989; 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--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

19
<PAGE>

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--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 Teknekron Software Systems since
1994.

Terry K. Glenn--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 the Distributor since 1986 and
Director thereof since 1991.

Vincent R. Giordano--Vice President and Portfolio Manager(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--Vice President and Portfolio Manager(1)(2)--Vice President
of the Manager and MLAM since 1984.

Donald C. Burke--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--Treasurer(1)(2)--Senior Vice President and Treasurer of
the Manager and MLAM since 1984; Treasurer of MLFD since 1984 and Vice
President since 1981; Senior Vice President and Treasurer of Princeton
Services since 1993.

Jerry Weiss--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 October 1, 1994, 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.

The Trust pays each Trustee not affiliated with the Manager a fee of $5,000
per year plus $500 per meeting attended, together with such Trustee's actual
out-of-pocket expenses relating to attendance at meetings. The Trust also pays
members of its Audit Committee, which consists of all the non- affiliated
Trustees a fee of $1,000 per year plus $250 per meeting attended. For the
fiscal year ended August 31, 1994, fees and expenses paid to the non-
affiliated Trustees aggregated $4,548.

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.

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<PAGE>

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 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 portion of the
average daily net assets not exceeding $500 million; 0.525% of portion of the
average daily net assets exceeding $500 million but not exceeding $1.0 billion;
and 0.50% of the portion of the average daily net assets exceeding $1.0
billion. For the fiscal year ended August 31, 1994, the total advisory fees
payable by the Fund to the Manager aggregated $509,552, all of which was
voluntarily waived.

California imposes limitations on the expenses of the Fund. These annual
expense limitations require that the Manager reimburse the Fund in an amount
necessary to prevent the aggregate ordinary operating expenses (excluding
taxes, brokerage fees and commissions, distribution fees and extraordinary
charges such as litigation costs) from exceeding in any fiscal year 2.5% of the
Fund's first $30,000,000 of average net assets, 2.0% of the next $70,000,000 of
average net assets and 1.5% of the remaining average net assets. The Manager's
obligation to reimburse the Fund is limited to the amount of the management
fee. Expenses not covered by this limitation are interest, taxes, brokerage
commissions and other items such as extraordinary legal expenses. No fee
payment will be made to the Manager during any fiscal year which will cause
such expenses to exceed expense limitations at the time of such payment. No fee
reimbursements were made during the fiscal year ended August 31, 1994 pursuant
to these operating expense limitations.

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 the Manager or any of its
subsidiaries. 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 as additional Series are added to the Trust, the
organizational expenses are allocated among the Series (including the Fund) in
a manner deemed equitable

21
<PAGE>

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
fiscal year ended August 31, 1994, the Fund reimbursed the Manager $39,696 for
accounting services. Certain expenses in connection with account maintenance
and the distribution of shares will be financed by the Fund pursuant to the
Distribution Plans in compliance with Rule 12b-1 under the 1940 Act. See
"Purchase of Shares--Deferred Sales Charge Alternatives--Class B and Class C
Shares--Distribution Plan".

The Manager is a limited partnership, the partners of which are ML & Co.,
Fund Asset Management, Inc., and Princeton Services.

Duration and Termination. Unless earlier terminated as described below, 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.

ALTERNATIVE SALES ARRANGEMENTS

The Fund issues four classes of shares under the Merrill Lynch Select
PricingSM 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 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.
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 the Manager or its affiliate, FAM. Funds advised by the
Manager or FAM are referred to herein as "MLAM-advised mutual funds".

The Fund has entered into 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

22
<PAGE>

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
February 26, 1993 (commencement of operations) to August 31, 1993 were
$321,978, of which the Distributor received $5,699 and Merrill Lynch received
$316,279. The gross sales charges for the sale of Class A shares for the fiscal
year ended August 31, 1994 were $23,814 of which the Distributor received
$2,428 and Merrill Lynch received $21,386.

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 or her spouse and their children
under the age of 21 years purchasing shares for his or her 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.

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 other MLAM-advised mutual funds. 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,
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 thirteen-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 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

23
<PAGE>

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 thirteen-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 during the term of such Letter, a purchase
brings the total amount invested to an amount equal to or in excess of the
amount indicated in the Letter, the purchaser will be entitled on that
purchase and subsequent purchases to the reduced percentage sales charge which
would be applicable to a single purchase equal to the total dollar value of
the Class A or Class D shares then being purchased under such Letter, 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.

TMA SM Managed Trusts. Class A shares are offered to TMA SM Managed Trusts
to which Merrill Lynch Trust Company provides discretionary trustee services
at net asset value plus a reduced sales charge of 0.50% of the offering price,
which is 0.50% of the net amount invested.

Purchase Privilege of Certain Persons. Trustees of the Trust and directors
or trustees of other MLAM-advised mutual funds, directors and employees of 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 any trust,
pension, profit-sharing or other benefit plan for such persons, may purchase
Class A shares of the Fund at net asset value.

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 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 must have been made within 60 days prior to the investment in the
Fund, and the proceeds from the redemption must have 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
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

24
<PAGE>

proceeds from a redemption of shares of such other mutual fund and such fund
was subject to a sales charge either at the time of purchase or on a deferred
basis. Second, such purchase of Class D share 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 such
shares of other mutual funds and that such shares have been outstanding for a
period of no less than six months. 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.

Closed-End Fund Investment Option. Class A shares of the Fund and other MLAM-
advised mutual funds (the "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 and fund shares prior to October 21, 1994
and wish to reinvest the net proceeds of a sale of their closed-end fund shares
of common stock 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 buy 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 of common stock 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. Eligible 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 at such day.

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 public or private investment company. The value of 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

25
<PAGE>

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.

Payments of the account maintenance fees 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
fees 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 the 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 the 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. (the "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 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

26
<PAGE>

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 August 31, 1994
with respect to the Class B shares of the Fund indicating the maximum
allowable payments that can be made under the NASD maximum sales charge rule
and the Distributor's voluntary maximum for the period February 26, 1993
(commencement of the public offering of Class B shares) to August 31, 1994.
Since Class C shares of the Fund had not been publicly issued prior to the
date of this Statement of Additional Information, information concerning Class
C shares is not yet provided below.

<TABLE>
<CAPTION>
DATA CALCULATED AS OF AUGUST 31, 1994
---------------------------------------------------------------------------------
(IN THOUSANDS)
ANNUAL
DISTRIBUTION
ALLOWABLE AMOUNTS FEE AT
AGGREGATE INTEREST MAXIMUM PREVIOUSLY AGGREGATE CURRENT
ELIGIBLE 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>
Under NASD Rule
as Adopted............. $82,841 $5,178 $493 $5,671 $467 $5,203 $187
Under Distributor's
Voluntary Waiver....... $82,841 $5,178 $414 $5,592 $467 $5,124 $187
</TABLE>
- --------
(1) Purchase price of all eligible Class B shares sold since February 26, 1993
(commencement of the public offering of Class B 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. Of the
distribution fee payments made prior to July 6, 1993 under a prior plan at
the 1.0% rate, 0.75% of average daily net assets has been treated as a
distribution fee and 0.25% of average daily net assets has been deemed to
have been a service fee and not subject to the NASD maximum sales charge
rule. See "Purchase of Shares-- Distribution Plans" in the Prospectus.
(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 or the NASD
maximum.

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

27
<PAGE>

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 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 redemption following the death or disability (as
defined in the Internal Revenue Code of 1986, as amended (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 fiscal year ended
August 31, 1994, the Distributor received CDSCs of $177,779, all of which was
paid to Merrill Lynch.

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 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 February 26, 1993
(commencement of operations) through August 31, 1993, the Fund engaged in no
transactions pursuant to such order. During the year ended August 31, 1994, the
Fund engaged in no transactions pursuant to such order. 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
Trustee will reconsider this matter from time to time.

Under the 1940 Act, the Fund may not purchase securities during the existence
of 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

28
<PAGE>

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 National Association of Securities Dealers,
Inc. 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 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 rate for the period February 26, 1993
(commencement of operations) through August 31, 1993 was 74.26% and for the
fiscal year ended August 31, 1994 was 93.04%.

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 the Fund is determined by the Manager once daily,
Monday through Friday, as of 4:15 P.M., New York City 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 net asset
value per share of the Class A shares and the net asset value per share of the
Class B shares are expected to be equivalent. Under certain circumstances,
however, the per share net asset value of the Class B, Class C and Class D
shares may be lower than the per share net asset value of the

29
<PAGE>

Class A shares reflecting the daily expense accruals of the account
maintenance and distribution fees (and incremental transfer agency costs)
applicable with respect to the Class B and Class C shares and the daily
expense accruals of the account maintenance fees applicable with respect to
the Class D shares; moreover, the per share net asset value of the Class B and
Class C shares generally will be lower than the per share net asset value of
its Class D shares, reflecting the daily expense accounts of the distribution
fees and higher transfer agency fees applicable with respect to the Class B
and Class C shares of the Fund. Even under those circumstances, the per share
net asset value of the four classes will tend to converge immediately after
the payment of dividends, which will differ by approximately the amount of the
expense accrual differential 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-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. The statements will serve as transaction confirmations for
automatic investment purchases and the reinvestment of taxable ordinary income
dividends, tax-exempt income and long-term capital gains distributions. The
statements also will show any other activity in the account since the
preceding statement. Shareholders will receive separate transaction
confirmations for each purchase or sale transaction other than automatic
investment purchase, and the reinvestment of taxable ordinary income
dividends, tax-exempt income and long-term capital gains distributions.
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 (paying any applicable CDSC) 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

30
<PAGE>

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 at the Transfer Agent. 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 the 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.

AUTOMATIC INVESTMENT PLANS

A shareholder may make additions to an Investment Account at any time by
purchasing Class A shares (if 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 through a service known as the
Automatic Investment Plan whereby the Fund is authorized through pre-authorized
checks 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. Alternatively, investors who maintain CMA(R) accounts may
arrange to have periodic investments made in the Fund in their CMA(R) accounts
or in certain related accounts in amounts of $100 or more through the CMA(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.

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 or 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 or her Class A or
Class D shares. Redemptions will be made at net asset value as determined at
the normal close of business on the New York Stock Exchange (currently 4:00
P.M., New York City time) on the 24th day of each month or the 24th day of the
last month of each quarter, whichever is applicable. If the New York Stock
Exchange is not

31
<PAGE>

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 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.

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 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 redemption 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
Systematic Redemption Program is not available if Fund shares are being
purchased within the account pursuant to the Automatic Investment Program. For
more information on the Systematic Redemption Program, eligible shareholders
should contact their Merrill Lynch 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 PricingSM 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 or her
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, but 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 will be 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

32
<PAGE>

described below. Class A, Class B, Class C and Class D shares also will be
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.

Exchanges of Class A or Class D shares outstanding ("outstanding Class A or
Class D shares") for Class A or Class D shares of another 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 shares, 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 or Class D shares acquired through dividend reinvestment
will be exchanged into the Class A or Class D shares of the other funds or into
shares of the Class A or 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 or Class C shares") offers to exchange its outstanding
Class B or Class C shares for Class B or Class C shares, respectively, (""new
Class B shares'') of another MLAM-advised mutual fund 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
deferred sales charge 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
CDSC schedule if such schedule is higher than the deferred sales charge
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 shares, the holding period for the outstanding
Class B shares is "tacked" to the holding period of the new Class B shares. For
example, an investor may exchange Class B shares of the Fund for those of
Merrill Lynch Global Resources Trust after having held the Fund's Class B
shares for two and a half years. The 2% sales load 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 Merrill Lynch Global Resources Trust
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 Merrill Lynch Global Resources Trust
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 a money
market fund advised by the Manager or its affiliates, but the period of time
that Class B or Class C shares are held in a 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 the money market fund which were acquired
as a result of an exchange for Class B or Class C shares of the Fund may,

33
<PAGE>

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. Thus, for example, an investor may exchange
Class B shares of the Fund for shares of Merrill Lynch Institutional Fund after
having held the Merrill Lynch Global Resources Trust 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 Merrill Lynch 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 continued 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:

<TABLE>
<S> <C>
Merrill Lynch Adjustable Rate
Securities Fund, Inc. .......... High current income, consistent with a policy
of limiting the degree of fluctuation in net
asset value, by investing 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, consistent
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 surrounding 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 portfolio
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.
</TABLE>

34
<PAGE>

<TABLE>
<S> <C>
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, High total investment return, consistent with
Inc. .......................... prudent risk, from investment in United
States and foreign equity, debt and money
market securities the combination of which
will be varied both with respect to types of
securities and markets in response to
changing market and economic trends.
Merrill Lynch Asset Income Fund, A high level of current income through
Inc. .......................... investment primarily in United States fixed
income securities.
Merrill Lynch Balanced Fund for
Investment and Retirement...... As high a level of total investment return as
is consistent with reasonable risk by
investing in common stock and other types of
securities, including fixed income
securities and convertible securities.
Merrill Lynch Basic Value Fund, Capital appreciation and, secondarily, income
Inc. .......................... through investment in securities, primarily
equities, that are undervalued and therefore
represent basic investment value.
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 portfolio
primarily of intermediate-term investment
grade California Municipal Bonds.
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.
</TABLE>

35
<PAGE>

<TABLE>
<S> <C>
Merrill Lynch Capital Fund, The highest total investment return
Inc. .......................... consistent with prudent risk through a fully
managed investment policy utilizing equity,
debt and convertible securities.
Merrill Lynch Colorado
Municipal Bond Fund ........... A portfolio of Merrill Lynch Multi-State
Municipal Series, 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
Municipal Series Trust, a series fund, whose
objective is to provide as high a level of
income exempt from Federal and Connecticut
income taxes as is consistent with prudent
investment management.
Merrill Lynch Corporate
Bond Fund, Inc. ............... Current income from three separate
diversified portfolios of fixed income
securities.
Merrill Lynch Developing Capital
Markets Fund, Inc. ............ Long-term appreciation through investment in
securities, principally equities, of issuers
in countries having smaller capital markets.
Merrill Lynch Dragon Fund, Capital appreciation primarily through
Inc. .......................... investment in equity and debt securities of
issuers domiciled in developing countries
located in Asia and the Pacific Basin.
Merrill Lynch EuroFund.......... Capital appreciation primarily through
investment in equity securities of
corporations domiciled in Europe.
Merrill Lynch Federal Securities High current return through investment in
Trust.......................... U.S. Government and Government agency
securities, including GNMA mortgage-backed
certificates and other mortgage-backed
Government securities.
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 consistent with
prudent investment management while seeking
to offer shareholders the opportunity to own
securities exempt from Florida intangible
personal property taxes through investment
in a portfolio primarily of intermediate-
term investment grade Florida Municipal
Bonds.
</TABLE>

36
<PAGE>

<TABLE>
<S> <C>
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 income taxes as
is consistent with prudent investment
management while seeking to offer
shareholders the opportunity to own
securities exempt from Florida intangible
personal property taxes.
Merrill Lynch Fund For Tomorrow, Long-term growth through investment in a
Inc. ........................... portfolio of good quality securities,
primarily common stock, potentially
positioned to benefit from demographic and
cultural changes as they affect consumer
markets.
Merrill Lynch Fundamental
Growth Fund, Inc. .............. Long-term growth of capital through
investment in a diversified portfolio of
equity securities placing particular
emphasis on companies that have exhibited an
above-average growth rates in earnings.
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 investment
in a global portfolio of debt instruments
denominated in various currencies and multi-
national currency units.
Merrill Lynch Global
Convertible Fund, Inc. ........ High total return from investment primarily
in an internationally 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 The highest total investment return
investor suitability standards). consistent with prudent risk through
worldwide investment in an internationally
diversified portfolio of securities.
</TABLE>

37
<PAGE>

<TABLE>
<S> <C>
Merrill Lynch Global Resources Long-term growth and protection of capital
Trust........................... from investment in securities of foreign and
domestic companies that possess substantial
natural resource assets.
Merrill Lynch Global
SmallCap Fund, Inc. ........... Long-term growth of capital by investing
primarily in equity securities of companies
with relatively small market capitalizations
located in various foreign countries and in
the United States.
Merrill Lynch Global Utility Capital appreciation and current income
Fund, Inc. .................... through investment of at least 65% of its
total assets in equity and debt securities
issued by domestic and foreign companies
that are primarily engaged in the ownership
or operation of facilities used to generate,
transmit or distribute electricity, telecom-
munications, gas or water.
Merrill Lynch Growth Fund for
Investment and Retirement....... Growth of capital and, secondarily, income
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 Capital appreciation through worldwide
standards)...................... investment in equity securities of companies
that derive or are expected to derive 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, Capital appreciation by investing primarily
Inc. ........................... 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.
</TABLE>

38
<PAGE>

<TABLE>
<S> <C>
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 investment
management through investment in a portfolio
primarily of intermediate-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 consistent 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 portfolio
primarily of intermediate-term investment
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
income taxes as is consistent with prudent
investment management.
Merrill Lynch Municipal Bond
Fund, Inc. ..................... Tax-exempt income from three separate
</TABLE> diversified portfolios of municipal bonds.

39
<PAGE>

<TABLE>
<S> <C>
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 exempt from Federal
income taxes by investing 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 a portfolio primarily of
intermediate-term investment 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 primarily of intermediate-term
investment grade New York Municipal Bonds.
</TABLE>

40
<PAGE>

<TABLE>
<S> <C>
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 investment
management.
Merrill Lynch North Carolina
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 North
Carolina income taxes as is consistent with
prudent investment management.
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 equity
securities of corporations domiciled 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 investment
management through investment in a portfolio
of intermediate-term investment grade
Pennsylvania Municipal Bonds.
</TABLE>

41
<PAGE>

<TABLE>
<S> <C>
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
income taxes as is consistent with prudent
investment management.
Merrill Lynch Phoenix Fund, Inc.
................................ Long-term growth of capital by investing in
equity and fixed income securities,
including tax-exempt securities, of issuers
in weak financial condition or experiencing
poor operating results believed to be
undervalued relative to the current or
prospective condition of such issuer.
Merrill Lynch Short-Term
Global Income Fund, Inc......... As high a level of current income as is
consistent with prudent investment
management from a global portfolio of high
quality debt securities denominated in
various currencies and multi-national
currency units and having remaining
maturities not exceeding three years.
Merrill Lynch Special Value Fund,
Inc. ........................... Long-term growth of capital from investment
in securities, primarily common stock, of
relatively small companies believed to have
special investment value and emerging growth
companies regardless of size.
Merrill Lynch Strategic Dividend Long-term total return from investment in
Fund............................ dividend paying common stocks that yield
more than Standard & Poor's 500 Composite
Stock Price Index.
Merrill Lynch Technology Fund,
Inc. ........................... Capital appreciation through worldwide
investment in equity securities of companies
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 income taxes as
is consistent with prudent investment
management by investing primarily in a
portfolio of long-term, investment grade
obligations issued by the State of Texas,
its political subdivisions, agencies and
instrumentalities.
</TABLE>

42
<PAGE>

<TABLE>
<S> <C>
Merrill Lynch Utility Income
Fund, Inc. ..................... High current income through investment in
equity and debt securities issued by
companies that 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 securities
denominated in various currencies, including
multinational currencies.
Class A Share Money Market Funds:
Merrill Lynch Ready Assets Trust. Preservation of capital, liquidity and the
highest possible current income consistent
with the foregoing objectives from the
short-term money market securities in which
the Trust invests.
Merrill Lynch Retirement Reserves
Money Fund (available only for
exchanges 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 investment 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. Government and
repurchase agreements relating to such
securities.
Merrill Lynch U.S. Treasury Money
Fund............................ Preservation of capital, liquidity and
current income through investment
exclusively in a diversified portfolio of
short-term marketable securities which are
direct obligations of the U.S. Treasury.

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 security 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.
</TABLE>

43
<PAGE>

<TABLE>
<S> <C>
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 investment in a diversified
portfolio of short-term, high quality
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 security 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.
</TABLE>

Before effecting an exchange, shareholders should obtain a currently
effective prospectus of the fund into which the exchange is to be made.
Exercise of the exchange privilege is treated as a sale for Federal income tax
purposes and, depending on the circumstances, a short-or long-term capital gain
or loss may be realized. In addition, a shareholder exchanging shares of any of
the funds may be subject to a backup withholding tax unless such shareholder
certifies under penalty of perjury that the taxpayer identification number on
file with any such fund is correct and that he is not otherwise subject to
backup withholding. See "Distributions and Taxes" below.

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" as such term is defined in Rule 17Ad-15 under
the Securities and 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.

44
<PAGE>

DISTRIBUTIONS AND TAXES

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 will be
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 the
Fund's 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 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 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 or California personal income tax purposes to the extent
attributable to exempt interest dividends. Shareholders are advised to consult
their tax advisers with respect to whether exempt-interest dividends retain

45
<PAGE>

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 for California Municipal Bonds also will be exempt from
California personal income taxes if, at the close of each quarter of the Fund's
taxable year, at least 50% of the value of the Fund's total assets consists of
California Municipal Bonds. The Trust intends to invest at least 50% of the
Fund's assets in California Municipal Bonds at all times. Shareholders subject
to income tax in states other than California will realize a lower after-tax
rate of return than California shareholders since the dividends distributed by
the Fund generally will not be exempt, to any significant degree, from 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 which portion is exempt from California income taxes. The Fund will
allocate exempt-interest dividends among Class A, Class B, Class C and Class D
shareholders for California income tax purposes based on a method similar to
that described above for Federal income tax purposes.

Distributions from investment income and capital gains of the Fund including
exempt-interest dividends may be subject to California franchise tax if
received by a corporate shareholder subject to such tax and may also be subject
to tax in states other than California and local taxes in cities other than
those in California. Accordingly, investors in the Fund, including, in
particular, corporate investors which may be subject to the California
corporate franchise tax, should consult their tax advisers with respect to the
application of such taxes as to an investment in the Fund, the receipt of Fund
dividends and as to their California tax situation in general.

To the extent that the Fund's distributions are derived from interest on its
taxable investments 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 California income tax purposes. Such
distributions are not eligible for the dividends received deduction for
corporations. Distributions, if any, of net long-term capital gains 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 and, for California income tax purposes, will be treated as capital
gains which are taxed at ordinary income tax rates. Under the Revenue
Reconciliation Act of 1993, 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. 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 to the extent of the
amount of such exempt-interest dividends. 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 to such holder (assuming the 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 specific 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 "private activity bonds" issued after August

46
<PAGE>

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.

If a shareholder exercises the exchange privilege within 90 days of acquiring
the shares, then such loss such shareholder can recognize on the exchange will
be reduced (or the gain increased) to the extent the sales charge paid to the
Fund 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 provisions of the Code, some shareholders may be subject to a
31% withholding tax on certain ordinary income dividend 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.

Ordinary income dividends paid by the Fund 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 advisors concerning the applicability of the United
States withholding tax.

47
<PAGE>

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 under the Code (as described
above) may subject corporate shareholders of the Fund to the Environmental Tax.

TAX TREATMENT OF FUTURES AND OPTIONS 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.

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
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.

----------------

The foregoing is a general and abbreviated summary of the applicable
provisions of the Code, Treasury regulations and California 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 California tax laws. The Code and the Treasury regulations, as
well as the California tax laws, are subject to change by legislative or
administrative action either prospectively or retroactively.

48
<PAGE>

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 California) and with specific questions as to Federal, state, local
or foreign taxes.

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.
Total return and 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 and 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.

49
<PAGE>

Set forth below is the total return, yield and tax-equivalent yield
information for Class A and Class B shares of the Fund for the period
indicated. Since Class C and Class D shares have not been issued prior to the
date of this Statement of Additional Information, performance information
concerning Class C and Class D shares is not yet provided.

<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
----------------- ----------------- ----------------- -----------------
AVERAGE ANNUAL TOTAL RETURN (INCLUDING MAXIMUM APPLICABLE SALES CHARGE)
<S> <C> <C> <C> <C>
One Year Ended August
31, 1994............... -5.38% $946.20 -5.66% $943.40
February 26, 1993 (In-
ception) to August 31,
1994................... -0.55% $ 991.70 -0.21% $ 996.80
<CAPTION>
ANNUAL TOTAL RETURN (EXCLUDING MAXIMUM APPLICABLE SALES CHARGE)
<S> <C> <C> <C> <C>
One Year Ended August
31, 1994............... -1.44% $ 985.60 -1.93% $ 980.70
February 26, 1993 (In-
ception) to August 31,
1993................... 4.81% $1,048.10 4.56% $1,045.60
<CAPTION>
AGGREGATE TOTAL RETURN (INCLUDING MAXIMUM APPLICABLE SALES CHARGE)
<S> <C> <C> <C> <C>
February 26, 1993 (In-
ception) to August 31,
1994................... -0.83% $ 991.70 -0.32% $ 996.80
YIELD
30 days ended on August
31, 1994............... 5.61% 5.32%
TAX-EQUIVALENT YIELD*
30 days ended on August
31, 1994............... 7.79% 7.39%
</TABLE>
- --------
* Based on a Federal income tax rate of 28%.

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 or Class C 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
charge or the waiver of sales charges, a lower amount of expenses may be
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 and Merrill
Lynch California 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 interests

50
<PAGE>

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. See "Purchase of Shares". The Trust has
received an order from the Commission permitting the issuance and sale of
multiple classes of shares of beneficial interest. 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.

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 have exclusive
voting rights with respect to matters relating to the 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 will be borne solely by
such class. There normally will be no meeting of shareholders for the purposes
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 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,
objectives 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 $37,435) were paid by the Fund and are amortized
over a period not exceeding five years. The proceeds realized by the Manager
(or any subsequent holder) upon the redemption of any of the shares initially
purchased by it will be reduced by the proportionate amount of any remaining
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.

51
<PAGE>

COMPUTATION OF OFFERING PRICE PER SHARE

An illustration of the computation of the offering price for Class A and
Class B shares of the Fund, based on the value of the Fund's net assets and
number of shares outstanding as of August 31, 1994 is set forth below.
Information is not provided for Class C or Class D shares since no Class C or
Class D shares were publicly offered prior to the date of this Statement of
Additional Information.

<TABLE>
<CAPTION>
AUGUST 31, 1994
-----------------------
CLASS A CLASS B
----------- -----------
<S> <C> <C>
Net Assets............................................. $15,945,665 $74,982,497
=========== ===========
Number of Shares Outstanding........................... 1,671,544 7,859,558
=========== ===========
Net Asset Value Per Share (net assets divided by number
of shares outstanding)................................ $ 9.54 $ 9.54
Sales Charge (for Class A shares: 4.00% of offering
price (4.17% of net asset value per share))*.......... .40 **
----------- -----------
Offering Price......................................... $ 9.94 $ 9.54
=========== ===========
</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. See "Purchase of Shares--Deferred
Sales Charge Alternatives--Class B and Class C Shares" in the Prospectus.

INDEPENDENT AUDITORS

Deloitte & Touche LLP, 117 Campus Drive, Princeton, New Jersey 08540-6400,
has been selected as the independent auditors of the Fund. The selection of
independent auditors is subject to ratification by the shareholders of the
Fund. In addition, the employment of such auditors may be terminated without
any penalty by vote of a majority of the outstanding shares of the Trust at a
meeting called for the purpose of terminating such employment. The independent
auditors are responsible for auditing the annual financial statements of the
Fund.

CUSTODIAN

The Bank of New York, 90 Washington Street 12th Floor, New York, New York
10286, 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

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.

52
<PAGE>

REPORTS TO SHAREHOLDERS

The fiscal year of the Fund ends on August 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 of 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 March 20, 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 California 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" (as defined in the Declaration) 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 1, 1994.

53
<PAGE>

APPENDIX I

ECONOMIC AND OTHER CONDITIONS IN CALIFORNIA

The following information as to certain California considerations is given to
investors in view of the Fund's policy of concentrating its investments in
California issuers. The Fund is therefore susceptible to political, economic,
regulatory or other factors affecting issuers of California municipal
securities. The following information constitutes only a brief summary of a
number of the complex factors which may have an impact on issuers of California
municipal securities and does not purport to be a complete or exhaustive
description of all adverse conditions to which issuers of California municipal
securities may be subject. Additionally, many factors, including national,
economic, social and environmental policies and conditions, which are not
within the control of such issuers, could have an adverse impact on the
financial condition of such issuers. The Fund cannot predict whether or to what
extent such factors or other factors may affect the issuers of California
municipal securities, the market value or marketability of such securities or
the ability of the respective issuers of such securities acquired by the Fund
to pay interest on or principal of such securities. Further, the
creditworthiness of obligations issued by local California issuers may be
unrelated to the creditworthiness of obligations issued by the State of
California. Such information is derived from sources that are generally
available to investors (such as official statements relating to the offerings
of California issuers) and is believed to be accurate. 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.

ECONOMIC CONDITIONS

California's economy is the largest among the 50 states and one of the
largest in the world. Total employment is about 14 million, the majority of
which is in the service, trade and manufacturing sectors.

Since the start of the 1990-91 fiscal year (July 1-June 30), the State of
California (sometimes referred to as the "State") has faced the worst economic,
fiscal and budget conditions since the 1930s. Construction, manufacturing
(especially aerospace), exports and financial services, among others, have all
been severely affected.

Job losses have been the worst of any post-war recession and have continued
through the end of 1993. The State Department of Finance (the "Department of
Finance") projects that non-farm employment levels will be stable in 1994 and
show modest growth in 1995, but pre-recession job levels are not expected to be
reached for several more years. Unemployment is expected to remain well above
the national average through 1994. The Department of Finance foresees slow
recovery from the recession in California beginning in 1994. Both the
California and national economic recoveries are much weaker than in previous
business cycles, and could be harmed by several factors, including rising
interest rates.

California has lost over 850,000 payroll jobs, making this by far the longest
and deepest downturn of the post-World War II era. By contrast, in both the
1969-70 and 1981-82 recessions, the State had recovered its job losses by two
years after the start of the recession.

Major cuts in federal defense spending are now recognized as the main source
of the recession and the largest obstacle to recovery. This year and for the
next several years to come, the principal question in the

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California outlook is when and whether other elements in the State's economy
can muster sufficient strength to overcome the continuing drag of defense cuts.

The State's tax revenue experience clearly reflects sharp declines in
employment, income and retail sales on a scale not seen in over 50 years. The
May 1994 Revision to the 1994-95 Governor's Budget, released May 20, 1994 (the
"May Revision"), assumes the State will start to recover from recessionary
conditions in 1994, with a modest upturn beginning in 1994 and continuing in
1995, a year later than predicted in the May 1993 Department of Finance
economic projection. Pre-recession job levels are not expected to be reached
until 1997. The following are excerpts from the May Revision discussion of
economic conditions.

Nation--Economic recovery is apparently proceeding at a steady pace for the
nation as a whole. The May Revision economic forecast for the United States is
moderately higher, reflecting both improved prospects and upward revisions in
several major data series.

The recovery gained momentum in the last quarter of 1993, with GDP expanding
at a 7 percent rate. This was stronger than assumed for the Budget forecast in
January, 1993. Strength in the recovery has been reflected in car sales,
housing starts, job gains, industrial production and corporate profits.
Business investment in equipment has strengthened beyond that expected for the
Budget forecast. Inflation remains under control, and appears to be coming in
lower than previously forecast.

On the down side, investment in nonresidential structures is coming in weaker
than anticipated. Federal spending for both defense and nondefense programs has
fallen more rapidly than forecast previously, and a surge in imports has
contributed to a large foreign trade deficit. California's Northridge
Earthquake was reflected in national data, although the effect was far smaller
and more temporary for the U.S. than it will be for the State.

The May Revision forecast has incorporated these developments. Gross domestic
product (GDP) for the first quarter 1994 grew at essentially the rate forecast
late last year. For all of 1994, however, real GDP is now expected to grow by
3.6 percent, compared to the 2.8 percent forecast in the Budget. Growth for
1995 is expected to be reduced as concerns mount over the impact of higher
interest rates.

Although assumptions underlying the Budget forecast included rising interest
rates, policy moves by the Federal Reserve in recent weeks have pushed rates up
faster than expected. The mortgage rate is of particular concern. There are
reports that housing activity--resales, refinancings, and new building--is
already slowing down. It will be difficult to keep recovery going if rates edge
higher in coming months.

Another downside risk is the as yet unresolved issue of health care coverage
and costs. Both interest rates and the health care question are critical
factors for job creation. Small businesses, in particular, could be adversely
affected by rising health costs, and it is this sector which creates many of
the new jobs during an economic upturn.

The May Revision shows stronger employment gains in 1994, but renewed
weakness in 1995. Even so, the recovery is still quite moderate by historical
standards, and the unemployment rate--essentially the same as forecast for the
Budget--will remain a concern.

California--There is growing evidence that California is showing signs of an
economic turnaround, and the May Revision forecast is revised up from the
January Budget forecast. Since the January Budget forecast,

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1993 nonfarm employment has been revised upward by 31,000. Employment in the
early months of 1994 has shown encouraging signs of growth, several months
sooner than was contemplated in the January Budget forecast. Between December
and April, payrolls were up by 50,000 jobs. The Northridge Earthquake may have
dampened economic activity briefly during late January and February, but the
rebuilding effects are now adding a small measure of stimulus.

Sectors which are contributing to California's recovery include construction
and related manufacturing, wholesale and retail trade, transportation and
several service industries such as amusements and recreation, business services
and management consulting. Electronics is showing modest growth and the rate of
decline in aerospace manufacturing is slowly diminishing. These trends are
expected to continue, and by next year, much of the restructuring in the
finance and utilities industries should be nearly completed. Thus, the State's
recovery should gain momentum over the next two years.

As a result of these factors, average 1994 nonfarm employment is now forecast
to maintain 1993 levels compared to a projected 0.6 percent decline in the
January budget. 1995 employment is expected to be up 1.6 percent, compared to
0.7 percent in the January budget.

The Northridge Earthquake resulted in a downward revision of this year's
personal income growth--from 4.0 percent in the January Budget to 3.6 percent.
However, this decline is more than explained by the $5.5 billion charge against
rental and proprietors' incomes--equal to 0.8 percent of total income--
reflecting uninsured damage from the quake. Next year, without the quake
effects, incomes grow 6.1 percent, compared to 5 percent in the January Budget.
Without these quake effects, income growth was little changed in the May
Revision compared to the January forecast contained in the Governor's Proposed
Budget.

The housing forecast remains essentially unchanged. Although existing home
sales have strengthened and subdivision surveys indicated increased new home
sales, building permits are up only slightly from recession lows. Gains are
expected in the months ahead, but higher mortgage interest rates will dampen
the upturn. Essentially, the earthquake adds a few thousand units to the
forecast, but this effect is offset by higher interest rates.

Interest rates represent one of several downside risks to the forecast. The
rise in interest rates has occurred more rapidly than contemplated in the
January Budget forecast. In addition to affecting housing, higher rates may
also dampen consumer spending, given the high proportion of California
homeowners with adjustable-rate mortgages. The May Revision forecast includes a
further rise in the Federal Funds rate to nearly 5 percent by the beginning of
1995. Should rates rise more steeply, housing and consumer spending would be
adversely affected.

The employment upturn is still tenuous. The Employment Development Department
revised down February's employment gain and March was revised to a small
decline. Unemployment rates in California have historically been volatile since
January ranging from a high of 10.1 percent to a low of 8.6 percent. The small
sample size coupled with changes made to the survey instrument in January
contribute to this volatility.

The State. The recession has seriously affected State tax revenues, which
basically mirror economic conditions. It has also caused increased expenditures
for health and welfare programs. The State has also been facing a structural
imbalance in its budget with the largest programs supported by the General
Fund--K-12 schools and community colleges, health and welfare, and
corrections--growing at rates higher than the

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growth rates for the principal revenue sources of the General Fund. As a
result, the State has experienced recurring budget deficits. The State
Controller reports that expenditures exceeded revenues for four of the five
fiscal years ending with 1991-92 and were essentially equal in 1992-93. By June
30, 1993, according to the Department of Finance, the State's Special Fund for
Economic Uncertainties had a deficit, on a budget basis, of approximately $2.8
billion. The 1993-94 Budget Act incorporated a Deficit Retirement and Reduction
Plan to repay this deficit over two fiscal years. The original budget for 1993-
94 reflected revenues which exceeded expenditures by approximately $2.0
billion. As a result of the continuing recession, the excess of revenues over
expenditures for the fiscal year is now expected to be only about $500 million.
Thus the accumulated budget deficit at June 30, 1994 is now estimated by the
Department of Finance to be approximately $2.0 billion, and the deficit will
not be retired by June 30, 1995 as planned.

The accumulated budget deficits over the past several years, together with
expenditures for school funding, which have not been reflected in the budget,
and reduction of available internal borrowable funds, have combined to
significantly deplete the State's cash resources to pay its ongoing expenses.
In order to meet its cash needs, the State has had to rely for several years on
a series of external borrowings, including borrowings past the end of a fiscal
year. Such borrowings are expected to continue in the future, provided that the
State may not issue any revenue anticipation notes, reimbursement warrants or
other registered warrants which by their terms are due and payable on or prior
to April 26, 1996, the maturity date of the 1994 Revenue Anticipation Warrants,
other than the Notes and the 1994 Revenue Anticipation Warrants. See "The
Notes", "Cash Management Plan" and "State Indebtedness--Short Term Borrowings".

Administration reports during the course of the 1993-94 Fiscal Year have
indicated that while economic recovery appears to have started in the second
half of the fiscal year, recessionary conditions continued longer than had been
anticipated when the 1993-94 Budget Act was adopted. Overall, revenues for the
1993-94 Fiscal Year were approximately $800 million lower than original
projections, and expenditures were approximately $780 million higher, primarily
because of higher health and welfare caseloads, lower property taxes which
require greater State support for K-14 education to make up the shortfall, and
lower than anticipated federal government payments for immigration-related
costs. The most recent reports, however, in May and June, 1994, indicated that
revenues in the second half of the 1993-94 Fiscal Year have been very close to
the projections made in the Governor's Budget of January 10, 1994, which is
consistent with a slow turnaround in the economy.

During the 1993-94 Fiscal Year, the State implemented the Deficit Retirement
and Reduction Plan, which was part of the 1993-94 Budget Act, by issuing $1.2
billion of revenue anticipation warrants in February 1994 maturing December 21,
1994. This borrowing reduced the cash deficit at the end of the 1993-94 Fiscal
Year. Nevertheless, because of the $1.5 billion variance from the original
Budget Act assumptions, the General Fund ended the Fiscal Year at June 30,
1994, carrying forward an accumulated deficit of approximately $2 billion.

Because of the revenue shortfall and the State's reduced internal borrowable
cash resources, in addition to the $1.2 billion of revenue anticipation
warrants issued as part of the Deficit Retirement and Reduction Plan, the State
issued an additional $2.0 billion of revenue anticipation warrants which were
needed to fund the State's obligations and expenses through the end of the
1993-94 Fiscal Year.

Northridge Earthquake. On January 17, 1994, a major earthquake measuring an
estimated 6.8 on the Richter Scale struck Los Angeles. Significant property
damage to private and public facilities occurred in a

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four-county area including northern Los Angeles County, Ventura County, and
parts of Orange and San Bernardino Counties. These areas were declared as State
and federal disaster areas by January 18. Current estimates of total property
damage (private and public) are in the range of $20 billion, but these
estimates are subject to change.

Despite such damage, on the whole, the vast majority of structures in the
areas, including large manufacturing and commercial buildings and all modern
high-rise offices, survived the earthquake with minimal or no damage,
validating the cumulative effect of strict building codes and thorough
preparation for such an emergency by the State and local agencies.

Damage to State-owned facilities included transportation corridors and
facilities such as Interstate Highways 5 and 10 and State Highways 14, 118 and
210. Most of the major highways (Interstates 5 and 10) have now been reopened.
The campus at California State University--Northridge (very near the epicenter)
suffered an estimated $350 million damage, resulting in temporary closure of
the campus. The campus has reopened on a reduced operating basis using borrowed
facilities elsewhere in the area and many temporary structures. There was also
some damage to University of California at Los Angeles. Overall, except for the
temporary road and bridge closures, and CSU-Northridge, the earthquake did not
and is not expected to significantly affect State government operations.

The President immediately allocated some available disaster funds, and
Congress has approved additional funds for a total of at least $9.5 billion of
federal funds for earthquake relief, including assistance to homeowners and
small businesses, and costs for repair of damaged public facilities. The
Governor has announced that the State's share for transportation projects would
come from existing Department of Transportation funds (thereby delaying other,
non-earthquake related projects), the State's share for certain other costs
(including local school building repairs) would come from reallocating existing
bond funds, and that a proposed program for homeowner and small business aid
supplemental to federal aid would have to be abandoned. Some other costs will
be borrowed from the federal government in a manner similar to that used by the
State of Florida after Hurricane Andrew. Pursuant to Senate Bill 2383,
repayment will have to be addressed in 1995-96 or beyond.

1994-95 Budget Act. The 1994-95 Fiscal Year represents the fourth consecutive
year the Governor and Legislature were faced with a very difficult budget
environment to produce a balanced budget. Many program cuts and budgetary
adjustments have already been made in the last three years. The Governor's
Budget Proposal, as updated in May and June, 1994, recognized that the
accumulated deficit could not be repaid in one year, and proposed a two-year
solution. The budget proposal sets forth revenue and expenditure forecasts and
revenue and expenditure proposals which result in operating surpluses for the
budget for 1994-95, and lead to the elimination of the accumulated budget
deficit, estimated at about $2.0 billion at June 30, 1994, by June 30, 1996.

The 1994-95 Budget Act, signed by the Governor on July 8, 1994, projects
revenues and transfers of $41.9 billion, $2.1 billion higher than revenues in
1993-94. This reflects the Administration's forecast of an improving economy.
Also included in this figure is a projected receipt of about $360 million from
the Federal Government to reimburse the State's cost of incarcerating
undocumented immigrants. The State will not know how much the Federal
Government will actually provide until the Federal Fiscal Year 1995 Budget is
completed, which is expected to be by October, 1994. The Legislature took no
action on a proposal in the

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January Governor's Budget to undertake an expansion of the transfer of certain
programs to counties, which would also have transferred to counties 0.5% of the
State's current sales tax.

The 1994-95 Budget Act contains no tax increases. Under legislation enacted
for the 1993-94 Budget, the renters' tax credit was suspended for two years
(1993 and 1994). A ballot proposition to permanently restore the renters' tax
credit after this year failed at the June, 1994 election. The Legislature
enacted a further one year suspension of the renters' tax credit, for 1995,
saving approximately $390 million in the 1995-96 Fiscal Year. Subsequent to the
enactment of the 1994-95 Budget Act, the State of California's bond rating was
lowered to A by Standard & Poor's Corporation and to A by Fitch Investors
Service, Inc. Moody's Investors Service, Inc. also lowered the State of
California's long-term rating to A1.

Certain issuers of California Municipal Bonds receive subventions from the
State which are eligible to be used to make payments on said Bonds. No
prediction can be made as to what effect continued decreases in subventions may
have on the ability of some issuers to make such payments.

CONSTITUTIONAL AND STATUTORY LIMITATIONS; RECENT INITIATIVES; PENDING
LITIGATION

Article XIIIA of the California Constitution (which resulted from the voter-
approved Proposition 13 in 1978) limits the taxing powers of California public
agencies. Article XIIIA provides that the maximum ad valorem tax on real
property cannot exceed 1% of the "full cash value" of the property, and
effectively prohibits the levying of any other ad valorem property tax for
general purposes. However, on May 3, 1986, Proposition 46, an amendment to
Article XIIIA, was approved by the voters of the State of California, creating
a new exemption under Article XIIIA permitting an increase in ad valorem taxes
on real property in excess of 1% for bonded indebtedness approved by two-thirds
of the voters voting on the proposed indebtedness. "Full cash value" is defined
as "the County Assessor's valuation of real property as shown on the 1975-76
tax bill under "full cash value" or, thereafter, the appraised value of real
property when purchased, newly constructed, or a change in ownership has
occurred after the 1975 assessment". The "full cash value" is subject to annual
adjustment to reflect increases (not to exceed 2%) or decreases in the consumer
price index or comparable local data, or to reflect reductions in property
value caused by damage, destruction or other factors.

Article XIIIB of the California Constitution limits the amount of
appropriations of the State and of local governments to the amount of
appropriations of the entity for the prior year, adjusted for changes in the
cost of living, population and the services that the local government has
financial responsibility for providing. To the extent the revenues of the state
and/or local government exceed its appropriations, the excess revenues must be
rebated to the public either directly or through a tax decrease. Expenditures
for voter-approved debt services are not included in the appropriations limit.

In 1986, California voters approved an initiative statute known as
Proposition 62. This initiative (i) required that any tax for general
governmental purposes imposed by local governments be approved by a majority of
the electorate of the government entity, (ii) required that any special tax
(defined as taxes levied for other than general government purposes) imposed by
a local government entity be approved by a two-thirds vote of the voters within
that jurisdiction, (iii) restricted the use of revenues from a special tax to
the purposes or for the service for which the special tax is imposed, (iv)
prohibited the imposition of ad valorem taxes on real property by local
governmental entities except as permitted by Article XIIIA, (v) prohibited the
imposition of transaction taxes and sales taxes on the sale of real property by
local governments,

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(vi) required that any tax imposed by a local government on or after August 1,
1985 be ratified by a majority vote of the electorate within two years of the
adoption of the initiative or be terminated by November 15, 1988, (vii)
required that, in the event a local government fails to comply with the
provisions of this measure, a reduction in the amount of property tax revenues
allocated to such local government occur in an amount equal to the revenues
received by such entity attributable to the tax levied in violation of the
initiative, and (viii) permitted those provisions to be amended exclusively by
the voters of the State of California. While several recent decisions of the
California Courts of Appeal have held that all or portions of Proposition 62
are unconstitutional, the California Supreme Court has yet to consider the
matter.

At the November 9, 1988 general election, California voters approved an
initiative known as Proposition 98. This initiative amends Article XIIIB to
require that (i) the California Legislature establish a prudent state reserve
fund in an amount as it shall deem reasonable and necessary and (ii) revenues
in excess of amounts permitted to be spent and which would otherwise be
returned pursuant to Article XIIIB by revision of tax rates or fee schedules,
be transferred and allocated (up to a maximum of 40%) to the State School Fund
and be expended solely for purposes of instructional improvement and
accountability. Proposition 98 also amends Article XVI to require that the
State of California provide a minimum level of funding for public schools and
community colleges. Commencing with the 1988-89 fiscal year, money to be
applied by the State for the support of school districts and community college
districts shall not be less than the greater of: (i) the amount which, as a
percentage of the State general fund revenues which may be appropriated
pursuant to Article XIIIB, equals the percentage of such State general fund
revenues appropriated for school districts and community college districts,
respectively, in fiscal year 1986-87 or (ii) the amount required to ensure that
the total allocations to school districts and community college districts from
the State general fund proceeds of taxes appropriated pursuant to Article XIIIB
and allocated local proceeds of taxes shall not be less than the total amount
from these sources in the prior year, adjusted for increases in enrollment and
adjusted for changes in the costs of living pursuant to the provisions of
Article XIIIB. The initiative permits the enactment of legislation, by a two-
thirds vote, to suspend the minimum funding requirement for one year. As a
result of Proposition 98, funds that the State might otherwise make available
to its political subdivisions may be allocated instead to satisfy such minimum
funding level.

On November 3, 1992, voters approved an initiative statute, Proposition 163,
which exempts certain food products, including candy and other snack foods,
from California's sales tax. The sales tax had been broadened to include those
items as part of the 1991-92 budget legislation.

Article XIIIA, Article XIIIB and a number of propositions were adopted
pursuant to California's constitutional initiative process. From time to time,
other initiative measures could be adopted by California voters. The adoption
of any such initiatives may cause California issuers to receive reduced
revenues, or to increase expenditures, or both.

Recent Initiatives. In July 1991, California increased taxes by adding two
new marginal tax rates, at 10% and 11%, effective for tax years 1991 through
1995. After 1995, the maximum personal income tax rate is scheduled to return
to 9.3%, and the alternative minimum tax rate is scheduled to drop from 8.5% to
7%. In addition, legislation in July 1991 raised the sales tax by 1.25%, of
which 0.5% was a permanent addition. This tax increase will be cancelled if a
court rules that such tax increase violates any constitutional requirements.
Although 0.5% of the State tax rate was scheduled to expire on June 30, 1993,
such amount was extended for six months for the benefit of counties and cities.
On November 2, 1993, voters approved extension of this 0.5% levy as a permanent
source of funding for local government.

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The November 2, 1993 special election ballot also contained an initiative
constitutional amendment providing parental choice regarding education. This
initiative would have required to state to allocate every school-age child a
scholarship in an amount equal to at least 50% of the prior year's per-pupil
State and local government expenditure for kindergarten through twelfth grade
education. Such scholarships would have been redeemable by public or private
schools. If passed, the parental choice initiative could have threatened the
fiscal stability of any school district in which a significant number of
students withdraw and enroll elsewhere. Although the initiative failed, other
parental choice initiatives have already been filed in an attempt to qualify
them for future voter consideration.

Pending Litigation. On June 20, 1994, the United States Supreme Court, in two
companion cases, upheld the validity of California's prior method of taxing
multinational corporations under a "unitary" method of accounting for their
worldwide earnings. Barclays Bank PLC v. Franchise Tax Board concerned foreign
corporations, and Colgate-Palmolive v. Franchise Tax Board concerned domestic
corporations.

In the spring of 1991, the Richmond Unified School District ("RUSD") Board of
Directors attempted to end classes six weeks early because of a fiscal crisis.
In response to lawsuits, a lower court judge, in a case called Butt v. State of
California, ordered the State, over objections from the Governor, to provide
funding to allow the school year to be completed, and an emergency loan was
arranged by the State Controller. On appeal, the California Supreme Court in
late December, 1992 upheld the lower court's action, ruling that the State
Constitution's guarantee of public education required the State to ensure a
full year's education in all school districts. The Court, however, overturned a
portion of the original order relating to the source of funds for RUSD's
emergency loan; the decision leaves unclear just where the State must find
funds to make any future loans of this kind.

In Parr v. State of California, a complaint was filed in federal court
claiming that payment of wages in registered warrants violated the Fair Labor
Standards Act ("FLSA"). The federal court held that the issuance of registered
warrants does violate the FLSA. The next phase of the trial will focus on the
issue of damages. The maximum amount of damages is the amount of the salary
originally owed or approximately $350 million.

The State is involved in a lawsuit seeking reimbursement for alleged state-
mandated costs. In Thomas Hayes v. Commission on State Mandates, the state
director of finance is appealing a 1984 decision by the State Board of Control.
The Board of Control decided in favor of local school districts' claims for
reimbursement for special education programs for handicapped students; however,
funds have not been appropriated. The amount of potential liability to the
State, if all potentially eligible school districts pursue timely claims, has
been estimated by the Department of Finance at over $1 billion.

The State is involved in two lawsuits related to contamination at the
Stringfellow toxic waste site. In one suit, the State is one of approximately
130 defendants in Penny Newman v. J. B. Stringfellow, et al. in which 3,800
plaintiffs are claiming damages of $850 million arising from contamination at
the Stringfellow toxic waste site. A conservative estimate of the State's
potential liability is $250 million to $550 million. A group of 17 of the
plaintiffs has received a verdict of $159,000 against the State. In a separate
lawsuit, United States, People of the State of California v. J. B.
Stringfellow, Jr. et al. the State is seeking recovery for past costs of
cleanup of the site, a declaration that the defendants are jointly and
severally liable for future costs, and an injunction ordering completion of the
cleanup. However, the defendants have filed a counterclaim against the State
for alleged negligent acts. Because the State is the present owner of the site,
the State may be found liable. Present estimates of the cleanup range from $200
million to $800 million.

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In 1992 the State, as part of an experimental work incentive program, reduced
welfare payments to approximately 2.7 million people who receive Aid to
Families with Dependent Children. The State's reduction in welfare payments was
challenged in federal court. In a recent United States Court of Appeals ruling,
the Court held that the State welfare cuts were improper. To date, the decision
has not been appealed. The Court's decision could cost the State approximately
$202 million a year in increased welfare benefit costs. In such event, the
State may shift some or all of the increased burden to local governments.

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APPENDIX II

RATINGS OF MUNICIPAL BONDS

DESCRIPTION OF MUNICIPAL BOND RATINGS OF MOODY'S INVESTORS SERVICE, INC.
("MOODY'S")

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.

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.

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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.

DESCRIPTION OF MUNICIPAL DEBT RATINGS OF STANDARD & POOR'S CORPORATION
("STANDARD & POOR'S")

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.

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<PAGE>

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 circumstances.

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 obligations;

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 higher-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 debt will likely have some quality and protective
characteristics, these are outweighed by large uncertainties
or major exposures to adverse conditions.

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.

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<PAGE>

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.

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.

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<PAGE>

A Standard & Poor's note rating reflects the liquidity concerns and market
access risks unique to notes. Notes due in 3 years or less will likely receive
a note rating. Notes maturing beyond 3 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 issuers 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 Moody'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.

DESCRIPTION OF INVESTMENT GRADE BOND RATINGS OF FITCH INVESTORS SERVICE, INC.
("FITCH")

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.

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<PAGE>

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 any 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.

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 [Arrow up]

Stable [Arrow left/right]

Declining [Arrow down]

Uncertain [Arrow up/down]

Credit trend indicators are not predictions that any rating change will
occur, and have a longer-term time frame than issues placed on FitchAlert.

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<PAGE>

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 particular 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.

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.

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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+".

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.

INS The symbol "INS" indicates that the rating is based on an
insurance policy or financial guaranty issued by an insurance
company.

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APPENDIX III

PORTFOLIO INSURANCE

Set forth below is further information with respect to the mutual fund
insurance policies (the "Policies") which the Fund may obtain from several
insurance companies with respect to insured Municipal Bonds held by the Fund.
The Fund has no obligation to obtain any such Policies and the terms of any
Policies actually obtained may vary significantly from the terms described
below.

In determining eligibility for insurance, insurance companies will apply
their own standards which correspond generally to the standards they normally
use in establishing the insurability of new issues of Municipal Bonds and which
are not necessarily the criteria which would be used in regard to the purchase
of such bonds of the Fund. The Policies do not insure (i) municipal securities
ineligible for insurance and (ii) municipal securities no longer owned by the
Fund.

The Policies do not guarantee the market value of the insured Municipal Bonds
or the value of the shares of the Fund. In addition, if the provider of an
original issuance insurance policy is unable to meet its obligations under such
policy or if the rating assigned to the insurance claims-paying ability of any
such insurer deteriorates, the insurance company will not have any obligation
to insure any issue held by the Fund which is adversely affected by either of
the above-described events. In addition to the payment of premiums, the
Policies may require that the Fund notify the insurance company as to all
Municipal Bonds in the Fund's portfolio and permit the insurance company to
audit their records. The insurance premiums will be payable monthly by the Fund
in accordance with a premium schedule to be furnished by the insurance company
at the time the Policies are issued. Premiums are based upon the amounts
covered and the composition of the portfolio.

The insurance companies will have insurance claims-paying ability ratings of
AAA from Standard & Poor's Corporation ("S&P") and Aaa from Moody's Investors
Service, Inc. ("Moody's").

An S&P insurance claims-paying ability rating is an assessment of an
operating insurance company's financial capacity to meet obligations under an
insurance policy in accordance with the terms. An insurer with an insurance
claims-paying ability rating of AAA has the highest rating assigned by S&P.
Capacity to honor insurance contracts is adjudged by S&P to be extremely strong
and highly likely to remain so over a long period of time. A Moody's insurance
claims-paying ability rating is an opinion of the ability of an insurance
company to repay punctually senior policyholder obligations and claims. An
insurer with an insurance claims-paying ability rating of Aaa is adjudged by
Moody's to be of the best quality. In the opinion of Moody's, the policy
obligations of an insurance company with an insurance claims-paying ability
rating of Aaa carry the smallest degree of credit risk and, while the financial
strength of these companies is likely to change, such changes as can be
visualized are most unlikely to impair the company's fundamentally strong
position.

An insurance claims-paying ability rating by S&P or Moody's does not
constitute an opinion on any specific contract in that such an opinion can only
be rendered upon the review of the specific insurance contract. Furthermore, an
insurance claims-paying ability rating does not take into account deductibles,
surrender or cancellation penalties or the timeliness of payment; nor does it
address the ability of a company to meet nonpolicy obligations (i.e., debt
contracts).

The assignment of ratings by S&P or Moody's to debt issues that are fully or
partially supported by insurance policies, contracts, or guarantees is a
separate process from the determination of claims-paying ability ratings. The
likelihood of a timely flow of funds from the insurer to the trustee for the
bondholders is a key element in the rating determination for such debt issues.

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<PAGE>

INDEPENDENT AUDITORS' REPORT

The Board of Trustees and Shareholders,
Merrill Lynch California Insured Municipal Bond Fund of
Merrill Lynch California Municipal Series Trust:

We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of Merrill Lynch California Insured Municipal Bond
Fund of Merrill Lynch California Municipal Series Trust as of August 31, 1994,
the related statements of operations for the year then ended and changes in net
assets and the financial highlights for the year then ended and for the period
February 26, 1993 (commencement of operations) to August 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 August
31, 1994 by correspondence with the custodian. 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
California Insured Municipal Bond Fund of Merrill Lynch California Municipal
Series Trust as of August 31, 1994, 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 29, 1994

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<PAGE>

PORTFOLIO ABBREVIATIONS

To simplify the listing of Merrill Lynch California Insured
Municipal Bond Fund's portfolio holdings in the Schedule of
Investments, we have abbreviated the names of some of the securities
according to the list at right.

AMT Alternative Minimum Tax (subject to)
COP Certificates of Participation
PCR Pollution Control Revenue Bonds
RITES Residual Interest Tax-Exempt Securities
RITR Residual Interest Trust Receipts
VRDN Variable Rate Demand Notes

<TABLE>
SCHEDULE OF INVESTMENTS (in Thousands)
<CAPTION>
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note la)

California--97.0%
<S> <S> <C> <S> <C>
AAA Aaa $ 2,500 Anaheim, California, Public Financing Authority Revenue Bonds (Electric
Utility San Juan), 2nd Series, 5.75% due 10/01/2022 (c) $ 2,351

AAA Aaa 1,000 Anaheim, California, Public Financing Authority, Tax Allocation Revenue Bonds,
RITES, 9.65% due 12/28/2018 (d)(e) 1,047

Brea, California, Redevelopment Agency, Tax Allocation Refunding Bonds
(Redevelopment Project A--B) (d):
AAA Aaa 3,920 6.125% due 8/01/2013 3,934
AAA Aaa 2,000 5.75% due 8/01/2023 1,880

California Health Facilities Financing Authority Revenue Bonds:
AAA Aaa 1,750 (Adventist Health System-West), Series B, 6.25% due 3/01/2021 (d) 1,745
BBB Baal 2,000 (Health Dimensions), Series A, 7.50% due 5/01/2015 2,056
A1+ VMIG1 100 (Saint Joseph Health System), Refunding, VRDN, Series A, 3.05% due
7/01/2013 (a) 100
AAA Aaa 2,000 (Scripps Memorial Hospital), Series A, 6.375% due 10/01/2022 (d) 2,027

California Pollution Control Financing Authority, PCR, Refunding (Shell Oil
Company Project), VRDN (a):
A1+ VMIG1 500 Series A, 3.05% due 10/01/2009 500
A1+ VMIG1 1,000 Series C, 3.05% due 11/01/2000 1,000

NR Aa3 1,600 California Pollution Control Financing Authority, Resource Recovery Revenue Bonds
(Honey Lake Power Project), AMT, VRDN, 3.25% due 9/01/2018 (a) 1,600

AAA Aaa 2,450 California State Department of Water Resources Revenue Bonds (Central Valley
Project), Series J, 6.125% due 12/01/2013 (d) 2,455

AAA Aaa 4,000 California State, Public Works Board, Lease Revenue Bonds (Various Universities of
California Projects), Series A, 6.40% due 12/01/2016 (b) 4,081

BBB Baa 1,935 Carson, California, Redevelopment Agency, Tax Allocation Refunding Bonds
(Redevelopment Project Area 2), 6% due 10/01/2013 1,805

AAA Aaa 2,360 Central Coast Water Authority, California, Revenue Bonds (State Water Project
Regional Facilities), 6.50% due 10/01/2014 (b) 2,430

AAA Aaa 2,000 Cerritos, California, Public Financing Authority, Revenue Refunding Bonds (Los
Coyotes Redevelopment Project Loan), Series A, 6.50% due 11/01/2023 (b) 2,101
</TABLE>

73
<PAGE>

<TABLE>
SCHEDULE OF INVESTMENTS (continued) (in Thousands)
<CAPTION>
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note la)

California (continued)
<S> <S> <C> <S> <C>
AAA Aaa $ 3,000 Coronado, California, Community Development Agency, Tax Allocation Revenue Bonds
(Coronado Community Development Project), 6.30% due 9/01/2022 (d) $ 3,022

AAA Aaa 1,200 Cucamonga County, California, Water District Facilities Refinancing Bonds,
COP, 6.50% due 9/01/2022 (c) 1,227

AAA Aaa 2,500 East Bay, California, Municipal Utility District Water System, Subordinated
Revenue Refunding Bonds, 6% due 6/01/2012 (d) 2,481

AAA Aaa 500 Eastern Municipal Water District, California, Water and Sewer Revenue Bonds, COP,
Series A, 6.50% due 7/01/2009 (c) 518

AAA Aaa 2,000 El Cajon, California, Redevelopment Agency, Tax Allocation Revenue Refunding
Bonds (El Cajon Redevelopment Project), 6.60% due 10/01/2022 (b) 2,065

AAA Aaa 2,235 Eureka, California, Public Financing Authority, Tax Allocation Revenue Refunding
Bonds (Eureka Redevelopment Projects), 6.25% due 11/01/2011 (f) 2,271

AAA Aaa 2,500 Fresno, California, Sewer Revenue Bonds (Fowler Avenue Project), Series A,
6.25% due 8/01/2011 (b) 2,539

A1 P1 1,600 Irvine Ranch, California, Water Improvement District No. 182, VRDN, Series A,
2.85% due 11/15/2013 (a) 1,600

AAA Aaa 2,500 Los Angeles, California, Convention and Exhibition Center Authority, Lease
Revenue Refunding Bonds, Series A, 6% due 8/15/2010 (d) 2,520

AA Aa 2,000 Los Angeles, California, Department of Water and Power, Electric Plant Revenue
Bonds, Registered RITR, 8.618% due 2/01/2020 2,007

AAA Aaa 1,000 Los Angeles, California, Wastewater System Revenue Bonds, Series B, 6.25% due
6/01/2012 (b) 1,014

AAA Aaa 3,000 Los Angeles County, California, Metropolitan Transportation Authority, Sales Tax
Revenue Refunding Bonds, Proposition A, Series A, 5.625% due 7/01/2018 (d) 2,776

AAA Aaa 1,000 Mesa, California, Consolidated Water District, COP (Water Project), 6.375% due
3/15/2012 (c) 1,027

AAA Aaa 2,000 Mountain View, California, Capital Improvements Financing Authority Revenue Bonds
(City Hall Community Theatre), 6.50% due 8/01/2016 (d) 2,051

AAA Aaa 3,500 Northern California Public Power Agency, Revenue Refunding Bonds (Hydroelectric
Project No. 1), Series A, 6.25% due 7/01/2012 (d) 3,556

AAA Aaa 1,000 Ontario, California, Redevelopment Financing Authority Revenue Bonds (Ontario
Redevelopment Project No. 1), 5.50% due 8/01/2018 (d) 911

A1 NR 200 Orange County, California, COP (Office and Courthouse Projects), VRDN, 3.10% due
12/01/2015 (a) 200
</TABLE>
74
<PAGE>

<TABLE>
SCHEDULE OF INVESTMENTS (concluded) (in Thousands)
<CAPTION>
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note la)

California (concluded)
<S> <S> <C> <S> <C>
AAA Aaa $ 3,000 Palmdale, California, Civic Authority Revenue Refunding Bonds (Merged Redevelopment
Project No. 1), Series A, 5.50% due 7/01/2023 (d) $ 2,708

NR Baa 1,410 Pleasanton, California, Joint Powers Financing Authority, Revenue Reassessment
Bonds, Series A, 6.15% due 9/02/2012 1,351

AAA Aaa 1,300 Rancho Cucamonga, California, Redevelopment Agency, Tax Allocation Refunding Bonds
(Rancho Redevelopment Project), 5.50% due 9/01/2023 (d) 1,173

AAA Aaa 1,000 Redwood City, California, Public Financing Authority, Local Agency Revenue
Refunding Bonds, Series A, 6.50% due 7/15/2011 (b) 1,030

Sacramento, California, Municipal Utility District, Electric Revenue Bonds (d):
AAA Aaa 1,500 Refunding, Series G, 6.50% due 9/01/2013 1,577
AAA Aaa 3,000 Series B, 6.375% due 8/15/2022 3,050

San Francisco, California, City and County Airport Commission, International
Airport, Revenue Refunding Bonds, Second Series:
AAA Aaa 4,000 First Issue, 6.30% due 5/01/2011 (b) 4,081
AAA Aaa 2,500 Second Issue, 6.75% due 5/01/2020 (d) 2,632

AAA Aaa 1,715 Santa Ana, California, Financing Authority, Lease Revenue Bonds (Police
Administration and Holding Facility), Series A, 6.25% due 7/01/2024 (d) 1,748

AAA Aaa 2,235 University of California Revenue Bonds (Multiple Purpose Projects), Series D,
6.30% due 9/01/2015 (d) 2,261

AAA Aaa 3,725 West Sacramento, California, Redevelopment Agency, Tax Allocation Bonds (West
Sacramento Redevelopment Project), 6.25% due 9/01/2021 (d) 3,735

Total Investments (Cost--$90,082)--97.0% 88,243
Other Assets Less Liabilities--3.0% 2,685
-------
Net Assets--100.0% $90,928
=======

<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 August 31, 1994.
(b)AMBAC Insured.
(c)FGIC Insured.
(d)MBIA Insured.
(e)The interest rate is subject to change periodically and inversely
to the prevailing market rates. The interest rate shown is the rate
in effect at August 31, 1994.
(f)Capital Guaranty.
NR--Not Rated.
Ratings of issues shown have not been audited by Deloitte & Touche LLP.

See Notes to Financial Statements.
</TABLE>

75
<PAGE>

FINANCIAL INFORMATION
<TABLE>
Statement of Assets and Liabilities as of August 31, 1994
<CAPTION>
<S> <S> <C> <C>
Assets: Investments, at value (identified cost--$90,081,701) (Note 1a) $88,242,644
Cash 1,211,093
Receivables:
Interest $ 1,497,883
Beneficial interest sold 284,087
Investment adviser (Note 2) 75,465 1,857,435
-----------
Deferred organization expenses (Note 1e) 39,939
Prepaid expenses and other assets (Note 1e) 60,537
-----------
Total assets 91,411,648
-----------

Liabilities: Payables:
Beneficial interest redeemed 157,725
Dividends to shareholders (Note 1f) 103,682
Distributor (Note 2) 31,647 293,054
-----------
Accrued expenses and other liabilities 190,432
-----------
Total liabilities 483,486
-----------

Net Assets: Net assets $90,928,162
===========

Net Assets Class A Shares of beneficial interest, $.10 par value,
Consist of: unlimited number of shares authorized $ 167,154
Class B Shares of beneficial interest, $.10 par value,
unlimited number of shares authorized 785,956
Paid-in capital in excess of par 94,367,101
Accumulated realized capital losses--net (2,187,253)
Accumulated distributions in excess of realized capital
gains--net (365,739)
Unrealized depreciation on investments--net (1,839,057)
-----------
Net assets $90,928,162
===========

Net Asset Value: Class A--Based on net assets of $15,945,665 and 1,671,544
shares of beneficial interest outstanding $ 9.54
===========
Class B--Based on net assets of $74,982,497 and 7,859,558
shares of beneficial interest outstanding $ 9.54
===========

See Notes to Financial Statements.
</TABLE>

76
<PAGE>

FINANCIAL INFORMATION (continued)

<TABLE>
Statement of Operations
<CAPTION>
For the Year Ended
August 31, 1994
<S> <S> <C>
Investment Interest and amortization of premium and discount earned $ 5,093,898
Income
(Note 1d):

Expenses: Investment advisory fees (Note 2) 509,552
Distribution fees--Class B (Note 2) 378,612
Printing and shareholder reports 137,839
Professional fees 82,667
Registration fees (Note 1e) 46,118
Accounting services (Note 2) 39,696
Transfer agent fees--Class B (Note 2) 28,420
Custodian fees 15,462
Amortization of organization expenses (Note 1e) 11,443
Pricing fees 6,369
Transfer agent fees--Class A (Note 2) 5,451
Trustees' fees and expenses 4,548
Other 2,466
-----------
Total expenses before reimbursement 1,268,643
Reimbursement of expenses (Note 2) (585,017)
-----------
Total expenses after reimbursement 683,626
-----------
Investment income--net 4,410,272
-----------

Realized & Realized loss on investments--net (1,974,493)
Unrealized Loss Change in unrealized appreciation on investments--net (4,299,648)
on Investments -----------
- --Net (Notes 1d Net Decrease in Net Assets Resulting from Operations $(1,863,869)
& 3): ===========

See Notes to Financial Statements.

</TABLE>

77
<PAGE>

FINANCIAL INFORMATION (continued)

<TABLE>
Statement of Changes in Net Assets
<CAPTION>
For the
Period
For the February 26,
Year Ended 1993++ to
August 31, August 31,
Increase (Decrease) in Net Assets: 1994 1993
<S> <S> <C> <C>
Operations: Investment income--net $ 4,410,272 $ 1,708,071
Realized loss on investments--net (1,974,493) (212,759)
Change in unrealized appreciation on investments--net (4,299,648) 2,460,591
----------- -----------
Net increase (decrease) in net assets resulting from
operations (1,863,869) 3,955,903
----------- -----------

Dividends & Investment income--net:
Distributions to Class A (874,505) (366,882)
Shareholders Class B (3,535,767) (1,341,189)
(Note 1f): In excess of realized gains on investments--net:
Class A (67,794) --
Class B (297,945) --
----------- -----------
Net decrease in net assets resulting from dividends and
distributions to shareholders (4,776,011) (1,708,071)
----------- -----------

Beneficial Net increase in net assets derived from beneficial interest
Interest transactions 7,602,289 87,617,921
Transactions ----------- -----------
(Note 4):

Net Assets: Total increase in net assets 962,409 89,865,753
Beginning of period 89,965,753 100,000
----------- -----------
End of period $90,928,162 $89,965,753
=========== ===========

<FN>
++Commencement of Operations.

See Notes to Financial Statements.
</TABLE>

78
<PAGE>

FINANCIAL INFORMATION (concluded)
<TABLE>
Financial Highlights
<CAPTION>
Class A Class B
For the For the
For the Period For the Period
The following per share data and ratios have been derived Year Feb. 26, Year Feb. 26,
from information provided in the financial statements. Ended 1993++ to Ended 1993++ to
Aug. 31, Aug. 31, Aug. 31, Aug. 31,
Increase (Decrease) in Net Asset Value: 1994 1993 1994 1993
<S> <S> <C> <C> <C> <C>
Per Share Net asset value, beginning of period $ 10.23 $ 10.00 $ 10.23 $ 10.00
Operating --------- --------- --------- ---------
Performance: Investment income--net .51 .24 .46 .22
Realized and unrealized gain (loss) on
investments--net (.65) .23 (.65) .23
--------- --------- --------- ---------
Total from investment operations (.14) .47 (.19) .45
--------- --------- --------- ---------
Less dividends and distributions:
Investment income--net (.51) (.24) (.46) (.22)
In excess of realized gain on investments--net (.04) -- (.04) --
--------- --------- --------- ---------
Total dividends and distributions (.55) (.24) (.50) (.22)
--------- --------- --------- ---------
Net asset value, end of period $ 9.54 $ 10.23 $ 9.54 $ 10.23
========= ========= ========= =========

Total Investment Based on net asset value per share (1.44%) 4.81%+++ (1.93%) 4.56%+++
Return:** ========= ========= ========= =========

Ratios to Expenses, net of reimbursement excluding
Average distribution fees .33% .14%* .33% .14%*
Net Assets: ========= ========= ========= =========
Expenses, net of reimbursement .33% .14%* .83% .64%*
========= ========= ========= =========
Expenses .96% 1.06%* 1.46% 1.56%*
========= ========= ========= =========
Investment income--net 5.16% 4.80%* 4.67% 4.31%*
========= ========= ========= =========

Supplemental Net assets, end of period (in thousands) $ 15,946 $ 17,105 $ 74,982 $ 72,861
Data: ========= ========= ========= =========
Portfolio turnover 93.04% 74.26% 93.04% 74.26%
========= ========= ========= =========

<FN>
++Commencement of Operations.
+++Aggregate total investment return.
*Annualized.
**Total investment returns exclude the effects of sales loads.

See Notes to Financial Statements.
</TABLE>

79
<PAGE>

NOTES TO FINANCIAL STATEMENTS

1. Significant Accounting Policies:
Merrill Lynch California Insured Municipal Bond Fund (the "Fund") is
part of Merrill Lynch California 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 both Class A and Class B Shares. Class A Shares are
sold with a front-end sales charge. Class B Shares may be subject to
a contingent deferred sales charge. Both classes of shares have
identical voting, dividend, liquidation and other rights and the
same terms and conditions, except that Class B Shares bear certain
expenses related to the distribution of such shares and have
exclusive voting rights with respect to matters relating to such
distribution expenditures. On September 27, 1994, shareholders
approved the implementation of the Merrill Lynch Select Pricing SM
System, which will offer two new classes of shares, Class C and
Class D. 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 a remaining maturity of sixty days or less are
valued on an amortized cost basis, which approximates market value.
Options, which are traded on exchanges, are valued at their last
sale price as of the close of such exchanges or, lacking any sales,
at the last available bid price. 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.

(b) 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
portfolio holdings 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.

80
<PAGE>

(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 realized gains are due primarily to differing tax treatments for
futures transactions and post-October losses.

2. Investment Advisory Agreement and Transactions with Affiliates:
The Fund has entered into an Investment Advisory Agreement with Fund
Asset Management, L.P. ("FAM"). Effective January 1, 1994, the
investment advisory business of FAM was reorganized from a
corporation to a limited partnership. Both prior to and after the
reorganization, ultimate control of FAM was vested with Merrill
Lynch & Co., Inc. ("ML & Co."). The general partner of FAM is
Princeton Services, Inc. ("PSI"), an indirect wholly-owned
subsidiary of ML & Co. The limited partners are ML & Co. and Fund
Asset Management, Inc. ("FAMI"), which is also an indirect wholly-
owned subsidiary of ML & Co.

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. The Management Agreement obligates FAM to
reimburse the Fund to the extent the Fund's expenses (excluding
interest, taxes, distribution fees, brokerage fees and commissions,
and extraordinary items) exceed 2.5% of the Fund's first $30 million
of average daily net assets, 2.0% of the next $70 million of average
daily net assets, and 1.5% of the average daily net assets in excess
thereof. FAM's obligation to reimburse the Fund is limited to the
amount of the management fee. No fee payment will be made to FAM
during any fiscal year which will cause such expenses to exceed
expense limitations at the time of such payment.

For the year ended August 31, 1994, FAM earned fees of $509,552, all
of which was voluntarily waived. FAM also voluntarily reimbursed the
Fund for additional expenses of $75,465.

The Fund has entered into a Distribution Agreement and Distribution
Plan with Merrill Lynch Funds Distributor, Inc. ("MLFD"), an
indirect wholly-owned subsidiary of M L& Co.

Pursuant to a distribution plan (the "Distribution Plan") adopted by
the Fund in accordance with Rule 12B-1 under the Investment Company
Act of 1940, the Fund pays MLFD an ongoing account maintenance fee
and a distribution fee, which are accrued daily and paid monthly at
the annual rates of 0.25% and 0.25%, respectively, of the average
daily net assets of the Class B Shares of the Fund. Pursuant to a
sub-agreement with MLFD, Merrill Lynch, Pierce, Fenner and 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 MLFD and MLPF&S for providing
account maintenance services to Class B shareholders. The ongoing
distribution fee compensates MLFD and MLPF&S for providing
shareholder and distribution services and bearing certain
distribution-related expenses of the Fund.

For the year ended August 31, 1994, MLFD earned underwriting
discounts of $2,428, and MLPF&S earned dealer concessions of $21,386
on sales of the Fund's Class A Shares.

MLPF&S also received contingent deferred sales charges of $177,779
relating to Class B Share transactions during the period.

Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of
ML & Co., is the Fund's transfer agent.

Accounting services are provided to the Fund by FAM at cost.

81
<PAGE>

Certain officers and/or trustees of the Fund are officers and/or
directors of FAM, FAMI, PSI, MLFD, MLPF&S, and/or ML & Co.

NOTES TO FINANCIAL STATEMENTS (concluded)

3. Investments:
Purchases and sales of investments, excluding short-term securities,
for the year ended August 31, 1994 were $85,395,237 and $80,395,482,
respectively.

Net realized and unrealized losses as of August 31, 1994 were as
follows:

Realized
Gains Unrealized
(Losses) Losses

Long-term investments $(2,401,726) $(1,839,057)
Short-term investment (6,430) --
Financial futures contracts 433,663 --
----------- -----------
Total $(1,974,493) $(1,839,057)
=========== ===========

As of August 31, 1994, net unrealized depreciation for Federal
income tax purposes aggregated $1,839,057, of which $437,286 related
to appreciated securities and $2,276,343 related to depreciated
securities. The aggregate cost of investments at August 31, 1994 for
Federal income tax purposes was $90,081,701.

4. Beneficial Interest Transactions:
Net increase in net assets derived from beneficial interest
transactions was $7,602,289 and $87,617,921 for the periods ended
August 31, 1994 and August 31, 1993, respectively.

Class A Shares for the Year Dollar
Ended August 31, 1994 Shares Amount

Shares sold 301,766 $ 3,002,096
Shares issued to shareholders
in reinvestment of dividends
and distributions 39,457 389,777
----------- -----------
Total issued 341,223 3,391,873
Shares redeemed (342,542) (3,318,587)
----------- -----------
Net increase (decrease) (1,319) $ 73,286
=========== ===========

Class A Shares for the Period Dollar
Feb. 26, 1993++ to Aug. 31, 1993 Shares Amount

Shares sold 1,916,382 $19,071,665
Shares issued to shareholders
in reinvestment of dividends
and distributions 14,668 145,493
----------- -----------
Total issued 1,931,050 19,217,158
Shares redeemed (263,187) (2,604,981)
----------- -----------
Net increase 1,667,863 $16,612,177
=========== ===========

[FN]
++Prior to February 26, 1993 (commencement of operations), the Fund
issued 5,000 shares to FAMI for $50,000.

Class B Shares for the Year Dollar
Ended August 31, 1994 Shares Amount

Shares sold 1,864,973 $18,580,245
Shares issued to shareholders
in reinvestment of dividends
and distributions 198,811 1,962,586
----------- -----------
Total issued 2,063,784 20,542,831
Shares redeemed (1,329,588) (13,013,828)
----------- -----------
Net increase 734,196 $ 7,529,003
=========== ===========

Class B Shares for the Period Dollar
Feb. 26, 1993++ to Aug. 31, 1993 Shares Amount

Shares sold 7,568,355 $75,475,197
Shares issued to shareholders
in reinvestment of dividends
and distributions 65,946 654,140
----------- -----------
Total issued 7,634,301 76,129,337
Shares redeemed (513,939) (5,123,593)
----------- -----------
Net increase 7,120,362 $71,005,744
=========== ===========

[FN]
++Prior to February 26, 1993 (commencement of operations), the Fund
issued 5,000 shares to FAMI for $50,000.

82
<PAGE>

[THIS PAGE IS INTENTIONALLY LEFT BLANK.]

83
<PAGE>

TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objective and Policies......................................... 2
Portfolio Insurance...................................................... 5
Description of Municipal Bonds and Temporary Investments.................. 7
Description of Municipal Bonds........................................... 7
Description of Temporary Investments..................................... 8
Repurchase Agreements.................................................... 9
Financial Futures Transactions and
Options................................................................. 10
Investment Restrictions................................................... 15
Management of the Trust................................................... 19
Trustees and Officers.................................................... 19
Management and Advisory Arrangements..................................... 20
Purchase of Shares........................................................ 22
Alternative Sales Arrangements........................................... 22
Initial Sales Charge Alternatives--Class A and Class D Shares............ 23
Reduced Initial Sales Charges............................................ 23
Distribution Plans....................................................... 26
Limitations on the Payment of Deferred Sales Charges..................... 26
Redemption of Shares...................................................... 27
Deferred Sales Charges Class B Shares.................................... 28
Portfolio Transactions.................................................... 28
Determination of Net Asset Value.......................................... 29
Shareholder Services...................................................... 30
Investment Account....................................................... 30
Automatic Investment Plans............................................... 31
Automatic Reinvestment of Dividends and Capital Gains Distributions...... 31
Systematic Withdrawal Plans--Class A and Class D Shares.................. 31
Exchange Privilege....................................................... 32
Distributions and Taxes................................................... 45
Environmental Tax........................................................ 48
Tax Treatment of Futures and Options Transactions........................ 48
Performance Data.......................................................... 49
General Information....................................................... 50
Description of Shares.................................................... 50
Computation of Offering Price Per Share.................................. 52
Independent Auditors..................................................... 52
Custodian................................................................ 52
Transfer Agent........................................................... 52
Legal Counsel............................................................ 52
Reports to Shareholders.................................................. 53
Additional Information................................................... 53
Appendix I
Economic and Other Conditions in
California.............................................................. 54
Appendix II
Ratings of Municipal Bonds............................................... 63
Appendix III
Portfolio Insurance...................................................... 71
Independent Auditors' Report.............................................. 72
Financial Statements...................................................... 73
</TABLE>

Code #16576-1094
Statement of
Additional Information

[ART]

- -------------------------------------------------------------------------------

MERRILL LYNCH CALIFORNIA INSURED MUNICIPAL BOND FUND

MERRILL LYNCH CALIFORNIA MUNICIPAL SERIES TRUST

October 21, 1994

Distributor:
Merrill Lynch Funds
Distributor, Inc.
<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 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