<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON DECEMBER 20, 1996
SECURITIES ACT FILE NO. 33-55864
INVESTMENT COMPANY ACT FILE NO. 811-4264
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM N-1A
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 [X]
PRE-EFFECTIVE AMENDMENT NO. [ ]
POST-EFFECTIVE AMENDMENT NO. 5 [X]
AND/OR
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 [X]
AMENDMENT NO. 20 [X]
(CHECK APPROPRIATE BOX OR BOXES)
------------------------
MERRILL LYNCH CALIFORNIA INSURED MUNICIPAL BOND FUND
OF MERRILL LYNCH CALIFORNIA MUNICIPAL SERIES TRUST
(EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
<TABLE>
<S> <C>
800 SCUDDERS MILL ROAD
PLAINSBORO, NEW JERSEY 08536
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
</TABLE>
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (609) 282-2800
ARTHUR ZEIKEL
MERRILL LYNCH CALIFORNIA MUNICIPAL SERIES TRUST
800 SCUDDERS MILL ROAD, PLAINSBORO, NEW JERSEY
MAILING ADDRESS: P.O. BOX 9011, PRINCETON, NEW JERSEY 08543-9011
(NAME AND ADDRESS OF AGENT FOR SERVICE)
------------------------
COPIES TO:
<TABLE>
<S> <C>
COUNSEL FOR THE TRUST: PHILIP L. KIRSTEIN,
BROWN & WOOD LLP ESQ.
ONE WORLD TRADE CENTER FUND ASSET MANAGEMENT
NEW YORK, NEW YORK 10048-0557 P.O. BOX 9011
ATTENTION: THOMAS R. SMITH, JR., ESQ. PRINCETON, NEW JERSEY
BRIAN M. KAPLOWITZ, ESQ. 08543-9011
</TABLE>
------------------------
IT IS PROPOSED THAT THIS FILING WILL BECOME EFFECTIVE (CHECK
APPROPRIATE BOX)
[X] immediately upon filing pursuant to paragraph (b)
[ ] on (date) pursuant to paragraph (b)
[ ] 60 days after filing pursuant to paragraph (a)(1)
[ ] on (date) pursuant to paragraph (a)(1)
[ ] 75 days after filing pursuant to paragraph (a)(2)
[ ] on (date) pursuant to paragraph (a)(2) of Rule 485.
IF APPROPRIATE, CHECK THE FOLLOWING BOX:
[ ] this post-effective amendment designates a new
effective date for a previously filed
post-effective amendment.
------------------------
THE REGISTRANT HAS REGISTERED AN INDEFINITE NUMBER OF ITS SHARES OF
BENEFICIAL INTEREST UNDER THE SECURITIES ACT OF 1933 PURSUANT TO RULE 24F-2
UNDER THE INVESTMENT COMPANY ACT OF 1940. THE NOTICE REQUIRED BY SUCH RULE FOR
THE REGISTRANT'S MOST RECENT FISCAL YEAR WAS FILED ON OCTOBER 22, 1996.
===============================================================================
<PAGE> 2
MERRILL LYNCH CALIFORNIA INSURED MUNICIPAL BOND FUND OF
MERRILL LYNCH CALIFORNIA MUNICIPAL SERIES TRUST
REGISTRATION STATEMENT ON FORM N-1A
CROSS REFERENCE SHEET
<TABLE>
<CAPTION>
N-1A ITEM NO. LOCATION
- ------------- ---------------------------------------
<S> <C> <C>
PART A
Item 1. Cover Page............................... Cover Page
Item 2. Synopsis................................. Fee Table
Item 3. Condensed Financial Information.......... Financial Highlights
Item 4. General Description of Registrant........ Investment Objective and Policies;
Additional Information
Item 5. Management of the Fund................... Fee Table; Management of the Trust;
Inside Back Cover Page
Item 5A. Management's Discussion of Fund
Performance............................ Not Applicable
Item 6. Capital Stock and Other Securities....... Cover Page; Additional Information
Item 7. Purchase of Securities Being Offered..... Cover Page; Merrill Lynch Select
Pricing(SM) System; Fee Table; Purchase
of Shares; Shareholder Services;
Additional Information; Inside Back
Cover Page
Item 8. Redemption or Repurchase................. Merrill Lynch Select Pricing(SM) System;
Fee Table; Purchase of Shares;
Redemption of Shares
Item 9. Pending Legal Proceedings................ Not Applicable
PART B
Item 10. Cover Page............................... Cover Page
Item 11. Table of Contents........................ Back Cover Page
Item 12. General Information and History.......... General Information
Item 13. Investment Objective and Policies........ Investment Objective and Policies;
Investment Restrictions
Item 14. Management of the Fund................... Management of the Trust
Item 15. Control Persons and Principal Holders of
Securities............................. Management of the Trust; General
Information--Additional Information
Item 16. Investment Advisory and Other Services... Management of the Trust; Purchase of
Shares; General Information
Item 17. Brokerage Allocation and Other
Practices.............................. Portfolio Transactions
Item 18. Capital Stock and Other Securities....... General Information--Description of
Shares
Item 19. Purchase, Redemption and Pricing of
Securities Being Offered............... Purchase of Shares; Redemption of
Shares; Determination of Net Asset
Value; Shareholder Services
Item 20. Tax Status............................... Distributions and Taxes
Item 21. Underwriters............................. Purchase of Shares
Item 22. Calculation of Performance Data.......... Performance Data
Item 23. Financial Statements..................... Financial Statements
</TABLE>
PART C
Information required to be included in Part C is set forth under the
appropriate Item, so numbered, in Part C to this Registration Statement.
<PAGE> 3
PROSPECTUS
DECEMBER 20, 1996
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 portfolio of
long-term, investment grade 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 ("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 12. 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. For more information on the Fund's investment objective and
policies, please see "Investment Objective and Policies" on page 10.
------------------------
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 9081, Princeton, New Jersey 08543-9081 [(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 NOR HAS THE SECURITIES AND EXCHANGE 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 December 20, 1996 (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> 4
FEE TABLE
A general comparison of the sales arrangements and other nonrecurring and
recurring expenses applicable to shares of the Fund follows:
<TABLE>
<CAPTION>
CLASS A(a) CLASS B(b) CLASS C CLASS D
----------- ----------------------- ------------- -----------
<S> <C> <C> <C> <C>
SHAREHOLDER TRANSACTION EXPENSES:
Maximum Sales Charge Imposed on Purchases
(as a percentage of offering price)...... 4.00%(c) None None 4.00%(c)
Sales Charge Imposed on Dividend
Reinvestments............................ None None None None
Deferred Sales Charge (as a percentage of
original purchase price or redemption
proceeds, whichever is lower)............ None(d) 4.0% during the first 1.0% for one None(d)
year, decreasing 1.0% year(f)
annually to 0.0% after
the fourth year(e)
Exchange Fee............................... None None None None
ANNUAL FUND OPERATING EXPENSES (AS A PERCENTAGE
AVERAGE NET ASSETS):
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% 0.04% 0.04% 0.03%
Miscellaneous.......................... 0.25% 0.25% 0.25% 0.25%
-------- ----- ----- -----
Total Other Expenses............... 0.30% 0.31% 0.31% 0.30%
-------- ----- ----- -----
Total Fund Operating Expenses(+)............... 0.85% 1.36% 1.46% 0.95%
======== ===== ===== =====
</TABLE>
- ---------------
(a) Class A shares are sold to a limited group of investors including existing
Class A shareholders and certain participants in fee-based programs. See
"Purchase of Shares--Initial Sales Charge Alternatives--Class A and Class D
Shares"--page 25 and "Shareholder Services -- Fee-Based Programs" -- page
36.
(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 27.
(c) Reduced for purchases of $25,000 and over and waived for purchases of Class
A shares in connection with certain fee-based programs. 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 25.
(d) Class A and Class D shares are not subject to a contingent deferred sales
charge ("CDSC"), except that certain purchases of $1,000,000 or more which
are not subject to an initial sales charge may instead be subject to a CDSC
of 1.0% of amounts redeemed within the first year after purchase. Such CDSC
may be waived in connection with redemptions to fund participation in
certain fee-based programs. See "Shareholder Services--Fee-Based
Programs"--page 36.
(e) The CDSC may be modified in connection with redemptions to fund
participation in certain fee-based programs. See "Shareholder
Services--Fee-Based Programs"--page 36.
(f) The CDSC may be waived in connection with redemptions to fund participation
in certain fee-based programs. See "Shareholder Services--Fee-Based
Programs"--page 36.
(g) See "Management of the Trust--Management and Advisory Arrangements"--page
21.
(h) See "Purchase of Shares--Distribution Plans"--page 30.
(i) See "Management of the Trust--Transfer Agency Services"--page 23.
+ For the fiscal year ended August 31, 1996, Fund Asset Management, L.P.
("FAM" or the "Manager") voluntarily waived a portion of the management fees
due from the Fund. Total Fund Operating Expenses in the Fee Table above have
been restated to assume the absence of any such waiver because the Manager
may discontinue or reduce such waiver of fees at any time without notice.
For the fiscal year ended August 31, 1996, the Manager waived management
fees totaling .36% for Class A shares, .37% for Class B shares, .36% for
Class C shares and .36% for Class D shares after which the Fund's total
expense ratio was .49% for Class A shares, .99% for Class B shares, 1.10%
for Class C shares and .59% for Class D shares.
2
<PAGE> 5
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 on page 2, (2) a 5% annual
return throughout the period and (3) redemption at
the end of the period:
Class A........................................... $ 48 $66 $85 $141
Class B........................................... $ 54 $63 $74 $164
Class C........................................... $ 25 $46 $80 $175
Class D........................................... $ 49 $69 $90 $152
An investor would pay the following expenses on the
same $1,000 investment assuming no redemption at the
end of the period:
Class A........................................... $ 48 $66 $85 $141
Class B........................................... $ 14 $43 $74 $164
Class C........................................... $ 15 $46 $80 $175
Class D........................................... $ 49 $69 $90 $152
</TABLE>
The foregoing Fee Table is intended to assist investors in understanding
the costs and expenses that a shareholder in the Fund will bear directly or
indirectly. The example set forth above assumes reinvestment of all dividends
and distributions and utilizes a 5% annual rate of return as mandated by
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 Conduct
Rules 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 PRICING(SM) SYSTEM
The Fund offers four classes of shares under the Merrill Lynch Select
Pricing(SM) System. The shares of each class may be purchased at a price equal
to the next determined net asset value per share subject to the sales charges
and ongoing fee arrangements described below. Shares of Class A and Class D are
sold to investors choosing the initial sales charge alternatives, and shares of
Class B and Class C are sold to investors choosing the deferred sales charge
alternatives. The Merrill Lynch Select Pricing(SM) System is used by more than
50 registered investment companies advised by Merrill Lynch Asset Management,
L.P. ("MLAM") or the Manager, an affiliate of MLAM. Funds advised by MLAM or the
Manager which utilize the Merrill Lynch Select Pricing(SM) System are referred
to herein as "MLAM-advised mutual funds".
Each Class A, Class B, Class C or Class D share of the Fund represents an
identical interest in the investment portfolio of the Fund and has the same
rights, except that Class B, Class C and Class D shares bear the expenses of the
ongoing account maintenance fees and Class B and Class C shares bear the
expenses of the ongoing distribution fees and the additional incremental
transfer agency costs resulting from the deferred sales charge arrangements. The
CDSCs and distribution and account maintenance fees that are
3
<PAGE> 6
imposed on Class B and Class C shares, as well as the account maintenance fees
that are imposed on the Class D shares, are imposed directly against those
classes and not against all assets of the Fund and, accordingly, such charges
will not affect the net asset value of any other class or have any impact on
investors choosing another sales charge option. Dividends paid by the Fund for
each class of shares will be calculated in the same manner at the same time and
will differ only to the extent that account maintenance and distribution fees
and any incremental transfer agency costs relating to a particular class are
borne exclusively by that class. Each class has different exchange privileges.
See "Shareholder Services--Exchange Privilege".
Investors should understand that the purpose and function of the initial
sales charges with respect to the Class A and Class D shares are the same as
those of the deferred sales charges with respect to the Class B and Class C
shares in that the sales charges applicable to each class provide for the
financing of the distribution of the shares of the Fund. The
distribution-related revenues paid with respect to a class will not be used to
finance the distribution expenditures of another class. Sales personnel may
receive different compensation for selling different classes of shares.
The following table sets forth a summary of the distribution arrangements
for each class of shares under the Merrill Lynch Select Pricing(SM) System,
followed by a more detailed description of each class and a discussion of the
factors that investors should consider in determining the method of purchasing
shares under the Merrill Lynch Select Pricing(SM) System that the investor
believes is most beneficial under his or her particular circumstances. More
detailed information as to each class of shares is set forth under "Purchase of
Shares".
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
ACCOUNT
MAINTENANCE DISTRIBUTION
CLASS SALES CHARGE(1) FEE FEE CONVERSION FEATURE
-------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
A Maximum 4.00% initial sales No
charge(2)(3) No No
-------------------------------------------------------------------------------------------------------
B CDSC for a period of 4 years, at a B shares convert to D shares
rate of 4.0% during the first year, automatically after
decreasing 1.0% annually to 0.0%(4) 0.25% 0.25% approximately ten years(5)
-------------------------------------------------------------------------------------------------------
C 1.0% CDSC for one year(6) 0.25% 0.35% No
-------------------------------------------------------------------------------------------------------
D Maximum 4.00% initial sales 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 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 and waived for purchases of Class A
shares in connection with certain fee-based programs. 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 a 1.0% CDSC if redeemed within one
year. Such CDSC may be waived in connection with redemptions to fund
participation in certain fee-based programs. See "Class A" and "Class D"
below.
(4) The CDSC may be modified in connection with redemptions to fund
participation in certain fee-based programs.
(5) The conversion period for dividend reinvestment shares and certain fee-based
programs may be 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.
(6) The CDSC may be waived in connection with redemptions to fund participation
in certain fee-based programs.
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
4
<PAGE> 7
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. Other
eligible investors include participants in certain fee-based programs. In
addition, Class A shares will be offered at net asset value to Merrill
Lynch & Co., Inc. ("ML&Co.") and its subsidiaries (the term
"subsidiaries", when used herein with respect to ML&Co., includes MLAM,
the Manager and certain other entities directly or indirectly
wholly-owned and controlled by ML&Co.) and their directors and employees,
and to members of the Boards of MLAM-advised mutual funds. The maximum
initial sales charge is 4.00%, which is reduced for purchases of $25,000
and over and waived for purchases of Class A shares in connection with
certain fee-based programs. Purchases of $1,000,000 or more may not be
subject to an initial sales charge but if the initial sales charge is
waived, such purchases may be subject to a 1.0% CDSC if the shares are
redeemed within one year after purchase. Such CDSC may be waived in
connection with redemptions to fund participation in certain fee-based
programs. 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, as well as a CDSC if they are
redeemed within four years of purchase. Such CDSC may be modified in
connection with redemptions to fund participation in certain fee-based
programs. 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 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
1.0% CDSC if they are redeemed within one year after purchase. Such
CDSC may be waived in connection with redemptions to fund participation
in certain fee-based programs. Although Class C shares are subject to a
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 account maintenance and
5
<PAGE> 8
higher 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.
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 may be subject to a CDSC of up to 1.0% if the shares are
redeemed within one year after purchase. Such CDSC may be waived in
connection with redemptions to fund participation in certain fee-based
programs. The schedule of initial sales charges and reductions for
Class D shares is the same as the schedule for Class A shares, except
that there is no waiver for purchases of Class D shares in connection
with certain fee-based programs. 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 that prefer an initial sales
charge alternative may elect to purchase Class D shares or, if an eligible
investor, Class A shares. Investors choosing the initial sales charge
alternative who are eligible to purchase Class A shares should purchase Class A
shares rather than Class D shares because there is an account maintenance fee
imposed on Class D shares. Investors qualifying for significantly reduced
initial sales charges may find the initial sales charge alternative particularly
attractive because similar sales charge reductions are not available with
respect to the CDSCs 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
6
<PAGE> 9
of the Fund after a conversion period of approximately ten years, and thereafter
investors will be subject to lower ongoing fees.
Certain investors may elect to purchase Class B shares if they determine it
to be most advantageous to have all 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> 10
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, 1996 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. Further information about the performance of the Fund is contained
in the Fund's most recent annual report to shareholders which may be obtained,
without charge, by calling or by writing the Trust at the telephone number or
address on the front cover of this Prospectus.
<TABLE>
<CAPTION>
CLASS A
-----------------------------------------------------
FOR THE YEAR FOR THE PERIOD
ENDED AUGUST 31, FEBRUARY 26, 1993+
-------------------------------- TO AUGUST 31,
1996 1995 1994 1993
------- ------- ------- ------------------
<S> <C> <C> <C> <C>
Increase (Decrease) in Net Asset Value:
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period............... $ 9.65 $ 9.54 $ 10.23 $ 10.00
------- ------- ------- -------
Investment income--net............................. .52 .52 .51 .24
Realized and unrealized gain (loss) on
investments--net.................................. .19 .11 (.65) .23
------- ------- ------- -------
Total from investment operations................... .71 .63 (.14) .47
------- ------- ------- -------
Less dividends and distributions:
Investment income--net............................. (.52) (.52) (.51) (.24)
Realized gain on investments--net.................. -- -- (.04) --
------- ------- ------- -------
Total dividends and distributions.................. (.52) (.52) (.55) (.24)
------- ------- ------- -------
Net asset value, end of period..................... $ 9.84 $ 9.65 $ 9.54 $ 10.23
======== ======== ======== ========
TOTAL INVESTMENT RETURN**:
Based on net asset value per share................. 7.44% 6.94% (1.44%) 4.81%#
======== ======== ======== ========
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of reimbursement..................... .49% .47% .33% .14%*
======== ======== ======== ========
Expenses........................................... .85% .87% .96% 1.06%*
======== ======== ======== ========
Investment income--net............................. 5.20% 5.53% 5.16% 4.80%*
======== ======== ======== ========
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands)........... $14,183 $14,204 $15,946 $ 17,105
======== ======== ======== ========
Portfolio Turnover................................. 87.77% 61.53% 93.04% 74.26%
======== ======== ======== ========
<CAPTION>
CLASS B
-------------------------------------------------------------
FOR THE YEAR FOR THE PERIOD
ENDED AUGUST 31, FEBRUARY 26, 1993+
---------------------------------------- TO AUGUST 31,
1996 1995 1994 1993
------------- --------- --------- ------------------
<S> <C> <C> <C> <C>
Increase (Decrease) in Net Asset Value:
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period............... $ 9.65 $ 9.54 $ 10.23 $ 10.00
------- ------- ------- -------
Investment income--net............................. .47 .48 .46 .22
Realized and unrealized gain (loss) on
investments--net.................................. .19 .11 (.65) .23
------- ------- ------- -------
Total from investment operations................... .66 .59 (.19) .45
------- ------- ------- -------
Less dividends and distributions:
Investment income--net............................. (.47) (.48) (.46) (.22)
Realized gain on investments--net.................. -- -- (.04) --
------- ------- ------- -------
Total dividends and distributions.................. (.47) (.48) (.50) (.22)
------- ------- ------- -------
Net asset value, end of period..................... $ 9.84 $ 9.65 $ 9.54 $ 10.23
======= ======== ======== ========
TOTAL INVESTMENT RETURN**:
Based on net asset value per share................. 6.89% 6.38% (1.93%) 4.56%#
======= ======== ======== ========
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of reimbursement..................... .99% .97% .83% .64%*
======= ======== ======== ========
Expenses........................................... 1.36% 1.38% 1.48% 1.56%*
======= ======== ======== ========
Investment income--net............................. 4.69% 5.02% 4.67% 4.31%*
======= ======== ======== ========
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands)........... $ 73,292 $ 71,670 $ 74,982 $ 72,861
======= ======== ======== ========
Portfolio Turnover................................. 87.77% 61.53% 93.04% 74.26%
======= ======== ======== ========
</TABLE>
- ---------------
+ Commencement of operations.
* Annualized.
** Total investment returns exclude the effects of sales loads.
# Aggregate total investment return.
8
<PAGE> 11
<TABLE>
<CAPTION>
CLASS C CLASS D
------------------------ ------------------------
FOR THE FOR THE
FOR THE PERIOD FOR THE PERIOD
YEAR OCTOBER 21, YEAR OCTOBER 21,
ENDED 1994+ TO ENDED 1994+ TO
AUGUST 31, AUGUST 31, AUGUST 31, AUGUST 31,
1996 1995 1996 1995
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Increase (Decrease) in Net Asset Value:
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period........ $ 9.64 $ 9.19 $ 9.65 $ 9.19
---------- ---------- ---------- ----------
Investment income--net...................... .46 .39 .51 .44
Realized and unrealized gain on
investments--net.......................... .20 .45 .20 .46
---------- ---------- ---------- ----------
Total from investment operations............ .66 .84 .71 .90
---------- ---------- ---------- ----------
Less dividends from investment
income--net............................... (.46) (.39) (.51) (.44)
---------- ---------- ---------- ----------
Net asset value, end of period.............. $ 9.84 $ 9.64 $ 9.85 $ 9.65
========== ========== ========== ==========
TOTAL INVESTMENT RETURN**:
Based on net asset value per share.......... 6.90% 9.38%# 7.44% 9.99%#
========== ========== ========== ==========
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of reimbursement.............. 1.10% 1.09%* .59% .57%*
========== ========== ========== ==========
Expenses.................................... 1.46% 1.49%* .95% .97%*
========== ========== ========== ==========
Investment income--net...................... 4.59% 4.76%* 5.09% 5.33%*
========== ========== ========== ==========
SUPPLEMENTAL DATA:
Net Assets, end of period (in thousands).... $ 4,901 $ 1,778 $ 4,304 $ 1,845
========== ========== ========== ==========
Portfolio Turnover.......................... 87.77% 61.53% 87.77% 61.53%
========== ========== ========== ==========
</TABLE>
- ---------------
+ Commencement of operations.
* Annualized.
** Total investment returns exclude the effects of sales loads.
# Aggregate total investment return.
9
<PAGE> 12
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 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
Ratings Services ("Standard & Poor's") (currently AAA, AA, A and BBB) or Fitch
Investors Service, Inc. ("Fitch") (currently AAA, AA, A and BBB). If Municipal
Bonds are unrated, such securities will possess creditworthiness comparable, in
the opinion of the Manager, to obligations in which the Fund may invest.
Municipal Bonds rated in the fourth highest rating category, while considered
"investment grade", have certain speculative characteristics and are more likely
to be downgraded to non-investment grade than obligations rated in one of the
top three rating categories. See Appendix II--"Ratings of Municipal Bonds" in
the Statement of Additional Information for more information regarding ratings
of debt securities. An issue of rated Municipal Bonds may cease to be rated or
its rating may be reduced below "investment grade" subsequent to its purchase by
the Fund. If an obligation is downgraded below investment grade, the Manager
will consider factors such as price, credit risk, market conditions, financial
condition of the issuer and interest rates to determine whether to continue to
hold the obligation in the Fund's portfolio.
The Fund may invest up to 20% of its total assets in Municipal Bonds that
are rated below Baa by Moody's or below BBB by Standard & Poor's or Fitch, or
which in the Manager's judgment, possess similar credit characteristics. Such
securities, sometimes referred to as "high yield" or "junk" bonds, are
predominantly speculative with respect to the capacity to pay interest and repay
principal in accordance with the terms of the security and generally involve a
greater volatility of price than securities in higher rating categories. The
market prices of high yielding, lower-rated securities may fluctuate more than
higher-rated securities and may decline significantly in periods of general
economic difficulty, which may follow periods of rising interest rates. In
purchasing such securities, the Fund will rely on the Manager's judgment,
analysis and experience in evaluating the creditworthiness of the issuer of such
securities. The Manager will take into consideration,
10
<PAGE> 13
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 value of Municipal Bonds may fall when interest rates rise and rise
when interest rates fall. In general, Municipal Bonds with longer maturities
will be subject to greater volatility resulting from interest rate fluctuations
than will similar obligations with shorter maturities.
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 judgment of the Trustees, such VRDO is
liquid. The Trustees may adopt guidelines and delegate to the Manager the daily
function of determining and monitoring liquidity of such VRDOs. The Trustees,
however, will retain sufficient oversight and be ultimately responsible for such
determinations.
The Fund ordinarily does not intend to realize investment income not exempt
from Federal and 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, income taxation. The Fund also
may invest in securities not issued by or on behalf of a state or territory or
by an agency or instrumentality thereof, if the Fund nevertheless believes such
securities to be exempt from Federal income taxation ("Non-Municipal Tax-Exempt
Securities"). Non-Municipal Tax-Exempt Securities may include securities issued
by other investment companies that invest in municipal
11
<PAGE> 14
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. Under normal conditions, it is generally anticipated that the Fund's
average weighted maturity would be in excess of ten years. 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"). 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 through SP-2 for notes and A-1 through
A-3 for VRDOs and commercial paper (as determined by Standard & Poor's), or F-1
through F-3 for notes, VRDOs and commercial paper (as determined by Fitch) or,
if unrated, of comparable quality in the opinion of the Manager. The Fund at all
times will have at least 80% of its 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 anticipated
12
<PAGE> 15
that 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.
13
<PAGE> 16
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 MUNICIPAL 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 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".
Moreover, 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. Since the start of the 1990-91 fiscal year, the
State of California has faced the worst economic, fiscal and budget conditions
since the 1930's. On July 5, 1994, all three of the rating agencies rating the
State of California's long-term debt lowered their ratings of the State of
California's general obligation bonds. Moody's lowered its rating from "Aa" to
"A1", Standard & Poor's lowered its rating from "A+" to "A" and termed its
outlook as "stable", and Fitch lowered its rating from "AA" to "A". No assurance
can be given that such ratings will not be lowered in the future. Although a
steady upturn has been underway since 1994, pre-recession job levels are not
expected to be reached until later in the decade. 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
14
<PAGE> 17
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 latter category includes industrial
development bonds ("IDBs") and, for bonds issued after August 15, 1986, private
activity bonds. General obligation bonds are secured by the issuer's pledge of
its faith, credit and taxing power for the repayment of principal and the
payment of interest. The taxing power of any governmental entity may be limited,
however, by provisions of its state constitution or laws, and an entity's
creditworthiness will depend on many factors, including potential erosion of its
tax base due to population declines, natural disasters, declines in the state's
industrial 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 may purchase IDBs and private activity bonds. IDBs and private
activity bonds are, in most cases, 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 generally 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. 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
so-called "moral obligation" bonds, which are normally issued by special purpose
15
<PAGE> 18
public authorities. 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 state or municipality in question.
The Fund may invest in Municipal Bonds (and Non-Municipal Tax-Exempt
Securities) the return on which is based on a particular index of value or
interest rates. For example, the Fund may invest in Municipal Bonds that pay
interest based on an index of Municipal Bond interest rates or based on the
value of gold or some other commodity. The principal amount payable upon
maturity of certain Municipal Bonds also may be based on the value of an index.
To the extent the Fund invests in these types of Municipal Bonds, the Fund's
return on such Municipal Bonds will be subject to risk with respect to the value
of the particular index. Interest and principal payable on the Municipal Bonds
may also be based on relative changes among particular indices. Also, the Fund
may invest in so-called "inverse floating obligations" or "residual interest
bonds" on which the interest rates typically decline as market rates increase
and increase as market rates decline. The Fund's return on such types of
Municipal Bonds (and Non-Municipal Tax-Exempt Securities) will be subject to
risk with respect to the value of the particular index, which may include
reduced or eliminated interest payments and losses of invested principal. Such
securities have the effect of providing a degree of investment leverage, since
they may increase or decrease in value in response to changes, as an
illustration, in market interest rates at a rate which is a multiple (typically
two) of the rate at which fixed-rate long-term tax exempt securities increase or
decrease in response to such changes. As a result, the market values of such
securities will generally be more volatile than the market values of fixed-rate
tax exempt securities. To seek to limit the volatility of these securities, the
Fund may purchase inverse floating obligations with shorter term maturities or
which contain limitations on the extent to which the interest rate may vary.
Certain investments in such obligations may be illiquid. The Fund may not invest
in such illiquid obligations if such investments, together with other illiquid
investments, would exceed 15% of the Fund's total assets. The Manager, however,
believes that indexed and inverse floating obligations represent flexible
portfolio management instruments for the Fund which allow the Fund to seek
potential investment rewards, hedge other portfolio positions or vary the degree
of investment leverage relatively efficiently under different market conditions.
Also included within the general category of Municipal Bonds are
participation certificates issued by government authorities or entities to
finance the acquisition or construction of equipment, land and/or facilities.
The certificates represent participations in a lease, an installment purchase
contract or a conditional sales contract (hereinafter collectively called "lease
obligations") relating to such equipment, land or facilities. Although lease
obligations do not constitute general obligations of the issuer for which the
issuer's unlimited taxing power is pledged, a lease obligation is frequently
backed by the issuer's covenant to budget for, appropriate and make the payments
due under the lease obligation. However, certain lease obligations contain
"non-appropriation" clauses which provide that the issuer has no obligation to
make lease or installment purchase payments in future years unless money is
appropriated for such purpose on a yearly basis. Although "non-appropriation"
lease obligations are secured by the leased property, disposition of the
property in the event of foreclosure might prove difficult. These securities
represent a 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
16
<PAGE> 19
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 obligations rated below investment grade, 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.
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 liquid securities having a market value at all times at
least equal to the amount of the forward commitment.
CALL RIGHTS
The Fund may purchase a Municipal Bond issuer's right to call all or a
portion of such Municipal Bond for mandatory tender for purchase (a "Call
Right"). A holder of a Call Right may exercise such right to require a mandatory
tender for the purchase of related Municipal Bonds, subject to certain
conditions. A Call Right that is not exercised prior to the maturity of the
related Municipal Bond will expire without value. The economic effect of holding
both the Call Right and the related Municipal Bond is identical to that of
holding a Municipal Bond as a non-callable security. Certain investments in such
obligations may be illiquid. The Fund may not invest in such illiquid
obligations if such investments, together with other illiquid investments, would
exceed 15% 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
17
<PAGE> 20
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 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-
18
<PAGE> 21
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 tender adjustable
notes) or liquid 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
19
<PAGE> 22
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 total assets. In the event of default by the
seller under a repurchase agreement, the Fund may suffer time delays and incur
costs or possible losses in connection with the disposition of the underlying
securities.
INVESTMENT RESTRICTIONS
The Fund's investment activities are subject to further restrictions that
are described in the Statement of Additional Information. Investment
restrictions and policies which are fundamental policies 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 which means the lesser of (i) 67%
of the shares represented at a meeting at which more than 50% of the outstanding
shares are represented or (ii) more than 50% of the outstanding shares. Among
its fundamental policies, the Fund may not invest more than 25% of its assets,
taken at market value at the time of each investment, in the securities of
issuers in any particular industry (excluding the U.S. Government and its
agencies and instrumentalities) (For purposes of this restriction, states,
municipalities and their political subdivisions are not considered to be part of
any industry). Investment restrictions and policies that are non-fundamental
policies may be changed by the Board of Trustees without shareholder approval.
As a non-fundamental policy, the Fund may not borrow amounts in excess of 20% of
its total assets taken at market value (including the amount borrowed), and then
only from banks as a temporary measure for extraordinary or emergency purposes.
In addition, the Fund will not purchase securities while borrowings are
outstanding.
As a non-fundamental policy, the Fund will not invest in securities which
cannot be readily resold because of legal or contractual restrictions or which
cannot otherwise be marketed, redeemed or put to the issuer or a third party, if
at the time of acquisition more than 15% of its total assets would be invested
in such securities. This restriction shall not apply to securities which mature
within seven days or securities which the Board of Trustees of the Trust has
otherwise determined to be liquid pursuant to applicable law. The Fund is
classified as non-diversified within the meaning of the 1940 Act, which means
that the Fund is not limited by the 1940 Act in the proportion of its assets
that it may invest in obligations of a single issuer. However, the Fund's
investments will be limited so as to qualify for the special treatment afforded
regulated investment companies under the Code. See "Distribution and
Taxes--Taxes". To qualify, among other requirements, the Trust will limit the
Fund's investment so that, at the close of each quarter of the taxable year, (i)
not more than 25% of the market value of the Fund's total assets will be
invested in the securities of a single issuer, and (ii) with respect to 50% of
the market value of its total assets, not more than 5% of the market value of
its total assets will be invested in the securities of a single issuer and the
Fund will not own more than 10% of the outstanding voting securities of a single
issuer. For purposes of this restriction, the Fund will regard each state and
each political subdivision, agency or instrumentality of such state and each
multi-state agency of which such state is a member and each public authority
which issues securities on behalf of a private entity as a separate issuer,
except that if the security is backed only by the assets and revenues of a
non-government entity then the entity with the ultimate responsibility for the
payment of interest and principal may be regarded as the sole issuer. These
tax-related limitations may be changed by the Trustees of the Trust to the
20
<PAGE> 23
extent necessary to comply with changes to the Federal tax requirements. A fund
which elects to be classified as "diversified" under the 1940 Act must satisfy
the foregoing 5% and 10% requirements with respect to 75% of its total assets.
To the extent that the Fund assumes large positions in the obligations of a
small number of issuers, the Fund's total return may fluctuate to a greater
extent than that of a diversified company as a result of changes in the
financial condition or in the market's assessment of the issuers.
Investors are referred to the Statement of Additional Information for a
complete description of the Fund's investment restrictions.
MANAGEMENT OF THE TRUST
TRUSTEES
The Trustees of the Trust consist of six individuals, five of whom are not
"interested persons" of the Trust as defined in the 1940 Act. The Trustees are
responsible for the overall supervision of the operations of the Trust and the
Fund and perform the various duties imposed on the directors or trustees of
investment companies by the 1940 Act.
The Trustees are:
ARTHUR ZEIKEL*--President of the Manager and its affiliate, MLAM; President
and Director of Princeton Services, Inc. ("Princeton Services"); Executive Vice
President of ML&Co.; and Director of the Distributor.
JAMES H. BODURTHA--Director and Executive Vice President, The China
Business Group, Inc.
HERBERT I. LONDON--John M. Olin Professor of Humanities, New York
University.
ROBERT R. MARTIN--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
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 130 registered investment companies. MLAM also
provides investment advisory services to individual and institutional accounts.
As of November 30, 1996, the Manager and MLAM had a total of approximately
$223.7 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
21
<PAGE> 24
administrative services and provides all of the office space, facilities,
equipment and necessary personnel for management of the Fund.
Walter O'Connor is the Portfolio Manager of the Fund and is responsible for
the day-to-day management of the Fund's investment portfolio. He has been a Vice
President of MLAM since 1993 and was an Assistant Vice President thereof from
1991 to 1993. Prior thereto, he was an Assistant Vice President of Prudential
Securities from 1984 to 1991.
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, 1996, the total fee paid by the Fund to the
Manager was $517,728 (based on average net assets of approximately $93.6
million).
The Management Agreement obligates the Trust on behalf of the Fund to pay
certain expenses incurred in the Fund's operations, including, among other
things, the management fee, legal and audit fees, unaffiliated Trustees' fees
and expenses, registration fees, custodian and transfer agency fees, accounting
and pricing costs, and certain of the costs of printing proxies, shareholder
reports, prospectuses and statements of additional information. Accounting
services are provided to the Fund by the Manager, and the Fund reimburses the
Manager for its costs in connection with such services. The Manager may waive
all or a portion of its management fee and may voluntarily assume all or a
portion of the Fund's expenses. For the fiscal year ended August 31, 1996, the
Fund reimbursed the Manager $46,382 for accounting services. For the fiscal year
ended August 31, 1996, the ratio of total expenses, to average net assets was
.85% for Class A shares, 1.36% for Class B shares, 1.46% for Class C shares and
.95% for Class D shares.
CODE OF ETHICS
The Board of Trustees of the Trust has adopted a Code of Ethics under Rule
17j-1 of the 1940 Act which incorporates the Code of Ethics of the Manager
(together, the "Codes"). The Codes significantly restrict the personal investing
activities of all employees of the Manager and, as described below, impose
additional, more onerous, restrictions on fund investment personnel.
The Codes require that all employees of the Manager preclear any personal
securities investment (with limited exceptions, such as government securities).
The preclearance requirement and associated procedures are designed to identify
any substantive prohibition or limitation applicable to the proposed investment.
The substantive restrictions applicable to all employees of the Manager include
a ban on acquiring any securities in a "hot" initial public offering and a
prohibition from profiting on short-term trading in securities. In addition, no
employee may purchase or sell any security which at the time is being purchased
or sold (as the case may be), or to the knowledge of the employee is being
considered for purchase or sale, by any fund advised by the Manager.
Furthermore, the Codes provide for trading "blackout periods" which prohibit
trading by investment personnel of the Fund within periods of trading by the
Fund in the same (or equivalent) security (15 or 30 days depending upon
transaction).
22
<PAGE> 25
TRANSFER AGENCY SERVICES
Merrill Lynch Financial Data Services, Inc. (the "Transfer Agent"), which
is a wholly-owned subsidiary of ML&Co., acts as the Trust's transfer agent
pursuant to a transfer agency, dividend disbursing agency and shareholder
servicing agency agreement (the "Transfer Agency Agreement"). Pursuant to the
Transfer Agency Agreement, the Transfer Agent is responsible for the issuance,
transfer and redemption of shares and the opening and maintenance of shareholder
accounts. Pursuant to the Transfer Agency Agreement, the Fund pays the Transfer
Agent an annual fee of $11.00 per Class A or Class D shareholder account and
$14.00 per Class B or Class C shareholder account, and the Transfer Agent is
entitled to reimbursement from the Fund for out-of-pocket expenses incurred by
the Transfer Agent under the Transfer Agency Agreement. For the year ended
August 31, 1996, the Fund paid the Transfer Agent a total fee of $37,217
pursuant to the Transfer Agency Agreement for providing transfer agency
services. At November 30, 1996, the Fund had 211 Class A shareholder accounts,
1,613 Class B shareholder accounts, 111 Class C shareholder accounts and 75
Class D shareholder accounts. At this level of accounts, the annual fee paid to
the Transfer Agent would aggregate approximately $27,000, plus out-of-pocket
expenses.
PURCHASE OF SHARES
The Distributor, an affiliate of the Manager, MLAM and Merrill Lynch, acts
as the distributor of the shares of the Fund. Shares of the Fund are offered
continuously for sale by the Distributor and other eligible securities dealers
(including Merrill Lynch). Shares of the Fund may be purchased from securities
dealers or by mailing a purchase order directly to the Transfer Agent. The
minimum initial purchase is $1,000 and the minimum subsequent purchase is $50.
The Fund 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 Pricing(SM)
System, as described below. The applicable offering price for purchase orders is
based upon the net asset value of the Fund next determined after receipt of the
purchase orders by the Distributor. As to purchase orders received by securities
dealers prior to the close of business on the New York Stock Exchange (the
"NYSE") (generally, 4:00 P.M., New York time), which includes orders received
after the close of business on the previous day, the applicable offering price
will be based on the net asset value determined as of 15 minutes after the close
of business on the NYSE on that day, provided the Distributor in turn receives
the order from the securities dealer prior to 30 minutes after the close of
business on the NYSE on that day. If the purchase orders are not received by the
Distributor prior to 30 minutes after the close of business on the NYSE, 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
Pricing(SM) System, which permits each investor to choose the method of
purchasing shares that the investor believes is most beneficial given the
23
<PAGE> 26
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, ongoing distribution fees and higher account
maintenance fees. A discussion of the factors that investors should consider in
determining the method of purchasing shares under the Merrill Lynch Select
Pricing(SM) System is set forth under "Merrill Lynch Select Pricing(SM) 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
CDSCs and distribution and account maintenance fees that are imposed on Class B
and Class C shares, as well as the account maintenance fees that are imposed on
Class D shares, will be imposed directly against those classes and not against
all assets of the Fund and, accordingly, such charges will not affect the net
asset value of any other class or have any impact on investors choosing another
sales charge option. Dividends paid by the Fund for each class of shares will be
calculated in the same manner at the same time and will differ only to the
extent that account maintenance and distribution fees and any incremental
transfer agency costs relating to a particular class are borne exclusively by
that class. Class B, Class C and Class D shares each have exclusive voting
rights with respect to the Rule 12b-1 distribution plan adopted with respect to
such class pursuant to which account maintenance and/or distribution fees are
paid. See "Distribution Plans" below. Each class has different exchange
privileges. See "Shareholder Services-- Exchange Privilege".
Investors should understand that the purpose and function of the initial
sales charges with respect to Class A and Class D shares are the same as those
of the deferred sales charges with respect to Class B and Class C shares in that
the sales charges applicable to each class provide for the financing of the
distribution of the shares of the Fund. The distribution-related revenues paid
with respect to a class will not be used to finance the distribution
expenditures of another class. Sales personnel may receive different
compensation for selling different classes of shares. Investors are advised that
only Class A and Class D shares may be available for purchase through securities
dealers, other than Merrill Lynch, which are eligible to sell shares.
24
<PAGE> 27
The following table sets forth a summary of the distribution arrangements
for each class of shares under the Merrill Lynch Select Pricing(SM) System.
<TABLE>
<S> <C> <C> <C> <C>
- -------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------
ACCOUNT
MAINTENANCE DISTRIBUTION
CLASS SALES CHARGE(1) FEE FEE CONVERSION FEATURE
-----------------------------------------------------------------------------------------------
A Maximum 4.00% initial sales No
charge(2)(3) No No
-----------------------------------------------------------------------------------------------
B CDSC for a period of 4 years, at a
rate of 4.0% during the first
year, decreasing 1.0% annually to B shares convert to D shares
0.0%(4) 0.25% 0.25% automatically after
approximately ten years(5)
-----------------------------------------------------------------------------------------------
C 1.0% CDSC for one year(6) 0.25% 0.35% No
-----------------------------------------------------------------------------------------------
D Maximum 4.00% initial sales No
charge(3) 0.10% 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 and waived for purchases of Class A
shares in connection with certain fee-based programs. 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 a 1.0% CDSC if redeemed within one
year. Such CDSC may be waived in connection with redemptions to fund
participation in certain fee-based programs.
(4) The CDSC may be modified in connection with redemptions to fund
participation in certain fee-based programs.
(5) The conversion period for dividend reinvestment shares and certain fee-based
programs may be 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.
(6) The CDSC may be waived in connection with redemptions to fund participation
in certain fee-based programs.
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.
25
<PAGE> 28
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 SALES LOAD AS DISCOUNT TO
PERCENTAGE OF PERCENTAGE* OF SELECTED DEALERS
OFFERING THE NET AMOUNT AS PERCENTAGE OF
AMOUNT OF PURCHASE 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 and on Class A purchases in connection with certain
fee-based programs. If the sales charge is waived in connection with a
purchase of $1,000,000 or more, such purchases may be subject to a CDSC of
1.0% if the shares are redeemed within one year after purchase. Such CDSC may
be waived in connection with redemptions to fund participation in certain
fee-based programs. 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, 1996, the Fund sold 192,761 Class A shares for
aggregate net proceeds of $1,890,855. The gross sales charges for the sale of
Class A shares of the Fund for that year were $9,669, of which $1,410 and $8,259
were received by the Distributor and Merrill Lynch, respectively. For the fiscal
year ended August 31, 1996, the Distributor received no CDSCs with respect to
redemption within one year after purchase of Class A shares purchased subject to
a front-end sales charge waiver. During the fiscal year ended August 31, 1996,
the Fund sold 263,889 Class D shares for aggregate net proceeds of $2,602,675.
The gross sales charges for the sale of Class D shares of the Fund for the year
were $11,008, of which $912 and $10,096 were received by the Distributor and
Merrill Lynch, respectively. For the fiscal year ended August 31, 1996, the
Distributor received no CDSCs with respect to redemption within one year after
purchase of Class D shares purchased subject to a front-end sales charge waiver.
Eligible Class A Investors. Class A shares are offered to a limited group
of investors and also will be issued upon reinvestment of dividends on
outstanding Class A shares. Investors that currently own Class A shares of the
Fund in a shareholder account are entitled to purchase additional Class A shares
of the Fund in that account. Class A shares are available at net asset value to
corporate warranty insurance reserve fund programs, provided that 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, collective
investment trusts for which Merrill Lynch Trust Company serves as trustee, and
purchases made in connection with certain fee-based programs. In addition, Class
A shares are offered at net asset value to ML&Co. and its subsidiaries and their
directors and employees and to members of the Boards of MLAM-advised investment
companies, including the Trust. Certain persons who acquired shares of certain
26
<PAGE> 29
MLAM-advised closed-end funds in their initial offerings who wish to reinvest
the net proceeds from a sale of their closed-end fund shares of common stock in
shares of the Fund also may purchase Class A shares of the Fund if certain
conditions set forth in the Statement of Additional Information are met. In
addition, 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. and, if certain conditions set forth in the Statement of
Additional Information are met, to shareholders of Merrill Lynch Municipal
Strategy Fund, Inc. and Merrill Lynch High Income Municipal Bond Fund, Inc. who
wish to reinvest the net proceeds from a sale of certain of their shares of
common stock pursuant to a tender offer conducted by such funds in shares of the
Fund and certain other MLAM-advised mutual 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". See "Shareholder Services --
Fee-Based Programs". Class A and Class D shares are offered at net asset value
to Employee Access Accounts(SM) available through qualified employers which
provide employer-sponsored retirement and savings plans that are eligible to
purchase such shares at net asset value. Class A shares are offered at net asset
value to shareholders of Merrill Lynch Senior Floating Rate Fund, Inc. and,
subject to certain conditions, Class A and Class D shares are offered at net
asset value to shareholders of Merrill Lynch Municipal Strategy Fund, Inc. and
Merrill Lynch High Income Municipal Bond Fund, Inc., who wish to reinvest in
shares of the Fund the net proceeds from a sale of certain of their shares of
common stock, pursuant to tender offers conducted by those funds.
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
ongoing account maintenance fees are used to compensate Merrill Lynch for
providing continuing account maintenance activities.
27
<PAGE> 30
Class B and Class C shares are sold without an initial sales charge so that
the Fund will receive the full amount of the investor's purchase payment.
Merrill Lynch compensates its financial consultants for selling Class B and
Class C shares at the time of purchase from its own funds. See "Distribution
Plans".
Proceeds from the CDSC and the distribution fee are paid to the Distributor
and are used in whole or in part by the Distributor to defray the expenses of
dealers (including Merrill Lynch) related to providing distribution-related
services to the Fund in connection with the sale of the Class B and Class C
shares, such as the payment of compensation to financial consultants for selling
Class B and Class C shares, from 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
YEAR SINCE PURCHASE OF 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, 1996, the Distributor received CDSCs of
$157,396 with respect to redemptions of Class B shares, all of which were paid
to Merrill Lynch.
28
<PAGE> 31
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 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).
The Class B CDSC is waived on redemptions of shares following the death or
disability (as defined in the Code) of a shareholder. Additional information
concerning the waiver of the Class B CDSC is set forth in the Statement of
Additional Information. The terms of the CDSC may be modified in connection with
redemptions to fund participation in certain fee-based programs. See
"Shareholder Services--Fee-Based Programs".
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. For the fiscal year ended August 31,
1996, the Distributor received CDSCs of $2,319 with respect to redemptions of
Class C shares, all of which were paid to Merrill Lynch. No CDSC will be
assessed in connection with redemptions to fund participation in certain fee-
based programs. See "Shareholder Services--Fee-Based Programs".
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
29
<PAGE> 32
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 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.
The Conversion Period may be modified for investors that participate in
certain fee-based programs. See "Shareholder Services--Fee-Based Programs".
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
30
<PAGE> 33
purchase Class B and Class C shares through dealers without the assessment of an
initial sales charge and at the same time permit the dealer to compensate its
financial consultants in connection with the sale of the Class B and Class C
shares. In this regard, the purpose and function of the ongoing distribution
fees and the CDSC are the same as those of the initial sales charge with respect
to the Class A and Class D shares of the Fund in that the deferred sales charges
provide for the financing of the distribution of the Fund's Class B and Class C
shares.
For the fiscal year ended August 31, 1996, the Fund paid the Distributor
$365,327 pursuant to the Class B Distribution Plan (based on average net assets
subject to such Class B Distribution Plan of approximately $72.7 million), all
of which was paid to Merrill Lynch for providing account maintenance and
distribution-related activities and services in connection with Class B shares.
For the fiscal year ended August 31, 1996, the Fund paid the Distributor $21,063
pursuant to the Class C Distribution Plan (based on average net assets subject
to such Class C Distribution Plan of approximately $3.5 million), all of which
was paid to Merrill Lynch for providing account maintenance and
distribution-related activities and services in connection with Class C shares.
For the fiscal year ended August 31, 1996, the Fund paid the Distributor $3,122
pursuant to the Class D Distribution Plan (based on average net assets subject
to such Class D Distribution Plan of approximately $3.1 million), all of which
was paid to Merrill Lynch for providing account maintenance activities in
connection with Class D shares. At November 30, 1996, the net assets of the Fund
subject to the Class B Distribution Plan aggregated approximately $74.0 million.
At this asset level, the annual fee payable pursuant to such Class B
Distribution Plan would aggregate approximately $370,000. At November 30, 1996,
the net assets of the Fund subject to the Class C Distribution Plan aggregated
approximately $5.0 million. At this asset level, the annual fee payable pursuant
to such Class C Distribution Plan would aggregate approximately $30,000. At
November 30, 1996, the net assets of the Fund subject to the Class D
Distribution Plan aggregated approximately $4.6 million. At this asset level,
the annual fee payable pursuant to such Class D Distribution Plan would
aggregate $4,600.
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 CDSCs 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 December 31, 1995, the fully allocated accrual expenses incurred by
the Distributor and Merrill Lynch for the period since the commencement of
operations of Class B shares exceeded fully allocated accrual revenues for such
period by approximately $1,554,000 (2.11% of Class B net assets at that date).
As of August 31, 1996, direct cash revenues for the period since the
commencement of operations of Class B shares exceeded direct cash expenses by
approximately $295,705 (0.40% of Class B net assets at that date). Similar fully
allocated accrual data for Class C shares is not presented because such revenues
and expenses for the
31
<PAGE> 34
period from October 21, 1994 (commencement of operations) to December 31, 1995
are de minimis. As of August 31, 1996, direct cash revenues for the period since
the commencement of operations of Class C shares exceeded direct cash expenses
by $8,880 (0.18% of Class C 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 Conduct Rules of the NASD imposes a
limitation on certain asset-based sales charges such as the distribution fee and
the CDSC borne by the Class B and Class C shares but not the account maintenance
fee. The maximum sales charge rule is applied separately to each class. As
applicable to the Fund, the maximum sales charge rule limits the aggregate of
distribution fee payments and CDSCs payable by the Fund to (1) 6.25% of eligible
gross sales of Class B shares and Class C shares, computed separately (defined
to exclude shares issued pursuant to dividend reinvestments and exchanges), plus
(2) interest on the unpaid balance for the respective class, computed
separately, at the prime rate plus 1% (the unpaid balance being the maximum
amount payable minus amounts received from the payment of the distribution fee
and the CDSC). In connection with the Class B shares, the Distributor has
voluntarily agreed to waive interest charges on the unpaid balance in excess of
0.50% of eligible gross sales. Consequently, the maximum amount payable to the
Distributor (referred to as the "voluntary maximum") in connection with the
Class B shares is 6.75% of eligible gross sales. The Distributor retains the
right to stop waiving the interest charges at any time. To the extent payments
would exceed the voluntary maximum, the Fund will not make further payments of
the distribution fee with respect to 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
32
<PAGE> 35
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, Merrill Lynch Financial Data Services, Inc.,
P.O. Box 45289, Jacksonville, Florida 32232-5289. Redemption requests delivered
other than by mail should be delivered to Merrill Lynch Financial Data Services,
Inc., 4800 Deer Lake Drive East, Jacksonville, Florida 32246-6484. Proper notice
of redemption in the case of shares deposited with the Transfer Agent may be
accomplished by a written letter requesting redemption. Proper notice of
redemption in the case of shares for which certificates have been issued may be
accomplished by a written letter as noted above accompanied by certificates for
the shares to be redeemed. Redemption requests should not be sent to the Trust.
The notice in either event requires the signature(s) of all persons in whose
name(s) the shares are registered, signed exactly as such name(s) appear(s) on
the Transfer Agent's register. The signature(s) on the redemption request must
be guaranteed by an "eligible guarantor institution" as such term is defined in
Rule 17Ad-15 under the Securities Exchange Act of 1934, as amended, the
existence and validity of which may be verified by the Transfer Agent through
the use of industry publications. Notarized signatures are not sufficient. In
certain instances, the Transfer Agent may require additional documents such as,
but not limited to, trust instruments, death certificates, appointments as
executor or administrator, or certificates of corporate authority. For
shareholders redeeming directly with the Transfer Agent, payments will be mailed
within seven days of receipt of a proper notice of redemption.
At various times the Trust may be requested to redeem Fund shares for which
it has not yet received good payment (e.g., cash, Federal funds or certified
check drawn on a United States bank). The Trust may delay or cause to be delayed
the mailing of a redemption check until such time as it has assured itself that
good payment has been collected for the purchase of such Fund shares, which may
take up to 10 days.
REPURCHASE
The Trust also will repurchase Fund shares through a shareholder's listed
securities dealer. The Trust normally will accept orders to repurchase Fund
shares by wire or telephone from dealers for their customers at the net asset
value next computed after receipt of the order by the dealer, provided that the
request for repurchase is received by the dealer prior to the close of business
on the NYSE (generally, 4:00 P.M., New York time) on the day received and is
received by the Fund from such dealer not later than 30 minutes after the close
of business on the NYSE on the same day. Dealers have the responsibility of
submitting such repurchase requests to the Trust not later than 30 minutes after
the close of business on the NYSE in order to obtain that day's closing price.
The foregoing 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. Repurchases 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.
33
<PAGE> 36
Redemption payments will be made within seven days of the proper tender of
the certificates, if any, and stock power or letter requesting redemption, in
each instance with signatures guaranteed as noted above.
REINSTATEMENT PRIVILEGE--CLASS A AND CLASS D SHARES
Shareholders who have redeemed their Class A or Class D shares have a
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. Alternatively, the
reinstatement privilege may be exercised through the investor's Merrill Lynch
Financial Consultant 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.
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 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 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.
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EXCHANGE PRIVILEGE
U.S. 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 Pricing(SM) System, Class A shareholders may
exchange Class A shares of the Fund for Class A shares of a second MLAM-advised
mutual fund if the shareholder holds any Class A shares of the second fund in
his 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 are exchangeable with shares of the
same class of other MLAM-advised mutual funds.
Shares of the Fund which are subject to a CDSC are exchangeable on the
basis of relative net asset value per share without the payment of any CDSC that
might otherwise be due upon redemption of the shares of the Fund. For purposes
of computing the CDSC that may be payable upon a disposition of the shares
acquired in the exchange, the holding period for the previously owned shares of
the Fund is "tacked" to the holding period for the newly acquired shares of the
other fund.
Class A, Class B, Class C and Class D shares also are exchangeable for
shares of certain MLAM-advised money market funds specifically designated as
available for exchange by holders of Class A, Class B, Class C or Class D
shares. The period of time that Class A, Class B, Class C or Class D shares are
held in a money market fund, however, will not count toward satisfaction of the
holding period requirement for reduction of any CDSC imposed on such shares, if
any, and with respect to Class B shares, toward satisfaction of the Conversion
Period.
Class B shareholders of the Fund exercising the exchange privilege will
continue to be subject to the Fund's CDSC schedule if such schedule is higher
than the CDSC schedule relating to the new Class B shares. 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.
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Exercise of the exchange privilege is treated as a sale of the exchanged
shares and a purchase of the acquired shares for Federal income tax purposes.
For further information, see "Shareholder Services-- Exchange Privilege" in the
Statement of Additional Information.
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 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. Alternatively, a Class A or Class D
shareholder whose shares are held within a CMA(R) or CBA(R) Account may elect to
have shares redeemed on a monthly, bimonthly, quarterly, semiannual or annual
basis through the CMA(R) or CBA(R) 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)
or CBA(R) accounts may arrange to have periodic investments made in the Fund in
their CMA(R) or CBA(R) account or in certain related accounts in amounts of $100
or more through the CMA(R) or CBA(R) Automated Investment Program.
FEE-BASED PROGRAMS
Certain Merrill Lynch fee-based programs, including pricing alternatives
for securities transactions (each referred to in this paragraph as a "Program"),
may permit the purchase of Class A shares at net asset value. Under specified
circumstances, participants in certain Programs may deposit other classes of
shares which will be exchanged for Class A shares. Initial or deferred sales
charges otherwise due in connection with such exchanges may be waived or
modified, as may the Conversion Period applicable to the deposited shares.
Termination of participation in a Program may result in the redemption of shares
held therein or the automatic exchange thereof to another class at net asset
value, which may be shares of a money market fund. In addition, upon termination
of participation in a Program, shares that have been held for less than
specified periods within such Program may be subject to a fee based upon the
current value of such shares. These Programs also generally prohibit such shares
from being transferred to another account at Merrill Lynch, to another
broker-dealer or to the Transfer Agent. Except in limited circumstances (which
may also involve an exchange as described above), such shares must be redeemed
and another class of shares purchased (which
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<PAGE> 39
may involve the imposition of initial or deferred sales charges and distribution
and account maintenance fees) in order for the investment not to be subject to
Program fees. Additional information regarding a specific Program (including
charges and limitations on transferability applicable to shares that may be held
in such Program) is available in such Program's client agreement and from
Merrill Lynch Investor Services at (800) MER-FUND (637-3863).
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. The Trust has applied for an exemptive order, subject to certain
conditions, permitting the Trust to, among other things, (i) purchase investment
grade tax-exempt securities from Merrill Lynch when Merrill Lynch is a member of
an underwriting syndicate for such securities and (ii) purchase tax-exempt
securities from and sell tax-exempt securities to Merrill Lynch in secondary
market transactions. Affiliated persons of the Trust may serve as its broker in
over-the-counter transactions conducted for the Fund on an agency basis only.
DISTRIBUTIONS AND TAXES
DISTRIBUTIONS
The net investment income of the Fund is declared as dividends daily prior
to the determination of the net asset value which is calculated 15 minutes after
the close of business on the NYSE (generally, 4:00 P.M., New York time) on that
day. The net investment income of the Fund for dividend purposes consists of
interest earned on portfolio securities, less expenses, in each case computed
since the most recent determination of the net asset value. Expenses of the
Fund, including the management fees and the account maintenance and
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<PAGE> 40
distribution fees, are accrued daily. Dividends of net investment income are
declared daily and reinvested monthly in the form of additional full and
fractional shares of the Fund at net asset value as of the close of business on
the "payment date" unless the shareholder elects to receive such dividends in
cash. Shares will accrue dividends as long as they are issued and outstanding.
Shares are issued and outstanding from the settlement date of a purchase order
to the day prior to the settlement date of a redemption order.
All net realized long- or short-term capital gains, if any, are declared
and distributed to the Fund's shareholders at least annually. Capital gains
distributions will be reinvested automatically in shares unless the shareholder
elects to receive such distributions in cash.
The per share dividends and distributions on each class of shares will be
reduced as a result of any account maintenance, distribution and transfer agency
fees applicable to that class. See "Additional Information--Determination of Net
Asset Value".
See "Shareholder Services" for information as to how to elect either
dividend reinvestment or cash payments. Portions of dividends and distributions
which are taxable to shareholders as described below are subject to income tax
whether they are reinvested in shares of the Fund or received in cash.
TAXES
The Trust intends to continue to qualify the Fund for the special tax
treatment afforded regulated investment companies ("RICs") under the Code. If it
so qualifies, 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" by the Trust, they
will be excludable from a shareholder's gross income for Federal income tax
purposes. Exempt-interest dividends are included, however, in determining the
portion, if any, of a person's social security benefits and railroad retirement
benefits subject to Federal income taxes. The portion of such exempt-interest
dividends paid from interest received by the Fund from California Municipal
Bonds also will be exempt from California 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 income taxes. Interest
on indebtedness incurred or continued to purchase or carry Fund shares is not
deductible for Federal or California 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 subject to
California franchise tax will not be exempt from California taxation.
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
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distributions are considered ordinary income for Federal and California income
tax purposes. Distributions, if any, from an excess of net long-term capital
gains over net short-term capital losses derived from the sale of securities or
from certain transactions in futures or options ("capital gain dividends") are
taxable as long-term capital gains for Federal income tax purposes, regardless
of the length of time the shareholder has owned Fund shares and, for California
income tax purposes, are treated as capital gains which are taxed at ordinary
income tax rates. Distributions by the Fund, whether from exempt-interest
income, ordinary income or capital gains, will not be eligible for the dividends
received deduction allowed to corporations under the Code.
All or a portion of the Fund's gain from the sale or redemption of
tax-exempt obligations purchased at a market discount will be treated as
ordinary income rather than capital gain. This rule may increase the amount of
ordinary income dividends received by shareholders. Distributions in excess of
the Fund's earnings and profits will first reduce the adjusted tax basis of a
holder's shares and, after such adjusted tax basis is reduced to zero, will
constitute capital gains to such holder (assuming the shares are held as a
capital asset). Any loss upon the sale or exchange of shares held for six months
or less will be disallowed to the extent of any exempt-interest dividends
received by the shareholder. In addition, any such loss that is not disallowed
under the rule stated above will be treated as long-term capital loss to the
extent of any capital gain 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. The alternative minimum tax applies to
interest received on certain "private activity bonds" issued after August 7,
1986. Private activity bonds are bonds which, although tax-exempt, are used for
purposes other than those generally performed by governmental units and which
benefit non-governmental entities (e.g., bonds used for industrial development
or housing purposes). Income received on such bonds is classified as an item of
"tax preference," which could subject certain 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.
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 any sales charge
paid to the Fund on the exchanged shares reduces any sales charge such
shareholder would have owed upon purchase of the new shares in the absence of
the exchange privilege. Instead, such sales charge will be treated as an amount
paid for the new shares.
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A loss realized on a sale or exchange of shares of the Fund will be
disallowed if other Fund shares are acquired (whether through the automatic
reinvestment of dividends or otherwise) within a 61-day period beginning 30 days
before and ending 30 days after the date that the shares are disposed of. In
such a case, the basis of the shares acquired will be adjusted to reflect the
disallowed loss.
Under certain Code provisions, some shareholders may be subject to a 31%
withholding tax on certain ordinary income dividends and on capital gain
dividends and redemption payments ("backup withholding"). Generally,
shareholders subject to backup withholding will be those for whom no certified
taxpayer identification number is on file with the Trust or who, to the Trust's
knowledge, have furnished an incorrect number. When establishing an account, an
investor must certify under penalty of perjury that such number is correct and
that such investor is not otherwise subject to backup withholding.
The Code provides that every person required to file a tax return must
include for information purposes on such return the amount of exempt-interest
dividends received from all sources (including the Fund) during the taxable
year.
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code, Treasury regulations and 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 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 advisors 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
all shares, to the extent any dividends are paid, will be calculated in the same
manner at the same time on the same day and will be in the same amount, except
that account maintenance fees and distribution charges and any incremental
transfer agency costs relating to each class of shares will be borne exclusively
by that class. The Fund will include performance data for all classes of shares
of the Fund in any advertisement or information including performance data of
the Fund.
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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,
1996 was 4.94% for Class A shares, 4.64% for Class B shares, 4.54% for Class C
shares and 4.85% for Class D shares and the tax-equivalent yield for the same
period (based on a Federal income tax rate of 28%) was 6.86% for Class A shares,
6.44% for Class B shares, 6.31% for Class C shares and 6.74% for Class D shares.
The yield without voluntary reimbursement or waiver of Fund expenses for the
30-day period would have been 4.65% for Class A shares, 4.34% for Class B
shares, 4.23% for Class C shares and 4.55% for Class D shares with a tax
equivalent yield of 6.46% for Class A shares, 6.03% for Class B shares, 5.88%
for Class C shares and 6.32% for Class D shares.
Total return, yield and tax-equivalent yield figures are based on the
Fund's historical performance and are not intended to indicate future
performance. The Fund's total return, yield and tax-equivalent yield will vary
depending on market conditions, the securities comprising the Fund's portfolio,
the Fund's operating 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 indicative of the Fund's relative
performance for any future period.
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ADDITIONAL INFORMATION
DETERMINATION OF NET ASSET VALUE
The net asset value of the shares of all classes of the Fund is determined
by the Manager once daily 15 minutes after the close of business on the NYSE
(generally, 4:00 P.M., New York time), on each day during which the NYSE 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
fees, higher account maintenance fees and higher transfer agency fees applicable
with respect to Class B and Class C shares. It is expected, however, that the
per share net asset value of the classes will tend to converge (although not
necessarily meet) immediately after the payment of dividends or distributions
which will differ by approximately the amount of the expense accrual
differentials between the classes.
ORGANIZATION OF THE TRUST
The Trust is an unincorporated business trust organized on 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. 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 Trustees of the Trust may classify and reclassify the
shares of any Series into additional classes at a future date.
Shareholders are entitled to one vote for each full share and to fractional
votes for fractional shares held in the election of Trustees (to the extent
hereinafter provided) and on other matters submitted to the vote of
shareholders. There normally will be no meeting of shareholders for the purpose
of electing Trustees unless and until such time as less than a majority of the
Trustees holding office have been elected by shareholders, at which time the
Trustees then in office will call a shareholders' meeting for the election of
Trustees. Shareholders may, in accordance with the terms of the Declaration of
Trust, cause a meeting of shareholders to be held for the purpose of voting on
the removal of Trustees. Also, the Trust will be required to call a special
meeting of shareholders of a Series in accordance with the requirements of the
1940 Act to seek approval of
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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:
Merrill Lynch Financial Data Services, Inc.
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 Merrill Lynch
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.
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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 Merrill Lynch Financial
Data Services, Inc., as an initial investment (minimum $1,000). I understand
that this purchase will be executed at the applicable offering price next to
be determined after this Application is received by you.
B. I already own shares of the following Merrill Lynch mutual funds that
would qualify for the Right of Accumulation as outlined in the Statement of
Additional Information: (Please list all funds. Use a separate sheet of paper
if necessary.)
1. ............................... 4. ...............................
..................................... .....................................
2. ............................... 5. ...............................
..................................... .....................................
3. ............................... 6. ...............................
..................................... .....................................
Name............................................................................
First Name Initial Last Name
Name of Co-Owner (if any).......................................................
First Name Initial Last Name
Address.........................................................................
............................................................. Date.............
(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 right of survivorship will be
presumed unless otherwise specified.)
- --------------------------------------------------------------------------------
2. DIVIDEND AND CAPITAL GAIN DISTRIBUTION OPTIONS
Ordinary Income Dividends Long-Term Capital Gains
--------------------------------- ---------------------------------
SELECT [ ] Reinvest SELECT [ ] Reinvest
ONE: [ ] Cash ONE: [ ] Cash
--------------------------------- ---------------------------------
If no election is made, dividends and capital gains will be automatically
reinvested at net asset value without a sales charge.
IF CASH, SPECIFY HOW YOU WOULD LIKE YOUR DISTRIBUTIONS PAID TO YOU:
[ ] Check or [ ] Direct Deposit to bank account
IF DIRECT DEPOSIT TO BANK ACCOUNT IS SELECTED, PLEASE COMPLETE BELOW:
I hereby authorize payment of dividend and capital gain distributions by direct
deposit to my bank account and, if necessary, debit entries and adjustments for
any credit entries made to my account in accordance with the terms I have
selected on the Merrill Lynch 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 Merrill Lynch Financial Data Services, Inc. amending or
terminating this service.
Signature of Depositor..........................................................
Signature of Depositor ............................. Date.......................
(if joint account, both must sign)
NOTE: IF DIRECT DEPOSIT TO BANK ACCOUNT IS SELECTED, YOUR BLANK, UNSIGNED CHECK
MARKED "VOID" OR A DEPOSIT SLIP FROM YOUR SAVINGS ACCOUNT SHOULD ACCOMPANY THIS
APPLICATION.
45
<PAGE> 48
MERRILL LYNCH CALIFORNIA INSURED MUNICIPAL BOND FUND -- AUTHORIZATION FORM
(PART 1) -- (CONTINUED)
- --------------------------------------------------------------------------------
3. SOCIAL SECURITY NUMBER OR TAXPAYER IDENTIFICATION NUMBER
--------------------------------------------------------
Social Security Number or Taxpayer Identification Number
Under penalty of perjury, I certify (1) that the number set forth above is my
correct Social Security Number or Taxpayer Identification Number and (2) that I
am not subject to backup withholding (as discussed in the Prospectus under
"Distribution and Taxes--Taxes") either because I have not been notified that I
am subject thereto as a result of a failure to report all interest or dividends,
or the Internal Revenue Service ("IRS") has notified me that I am no longer
subject thereto.
INSTRUCTION: YOU MUST STRIKE OUT THE LANGUAGE IN (2) ABOVE IF YOU HAVE BEEN
NOTIFIED THAT YOU ARE SUBJECT TO BACKUP WITHHOLDING DUE TO UNDERREPORTING AND IF
YOU HAVE NOT RECEIVED A NOTICE FROM THE IRS THAT BACKUP WITHHOLDING HAS BEEN
TERMINATED. THE UNDERSIGNED AUTHORIZES THE FURNISHING OF THIS CERTIFICATION TO
OTHER MERRILL LYNCH SPONSORED MUTUAL FUNDS.
..................................... ......................................
Signature of Owner Signature of Co-Owner (if any)
- --------------------------------------------------------------------------------
4. LETTER OF INTENTION--CLASS A AND D SHARES ONLY (SEE TERMS AND CONDITIONS IN
THE STATEMENT OF ADDITIONAL INFORMATION)
......................, 19....
Date of initial purchase
Dear Sir/Madam:
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.
<TABLE>
<S> <C>
By............................................................. ...............................................................
Signature of Owner Signature of Co-Owner
(If registered in joint parties, both must sign)
</TABLE>
In making purchases under this letter, the following are the related accounts
on which reduced offering prices are to apply:
<TABLE>
<S> <C>
(1) Name ...................................................... (2) Name.......................................................
Account Number ................................................ Account Number.................................................
</TABLE>
- --------------------------------------------------------------------------------
5. FOR DEALER ONLY
- --------------------------------------------------------------------------------
Branch Office, Address, Stamp.
- --------------------------------------------------------------------------------
This form when completed should be mailed to:
Merrill Lynch California Insured Municipal Bond Fund
c/o Merrill Lynch Financial Data Services, Inc.
P.O. Box 45289
Jacksonville, Florida 32232-5289
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 or sales made under a Letter of
Intention, Automatic Investment Plan or Systematic Withdrawal Plan. We guarantee
the Shareholder's signature.
...............................................................
Dealer Name and Address
By ............................................................
Authorized Signature of Dealer
..............................
- --------- ------------
Branch-Code F/C No. F/C Last Name
- ------------------------- ---------------
Dealer's Customer A/C No.
46
<PAGE> 49
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
<TABLE>
<CAPTION>
<S> <C>
------------------------------------
Name of Owner.......................................................................
------------------------------------
Name of Co-Owner (if any)........................................................... Social Security No.
Address............................................................................. or Taxpayer Identification No.
....................................................................................
Account Number...........................
(if existing account)
</TABLE>
- --------------------------------------------------------------------------------
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 MY BANK ACCOUNT AND, IF
NECESSARY, DEBIT ENTRIES AND ADJUSTMENTS FOR ANY CREDIT ENTRIES MADE TO MY
ACCOUNT. I AGREE THAT THIS AUTHORIZATION WILL REMAIN IN EFFECT UNTIL I PROVIDE
WRITTEN NOTIFICATION TO MERRILL LYNCH FINANCIAL DATA SERVICES, INC. AMENDING OR
TERMINATING THIS SERVICE.
SPECIFY TYPE OF ACCOUNT (CHECK ONE): [ ] checking [ ] savings
Name on your Account............................................................
Bank Name.......................................................................
Bank Number ......................................Account Number................
Bank Address....................................................................
......................................................................
Signature of Depositor............................Date..........................
Signature of Depositor..........................................................
(if joint account, both must sign)
NOTE: IF DIRECT DEPOSIT IS ELECTED, YOUR BLANK, UNSIGNED CHECK MARKED "VOID" OR
A DEPOSIT SLIP FROM YOUR SAVINGS ACCOUNT SHALL ACCOMPANY THIS APPLICATION.
47
<PAGE> 50
MERRILL LYNCH CALIFORNIA INSURED MUNICIPAL BOND FUND--AUTHORIZATION FORM
(PART 2)--(CONTINUED)
- --------------------------------------------------------------------------------
3. APPLICATION FOR AUTOMATIC INVESTMENT PLAN
I hereby request that Merrill Lynch Financial Data Services, Inc. draw an
automated clearing house ("ACH") debit on my checking account as described below
each month to purchase: (choose one)
[ ] Class A shares [ ] Class B shares
[ ] Class C shares [ ] Class D shares
of Merrill Lynch 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.
MERRILL LYNCH FINANCIAL DATA SERVICES, INC.
You are hereby authorized to draw an ACH debit each month on my bank account for
investment in Merrill Lynch California Insured Municipal Bond Fund as indicated
below:
Amount of each check or ACH debit $..........................................
Account Number...............................................................
Please date and invest ACH debits on the 20th of each month beginning
.................................. or as soon thereafter as possible.
(month)
I agree that you are preparing these ACH debits voluntarily at my request and
that you shall not be liable for any loss arising from any delay in preparing or
failure to prepare any such check or debit. If I change banks or desire to
terminate or suspend this program, I agree to notify you promptly in writing. I
hereby authorize you to take any action to correct erroneous ACH debits of my
bank account or purchases of Fund shares including liquidating shares of the
Fund and crediting my bank account. I further agree that if a check or debit is
not honored upon presentation, Merrill Lynch Financial Data Services, Inc. is
authorized to discontinue immediately the Automatic Investment Plan and to
liquidate sufficient shares held in my account to offset the purchase made with
the dishonored debit.
................. .......................................
Date Signature of Depositor
.......................................
Signature of Depositor
(If joint account, both must sign)
AUTHORIZATION TO HONOR ACH DEBITS DRAWN
BY MERRILL LYNCH FINANCIAL DATA SERVICES, INC.
To..........................................................................Bank
(Investor's Bank)
Bank Address....................................................................
City .................... State ........ Zip Code...............................
As a convenience to me, I hereby request and authorize you to pay and charge to
my account ACH debits drawn on my account by and payable to Merrill Lynch
Financial Data Services, Inc., I agree that your rights in respect to each such
debit shall be the same as if it were a check drawn on you and signed personally
by me. This authority is to remain in effect until revoked by me in writing.
Until you receive such notice, you shall be fully protected in honoring any such
debit. I further agree that if any such debit be dishonored, whether with or
without cause and whether intentionally or inadvertently, you shall be under no
liability.
................. .......................................
Date Signature of Depositor
................. .......................................
Bank Account Signature of Depositor
Number (If joint account, both must sign)
NOTE: IF AUTOMATIC INVESTMENT PLAN IS ELECTED, YOUR BLANK, UNSIGNED CHECK MARKED
"VOID" SHOULD ACCOMPANY THIS APPLICATION.
48
<PAGE> 51
MANAGER
Fund Asset Management
Administrative Offices:
800 Scudders Mill Road
Plainsboro, New Jersey
Mailing Address:
P.O. Box 9011
Princeton, New Jersey 08543-9011
DISTRIBUTOR
Merrill Lynch Funds Distributor, Inc.
Administrative Offices:
800 Scudders Mill Road
Plainsboro, New Jersey
Mailing Address:
P.O. Box 9081
Princeton, New Jersey 08543-9081
CUSTODIAN
The Bank of New York
90 Washington Street, 12th Floor
New York, New York 10286
TRANSFER AGENT
Merrill Lynch Financial Data Services, Inc.
Administrative Offices:
4800 Deer Lake Drive East
Jacksonville, Florida 32246-6484
Mailing Address:
P.O. Box 45289
Jacksonville, Florida 32232-5289
INDEPENDENT AUDITORS
Deloitte & Touche LLP
117 Campus Drive
Princeton, New Jersey 08540-6400
COUNSEL
Brown & Wood LLP
One World Trade Center
New York, New York 10048-0557
<PAGE> 52
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, IN CONNECTION
WITH THE OFFER CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER
INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE TRUST, THE MANAGER OR THE DISTRIBUTOR. THIS PROSPECTUS DOES NOT
CONSTITUTE AN OFFERING IN ANY STATE IN WHICH SUCH OFFERING MAY NOT LAWFULLY BE
MADE.
-------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Fee Table...................................... 2
Merrill Lynch Select Pricing(SM) System........ 3
Financial Highlights........................... 8
Investment Objective and Policies.............. 10
Portfolio Insurance.......................... 12
Potential Benefits........................... 14
Special and Risk Considerations Relating to
Municipal Bonds............................ 14
Description of Municipal Bonds............... 14
When-Issued Securities and Delayed Delivery
Transactions............................... 17
Call Rights.................................. 17
Financial Futures Transactions and Options... 17
Repurchase Agreements........................ 19
Investment Restrictions...................... 20
Management of the Trust........................ 21
Trustees..................................... 21
Management and Advisory Arrangements......... 21
Code of Ethics............................... 22
Transfer Agency Services..................... 23
Purchase of Shares............................. 23
Initial Sales Charge Alternatives--
Class A and Class D Shares................. 25
Deferred Sales Charge Alternatives--
Class B and Class C Shares................. 27
Distribution Plans........................... 30
Limitations on the Payment of Deferred Sales
Charges.................................... 32
Redemption of Shares........................... 32
Redemption................................... 33
Repurchase................................... 33
Reinstatement Privilege--
Class A and Class D Shares................. 34
Shareholder Services........................... 34
Investment Account........................... 34
Exchange Privilege........................... 35
Automatic Reinvestment of Dividends and
Capital Gains Distributions................ 36
Systematic Withdrawal Plans.................. 36
Automatic Investment Plans................... 36
Fee-Based Programs........................... 36
Portfolio Transactions......................... 37
Distributions and Taxes........................ 37
Distributions................................ 37
Taxes........................................ 38
Performance Data............................... 40
Additional Information......................... 42
Determination of Net Asset Value............. 42
Organization of the Trust.................... 42
Shareholder Reports.......................... 43
Shareholder Inquiries........................ 43
Authorization Form............................. 45
Code # 16574-1296
</TABLE>
[MERRILL LYNCH LOGO]
MERRILL LYNCH
CALIFORNIA INSURED
MUNICIPAL BOND FUND
MERRILL LYNCH CALIFORNIA
MUNICIPAL SERIES TRUST
[Mlynch Compass]
PROSPECTUS
December 20, 1996
Distributor:
Merrill Lynch
Funds Distributor, Inc.
This prospectus should be
retained for future reference.
<PAGE> 53
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 income taxes as is
consistent with prudent investment management. The Fund invests primarily in a
non-diversified portfolio of long-term investment grade 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 ("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 December
20, 1996 (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 December 20, 1996.
<PAGE> 54
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 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 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 ("IDBs") or private activity bonds. The interest on
such obligations may bear a fixed rate or be payable at a variable or floating
rate. The Municipal Bonds purchased by the Fund will be primarily what are
commonly referred to as "investment grade" securities, which are obligations
rated at the time of purchase within the four highest quality ratings as
determined by either Moody's Investors Service, Inc. ("Moody's") (currently Aaa,
Aa, A and Baa), Standard & Poor's Ratings Services ("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" or "FAM"), 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 income 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 applicable law. 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 or
2
<PAGE> 55
taxable money market obligations with a maturity of one year or less (such
short-term obligations being referred to herein as "Temporary Investments").
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 Municipal Bonds or Temporary Investments (valued on a daily
basis) equal at all times to the amount of the when-issued commitment.
The Fund may invest in Municipal Bonds (and Non-Municipal Tax-Exempt
Securities) the return on which is based on a particular index of value or
interest rates. For example, the Fund may invest in Municipal Bonds that pay
interest based on an index of Municipal Bond interest rates or based on the
value of gold or some other commodity. The principal amount payable upon
maturity of certain Municipal Bonds also may be based on the value of an index.
Also, the Fund may invest in so-called "inverse floating obligations" or
"residual interest bonds" on which the interest rates typically decline as
market rates increase and increase as market rates decline. To the extent the
Fund invests in these types of Municipal Bonds, the Fund's return on such
Municipal Bonds will be subject to risk with respect to the value of the
particular index, which may include reduced or eliminated interest payments and
losses of invested principal. Such securities have the effect of providing a
degree of investment leverage, since they may increase or decrease in value in
response to changes, as an illustration, in market interest rates at a rate
which is a multiple (typically two) of the rate 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. 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. The Manager believes, however, that indexed and inverse floating
obligations represent flexible portfolio management instruments for the Fund
which allow the Fund to seek potential investment rewards, hedge other portfolio
positions or vary the degree of investment leverage relatively efficiently under
different market conditions.
3
<PAGE> 56
The Fund may purchase a Municipal Bond issuer's right to call all or a
portion of such Municipal Bond for mandatory tender for purchase (a "Call
Right"). A holder of a Call Right may exercise such right to require a mandatory
tender for the purchase of related Municipal Bonds, subject to certain
conditions. A Call Right that is not exercised prior to the maturity of the
related Municipal Bond will expire without value. The economic effect of holding
both the Call Right and the related Municipal Bond is identical to 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.
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> 57
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 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.
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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 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.
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.
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).
DESCRIPTION OF MUNICIPAL BONDS AND TEMPORARY INVESTMENTS
Set forth below is a description of the Municipal Bonds and Temporary
Investments in which the Fund may invest. A more complete discussion concerning
futures and options transactions is set forth under "Investment Objective and
Policies" in the Prospectus. Information with respect to ratings assigned to
tax-
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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 "IDBs" or private activity bonds are issued by or on behalf of
public authorities to finance various privately owned or operated 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 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.
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
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in the event of foreclosure might prove difficult. These securities represent a
type of financing that has not yet developed the depth of marketability
associated with more conventional securities. Certain investments in lease
obligations may be illiquid. The Fund may not invest in illiquid lease
obligations if such investments, together with all other illiquid investments,
would exceed 15% 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
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 securities 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
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adjustable at intervals (ranging from daily to up to one year) to some
prevailing market rate for similar investments, such adjustment formula being
calculated to maintain the market value of the VRDO at approximately the par
value of the VRDOs on the adjustment date. The adjustments typically are based
upon the Public Securities Association Index 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
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securities, or an affiliate thereof. Under such agreements, the seller agrees,
upon entering into the contract, to repurchase the security at a mutually agreed
upon time and price, thereby determining the yield during the term of the
agreement. This results in a fixed rate of return insulated from market
fluctuations during such period. In repurchase agreements, the prices at which
the trades are conducted do not reflect accrued interest on the underlying
obligations. Such agreements usually cover short periods, such as under one
week. Repurchase agreements may be construed to be collateralized loans by the
purchaser to the seller secured by the securities transferred to the purchaser.
In 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 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
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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.
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
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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 a decrease 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 a put option
on a financial futures contract is analogous to the purchase of a protective put
option 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.
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
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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 Commission exempting it from the
provisions of Section 17(f) and Section 18(f) of the Investment Company Act of
1940, as amended (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 liquid 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.
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
13
<PAGE> 66
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.
Municipal Bond Index financial futures contracts were approved for trading
in 1986. Trading in such financial futures contracts may tend to 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.
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<PAGE> 67
INVESTMENT RESTRICTIONS
The Fund has adopted a number of fundamental and non-fundamental
restrictions and policies relating to the investment of its assets and its
activities. The fundamental policies set forth below may not be changed without
the approval of the holders of a majority of the Fund's outstanding voting
securities (which for this purpose and under the 1940 Act means the lesser of
(i) 67% of the Fund's shares present at a meeting at which more than 50% of the
outstanding shares of the Fund are represented or (ii) more than 50% of the
Fund's outstanding shares). The Fund may not:
1. Invest more than 25% of its assets, taken at market value at the
time of each investment, in the securities of issuers in any particular
industry (excluding the U.S. Government and its agencies and
instrumentalities). For purposes of this restriction, states,
municipalities and their political subdivisions are not considered part of
any industry.
2. Make investments for the purpose of exercising control or
management.
3. Purchase or sell real estate, except that, to the extent permitted
by applicable law, the Fund may invest in securities directly or indirectly
secured by real estate or interests therein or issued by companies which
invest in real estate or interests therein.
4. Make loans to other persons, except that the acquisition of bonds,
debentures or other corporate debt securities and investment in government
obligations, commercial paper, pass-through instruments, certificates of
deposit, bankers acceptances, repurchase agreements or any similar
instruments shall not be deemed to be the making of a loan, and except
further that the Fund may lend its portfolio securities, provided that the
lending of portfolio securities may be made only in accordance with
applicable law and the guidelines set forth in the Fund's Prospectus and
Statement of Additional Information, as they may be amended from time to
time.
5. Issue senior securities to the extent such issuance would violate
applicable law.
6. Borrow money, except that (i) the Fund may borrow from banks (as
defined in the 1940 Act) in amounts up to 33 1/3% of its total assets
(including the amount borrowed), (ii) the Fund may borrow up to an
additional 5% of its total assets for temporary purposes, (iii) the Fund
may obtain such short-term credit as may be necessary for the clearance of
purchases and sales of portfolio securities and (iv) the Fund may purchase
securities on margin to the extent permitted by applicable law. The Fund
may not pledge its assets other than to secure 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.
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<PAGE> 68
Under the non-fundamental investment restrictions, the Fund may not:
a. Purchase securities of other investment companies, except to the
extent such purchases are permitted by applicable law.
b. Make short sales of securities or maintain a short position, except
to the extent permitted by applicable law. The Fund currently does not
intend to engage in short sales, except short sales "against the box".
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.
d. 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. In addition, the Fund will
not purchase securities while borrowings are outstanding.
In addition, to comply with Federal income tax requirements for
qualification as a "regulated investment company", the Fund's investments will
be limited in a manner such that, at the close of each quarter of each fiscal
year, (a) no more than 25% of the Fund's total assets are invested in the
securities of a single issuer, and (b) with regard to at least 50% of the Fund's
total assets, no more than 5% of its total assets are invested in the securities
of a single issuer. [For purposes of this restriction, the Fund will regard each
state and each political subdivision, agency or instrumentality of such state
and each multi-state agency of which such state is a member and each public
authority which issues securities on behalf of a private entity as a separate
issuer, except that if the security is backed only by the assets and revenues of
a non-governmental entity then the entity with the ultimate responsibility for
the payment of interest and principal may be regarded as the sole issuer.] These
tax-related limitations may be changed by the Trustees of the Trust to the
extent necessary to comply with changes to the Federal income tax requirements.
------------------------
Because of the affiliation of Merrill Lynch, 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
pursuant to a permissive order or otherwise in compliance with the provisions of
the 1940 Act and the rules and regulations thereunder. Included among such
restricted transactions are purchases from or sales to Merrill Lynch of
securities in transactions in which it acts as principal. See "Portfolio
Transactions". An exemptive order has been obtained which permits the Trust to
effect principal transactions with Merrill Lynch in high quality, short-term,
tax-exempt securities subject to conditions set forth in such order.
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<PAGE> 69
MANAGEMENT OF THE TRUST
TRUSTEES AND OFFICERS
Information about the Trustees, executive officers and the portfolio
manager of the Trust, their ages and their principal occupations for at least
the last five years, is set forth below. Unless otherwise noted, the address of
each Trustee and executive officer is P.O. Box 9011, Princeton, New Jersey
08543-9011.
ARTHUR ZEIKEL (64)--President and Trustee (1)(2)--President of the Manager
(which term, as used herein, includes the Manager's corporate predecessors)
since 1977; President of Merrill Lynch Asset Management, L.P. ("MLAM," which
term, as used herein, includes MLAM's corporate predecessors) since 1977;
President and Director of Princeton Services, Inc. ("Princeton Services") since
1993; Executive Vice President of Merrill Lynch & Co., Inc. ("ML&Co.") since
1990; Director of Merrill Lynch Funds Distributor, Inc. ("MLFD" or the
"Distributor") since 1977.
JAMES H. BODURTHA (52)--Trustee (2)--36 Popponesset Road, Cotuit,
Massachusetts 02635. Director and Executive Vice President, The China Business
Group, Inc. since 1996; Chairman and Chief Executive Officer, China Enterprise
Management Corporation from 1993 to 1996; Chairman, Berkshire Corporation since
1980; Partner, Squire, Sanders & Dempsey from 1980 to 1993.
HERBERT I. LONDON (57)--Trustee (2)--113-115 University Place, New York,
New York 10003. John M. Olin Professor of Humanities, New York University since
1993 and Professor thereof since 1980; Dean, Gallatin Division of New York
University from 1978 to 1993; Distinguished Fellow, Herman Kahn Chair, Hudson
Institute from 1984 to 1985; Trustee, Hudson Institute, since 1980; Director,
Damon Corporation since 1991; Overseer, Center for Naval Analyses from 1983 to
1993; Limited Partner, Hypertech L.P. since 1996.
ROBERT R. MARTIN (69)--Trustee (2)--513 Grand Hill, St. Paul, Minnesota
55102. 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; Chairman of the Board, WTC Industries,
Inc. in 1994; Trustee, Northland College since 1992.
JOSEPH L. MAY (67)--Trustee (2)--424 Church Street, Suite 2000, Nashville,
Tennessee 37219. Attorney in private practice since 1984; President, May and
Athens Hosiery Mills Division, Wayne-Gossard Corporation from 1954 to 1983; Vice
President, Wayne-Gossard Corporation from 1972 to 1983; Chairman, The May
Corporation (personal holding company) from 1972 to 1983; Director, Signal
Apparel Co. from 1972 to 1989.
ANDRE F. PEROLD (44)--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.
TERRY K. GLENN (56)--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; President of Princeton Administrators, L.P. since 1988.
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<PAGE> 70
VINCENT R. GIORDANO (52)--Vice President (1)(2)--Portfolio Manager of the
Manager and MLAM since 1977 and Senior Vice President of the Manager and MLAM
since 1984; Vice President of MLAM from 1980 to 1984; Senior Vice President of
Princeton Services since 1993.
KENNETH A. JACOB (45)--Vice President (1)(2)--Vice President of the Manager
and MLAM since 1984.
WALTER O'CONNOR (35)--Portfolio Manager(1)(2)--Vice President of MLAM since
1993; Assistant Vice President of MLAM from 1991 to 1993; Assistant Vice
President of Prudential Securities from 1984 to 1991.
DONALD C. BURKE (36)--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 (47)--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 (38)--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 November 30, 1996, the Trustees and officers of the Trust as a group (12
persons) owned an aggregate of less than 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.
COMPENSATION OF TRUSTEES
The Trust pays each Trustee not affiliated with the Manager (each a
"non-affiliated Trustee") 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 and Nominating
Committee, (the "Committee") which consists of all the non-affiliated Trustees,
a fee of $1,000 per year plus $250 per meeting attended. The Trust reimburses
each non-affiliated Trustee for his out-of-pocket expenses relating to
attendance at Board and Committee meetings. The fees and expenses of the
Trustees are allocated to the respective series of the Trust on the basis of
asset size. For the fiscal year ended August 31, 1996, fees and expenses paid to
the non-affiliated Trustees which were allocated to the Fund aggregated $8,879.
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<PAGE> 71
The following table sets forth for the fiscal year ended August 31, 1996,
compensation paid by the Fund to the non-affiliated Trustees and for the
calendar year ended December 31, 1995, the aggregate compensation paid by all
registered investment companies (including the Fund) advised by FAM and its
affiliate. MLAM ("FAM/MLAM Advised Funds") to the non-affiliated Trustees:
<TABLE>
<CAPTION>
AGGREGATE
COMPENSATION
PENSION OR FROM FUND AND
RETIREMENT OTHER
BENEFITS FAM/MLAM
ACCRUED AS ADVISED FUNDS
COMPENSATION PART OF FUND'S PAID TO
NAME OF TRUSTEE FROM FUND EXPENSES TRUSTEE(1)
- ------------------------------------------------------ ------------ -------------- -------------
<S> <C> <C> <C>
James H. Bodurtha..................................... $1,044 None $ 157,500*
Herbert I. London..................................... $1,044 None $ 157,500
Robert R. Martin...................................... $1,044 None $ 157,500
Joseph L. May......................................... $1,044 None $ 157,500
Andre F. Perold....................................... $1,044 None $ 157,500
</TABLE>
- ------------
(1) The Trustees serve on the boards of FAM/MLAM Advised Funds as follows: Mr.
Bodurtha (22 registered investment companies consisting of 46 portfolios);
Mr. London (22 registered investment companies consisting of 46 portfolios);
Mr. Martin (22 registered investment companies consisting of 46 portfolios);
Mr. May (22 registered investment companies consisting of 46 portfolios);
and Mr. Perold (22 registered investment companies consisting of 46
portfolios).
* $157,500 represents the amount Mr. Bodurtha would have received if he had
been a Trustee for the entire calendar year ended December 31, 1995. Mr.
Bodurtha was elected to the Trust's Board of Trustees effective June 23,
1995.
MANAGEMENT AND ADVISORY ARRANGEMENTS
Reference is made to "Management of the Trust--Management and Advisory
Arrangements" in the Prospectus for certain information concerning the
management and advisory arrangements of the Fund.
Securities may be held by, or be appropriate investments for, the Fund as
well as other funds or investment advisory clients of the Manager or its
affiliates. Because of different objectives or other factors, a particular
security may be bought for one or more clients when one or more clients are
selling the same security. If purchases or sales of securities for the Fund or
other funds for which they act as manager or for their advisory clients arise
for consideration at or about the same time, transactions in such securities
will be made, insofar as feasible, for the respective funds and clients in a
manner deemed equitable to all. To the extent that transactions on behalf of
more than one client of the Manager or its affiliates during the same 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 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 advisory fee paid
by the Fund to the Manager aggregated $509,552, all of which was voluntarily
waived. For the fiscal year ended August 31, 1995, the total advisory fee paid
by the Fund to the Manager aggregated $478,480, of which $354,675 was
voluntarily waived.
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<PAGE> 72
For the fiscal year ended August 31, 1996, the total advisory fee paid by the
Fund to the Manager aggregated $517,728, of which $346,114 was voluntarily
waived.
The Management Agreement obligates the Manager to provide investment
advisory services and to pay all compensation of and furnish office space for
officers and employees of the Trust connected with investment and economic
research, trading and investment management of the Trust, as well as the fees of
all Trustees of the Trust who are affiliated persons of ML&Co. or any of its
affiliates. The Fund pays all other expenses incurred in its operation and, if
other series shall be added ("Series"), a portion of the Trust's general
administrative expenses will be allocated on the basis of the asset size of the
respective Series. Expenses that will be borne directly by the Series include,
among other things, redemption expenses, expenses of portfolio transactions,
expenses of registering the shares under Federal and state securities laws,
pricing costs (including the daily calculation of net asset value), expenses of
printing shareholder reports, prospectuses and statements of additional
information (except to the extent paid by the Distributor as described below),
fees for legal and auditing services, Commission fees, interest, certain taxes,
and other expenses attributable to a particular Series. Expenses which will be
allocated on the basis of asset size of the respective Series include fees and
expenses of unaffiliated Trustees, state franchise taxes, costs of printing
proxies and other expenses related to shareholder meetings, and other expenses
properly payable by the Trust. The organizational expenses of the Trust were
paid by the Trust, and as additional Series are added to the Trust, the
organizational expenses are allocated among the Series (including the Fund) in a
manner deemed equitable by the Trustees. Depending upon the nature of a lawsuit,
litigation costs may be assessed to the specific Series to which the lawsuit
relates or allocated on the basis of the asset size of the respective Series.
The Trustees have determined that this is an appropriate method of allocation of
expenses. Accounting services are provided to the Fund by the Manager and the
Fund reimburses the Manager for its costs in connection with such services. For
the fiscal years ended August 31, 1994, 1995 and 1996, the Fund reimbursed the
Manager $39,696, $46,158 and $46,382, respectively, 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 Plans".
The Manager is a limited partnership, the partners of which are ML & Co.
and Princeton Services. ML & Co. and Princeton Services are "controlling
persons" of the Manager as defined under the 1940 Act because of their ownership
of its voting securities or their power to exercise a controlling influence over
its management or policies.
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.
20
<PAGE> 73
The Fund issues four classes of shares under the Merrill Lynch Select
Pricing(SM) System: shares of Class A and Class D are sold to investors choosing
the initial sales charge alternatives and shares of Class B and Class C are sold
to investors choosing the deferred sales charge alternatives. Each Class A,
Class B, Class C and Class D share of the Fund represents 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
registered investment companies advised by the Manager or its affiliate, FAM.
Funds advised by the Manager or FAM which utilize the Merrill Lynch Select
Pricing(SM) System 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
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 fiscal year
ended August 31, 1994 were $23,814 of which the Distributor received $2,428 and
Merrill Lynch received $21,386. The gross sales charges for the sale of Class A
shares for the fiscal year ended August 31, 1995 were $14,929, of which the
Distributor received $1,321 and Merrill Lynch received $13,608. The gross sales
charges for the sale of Class A shares for the fiscal year ended August 31, 1996
were $9,669, of which the Distributor received $1,410 and Merrill Lynch received
$8,259. The gross sales charges for the sale of Class D shares for the period
October 21, 1994 (commencement of operations) to August 31, 1995 were $28,487,
of which the Distributor received $2,544 and Merrill Lynch received $25,943. The
gross sales charges for the sale of Class D shares for the fiscal year ended
August 31, 1996 were $11,008, of which the Distributor received $912 and Merrill
Lynch received $10,096. For the fiscal years ended August 31, 1994, 1995 and
1996, the Distributor received no CDSCs with respect to redemption within one
year after purchase of Class A shares purchased subject to a front-end sales
charge waiver. For the period October 21, 1994 (commencement of operations) to
August 31, 1995 and for the fiscal year ended August 31, 1996, the Distributor
received no CDSCs with respect to redemption within one year after purchase of
Class D shares purchased subject to a front-end sales charge waiver.
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
21
<PAGE> 74
their own account and to single purchases by a trustee or other fiduciary
purchasing shares for a single trust estate or single fiduciary account although
more than one beneficiary is involved. The term "purchase" also includes
purchases by any "company", as that term is defined in the 1940 Act, but does
not include purchases by any such company which has not been in existence for at
least six months or which has no purpose other than the purchase of shares of
the Fund or shares of other registered investment companies at a discount;
provided, however, that it shall not include purchases by any group of
individuals whose sole organizational nexus is that the participants therein are
credit cardholders of a company, policyholders of an insurance company,
customers of either a bank or broker-dealer or clients of an investment adviser.
Closed-End Investment Option. Class A shares of the Fund and other
MLAM-advised mutual funds ("Eligible Class A shares") are offered at net asset
value to shareholders of certain closed-end funds advised by the Manager or MLAM
who purchased such closed-end fund shares prior to October 21, 1994, the date
the Merrill Lynch Select Pricing(SM) System commenced operations, and wish to
reinvest the net proceeds of a sale of their closed-end fund shares in Eligible
Class A shares, if the conditions set forth below are satisfied. Alternatively,
closed-end fund shareholders who purchased such shares on or after October 21,
1994 and wish to reinvest the net proceeds from a sale of their closed-end fund
shares are offered Class A shares (if eligible to 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.
Shareholders of certain MLAM-advised continuously offered closed-end funds
may reinvest at net asset value the net proceeds from a sale of certain shares
of common stock of such funds in shares of the Fund. Upon exercise of this
investment option, shareholders of Merrill Lynch Senior Floating Rate Fund, Inc.
will receive Class A shares of the Fund and shareholders of Merrill Lynch
Municipal Strategy Fund, Inc. and Merrill Lynch High Income Municipal Bond Fund,
Inc. will receive Class D shares of the Fund, except that shareholders already
owning Class A shares of the Fund will be eligible to purchase additional Class
A shares pursuant to this option, if such additional Class A shares will be held
in the same account as the existing Class A shares and the other requirements
pertaining to the reinvestment privilege are met. In order to exercise this
investment option, a shareholder of one of the above-referenced continuously
offered closed-end funds (an "eligible fund") must sell his or her shares of
common stock of the eligible fund (the "eligible shares") back to the eligible
fund in connection with a tender offer conducted by the eligible fund and
reinvest the proceeds immediately in the designated class of shares of the Fund.
This investment option is available only with respect to eligible shares as to
which no Early Withdrawal Charge or CDSC (each as defined in the eligible fund's
prospectus) is applicable. Purchase orders from eligible fund shareholders
wishing to exercise this investment option will be accepted only on the day that
the related tender offer terminates and will be effected at the net asset value
of the designated class of the Fund on such day.
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
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<PAGE> 75
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 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 a purchase during the
term of such Letter would otherwise be subject to a further reduced sales charge
based on the right of accumulation, the purchaser will be entitled on that
purchase and subsequent purchases to that further reduced percentage sales
charge but there will be no retroactive reduction of the sales charges on any
previous purchase. The value of any shares redeemed or otherwise disposed of by
the purchaser prior to termination or completion of the Letter of Intention will
be deducted from the total purchases made under such Letter. An exchange from a
MLAM-advised money market fund into the Fund that creates a sales charge will
count toward completing a new or existing Letter of Intention from the Fund.
Employee Access Accounts(SM). Class A or Class D shares are offered at net
asset value to Employee Access Accounts available through qualified employers
that provide employer sponsored retirement or savings plans that are eligible to
purchase such shares at net asset value. The initial minimum for such accounts
is $500, except that the initial minimum for shares purchased for such accounts
pursuant to the Automatic Investment Program is $50.
23
<PAGE> 76
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, members of
the Boards of other MLAM-advised investment companies, ML&Co. and its
subsidiaries (the term "subsidiaries", when used herein with respect to ML&Co.,
includes MLAM, the Manager and certain other entities directly or indirectly
wholly owned and controlled by ML&Co.) and their directors and employees and any
trust, pension, profit-sharing or other benefit plan for such persons, may
purchase Class A shares of the Fund at net asset value.
Class D shares of the Fund are 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 a
sales charge, to an investor who has a business relationship with a Merrill
Lynch Financial Consultant and who has invested in a mutual fund sponsored by a
non-Merrill Lynch company for which Merrill Lynch has served as a selected
dealer and where Merrill Lynch has either received or given notice that such
arrangement will be terminated ("notice"), if the following conditions are
satisfied: first, the investor must purchase Class D shares of the Fund with
proceeds from a redemption of shares of such other mutual fund and the shares of
such other fund were subject to a sales charge either at the time of purchase or
on a deferred basis; and second, such purchase of Class D shares must be made
within 90 days after such notice.
Class D shares of the Fund are offered at net asset value, without a sales
charge, to an investor who has a business relationship with a Merrill Lynch
Financial Consultant and who has invested in a mutual fund for which Merrill
Lynch has not served as a selected dealer if the following conditions are
satisfied: first, the investor must advise Merrill Lynch that it will purchase
Class D shares of the Fund with proceeds from the redemption of shares of such
other mutual fund and that such shares have been outstanding for a period of no
less than six months; and second, such purchase of Class D shares must be made
within 60 days after the redemption and the proceeds from the redemption must be
maintained in the interim in cash or a money market fund.
Acquisition of Certain Investment Companies. The public offering price of
Class D shares may be reduced to the net asset value per Class D share in
connection with the acquisition of the assets of or merger or consolidation with
a 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 policies of the Fund; (ii) are acquired for investment
and not for resale (subject to the understanding that the
24
<PAGE> 77
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 Conduct Rules 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
unpaid balance
25
<PAGE> 78
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,
1996 with respect to the Class B and Class C shares of the Fund indicating the
maximum allowable payments that can be made under the NASD maximum sales charge
rule and, with respect to the Class B shares, the Distributor's voluntary
maximum.
<TABLE>
<CAPTION>
DATA CALCULATED AS OF AUGUST 31, 1996
----------------------------------------------------------------------------------
(IN THOUSANDS)
ALLOWABLE AMOUNTS
ELIGIBLE AGGREGATE INTEREST MAXIMUM PREVIOUSLY AGGREGATE
GROSS SALES ON UNPAID AMOUNT PAID TO UNPAID
SALES(1) CHARGES BALANCE(2) PAYABLE DISTRIBUTOR(3) BALANCE
-------- --------- ---------- ------- -------------- ---------
<S> <C> <C> <C> <C> <C> <C>
CLASS B SHARES, FOR THE PERIOD
FEBRUARY 26, 1993 (COMMENCEMENT
OF OPERATIONS) TO AUGUST 31,
1996:
Under NASD Rule as Adopted........ $103,347 $ 6,459 $1,602 $8,061 $1,332 $ 6,729
Under Distributor's Voluntary
Waiver.......................... $103,347 $ 6,459 $ 517 $6,976 $1,332 $ 5,644
CLASS C SHARES, FOR THE PERIOD
OCTOBER 21, 1994 (COMMENCEMENT
OF OPERATIONS) TO AUGUST 31,
1996:
Under NASD Rule as Adopted........ $ 5,607 $ 350 $ 26 $ 376 $ 17 $ 359
<CAPTION>
ANNUAL
DISTRIBUTION
FEES AT CURRENT
NET ASSET
LEVEL(4)
---------------
<S> <C>
CLASS B SHARES, FOR THE PERIOD
FEBRUARY 26, 1993 (COMMENCEMENT
OF OPERATIONS) TO AUGUST 31,
1996:
Under NASD Rule as Adopted........ $ 183
Under Distributor's Voluntary
Waiver.......................... $ 183
CLASS C SHARES, FOR THE PERIOD
OCTOBER 21, 1994 (COMMENCEMENT
OF OPERATIONS) TO AUGUST 31,
1996:
Under NASD Rule as Adopted........ $ 17
</TABLE>
- ------------------
(1) Purchase price of all eligible Class B or Class C shares sold during the
periods indicated other than shares acquired through dividend reinvestment
and the exchange privilege.
(2) Interest is computed on a monthly basis based upon the prime rate, as
reported in The Wall Street Journal, plus 1.0% as permitted under the NASD
Rule.
(3) Consists of CDSC payments, distribution fee payments and accruals.
(4) Provided to illustrate the extent to which the current level of distribution
fee payments (not including any CDSC payments) is amortizing the unpaid
balance. No assurance can be given that payments of the distribution fee
will reach either the voluntary maximum or the NASD maximum.
26
<PAGE> 79
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 (the "NYSE") is restricted as determined by the Commission
or the NYSE is closed (other than customary weekend and holiday closings), for
any period during which an emergency exists, as defined by the Commission, as a
result of which disposal of portfolio securities or determination of the net
asset value of the Fund is not reasonably practicable, and for such other
periods as the Commission may by order permit for the protection of shareholders
of the Fund.
DEFERRED SALES CHARGES--CLASS B AND CLASS C SHARES
As discussed in the Prospectus under "Purchase of Shares--Deferred Sales
Charge Alternatives-- Class B and Class C Shares", while Class B shares redeemed
within four years of purchase are subject to a CDSC under most circumstances,
the charge is waived on redemptions of Class B shares following the death or
disability of a Class B shareholder. Redemptions for which the waiver applies
are any partial or complete 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 years ended
August 31, 1994, 1995 and 1996, the Distributor received CDSCs of $177,779,
$347,212 and $157,396, respectively, with respect to redemptions of Class B
shares, all of which were paid to Merrill Lynch. For the period October 21, 1994
(commencement of operations) to August 31, 1995 and for the fiscal year ended
August 31, 1996, the Distributor received CDSCs of $76 and $2,319, respectively,
with respect to redemptions of Class C shares, all of which were 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 fiscal year ended August 31, 1994, the Fund engaged in no
transactions pursuant to such order. For the fiscal year ended August 31, 1995,
the Fund engaged in 14 transactions pursuant to such order for an aggregate
market value of approximately $12.3 million. For the fiscal year ended August
31, 1996, the Fund engaged in one transaction pursuant to such order for an
aggregate market value of approximately $2.3 million. The Trust has applied for
an exemptive order, subject to certain conditions, permitting the Trust to,
among other things, (i) purchase investment grade tax-exempt securities from
Merrill Lynch when Merrill Lynch is a member of an underwriting syndicate for
such securities and (ii) purchase tax-exempt securities from and sell tax-exempt
securities to Merrill Lynch in secondary market transactions. Affiliated persons
of the Trust may serve as
27
<PAGE> 80
broker for the Fund in over-the-counter transactions conducted on an agency
basis. Certain court decisions have raised questions as to the extent to which
investment companies should seek exemptions under the 1940 Act in order to seek
to recapture underwriting and dealer spreads from affiliated entities. The
Trustees have considered all factors deemed relevant, and have made a
determination not to seek such recapture at this time. The Trustees will
reconsider this matter from time to time.
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. As
indicated above, the Trust had applied for a conditional exemption from these
restrictions.
The Fund does not expect to use any particular dealer in the execution of
transactions but, subject to obtaining the best net results, dealers who provide
supplemental investment research (such as information concerning tax-exempt
securities, economic data and market forecasts) to the Manager may receive
orders for transactions by the Fund. Information so received will be in addition
to and not in lieu of the services required to be performed by the Manager under
its Management Agreement and the expenses of the Manager will not necessarily be
reduced as a result of the receipt of such supplemental information.
The Trust has no obligation to deal with any broker in the execution of
transactions for the Fund's portfolio securities. In addition, consistent with
the Conduct Rules of the NASD and policies established by the Trustees of the
Trust, the Manager may consider sales of shares of the Fund as a factor in the
selection of brokers or dealers to execute portfolio transactions for the Fund.
Generally, the Fund does not purchase securities for short-term trading
profits. However, the Fund may dispose of securities without regard to the time
they have been held when such action, for defensive or other reasons, appears
advisable to its Manager. 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 fiscal years
ended August 31, 1995 and 1996 were 61.53% and 87.77%, respectively.
Section 11(a) of the Securities Exchange Act of 1934, as amended, generally
prohibits members of the U.S. national securities exchanges from executing
exchange transactions for their affiliates and institutional accounts which they
manage unless the member (i) has obtained prior express authorization from the
account to effect such transactions, (ii) at least annually furnishes the
account with a statement setting forth the aggregate compensation received by
the member in effecting such transactions, and (iii) complies with any rules the
Commission has prescribed with respect to the requirements of clauses (i) and
(ii). To the extent Section 11(a) would apply to Merrill Lynch acting as a
broker for the Fund in any of its portfolio transactions executed on any such
securities exchange of which it is a member, appropriate consents have been
obtained from the Fund and annual statements as to aggregate compensation will
be provided to the Fund.
28
<PAGE> 81
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, Monday through Friday, as of 15 minutes after the
close of business on the NYSE (generally, 4:00 P.M., New York time) on each day
during which the NYSE is open for trading. The NYSE 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 the Distributor, are accrued daily. The per share net asset
value of Class B, Class C and Class D shares generally will be lower than the
per share net asset value of Class A shares, reflecting the higher daily expense
accruals of the account maintenance, distribution and higher transfer agency
fees applicable with respect to Class B and Class C shares and the daily expense
accruals of the account maintenance fees applicable with respect to Class D
shares. Moreover, the per share net asset value of Class B and Class C shares
generally will be lower than the per share net asset value of Class D shares,
reflecting the daily expense accruals of the distribution fees, higher account
maintenance fees and higher transfer agency fees applicable with respect to
Class B and Class C shares of the Fund. It is expected, however, that the per
share net asset value of the four classes will tend to converge (although not
necessarily meet) immediately after the payment of dividends, which will differ
by approximately the amount of the expense accrual differentials between the
classes.
The Municipal Bonds and other portfolio securities in which the Fund
invests are traded primarily in over-the-counter municipal bond and money
markets and are valued at the last available bid price in the over-the-counter
market or on the basis of yield equivalents as obtained from one or more dealers
that make markets in the securities. One bond is the "yield equivalent" of
another bond when, taking into account market price, maturity, coupon rate,
credit rating and ultimate return of principal, both bonds will theoretically
produce an equivalent return to the bondholder. Financial futures contracts and
options thereon, which are traded on exchanges, are valued at their settlement
prices as of the close of business on 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 also will receive separate transaction confirmations
29
<PAGE> 82
for each purchase or sale transaction other than automatic investment purchase
and the reinvestment of ordinary income dividends and long-term capital gain
distributions. A shareholder may make additions to his or her 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.
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. If
the new brokerage firm is willing to accommodate the shareholder in this manner,
the shareholder must request that he or she be issued certificates for his or
her shares, and then must turn the certificates over to the new firm for re-
registration as described in the preceding sentence.
AUTOMATIC INVESTMENT PLANS
A shareholder may make additions to an Investment Account at any time by
purchasing Class A 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) or CBA(R) accounts may
arrange to have periodic investments made in the Fund in their CMA(R) or CBA(R)
account or in certain related accounts, in amounts of $100 or more through the
CMA(R) or CBA(R) Automated Investment Program.
AUTOMATIC REINVESTMENT OF DIVIDENDS AND CAPITAL GAINS DISTRIBUTIONS
Unless specific instructions are given as to the method of payment of
dividends and capital gains distributions, dividends and distributions will be
automatically reinvested 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.
30
<PAGE> 83
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
15 minutes after the close of business on the NYSE (generally, 4:00 P.M., New
York time) on the 24th day of each month or the 24th day of the last month of
each quarter, whichever is applicable. If the NYSE is not open for business on
such date, the Class A or Class D shares will be redeemed at the close of
business on the following business day. The check for the withdrawal payment
will be mailed, or the direct deposit for the withdrawal payment will be made,
on the next business day following redemption. When a shareholder is making
systematic withdrawals, dividends and distributions on all Class A or Class D
shares in the Investment Account are reinvested automatically in the Fund's
Class A or Class D shares, respectively. A shareholder's Systematic Withdrawal
Plan may be terminated at any time, without charge or penalty, by the
shareholder, the Trust, the Transfer Agent or the Distributor. Withdrawal
payments should not be considered as dividends, yield or income. Each withdrawal
is a taxable event. If periodic withdrawals continuously exceed reinvested
dividends, the shareholder's original investment may be reduced correspondingly.
Purchases of additional Class A or Class D shares concurrent with withdrawals
are ordinarily disadvantageous to the shareholder because of sales charges and
tax liabilities. The Trust will not knowingly accept purchase orders for Class A
or Class D shares of the Fund from investors who maintain a Systematic
Withdrawal Plan unless such purchase is equal to at least one year's scheduled
withdrawals or $1,200, whichever is greater. Periodic investments may not be
made into an Investment Account in which the shareholder has elected to make
systematic withdrawals.
Alternatively, a Class A or Class D shareholder whose shares are held
within a CMA(R) or CBA(R) Account may elect to have shares redeemed on a
monthly, bimonthly, quarterly, semiannual or annual basis through the CMA(R) or
CBA(R) Systematic Redemption Program. The minimum fixed dollar amount redeemable
is $25. The proceeds of systematic redemptions will be posted to the
shareholder's account three 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 CMA(R) or CBA(R) 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. Under the Merrill Lynch Select
Pricing(SM) System, Class A shareholders may exchange Class A shares of the Fund
for Class A shares of a second MLAM-advised mutual fund if the shareholder
31
<PAGE> 84
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 are exchangeable
with shares of the same class of other MLAM-advised mutual funds. For purposes
of computing the CDSC that may be payable upon a disposition of the shares
acquired in the exchange, the holding period for the previously owned shares of
the Fund is "tacked" to the holding period for the newly acquired shares of the
other fund as more fully described below. Class A, Class B, Class C and Class D
shares are also exchangeable for shares of certain MLAM-advised money market
funds as follows: Class A shares may be exchanged for shares of Merrill Lynch
Ready Assets Trust, Merrill Lynch Retirement Reserves Money Fund (available only
for exchanges within certain retirement plans), Merrill Lynch U.S.A. Government
Reserves and Merrill Lynch U.S. Treasury Money Fund; Class B, Class C and Class
D shares may be exchanged for shares of Merrill Lynch Government Fund, Merrill
Lynch Institutional Fund, Merrill Lynch Institutional Tax-Exempt Fund and
Merrill Lynch Treasury Fund. 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 share, respectively, plus an amount equal
to the difference, if any, between the sales charge previously paid on the
outstanding Class A or Class D shares and the sales charge payable at the time
of the exchange on the new Class A or Class D shares. With respect to
outstanding Class A or Class D shares as to which previous exchanges have taken
place, the "sales charge previously paid" shall include the aggregate of the
sales charges paid with respect to such Class A or Class D shares in the initial
purchase and any subsequent exchange. Class A or Class D shares issued pursuant
to dividend reinvestment are sold on a no-load basis in each of the funds
offering Class A or Class D shares. For purposes of the exchange privilege,
Class A 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 certain money market funds without a sales charge.
In addition, each of the funds with Class B and Class C shares outstanding
offers to exchange its Class B or Class C shares for Class B or Class C shares,
respectively, of MLAM-advised mutual funds ("new Class B or Class C shares") on
the basis of relative net asset value per Class B or Class C share, without the
payment of any CDSC that might otherwise be due on redemption of the outstanding
shares. Class B shareholders of the Fund exercising the exchange privilege will
continue to be subject to the Fund's CDSC schedule if such schedule is higher
than the CDSC schedule relating to the new Class B shares acquired through use
of the exchange privilege. In addition, Class B shares of the Fund acquired
through use of the exchange privilege will be subject to the Fund's CDSC
schedule if such schedule is higher than the CDSC schedule relating to the Class
B shares of the fund from which the exchange has been made. For purposes of
computing the sales load
32
<PAGE> 85
that may be payable on a disposition of the new Class B or Class C shares, the
holding period for the outstanding Class B or Class C shares is "tacked" to the
holding period of the new Class B or Class C shares. For example, an investor
may exchange Class B shares of the Fund for those of Merrill Lynch Special Value
Fund, Inc. ("Special Value Fund") after having held the Fund's Class B shares
for two and a half years. The 2% CDSC that generally would apply to a redemption
would not apply to the exchange. Three years later the investor may decide to
redeem the Class B shares of Special Value Fund and receive cash. There will be
no CDSC due on this redemption, since by "tacking" the two and a half year
holding period of the Fund's Class B shares to the three year holding period for
the Special Value Fund Class B shares, the investor will be deemed to have held
the new Class B shares for more than five years.
Shareholders also may exchange shares of the Fund into shares of certain
money market funds 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, 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 newly acquired 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 Fund Class B shares for two and a half
years and three years later decide to redeem the shares of Merrill Lynch
Institutional Fund for cash. At the time of this redemption, the 2% CDSC that
would have been due had the Class B shares of the Fund been redeemed for cash
rather than exchanged for shares of 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 would not incur a
CDSC.
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 or she is not otherwise subject
to backup withholding. See "Distributions and Taxes" below.
To exercise the exchange privilege, a shareholder should contact his or her
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
33
<PAGE> 86
and may thereafter resume such offering from time to time. The exchange
privilege is available only to U.S. shareholders in states where the exchange
legally may be made.
DISTRIBUTIONS AND TAXES
The Trust intends to continue to qualify the Fund for the special tax
treatment afforded regulated investment companies ("RICs") under the Internal
Revenue Code of 1986, as amended (the "Code"). If it so qualifies, 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 its
income.
As discussed in the Fund's Prospectus, the Trust has established other
series in addition to the Fund (together with the Fund, the "Series"). Each
Series of the Trust is treated as a separate corporation for Federal income tax
purposes. Each Series therefore is considered to be a separate entity in
determining its treatment under the rules for RICs described in the Prospectus.
Losses in one Series do not offset gains in another Series, and the requirements
(other than certain organizational requirements) for qualifying for RIC status
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 its total
assets consists of obligations exempt from Federal income tax ("tax-exempt
obligations") under Section 103(a) of the Code (relating generally to
obligations of a state or local governmental unit), the Fund shall be qualified
to pay exempt-interest dividends to its Class A, Class B, Class C and Class D
shareholders (together, the "shareholders"). Exempt-interest dividends are
dividends or any part thereof paid by the Fund which are attributable to
interest on tax-exempt obligations and designated by the Trust as
exempt-interest dividends in a written notice mailed to the Fund's shareholders
within 60 days after the close of the Fund's taxable year. For this purpose, the
Fund will allocate interest from tax-exempt obligations (as 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 rule permitting the issuance and sale
of multiple classes of shares) that is based on the gross income allocable to
Class A, Class B, Class C and Class D shareholders during the taxable year or
such other method as the Internal Revenue Service may prescribe. To the extent
that the dividends distributed to the Fund's shareholders are derived from
interest income exempt from Federal income tax under Code Section 103(a), and
are properly designated as "exempt-interest dividends," they will be excludable
from a shareholder's gross income for Federal income tax purposes.
Exempt-interest dividends are included, however, in determining the portion, if
any, of a person's social security benefits and railroad retirement benefits
subject to Federal income taxes. Interest on indebtedness incurred or continued
to purchase or carry shares of a RIC paying exempt-interest dividends, such as
the Fund, will not be deductible by the investor for Federal or California
income tax purposes to the extent attributable to exempt interest dividends.
Shareholders are
34
<PAGE> 87
advised to consult their tax advisors with respect to whether exempt-interest
dividends retain the exclusion under Code Section 103(a) if a shareholder would
be treated as a "substantial user" or "related person" under Code Section 147(a)
with respect to property financed with the proceeds of an issue of "industrial
development bonds" or "private activity bonds," if any, held by the Fund.
The portion of the Fund's exempt-interest dividends paid from interest
received by the Fund from California Municipal Bonds also will be exempt from
California 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 Fund intends to invest at least 50% of its
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 income
taxation by such other states. The Trust will inform shareholders annually
regarding the portion of the Fund's distributions which constitutes
exempt-interest dividends and the portion which is exempt from 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. Accordingly,
investors in the Fund, including, in particular, corporate investors which may
be subject to the California corporate franchise tax, should consult their tax
advisors with respect to the application of such taxes 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.
Distributions, if any, from an excess of net long-term capital gains over net
short-term capital losses derived from the sale of securities or from certain
transactions in futures or options ("capital gain dividends") are taxable as
long-term capital gains for Federal income tax purposes, regardless of the
length of time the shareholder has owned Fund shares and, for California income
tax purposes, will be treated as capital gains which are taxed at ordinary
income tax rates. Distributions by the Fund, whether from exempt-interest
income, ordinary income or capital gains, will not be eligible for the dividends
received deduction allowed to corporations under the Code.
All or a portion of the Fund's gain from the sale or redemption of
tax-exempt obligations purchased at a market discount will be treated as
ordinary income rather than capital gain. This rule may increase the amount of
ordinary income dividends received by shareholders. Distributions in excess of
the Fund's earnings and profits will first reduce the adjusted tax basis of a
holder's shares and, after such adjusted tax basis is reduced to zero, will
constitute capital gains 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 disallowed to the extent of any exempt-interest dividends
received by the shareholder. In addition, any such loss that is not disallowed
under the rule stated above will be treated as long-term capital loss to the
extent of any capital gain 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 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.
35
<PAGE> 88
The Code subjects interest received on certain otherwise tax-exempt
securities to an alternative minimum tax. The alternative minimum tax applies to
interest received on certain "private activity bonds" issued after August 7,
1986. Private activity bonds are bonds which, although tax-exempt, are used for
purposes other than those generally performed by governmental units and which
benefit non-governmental entities (e.g., bonds used for industrial development
or housing purposes). Income received on such bonds is classified as an item of
"tax preference," which could subject certain 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 Fund may invest in high yield securities, as previously described.
Furthermore, the Fund may also invest in instruments the return on which
includes nontraditional features such as indexed principal or interest payments
("nontraditional instruments"). These instruments may be subject to special tax
rules under which the Fund may be required to accrue and distribute income
before amounts due under the obligations are paid. In addition, it is possible
that all or a portion of the interest payments on such high yield securities
and/or nontraditional instruments could be recharacterized as taxable ordinary
income.
No gain or loss will be recognized by Class B shareholders on the
conversion of their Class B shares into Class D shares. A shareholder's basis in
the Class D shares acquired will be the same as such shareholder's basis in the
Class B shares converted, and the holding period of the acquired Class D shares
will include the holding period for the converted Class B shares.
If a shareholder exercises an exchange privilege within 90 days of
acquiring the shares, then the loss the shareholder can recognize on the
exchange will be reduced (or the gain increased) to the extent any sales charge
paid to the Fund on the exchanged shares reduces any sales charge the
shareholder would have owed upon purchase of the new shares in the absence of
the exchange privilege. Instead, such sales charge will be treated as an amount
paid for the new shares.
A loss realized on a sale or exchange of shares of the Fund will be
disallowed if other Fund shares are acquired (whether through the automatic
reinvestment of dividends or otherwise) within a 61-day period beginning 30 days
before and ending 30 days after the date that the shares are disposed of. In
such a case, the basis of the shares acquired will be adjusted to reflect the
disallowed loss.
Ordinary income dividends paid to shareholders who are nonresident aliens
or foreign entities will be subject to a 30% United States withholding tax under
existing provisions of the Code applicable to foreign individuals and entities
unless a reduced rate of withholding or a withholding exemption is provided
under applicable treaty law. Nonresident shareholders are urged to consult their
own advisors concerning the applicability of the United States withholding tax.
Under certain Code provisions, some shareholders may be subject to a 31%
withholding tax on certain ordinary income dividends and on capital gain
dividends and redemption payments ("backup withholding"). Generally,
shareholders subject to backup withholding will be those for whom no certified
taxpayer identification number is on file with the Trust or who, to the Trust's
knowledge, have furnished an incorrect
36
<PAGE> 89
number. When establishing an account, an investor must certify under penalty of
perjury that such number is correct and that such investor is not otherwise
subject to backup withholding.
The Code provides that every person required to file a tax return must
include for information purposes on such return the amount of exempt-interest
dividends received from all sources (including the Fund) during the taxable
year.
ENVIRONMENTAL TAX
The Code previously imposed 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 has
expired for tax years beginning after December 31, 1995, but may be reinstated
in the future. The Environmental Tax was imposed even if the corporation was not
required to pay an alternative minimum tax because the corporation's regular
income tax liability exceeded its minimum tax liability. The Code provides,
however, that a RIC, such as the Fund, would not be subject to the Environmental
Tax. However, exempt-interest dividends paid by the Fund that create alternative
minimum taxable income for corporate shareholders (as described above) could
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. The
mark-to-market rules outlined above, however, will not apply to certain
transactions entered into by the Fund solely to reduce the risk of changes in
price or interest rates with respect to its investments.
Code Section 1092, which applies to certain "straddles," may affect the
taxation of the Fund's sales of securities and 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 sales of
securities and 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
37
<PAGE> 90
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 advisors 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.
From time to time, the Fund may include the Fund's Morningstar risk-adjusted
performance ratings in advertisements or supplemental sales literature. 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 and tax-equivalent yield are determined
separately for Class A, Class B, Class C and Class D shares in accordance with
formulas specified by the Commission.
Average annual total return quotations for the specified periods are
computed by finding the average annual compounded rates of return (based on net
investment income and any realized and unrealized capital gains or losses on
portfolio investments over such periods) that would equate the initial amount
invested to the redeemable value of such investment at the end of each period.
Average annual total return is computed assuming all dividends and distributions
are reinvested and taking into account all applicable recurring and nonrecurring
expenses, including the maximum sales charge in the case of Class A and Class D
shares and the CDSC that would be applicable to a complete redemption of the
investment at the end of the specified period in the case of the Class B and
Class C shares.
The Fund also may quote annual, average annual and annualized total return
and aggregate total return performance data, both as a percentage and as a
dollar amount based on a hypothetical $1,000 investment, for various periods
other than those noted below. Such data will be computed as described above,
except that (1) as required by the periods of the quotations, actual annual,
annualized or aggregate data, rather than average annual data, may be quoted and
(2) the maximum applicable sales charges will not be included with respect to
annual or annualized rates of return calculations. Aside from the impact on the
performance data calculations of including or excluding the maximum applicable
sales charges, actual annual or annualized total return data generally will be
lower than average annual total return data since the average rates of return
reflect compounding of return; aggregate total return data generally will be
higher than average annual total return data since the aggregate rates of return
reflect compounding over a longer period of time.
38
<PAGE> 91
Set forth below is the total return, yield and tax-equivalent yield
information for Class A, Class B, Class C and Class D shares of the Fund for the
periods indicated.
<TABLE>
<CAPTION>
CLASS A SHARES CLASS B SHARES
------------------------------ -------------------------------
REDEEMABLE REDEEMABLE
EXPRESSED AS VALUE OF A EXPRESSED AS A VALUE OF A
A PERCENTAGE HYPOTHETICAL PERCENTAGE HYPOTHETICAL
BASED ON A $1,000 BASED ON A $1,000
HYPOTHETICAL INVESTMENT AT HYPOTHETICAL INVESTMENT AT
$1,000 THE END OF $1,000 THE END OF
PERIOD INVESTMENT THE PERIOD INVESTMENT THE PERIOD
- ----------------------------------------------- ------------- -------------- -------------
<S> <C> <C> <C> <C>
AVERAGE ANNUAL TOTAL RETURN
(including maximum applicable sales charge)
One year ended August 31, 1996.... 3.14% $1,031.40 2.89% $1,028.90
Inception (February 26, 1993) to
August 31, 1996................. 3.79% $1,139.40 4.22% $1,156.10
Inception (October 21, 1994) to
August 31, 1996.................
ANNUAL TOTAL RETURN
(excluding maximum applicable sales charge)
Year ended August 31, 1996........ 7.44% $1,074.40 6.89% $1,068.90
Year ended August 31, 1995........ 6.94% $1,069.40 6.38% $1,063.80
Year ended August 31, 1994........ (1.44)% $ 985.60 (1.93)% $ 980.70
Inception (February 26, 1993) to
August 31, 1993................. 4.81% $1,048.10 4.56% $1,045.60
Inception (October 21, 1994) to
August 31, 1995.................
AGGREGATE TOTAL RETURN
(including maximum applicable sales charge)
Inception (February 26, 1993) to
August 31, 1996................. 13.94% $1,139.40 15.61% $1,156.10
Inception (October 21, 1994) to
August 31, 1996.................
YIELD
30 days ended August 31, 1996..... 4.94% 4.64%
TAX EQUIVALENT YIELD*
30 days ended August 31, 1996..... 6.86% 6.44%
<CAPTION>
CLASS C SHARES CLASS D SHARES
------------------------------- -------------------------------
REDEEMABLE REDEEMABLE
EXPRESSED AS A VALUE OF A EXPRESSED AS A VALUE OF A
PERCENTAGE HYPOTHETICAL PERCENTAGE HYPOTHETICAL
BASED ON A $1,000 BASED ON A $1,000
HYPOTHETICAL INVESTMENT AT HYPOTHETICAL INVESTMENT AT
$1,000 THE END OF $1,000 THE END OF
PERIOD INVESTMENT THE PERIOD INVESTMENT THE PERIOD
- ---------------------------------- -------------- ------------- -------------- -------------
<S> <C> <C> <C> <C>
AVERAGE ANNUAL TOTAL RETURN
(including maximum applicable sales charge)
One year ended August 31, 1996.... 5.90% $1,059.00 3.14% $1,031.40
Inception (February 26, 1993) to
August 31, 1996.................
Inception (October 21, 1994) to
August 31, 1996................. 8.76% $1,169.30 7.01% $1,134.50
ANNUAL TOTAL RETURN
(excluding maximum applicable sales charge)
Year ended August 31, 1996........ 6.90% $1,069.00 7.44% $1,074.40
Year ended August 31, 1995........
Year ended August 31, 1994........
Inception (February 26, 1993) to
August 31, 1993.................
Inception (October 21, 1994) to
August 31, 1995................. 9.38% $1,093.80 9.99% $1,099.90
AGGREGATE TOTAL RETURN
(including maximum applicable sales charge)
Inception (February 26, 1993) to
August 31, 1996.................
Inception (October 21, 1994) to
August 31, 1996................. 16.93% $1,169.30 13.45% $1,134.50
YIELD
30 days ended August 31, 1996..... 4.54% 4.85%
TAX EQUIVALENT YIELD*
30 days ended August 31, 1996..... 6.31% 6.74%
</TABLE>
- ---------------
* Based on a Federal income tax rate of 28%.
39
<PAGE> 92
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 in the same assets of the Fund
and are identical in all respects except that the Class B, Class C and Class D
shares bear certain expenses related to the account maintenance and/or
distribution of such shares and have exclusive voting rights with respect to
matters relating to such account maintenance and/or distribution expenditures.
The Board of Trustees of the Trust may classify and reclassify the shares of any
Series into additional classes at a future date.
All shares of the Trust have equal voting rights, except that only shares
of the respective Series are entitled to vote on matters concerning only that
Series and, as noted above, Class B, Class C and Class D shares 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 are 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
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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
were paid by the Fund and are being 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.
COMPUTATION OF OFFERING PRICE PER SHARE
An illustration of the computation of the offering price for Class A, Class
B, Class C and Class D shares of the Fund, based on the value of the Fund's net
assets and number of shares outstanding as of August 31, 1996 is set forth
below.
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C CLASS D
----------- ----------- ---------- ----------
<S> <C> <C> <C> <C>
Net Assets.................................. $14,182,528 $73,292,287 $4,901,025 $4,303,803
========== ========== ========= =========
Number of Shares Outstanding................ 1,441,410 7,448,173 498,310 437,072
========== ========== ========= =========
Net Asset Value Per Share (net assets
divided by number of shares
outstanding).............................. $ 9.84 $ 9.84 $ 9.84 $ 9.85
Sales Charge (for Class A and Class D
shares: 4.00% of offering price (4.17% of
net asset value per share))*.............. .41 ** ** .41
----------- ----------- ---------- ----------
Offering Price.............................. $ 10.25 $ 9.84 $ 9.84 $ 10.26
========== ========== ========= =========
</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 and
"Redemption of Shares -- Deferred Sales Charges -- Class B and Class C
Shares" herein.
INDEPENDENT AUDITORS
Deloitte & Touche LLP, 117 Campus Drive, Princeton, New Jersey 08540-6400,
has been selected as the independent auditors of the Fund. The independent
auditors are responsible for auditing the annual financial statements of the
Fund.
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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
Merrill Lynch Financial Data Services, Inc., 4800 Deer Lake Drive East,
Jacksonville, Florida 32246-6484, acts as the Trust's transfer agent. The
Transfer Agent is responsible for the issuance, transfer and redemption of
shares and the opening, maintenance and servicing of shareholder accounts. See
"Management of the Trust--Transfer Agency Services" in the Prospectus.
LEGAL COUNSEL
Brown & Wood LLP, One World Trade Center, New York, New York 10048-0557, is
counsel for the Trust.
REPORTS TO SHAREHOLDERS
The fiscal year of the Fund ends on 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 and the 1940 Act, 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 December 1, 1996.
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<PAGE> 95
APPENDIX I
ECONOMIC AND OTHER CONDITIONS IN CALIFORNIA
The following information is a brief summary of factors affecting the
economy of the State and does not purport to be a complete description of such
factors. Other factors will affect issuers. The summary is based primarily upon
one or more publicly available offering statements relating to debt offerings of
state issuers, however, it has not been updated nor will it be updated during
the year. The Trust has not independently verified the information.
ECONOMIC CONDITIONS
The economy of the State of California (sometimes referred to as the
"State") is the largest among the 50 states and one of the largest in the world.
This diversified economy has major components in agriculture, manufacturing,
high technology, trade, entertainment, tourism, construction and services. Total
State gross domestic product of about $890 billion in 1995 was larger than all
but six nations in the world.
California's July 1, 1994 population of over 32 million represented over 12
percent of the total United States population. The official 1990 Census
population was 29,760,021 as of April 1, 1990, which represented an increase of
over 6 million persons, or 26 percent, during the decade of the 1980s. As of the
April 1, 1990 Census, the median age of California's population was 31.5 years,
younger than the 1990 U.S. median of 32.9 years.
California's population is concentrated in metropolitan areas. As of the
April 1, 1990 Census, 96 percent resided in the 23 Metropolitan Statistical
Areas in the State. Overall, California's population per square mile was 191 in
1990. As of July 1, 1995, the 5-county Los Angeles area accounted for 49
percent, with 15.6 million residents. The 10-county San Francisco Bay Area
represented 21 percent, with a population of 6.6 million.
After suffering through a severe recession, California's economy has been
on a steady recovery since the start of 1994. Employment grew by over 500,000 in
1994 and 1995, and the pre-recession level of total employment is expected to be
matched in 1996. The strongest growth has been in export-related industries,
business services, electronics, entertainment and tourism, all of which have
offset the recession-related losses which were heaviest in aerospace and
defense-related industries (which accounted for two-thirds of the job losses),
finance and insurance. Residential housing construction, with new permits for
under 100,000 annual new units issued in 1994 and 1995, is weaker than in
previous recoveries, but has been growing slowly since 1993.
The State. In the years following enactment of the Federal Tax Reform Act
of 1986, and conforming changes to the State's tax laws, taxpayer behavior
became much more difficult to predict, and the State experienced a series of
fiscal years in which revenue came in significantly higher or lower than
original estimates. The 1989-90 Fiscal Year ended with revenues below estimates,
so that the State's budget reserve (the Special Fund for Economic Uncertainties
or "SFEU") was fully depleted by June 30, 1990. This date essentially coincided
with the start of the current recession, which severely affected State General
Fund revenues and increased expenditures above initial budget appropriations due
to greater health and welfare costs. The State's budget problems in recent years
have also been caused by a structural imbalance which has been identified by the
current and previous Administrations. The largest General Fund Program--K-14
education, health, welfare and corrections--was increasing faster than the
revenue base, driven by the State's
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rapid population growth. These pressures will continue as population trends
maintain strong demand for health and welfare services, as the school-age
population continues to grow and as the State's corrections program responds to
a "Three Strikes" law enacted in 1994, which requires mandatory life prison
terms for certain third-time felony offenders.
Prior Years. As a result of these factors and others, from the late 1980s
until 1992-93, the State had a period of budget imbalance. During this period,
expenditures exceeded revenues in four out of six years, and the State
accumulated and sustained a budget deficit in the SFEU approaching $2.8 billion
at its peak at June 30, 1993. Starting in the 1990-91 Fiscal Year and for each
fiscal year thereafter, each budget required multi-bullion dollar actions to
bring projected revenues and expenditures into balance and to close large
"budget gaps" which were identified. Despite budget actions by the Legislature,
the effects of the recession led to large, unanticipated deficits in the budget
reserve, the SFEU, as compared to projected positive balances. By the 1993-94
Fiscal Year, the accumulated deficit was so large that it was impractical to
budget to retire it in one year, so a two-year program was implemented, using
the issuance of revenue anticipation warrants to carry a portion of the deficit
over the end of the fiscal year. When the economy failed to recover sufficiently
in 1993-94, a second two-year plan was implemented in 1994-95.
Another consequence of the accumulated budget deficits, together with other
factors such as disbursement of funds to local school districts "borrowed" from
future fiscal years and hence not shown in the annual budget, was to
significantly reduce the State's cash resources available to pay its ongoing
obligations. The State's cash condition became so serious in late Spring of 1992
that the State Controller was required to issue revenue anticipation warrants
maturing in the following fiscal year in order to pay the State's continuing
obligations. The State was forced to rely increasingly on external debt markets
to meet its cash needs, as a succession of notes and warrants were issued in the
period from June 1992 to July 1994, often needed to pay previously maturing
notes or warrants. These borrowings were used also in part to spread out the
repayment of the accumulated budget deficit over the end of the fiscal year.
The 1994-1995 Fiscal Year represented the fourth consecutive year that the
Governor and the Legislature were faced with a very difficult budget environment
to produce a balanced budget. Many program cuts and budgetary adjustments had
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.
Pursuant to the Budget Adjustment Law (the "Law"), the State Controller was
required to make a report by November 15, 1994 on whether the projected cash
resources for the General Fund as of June 30, 1995 would decrease more that $430
million from the amount projected by the State in its Official Statement in July
1994 for the sale $4,000,000,000 of revenue anticipation warrants. On November
15, 1994, the State Controller issued the report on the State's cash position
required by the Law. The report indicated that the cash position of the General
Fund on June 30, 1995 would be $581 million better than was estimated in the
July 1994 cash flow projections and therefore, no budget adjustment procedures
would be invoked for the 1994-95 Fiscal Year.
On October 15, 1995, when the State Controller, in conjunction with the
Legislative Analyst's Office, reviewed the estimated cash condition of the
General Fund for the 1995-96 Fiscal Year, the State Controller estimated that
the General Fund would have internal cash resources on June 30, 1996 (i.e.,
external borrowing would not be needed to pay all obligations due). If a cash
shortfall had been identified by the State Controller,
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the State Legislature would have been required to enact legislation providing
for sufficient General Fund expenditure reductions, revenue increase, or both.
1995-96. On January 10, 1995, the Governor presented his 1995-96 Fiscal
Year budget proposal (the "Proposed Budget"). Two of the principal features of
the Proposed Budget were a phased 15% cut in personal income and corporate taxes
and a further expansion of the "realignment" process to transfer more
responsibility and funding sources for certain health and welfare programs to
local governments. Neither of these proposals was approved by the Legislature.
As a result of the improving economy, with resulting improved revenue and
caseload estimates, the State entered the 1995-96 budget negotiations with the
smallest nominal "budget gap" to be enclosed in many years.
The 1995-96 Budget Act was signed by the Governor on August 3, 1995. The
Budget Act projects General Fund revenues and transfers of $44.1 billion, a 3.5
percent increase from the prior year. Expenditures are budgeted at $43.4
billion, a 4 percent increase. The Department of Finance projects that, after
repaying the last of the carryover budget deficit, there will be a positive
balance of $28 million in the budget reserve, the SFEU, at June 30, 1996. The
Budget Act also projects Special Fund revenues of $12.7 billion and appropriates
Special Fund expenditures of $13.4 billion.
1996-1997. The following are principal features of the 1996-97 Budget Act:
1. Proposition 98 funding for schools and community college districts
increased by almost $1.6 billion (General Fund) and $1.65 billion total
above revised 1995-96 levels. Almost half of this money was budgeted to
fund class-size reductions in kindergarten and grades 1-3. Also, for the
second year in a row, the full cost of living allowance (3.2 percent) was
funded. The Proposition 98 increases have brought K-12 expenditures to
almost $4,800 per pupil (also called per ADA, or Average Daily Attendance),
an almost 15% increase over the level prevailing during the recession
years. Community colleges will receive an increase in funding of $157
million for 1996-97 out of this $1.6 billion total.
Because of the higher than projected revenues in 1995-96, an
additional $1.1 billion ($190 per K-12 ADA and $145 million for community
colleges) was appropriated and retroactively applied towards the 1995-96
Proposition 98 guarantee, bringing K-12 expenditures in that year to over
$4,600 per ADA. These new funds were appropriated for a variety of
purposes, including block grants, allocations for each school site,
facilities for class size reduction, and a reading initiative. Similar
retroactive increases totaling $230 million, based on final figures on
revenues and State population growth, were made to the 1991-92 and the
1994-95 Proposition 98 guarantees, most of which was allocated to each
school site.
2. The Budget Act assumed savings of approximately $660 million in
health and welfare costs which required changes in federal law, including
federal welfare reform. The Budget Act further assumed federal law changes
in August 1996 which would allow welfare cash grant levels to be reduced by
October 1, 1996. These cuts totaled approximately $163 million of the
anticipated $660 million savings.
3. A 4.9 percent increase in funding for the University of California
($130 million General Fund) and the California State University system
($101 million General Fund), with no increases in student fees, maintaining
the second year of the Governor's four-year "Compact" with the State's
higher education units.
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4. The Budget Act assumed the federal government will provide
approximately $700 million in new aid for incarceration and health care
costs of illegal immigrants. These funds reduce appropriations in these
categories that would otherwise have to be paid from the General Fund. (For
purposes of cash flow projections, the Department of Finance expects $540
million of this amount to be received during the 1996-97 Fiscal Year.)
5. General Fund support for the Department of Corrections was
increased by about 7 percent over the prior year, reflecting estimates of
increased prison population.
6. With respect to aid to local governments, the principal new
programs included in the Budget Act are $100 million in grants to cities
and counties for law enforcement purposes, and budgeted $50 million for
competitive grants to local governments for programs to combat juvenile
crime.
The Budget Act did not contain any tax increases. As noted, there was a
reduction in corporate taxes. In addition, the Legislature approved another
one-year suspension of the Renters Tax Credit, saving $520 million in
expenditures.
Federal Welfare Reform. Following enactment of the 1996-97 Budget Act,
Congress passed and the President signed (on August 22, 1996) the Personal
Responsibility and Work Opportunity Act of 1996 (P.L. 104-193, the "Law") making
a fundamental reform of the current welfare system. Among many provisions, the
Law includes:(i) conversion of Aid to Families with Dependent Children from an
entitlement program to a block grant titled Temporary Assistance for Needy
Families (TANF), with lifetime time limits on TANF recipients, work requirements
and other changes; (ii) provisions denying certain federal welfare and public
benefits to legal noncitizens, allowing states to elect to deny additional
benefits (including TANF) to legal noncitizens, and generally denying almost all
benefits to illegal immigrants; and (iii) changes in the Food Stamp program,
including reducing maximum benefits and imposing work requirements.
The Law requires states to implement the new TANF program not later than
July 1, 1997 and provides California approximately $3.7 billion in block grant
funds for FY 1996-97 for the provisions of the Law. States are allowed to
implement TANF as soon as possible and will receive a prorated block grant
effective the date of application. The California State Plan is to be submitted
in time to allow grant reductions to be implemented effective January 1, 1997
(allowing $92 million of the $163 million referred to in para.2 above to be
saved) and to allow the State to capture approximately $267 million in
additional federal block grant funds over the currently budgeted level. None of
the other federal changes needed to achieve the balance of the $660 million cost
savings were enacted. Thus, in lieu of the $660 million savings initially
assumed to be saved, it is now projected that savings will total approximately
$360 million.
A preliminary analysis of the law by the Legislative Analyst's Office
indicates that an overall assessment of how these changes will affect the
State's General Fund will not be known for some time, and will depend on how the
State implements the Law. There are many choices including how quickly the State
implements the Law; the degree to which the State elects to make up for cuts in
federal aid, provide more aid to counties, or cut some of its own existing
programs for noncitizens; and the State's ability to avoid certain penalties
written into the Law.
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LOCAL GOVERNMENTS
The primary units of local government in California are the counties,
ranging in population from 1,300 (Alpine) to over 9,000,000 (Los Angeles).
Counties are responsible for the provision of many basic services, including
indigent healthcare, welfare, courts, jails and public safety in unincorporated
areas. There are also about 480 incorporated cities, and thousands of other
special districts formed for education, utility and other services. The fiscal
condition of local governments has been constrained since the enactment of
"Proposition 13" in 1978, which reduced and limited the future growth of
property taxes, and limited the ability of local governments to impose "special
taxes" (those devoted to a specific purpose) without two-thirds voter approval.
A recent California Supreme Court decision had upheld the constitutionality of
an initiative statute, previously held invalid by lower courts, which requires
voter approval for "general" as well as "special" taxes at the local level.
Counties, in particular, have had fewer options to raise revenues than other
local government entities, and have been required to maintain many services.
In the aftermath of Proposition 13, the State provided aid from the General
Fund to make up some of the loss of property tax moneys, including taking over
the principal responsibility for funding local K-12 schools and community
colleges. Under the pressure of the recent recession, the Legislature has
eliminated the remnants of this post-Proposition 13 aid to entities other than
K-14 education districts, although it has also provided additional funding
sources (such as sales taxes) and reduced mandates for local services. Many
counties continue to be under severe fiscal stress. While such stress has in
recent years most often been experienced by smaller, rural counties, larger
urban counties, such as Los Angeles, have also been affected. Orange County
implemented significant reductions in services and personnel, and continues to
face fiscal constraints in the aftermath of its bankruptcy.
CONSTITUTIONAL AND STATUTORY LIMITATIONS; RECENT INITIATIVES; PENDING
LEGISLATION
Constitutional and Statutory Limitations. 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 percent of the
"full cash value" of the property, and effectively prohibits the levying of any
other ad valorem tax on real property 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
percent 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 percent) 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 the 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 local government has financial
responsibility for providing. To the extent that 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.
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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 a local governmental entity be approved by a
majority of the electorate of the governmental entity, (ii) required that any
special tax (defined as taxes levied for other than general government purposes)
imposed by a local governmental 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 services 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, (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 occurs 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.
On September 28, 1995 the California Supreme Court upheld the
constitutionality of the provision requiring a two-thirds vote in order for a
local government to impose a "special tax". Although the Supreme Court has yet
to rule on the provision requiring a majority vote for a "general tax", it
appears that the Supreme Court is favorably disposed to uphold that portion of
Proposition 62 as well. In that event, a number of taxes currently being
collected (especially by counties and general law cities) would be invalidated.
Prior collection of such taxes may also be subject to claims for refund unless
the Supreme Court chooses to apply its ruling prospectively. The California
Supreme Court has yet to consider the validity of Proposition 62 with regard to
charter cities.
Recent Initiatives. 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 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 cost 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 requirements 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.
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During the recent recession, General Fund revenues for several years were
less than originally projected, so that the original Proposition 98
appropriations turned out to be higher than the minimum percentage provided in
the law. The Legislature responded to these developments by designating the
"extra" Proposition 98 payments in one year as a "loan" from future years'
Proposition 98 entitlements and also intended that the "extra" payments would
not be included in the Proposition 98 "base" for calculating future years'
entitlement. By implementing these actions, per-pupil funding from Proposition
98 sources stayed almost constant at approximately $4,220 from Fiscal Year
1991-92 to Fiscal Year 1993-94.
In 1992, a lawsuit was filed, called California Teachers' Association v.
Gould, which challenged the validity of these off-budget loans. As part of the
negotiations leading to the 1995-96 Budget Act, an oral agreement was reached to
settle this case. The settlement was approved by the court in July 1996.
The settlement provides, among other things, that both the State and K-14
schools share in the repayment of prior years' emergency loans to schools. Of
the total $1.76 billion in loans, the State will repay $935 million by
forgiveness of the amount owed, while schools will repay $825 million. The State
share of the repayment will be reflected as expenditures above the current
Proposition 98 base calculation. The schools' share of the repayment will count
as appropriations that count toward satisfying the Proposition 98 guarantee, or
from "below" the current base. Repayments are spread over the eight-year period
of 1994-95 through 2001-02 to mitigate any adverse fiscal impact. The Director
of Finance has certified that a settlement has occurred, allowing approximately
$377 million in appropriations from the 1995-96 Fiscal Year to schools to be
disbursed.
On November 8, 1994, the voters approved Proposition 187, an initiative
statute ("Proposition 187"). Proposition 187 specifically prohibits funding by
the State of social services, health care services and public school education
for the benefit of any person not verified as either a United States citizen or
a person legally admitted to the United States. Among the provisions in
Proposition 187 pertaining to public school education, the measure requires,
commencing January 1, 1995, that every school district in the State verify the
legal status of every child enrolling in the district for the first time. By
January 1, 1996, each school district must also verify the legal status of
children already enrolled in the district and of all parents or guardians of all
students. If the district "reasonably suspects" that a student, parent or
guardian is not legally in the United States, that district must report the
student to the United States Immigration and Naturalization Service and certain
other parties. The measure also prohibits a school district from providing
education to a student it does not verify as either a United States citizen or a
person legally admitted to the United States. The State Legislative Analyst
estimates that verification costs could be in the tens of millions of dollars on
a statewide level (including verification costs incurred by other local
governments), with first-year costs potentially in excess of $100 million.
The reporting requirements may violate the Family Education Rights and
Privacy Act ("FERPA"), which generally prohibits schools that receive Federal
funds from disclosing information in student records without parental consent.
Compliance with FERPA is a condition of receiving Federal education funds, which
total $2.3 billion annually to California school districts. The Secretary of the
United States Department of Education has indicated that the reporting
requirements in Proposition 187 could jeopardize the ability of school districts
to receive these funds.
Opponents of Proposition 187 have filed at least eight lawsuits challenging
the constitutionality and validity of the measure. On November 2, 1995, a United
States District Court judge struck down the central
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provisions of Proposition 187 by ruling that parts of Proposition 187 conflict
with Federal power over immigration. The ruling concluded that states may not
enact their own schemes to "regulate immigration or devise immigration
regulations which run parallel or purport to supplement Federal immigration
law". As a consequence of the ruling, students may not be denied public
education and may not be asked about their immigration status when enrolling in
public schools. Further, the ruling struck down the requirements of Proposition
187 that teachers and district employees report information on the immigrant
status of students, parents and guardians. An appeal has been filed.
Article XIIIA, Article XIIIB and a number of other 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.
Pending Litigation. The State is a party to numerous legal proceedings,
many of which normally occur in governmental operations. Some of the more
significant lawsuits pending against the State are described herein. The State
is a defendant in 12 lawsuits involving the exclusion of small business stock
gains from preference tax and in some cases, also from taxation. The lead cases
are Mervin Morris v. Franchise Tax Board and James Lennane v. Franchise Tax
Board. The majority of the remaining cases had been deferred pending the outcome
of the Morris and Lennane cases. The Supreme Court has ruled against the State
in Lennane but has not yet ruled in Morris. The State has lost at least $80
million as a result of the Lennane decision.
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 but subsequently withdrew its order. The parties
have agreed to a settlement which has to be approved by the trial court. Under
the terms of the judgment, a maximum of $1.3 million will be paid to eligible
separated State employees and approximately $1 million will be paid in statutory
attorney's fees and costs. In addition, eligible current State employees will
receive employee leave, in an amount presently not quantified.
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.
In another case, the State is a defendant in Long Beach Unified School
Districts v. State of California. In this case, the school district seeks
reimbursement for voluntary desegregation costs incurred in the implementation
of California Department of Education guidelines. The years of reimbursement are
from Fiscal Year 1977-78 and each fiscal year thereafter to the present. The
district prevailed in a superior court, and the case has been decided by a State
appellate court against the State. A petition for review was denied and the
superior court judgment has become final, but the court retains jurisdiction to
oversee payment. The State anticipates that the unfavorable outcome will affect
pending claims by other school districts, and the total loss could be in excess
of $300 million.
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<PAGE> 103
A Federal Court of Appeals in the case of Deanna Beno et al. v. Donna
Shalala, reversing a trial court ruling in favor of the State, recently
determined that the Secretary of the United States Department of Health and
Human Services violated the Federal Administrative Procedure Act when she
approved California's Assistance Payment Demonstration Project, which in part,
granted California a waiver from complying with requirements for state
participation in the Federal program for medical assistance ("Medicaid"). The
waiver has allowed California to reduce payments under the Aid to Families with
Dependent Children program ("AFDC"), below 1988 payment levels without violating
Medicaid requirements relating to maintenance of AFDC payments levels.
California had relied, in part, on the waiver to reduce state AFDC payments in
1992, 1993 and 1994. The Court of Appeals remanded the case to the trial court
with instructions to remand the Demonstration Project to the Secretary for
additional consideration of objections raised by the plaintiffs. The State
submitted a renewed waiver request to the Secretary, which was granted in early
1996.
One of the features of the 1994-95 Budget Act is a 2.3 percent reduction in
AFDC payments. In Welch v. Anderson, on August 19, 1994, the San Francisco
Superior Court issued a preliminary injunction against the California Director
of Social Services to prevent the 2.3 percent AFDC cuts from becoming effective
September 1, 1994. While September cuts were already in process and could not be
halted, the court ordered the cuts to be restored. The preliminary injunction
has been upheld and the case on the merits remains pending.
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. The State is a defendant because it chose the
site and approved the deposit of toxic wastes. Seventeen of the 3,800 plaintiffs
have litigated their claims; in half of these cases plaintiffs' verdicts in the
total amount of $159,000 were received and in the remaining cases verdicts were
entered for the State. The other cases have been settled for $13.5 million. In
the separate suit described in United States, People of the State of California
v. J.B. Stringfellow Jr. et al., the State has been found liable by the District
Court on the counterclaim. The amount of liability is still being litigated
although allocation of liability has been determined by the trial court,
including an allocation of liability to the State.
The State is a defendant in a coordinated action involving 3,000 plaintiffs
seeking recovery for damages caused by the Yuba River flood of February 1986.
The appellate court affirmed the trial court finding of liability in inverse
condemnation and awarded damages of $500,000 to 12 sample plaintiffs. Potential
liability to the remaining 300 plaintiffs, from claims filed, ranges from $800
million to $1.5 billion.
The State in involved in a case concerning the default by Triad Healthcare
on a $167 million loan guaranteed by the Cal-Mortgage Loan Insurance Division of
the Office of Statewide Health Planning and Development ("Cal-Mortgage"). Monies
for the loan were raised through the sale of Certificates of Participation and
Cal-Mortgage insured the debt service payments. Since July 1993, Triad has
failed to make its monthly debt service payments; therefore, the reserve account
of the bonds has been used to make the payments. Once the reserve account is
exhausted, additional debt service payments would be made from the Health
Facility Construction Loan Insurance Fund as they become due. However, if there
is any shortfall in this fund, the State's General Fund would be used to make up
the difference.
In Jernigan & Burleson v. State, filed in Federal district court, the
prison inmate plaintiffs claim they are entitled to minimum wages while working
for the Prison Industry Authority. The inmates claim that the State
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<PAGE> 104
has violated the FLSA. Plaintiffs are seeking back pay for the period from
August 1990 onward, and liquidated damages for a total of approximately $350
million. In June 1995, the district court ruled that the inmates are not
employees under the FLSA. The decision has been appealed to the Ninth Circuit
Court of Appeals, which affirmed the District Court decision holding that the
inmates are not employees under the FLSA. The inmates have filed a Petition for
Rehearing and a Petition for Hearing En Banc with the Ninth Circuit.
Additional lawsuits challenge the transfer of moneys from special fund
accounts within the State Treasury to the State's General Fund pursuant to the
Budget Acts of 1991, 1992, 1993 and 1994. Plaintiffs in the two cases titled
Abramovitz et al. v. Wilson et al., filed in State and Federal courts, seek to
have the transfers reversed and the monies allegedly totalling approximately
$400 million returned to the special funds. Plaintiffs in the case of Kurt
Hathaway, et al. v. Wilson, filed in State court, seek to reverse transfers of
money from special fund accounts to the State's General Fund authorized in the
1994 and 1995 Budget Acts, allegedly totalling approximately $370 million. The
State disputes both liability and the amount claimed. In the case of
Professional Engineers in California Government v. Wilson, several State
employees' unions have challenged transfers made from special funds to the
General Fund pursuant to the Budget Acts of 1993, 1994 and 1995 and seek
reimbursement of over $400 million to these special funds.
In the case of Board of Administration, California Public Employees'
Retirement System, et al. v. Pete Wilson, Governor, et al., plaintiffs
challenged the constitutionality of legislation which deferred payment of the
State's employer contribution to the Public Employees' Retirement System
("PERS") beginning in Fiscal Year 1992-1993. On January 11, 1995, the Sacramento
County Superior Court entered a judgment finding that the legislation
unconstitutionally impaired the vested contract rights of PERS members. The
judgment provides for issuance of a writ of mandate directing State defendants
to disregard the provisions of the legislation, to implement the statute
governing employer contributions that existed before the changes in the
legislation were found to be unconstitutional and to transfer to PERS the
1993-94 and 1994-95 contributions that are unpaid to date. The State defendants
have appealed.
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<PAGE> 105
APPENDIX II
RATINGS OF MUNICIPAL BONDS
DESCRIPTION OF MUNICIPAL BOND RATINGS OF MOODY'S INVESTORS SERVICE, INC.
("MOODY'S")
<TABLE>
<S> <C>
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.
</TABLE>
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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<PAGE> 106
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 RATINGS SERVICES
("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> 107
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:
<TABLE>
<S> <C>
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 Debt rated "BB", "B", "CCC", "CC" and "C" is regarded, on balance, as
B predominately speculative with respect to capacity to pay interest and repay
CCC principal in accordance with the terms of the obligations. "BB" indicates the
CC lowest degree of speculation and "C" the highest degree of speculation. While
C 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.
</TABLE>
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> 108
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:
<TABLE>
<C> <S>
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.
</TABLE>
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> 109
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 Standard & Poor's publications.
Suspension or withdrawal may occur if new and material circumstances arise, the
effects of which preclude satisfactory analysis; if there is no longer available
reasonable up-to-date information to permit a judgment to be formed; if a bond
is called for redemption; or for other reasons.
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.
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Bonds that have the same rating are of similar but not necessarily
identical credit quality since the rating categories do not fully reflect small
differences in the degrees of credit risk.
Fitch ratings are not recommendations to buy, sell, or hold any security.
Ratings do not comment on the adequacy of market price, the suitability of any
security for a particular investor, or the tax-exempt nature or taxability of
payments made in respect of any security.
Fitch ratings are based on information obtained from issuers, other
obligors, underwriters, their experts, and other sources Fitch believes to be
reliable. Fitch does not audit or verify the truth or accuracy of such
information. Ratings may be changed, suspended, or withdrawn as a result of
changes in, or the unavailability of, information or for any other reasons.
<TABLE>
<C> <S>
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.
</TABLE>
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:
<TABLE>
<S> <C>
Improving [ARROW UP]
Stable [ARROW LEFT; ARROW RIGHT]
Declining [ARROW DOWN]
Uncertain [ARROW UP; ARROW DOWN]
</TABLE>
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Credit trend indicators are not predictions that any rating change will
occur, and have a longer-term time frame than issues placed on FitchAlert.
<TABLE>
<S> <C>
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.
</TABLE>
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.
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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.
<TABLE>
<S> <C>
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.
</TABLE>
Plus (+) or Minus (-): Plus and minus signs are used with a rating symbol
to indicate the relative position of a credit within the rating category. Plus
and minus signs, however, are not used in the "DDD", "DD", or "D" categories.
DESCRIPTION OF FITCH INVESTMENT GRADE SHORT-TERM RATINGS
Fitch's short-term ratings apply to debt obligations that are payable on
demand or have original maturities of generally up to three years, including
commercial paper, certificates of deposit, medium-term notes, and municipal and
investment notes.
The short-term rating places greater emphasis than a long-term rating on
the existence of liquidity necessary to meet the issuer's obligations in a
timely manner.
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Fitch short-term ratings are as follows:
<TABLE>
<S> <C>
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.
</TABLE>
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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 Ratings Services ("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.
62
<PAGE> 115
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, 1996,
the related statements of operations for the year then ended and changes in net
assets for each of the years in the two-year period then ended, and the
financial highlights for each of the years in the three-year period 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, 1996 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, 1996, 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 30, 1996
63
<PAGE> 116
MERRILL LYNCH CALIFORNIA INSURED MUNICIPAL BOND FUND AUGUST 31, 1996
<TABLE>
SCHEDULE OF INVESTMENTS (in Thousands)
<CAPTION>
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note 1a)
California--97.9%
<S> <C> <C> <C> <C>
AAA Aaa $1,000 Anaheim, California, Public Financing Authority, Tax Allocation Revenue
Bonds, RITES, 9.03% due 12/28/2018 (d)(e) $ 1,117
AAA Aaa 1,000 Brea, California, Redevelopment Agency, Tax Allocation Bonds (Redevelopment
Project A-B), 6.125% due 8/01/2013 (d) 1,034
AAA Aaa 1,290 California Fairs Financing Authority Revenue Bonds, 6.50% due 7/01/2011 (f) 1,376
AA- Aa 1,965 California HFA, Home Mortgage Revenue Bonds, AMT, Series F-1, 7% due 8/01/2026 2,064
California Health Facilities Financing Authority Revenue Bonds, Series A:
A1+ VMIG1++ 1,200 Refunding (Catholic West), VRDN, Series D, 3.25% due 7/01/2018 (a)(d) 1,200
BB Aaa 2,000 Refunding (Good Samaritan Health System), 7.50% due 5/01/2000 (g) 2,235
AAA Aaa 1,050 Refunding (Kaiser), 6.25% due 3/01/2021 (b) 1,071
AAA Aaa 2,000 (Scripps Memorial Hospital), 6.375% due 10/01/2022 (d) 2,090
A1+ VMIG1++ 1,300 (Scripps Memorial Hospital), VRDN, 3.35% due 12/01/2005 (a)(d) 1,300
California Pollution Control Financing Authority, Resource Recovery Revenue
Bonds, VRDN, AMT (a):
NR* NR* 600 (Delano Project), 3.50% due 8/01/2019 600
NR* P1 1,100 (Delano Project), Series 1991, 3.50% due 8/01/2019 1,100
NR* Aa3 100 (Honey Lake Power Project), 3.50% due 9/01/2018 100
NR* P1 100 Refunding (Ultra Power Malaga Project), Series B, 3.55% due 4/01/2017 100
A1+ VMIG1++ 100 California Pollution Control Financing Authority, Solid Waste Disposal
Revenue Bonds (Shell Oil Co.-Martinez Project), VRDN, AMT, Series B, 3.50%
due 12/01/2024 (a) 100
California State Public Works Board, Lease Revenue Bonds, Series A:
A A 2,000 (Department of Corrections-Monterey County Soledad II), 7% due 11/01/2019 2,199
AAA Aaa 4,000 (Various University of California Projects), 6.40% due 12/01/2016 (b) 4,236
</TABLE>
PORTFOLIO ABBREVIATIONS
To simplify the listings of Merrill Lynch California Insured
Municipal Bond Fund's portfolio holdings in the Schedule of
Investments, we have abbreviated the names of many of the securities
according to the list below and at right.
AMT Alternative Minimum Tax (subject to)
COP Certificates of Participation
GO General Obligation Bonds
HFA Housing Finance Agency
INFLOS Inverse Floating Rate Municipal Bonds
RITES Residual Interest Tax-Exempt Securities
RITR Residual Interest Trust Receipts
UT Unlimited Tax
VRDN Variable Rate Demand Notes
64
<PAGE> 117
MERRILL LYNCH CALIFORNIA INSURED MUNICIPAL BOND FUND AUGUST 31, 1996
<TABLE>
SCHEDULE OF INVESTMENTS (continued) (in Thousands)
<CAPTION>
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note 1a)
California (continued)
<S> <C> <C> <C> <C>
AAA Aaa $3,500 California State, Veterans' Bonds, AMT, UT, Series BD, BE and BF, 6.375%
due 2/01/2027(b) $ 3,540
Central Coast Water Authority, California, Revenue Bonds (State Water
Project Regional Facilities) (b):
AAA Aaa 4,090 6.35% due 10/01/2007 4,399
AAA Aaa 2,360 6.50% due 10/01/2014 2,535
AAA Aaa 1,200 Cucamonga County, California, Water District Facilities Refinancing Bonds,
COP, 6.50% due 9/01/2022 (c) 1,279
AAA Aaa 4,000 El Cajon, California, Redevelopment Agency, Tax Allocation Bonds (El Cajon
Redevelopment Project), 6.60% due 10/01/2022 (b) 4,279
AAA Aaa 2,500 Fresno, California, Sewer Revenue Bonds (Fowler Avenue Project), Series A,
6.25% due 8/01/2011 (b) 2,611
AAA Aaa 2,500 Industry, California, Urban Development Agency Refunding Bonds
(Transportation District Industrial Redevelopment Project 2), 6.50% due
11/01/2016 (d) 2,718
AA- Aa 2,000 Los Angeles, California, Department of Water and Power, Electric Plant
Revenue Bonds, Registered RITR, 8.327% due 2/01/2020 (e) 2,137
AAA Aaa 2,000 Los Angeles, California, Harbor Department Revenue Bonds, AMT, Series B,
6.625% due 8/01/2019 (b) 2,107
AAA Aaa 1,000 Los Angeles County, California, COP (Correctional Facilities Project),
6.50% due 9/01/2000 (d)(g) 1,091
AAA Aaa 3,000 Los Angeles County, California, Public Works Financing Authority, Lease
Revenue Refunding Bonds, Series A, 6% due 9/01/2006 (d) 3,200
AAA Aaa 1,000 Mesa, California, Consolidated Water District, COP (Water Project),
6.375% due 3/15/2012 (c) 1,051
AAA Aaa 2,140 Mount Diablo, California, Unified School District, Community Facilities-
Special District Tax No. 1 Bonds, 6.30% due 8/01/2022 (b) 2,222
AAA Aaa 2,500 Mountain View, California, Capital Improvements Financing Authority
Revenue Bonds (City Hall Community Theatre), 6.50% due 8/01/2016 (d) 2,662
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) 3,658
AAA Aaa 2,000 Oakland, California, Joint Powers Financing Authority, Lease Revenue Bonds
(Oakland Administration Buildings), 5.90% due 8/01/2016 (b) 2,000
AAA Aaa 3,000 Orchard, California, School District, GO, UT, Series A, 6.50% due
8/01/2019 (c) 3,198
AAA Aaa 1,500 Rancho, California, Water District Financing Authority, Revenue Refunding
Bonds, 6.25% due 8/01/2012 (c) 1,565
Sacramento, California, Municipal Utility District, Electric Revenue Bonds:
AAA Aaa 2,000 INFLOS, 8.717% due 8/15/2018 (c)(e) 2,095
AAA Aaa 3,000 Series B, 6.375% due 8/15/2022 (d) 3,138
</TABLE>
65
<PAGE> 118
MERRILL LYNCH CALIFORNIA INSURED MUNICIPAL BOND FUND AUGUST 31, 1996
<TABLE>
SCHEDULE OF INVESTMENTS (concluded) (in Thousands)
<CAPTION>
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note 1a)
California (concluded)
<S> <C> <C> <C> <C>
San Francisco, California, City and County Airport Commission,
International Airport, Revenue Refunding Bonds, Second Series:
AAA Aaa $3,750 First Issue, 6.50% due 5/01/2013 (b) $ 4,019
AAA Aaa 2,500 Second Issue, 6.75% due 5/01/2020 (d) 2,728
Southern California Public Power Authority Revenue Bonds (b):
AAA Aaa 2,500 (Mead Phoenix Project), Series A, 5% due 7/01/2017 2,246
A1+ VMIG1++ 600 (Southern Transmission Project),VRDN, 3.20% due 7/01/2019 (a) 600
Stockton, California, COP, Revenue Bonds (Wastewater Treatment Plant
Expansion), Series A (c):
AAA Aaa 2,500 6.70% due 9/01/2014 2,721
AAA Aaa 2,500 6.80% due 9/01/2024 2,739
University of California Revenue Bonds (Multiple Purpose Projects),
Series D (d):
AAA Aaa 3,685 6.30% due 9/01/2015 3,862
AAA Aaa 2,250 6.375% due 9/01/2019 2,354
Total Investments(Cost--$92,348)--97.9% 94,676
Other Assets Less Liabilities--2.1% 2,004
-------
Net Assets--100.0% $96,680
=======
<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, 1996.
(b)AMBAC Insured.
(c)FGIC Insured.
(d)MBIA Insured.
(e)The interest rate is subject to change periodically and inversely
based upon prevailing market rates. The interest rate shown is the
rate in effect at August 31, 1996.
(f)FSA Insured.
(g)Prerefunded.
*Not Rated.
++Highest short-term rating by Moody's Investors Service, Inc.
Ratings of issues shown have not been audited by Deloitte & Touche LLP.
See Notes to Financial Statements.
</TABLE>
66
<PAGE> 119
MERRILL LYNCH CALIFORNIA INSURED MUNICIPAL BOND FUND AUGUST 31, 1996
FINANCIAL INFORMATION
<TABLE>
Statement of Assets and Liabilities as of August 31, 1996
<S> <C> <C> <C>
Assets: Investments, at value (identified cost--$92,348,094) (Note 1a) $ 94,676,333
Cash 14,286
Receivables:
Interest $ 1,467,803
Beneficial interest sold 862,963 2,330,766
------------
Deferred organization expenses (Note 1e) 17,023
Prepaid registered fees and other assets (Note 1e) 33,605
------------
Total assets 97,072,013
------------
Liabilities: Payables:
Beneficial interest redeemed 142,056
Dividends to shareholders (Note 1f) 86,436
Distributor (Note 2) 36,096
Investment adviser (Note 2) 21,883 286,471
------------
Accrued expenses and other liabilities 105,899
------------
Total liabilities 392,370
------------
Net Assets: Net assets $ 96,679,643
============
Net Assets Class A Shares of beneficial interest, $.10 par value,
Consist of: unlimited number of shares authorized $ 144,141
Class B Shares of beneficial interest, $.10 par value,
unlimited number of shares authorized 744,817
Class C Shares of beneficial interest, $.10 par value,
unlimited number of shares authorized 49,831
Class D Shares of beneficial interest, $.10 par value,
unlimited number of shares authorized 43,707
Paid-in capital in excess of par 97,533,770
Accumulated realized capital losses on investments--net (Note 5) (4,164,862)
Unrealized appreciation on investments--net 2,328,239
------------
Net assets $ 96,679,643
============
Net Asset Value: Class A--Based on net assets of $14,182,528 and 1,441,410
shares of beneficial interest outstanding $ 9.84
============
Class B--Based on net assets of $73,292,287 and 7,448,173
shares of beneficial interest outstanding $ 9.84
============
Class C--Based on net assets of $4,901,025 and 498,310
shares of beneficial interest outstanding $ 9.84
============
Class D--Based on net assets of $4,303,803 and 437,072
shares of beneficial interest outstanding $ 9.85
============
See Notes to Financial Statements.
</TABLE>
67
<PAGE> 120
MERRILL LYNCH CALIFORNIA INSURED MUNICIPAL BOND FUND AUGUST 31, 1996
<TABLE>
FINANCIAL INFORMATION (continued)
<CAPTION>
Statement of Operations
For the Year Ended
August 31, 1996
<S> <C> <C> <C>
Investment Income Interest and amortization of premium and discount earned $ 5,365,221
(Note 1d):
Expenses: Investment advisory fees (Note 2) $ 517,728
Account maintenance and distribution fees--Class B (Note 2) 365,327
Registration fees (Note 1e) 70,662
Professional fees 51,077
Printing and shareholder reports 47,501
Accounting services (Note 2) 46,382
Transfer agent fees--Class B (Note 2) 29,916
Account maintenance and distribution fees--Class C (Note 2) 21,063
Custodian fees 14,925
Amortization of organization expenses (Note 1e) 11,474
Trustees' fees and expenses 8,879
Transfer agent fees--Class A (Note 2) 4,856
Pricing fees 4,836
Account maintenance fees--Class D (Note 2) 3,122
Transfer agent fees--Class C (Note 2) 1,406
Transfer agent fees--Class D (Note 2) 1,039
------------
Total expenses before reimbursement 1,200,193
Reimbursement of expenses (Note 2) (346,114)
------------
Total expenses after reimbursement 854,079
------------
Investment income--net 4,511,142
------------
Realized & Realized gain on investments--net 605,747
Unrealized Change in unrealized appreciation on investments--net 1,181,849
Gain on ------------
Investments--Net Net Increase in Net Assets Resulting from Operations $ 6,298,738
(Notes 1b, 1d & 3): ============
See Notes to Financial Statements.
</TABLE>
68
<PAGE> 121
MERRILL LYNCH CALIFORNIA INSURED MUNICIPAL BOND FUND AUGUST 31, 1996
FINANCIAL INFORMATION (continued)
<TABLE>
Statements of Changes in Net Assets
<CAPTION>
For the Year Ended August 31,
Increase (Decrease) in Net Assets: 1996 1995
<S> <C> <C> <C>
Operations: Investment income--net $ 4,511,142 $ 4,444,002
Realized gain (loss) on investments--net 605,747 (2,217,617)
Change in unrealized appreciation/depreciation on investments--net 1,181,849 2,985,447
------------ ------------
Net increase in net assets resulting from operations 6,298,738 5,211,832
------------ ------------
Dividends to Investment income--net:
Shareholders Class A (752,385) (814,541)
(Note 1f): Class B (3,437,910) (3,562,702)
Class C (161,469) (29,658)
Class D (159,378) (37,101)
------------ ------------
Net decrease in net assets resulting from dividends to
shareholders (4,511,142) (4,444,002)
------------ ------------
Beneficial Interest Net increase (decrease) in net assets derived from beneficial
Transactions interest transactions 5,394,929 (2,198,874)
(Note 4): ------------ ------------
Net Assets: Total increase (decrease) in net assets 7,182,525 (1,431,044)
Beginning of year 89,497,118 90,928,162
------------ ------------
End of year $ 96,679,643 $ 89,497,118
============ ============
See Notes to Financial Statements.
</TABLE>
69
<PAGE> 122
MERRILL LYNCH CALIFORNIA INSURED MUNICIPAL BOND FUND AUGUST 31, 1996
FINANCIAL INFORMATION (continued)
<TABLE>
Financial Highlights
<CAPTION>
Class A
For the
Period
The following per share data and ratios have been derived Feb. 26,
from information provided in the financial statements. 1993++ to
For the Year Ended August 31, Aug. 31,
Increase (Decrease) in Net Asset Value: 1996 1995 1994 1993
<S> <C> <C> <C> <C> <C>
Per Share Net asset value, beginning of period $ 9.65 $ 9.54 $ 10.23 $ 10.00
Operating -------- -------- -------- --------
Performance: Investment income--net .52 .52 .51 .24
Realized and unrealized gain (loss) on investments
--net .19 .11 (.65) .23
-------- -------- -------- --------
Total from investment operations .71 .63 (.14) .47
-------- -------- -------- --------
Less dividends and distributions:
Investment income--net (.52) (.52) (.51) (.24)
In excess of realized gain on investments--net -- -- (.04) --
-------- -------- -------- --------
Total dividends and distributions (.52) (.52) (.55) (.24)
-------- -------- -------- --------
Net asset value, end of period $ 9.84 $ 9.65 $ 9.54 $ 10.23
======== ======== ======== ========
Total Investment Based on net asset value per share 7.44% 6.89% (1.44%) 4.81%+++
Return:** ======== ======== ======== ========
Ratios to Expenses, net of reimbursement .49% .47% .33% .14%*
Average ======== ======== ======== ========
Net Assets: Expenses .85% .87% .96% 1.06%*
======== ======== ======== ========
Investment income--net 5.20% 5.53% 5.16% 4.80%*
======== ======== ======== ========
Supplemental Net assets, end of period (in thousands) $ 14,183 $ 14,204 $ 15,946 $ 17,105
Data: ======== ======== ======== ========
Portfolio turnover 87.77% 61.53% 93.04% 74.26%
======== ======== ======== ========
<FN>
*Annualized.
**Total investment returns exclude the effects of sales loads.
++Commencement of Operations.
+++Aggregate total investment return.
See Notes to Financial Statements.
</TABLE>
70
<PAGE> 123
MERRILL LYNCH CALIFORNIA INSURED MUNICIPAL BOND FUND AUGUST 31, 1996
FINANCIAL INFORMATION (continued)
<TABLE>
Financial Highlights (continued)
<CAPTION>
Class B
For the
Period
The following per share data and ratios have been derived Feb. 26,
from information provided in the financial statements. 1993++ to
For the Year Ended August 31, Aug. 31,
Increase (Decrease) in Net Asset Value: 1996 1995 1994 1993
<S> <C> <C> <C> <C> <C>
Per Share Net asset value, beginning of period $ 9.65 $ 9.54 $ 10.23 $ 10.00
Operating -------- -------- -------- --------
Performance: Investment income--net .47 .48 .46 .22
Realized and unrealized gain (loss) on investments
--net .19 .11 (.65) .23
-------- -------- -------- --------
Total from investment operations .66 .59 (.19) .45
-------- -------- -------- --------
Less dividends and distributions:
Investment income--net (.47) (.48) (.46) (.22)
In excess of realized gain on investments--net -- -- (.04) --
-------- -------- -------- --------
Total dividends and distributions (.47) (.48) (.50) (.22)
-------- -------- -------- --------
Net asset value, end of period $ 9.84 $ 9.65 $ 9.54 $ 10.23
======== ======== ======== ========
Total Investment Based on net asset value per share 6.89% 6.35% (1.93%) 4.56%+++
Return:** ======== ======== ======== ========
Ratios to Expenses, net of reimbursement .99% .97% .83% .64%*
Average ======== ======== ======== ========
Net Assets: Expenses 1.36% 1.38% 1.48% 1.56%*
======== ======== ======== ========
Investment income--net 4.69% 5.02% 4.67% 4.31%*
======== ======== ======== ========
Supplemental Net assets, end of period (in thousands). $ 73,292 $ 71,670 $ 74,982 $ 72,861
Data: ======== ======== ======== ========
Portfolio turnover 87.77% 61.53% 93.04% 74.26%
======== ======== ======== ========
<FN>
*Annualized.
**Total investment returns exclude the effects of sales loads.
++Commencement of Operations.
+++Aggregate total investment return.
See Notes to Financial Statements.
</TABLE>
71
<PAGE> 124
MERRILL LYNCH CALIFORNIA INSURED MUNICIPAL BOND FUND AUGUST 31, 1996
FINANCIAL INFORMATION (concluded)
<TABLE>
Financial Highlights (concluded)
<CAPTION>
Class C Class D
For the For the
For the Period For the Period
The following per share data and ratios have been derived Year Oct. 21, Year Oct. 21,
from information provided in the financial statements. Ended 1994++ to Ended 1994++ to
Aug. 31, Aug. 31, Aug. 31, Aug. 31,
Increase (Decrease) in Net Asset Value: 1996 1995 1996 1995
<S> <C> <C> <C> <C> <C>
Per Share Net asset value, beginning of period $ 9.64 $ 9.19 $ 9.65 $ 9.19
Operating -------- -------- -------- --------
Performance: Investment income--net .46 .39 .51 .44
Realized and unrealized gain on investments--net .20 .45 .20 .46
-------- -------- -------- --------
Total from investment operations .66 .84 .71 .90
-------- -------- -------- --------
Less dividends from investment income--net (.46) (.39) (.51) (.44)
-------- -------- -------- --------
Net asset value, end of period $ 9.84 $ 9.64 $ 9.85 $ 9.65
======== ======== ======== ========
Total Investment Based on net asset value per share 6.90% 9.35%+++ 7.44% 9.94%+++
Return:** ======== ======== ======== ========
Ratios to Expenses, net of reimbursement 1.10% 1.09%* .59% .57%*
Average Net ======== ======== ======== ========
Assets: Expenses 1.46% 1.49%* .95% .97%*
======== ======== ======== ========
Investment income--net 4.59% 4.76%* 5.09% 5.33%*
======== ======== ======== ========
Supplemental Net assets, end of period (in thousands) $ 4,901 $ 1,778 $ 4,304 $ 1,845
Data: ======== ======== ======== ========
Portfolio turnover 87.77% 61.53% 87.77% 61.53%
======== ======== ======== ========
<FN>
*Annualized.
**Total investment returns exclude the effects of sales loads.
++Commencement of Operations.
+++Aggregate total investment return.
See Notes to Financial Statements.
</TABLE>
72
<PAGE> 125
MERRILL LYNCH CALIFORNIA INSURED MUNICIPAL BOND FUND AUGUST 31, 1996
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 four classes of shares under the Merrill Lynch
Select Pricing SM System. Shares of Class A and Class D are sold
with a front-end sales charge. Shares of Class B and Class C may be
subject to a contingent deferred sales charge. All classes of shares
have identical voting, dividend, liquidation and other rights and
the same terms and conditions, except that Class B, Class C and
Class D Shares bear certain expenses related to the account
maintenance of such shares, and Class B and Class C Shares also bear
certain expenses related to the distribution of such shares. Each
class has exclusive voting rights with respect to matters relating
to its account maintenance and distribution expenditures. The
following is a summary of significant accounting policies followed
by the Fund.
(a) Valuation of investments-Municipal bonds and other portfolio
securities in which the Fund invests are traded primarily in the
over-the-counter municipal bond and money markets and are valued at
the last available bid price in the over-the-counter market or on
the basis of yield equivalents as obtained from one or more dealers
that make markets in the securities. Financial futures contracts and
options thereon, which are traded on exchanges, are valued at their
settlement prices as of the close of such exchanges. Short-term
investments with remaining maturities of sixty days or less are
valued 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 Board of Trustees of the Trust, including
valuations furnished by a pricing service retained by the Trust,
which may utilize a matrix system for valuations. The procedures of
the pricing service and its valuations are reviewed by the officers
of the Trust under the general supervision of the Trustees.
(b) Derivative financial instruments-The Fund may engage in various
portfolio strategies to seek to increase its return by hedging its
portfolio against adverse movements in the debt markets. Losses may
arise due to changes in the value of the contract or if the
counterparty does not perform under the contract.
* Financial futures contracts-The Fund may purchase or sell interest
rate futures contracts and options on such futures contracts for the
purpose of hedging the market risk on existing securities or the
intended purchase of securities. Futures contracts are contracts for
delayed delivery of securities at a specific future date and at a
specific price or yield. Upon entering into a contract, the Fund
deposits and maintains as collateral such initial margin as required
by the exchange on which the transaction is effected. Pursuant to
the contract, the Fund agrees to receive from or pay to the broker
an amount of cash equal to the daily fluctuation in value of the
contract. Such receipts or payments are known as variation margin
and are recorded by the Fund as unrealized gains or losses. When the
contract is closed, the Fund records a realized gain or loss equal
to the difference between the value of the contract at the time it
was opened and the value at the time it was closed.
(c) Income taxes-It is the Fund's policy to comply with the
requirements of the Internal Revenue Code applicable to regulated
investment companies and to distribute substantially all of its
taxable income to its shareholders. Therefore, no Federal income tax
provision is required.
(d) Security transactions and investment income-Security
transactions are recorded on the dates the transactions are entered
into (the trade dates). Interest income is recognized on the accrual
basis. Discounts and market premiums are amortized into interest
income. Realized gains and losses on security transactions are
determined on the identified cost basis.
(e) Deferred organization expenses and prepaid registration fees-
Deferred organization expenses are charged to expense on a straight-
line basis over a five-year period. Prepaid registration fees are
charged to expense as the related shares are issued.
73
<PAGE> 126
MERRILL LYNCH CALIFORNIA INSURED MUNICIPAL BOND FUND AUGUST 31, 1996
NOTES TO FINANCIAL STATEMENTS (continued)
(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 date.
2. Investment Advisory Agreement and
Transactions with Affiliates:
The Fund has entered into an Investment Advisory Agreement with Fund
Asset Management, L.P. ("FAM"). The general partner of FAM is
Princeton Services, Inc. ("PSI"), an indirect wholly-owned
subsidiary of Merrill Lynch & Co., Inc. ("ML & Co."), which is the
limited partner. The Fund has also entered into a Distribution
Agreement and Distribution Plans with Merrill Lynch Funds
Distributor, Inc. ("MLFD" or "Distributor"), a wholly-owned
subsidiary of Merrill Lynch Group, Inc.
FAM is responsible for the management of the Fund's portfolio and
provides the necessary personnel, facilities, equipment and certain
other services necessary to the operations of the Fund. For such
services, the Fund pays a monthly fee based upon the average daily
value of the Fund's net assets at the following annual rates: 0.55%
of the Fund's average daily net assets not exceeding $500 million;
0.525% of average daily net assets in excess of $500 million but not
exceeding $1 billion; and 0.50% of average daily net assets in
excess of $1 billion. The Investment Advisory 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, 1996, FAM earned fees of $517,728, of which
$346,114 was voluntarily waived.
Pursuant to the distribution plans (the "Distribution Plans")
adopted by the Fund in accordance with Rule 12b-1 under the
Investment Company Act of 1940, the Fund pays the Distributor
ongoing account maintenance and distribution fees. The fees are
accrued daily and paid monthly at annual rates based upon the
average daily net assets of the shares as follows:
Account Distribution
Maintenance Fee Fee
Class B 0.25% 0.25%
Class C 0.25% 0.35%
Class D 0.10% --
Pursuant to a sub-agreement with the Distributor, Merrill Lynch,
Pierce, Fenner & Smith Inc. ("MLPF&S"), a subsidiary of ML & Co.,
also provides account maintenance and distribution services to the
Fund. The ongoing account maintenance fee compensates the
Distributor and MLPF&S for providing account maintenance services to
Class B, Class C and Class D shareholders. The ongoing distribution
fee compensates the Distributor and MLPF&S for providing shareholder
and distribution-related services to Class B and Class C shareholders.
For the year ended August 31, 1996, MLFD earned underwriting
discounts and MLPF&S earned dealer concessions on sales of the
Fund's Class A and Class D Shares as follows:
MLFD MLPF&S
Class A $1,410 $ 8,259
Class D $ 912 $10,096
For the year ended August 31, 1996, MLPF&S received contingent
deferred sales charges of $157,396 and $2,319 relating to
transactions in Class B and Class C Shares, respectively.
Merrill Lynch Financial Data Services, Inc. ("MLFDS"), a wholly-
owned subsidiary of ML & Co., is the Fund's transfer agent.
Accounting services are provided to the Fund by FAM at cost.
74
<PAGE> 127
MERRILL LYNCH CALIFORNIA INSURED MUNICIPAL BOND FUND AUGUST 31, 1996
Certain officers and/or trustees of the Fund are officers and/or
directors of FAM, PSI, MLPF&S, MLFDS, MLFD, and/or ML & Co.
3. Investments:
Purchases and sales of investments, excluding short-term securities,
for the year ended August 31, 1996 were $75,954,351 and $75,054,038,
respectively.
Net realized and unrealized gains (losses) as of August 31, 1996
were as follows:
Realized Unrealized
Gains (Losses) Gains
Long-term investments $ 766,884 $ 2,328,239
Financial futures
contracts (161,137) --
------------ ------------
Total $ 605,747 $ 2,328,239
============ ============
As of August 31, 1996, net unrealized appreciation for Federal
income tax purposes aggregated $2,328,239, of which $2,578,107
related to appreciated securities and $249,868 related to
depreciated securities. The aggregate cost of investments at August
31, 1996 for Federal income tax purposes was $92,348,094.
4. Beneficial Interest Transactions:
Net increase (decrease) in net assets derived from beneficial
interest transactions was $5,394,929 and $(2,198,874) for the years
ended August 31, 1996 and August 31, 1995, respectively.
Transactions in shares of beneficial interest for each class were as
follows:
Class A Shares for the Year Dollar
Ended August 31, 1996 Shares Amount
Shares sold 192,761 $ 1,890,855
Shares issued to share-
holders in reinvestment
of dividends 28,926 285,031
----------- -----------
Total issued 221,687 2,175,886
Shares redeemed (252,553) (2,492,063)
----------- -----------
Net decrease (30,866) $ (316,177)
=========== ===========
Class A Shares for the Year Dollar
Ended August 31, 1995 Shares Amount
Shares sold 182,796 $ 1,683,426
Shares issued to share-
holders in reinvestment
of dividends 33,346 310,570
----------- -----------
Total issued 216,142 1,993,996
Shares redeemed (415,410) (3,820,473)
----------- -----------
Net decrease (199,268) $(1,826,477)
=========== ===========
Class B Shares for the Year Dollar
Ended August 31, 1996 Shares Amount
Shares sold 1,369,886 $13,477,417
Shares issued to share-
holders in reinvestment
of dividends 155,360 1,531,776
----------- -----------
Total issued 1,525,246 15,009,193
Shares redeemed (1,469,919) (14,486,720)
Automatic conversion
of shares (35,131) (353,395)
----------- -----------
Net increase 20,196 $ 169,078
=========== ===========
Class B Shares for the Year Dollar
Ended August 31, 1995 Shares Amount
Shares sold 1,704,924 $15,799,247
Shares issued to share-
holders in reinvestment
of dividends 174,843 1,629,535
----------- -----------
Total issued 1,879,767 17,428,782
Shares redeemed (2,311,348) (21,348,197)
----------- -----------
Net decrease (431,581) $(3,919,415)
=========== ===========
Class C Shares for the Year Dollar
Ended August 31, 1996 Shares Amount
Shares sold 424,343 $ 4,215,073
Shares issued to share-
holders in reinvestment
of dividends 11,412 112,281
----------- -----------
Total issued 435,755 4,327,354
Shares redeemed (121,901) (1,209,318)
----------- -----------
Net increase 313,854 $ 3,118,036
=========== ===========
75
<PAGE> 128
MERRILL LYNCH CALIFORNIA INSURED MUNICIPAL BOND FUND AUGUST 31, 1996
NOTES TO FINANCIAL STATEMENTS (concluded)
Class C Shares for the Period
October 21, 1994++ to Dollar
August 31, 1995 Shares Amount
Shares sold 247,131 $ 2,347,801
Shares issued to share-
holders in reinvestment
of dividends 1,481 14,182
----------- -----------
Total issued 248,612 2,361,983
Shares redeemed (64,156) (608,073)
----------- -----------
Net increase 184,456 $ 1,753,910
=========== ===========
[FN]
++Commencement of Operations.
Class D Shares for the Dollar
Year Ended August 31, 1996 Shares Amount
Shares sold 263,889 $ 2,602,675
Automatic conversion
of shares 35,107 353,395
Shares issued to share-
holders in reinvestment
of dividends 10,947 107,791
----------- -----------
Total issued 309,943 3,063,861
Shares redeemed (63,998) (639,869)
----------- -----------
Net increase 245,945 $ 2,423,992
=========== ===========
Class D Shares for the Period
October 21, 1994++ to Dollar
August 31, 1995 Shares Amount
Shares sold 308,159 $ 2,879,606
Shares issued to share-
holders in reinvestment
of dividends 1,745 16,707
----------- -----------
Total issued 309,904 2,896,313
Shares redeemed (118,777) (1,103,205)
----------- -----------
Net increase 191,127 $ 1,793,108
=========== ===========
[FN]
++Commencement of Operations.
5. Capital Loss Carryforward:
At August 31, 1996, the Fund had a net capital loss carryforward of
approximately $3,966,000, of which $2,950,000 expires in 2003 and
$1,016,000 expires in 2004. This amount will be available to offset
like amounts of any future taxable gains.
76
<PAGE> 129
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<PAGE> 130
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<PAGE> 131
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objective and Policies............... 2
Portfolio Insurance........................... 5
Description of Municipal Bonds and Temporary
Investments................................... 6
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......................... 17
Trustees and Officers......................... 17
Compensation of Trustees...................... 18
Management and Advisory Arrangements.......... 19
Purchase of Shares.............................. 20
Initial Sales Charge Alternatives--Class A and
Class D Shares.............................. 21
Reduced Initial Sales Charges................. 22
Distribution Plans............................ 25
Limitations on the Payment of Deferred Sales
Charges..................................... 25
Redemption of Shares............................ 27
Deferred Sales Charges--Class B and Class C
Shares...................................... 27
Portfolio Transactions.......................... 27
Determination of Net Asset Value................ 29
Shareholder Services............................ 29
Investment Account............................ 29
Automatic Investment Plans.................... 30
Automatic Reinvestment of Dividends and
Capital Gains Distributions................. 30
Systematic Withdrawal Plans--Class A and Class
D Shares.................................... 31
Exchange Privilege............................ 31
Distributions and Taxes......................... 34
Environmental Tax............................. 37
Tax Treatment of Futures and Options
Transactions................................ 37
Performance Data................................ 38
General Information............................. 40
Description of Shares......................... 40
Computation of Offering Price Per Share....... 41
Independent Auditors.......................... 41
Custodian..................................... 42
Transfer Agent................................ 42
Legal Counsel................................. 42
Reports to Shareholders....................... 42
Additional Information........................ 42
Appendix I
Economic and Other Conditions in California... 43
Appendix II
Ratings of Municipal Bonds.................... 53
Appendix III
Portfolio Insurance........................... 62
Independent Auditors' Report.................... 63
Financial Statements............................ 64
Code #16576-1296
</TABLE>
[MERRILL LYNCH LOGO]
MERRILL LYNCH
CALIFORNIA INSURED
MUNICIPAL BOND FUND
MERRILL LYNCH CALIFORNIA
MUNICIPAL SERIES TRUST
[Mlynch Compass]
STATEMENT OF
ADDITIONAL
INFORMATION
December 20, 1996
Distributor:
Merrill Lynch
Funds Distributor, Inc.
<PAGE> 132
APPENDIX FOR GRAPHIC AND IMAGE MATERIAL
Pursuant to Rule 304 of Regulation S-T, the following table presents
fair and accurate narrative descriptions of graphic and image material omitted
from this EDGAR Submission File due to ASCII-incompatibility and
cross-references this material to the location of each occurrence in the text.
<TABLE>
<CAPTION>
DESCRIPTION OF OMITTED LOCATION OF GRAPHIC
GRAPHIC OR IMAGE OR IMAGE IN TEXT
- ---------------------- -------------------
<S> <C>
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.
</TABLE>
<PAGE> 133
PART C. OTHER INFORMATION
ITEM 24. FINANCIAL STATEMENTS AND EXHIBITS.
(a) FINANCIAL STATEMENTS:
CONTAINED IN PART A:
Financial Highlights for each of the years in the three-year
period ended August 31, 1996 and for the period February 26, 1993
(commencement of operations) to August 31, 1993.
CONTAINED IN PART B:
Schedule of Investments as of August 31, 1996.
Statement of Assets and Liabilities as of August 31, 1996.
Statement of Operations for the year ended August 31, 1996.
Statements of Changes in Net Assets for each of the years in the
two-year period ended August 31, 1996.
Financial Highlights for each of the years in the three-year
period ended August 31, 1996 and for the period February 26, 1993
(commencement of operations) to August 31, 1993.
(b) EXHIBITS:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------ ----------------------------------------------------------------------------
<S> <C> <C>
1(a) -- Declaration of Trust of the Registrant, dated March 20, 1985.(a)
(b) -- Amendment to Declaration of Trust, dated July 25, 1985.(a)
(c) -- Amendment to Declaration of Trust, dated October 3, 1988.(a)
(d) -- Instrument establishing Merrill Lynch California Insured Municipal Bond Fund
(the "Fund") as a Series of Registrant.(a)
(e) -- Instrument establishing Class A shares and Class B shares of beneficial
interest of the Fund(a).
(f) -- Amendment to Declaration of Trust, dated October 17, 1994 and instrument
establishing Class C and Class D shares of beneficial interest of the
Fund.(f)
2 -- By-Laws of the Registrant.(a)
3 -- None.
4 -- Portions of the Declaration of Trust, Establishment and Designation and
By-Laws of the Registrant defining the rights of holders of the Fund as a
series of the Registrant.(b)
5(a) -- Management Agreement between the Registrant and Fund Asset Management,
Inc.(a)
(b) -- Supplement to Management Agreement between Registrant and Fund Asset
Management, Inc.(e)
6(a) -- Form of Revised Class A Shares Distribution Agreement between Registrant and
Merrill Lynch Funds Distributor, Inc. (including Form of Selected Dealers
Agreement).(e)
(b) -- Class B Shares Distribution Agreement between Registrant and Merrill Lynch
Funds Distributor, Inc.(a)
(c) -- Form of Class C Shares Distribution Agreement between Registrant and Merrill
Lynch Funds Distributor, Inc. (including Form of Selected Dealers
Agreement).(e)
(d) -- Form of Class D Shares Distribution Agreement between Registrant and Merrill
Lynch Funds Distributor, Inc. (including Form of Selected Dealers
Agreement).(e)
(e) -- Letter Agreement between the Fund and Merrill Lynch Funds Distributor, Inc.,
dated September 15, 1993, in connection with the Merrill Lynch Mutual Fund
Adviser Program.(d)
7 -- None.
8 -- Custody Agreement between Registrant and The Bank of New York.(a)
9 -- Transfer Agency, Dividend Disbursing Agency and Shareholder Servicing Agency
Agreement between Registrant and Merrill Lynch Financial Data Services,
Inc.(a)
10 -- None.
11 -- Consent of Deloitte & Touche LLP, independent auditors for the Registrant.
12 -- None.
13 -- Certificate of Fund Asset Management, Inc.(a)
14 -- None.
</TABLE>
C-1
<PAGE> 134
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------ ----------------------------------------------------------------------------
<S> <C> <C>
15(a) -- Amended and Restated Class B Shares Distribution Plan and Class B Shares
Distribution Plan Sub-Agreement.(d)
(b) -- Form of Class C Shares Distribution Plan and Class C Shares Distribution
Plan Sub-Agreement of the Registrant.(e)
(c) -- Form of Class D Shares Distribution Plan and Class D Shares Distribution
Plan Sub-Agreement of the Registrant.(e)
16(a) -- Schedule of computation of each performance quotation provided in the
Registration Statement in response to Item 22 relating to Class A Shares.(c)
(b) -- Schedule for computation of each performance quotation provided in the
Registration Statement in response to Item 22 relating to Class B Shares.(c)
(c) -- Schedule for computation of each performance quotation provided in the
Registration Statement in response to Item 22 relating to Class C Shares.(a)
(d) -- Schedule for computation of each performance quotation provided in the
Registration Statement in response to Item 22 relating to Class D Shares.(a)
17(a) -- Financial Data Schedule for Class A Shares.
(b) -- Financial Data Schedule for Class B Shares.
(c) -- Financial Data Schedule for Class C Shares.
(d) -- Financial Data Schedule for Class D Shares.
18 -- Merrill Lynch Select PricingSM System Plan pursuant to Rule 18f-3.(g)
</TABLE>
- ---------------
(a) Filed on December 29, 1995 as an Exhibit to Post-Effective Amendment No. 4
to Registrant's Registration Statement on Form N-1A under the Securities Act
of 1933, as amended, relating to shares of the Fund (File No. 33-55864) (the
"Registration Statement").
(b) Reference is made to Article II, Section 2.3 and Articles V, VI, VII, IX, X
and XI of the Registrant's Declaration of Trust, as amended, filed as
Exhibits 1(a), 1(b) and 1(c) with Post-Effective Amendment No. 4 to the
Registration Statement and to Exhibit 1(f) which is incorporated by
reference herein; to the Certificates of Establishment and Designation
establishing the Fund as a series of the Registrant and establishing Class A
and Class B shares of beneficial interest of the Fund, filed as Exhibits
1(d) and 1(e), respectively, with Post-Effective Amendment No. 4 to the
Registration Statement; and to Articles I, V and VI of the Registrant's
By-Laws, filed as Exhibit 2 with Post-Effective Amendment No. 4 to the
Registration Statement.
(c) Filed on July 23, 1993 as an Exhibit to Post-Effective Amendment No. 1 to
the Registration Statement.
(d) Filed on December 23, 1993 as an Exhibit to Post-Effective Amendment No. 2
to the Registration Statement.
(e) Filed on October 13, 1994 as an Exhibit to Post-Effective Amendment No. 3 to
the Registration Statement.
(f) Incorporated by reference to Exhibit 1(g) to Post-Effective Amendment No. 11
to the Registration Statement on Form N-1A under the Securities Act of 1933,
as amended, filed on December 29, 1995, relating to shares of Merrill Lynch
California Municipal Bond Fund series of the Registrant (File No. 2-96581).
(g) Incorporated by reference to Exhibit 18 to Post-Effective Amendment No. 13
to the Registration Statement on Form N-1A under the Securities Act of 1933,
as amended, filed on January 25, 1996, relating to shares of Merrill Lynch
New York Municipal Bond Fund series of Merrill Lynch Multi-State Municipal
Series Trust (File No. 2-99473).
C-2
<PAGE> 135
ITEM 25. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH REGISTRANT.
The Registrant is not controlled by or under common control with any
person.
ITEM 26. NUMBER OF HOLDERS OF SECURITIES.
<TABLE>
<CAPTION>
NUMBER OF
HOLDERS AT
TITLE OF CLASS NOVEMBER 30, 1996*
- ---------------------------------------------------------------------------- -------------------
<S> <C>
Class A shares of beneficial interest, par value $0.10 per share............ 211
Class B shares of beneficial interest, par value $0.10 per share............ 1,613
Class C shares of beneficial interest, par value $0.10 per share............ 111
Class D shares of beneficial interest, par value $0.10 per share............ 75
</TABLE>
- ---------------
(*) The number of holders includes holders of record plus beneficial owners,
whose shares are held of record by Merrill Lynch, Pierce, Fenner & Smith
Incorporated.
ITEM 27. INDEMNIFICATION.
Section 5.3 of the Registrant's Declaration of Trust provides as follows:
"The Trust shall indemnify each of its Trustees, officers, employees, and
agents (including persons who serve at its request as directors, officers or
trustees of another organization in which it has any interest as a shareholder,
creditor or otherwise) against all liabilities and expenses (including amounts
paid in satisfaction of judgments, in compromise, as fines and penalties, and as
counsel fees) reasonably incurred by him in connection with the defense or
disposition of any action, suit or other proceeding, whether civil or criminal,
in which he may be involved or with which he may be threatened, while in office
or thereafter, by reason of his being or having been such a trustee, officer,
employee or agent, except with respect to any matter as to which he shall have
been adjudicated to have acted in bad faith, willful misfeasance, gross
negligence or reckless disregard of his duties; provided, however, that as to
any matter disposed of by a compromise payment by such person, pursuant to a
consent decree or otherwise, no indemnification either for said payment or for
any other expenses shall be provided unless the Trust shall have received a
written opinion from independent legal counsel approved by the Trustees to the
effect that if either the matter of willful misfeasance, gross negligence or
reckless disregard of duty, or the matter of good faith and reasonable belief as
to the best interests of the Trust, had been adjudicated, it would have been
adjudicated in favor of such person. The rights accruing to any Person under
these provisions shall not exclude any other right to which he may be lawfully
entitled; provided that no Person may satisfy any right in indemnity or
reimbursement granted herein or in Section 5.1 or to which he may be otherwise
entitled except out of the property of the Trust, and no Shareholder shall be
personally liable to any Person with respect to any claim for indemnity or
reimbursement or otherwise. The Trustees may make advance payments in connection
with indemnification under this Section 5.3, provided that the indemnified
person shall have given a written undertaking to reimburse the Trust in the
event it is subsequently determined that he is not entitled to such
indemnification."
Insofar as the conditional advancing of indemnification monies for actions
based upon the Investment Company Act of 1940, as amended, may be concerned,
such payments will be made only on the following conditions: (i) the advances
must be limited to amounts used, or to be used, for the preparation or
presentation of a defense to the action, including costs connected with the
preparation of a settlement; (ii) advances may be made only upon receipt of a
written promise by, or on behalf of, the recipient to repay that amount of the
advance which exceeds the amount which it is ultimately determined he is
entitled to receive from the Registrant by reason of indemnification; and
(iii)(a) such promise must be secured by a surety bond, other suitable insurance
or an equivalent form of security which assures that any repayments may be
obtained by the Registrant without delay or litigation, which bond, insurance or
other form of security must be provided by the recipient of the advance, or (b)
a majority of a quorum of the Registrant's disinterested, non-party Trustees, or
an independent legal counsel in a written opinion, shall determine, based upon a
review of readily available facts, that the recipient of the advance ultimately
will be found entitled to indemnification.
C-3
<PAGE> 136
In Section 9 of the Distribution Agreements relating to the securities
being offered hereby, the Registrant agrees to indemnify the Distributor and
each person, if any, who controls the Distributor within the meaning of the
Securities Act of 1933, as amended (the "1933 Act"), against certain types of
civil liabilities arising in connection with the Registration Statement or
Prospectus and Statement of Additional Information.
Insofar as indemnification for liabilities arising under the 1933 Act may
be permitted to Trustees, officers and controlling persons of the Registrant and
the principal underwriter pursuant to the foregoing provisions or otherwise, the
Registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the
1933 Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
Registrant of expenses incurred or paid by a Trustee, officer, or controlling
person of the Registrant and the principal underwriter in connection with the
successful defense of any action, suit or proceeding) is asserted by such
Trustee, officer or controlling person or the principal underwriter in
connection with the shares being registered, the Registrant will, unless in the
opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the 1933 Act and
will be governed by the final adjudication of such issue.
ITEM 28. BUSINESS AND OTHER CONNECTIONS OF INVESTMENT ADVISER.
Fund Asset Management, L.P. (the "Manager" or "FAM") acts as the investment
adviser for the following open-end investment companies: CBA Money Fund, CMA
Government Securities Fund, CMA Money Fund, CMA Multi-State Municipal Series
Trust, CMA Tax-Exempt Fund, CMA Treasury Fund, The Corporate Fund Accumulation
Program, Inc., Financial Institutions Series Trust, Merrill Lynch Basic Value
Fund, Inc., Merrill Lynch California Municipal Series Trust, Merrill Lynch
Corporate Bond Fund, Inc., Merrill Lynch Emerging Tigers Fund, Inc., Merrill
Lynch Federal Securities Trust, Merrill Lynch Funds for Institutions Series,
Merrill Lynch Multi-State Limited Maturity Municipal Series Trust, Merrill Lynch
Multi-State Municipal Series Trust, Merrill Lynch Municipal Bond Fund, Inc.,
Merrill Lynch Phoenix Fund, Inc., Merrill Lynch Special Value Fund Inc., Merrill
Lynch World Income Fund, Inc., and The Municipal Fund Accumulation Program, Inc.
and the following closed-end investment companies: Apex Municipal Fund, Inc.,
Corporate High Yield Fund, Inc., Corporate High Yield Fund II, Inc., Income
Opportunities Fund 1999, Inc., Income Opportunities Fund 2000, Inc., Merrill
Lynch Municipal Strategy Fund, Inc., MuniAssets Fund Inc., MuniEnhanced Fund,
Inc., MuniInsured Fund, Inc., MuniVest Fund, Inc., MuniVest Fund II, Inc.,
MuniVest California Insured Fund, Inc., MuniVest Florida Fund, MuniVest Michigan
Insured Fund, Inc., MuniVest New Jersey Fund, Inc., MuniVest New York Insured
Fund, Inc., MuniVest Pennsylvania Insured Fund, MuniYield Arizona Fund, Inc.,
MuniYield California Fund, Inc., MuniYield California Insured Fund, Inc.,
MuniYield California Insured Fund II, Inc., MuniYield Florida Fund, MuniYield
Florida Insured Fund, MuniYield Fund, Inc., MuniYield Insured Fund, Inc.,
MuniYield Insured Fund II, Inc., MuniYield Michigan Fund, Inc., MuniYield
Michigan Insured Fund, Inc., MuniYield New Jersey Fund, Inc., MuniYield New
Jersey Insured Fund, Inc., MuniYield New York Insured Fund, Inc., MuniYield New
York Insured Fund II, Inc., MuniYield New York Insured Fund III, Inc., MuniYield
Pennsylvania Fund, MuniYield Quality Fund, Inc., MuniYield Quality Fund II,
Inc., Senior High Income Portfolio, Inc., Taurus MuniCalifornia Holdings, Inc.,
Taurus MuniNew York Holdings, Inc. and Worldwide DollarVest Fund, Inc.
Merrill Lynch Asset Management, L.P. ("MLAM"), an affiliate of the Manager,
acts as the investment adviser for the following open-end investment companies:
Merrill Lynch Adjustable Rate Securities Fund, Inc., Merrill Lynch Americas
Income Fund, Inc., Merrill Lynch Asset Builder Program, Inc., Merrill Lynch
Asset Growth Fund, Inc., Merrill Lynch Asset Income Fund, Inc., Merrill Lynch
Capital Fund, Inc., Merrill Lynch Developing Capital Markets Fund, Inc., Merrill
Lynch Dragon Fund, Inc., Merrill Lynch EuroFund, Merrill Lynch Fund for
Tomorrow, Inc., Merrill Lynch Fundamental Growth Fund, Inc., Merrill Lynch
Global Bond Fund for Investment and Retirement, Merrill Lynch Global Allocation
Fund, Inc., Merrill Lynch Global Convertible Fund, Inc., Merrill Lynch Global
Holdings, Inc., Merrill Lynch Global Resources Trust, Merrill Lynch Global
SmallCap Fund, Inc., Merrill Lynch Global Utility Fund, Inc., Merrill Lynch
Global Value Fund, Inc., Merrill Lynch Growth Fund, Merrill Lynch Healthcare
Fund, Inc., Merrill Lynch
C-4
<PAGE> 137
Institutional Intermediate Fund, Merrill Lynch International Equity Fund,
Merrill Lynch Latin America Fund, Inc., Merrill Lynch Middle East/Africa Fund,
Inc., Merrill Lynch Municipal Series Trust, Merrill Lynch Pacific Fund, Inc.,
Merrill Lynch Ready Assets Trust, Merrill Lynch Retirement Series Trust, Merrill
Lynch Series Fund, Inc., Merrill Lynch Short-Term Global Income Fund, Inc.,
Merrill Lynch Strategic Dividend Fund, Merrill Lynch Technology Fund, Inc.,
Merrill Lynch U.S. Treasury Money Fund, Merrill Lynch U.S.A. Government
Reserves, Merrill Lynch Utility Income Fund, Inc., and Merrill Lynch Variable
Series Funds, Inc. and the following closed-end investment companies:
Convertible Holdings, Inc., Merrill Lynch High Income Municipal Bond Fund, Inc.
and Merrill Lynch Senior Floating Rate Fund, Inc.
The address of each of these investment companies is P.O. Box 9011,
Princeton, New Jersey 08543-9011, except that the address of Merrill Lynch Funds
for Institutions Series and Merrill Lynch Institutional Intermediate Fund is One
Financial Center, 15th Floor, Boston, Massachusetts 02111-2646. The address of
the Manager, MLAM, Princeton Services, Inc. ("Princeton Services") and Princeton
Administrators, L.P. is also P.O. Box 9011, Princeton, New Jersey 08543-9011.
The address of Merrill Lynch Funds Distributor, Inc. ("MLFD") is P.O. Box 9081,
Princeton, New Jersey 08543-9081. The address of Merrill Lynch, Pierce, Fenner &
Smith Incorporated ("Merrill Lynch") and Merrill Lynch & Co., Inc. ("ML & Co.")
is World Financial Center, North Tower, 250 Vesey Street, New York, New York
10281. The address of the Fund's transfer agent, Merrill Lynch Financial Data
Services, Inc. ("MLFDS") is 4800 Deer Lake Drive East, Jacksonville, Florida
32246-6484.
Set forth below is a list of each executive officer and partner of the
Manager indicating each business, profession, vocation or employment of a
substantial nature in which each such person has been engaged since September 1,
1994 for his or its own account or in the capacity of director, officer, partner
or trustee. In addition, Mr. Zeikel is President, Mr. Richard is Treasurer and
Mr. Glenn is Executive Vice President of substantially all of the investment
companies described in the first two paragraphs of this item and Messrs.
Giordano, Harvey, Hewitt, Kirstein and Monagle are directors, trustees or
officers of one or more of such companies.
OFFICERS AND PARTNERS OF FAM ARE SET FORTH AS FOLLOWS:
<TABLE>
<CAPTION>
OTHER SUBSTANTIAL BUSINESS,
NAME POSITION(S) WITH MANAGER PROFESSION, VOCATION OR EMPLOYMENT
- -------------------------- ------------------------ ----------------------------------------
<S> <C> <C>
ML & Co. ................. Limited Partner Financial Services Holding Company;
Limited Partner of MLAM
Princeton Services, General Partner General Partner of MLAM
Inc. ...................
Arthur Zeikel............. President President of MLAM; President and
Director of Princeton Services; Director
of MLFD; Executive Vice President of
ML & Co.
Terry K. Glenn............ Executive Vice President Executive Vice President of MLAM;
Executive Vice President and Director
of Princeton Services; President and
Director of MLFD; Director of MLFDS;
President of Princeton Administrators,
L.P.
Vincent R. Giordano....... Senior Vice President Senior Vice President of MLAM; Senior
Vice President of Princeton Services
Elizabeth Griffin......... Senior Vice President Senior Vice President of MLAM
Norman R. Harvey.......... Senior Vice President Senior Vice President of MLAM; Senior
Vice President of Princeton Services
Michael J. Hennewinkel.... Senior Vice President Senior Vice President of MLAM; Senior
Vice President of Princeton Services
N. John Hewitt............ Senior Vice President Senior Vice President of MLAM; Senior
Vice President of Princeton Services
</TABLE>
C-5
<PAGE> 138
<TABLE>
<CAPTION>
OTHER SUBSTANTIAL BUSINESS,
NAME POSITION(S) WITH MANAGER PROFESSION, VOCATION OR EMPLOYMENT
- -------------------------- ------------------------ ----------------------------------------
<S> <C> <C>
Philip L. Kirstein........ Senior Vice President, Senior Vice President, General Counsel
General Counsel and and Secretary of MLAM; Senior Vice
Secretary President, General Counsel, Director
and Secretary of Princeton Services;
Director of MLFD
Ronald M. Kloss........... Senior Vice President Senior Vice President and Controller of
and Controller MLAM; Senior Vice President and
Controller of Princeton Services
Stephen M.M. Miller....... Senior Vice President Executive Vice President of Princeton
Administrators, L.P.; Senior Vice
President of Princeton Services
Joseph T. Monagle, Jr. ... Senior Vice President Senior Vice President of MLAM; Senior
Vice President of Princeton Services
Michael L. Quinn.......... Senior Vice President Senior Vice President of MLAM; Senior
Vice President of Princeton Services;
Managing Director and First Vice
President of Merrill Lynch from 1989
to 1995
Richard L. Reller......... Senior Vice President Senior Vice President of MLAM; Senior
Vice President of Princeton Services
Gerald M. Richard......... Senior Vice President Senior Vice President of MLAM; Vice
and Treasurer President and Treasurer of MLFD
Ronald L. Welburn......... Senior Vice President Senior Vice President of MLAM; Senior
Vice President of Princeton Services
Anthony Wiseman........... Senior Vice President Senior Vice President of MLAM; Senior
Vice President of Princeton Services
</TABLE>
ITEM 29. PRINCIPAL UNDERWRITERS.
(a) MLFD acts as the principal underwriter for the Registrant and for each
of the open-end investment companies referred to in the first two paragraphs of
Item 28 except CBA Money Fund, CMA Government Securities Fund, CMA Money Fund,
CMA Multi-State Municipal Series Trust, CMA Tax-Exempt Fund, CMA Treasury Fund,
The Corporate Fund Accumulation Program, Inc., MuniAssets Fund, Inc., and The
Municipal Fund Accumulation Program, Inc. and MLFD also acts as the principal
underwriter for the following closed-end investment companies: Merrill Lynch
High Income Municipal Bond Fund, Inc., Merrill Lynch Strategy Fund, Inc. and
Merrill Lynch Senior Floating Rate Fund, Inc.
C-6
<PAGE> 139
(b) Set forth below is information concerning each director and officer of
MLFD. The principal business address of each such person is P.O. Box 9011,
Princeton, New Jersey 08543-9011, except that the address of Messrs. Aldrich,
Brady, Breen, Crook, Fatseas and Wasel is One Financial Center, 23rd floor,
Boston, Massachusetts 02111-2646.
<TABLE>
<CAPTION>
(2) (3)
(1) POSITION(S) AND OFFICES POSITIONS AND OFFICES
NAME WITH MLFD WITH REGISTRANT
- ------------------------------ ------------------------------------- ------------------------
<S> <C> <C>
Terry K. Glenn................ President and Director Executive Vice President
Arthur Zeikel................. Director President and Trustee
Philip L. Kirstein............ Director None
William E. Aldrich............ Senior Vice President None
Robert W. Crook............... Senior Vice President None
Kevin P. Boman................ Vice President None
Michael J. Brady.............. Vice President None
William M. Breen.............. Vice President None
Mark A. DeSario............... Vice President None
James T. Fatseas.............. Vice President None
Debra W. Landsman-Yaros....... Vice President None
Michelle T. Lau............... Vice President None
Gerald M. Richard............. Vice President and Treasurer Treasurer
Salvatore Venezia............. Vice President None
William Wasel................. Vice President None
Robert Harris................. Secretary None
</TABLE>
(c) Not applicable.
ITEM 30. LOCATION OF ACCOUNTS AND RECORDS.
All accounts, books and other documents required to be maintained by
Section 31(a) of the Investment Company Act of 1940, as amended, and the rules
thereunder are maintained at the offices of the Registrant, 800 Scudders Mill
Road, Plainsboro, New Jersey 08536, and Merrill Lynch Financial Data Services,
Inc., 4800 Deer Lake Drive East, Jacksonville, Florida 32246-6484.
ITEM 31. MANAGEMENT SERVICES.
Other than as set forth under the caption "Management of the
Trust--Management and Advisory Arrangements" in the Prospectus constituting Part
A of the Registration Statement and under "Management of the Trust--Management
and Advisory Arrangements" in the Statement of Additional Information
constituting Part B of the Registration Statement, the Registrant is not a party
to any management-related service contract.
ITEM 32. UNDERTAKINGS.
(a) Not applicable.
(b) Not applicable.
(c) Registrant undertakes to furnish each person to whom a prospectus is
delivered with a copy of the Registrant's latest annual report to
shareholders, upon request and without charge.
C-7
<PAGE> 140
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant certifies that it meets all of
the requirements for effectiveness of this Post-Effective Amendment to its
Registration Statement pursuant to Rule 485(b) under the Securities Act of 1933
and has duly caused this Registration Statement to be signed on its behalf by
the undersigned, thereunto duly authorized, in the Township of Plainsboro, and
State of New Jersey, on the 20th day of December, 1996.
MERRILL LYNCH CALIFORNIA MUNICIPAL
SERIES TRUST
(REGISTRANT)
BY /S/ GERALD M. RICHARD
------------------------------------
(Gerald M. Richard, Treasurer)
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed below by the following persons in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- --------------------------------------------- ------------------------ ------------------
<S> <C> <C>
President and Trustee
ARTHUR ZEIKEL* (Principal Executive
- --------------------------------------------- Officer)
(Arthur Zeikel)
/s/ GERALD M. RICHARD* Treasurer (Principal December 20, 1996
- --------------------------------------------- Financial and
(Gerald M. Richard) Accounting Officer)
JAMES H. BODURTHA* Trustee
- ---------------------------------------------
(James H. Bodurtha)
HERBERT I. LONDON* Trustee
- ---------------------------------------------
(Herbert I. London)
ROBERT R. MARTIN* Trustee
- ---------------------------------------------
(Robert R. Martin)
JOSEPH L. MAY* Trustee
- ---------------------------------------------
(Joseph L. May)
ANDRE F. PEROLD* Trustee
- ---------------------------------------------
(Andre F. Perold)
*By /s/ GERALD M. RICHARD December 20, 1996
- ---------------------------------------------
(Gerald M. Richard, Attorney-in-fact)
</TABLE>
C-8
<PAGE> 141
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
- ------
<S> <C> <C>
11 -- Consent of Deloitte & Touche LLP, independent auditors for the
Registrant.
17(a) -- Financial Data Schedule for Class A shares.
(b) -- Financial Data Schedule for Class B shares.
(c) -- Financial Data Schedule for Class C shares.
(d) -- Financial Data Schedule for Class D shares.
</TABLE>
<PAGE> 1
EXHIBIT 11
INDEPENDENT AUDITORS' CONSENT
Merrill Lynch California Insured Municipal Bond Fund of
Merrill Lynch California Municipal Series Trust:
We consent to the use in Post-Effective Amendment No. 5 to Registration
Statement No. 33-55864 of our report dated September 30, 1996 appearing in the
Statement of Additional Information, which is a part of such Registration
Statement, and to the reference to us under the caption "Financial Highlights"
appearing in the Prospectus, which also is a part of such Registration
Statement.
Deloitte & Touche LLP
Princeton, New Jersey
December 20, 1996
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