<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON NOVEMBER 26, 1997
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. [_]
[X]
POST-EFFECTIVE AMENDMENT NO. 6
AND/OR
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 [X]
AMENDMENT NO. 22 [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)
800 SCUDDERS MILL ROAD
PLAINSBORO, NEW JERSEY 08536
(ADDRESS OF PRINCIPAL EXECUTIVE (ZIP CODE)
OFFICES)
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:
COUNSEL FOR THE TRUST: PHILIP L. KIRSTEIN, ESQ.
BROWN & WOOD LLP FUND ASSET MANAGEMENT
ONE WORLD TRADE CENTER P.O. BOX 9011
NEW YORK, NEW YORK 10048-0557 PRINCETON, NEW JERSEY
ATTENTION: THOMAS R. SMITH, JR., 08543-9011
ESQ.
BRIAN M. KAPLOWITZ, ESQ.
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.
TITLE OF SECURITIES BEING REGISTERED: Shares of Beneficial
Interest, par value $.10 per share.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
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
----------- --------
<C> <S> <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 Investment Objective and Policies;
Registrant................ 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 Cover Page; Merrill Lynch Select
Being Offered............. PricingSM System; Fee Table;
Purchase of Shares; Shareholder
Services; Additional Information;
Inside Back Cover Page
Item 8. Redemption or Repurchase... Merrill Lynch Select PricingSM
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................... Additional Information
Item 13. Investment Objective and Investment Objective and Policies;
Policies.................. Investment Restrictions
Item 14. Management of the Fund..... Management of the Trust
Item 15. Control Persons and
Principal Holders of Management of the Trust; General
Securities................ Information--Additional Information
Item 16. Investment Advisory and Management of the Trust; Purchase of
Other Services............ Shares; General Information
Item 17. Brokerage Allocation and
Other Practices........... Portfolio Transactions
Item 18. Capital Stock and Other General Information--Description of
Securities................ Shares
Item 19. Purchase, Redemption and
Pricing of Securities Purchase of Shares; Redemption of
Being Offered............. 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
PART C
</TABLE>
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>
PROSPECTUS
NOVEMBER 26, 1997
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 that seeks 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 U.S. 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 PricingSM System permits an
investor to choose the method of purchasing shares that the investor believes
is most beneficial given the amount of the purchase, the length of time the
investor expects to hold the shares and other relevant circumstances. 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 except that for participants in certain
fee-based programs the minimum initial purchase is $500 and the minimum
subsequent purchase is $50. Merrill Lynch may charge its customers a
processing fee (presently $5.35) for confirming purchases and repurchases.
Purchases and redemptions made directly through Merrill Lynch Financial Data
Services, Inc. (the "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 COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO
THE CONTRARY IS A CRIMINAL OFFENSE.
---------------
This Prospectus is a concise statement of information about the Fund that is
relevant to making an investment in the Fund. This Prospectus should be
retained for future reference. A statement containing additional information
about the Fund, dated November 26, 1997 (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 Commission maintains a Web site
(http://www.sec.gov) that contains the Statement of Additional Information,
material incorporated by reference and other information regarding the Fund.
The Statement of Additional Information is hereby incorporated by reference
into this Prospectus. The Fund is a separate series of the Trust, an open-end
management investment company organized as a Massachusetts business trust.
---------------
FUND ASSET MANAGEMENT--MANAGER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC.--DISTRIBUTOR
<PAGE>
FEE TABLE
A general comparison of the sales arrangements and other nonrecurring and
recurring expenses applicable to shares of the Fund follows:
<TABLE>
<CAPTION>
CLASS A(a) CLASS B(b) CLASS C CLASS D
---------- ---------- ------- -------
<S> <C> <C> <C> <C>
SHAREHOLDER TRANSACTION
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 None(d) 4.0% during the first 1.0% for one None(d)
original purchase year, decreasing 1.0% year(f)
price or redemption annually to 0.0% after
proceeds, whichever the fourth year(e)
is lower).............
Exchange Fee........... None None None None
ANNUAL FUND OPERATING
EXPENSES (AS A PERCENT-
AGE OF AVERAGE NET AS-
SETS):
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
Custodian Fees....... 0.01% 0.01% 0.01% 0.01%
Shareholder Servicing 0.02%
Costs(i)............ 0.03% 0.03% 0.02%
Other................ 0.31% 0.30% 0.30% 0.30%
---- ---- ---- ----
TOTAL OTHER EXPENSES.... 0.34% 0.34% 0.34% 0.33%
---- ---- ---- ----
TOTAL FUND OPERATING
EXPENSES(J)............ 0.89% 1.39% 1.49% 0.98%
==== ==== ==== ====
</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 26.
(c) Reduced for purchases of $25,000 and over and waived for purchases of
Class A shares by participants 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 that
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 certain fee-based programs. See
"Shareholder Services--Fee-Based Programs" --page 36.
(e) The CDSC may be modified in connection with certain fee-based programs.
See "Shareholder Services--Fee-Based Programs" --page 36.
(f) The CDSC may be waived in connection with 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 29.
(i) See "Management of the Trust--Transfer Agency Services" --page 22.
(j) For the fiscal year ended August 31, 1997, 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, 1997, the Manager
waived management fees totaling 0.26% for Class A shares, 0.25% for Class
B shares, 0.25% for Class C shares and 0.24% for Class D shares after
which the Fund's total expense ratio was 0.63% for Class A shares, 1.14%
for Class B shares, 1.24% for Class C shares and 0.74% for Class D shares.
2
<PAGE>
EXAMPLE:
<TABLE>
<CAPTION>
CUMULATIVE EXPENSES PAID
FOR THE PERIOD OF:
-------------------------------
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
An investor would pay the following expenses on
a $1,000 investment including the maximum $40
front-end sales charge (Class A and Class D
shares only) and assuming (1) the Total Fund
Operating Expenses for each class set forth on
page 2, (2) a 5% annual return throughout the
period and (3) redemption at the end of the
period (including any applicable CDSC for
Class B and Class C shares):
Class A...................................... $49 $67 $87 $145
Class B...................................... $54 $64 $76 $167
Class C...................................... $25 $47 $81 $178
Class D...................................... $50 $70 $92 $155
An investor would pay the following expenses on
the same $1,000 investment assuming no
redemption at the end of the period:
Class A...................................... $49 $67 $87 $145
Class B...................................... $14 $44 $76 $167
Class C...................................... $15 $47 $81 $178
Class D...................................... $50 $70 $92 $155
</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
$5.35) for confirming purchases and repurchases. Purchases and redemptions
made 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 that use 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, distribution and account maintenance fees that are imposed on Class
B and
3
<PAGE>
Class C shares, as well as the account maintenance fees that are imposed on
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 CDSCs and distribution fees with respect to the Class B and Class
C shares in that the sales charges and distribution fees applicable to each
class provide for the financing of the distribution of the shares of the Fund.
The distribution-related revenues paid with respect to a class will not be
used to finance the distribution expenditures of another class. Sales
personnel may receive different compensation for selling different classes of
shares.
The following table sets forth a summary of the distribution arrangements
for each class of shares under the Merrill Lynch Select Pricing(SM) System,
followed by a more detailed description of each class and a discussion of the
factors that investors should consider in determining the method of purchasing
shares under the Merrill Lynch Select Pricing(SM) System that the investor
believes is most beneficial under his or her particular circumstances. More
detailed information as to each class of shares is set forth under "Purchase
of Shares."
<TABLE>
<CAPTION>
ACCOUNT
SALES MAINTENANCE DISTRIBUTION CONVERSION
CLASS CHARGE(/1/) FEE FEE FEATURE
- -----------------------------------------------------------------------------------------
<C> <S> <C> <C> <C>
A Maximum 4.00% initial sales No No No
charge(/2/)(/3/)
- -----------------------------------------------------------------------------------------
B 0.25% 0.25% B shares convert to D
CDSC for a period of four years, shares
at a rate of 4.0% during the automatically after
first year, decreasing 1.0% approximately ten
annually to 0.0%(/4/) years(/5/)
- -----------------------------------------------------------------------------------------
1.0% CDSC for one
C year(/6/) 0.25% 0.35% No
- -----------------------------------------------------------------------------------------
Maximum 4.00% initial sales
D charge(/3/) 0.10% No No
</TABLE>
- --------
(1) Initial sales charges are imposed at the time of purchase as a percentage
of the offering price. CDSCs 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 by participants 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 certain fee-based programs. See "Class A" and "Class D" below.
(4) The CDSC may be modified in connection with certain fee-based programs.
(5) The conversion period for dividend reinvestment shares and certain fee-
based programs was 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 certain fee-based programs.
4
<PAGE>
Class A: Class A shares incur an initial sales charge when they are purchased
and bear no ongoing distribution or account maintenance fees. Class
A shares are offered to a limited group of investors and also will
be issued upon reinvestment of dividends on outstanding Class A
shares. Investors that currently own Class A shares in a shareholder
account are entitled to purchase additional Class A shares in that
account. 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."), 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 of 4.00% is
reduced for purchases of $25,000 and over and waived for purchases
by participants 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 certain fee-based programs. Sales charges also are
reduced under a right of accumulation that 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 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 certain fee-
based programs. Although Class C shares are subject to a CDSC for
5
<PAGE>
only one year (as compared to four years for Class B), Class C shares
have no conversion feature and, accordingly, an investor who
purchases Class C shares will be subject to account maintenance and
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. The maximum initial sales
charge of 4.00% is reduced for purchases of $25,000 and over.
Purchases of $1,000,000 or more may not be subject to an initial
sales charge but if the initial sales charge is waived such
purchases may be subject to a CDSC of up to 1.0% if the shares are
redeemed within one year after purchase. Such CDSC may be waived in
connection with 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 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 that 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
6
<PAGE>
maintenance fees and distribution fees; however, the ongoing account
maintenance and distribution fees potentially may be offset to the extent any
return is realized on the additional funds initially invested in Class B or
Class C shares. In addition, Class B shares will be converted into Class D
shares of the Fund after a conversion period of approximately ten years, and
thereafter investors will be subject to lower ongoing fees.
Certain investors may elect to purchase Class B shares if they determine it
to be most advantageous to have all of their funds invested initially and
intend to hold their shares for an extended period of time. Investors in Class
B shares should take into account whether they intend to redeem their shares
within the CDSC period and, if not, whether they intend to remain invested
until the end of the conversion period and thereby take advantage of the
reduction in ongoing fees resulting from the conversion into Class D shares.
Other investors, however, may elect to purchase Class C shares if they
determine that it is advantageous to have all of their assets invested
initially and they are uncertain as to the length of time they intend to hold
their assets in MLAM-advised mutual funds. Although Class C shareholders are
subject to a shorter CDSC period at a lower rate, they are subject to higher
distribution fees and forgo the Class B conversion feature, making their
investment subject to account maintenance and distribution fees for an
indefinite period of time. In addition, while both Class B and Class C
distribution fees are subject to the limitations on asset-based sales charges
imposed by the NASD, the Class B distribution fees are further limited under a
voluntary waiver of asset-based sales charges. See "Purchase of Shares--
Limitations on the Payment of Deferred Sales Charges."
7
<PAGE>
FINANCIAL HIGHLIGHTS
The financial information in the table below has been audited in conjunction
with the annual audits of the financial statements of the Fund by Deloitte &
Touche LLP, independent auditors. Financial statements for the year ended
August 31, 1997 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 CLASS B
------------------------------------------------ ------------------------------------------------
FOR THE FOR THE
PERIOD PERIOD
FOR THE YEAR FEBRUARY 26, FOR THE YEAR FEBRUARY 26,
ENDED AUGUST 31, 1993+ TO ENDED AUGUST 31, 1993+ TO
---------------------------------- AUGUST 31, ---------------------------------- AUGUST 31,
1997 1996 1995 1994 1993 1997 1996 1995 1994 1993
------- ------- ------- ------- ------------ ------- ------- ------- ------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Increase (Decrease) in
Net Asset Value:
PER SHARE OPERATING
PERFORMANCE:
Net asset value,
beginning of period.... $ 9.84 $ 9.65 $ 9.54 $ 10.23 $ 10.00 $ 9.84 $ 9.65 $ 9.54 $ 10.23 $ 10.00
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Investment income--
net................... .50 .52 .52 .51 .24 .45 .47 .48 .46 .22
Realized and unrealized
gain (loss) on
investments--net...... .41 .19 .11 (.65) .23 .41 .19 .11 (.65) .23
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total from investment
operations............. .91 .71 .63 (.14) .47 .86 .66 .59 (.19) .45
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Less dividends and
distributions:
Investment income--
net................... (.50) (.52) (.52) (.51) (.24) (.45) (.47) (.48) (.46) (.22)
In excess of realized
gain on
investments--net...... -- -- -- (.04) -- -- -- -- (.04) --
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total dividends and
distributions.......... (.50) (.52) (.52) (.55) (.24) (.45) (.47) (.48) (.50) (.22)
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Net asset value, end of
period................. $ 10.25 $ 9.84 $ 9.65 $ 9.54 $ 10.23 $ 10.25 $ 9.84 $ 9.65 $ 9.54 $ 10.23
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
TOTAL INVESTMENT
RETURN**:
Based on net asset value
per share.............. 9.50% 7.44% 6.94% (1.44%) 4.81%# 8.95% 6.89% 6.38% (1.93%) 4.56%#
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
RATIOS TO AVERAGE NET
ASSETS:
Expenses, net of
reimbursement.......... .63% .49% .47% .33% .14%* 1.14% .99% .97% .83% .64%*
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
Expenses................ .89% .85% .87% .96% 1.06%* 1.39% 1.36% 1.38% 1.48% 1.56%*
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
Investment income--net.. 5.03% 5.20% 5.53% 5.16% 4.80%* 4.52% 4.69% 5.02% 4.67% 4.31%*
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
SUPPLEMENTAL DATA:
Net assets, end of
period (in thousands).. $12,438 $14,183 $14,204 $15,946 $17,105 $69,320 $73,292 $71,670 $74,982 $72,861
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
Portfolio Turnover...... 67.28% 87.77% 61.53% 93.04% 74.26% 67.28% 87.77% 61.53% 93.04% 74.26%
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
</TABLE>
- -------
+ Commencement of Operations.
# Aggregate total investment return.
* Annualized.
** Total investment returns exclude the effects of sales loads.
8
<PAGE>
<TABLE>
<CAPTION>
CLASS C CLASS D
--------------------------- ---------------------------
FOR THE FOR THE
FOR THE PERIOD FOR THE PERIOD
YEAR ENDED OCTOBER 21, YEAR ENDED OCTOBER 21,
AUGUST 31, 1994+ TO AUGUST 31, 1994+ TO
-------------- AUGUST 31, -------------- AUGUST 31,
1997 1996 1995 1997 1996 1995
------ ------ ----------- ------ ------ -----------
<S> <C> <C> <C> <C> <C> <C>
Increase (Decrease) in
Net Asset Value:
PER SHARE OPERATING
PERFORMANCE:
Net asset value,
beginning of period.... $ 9.84 $ 9.64 $ 9.19 $ 9.85 $ 9.65 $ 9.19
------ ------ ------ ------ ------ ------
Investment income--
net................... .44 .46 .39 .49 .51 .44
Realized and unrealized
gain on
investments--net...... .40 .20 .45 .41 .20 .46
------ ------ ------ ------ ------ ------
Total from investment
operations............. .84 .66 .84 .90 .71 .90
------ ------ ------ ------ ------ ------
Less dividends from
investment income--
net.................... (.44) (.46) (.39) (.49) (.51) (.44)
------ ------ ------ ------ ------ ------
Net asset value, end of
period................. $10.24 $ 9.84 $ 9.64 $10.26 $ 9.85 $ 9.65
====== ====== ====== ====== ====== ======
TOTAL INVESTMENT
RETURN**:
Based on net asset value
per share.............. 8.74% 6.90% 9.38%# 9.39% 7.44% 9.99%#
====== ====== ====== ====== ====== ======
RATIOS TO AVERAGE NET
ASSETS:
Expenses, net of
reimbursement.......... 1.24% 1.10% 1.09%* .74% .59% .57%*
====== ====== ====== ====== ====== ======
Expenses................ 1.49% 1.46% 1.49%* .98% .95% .97%*
====== ====== ====== ====== ====== ======
Investment income--net.. 4.42% 4.59% 4.76%* 4.92% 5.09% 5.33%*
====== ====== ====== ====== ====== ======
SUPPLEMENTAL DATA:
Net Assets, end of
period (in thousands).. $5,361 $4,901 $1,778 $4,939 $4,304 $1,845
====== ====== ====== ====== ====== ======
Portfolio Turnover...... 67.28% 87.77% 61.53% 67.28% 87.77% 61.53%
====== ====== ====== ====== ====== ======
</TABLE>
- --------
+ Commencement of Operations.
# Aggregate total investment return.
* Annualized.
** Total investment returns exclude the effects of sales loads.
9
<PAGE>
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to provide shareholders with as high
a level of income exempt from Federal and California income taxes as is
consistent with prudent investment management. The Fund seeks to achieve its
objective while providing investors with the opportunity to invest in a non-
diversified portfolio of securities consisting primarily of long-term
obligations issued by or on behalf of the State of California, its political
subdivisions, agencies and instrumentalities, and obligations of other
qualifying issuers, such as issuers located in Puerto Rico, the U.S. 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,
among other things, the issuer's financial resources, its sensitivity to
economic conditions and trends, its operating history, the
10
<PAGE>
quality of its management and regulatory matters. See "Investment Objective
and Policies" in the Statement of Additional Information for a more detailed
discussion of the pertinent risk factors involved in investing in "high yield"
or "junk" bonds and Appendix II--"Ratings of Municipal Bonds" in the Statement
of Additional Information for additional information regarding ratings of debt
securities. The Fund does not intend to purchase debt securities that are in
default or which the Manager believes will be in default.
Certain Municipal Bonds may be entitled to the benefits of letters of credit
or similar credit enhancements issued by financial institutions. In such
instances, the Trustees and the Manager will take into account in assessing
the quality of such bonds not only the creditworthiness of the issuer of such
Municipal Bonds but also the creditworthiness of the financial institution.
The Fund's investments may also include variable rate demand obligations
("VRDOs") and VRDOs in the form of participation interests ("Participating
VRDOs") in variable rate tax-exempt obligations held by a financial
institution. The VRDOs in which the Fund will invest are tax-exempt
obligations which contain a floating or variable interest rate adjustment
formula and an unconditional right of demand on the part of the holder thereof
to receive payment of the unpaid principal balance plus accrued interest on a
short notice period not to exceed seven days. Participating VRDOs provide the
Fund with a specified undivided interest (up to 100%) of the underlying
obligation and the right to demand payment of the unpaid principal balance
plus accrued interest on the Participating VRDOs from the financial
institution on a specified number of days' notice, not to exceed seven days.
There is, however, the possibility that because of a default or insolvency,
the demand feature of VRDOs or Participating VRDOs may not be honored. The
Fund has been advised by its counsel that the Fund should be entitled to treat
the income received on Participating VRDOs as interest from tax-exempt
obligations.
VRDOs that contain an unconditional right of demand to receive payment of
the unpaid principal balance plus accrued interest on a notice period
exceeding seven days may be deemed illiquid securities. A VRDO with a demand
notice period exceeding seven days will therefore be subject to the Fund's
restriction on illiquid investments unless, in the 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 to the issuer, 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 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.
11
<PAGE>
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 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 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.
12
<PAGE>
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.
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.
13
<PAGE>
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 value of Municipal Bonds generally may be affected by uncertainties in
the municipal markets as a result of legislation or litigation changing the
taxation of Municipal Bonds or the rights of Municipal Bond holders in the
event of bankruptcy. Municipal bankruptcies are rare, and certain provisions
of the U.S. Bankruptcy Code governing such bankruptcies are unclear. Further,
the application of state law to Municipal Bond issuers could produce varying
results among the states or among Municipal Bond issuers within a state. These
uncertainties could have a significant impact on the prices of the California
Municipal Bonds or Municipal Bonds in which the Fund invests.
The Manager does not believe that the current economic conditions in
California or other factors described above will have a significant adverse
effect on the Fund's ability to invest in high quality California Municipal
Bonds. Because the Fund's portfolio will be comprised primarily of investment
grade securities, the Fund is expected to be less subject to market and credit
risks than a fund that invests primarily in lower quality California Municipal
Bonds. See "Description of Municipal Bonds" in the Statement of Additional
Information and see also Appendix I--"Economic and Other Conditions in
California" 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 (such as water, sewer, gas, electricity, solid waste, health
care, transportation, education and housing facilities), refunding of
outstanding obligations and obtaining funds for general operating expenses and
loans to other public institutions and facilities. In addition, certain types
of bonds are issued by or on behalf of public authorities to finance various
privately operated facilities, including certain facilities for the local
furnishing of electric energy or gas, sewage facilities, solid waste disposal
facilities and other specialized facilities. In the case of certain community
facilities district special tax ("Mello-Roos" in the case of California
Municipal Bonds), tax increment (or tax allocation) and assessment bonds, the
payment of
14
<PAGE>
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's 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 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
15
<PAGE>
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
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 entity 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.
16
<PAGE>
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 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. Recent
legislation has created new categories of capital gains taxable at different
rates which the Fund may pass through to shareholders. 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-
17
<PAGE>
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-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
18
<PAGE>
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 liquidity of a secondary market in a financial futures contract may be
adversely affected by "daily price fluctuation limits" established by
commodity exchanges which limit the amount of fluctuation in a futures
contract price during a single trading day. Once the daily limit has been
reached in the contract, no trades may be entered into at a price beyond the
limit, thus preventing the liquidation of open futures positions. Prices have
in the past reached and exceeded the daily limit on a number of consecutive
trading days.
The successful use of transactions in financial futures also depends on the
ability of the Manager to forecast correctly the direction and extent of
interest rate movements within a given time frame. To the extent these rates
remain stable during the period in which a financial futures contract is held
by the Fund or moves in a direction opposite to that anticipated, the Fund may
realize a loss on the hedging transaction which is not fully or partially
offset by an increase in the value of portfolio securities. As a result, the
Fund's total return for such period may be less than if it had not engaged in
the hedging transaction. Furthermore, the Fund will only engage in hedging
transactions from time to time and may not necessarily be engaging in hedging
transactions when movements in interest rates occur.
Reference is made to the Statement of Additional Information for further
information on financial futures contracts and certain options thereon.
REPURCHASE AGREEMENTS
As Temporary Investments, the Fund may invest in securities pursuant to
repurchase agreements. Repurchase agreements may be entered into only with a
member bank of the Federal Reserve System or a primary dealer in U.S.
Government securities, or an affiliate thereof. Under such agreements, the
seller agrees, upon entering into the contract, to repurchase the security
from the Fund at a mutually agreed upon time and price, thereby determining
the yield during the term of the agreement. This results in a fixed rate of
return insulated from market fluctuations during such period. The Fund may not
invest in repurchase agreements maturing in more than seven days if such
investments, together with the Fund's other illiquid investments, would exceed
15% of the Fund's 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
19
<PAGE>
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 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.
20
<PAGE>
The Trustees are:
Arthur Zeikel*--President of the Manager and its affiliate, MLAM; President
and Director of Princeton Services, Inc. ("Princeton Services"); and Executive
Vice President of ML & Co.
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 140 registered investment companies. MLAM also
provides investment advisory services to individual and institutional
accounts. As of October 31, 1997, the Manager and MLAM had a total of
approximately $271.9 billion in investment company and other portfolio assets
under management, including accounts of certain affiliates of the Manager.
Subject to the direction of the Trustees, the Manager is responsible for the
actual management of the Fund's portfolio and constantly reviews the Fund's
holdings in light of its own research analysis and that from other relevant
sources. The responsibility for making decisions to buy, sell or hold a
particular security rests with the Manager, subject to review by the Board of
Trustees. The Manager performs certain of the other administrative services
and provides all of the office space, facilities, equipment and necessary
personnel for management of the Fund.
Walter O'Connor is the Vice President and Portfolio Manager of the Fund and
has been responsible for the day-to-day management of the Fund's investment
portfolio since December, 1995. 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 average daily net assets
not exceeding $500 million; 0.525% of the average daily net assets exceeding
$500 million but not exceeding $1.0 billion; and 0.50% of the portion of the
average daily net assets exceeding $1.0 billion. For the fiscal year ended
August 31, 1997, the total fee paid by the Fund to the Manager was $525,625
(based on average daily net assets of approximately $95.8 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
21
<PAGE>
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, 1997, the Fund reimbursed the Manager $86,203 for
accounting services. For the fiscal year ended August 31, 1997, the ratio of
total expenses, to average net assets was .89% for Class A shares, 1.39% for
Class B shares, 1.49% for Class C shares and .98% 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 that 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 that
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).
TRANSFER AGENCY SERVICES
The Transfer Agent, which is a 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 Transfer Agent receives an annual fee of up to $11.00 per Class
A or Class D account and up to $14.00 per Class B or Class C account, and the
Transfer Agent is entitled to reimbursement for certain transaction charges
and out-of-pocket expenses incurred by the Transfer Agent under the Transfer
Agency Agreement. Additionally, a $.20 monthly closed account charge will be
assessed on all accounts which close during the calendar year. Application of
this fee will commence the month following the month the account is closed. At
the end of the calendar year, no further fees will be due. For purposes of the
Transfer Agency Agreement, the term "account" includes a shareholder account
maintained directly by the Transfer Agent and any other account representing
the beneficial interest of a person in the relevant share class on a
recordkeeping system, provided the recordkeeping system is maintained by a
subsidiary of ML & Co. For the fiscal year ended August 31, 1997, the total
fee paid by the Fund to the Transfer Agent was $28,394 pursuant to the
Transfer Agency Agreement.
22
<PAGE>
PURCHASE OF SHARES
The Distributor, an affiliate of each 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, except that for participants in certain fee-based
programs, the minimum initial purchase is $500 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 on that day, 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 $5.35) to confirm a sale
of shares to such customers. Purchases made 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
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, 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
23
<PAGE>
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 (except that Class B shareholders may vote
upon any material changes to expenses charged under the Class D Distribution
Plan). 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 CDSCs and distribution fees with respect to Class B and Class C shares
in that the sales charges and distribution fees 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, that are
eligible to sell shares.
The following table sets forth a summary of the distribution arrangements
for each class of shares under the Merrill Lynch Select PricingSM System.
<TABLE>
<CAPTION>
ACCOUNT
SALES MAINTENANCE DISTRIBUTION CONVERSION
CLASS CHARGE(/1/) FEE FEE FEATURE
- -----------------------------------------------------------------------------------------
<C> <S> <C> <C> <C>
A Maximum 4.00% initial sales No No No
charge(/2/)(/3/)
- -----------------------------------------------------------------------------------------
B 0.25% 0.25% B shares convert to D
CDSC for a period of four years, shares
at a rate of 4.0% during the automatically after
first year, decreasing 1.0% approximately ten
annually to 0.0%(/4/) years(/5/)
- -----------------------------------------------------------------------------------------
1.0% CDSC for one
C year(/6/) 0.25% 0.35% No
- -----------------------------------------------------------------------------------------
Maximum 4.00% initial sales
D charge(/3/) 0.10% No No
</TABLE>
(1) Initial sales charges are imposed at the time of purchase as a percentage
of the offering price. CDSCs may be imposed if the redemption occurs
within the applicable CDSC time period. The charge will be assessed on an
amount equal to the lesser of the proceeds of redemption or the cost of
the shares being redeemed.
(2) Offered only to eligible investors. See "Initial Sales Charge
Alternatives--Class A and Class D Shares--Eligible Class A Investors."
(3) Reduced for purchases of $25,000 or more and waived for purchases of Class
A shares by participants 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 certain fee-based programs.
(4) The CDSC may be modified in connection with certain fee-based programs.
(5) The conversion period for dividend reinvestment shares and certain fee-
based programs was 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 certain fee-based programs.
24
<PAGE>
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.
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 CHARGE AS DISCOUNT TO
SALES CHARGE AS PERCENTAGE* OF SELECTED DEALERS
PERCENTAGE OF THE NET AMOUNT AS PERCENTAGE OF
AMOUNT OF PURCHASE OFFERING PRICE INVESTED THE OFFERING PRICE
- ------------------ --------------- --------------- ------------------
<S> <C> <C> <C>
Less than $25,000.......... 4.00% 4.17% 3.75%
$25,000 but less than
$50,000................... 3.75% 3.90% 3.50%
$50,000 but less than
$100,000.................. 3.25% 3.36% 3.00%
$100,000 but less than
$250,000.................. 2.50% 2.56% 2.25%
$250,000 but less than
$1,000,000................ 1.50% 1.52% 1.25%
$1,000,000 and over**...... 0.00% 0.00% 0.00%
</TABLE>
- --------
* Rounded to the nearest one-hundredth percent.
** The initial sales charge may be waived on Class A and Class D purchases of
$1,000,000 or more and on Class A purchases by participants 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 1.0% CDSC if the shares are redeemed within one year after
purchase. Such CDSC may be waived in connection with 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.
For the fiscal year ended August 31, 1997, the Fund sold 167,842 Class A
shares for aggregate net proceeds of $1,721,861. The gross sales charges for
the sale of Class A shares of the Fund for that year were $1,485, of which
$150 and $1,335 were received by the Distributor and Merrill Lynch,
respectively. For the fiscal year ended August 31, 1997, 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
fiscal year ended August 31, 1997, the Fund sold 59,711 Class D shares for
aggregate net proceeds of $601,386. The gross sales charges for the sale of
Class D shares of the Fund for the year were $3,599, of which $503 and $3,096
were received by the Distributor and Merrill Lynch, respectively. For the
fiscal year ended August 31, 1997, 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 and U.S. branches
of foreign banking institutions provided that the program or branch 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 TMASM Managed Trusts to which Merrill Lynch
Trust
25
<PAGE>
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 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."
Provided applicable threshold requirements are met, either Class A or Class
D shares are offered at net asset value to Employee Access(SM) Accounts
available through authorized employers. 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,
which declines each year, while Class C shares are subject only to a one-year
1.0% CDSC. On the other hand, approximately ten years
26
<PAGE>
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."
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. The proceeds from the account maintenance fees are used
to compensate the Distributor and Merrill Lynch (pursuant to a sub-agreement)
for providing continuing account maintenance activities. 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. 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 that 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.
27
<PAGE>
The following table sets forth the rates of the Class B CDSC:
<TABLE>
<CAPTION>
CDSC AS A
PERCENTAGE
YEAR SINCE PURCHASE OF DOLLAR AMOUNT
PAYMENT MADE SUBJECT TO CHARGE
------------------- -----------------
<S> <C>
0-1........................................................ 4.0%
1-2........................................................ 3.0%
2-3........................................................ 2.0%
3-4........................................................ 1.0%
4 and thereafter........................................... None
</TABLE>
For the fiscal year ended August 31, 1997, the Distributor received CDSCs of
$129,315 with respect to redemptions of Class B shares, all of which were paid
to Merrill Lynch. Additional CDSCs payable to the Distributor may have been
waived or converted to a contingent obligation in connection with a
shareholder's participation in certain fee-based programs.
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. The Class B CDSC also is
waived for any Class B shares that are purchased within qualifying Employee
Access(SM) Accounts. 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 certain fee-based programs. See
"Shareholder Services--Fee-Based Programs."
Contingent Deferred Sales Charges--Class C Shares. Class C shares that 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. The Class C CDSC may be waived in
connection with certain fee-based programs. See "Shareholder Services--Fee-
Based Programs." For the fiscal year ended August 31, 1997, the Distributor
received CDSCs of $1,735 with respect to redemptions of Class C shares, all of
which were paid to Merrill Lynch.
28
<PAGE>
In determining whether a Class C CDSC is applicable to a redemption, the
calculation will be determined in the manner that results in the lowest
possible rate being charged. Therefore, it will be assumed that the redemption
is first of shares held for over one year or shares acquired pursuant to
reinvestment of dividends or distributions and then of shares held longest
during the one year period. The charge will not be applied to dollar amounts
representing an increase in the net asset value since the time of purchase. A
transfer of shares from a shareholder's account to another account will be
assumed to be made in the same order as a redemption.
Conversion of Class B Shares to Class D Shares. After approximately ten
years (the "Conversion Period"), Class B shares will be converted
automatically into Class D shares of the Fund. Class D shares are subject to
an ongoing account maintenance fee of 0.10% of net assets but are not subject
to the distribution fee that is borne by Class B shares. Automatic conversion
of Class B shares into Class D shares will occur at least once each month (on
the "Conversion Date") on the basis of the relative net asset values of the
shares of the two classes on the Conversion Date, without the imposition of
any sales load, fee or other charge. Conversion of Class B shares to Class D
shares will not be deemed a purchase or sale of the shares for Federal income
tax purposes.
In addition, shares purchased through reinvestment of dividends on Class B
shares also will convert automatically to Class D shares. The Conversion Date
for dividend reinvestment shares will be calculated taking into account the
length of time the shares underlying such dividend reinvestment shares were
outstanding. If at a Conversion Date the conversion of Class B shares to Class
D shares of the Fund in a single account will result in less than $50 worth of
Class B shares being left in the account, all of the Class B shares of the
Fund held in the account on the Conversion Date will be converted to Class D
shares of the Fund.
Share certificates for Class B shares of the Fund to be converted must be
delivered to the Transfer Agent at least one week prior to the Conversion Date
applicable to those shares. In the event such certificates are 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 also may be modified for investors who 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.
29
<PAGE>
The Distribution Plans for Class B, Class C and Class D shares each provide
that the Fund pays the Distributor an account maintenance fee relating to the
shares of the relevant class, accrued daily and paid monthly, at the annual
rates of 0.25%, 0.25% and 0.10%, respectively, of the average daily net assets
of the Fund attributable to shares of the relevant class in order to
compensate the Distributor and Merrill Lynch (pursuant to a sub-agreement) in
connection with account maintenance activities.
The Distribution Plans for Class B and Class C shares each provide that the
Fund also pays the Distributor a distribution fee relating to the shares of
the relevant class, accrued daily and paid monthly, at the annual rates of
0.25% and 0.35%, respectively, of the average daily net assets of the Fund
attributable to the shares of the relevant class in order to compensate the
Distributor and Merrill Lynch (pursuant to a sub-agreement) for providing
shareholder and distribution services, and bearing certain distribution-
related expenses of the Fund, including payments to financial consultants for
selling Class B and Class C shares of the Fund. The Distribution Plans
relating to Class B and Class C shares are designed to permit an investor to
purchase Class B and Class C shares through dealers without the assessment of
an initial sales charge and at the same time permit the dealer to compensate
its financial consultants in connection with the sale of the Class B and Class
C shares. In this regard, the purpose and function of the ongoing distribution
fees and the CDSC are the same as those of the initial sales charge with
respect to the Class A and Class D shares of the Fund in that the deferred
sales charges provide for the financing of the distribution of the Fund's
Class B and Class C shares.
For the fiscal year ended August 31, 1997, the Fund paid the Distributor
$359,250 pursuant to the Class B Distribution Plan (based on average daily net
assets subject to such Class B Distribution Plan of approximately $72.0
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, 1997, the Fund paid
the Distributor $31,088 pursuant to the Class C Distribution Plan (based on
average daily net assets subject to such Class C Distribution Plan of
approximately $5.2 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, 1997,
the Fund paid the Distributor $4,693 pursuant to the Class D Distribution Plan
(based on average daily net assets subject to such Class D Distribution Plan
of approximately $4.7 million), all of which was paid to Merrill Lynch for
providing account maintenance activities in connection with Class D shares.
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, 1996, 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
30
<PAGE>
for such period by approximately $1,552,000 (2.12% of Class B net assets at
that date). As of August 31, 1997, direct cash revenues for the period since
the commencement of operations of Class B shares exceeded direct cash expenses
by approximately $600,240 (.87% of Class B net assets at that date). As of
December 31, 1996, the fully allocated accrual expenses incurred by the
Distributor and Merrill Lynch for the period since commencement of operations
of Class C shares exceeded fully allocated accrual revenues by approximately
$13,000 (.27% of Class C net assets at that date). As of August 31, 1997, for
Class C Shares direct cash revenues for the period since the commencement of
operations of Class C shares exceeded direct cash expenses by $35,439 (0.66%
of Class C net assets at that date).
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.
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."
31
<PAGE>
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 that may be applicable, there will be no
charge for redemption if the redemption request is sent directly to the
Transfer Agent. Shareholders liquidating their holdings will receive upon
redemption all dividends reinvested through the date of redemption. The value
of shares at the time of redemption may be more or less than the shareholder's
cost depending on the market value of the securities held by the Fund at such
time.
REDEMPTION
A shareholder wishing to redeem shares may do so by tendering the shares
directly to the Transfer Agent, 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 redemption request 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.
32
<PAGE>
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 $5.35) to confirm a repurchase of
shares to such customers. Repurchases made 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.
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
described below that are 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
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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 such shares
and then must turn the certificates over to the new firm for re-registration
as described in the preceding sentence.
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 the 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 that 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
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Class D shares. The period of time that Class A, Class B, Class C or Class D
shares are held in a money market fund, however, will not count toward
satisfaction of the holding period requirement for reduction of any CDSC
imposed on such shares, if any, and with respect to Class B shares, toward
satisfaction of the Conversion Period.
Class B shareholders of the Fund exercising the exchange privilege will
continue to be subject to the Fund's CDSC schedule if such schedule is higher
than the CDSC schedule relating to the new Class B shares. In addition, Class
B shares of the Fund acquired through use of the exchange privilege will be
subject to the Fund's CDSC schedule if such schedule is higher than the CDSC
schedule relating to the Class B shares of the MLAM-advised mutual fund from
which the exchange has been made.
Exercise of the exchange privilege is treated as a sale 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 written
notification to Merrill Lynch, if the shareholder's account is maintained with
Merrill Lynch or by written notification or telephone (1-800-MER-FUND) to the
Transfer Agent if the shareholder's account is maintained with the Transfer
Agent, elect to have subsequent dividends or both dividends and capital gains
distributions paid in cash, rather than reinvested, in which event payment
will be mailed monthly. The Fund is not responsible for any failure of
delivery to the shareholder's address of record and no interest will accrue on
amounts represented by uncashed distribution or redemption checks. 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 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 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. With
respect to redemptions of Class B or Class C shares pursuant to a systematic
withdrawal plan, the maximum number of Class B or Class C shares that can be
redeemed from an account annually shall not exceed 10% of the value of shares
of such class in that account at the time the election to join the systematic
withdrawal plan was made. Any CDSC that otherwise might be due on such
redemption of Class B or Class C shares will be waived. Shares redeemed
pursuant to a systematic withdrawal plan will be redeemed in the same order as
Class B or Class C shares are otherwise redeemed. See "Purchase of Shares--
Deferred Sales Charge Alternatives--Class B and Class C Shares--Contingent
Deferred Sales Charges--Class B Shares" and "--Contingent Deferred Sales
Charges--Class C Shares." Where the systematic withdrawal plan is applied to
Class B shares, upon conversion of the last Class B shares in an account to
Class D shares, the systematic withdrawal plan will automatically be applied
thereafter to Class D shares. See "Purchase of Shares--Deferred Sales Charge
Alternatives--Class B and Class C Shares--Conversion of Class B Shares to
Class D Shares."
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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 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 the Transfer
Agent at (800) MER-FUND or (800) 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
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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 Fund may not purchase securities, including
Municipal Bonds, during the existence of any underwriting syndicate of which
Merrill Lynch is a member or in a private placement in which Merrill Lynch
serves as placement agent except pursuant to procedures approved by the
Trustees of the Trust which either comply with rules adopted by the Commission
or with interpretations of the Commission staff. An affiliated person 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 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 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. As
long as 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
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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 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.
Distributions from investment income and capital gains of the Fund, including
exempt-interest dividends, may also be subject to state taxes in states other
than California and may be subject to local taxes in other states.
Accordingly, investors in the Fund, 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 the receipt of
Fund dividends and to the holding of shares in the Fund.
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, are treated as capital gains which are taxed at ordinary
income tax rates. Recent legislation creates additional categories of capital
gains taxable at different rates. Not later than 60 days after the close of
its taxable year, the Fund will provide its shareholders with a written notice
designating the amounts of any exempt-interest dividends, ordinary income
dividends or capital gain dividends, as well as the amount of capital gain
dividends in the different categories of capital gain referred to above.
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
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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.
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.
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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 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.
The Fund also may quote total return and aggregate total return performance
data for various specified time periods. Such data will be calculated
substantially as described above, except that (1) the rates of return
calculated will not be average annual rates, but rather, actual annual,
annualized or aggregate rates of return and (2) the maximum applicable sales
charges will not be included with respect to annual or annualized rates of
return calculations. Aside from the impact on the performance data
calculations of including or excluding the maximum applicable sales charges,
actual annual or annualized total return data generally will be lower than
average annual total return data since the average annual rates of return
reflect compounding; aggregate total return data generally will be higher than
average annual total return data since the aggregate rates of return reflect
compounding over a longer period of time. In advertisements distributed to
investors whose purchases are subject to waiver of the CDSC in the case of
Class B or Class C shares or reduced sales charges in the case of Class A or
Class D shares, the performance data may take into account the reduced, and
not the maximum, sales charge or may not take into account the CDSC and
therefore may reflect greater total return since, due to the reduced sales
charges or waiver of the CDSC, a lower amount of expenses is deducted. See
"Purchase of Shares." The Fund's total return may be expressed either as a
percentage or as a dollar amount in order to illustrate such total return on a
hypothetical $1,000 investment in the Fund at the beginning of each specified
period.
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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, 1997 was 3.98% for Class A shares, 3.64% for Class B
shares, 3.54% for Class C shares and 3.89% for Class D shares and the tax-
equivalent yield for the same period (based on a Federal income tax rate of
28%) was 5.53% for Class A shares, 5.06% for Class B shares, 4.92% for Class C
shares and 5.40% for Class D shares. The yield without voluntary reimbursement
or waiver of Fund expenses for the 30-day period would have been 3.88% for
Class A shares, 3.54% for Class B shares, 3.44% for Class C shares and 3.78%
for Class D shares with a tax equivalent yield of 5.38% for Class A shares,
4.92% for Class B shares, 4.77% for Class C shares and 5.25% 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. and Morningstar Publications,
Inc. ("Morningstar"), or to data contained in publications such as Money
Magazine, U.S. News & World Report, Business Week, Forbes Magazine and Fortune
Magazine. From time to time, the Fund may include the Fund's Morningstar risk-
adjusted performance ratings in advertisements or supplemental sales
literature. As with other performance data, performance comparisons should not
be considered indicative of the Fund's relative performance for any future
period.
ADDITIONAL INFORMATION
DETERMINATION OF NET ASSET VALUE
The net asset value of the shares of all classes of the Fund is determined
by the Manager once daily 15 minutes after the close of business on the 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 (including interest and dividends accrued but not yet received) minus
all liabilities (including accrued expenses) 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
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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 a 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, $.10 par value per share, 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
relating to the distribution of such shares. Each class has exclusive voting
rights with respect to matters relating to distributions and/or account
maintenance expenditures, as applicable. See "Purchase of Shares." The
Trustees of the Trust may classify and reclassify the shares of any Series
into additional or other 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 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. Upon liquidation or dissolution of a Series, each issued
and outstanding share of that Series is entitled to participate equally in
dividends and distributions declared by the respective Series and in net
assets of such Series 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
42
<PAGE>
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.
43
<PAGE>
[This page intentionally left blank]
44
<PAGE>
MERRILL LYNCH CALIFORNIA INSURED MUNICIPAL BOND FUND--AUTHORIZATION FORM
(PART 1)
- -------------------------------------------------------------------------------
1. SHARE PURCHASE APPLICATION
I, being of legal age, wish to purchase: (choose one)
[_] Class A shares [_] Class B shares [_] Class C shares [_] Class D shares
of Merrill Lynch California Insured Municipal Bond Fund and establish an
Investment Account as described in the Prospectus. In the event that I am not
eligible to purchase Class A shares, I understand that Class D shares will be
purchased.
Basis for establishing an Investment Account:
A. I enclose a check for $ . . . . . . payable to 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 One: Select One:
[_] Reinvest [_] Reinvest
[_] Cash [_] 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>
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......
Dear Sir/Madam: Date of initial purchase
Although I am not obligated to do so, I intend to purchase shares of Merrill
Lynch California Insured Municipal Bond Fund or any other investment company
with an initial sales charge or deferred sales charge for which Merrill Lynch
Funds Distributor, Inc. acts as distributor over the next 13 month period
which will equal or exceed:
[_] $25,000 [_] $50,000 [_] $100,000 [_] $250,000 [_] $1,000,000
Each purchase will be made at the then reduced offering price applicable to
the amount checked above, as described in the Merrill Lynch California Insured
Municipal Bond Fund Prospectus.
I agree to the terms and conditions of this Letter of Intention. I hereby
irrevocably constitute and appoint Merrill Lynch Funds Distributor, Inc., my
attorney, with full power of substitution, to surrender for redemption any or
all shares of Merrill Lynch California Insured Municipal Bond Fund held as
security.
By .................................. .....................................
Signature of Owner Signature of Co-Owner
(If registered in joint parties,
both must sign)
In making purchases under this letter, the following are the related
accounts on which reduced offering prices are to apply:
(1) Name............................. (2) Name.............................
Account Number....................... Account Number.......................
- -------------------------------------------------------------------------------
5. FOR DEALER ONLY
Branch Office, Address, Stamp.
We hereby authorize Merrill Lynch
Funds Distributor, Inc. to act as
our agent in connection with
transactions under this
authorization form and agree to
notify the Distributor of any
purchases or sales made under a
Letter of Intention, Automatic
Investment Plan or Systematic
Withdrawal Plan. We guarantee the
shareholder's signature.
This form when completed should be .....................................
mailed to: Dealer Name and Address
Merrill Lynch California Insured By ..................................
Municipal Bond Fund Authorized Signature of Dealer
c/o Merrill Lynch Financial
Data Services, Inc.
P.O. Box 45289 [ ][ ][ ] [ ][ ][ ][ ].............
Jacksonville, Florida 32232-5289 Branch-Code F/C No. F/C Last Name
[ ][ ][ ] [ ][ ][ ][ ][ ]
Dealer's Customer A/C No.
46
<PAGE>
MERRILL LYNCH CALIFORNIA INSURED MUNICIPAL BOND FUND--AUTHORIZATION FORM
(PART 2)
- -------------------------------------------------------------------------------
NOTE: THIS FORM IS REQUIRED TO APPLY FOR THE SYSTEMATIC WITHDRAWAL OR
AUTOMATIC INVESTMENT PLANS ONLY.
- -------------------------------------------------------------------------------
1. ACCOUNT REGISTRATION
Name of Owner...................... [ ]
Social Security No. or
Name of Co-Owner (if any).......... Taxpayer Identification No.
Address............................ Account Number ....................
(if existing account)
...................................
- -------------------------------------------------------------------------------
2. SYSTEMATIC WITHDRAWAL PLAN--(SEE TERMS AND CONDITIONS IN THE STATEMENT OF
ADDITIONAL INFORMATION)
MINIMUM REQUIREMENTS: $10,000 for monthly disbursements, $5,000 for
quarterly, of [_] Class A, [_] Class B*, [_] Class C* 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 or as soon as possible thereafter.
(month)
SPECIFY THE AMOUNT OF THE WITHDRAWAL YOU WOULD LIKE PAID TO YOU (CHECK
ONE): [_] $ of [_] Class A, [_] Class B*, [_] Class C* 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 of your Account...........................................................
Bank Name......................................................................
Bank Number........................ Account Number............................
Bank Address...................................................................
........................................................................
Signature of Depositor................................. Date..................
Signature of Depositor.........................................................
(if joint account, both must sign)
NOTE: IF DIRECT DEPOSIT IS ELECTED, YOUR BLANK, UNSIGNED CHECK MARKED "VOID"
OR A DEPOSIT SLIP FROM YOUR SAVINGS ACCOUNT SHALL ACCOMPANY THIS APPLICATION.
* ANNUAL WITHDRAWAL CANNOT EXCEED 10% OF THE VALUE OF SHARES OF SUCH CLASS
HELD IN THE ACCOUNT AT THE TIME THE ELECTION TO JOIN THE SYSTEMATIC
WITHDRAWAL PLAN IS MADE.
47
<PAGE>
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 AUTHORIZATION TO HONOR ACH DEBITS
SERVICES, INC. DRAWN
BY MERRILL LYNCH FINANCIAL DATA
SERVICES, INC.
You are hereby authorized to draw an
ACH debit each month on my bank To...............................Bank
account for investment in Merrill (Investor's Bank)
Lynch California Insured Municipal
Bond Fund as indicated below: Bank Address.........................
City...... State...... Zip Code......
Amount of each check or ACH debit
$................................. As a convenience to me, I hereby
request and authorize you to pay and
charge to my account ACH debits
Account Number ................... drawn on my account by and payable
to Merrill Lynch Financial Data
Please date and invest ACH debits on Services, Inc. I agree that your
the 20th of each month beginning rights in respect to each such debit
shall be the same as if it were a
............ or as soon thereafter as check drawn on you and signed
(month) possible. personally by me. This authority is
to remain in effect until revoked by
me in writing. Until you receive
I agree that you are preparing these such notice, you shall be fully
ACH debits voluntarily at my request protected in honoring any such
and that you shall not be liable for debit. I further agree that if any
any loss arising from any delay in such debit be dishonored, whether
preparing or failure to prepare any with or without cause and whether
such check or debit. If I change intentionally or inadvertently, you
banks or desire to terminate or shall be under no liability.
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 Date Signature of
purchases of Fund shares including Depositor
liquidating shares of the Fund and
crediting my bank account. I further ............ ......................
agree that if a check or debit is not Bank Signature of Depositor
honored upon presentation, Merrill Account (If joint account,
Lynch Financial Data Services, Inc. Number both must sign)
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)
NOTE: IF AUTOMATIC INVESTMENT PLAN IS ELECTED, YOUR BLANK, UNSIGNED CHECK
MARKED "VOID" SHOULD ACCOMPANY THIS APPLICATION.
48
<PAGE>
[THIS PAGE INTENTIONALLY LEFT BLANK]
<PAGE>
[THIS PAGE INTENTIONALLY LEFT BLANK]
<PAGE>
MANAGER
Fund Asset Management
Administrative Offices:
800 Scudders Mill Road
Plainsboro, New Jersey
Mailing Address:
P.O. Box 9011
Princeton, New Jersey 08543-9011
DISTRIBUTOR
Merrill Lynch Funds Distributor, Inc.
Administrative Offices:
800 Scudders Mill Road
Plainsboro, New Jersey
Mailing Address:
P.O. Box 9081
Princeton, New Jersey 08543-9081
CUSTODIAN
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>
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRE-
SENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, IN CONNECTION WITH
THE OFFER CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER IN-
FORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE TRUST, THE MANAGER OR THE DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTI-
TUTE AN OFFERING IN ANY STATE IN WHICH SUCH OFFERING MAY NOT LAWFULLY BE MADE.
---------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Fee Table.................................................................. 2
Merrill Lynch Select PricingSM System..................................... 3
Financial Highlights...................................................... 8
Investment Objective and Policies......................................... 10
Portfolio Insurance....................................................... 12
Potential Benefits........................................................ 13
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................................................... 19
Management of the Trust.................................................... 20
Trustees.................................................................. 20
Management and Advisory Arrangements...................................... 21
Code of Ethics............................................................ 22
Transfer Agency Services.................................................. 22
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............................................... 26
Distribution Plans........................................................ 29
Limitations on the Payment of Deferred Sales Charges...................... 31
Redemption of Shares....................................................... 32
Redemption................................................................ 32
Repurchase................................................................ 32
Reinstatement Privilege--
Class A and Class D Shares............................................... 33
Shareholder Services....................................................... 33
Investment Account........................................................ 33
Exchange Privilege........................................................ 34
Automatic Reinvestment of Dividends and Capital Gains Distributions....... 35
Systematic Withdrawal Plans............................................... 35
Automatic Investment Plans................................................ 36
Fee-Based Programs........................................................ 36
Portfolio Transactions..................................................... 36
Distributions and Taxes.................................................... 37
Distributions............................................................. 37
Taxes..................................................................... 37
Performance Data........................................................... 40
Additional Information..................................................... 41
Determination of Net Asset Value.......................................... 41
Organization of the Trust................................................. 42
Shareholder Reports....................................................... 42
Shareholder Inquiries..................................................... 43
Authorization Form......................................................... 45
</TABLE>
Code# 16574-1197
[LOGO] MERRILL LYNCH
Merrill Lynch
California Insured
Municipal Bond Fund
Merrill Lynch California
Municipal Series Trust
[Art]
PROSPECTUS
November 26, 1997
Distributor:
Merrill Lynch
Funds Distributor, Inc.
This prospectus should be retained for future reference.
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
MERRILL LYNCH CALIFORNIA INSURED MUNICIPAL BOND FUND
MERRILL LYNCH CALIFORNIA MUNICIPAL SERIES TRUST
P.O. BOX 9011, PRINCETON, NEW JERSEY 08543-9011 . PHONE NO. (609) 282-2800
----------------
Merrill Lynch California Insured Municipal Bond Fund (the "Fund") is a
series of Merrill Lynch California Municipal Series Trust (the "Trust"), an
open-end management investment company organized as a Massachusetts business
trust. The investment objective of the Fund is to provide shareholders with as
high a level of income exempt from Federal and California 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 U.S. 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 PricingSM System, the Fund offers four
classes of shares, each with a different combination of sales charges, ongoing
fees and other features. The Merrill Lynch Select PricingSM System permits an
investor to choose the method of purchasing shares that the investor believes
is most beneficial given the amount of the purchase, the length of time the
investor expects to hold the shares and other relevant circumstances.
----------------
The Statement of Additional Information of the Fund is not a prospectus and
should be read in conjunction with the prospectus of the Fund, dated November
26, 1997 (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 November 26, 1997.
<PAGE>
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to provide shareholders with as high
a level of income exempt from Federal and California income taxes as is
consistent with prudent investment management. The Fund seeks to achieve its
objective 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 U.S. 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 to the issuer, 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 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
2
<PAGE>
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 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 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 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.
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
3
<PAGE>
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 could be
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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
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Objective and Policies" in the Prospectus. Information with respect to ratings
assigned to tax-exempt obligations which the Fund may purchase is set forth in
Appendix II to this Statement of Additional Information.
DESCRIPTION OF MUNICIPAL BONDS
Municipal Bonds include debt obligations issued to obtain funds for various
public purposes, including construction of a wide range of public facilities,
refunding 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 also 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 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
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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 entity 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 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 VRDOs at approximately the par
value of the VRDOs on the adjustment date. The adjustments typically are based
upon the Public Securities Association
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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 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
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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 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
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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
"marking 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 deals in financial futures contracts based on a long-term municipal
bond index developed by the Chicago Board of Trade ("CBT") and The Bond Buyer
(the "Municipal Bond Index"). The Municipal Bond Index is comprised of 40 tax-
exempt municipal revenue 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 that may become available if the
Manager and the Trustees should determine that there is normally a sufficient
correlation between the prices of such futures contracts and the Municipal
Bonds in which the Fund invests to make such hedging appropriate.
Futures Strategies. The Fund may sell a financial futures contract (i.e.,
assume a short position) in anticipation of a decline in the value of its
investments in Municipal Bonds resulting from an increase in interest rates or
otherwise. The risk of decline could be reduced without employing futures as a
hedge by selling such Municipal Bonds and either reinvesting the proceeds in
securities with shorter maturities or by holding assets in cash. This
strategy, however, entails increased transaction costs in the form of dealer
spreads and typically would reduce the average yield of the Fund's portfolio
securities as a result of the shortening of maturities. The sale of 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
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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 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
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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 Futures Transactions and Options. Investment in futures
contracts involves the risk of imperfect correlation between movements in the
price of the futures contract and the price of the security being hedged. The
hedge will not be fully effective when there is imperfect correlation between
the movements in the prices of two financial instruments. For example, if the
price of the futures contract moves more than the price of the hedged
security, the Fund will experience either a loss or gain on the futures
contract which is not offset completely by movements in the price of the
hedged securities. To compensate for imperfect correlations, the Fund may
purchase or sell futures contracts in a greater dollar amount than the hedged
securities if the volatility of the hedged securities is historically greater
than the volatility of the futures contracts. Conversely, the Fund may
purchase or sell fewer futures contracts if the volatility of the price of the
hedged securities is historically less than that of the futures contracts.
The particular municipal bonds comprising the index underlying the Municipal
Bond Index financial futures 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 futures contracts
will depend in part on the degree to which price movements in the index
underlying the futures contract correlate with the price movements of the
Municipal Bonds held by the Fund. The correlation may be affected by
disparities in the average maturity, ratings, geographical mix or structure of
the Fund's investments as compared to those comprising the Municipal Bond
Index, and general economic or political factors. In addition, the correlation
between movements in the value of the Municipal Bond Index may be subject to
change over time as additions to and deletions from the Municipal Bond Index
alter its structure. The correlation between futures contracts on U.S.
Government securities and the Municipal Bonds held by the Fund may be
adversely affected by similar factors and the risk of imperfect correlation
between movements in the prices of such futures contracts and the prices of
the Municipal Bonds held by the Fund may be greater.
13
<PAGE>
The Fund expects to liquidate a majority of the futures contracts it enters
into through offsetting transactions on the applicable contract market. There
can be no assurance, however, that a liquid secondary market will exist for
any particular futures contract at any specific time. Thus, it may not be
possible to close out a futures position. In the event of adverse price
movements, the Fund would continue to be required to make daily cash payments
of variation margin. In such situations, if the Fund has insufficient cash, it
may be required to sell portfolio securities to meet daily variation margin
requirements at a time when it may be disadvantageous to do so. The inability
to close out futures positions also could have an adverse impact on the Fund's
ability to hedge effectively its investments in Municipal Bonds. The Fund will
enter into a futures position only if, in the judgment of the Manager, there
appears to be an actively traded secondary market for such futures contracts.
The successful use of transactions in futures and related options also
depends on the ability of the Manager to forecast correctly the direction and
extent of interest rate movements within a given time frame. To the extent
interest rates remain stable during the period in which a futures contract or
option is held by the Fund or such rates move in a direction opposite to that
anticipated, the Fund may realize a loss on the hedging transaction which is
not fully or partially offset by an increase in the value of portfolio
securities. As a result, the Fund's total return for such period may be less
than if it had not engaged in the hedging transaction.
Because of low initial margin deposits made on the opening of a futures
position, futures transactions involve substantial leverage. As a result,
relatively small movements in the price of the futures contracts can result in
substantial unrealized gains or losses. Because the Fund will engage in the
purchase and sale of futures contracts solely for hedging purposes, however,
any losses incurred in connection therewith should, if the hedging strategy is
successful, be offset in whole or in part by increases in the value of
securities held by the Fund or decreases in the price of securities the Fund
intends to acquire.
The amount of risk the Fund assumes when it purchases an option on a futures
contract is the premium paid for the option plus related transaction costs. In
addition to the correlation risks discussed above, the purchase of an option
on a futures contract also entails the risk that changes in the value of the
underlying futures contract will not be reflected fully in the value of the
option purchased.
Municipal Bond Index futures contracts were approved for trading in 1986.
Trading in such futures contracts may tend to be less liquid than that in
other futures contracts. The trading of futures contracts also is subject to
certain market risks, such as inadequate trading activity, which could at
times make it difficult or impossible to liquidate existing positions.
INVESTMENT RESTRICTIONS
The Fund has adopted a number of fundamental and non-fundamental
restrictions and policies relating to the investment of its assets and its
activities. The fundamental policies set forth below may not be changed
without the approval of the holders of a majority of the Fund's outstanding
voting securities (which for this 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
14
<PAGE>
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.
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. As a matter of
policy, however, the Fund will not purchase shares of any registered open-
end investment company or registered unit investment trust, in reliance on
Section 12(d)(1)(F) or (G) (the "fund of funds" provisions) of the 1940
Act, at any time the Fund's shares are owned by another investment company
that is part of the same group of investment companies as the Fund.
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
15
<PAGE>
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.
MANAGEMENT OF THE TRUST
TRUSTEES AND OFFICERS
Information about the Trustees, executive officers of the Trust and the
portfolio manager of the Fund, including 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 (65)--President and Trustee (1)(2)--President of the Manager
(which term, as used herein, includes its corporate predecessors) since 1977;
President of Merrill Lynch Asset Management, L.P. ("MLAM," which term, as used
herein, includes its 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.
James H. Bodurtha (53)--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,
16
<PAGE>
China Enterprise Management Corporation from 1993 to 1996; Chairman, Berkshire
Corporation since 1980; Partner, Squire, Sanders & Dempsey from 1980 to 1993.
Herbert I. London (58)--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; President, Hudson Institute since 1997
and Trustee since 1980; Dean, Gallatin Division of New York University from
1976 to 1993; Distinguished Fellow, Herman Kahn Chair, Hudson Institute from
1984 to 1985; Director, Damon Corporation from 1991 to 1995; Overseer, Center
for Naval Analyses from 1983 to 1993; Limited Partner, Hypertech LP in 1996.
Robert R. Martin (70)--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 (68)--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 (45)--Trustee (2)--Morgan Hall, Soldiers Field, Boston,
Massachusetts 02163. Professor, Harvard Business School since 1989 and
Associate Professor from 1983 to 1989; Trustee, The Common Fund since 1989;
Director, Quantec Limited since 1991 and TIBCO from 1994 to 1996.
Terry K. Glenn (57)--Executive Vice President (1)(2)--Executive Vice
President of the Manager and MLAM since 1983; Executive Vice President and
Director of Princeton Services since 1993; President of Merrill Lynch Funds
Distributor, Inc. ("MLFD" or the "Distributor") since 1986 and Director
thereof since 1991; President of Princeton Administrators, L.P. since 1988.
Vincent R. Giordano (53)--Senior Vice President (1)(2)--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 (46)--Vice President (1)(2)--First Vice President of MLAM
since 1997; Vice President of MLAM from 1984 to 1997; Vice President of the
Manager since 1984.
Walter O'Connor (36)--Vice President and Portfolio Manager of the Fund
(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 (37)--Vice President (1)(2)--First Vice President of MLAM
since 1997; Vice President of MLAM from 1990 to 1997; Director of Taxation of
MLAM since 1990.
Gerald M. Richard (48)--Treasurer (1)(2)--Senior Vice President and
Treasurer of the Manager and MLAM since 1984; Senior Vice President and
Treasurer of Princeton Services since 1993; Treasurer of MLFD since 1984 and
Vice President thereof since 1981.
17
<PAGE>
Robert E. Putney, III (37)--Secretary (1)(2)--Director (Legal Advisory) of
MLAM since 1997; Vice President of MLAM from 1994 to 1997; Attorney employed
by MLAM from 1991 to 1994; Attorney in private practice prior thereto.
- --------
(1) Interested person, as defined in the 1940 Act, of the Trust.
(2) Such Trustee or officer is a director, trustee or officer of certain other
investment companies for which the Manager or MLAM acts as investment
adviser or manager.
At October 31, 1997, the Trustees and officers of the Trust as a group (13
persons) owned an aggregate of less than 1.0% of the outstanding shares of the
Fund. At such date, Mr. Zeikel, a Trustee and officer of the Trust, and the
other officers of the Trust owned an aggregate of less than 1.0% of the
outstanding shares of Common Stock of ML & Co.
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, 1997, fees
and expenses paid to the non-affiliated Trustees that were allocated to the
Fund aggregated $3,149.
The following table sets forth for the fiscal year ended August 31, 1997,
compensation paid by the Fund to the non-affiliated Trustees and for the
calendar year ended December 31, 1996, the aggregate compensation paid by all
registered investment companies (including the Trust) advised by FAM and its
affiliate. MLAM ("FAM/MLAM Advised Funds") to the non-affiliated Trustees:
<TABLE>
<CAPTION>
AGGREGATE
PENSION OR COMPENSATION
RETIREMENT FROM TRUST AND OTHER
BENEFITS FAM/MLAM
ACCRUED AS ADVISED FUNDS
COMPENSATION PART OF TRUST'S PAID TO
NAME OF TRUSTEE FROM FUND EXPENSES TRUSTEE(1)
- --------------- ------------ --------------- --------------------
<S> <C> <C> <C>
James H. Bodurtha............. $1,182 None $148,500
Herbert I. London............. $1,182 None $148,500
Robert R. Martin.............. $1,182 None $148,500
Joseph L. May................. $1,182 None $148,500
Andre F. Perold............... $1,182 None $148,500
</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).
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.
18
<PAGE>
Securities may be held by, or be appropriate investments for, the Fund as
well as other funds or investment advisory clients of the Manager or its
affiliates. Because of different objectives or other factors, a particular
security may be bought for one or more clients when one or more clients are
selling the same security. If purchases or sales of securities for the Fund or
other funds for which they act as manager or for their advisory clients arise
for consideration at or about the same time, transactions in such securities
will be made, insofar as feasible, for the respective funds and clients in a
manner deemed equitable to all. To the extent that transactions on behalf of
more than one client of the Manager or its affiliates during the same period
may increase the demand for securities being purchased or the supply of
securities being sold, there may be an adverse effect on price.
Pursuant to a management agreement between the Trust on behalf of the Fund
and the Manager (the "Management Agreement"), the Manager receives for its
services to the Fund monthly compensation based upon the average daily net
assets of the Fund at the following annual rates: 0.55% of the portion of the
average daily net assets not exceeding $500 million; 0.525% of 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, 1995, the total advisory
fee paid by the Fund to the Manager aggregated $478,480, of which $354,675 was
voluntarily waived. 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. For the fiscal year ended August 31, 1997,
the total advisory fee paid by the Fund to the Manager aggregated $525,625 of
which $238,835 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 Merrill Lynch Funds
Distributor, Inc. ("MLFD" or 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 that 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, 1995, 1996 and 1997, the
Fund reimbursed the Manager $46,158, $46,382, and $86,203, 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."
19
<PAGE>
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.
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
(except that Class B shareholders may vote upon any material changes to
expenses charged under the Class D Distribution Plan). 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 that 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, 1995 were $14,929, of which the Distributor received $1,321
and Merrill Lynch received $13,608. The gross sales charges
20
<PAGE>
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 A shares for the fiscal
year ended August 31, 1997 were $1,485 of which the Distributor received $150
and Merrill Lynch received $1,335. For the fiscal years ended August 31, 1995,
1996 and 1997, the Distributor received no contingent deferred sales charges
("CDSCs") with respect to redemption within one year after purchase of Class A
shares purchased subject to a front-end sales charge waiver. 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. The gross sales charges for the sale of Class D shares
for the fiscal year ended August 31, 1997 were $3,599 of which the Distributor
received $503 and Merrill Lynch received $3,096. For the period October 21,
1994 (commencement of operations) to August 31, 1995 and for the fiscal years
ended August 31, 1996 and 1997, 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 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 that has not been in existence for at
least six months or which has no purpose other than the purchase of shares of
the Fund or shares of other registered investment companies at a discount;
provided, however, that it shall not include purchases by any group of
individuals whose sole organizational nexus is that the participants therein
are credit cardholders of a company, policyholders of an insurance company,
customers of either a bank or broker-dealer or clients of an investment
adviser.
Closed-End Investment Option. Class A shares of the Fund and other MLAM-
advised mutual funds ("Eligible Class A shares") are offered at net asset
value to shareholders of certain closed-end funds advised by the Manager or
MLAM who purchased such closed-end fund shares prior to October 21, 1994, the
date the Merrill Lynch Select PricingSM System commenced operations, and wish
to reinvest the net proceeds from 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
21
<PAGE>
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 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
22
<PAGE>
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(SM) Accounts. Provided applicable threshold requirements are
met, either Class A or Class D shares are offered at net asset value to
Employee Access(SM) Accounts available through authorized employers. The initial
minimum for such accounts is $500, except that the initial minimum for shares
purchased for such accounts pursuant to the Automatic Investment Program is
$50.
TMA(SM) Managed Trusts. Class A shares are offered to 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
23
<PAGE>
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 that might
result from an acquisition of assets having net unrealized appreciation that
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 that (i) meet
the investment objectives and policies of the Fund; (ii) are acquired for
investment and not for resale (subject to the understanding that the
disposition of the Fund's portfolio securities shall at all times remain
within its control); and (iii) are liquid securities, the value of which is
readily ascertainable, that 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
24
<PAGE>
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 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.
The following table sets forth comparative information as of August 31, 1997
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, 1997
------------------------------------------------------------------------------
ANNUAL
ALLOWABLE AMOUNTS DISTRIBUTION
ELIGIBLE AGGREGATE INTEREST MAXIMUM PREVIOUSLY AGGREGATE FEES AT CURRENT
GROSS SALES ON UNPAID AMOUNT PAID TO UNPAID NET ASSET
SALES(1) CHARGES BALANCE(2) PAYABLE DISTRIBUTOR(3) BALANCE LEVEL(4)
-------- --------- ---------- ------- -------------- --------- ---------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
CLASS B SHARES, FOR THE
PERIOD FEBRUARY 26,
1993 (COMMENCEMENT OF
OPERATIONS) TO AUGUST
31, 1997:
Under NASD Rule as
Adopted................ $112,502 $7,031 $2,274 $9,305 $1,645 $7,660 $173
Under Distributor's
Voluntary Waiver....... $112,502 $7,031 $ 563 $7,594 $1,645 $5,949 $173
CLASS C SHARES, FOR THE
PERIOD OCTOBER 21, 1994
(COMMENCEMENT OF
OPERATIONS) TO AUGUST
31, 1997:
Under NASD Rule as
Adopted................ $ 8,101 $ 506 $ 67 $ 573 $ 37 $ 537 $ 19
</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.
(Footnotes continued on next page)
25
<PAGE>
(Footnotes continued from previous page)
(3) Consists of CDSC payments, distribution fee payments and accruals. See
"Purchase of Shares--Distribution Plans" in the Prospectus. This figure
may include CDSCs that were deferred when a shareholder redeemed shares
prior to the expiration of the applicable CDSC period and invested the
proceeds, without the imposition of a sales charge, in Class A shares in
conjunction with the shareholder's participation in the Merrill Lynch
Mutual Fund Advisor (Merrill Lynch MFASM) Program (the "MFA Program"). The
CDSC is booked as a contingent obligation that may be payable if the
shareholder terminates participation in the MFA Program.
(4) Provided to illustrate the extent to which the current level of
distribution fee payments (not including any CDSC payments) is amortizing
the unpaid balance. No assurance can be given that payments of the
distribution fee will reach either the voluntary maximum or the NASD
maximum.
REDEMPTION OF SHARES
Reference is made to "Redemption of Shares" in the Prospectus for certain
information as to the redemption and repurchase of Fund shares.
The right to redeem shares or to receive payment with respect to any such
redemption may be suspended for more than seven days only for any period
during which trading on 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.
The value of shares at the time of the redemption may be more or less than
the shareholder's cost, depending in part on the market value of the
securities held by the Fund at such time.
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 in
certain circumstances including 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, 1995, 1996 and 1997, the Distributor received CDSCs of $347,212,
$157,396 and $129,315, respectively, with respect to redemptions of Class B
shares, all of which were paid to Merrill Lynch. Additional CDSCs payable to
the Distributor during the fiscal year ended August 31, 1997 may have been
waived or converted to a contingent obligation in connection with a
shareholder's participation in certain fee-based programs. For the fiscal
period October 21, 1994 (commencement of operations) to August 31, 1995 and
for the fiscal years ended August 31, 1996 and 1997, the Distributor received
CDSCs of $76, $2,319 and $1,735, 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
26
<PAGE>
Commission. Since over-the-counter ("OTC") 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,
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. For the
fiscal year ended August 31, 1997, the Fund engaged in no transactions
pursuant to such order. Affiliated persons of the Trust may serve as broker
for the Fund in OTC 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.
The Fund may not purchase securities, including Municipal Bonds, during the
existence of any underwriting syndicate of which Merrill Lynch is a member or
in a private placement in which Merrill Lynch serves as placement agent except
pursuant to procedures approved by the Trustees of the Trust which either
comply with rules adopted by the Commission or with interpretations of the
Commission Staff. Rule 10f-3 under the 1940 Act sets forth conditions under
which the Fund may purchase municipal bonds from an underwriting syndicate of
which Merrill Lynch is a member. The rule sets forth requirements relating to,
among other things, the terms of an issue of municipal bonds purchased by the
Fund, the amount of municipal bonds which may be purchased in any one issue
and the assets of the Fund which may be invested in a particular issue.
The Fund does not expect to use any particular dealer in the execution of
transactions but, subject to obtaining the best net results, dealers who
provide supplemental investment research (such as information concerning tax-
exempt securities, economic data and market forecasts) to the Manager may
receive orders for transactions by the Fund. Information so received will be
in addition to and not in lieu of the services required to be performed by the
Manager under its Management Agreement and the expenses of the Manager will
not necessarily be reduced as a result of the receipt of such supplemental
information.
The Trust has no obligation to deal with any broker in the execution of
transactions for the Fund's portfolio securities. In addition, consistent with
the 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. As a result of the investment policies
described in the Prospectus, the Fund's annual portfolio turnover rate may be
higher than that of other investment companies, under normal circumstances.
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, 1996 and
1997 were 87.77% and 67.28%, respectively.
27
<PAGE>
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 that
they manage unless the member (i) has obtained prior express authorization
from the account to effect such transactions, (ii) at least annually furnishes
the account with a statement setting forth the aggregate compensation received
by the member in effecting such transactions, and (iii) complies with any
rules the Commission has prescribed with respect to the requirements of
clauses (i) and (ii). To the extent Section 11(a) would apply to Merrill Lynch
acting as a broker for the Fund in any of its portfolio transactions executed
on any such securities exchange of which it is a member, appropriate consents
have been obtained from the Fund and annual statements as to aggregate
compensation will be provided to the Fund.
DETERMINATION OF NET ASSET VALUE
Reference is made to "Additional Information--Determination of Net Asset
Value" in the Prospectus for information concerning the 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, Martin Luther King, Jr. 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 (including
interest and dividends accrued but not yet received) minus all liabilities
(including accrued expenses) 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 OTC municipal bond and money markets and are valued at
the last available bid price in the OTC 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
28
<PAGE>
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 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
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
29
<PAGE>
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 Merrill Lynch in writing if their
account is maintained with Merrill Lynch or notify the Transfer Agent in
writing or by telephone (1-800-MER-FUND) if their account is maintained with
the Transfer Agent, that they no longer wish to have their dividends and/or
capital gains distributions reinvested in shares of the Fund or vice versa
and, commencing ten days after the receipt by the Transfer Agent of such
notice, such instructions will be effected.
SYSTEMATIC WITHDRAWAL PLANS
A shareholder may elect to make systematic withdrawals from an Investment
Account of Class A, Class B, Class C or Class D shares on either a monthly or
quarterly basis as provided below. Quarterly withdrawals are available for
shareholders who have acquired 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 shares having a value of $10,000 or more.
At the time of each withdrawal payment, sufficient 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 the dollar
amount and class of shares to be redeemed 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 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 shares in
the Investment Account are reinvested automatically in Fund shares. 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.
With respect to redemptions of Class B and Class C shares pursuant to a
systematic withdrawal plan, the maximum number of Class B or Class C shares
that can be redeemed from an account annually shall not exceed 10% of the
value of shares of such Class in that account at the time the election to join
the systematic withdrawal plan was made. Any CDSC that otherwise might be due
on such redemption of Class B or Class C shares will be waived. Shares
redeemed pursuant to a systematic withdrawal plan will be redeemed in the same
order as Class B or Class C shares are otherwise redeemed. See "Purchase of
Shares--Deferred Sales Charge
30
<PAGE>
Alternatives--Class B and Class C Shares--Contingent Deferred Sales Charges--
Class B Shares" and "--Contingent Deferred Sales Charges--Class C Shares" in
the Prospectus. Where the systematic withdrawal plan is applied to Class B
shares, upon conversion of the last Class B shares in an account to Class D
shares, the systematic withdrawal plan will automatically be applied
thereafter to Class D shares. See "Purchase of Shares--Deferred Sales Charge
Alternatives--Class B and C Shares--Conversion of Class B Shares to Class D
Shares" in the Prospectus; if an investor wishes to change the amount being
withdrawn in a systematic withdrawal plan the investor should contact his or
her Financial Consultant.
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 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 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 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 $50. The proceeds of
systematic redemptions will be posted to the shareholder's account three
business days after the date the shares are redeemed. All redemptions are made
at net asset value. A shareholder may elect to have his or her shares redeemed
on the first, second, third or fourth Monday of each month, in the case of
monthly redemptions, or of every other month, in the case of bimonthly
redemptions. For quarterly, semiannual or annual redemptions, the shareholder
may select the month in which the shares are to be redeemed and may designate
whether the redemption is to be made on the first, second, third or fourth
Monday of the month. If the Monday selected is not a business day, the
redemption will be processed at net asset value on the next business day. The
CMA(R) or CBA(R) 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 Financial Consultant.
EXCHANGE PRIVILEGE
U.S. 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 PricingSM System, Class A shareholders may exchange Class A
shares of the Fund for Class A shares of a second MLAM-advised mutual fund if
the shareholder holds any Class A shares of the second fund in his or her
account in which the exchange is made at the time of the exchange or is
otherwise eligible to purchase Class A shares of the second fund. If the Class
A shareholder wants to exchange Class A shares for shares of a second MLAM-
advised mutual fund, but does not hold Class A shares of the second fund in
his 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. 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
31
<PAGE>
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 at
least 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 with a reduced or 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
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 Special Value Fund 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
32
<PAGE>
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 that 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 that 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.
To exercise the exchange privilege, a shareholder should contact his or her
Merrill Lynch Financial Consultant, who will advise the Fund of the exchange.
Shareholders of the Fund, and shareholders of the other MLAM-advised funds
with shares for which certificates have not been issued, may exercise the
exchange privilege by wire through their securities dealers. The Fund reserves
the right to require a properly completed Exchange Application. This exchange
privilege may be modified or terminated at any time in accordance with the
rules of the Commission. The Fund reserves the right to limit the number of
times an investor may exercise the exchange privilege. Certain funds may
suspend the continuous offering of their shares to the general public at any
time and may thereafter resume such offering from time to time. The exchange
privilege is available only to U.S. shareholders in states where the exchange
legally may be made.
DISTRIBUTIONS AND TAXES
The Trust intends to continue to qualify the Fund for the special tax
treatment afforded regulated investment companies ("RICs") under the Code. As
long as 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
33
<PAGE>
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 that 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, including new categories of 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 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 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 that constitutes exempt-interest dividends and the
portion that is exempt from California income taxes. The Fund will allocate
exempt-interest dividends among Class A, Class B, Class C and Class D
shareholders for California income tax purposes based on a method similar to
that described above for Federal income tax purposes.
Distributions from investment income and capital gains of the Fund,
including exempt-interest dividends, may be subject to California franchise
tax if received by a corporate shareholder subject to such tax and may also be
subject to tax in states other than California and local taxes in other
states. Accordingly, investors in the Fund, including, in particular,
corporate investors which may be subject to the California corporate franchise
tax,
34
<PAGE>
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 that are taxed at
ordinary income tax rates. Recent legislation creates additional categories of
capital gains taxable at different rates. Not later than 60 days after the
close of its taxable year, the Fund will provide its shareholders with a
written notice designating the amounts of any exempt-interest dividends,
ordinary income dividends or capital gain dividends, as well as the amount of
capital gain dividends in the different categories of capital gain referred to
above. 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.
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
35
<PAGE>
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 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.
TAX TREATMENT OF OPTIONS AND FUTURES TRANSACTIONS
The Fund may purchase or sell municipal bond index futures contracts and
interest rate futures contracts on U.S. Government securities ("financial
futures contracts"). The Fund may also purchase and write call and put options
on such financial futures contracts. In general, unless an election is
available to the Fund or an exception applies, such options and financial
futures contracts that are "Section 1256 contracts" will be "marked to market"
for Federal income tax purposes at the end of each taxable year, i.e., each
such option or financial futures contract will be treated as sold for its fair
market value on the last day of the taxable year, and any gain or loss
attributable to Section 1256 contracts will be 60% long-term and 40% short-
term capital gain or loss. Application of these rules to Section 1256
contracts held by the Fund may alter the timing and character of
36
<PAGE>
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.
----------------
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code, Treasury regulations and California tax laws presently
in effect. For the complete provisions, reference should be made to the
pertinent Code sections, the Treasury regulations promulgated thereunder and
the applicable California tax laws. The Code and the Treasury regulations, as
well as the California tax laws, are subject to change by legislative,
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 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
37
<PAGE>
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>
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 CLASS C SHARES CLASS D SHARES
-------------------------- ---------------------------- ---------------------------- ----------------------------
REDEEMABLE REDEEMABLE REDEEMABLE REDEEMABLE
EXPRESSED AS VALUE OF A EXPRESSED AS A VALUE OF A EXPRESSED AS A VALUE OF A EXPRESSED AS A VALUE OF A
A PERCENTAGE HYPOTHETICAL PERCENTAGE HYPOTHETICAL PERCENTAGE HYPOTHETICAL PERCENTAGE HYPOTHETICAL
BASED ON A $1,000 BASED ON A $1,000 BASED ON A $1,000 BASED ON A $1,000
HYPOTHETICAL INVESTMENT AT HYPOTHETICAL INVESTMENT AT HYPOTHETICAL INVESTMENT AT HYPOTHETICAL INVESTMENT AT
$1,000 THE END OF $1,000 THE END OF $1,000 THE END OF $1,000 THE END OF
PERIOD INVESTMENT THE PERIOD INVESTMENT THE PERIOD INVESTMENT THE PERIOD INVESTMENT THE PERIOD
------ ------------ ------------- -------------- ------------- -------------- ------------- -------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
AVERAGE ANNUAL TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGE)
One year ended
August 31,
1997............ 5.12% $1,051.20 4.95% $1,049.50 7.74% $1,077.40 5.01% $1,050.10
Inception
(February 26,
1993) to August
31, 1997........ 5.03% $1,247.70 5.45% $1,270.40 -- -- -- --
Inception
(October 21,
1994) to August
31, 1997........ -- -- -- -- 8.76% $1,271.40 7.84% $1,241.00
ANNUAL TOTAL RETURN
(EXCLUDING MAXIMUM APPLICABLE SALES CHARGE)
Year ended
August 31,
1997............ 9.50% $1,095.00 8.95% $1,089.50 8.74% $1,087.40 9.39% $1,093.90
Year ended
August 31,
1996............ 7.44% $1,074.40 6.89% $1,068.90 6.90% $1,069.00 7.44% $1,074.40
Year ended
August 31,
1995............ 6.94% $1,069.40 6.38% $1,063.80 -- -- -- --
Inception
(October 21,
1994) to August
31, 1995........ -- -- -- -- 9.38% $1,093.80 9.99% $1,099.90
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 -- -- -- --
AGGREGATE TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGE)
Inception
(February 26,
1993) to August
31, 1997........ 24.77% $1,247.70 27.04% $1,270.40 -- -- -- --
Inception
(October 21,
1994) to August
31, 1997........ -- -- -- -- 27.14% $1,271.40 24.10% $1,241.00
YIELD
30 days ended
August 31,
1997............ 3.98% -- 3.64% -- 3.54% -- 3.89% --
TAX EQUIVALENT YIELD*
30 days ended
August 31,
1997............ 5.53% -- 5.06% -- 4.92% -- 5.40% --
</TABLE>
- ----
* Based on a Federal income tax rate of 28%.
39
<PAGE>
In order to reflect the reduced sales charges, in the case of Class A or
Class D shares, or the waiver of the CDSC, in the case of Class B 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 charges 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 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 or
other 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 account maintenance
and/or distribution expenses, as appropriate, being borne solely by such
class. Each issued and outstanding share of a Series is entitled to one vote
and to participate equally in dividends and distributions with respect to that
Series and, upon liquidation or dissolution of the Series, in the net assets
of such Series remaining after satisfaction of outstanding liabilities, except
that, as noted above, expenses relating to distribution and/or account
maintenance of the Class B, Class C and Class D shares are borne solely by the
respective 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
will be freely transferable. Holders of shares of any Series are entitled to
redeem their shares as set forth elsewhere herein and
40
<PAGE>
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, other than
amendments necessary to conform the Declaration to certain laws or
regulations, to change the name of the Trust, or to make certain non-material
changes, without the affirmative vote of a majority of the outstanding shares
of the Trust or of the affected Series or Class, as applicable.
Under Massachusetts law, shareholders of a business trust may, under certain
circumstances, be held personally liable as partners for the trust's
obligations. However, the risk of a shareholder incurring financial loss on
account of shareholder liability is limited to circumstances in which both
inadequate insurance existed and the trust itself was unable to meet its
obligations.
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. 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, 1997 is set forth
below.
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C CLASS D
----------- ----------- ---------- ----------
<S> <C> <C> <C> <C>
Net Assets....................... $12,437,427 $69,320,188 $5,361,183 $4,939,007
=========== =========== ========== ==========
Number of Shares Outstanding..... 1,213,650 6,763,433 523,342 481,550
=========== =========== ========== ==========
Net Asset Value Per Share (net
assets divided by number of
shares outstanding)............. $ 10.25 $ 10.25 $ 10.24 $ 10.26
Sales Charge (for Class A and
Class D shares: 4.00% of
offering price; 4.17% of net
asset value per share)*......... .43 ** ** .43
----------- ----------- ---------- ----------
Offering Price................... $ 10.68 $ 10.25 $ 10.24 $ 10.69
=========== =========== ========== ==========
</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 selection of
independent auditors is subject to approval by the independent Trustees of the
Trust. The independent auditors are responsible for auditing the annual
financial statements of the Fund.
41
<PAGE>
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 October 31, 1997.
42
<PAGE>
APPENDIX I
ECONOMIC AND OTHER CONDITIONS IN CALIFORNIA
The following information is a brief summary of factors affecting the
economy of the State of California ("California" or "State") and does not
purport to be a complete description of such factors. Other factors will
affect State 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
Fund has not independently verified the information.
GENERAL ECONOMIC CONDITIONS
The economy of the State of California is the largest among the 50 states
and one of the largest in the world and has major components in agriculture,
manufacturing, high technology, trade, entertainment, tourism, construction
and services. Total State gross domestic product is expected to exceed $1
trillion in 1997. On a stand-alone basis, California's economy is larger than
all but six nations in the world.
California's July 1, 1996 population of over 32 million represented over 12%
of the total United States population. As of July 1, 1990 the population of
29,944,000 represented an increase of over 6 million persons, or 26%, during
the decade of the 1980's.
California's population is concentrated in metropolitan areas. As of the
April 1, 1990 Census, 96% of the citizens resided in the 23 Metropolitan
Statistical Areas in the State. As of July 1, 1995, the 5-county Los Angeles
area accounted for 49%, with 15.7 million residents. The 10-county San
Francisco Bay Area represented 21% with a population of 6.7 million.
From 1990-1993, the State suffered through a severe recession, the worst
since the 1930's, heavily influenced by large cutbacks in defense/aerospace
industries and military base closures and by a major drop in real estate
construction. California's economy has been recovering and growing steadily
since the start of 1994; currently the State's economic growth is outpacing
the rest of the nation. More than 300,000 nonfarm jobs were added in the State
in 1996, while personal income grew by more than $55 billion. Another 380,000
jobs are expected to be created in 1997. The unemployment rate, while still
higher than the national average, fell to the low 6% range in mid-1997,
compared to over 10% at the worst of the recession.
California's economic expansion is being fueled by growth in high-technology
industries, including computer software, electronics manufacturing and motion
picture/television production; growth is also strong in business services,
export trade, and manufacturing, with even the aerospace sector now showing
increased employment. The State's economy is now more diversified than it was
during the 1980's. Nonresidential real estate construction has grown rapidly
in response to the growth in the economy. Residential construction has been
growing slowly since the depths of the recession, but remains much lower (as
measured by annual new unit permits) than the late 1980's.
THE STATE
Fiscal Years Prior to 1995-96. The State's budget problems in recent years
were caused by a combination of external economic conditions and a structural
imbalance in that the largest general fund programs--K-14 education, health,
welfare and corrections--were increasing faster than the revenue base, driven
by the State's
43
<PAGE>
rapid population growth. These pressures are expected to 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 a certain third-time felony offenders.
As a result of these factors and others, and especially because a severe
recession between 1990-94 reduced revenues and increased expenditures for
social welfare programs, from the late 1980's 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 its budget reserve, the Special Fund for Economic Uncertainties
("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 multibillion dollar actions to bring projected revenues and
expenditures into balance. The State Legislature and Governor agreed on the
following principal steps to produce Budget Acts in the years 1991-92 to 1994-
95, although not all these actions were taken in each year.
. significant cuts in health and welfare program expenditures;
. transfers of program responsibilities and funding from the State to local
governments (referred to as "realignment"), coupled with some reduction
in mandates on local government;
. transfer of about $3.6 billion in local property tax revenues from
cities, counties, redevelopment agencies and some other districts to
local school districts, thereby reducing State funding for schools under
Proposition 98 (discussed below);
. reduction in growth of support for higher education programs, coupled
with increases in student fees, through the 1994-95 Fiscal Year;
. maintenance of the minimum Proposition 98 funding guarantee for K-14
schools, and the disbursement of additional funds to keep a constant
level of about $4,200 per K-12 pupils through the 1993-94 Fiscal Year;
. revenue increases (particularly in the 1991-92 Fiscal Year budget), most
of which were for a short duration;
. increased reliance on aid from the federal government to offset the costs
of incarcerating, educating and providing health and welfare services to
illegal immigrants, although during this time frame, most of the
additional aid requested by the Administration was not received; and
. various one-time adjustments and accounting changes.
Despite these budget actions, as noted, the effects of the recession led to
large, unanticipated deficits in the budget reserve, the SFEU, as compared to
project 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, again using cross-fiscal year revenue
anticipation warrants to partly finance the deficit into the 1995-96 fiscal
year.
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. When the
44
<PAGE>
Legislature and the Governor failed to adopt a budget for the 1992-93 Fiscal
Year by July 1, 1992, which would have allowed the State to carry out its
normal annual cash flow borrowing to replenish its cash reserves, the State
Controller issued registered warrants to pay a variety of obligations
representing prior years' or continuing appropriations, and mandates from
court order. Available funds were used to make constitutionally-mandated
payments, such as debt service on bonds and warrants. Between July 1 and
September 4, 1992, when the budget was adopted, the State Controller issued a
total of approximately $3.8 billion of registered warrants.
During the past several fiscal years, the State was forced to rely
increasingly on external debt markets to meet its cash needs, as a succession
of notes and revenue anticipation 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 a fiscal year, as noted earlier.
The last and largest of these borrowings was $4.0 billion of revenue
anticipation warrants which were issued in July 1994 and matured on April 25,
1996.
1995-96 Fiscal Year. The 1995-96 Budget Act was signed by the Governor on
August 3, 1995, 34 days after the start of the fiscal year. The Budget Act
projected general fund revenues and transfers of $44.1 billion, a 3.5%
increase from the prior year. Expenditures were budgeted at $43.4 billion, a 4
percent increase. The Budget Act also projected Special Fund revenues of $12.7
billion and appropriated Special Fund expenditures of $13.0 billion.
Final data for the 1995-96 Fiscal Year showed revenues and transfers of
$46.1 billion, some $2 billion over the original fiscal year estimate, which
was attributed to the strong economic recovery. Expenditures also increased,
to an estimated $45.4 billion, as a result of the requirement to expend
revenues for schools under Proposition 98, and, among other things, failure of
the federal government to enact welfare reform during the fiscal year and to
budget new aid for illegal immigrant costs, both of which had been counted on
to allow reductions in State costs. SFEU had a small negative balance of about
$87 million at June 30, 1996, all but eliminating the accumulated budget
deficit from the early 1990's. Available internal borrowable resources
(available cash, after payment of all obligations due) on June 30, 1996 was
about $3.8 billion, representing a significant improvement in the State's cash
position, and ending the need for deficit borrowing over the end of the fiscal
year. The State's improved cash position allowed it to repay the $4.0 billion
Revenue Anticipation Warrant issue on April 25, 1996, and to issue only $2.0
billion of revenue anticipation notes during the fiscal year, which matured on
June 28, 1996.
The 1995-96 Budget Act included substantial additional funding under
Proposition 98 for schools and community colleges (about $1.0 billion general
fund and $1.2 billion total above 1994-95 levels). Because of higher than
projected revenues in 1994-95, an additional $561 million ($92 per K-12 pupil
(also called per ADA, or average daily attendance)) was appropriated to the
1994-95 Proposition 98 entitlement. A large part of this was a block grant of
about $50 per pupil for any one-time purpose. For the first time in several
years, a full 2.7 percent cost of living allowance was funded. The budget was
based on the settlement of the CTA v. Gould litigation. Cuts in health and
welfare costs totaled about $220 million, almost $700 million less than had
been anticipated, because of the failure by the federal government to approve
certain of these actions in a timely manner. The federal government also
failed to appropriate all but $31 million of an anticipated $500 million in
new federal aid for incarceration and health care costs of illegal immigrants.
Funding from the general fund for the University of California was increased
by $106 million and for the California State University system by $97 million,
with no increase in student fees.
45
<PAGE>
1996-97 Fiscal Year. The 1996-97 Budget Act was signed by the Governor on
July 15, 1996, along with various implementing bills. The Governor vetoed
about $82 million of appropriations (both general fund and Special Fund). With
the signing of the Budget Act, the State implemented its regular cash flow
borrowing program with the issuance of $3.0 billion of Revenue Anticipation
Notes to mature on June 30, 1997. The Budget Act appropriated a modest budget
reserve in the SFEU of $305 million, as of June 30, 1997. The Department of
Finance projected that, on June 30, 1997, the State's available internal
borrowing (cash) resources will be $2.9 billion, after payment of all
obligations due by that date, so that no cross-fiscal year borrowing will be
needed.
Revenues. The Legislature rejected the Governor's proposed 15% cut in
personal income taxes (to be phased in over three years), but did not approve
a 5% cut in bank and corporation taxes, to be effective for income years
starting on January 1, 1997. As a result, revenues for the Fiscal Year were
estimated to total $47.643 billion, a 3.3% increase over the final estimated
1995-96 revenues. Special Fund revenues were estimated to be $13.3 billion.
Expenditures. The Budget Act contained general fund appropriations totaling
$47.251 billion, a 4.0% increase over the final estimated 1995-96
expenditures. Special Fund expenditures were budgeted at $12.6 billion.
The following are principal features of the 1996-97 Budget Act:
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%) was funded.
The Proposition 98 increases have brought K-12 expenditures to almost
$4,800 per ADA, 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 were allocated to each school site.
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.
A 4.9% 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.
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
46
<PAGE>
projections, the State Department of Finance expects $540 million of this
amount to be received during the 1996-97 fiscal year.)
General fund support for the State Department of Corrections was
increased by about 7% over the prior year, reflecting estimates of
increased prison population.
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.
Subsequent Events. On January 9, 1997, the Governor released his proposed
budget for the 1997-98 Fiscal Year (the "Proposed Budget"). The Proposed
Budget estimated general fund revenues and transfers in 1997-98 of $50.7
billion, a 4.6% increase from revised 1996-97 figures. The Governor proposes
expenditures of $50.3 billion, a 3.9% increase from 1996-97. The Proposed
Budget projected a balance in the SFEU of $553 million on June 30, 1998.
At the time of the May Revision, released on May 14, 1997, the Department of
Finance increased its revenue estimate for the upcoming fiscal year by $1.3
billion, in response to the continued strong growth in the State's economy.
Budget negotiations continued into the summer, with major issues to be
resolved including final agreement on State welfare reform, increase in State
employee salaries and consideration of a tax cut proposed by the Governor.
In May 1997, action was taken by the California Supreme Court in an ongoing
lawsuit, PERS v. Wilson, which made final a judgment against the State
requiring an immediate payment from the General Fund to the Public Employees
Retirement Fund ("PERF") to make up certain deferrals in annual retirement
fund contributions which had been legislated in earlier years for budget
savings, and which the courts found to be unconstitutional. On July 30, 1997,
following a direction from the Governor, the Controller transferred $1.235
billion from the General Fund to the PERF in satisfaction of the judgment,
representing the principal amount of the improperly deferred payments from
1995-96 and 1996-97.
1997-98 Fiscal Year. Once the pension payment eliminated essentially all the
"increased" revenue in the budget, final agreement was reached within a few
weeks on the welfare package and the remainder of the budget. The Legislature
passed the Budget Bill on August 11, 1997, along with numerous related bills
to implement its provisions. Agreement was not finally reached, however, on
one aspect of the budget plan, concerning the Governor's proposal for a
comprehensive educational testing program.
On August 18, 1997, the Governor signed the Budget Act, but vetoed about
$314 million of specific spending items, primarily in health and welfare and
education areas from both the General Fund and Special Funds. The Governor
announced that he was prepared to restore about $200 million of education
spending upon satisfactory completion of legislation on the education testing
program.
The Budget Act anticipates General Fund revenues and transfers of $52.5
billion (a 6.8 percent increase over the final 1996-97 amount), and
expenditures of $52.8 billion (an 8.0 percent increase from the 1996-97
levels). On a budgetary basis, the budget reserve (SFEU) is projected to
decrease from $408 million at June 30, 1997 to $112 million at June 30, 1998.
(The expenditure figure assumes restoration of $200 million of vetoed
funding.) The Budget Act also includes Special Fund expenditures of $14.4
billion (as against estimated Special Fund
47
<PAGE>
revenues of $14.0 billion), and $2.1 billion of expenditures from various Bond
Funds. The State has implemented its normal annual cash flow borrowing
program, issuing $3 billion of notes which mature on June 30, 1998.
The following are major features of the 1997-98 Budget Act:
1. For the second year in a row, the Budget contains a large increase in
funding for K-14 education under Proposition 98, reflecting strong revenues
which have exceeded initial budgeted amounts. Part of the nearly $1.75
billion in increased spending is allocated to prior fiscal years. Funds are
provided to fully pay for the cost-of-living increase component of
Proposition 98, and to extend class size reduction and reading initiatives.
2. The Budget Act reflects the $1.235 billion pension case judgment
payment, and brings funding of the State's pension contribution back to the
quarterly basis which existed prior to the deferral actions which were
invalidated by the courts. There is no provision for any additional
payments relating to this court case.
3. Continuing the third year of a four-year "compact" which the
Administration has made with higher education units, funding from the
General Fund for the University of California and California State
University has increased by about 6 percent ($121 million and $107 million,
respectively), and there was no increase in student fees.
4. Because of the effect of the pension payment, most other State
programs were continued at 1996-97 levels.
5. Health and welfare costs are contained, continuing generally the grant
levels from prior years, as part of the initial implementation of the new
CalWORKs program.
6. Unlike prior years, this Budget Act does not depend on federal budget
actions. About $300 million in federal funds, already included in the
federal FY 1997 and 1998 budgets, are included in the Budget Act, to offset
incarceration costs for illegal aliens.
7. The Budget Act contains no tax increases, and no tax reductions. The
Renters Tax Credit was suspended for another year, saving approximately
$500 million.
Federal Welfare Reform. Congress passed and the President signed (on August
22, 1996) the Personal Responsibility and Work Opportunity Act of 1996 (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.
As part of the 1997-98 Budget Act legislative package, the State Legislature
and Governor agreed on a comprehensive reform of the State's public assistance
programs to implement the new federal Law. The new basic State welfare program
is called California Work Opportunity and Responsibility to Kids Act
("CalWORKs"), which replaces the former Aid to Families with Dependent
Children (AFDC) and Greater Avenues to Independence (GAIN) programs effective
January 1, 1998. Consistent with the federal Law, CalWORKs contains new time
limits on receipt of welfare aid, both lifetime as well as for any current
time on aid. The centerpiece of CalWORKs is the linkage of eligibility to work
participation requirements.
48
<PAGE>
Administration of the new Welfare-to-Work programs will be largely at the
county level, and counties are given financial incentives for success in this
program.
Although the longer-term impact of the new federal Law and CalWORKs cannot
be determined until there has been some experience, the State does not
presently anticipate that these new programs will have any adverse financial
impact on the General Fund. Overall TANF grants from the federal government
are expected to equal or exceed the amounts the State would have received
under the old AFDC program.
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.
Counties, in particular, have had fewer options to raise revenues than many
other local government entities, and have been required to maintain many
services. The entire statewide welfare system has been changed in response to
the change in federal welfare law enacted in 1996 (see "Welfare Reform"
above). Under the CalWORKs program, counties are given flexibility to develop
their own plans, consistent with State law, to implement Welfare-to-Work and
to administer many of its elements. Counties are also given financial
incentives if, at the individual county level or statewide, the CalWORKs
program produces savings associated with specified Welfare-to-Work outcomes;
counties may also suffer penalties for failing to meet federal standards.
Under CalWORKs, counties will still be required to provide "general
assistance" aid to certain persons who cannot obtain welfare from other
programs. It is yet not known how the CalWORKs system will affect county
finances in the long run.
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, which had been
caused at least in part by large investment losses in its pooled investment
funds.
On November 5, 1996, voters approved Proposition 218, entitled the "Right to
Vote on Taxes Act," which incorporates new Articles XIIIC and XIIID into the
California Constitution. These new provisions enact limitations on the ability
of local government agencies to impose or raise various taxes, fees, charges
and assessments without voter approval. Certain "general taxes" imposed after
January 1, 1995 must be approved by voters in order to remain in effect. In
addition, Article XIIIC clarifies the right of local voters to reduce taxes,
fees, assessments or charges through local initiatives.
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Proposition 218 does not affect the State or its ability to levy or collect
taxes. There are a number of ambiguities concerning the Proposition and its
impact on local governments and their bonded debt which will require
interpretation by the courts or the State Legislature. The State Legislative
Analyst estimated that enactment of Proposition 218 would reduce local
government revenues statewide by over $100 million a year, and that over time,
annual revenues to local government would be reduced by several hundred
million dollars.
In May 1996, a taxpayer filed an action (the "Rider Case") against the City
of San Diego ("San Diego") and the San Diego Convention Center Expansion
Authority (the "Authority") challenging the validity of a lease revenue
financing involving a lease having features similar to the leases commonly
used in California lease-based financings such as certificates of
participation. In the Rider Case, the plaintiffs maintain that voter approval
is required for the San Diego lease (a) since the lease constituted
indebtedness prohibited by Article XVI, Section 18 of the California
Constitution without a two-thirds vote of the electorate, and (b) since San
Diego was prohibited under its charter from issuing bonds without a two-thirds
vote of the electorate, and the power of the Authority, a joint powers'
authority, one of the members of which is San Diego, to issue bonds is no
greater than the power of San Diego. In response to San Diego's motion for
summary judgment, the trial court rejected the plaintiffs' arguments and ruled
that the lease was constitutionally valid and that the Authority's related
lease revenue bonds did not require voter approval. The plaintiffs appealed
the matter to the Court of Appeals for the Fourth District, which likewise
affirmed the validity of the lease and of the lease revenue bond financing
arrangements. The plaintiffs then filed a petition for review with the
California State Supreme Court, and, on April 2, 1997, the California Supreme
Court granted the plaintiff's petition for review. No decision from the State
Supreme Court is expected until sometime during the 1998 calendar year.
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% 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%
for bonded indebtedness approved by two-thirds of the voters voting on the
proposed indebtedness. "Full cash value" is defined as "the County Assessor's
valuation of real property as shown on the 1975-76 tax bill under "full cash
value" or, thereafter, the appraised value of real property when purchased,
newly constructed, or a change in ownership has occurred after the 1975
assessment." The "full cash value" is subject to annual adjustment to reflect
increases (not to exceed 2%) or decreases in the consumer price index or
comparable local data, or to reflect reductions in property value caused by
damage, destruction or other factors.
Article XIIIB of the California Constitution limits the amount of
appropriations of the State and of the local governments to the amount of
appropriation 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 in 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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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 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.
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. The settlement
of this case, finalized in July 1996, 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 an
appropriation 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.
Substantially increased general find revenues, above the initial budget
projections, in the 1994-95, 1995-96 and 1996-97 fiscal years have resulted or
will result in retroactive increases in Proposition 98 appropriations from
subsequent fiscal years' budgets.
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
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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 the 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 Educational 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 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 involved in a lawsuit, Thomas Hayes v. Commission on State
Mandates, related to state-mandated costs. The action involves an appeal by
the Director of Finance from a 1984 decision by the State Board of Control
(now succeeded by the Commission on State Mandates ("Commission")). The Board
of Control decided in favor of local school districts' claims for
reimbursement for special education programs for handicapped students. The
case was then brought to the trial court by the State and later remanded to
the Commission for redetermination. The Commission has since expanded the
claim to include supplemental claims filed by seven other educational
institutions; the issuance of a final consolidated decision is anticipated
sometime in early 1997. To date, the Legislature has not appropriated funds.
The liability of the State, if all potentially eligible school districts
pursue timely claims, has been estimated by the Department of Finance at more
than $1 billion.
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The State is involved in a lawsuit related to contamination at the
Stringfellow toxic waste site. In United States, People of the State of
California v. J.B. Stringfellow, Jr., et al., the State is seeking recovery
for post costs of cleanup of the site, a declaration that the defendants are
jointly and severally liable for future costs, and an injunction ordering
completion of the cleanup. However, the defendants have filed a counterclaim
against the State for alleged negligent acts. Because the State is the present
owner of the site, the State may be found liable. Present estimates of the
cleanup range from $200 million to $800 million.
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. An appeal has been filed.
In Professional Engineers in California Government v. Wilson, the
petitioners are challenging several appropriations in the 1993, 1994, and 1995
Budget Acts. The appropriations mandate the transfer of approximately $262
million from the State Highway Account and $113 million from the Motor Vehicle
Account to the general fund and appropriate approximately $6 million from the
State Highway Account to fund a highway-grade crossing program administered by
the Public Utilities Commission. Petitioners contend that the transfers
violate several constitutional provisions and request that the moneys be
returned to the State Highway Account and Motor Vehicle Account.
The State is a defendant in Just Say No To Tobacco Dough Campaign v. State
of California, where the petitioners challenge the appropriation of
approximately $166 million of Proposition 99 funds in the Cigarette and
Tobacco Products Surtax Fund for years ended June 30, 1990, through June 30,
1995 for programs which were allegedly not health education or tobacco-related
disease research. If the State loses, the general fund and funds from other
sources would be used to reimburse the Cigarette and Tobacco Products Surtax
Fund for approximately $166 million.
The State is a defendant in the case of Kurt Hathaway, et al. v. Wilson, et
al., where the plaintiffs are challenging the legality of various budget
action transfers and appropriations from particular special funds for years
ended June 30, 1995 and June 30, 1996. The plaintiffs allege that the
transfers and appropriations are contrary to the substantive law establishing
the funds and providing for interest accruals to the funds, violate the single
subject requirement of the State Constitution, and is an invalid "special
law." Plaintiffs seek to have monies totaling approximately $335 million
returned to the special funds.
The State is a defendant in two related cases, Beno vs. Sullivan ("Beno")
and Welch v. Anderson ("Welch"), concerning reductions in Aid to Families with
Dependent Children ("AFDC") grant payments. In the Beno case, plaintiffs seek
to invalidate AFDC grant reductions and in the Welch case, plaintiffs contend
that AFDC grant reductions are not authorized by state law. The Beno case
concerns the total grant reductions while the Welch case concerns the period
of time the State did not have a waiver for those reductions. The State's
potential liability for retroactive AFDC grant reductions is estimated at $831
million if the plaintiffs are awarded the full amount in both cases.
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
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1992-93. 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 contributions that were unpaid
to date. On February 19, 1997, the State Court of Appeals affirmed the
decision of the Superior Court, and the Supreme Court subsequently refused to
hear the case, making the Court of Appeals' ruling final. On July 30, 1997 the
Controller transferred $1,235 billion from the General Fund to PERS in
repayment of the principal amount determined to have been improperly deferred.
Subsequent State payments to PERS will be made on a quarterly basis. No
prejudgment interest has been paid in accordance with the trial court ruling
that there was insufficient evidence that money for that purpose had been
appropriated and was available. No post-judgment interest was ordered.
STATE GENERAL OBLIGATION BOND RATINGS
As of the date of this Statement of Additional Information, the State's
general obligation bonds are rated A1 by Moody's Investors Services, Inc., A+
by Standard & Poor's Ratings Services, and AA- by Fitch Investors Service,
Inc.
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APPENDIX II
RATINGS OF MUNICIPAL BONDS
DESCRIPTION OF MUNICIPAL BOND RATINGS OF MOODY'S INVESTORS SERVICE, INC.
("MOODY'S")
Aaa
Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally
referred to as "gilt edge." Interest payments are protected by a large
or by an exceptionally stable margin and principal is secure. While
the various protective elements are likely to change, such changes as
can be visualized are most unlikely to impair the fundamentally strong
position of such issues.
Aa Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are
generally known as high grade bonds. They are rated lower than the
best bonds because margins of protection may not be as large as in Aaa
securities or fluctuation of protective elements may be of greater
amplitude or there may be other elements present which make the long-
term risks appear somewhat larger than in Aaa securities.
A Bonds which are rated A possess many favorable investment attributes
and are to be considered as upper medium grade obligations. Factors
giving security to principal and interest are considered adequate, but
elements may be present which suggest a susceptibility to impairment
sometime in the future.
Baa Bonds which are rated Baa are considered as medium grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest
payment and principal security appear adequate for the present but
certain protective elements may be lacking or may be
characteristically unreliable over any great length of time. Such
bonds lack outstanding investment characteristics and in fact have
speculative characteristics as well.
Ba Bonds which are rated Ba are judged to have speculative elements;
their future cannot be considered as well assured. Often the
protection of interest and principal payments may be very moderate and
thereby not well safeguarded during both good and bad times over the
future. Uncertainty of position characterizes bonds in this class.
B Bonds which are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or
of maintenance of other terms of the contract over any long period of
time may be small.
Caa Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to
principal or interest.
Ca Bonds which are rated Ca represent obligations which are speculative
in a high degree. Such issues are often in default or have other
marked shortcomings.
C
Bonds which are rated C are the lowest rated class of bonds and issues
so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
Note: Those bonds in the Aa, A, Baa, Ba and B groups which Moody's believes
possess the strongest investment attributes are designated by the symbols Aa1,
A1, Baa1, Ba1 and B1.
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Short-term Notes: The four ratings of Moody's for short-term notes are MIG
1/VMIG1, MIG 2/VMIG2, MIG 3/VMIG3 and MIG 4/VMIG4; MIG 1/VMIG1 denotes "best
quality . . . strong protection by established cash flows"; MIG 2/VMIG2
denotes "high quality" with ample margins of protection; MIG 3/VMIG3 notes are
of "favorable quality . . . but . . . lacking the undeniable strength of the
preceding grades"; MIG 4/VMIG4 notes are of "adequate quality . . .
[p]rotection commonly regarded as required of an investment security is
present . . . there is specific risk."
DESCRIPTION OF MOODY'S 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 ability of
rated issuers:
Issuers rated Prime-1 (or supporting institutions) have a superior ability
for repayment of short-term promissory obligations. Prime-1 repayment ability
will often be evidenced by the following characteristics: leading market
positions in well-established industries; high rates of return on funds
employed; conservative capitalization structure 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 supporting institutions) have a strong ability 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, may 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 supporting institutions) have an acceptable
ability for repayment of short-term promissory obligations. The effect of
industry characteristics and market compositions may be more pronounced.
Variability in earnings and profitability may result in changes in the level
of debt protection measurements and may require 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 STANDARD & POOR'S RATINGS SERVICES ("STANDARD & POOR'S")
MUNICIPAL DEBT RATINGS
A Standard & Poor's municipal debt rating is a current opinion of the
creditworthiness of an obligor with respect to a specific financial
obligation, a specific class of financial obligations or a specific program.
It takes into consideration the creditworthiness of guarantors, insurers, or
other forms of credit enhancement on the obligation.
The debt rating is not a recommendation to purchase, sell or hold a
financial obligation, 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 obligors or
obtained by Standard & Poor's from other sources it 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 based on other circumstances.
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The ratings are based, in varying degrees, on the following considerations:
I. Likelihood of payment-capacity and willingness of the obligor to meet
its financial commitment on an obligation in accordance with the terms of
the obligation;
II. Nature of and provisions of the obligation; and
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 meet its financial commitment on the obligation is extremely
strong.
AA Debt rated "AA" differs from the highest-rated obligations only in small
degree. The obligor's capacity to meet its financial commitment on the
obligation is very strong.
A Debt rated "A" is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher-
rated categories. However, the obligor's capacity to meet its financial
commitment on the obligation is still strong.
BBB Debt rated "BBB" exhibits adequate protection parameters. However,
adverse economic conditions or changing circumstances are more likely to
lead to a weakened capacity of the obligor to meet its financial
commitment on the obligation.
BBBCCCCCC
Debt rated "BB," "B," "CCC," "CC" and "C" are regarded, as having
significant speculative characteristics."BB" indicates the least degree
of speculation and "C" the highest degree of speculation. While such debt
will likely have some quality and protective characteristics, these may
be outweighed by large uncertainties or major exposures to adverse
conditions.
D
Debt rated "D" is in payment default. The "D" rating category is used
when payments or an obligation 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 or
the taking of a similar action if payments on an obligation are
jeopardized.
Plus (+) or Minus (-): The ratings from "AA" to "CCC" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
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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 several categories, ranging from "A"
for the highest quality obligations to "D" for the lowest. These categories
are as follows:
A-1
This designation 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 an adequate capacity for timely
payment. They are, however, 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 Standard & Poor's
believes that such payments will be made during such grace period.
A Commercial Paper rating is not a recommendation to purchase or sell a
security. The ratings are based on current information furnished to Standard &
Poor's by the issuer and obtained by Standard & Poor's from other sources it
considers reliable. The ratings may be changed, suspended, or withdrawn as a
result of changes in, or unavailability of, such information.
DESCRIPTION OF STANDARD & POOR'S SHORT-TERM ISSUE CREDIT RATINGS
A Standard & Poor's note rating reflects the liquidity factors and market
access risks unique to notes. Notes due in three years or less will likely
receive a note rating. Notes maturing beyond three years will most likely
receive a long-term debt rating. The following criteria will be used in making
that assessment.
--Amortization schedule--the larger the final maturity relative to other
maturities, the more likely it will be treated as a note.
--Source of payment--the more dependent the issue is on the market for its
refinancing, the more likely it will be treated as a note.
Note rating symbols are as follows:
SP-1 Strong capacity to pay principal and interest. An issue determined to
possess a very strong capacity to pay debt service is given a plus (+)
designation.
SP-2 Satisfactory capacity to pay principal and interest with some
vulnerability to adverse financial and economic changes over the term of
the notes.
SP-3 Speculative capacity to pay principal and interest.
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DESCRIPTION OF FITCH INVESTORS SERVICE, INC. ("FITCH") INVESTMENT GRADE BOND
RATINGS
Fitch investment grade bond ratings provide a guide to investors in
determining the credit risk associated with a particular security. The ratings
represent Fitch's assessment of the issuer's ability to meet the obligations
of a specific debt issue or class of debt in a timely manner.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the current and prospective
financial condition and operating performance of the issuer and of any
guarantor, as well as the economic and political environment that might affect
the issuer's future financial strength and credit quality.
Fitch ratings do not reflect any credit enhancement that may be provided by
insurance policies or financial guaranties unless otherwise indicated.
Bonds carrying 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.
AAA Bonds considered to be investment grade and of the highest credit
quality. The obligor has an exceptionally strong ability to pay interest
and repay principal, which is unlikely to be affected by reasonably
foreseeable events.
AA
Bonds considered to be investment grade and of very high credit quality.
The obligor's ability to pay interest and repay principal is very
strong, although not quite as strong as bonds rated "AAA." Because bonds
rated in the "AAA" and "AA" categories are not significantly vulnerable
to foreseeable future developments, short-term debt of these issuers is
generally rated "F-1+."
A Bonds considered to be investment grade and of high credit quality. The
obligor's ability to pay interest and repay principal is considered to
be strong, but may be more vulnerable to adverse changes in economic
conditions and circumstances than bonds with higher ratings.
BBB Bonds considered to be investment grade and of satisfactory credit
quality. The obligor's ability to pay interest and repay principal is
considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have adverse impact on these
bonds, and therefore, impair timely payment. The likelihood that the
ratings of these bonds will fall below investment grade is higher than
for bonds with higher ratings.
Plus (+) or Minus (-): Plus and minus signs are used with a rating symbol to
indicate the relative position of a credit within the rating category. Plus
and minus signs, however, are not used in the "AAA" category.
59
<PAGE>
NR Indicates that Fitch does not rate the specific issue.
Conditional
A conditional rating is premised on the successful completion of a
project or the occurrence of a specific event.
Suspended
A rating is suspended when Fitch deems the amount of information
available from the issuer to be inadequate for rating purposes.
Withdrawn
A rating will be withdrawn when an issue matures or is called or
refinanced and, at Fitch's discretion, when an issuer fails to
furnish proper and timely information.
FitchAlert
Ratings are placed on FitchAlert to notify investors of an
occurrence that is likely to result in a rating change and the
likely direction of such change. These are designated as
"Positive," indicating a potential upgrade, "Negative," for
potential downgrade, or "Evolving," where ratings may be raised or
lowered. FitchAlert is relatively short-term, and should be
resolved within 12 months.
Ratings Outlook: An outlook is used to describe the most likely direction of
any rating change over the intermediate term. It is described as "Positive" or
"Negative." The absence of a designation indicates a stable outlook.
DESCRIPTION OF FITCH SPECULATIVE GRADE BOND RATINGS
Fitch speculative grade bond ratings provide a guide to investors in
determining the credit risk associated with a particular security. The ratings
("BB" to "C") represent Fitch's assessment of the likelihood of timely payment
of principal and interest in accordance with the terms of obligation for bond
issues not in default. For defaulted bonds, the rating ("DDD" to "D") is an
assessment of the ultimate recovery value through reorganization or
liquidation.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the current and prospective
financial condition and operating performance of the issuer and any guarantor,
as well as the economic and political environment that might affect the
issuer's future financial strength.
Bonds that have the same rating are of similar but not necessarily identical
credit quality since rating categories cannot fully reflect the differences in
degrees of credit risk.
BB Bonds are considered speculative. The obligor's ability to pay interest
and repay principal may be affected over time by adverse economic
changes. However, business and financial alternatives can be identified
which could assist the obligor in satisfying its debt service
requirements.
B Bonds are considered highly speculative. While bonds in this class are
currently meeting debt service requirements, the probability of
continued timely payment of principal and interest reflects the
obligor's limited margin of safety and the need for reasonable business
and economic activity throughout the life of the issue.
CCC
Bonds have certain identifiable characteristics which, if not remedied,
may lead to default. The ability to meet obligations requires an
advantageous business and economic environment.
CC
Bonds are minimally protected. Default in payment of interest and/or
principal seems probable over time.
60
<PAGE>
C Bonds are in imminent default in payment of interest or principal.
DDD DD D
Bonds are in default on interest and/or principal payments. Such bonds
are extremely speculative and should be valued on the basis of their
ultimate recovery value in liquidation or reorganization of the obligor.
"DDD" represents the highest potential for recovery on these bonds, and
"D" represents the lowest potential for recovery.
Plus (+) or Minus (-): Plus and minus signs are used with a rating symbol to
indicate the relative position of a credit within the rating category. Plus
and minus signs, however, are not used in the "DDD," "DD," or "D" categories.
DESCRIPTION OF FITCH INVESTMENT GRADE SHORT-TERM RATINGS
Fitch's short-term ratings apply to debt obligations that are payable on
demand or have original maturities of generally up to three years, including
commercial paper, certificates of deposit, medium-term notes, and municipal
and investment notes.
The short-term rating places greater emphasis than a long-term rating on the
existence of liquidity necessary to meet the issuer's obligations in a timely
manner.
Fitch short-term ratings are as follows:
F-1+Exceptionally Strong Credit Quality. Issues assigned this rating are
regarded as having the strongest degree of assurance for timely
payment.
F-1
Very Strong Credit Quality. Issues assigned this rating reflect an
assurance of timely payment only slightly less in degree than issues
rated "F-1+."
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.
61
<PAGE>
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>
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, 1997, the related statements of operations for the year then ended
and changes in net assets for each of the years in the two-year period then
ended, and the financial highlights for each of the years in the four-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, 1997 by correspondence with the custodian and broker. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of Merrill Lynch
California Insured Municipal Bond Fund of Merrill Lynch California Municipal
Series Trust as of August 31, 1997, the results of its operations, the changes
in its net assets, and the financial highlights for the respective stated
periods in conformity with generally accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
October 7, 1997
63
<PAGE>
<TABLE>
<CAPTION>
Merrill Lynch California Insured Municipal Bond Fund August 31, 1997
SCHEDULE OF INVESTMENTS (in Thousands)
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note 1a)
<S> <C> <C> <C> <C>
California -- 96.3%
AAA Aaa $1,000 Anaheim, California, Public Financing Authority, Tax Allocation
Revenue Bonds, RITES, 9.12% due 12/28/2018 (d)(e) $1,179
AAA Aaa 1,290 California Fairs Financing Authority Revenue Bonds, 6.50% due 7/01/2011
(f) 1,399
AA - Aa 1,965 California HFA, Home Mortgage Revenue Bonds, AMT, Series F-1, 7% due
8/01/2026 2,102
California Health Facilities Financing Authority Revenue Bonds, Series A:
BB Aaa 2,000 Refunding (Good Samaritan Health System), 7.50% due 5/01/2000 (g) 2,206
AAA Aaa 2,000 (Scripps Memorial Hospital), 6.375% due 10/01/2022 (d)(h) 2,170
A1 NR* 300 California Pollution Control Financing Authority, PCR, Refunding (Pacific
Gas and Electric Co.), VRDN, AMT, Series G, 3.50% due 2/01/2016 (a) 300
NR* P1 100 California Pollution Control Financing Authority, Resource Recovery
Revenue Refunding Bonds (Ultra Power Malaga Project), VRDN, AMT, Series B,
3.55% due 4/01/2017 (a) 100
California State Public Works Board, Lease Revenue Bonds, Series A (g):
A Aaa 2,000 (Department of Corrections -- Monterey County Soledad II), 7% due
11/01/2004 2,345
AAA Aaa 2,000 (Various University of California Projects), 6.40% due 12/01/2002 (b) 2,234
AAA Aaa 2,500 California State, Veterans' Bonds, AMT, UT, Series BD, BE and BF, 6.375%
due 2/01/2027 (b) 2,570
NR* Aa2 300 California Statewide Community Development Authority, Solid Waste
Facilities Revenue Bonds (Chevron U.S.A. Inc. Project), VRDN, AMT, 3.50%
due 12/15/2024 (a) 300
AAA Aaa 1,200 Cucamonga County, California, Water District Facilities Refinancing Bonds,
COP, 6.50% due 9/01/2022 (c) 1,301
AAA Aaa 2,000 East Bay, California, Municipal Utilities District, Water System Revenue
Bonds, 6.50% due 6/01/2004 (b)(g) 2,272
AAA Aaa 4,000 El Cajon, California, Redevelopment Agency, Tax Allocation Bonds (El Cajon
Redevelopment Project), 6.60% due 10/01/2022 (b) 4,369
AAA Aaa 2,500 Fresno, California, Sewer Revenue Bonds (Fowler Avenue Project), Series A,
6.25% due 8/01/2011 (b) 2,684
AAA Aaa 2,500 Industry, California, Urban Development Agency Refunding Bonds
(Transportation District Industrial Redevelopment Project 2), 6.50% due
11/01/2016 (d) 2,739
AAA Aaa 1,795 Los Angeles, California, Convention and Exhibition Center Authority, Lease
Revenue Refunding Bonds, Series A, 5.125% due 8/15/2021 (d) 1,701
A+ Aa3 4,000 Los Angeles, California, Department of Water and Power, Electric Plant
Revenue Refunding Bonds, 6.375% due 2/01/2020 4,277
Los Angeles, California, Harbor Department Revenue Bonds, AMT:
AAA Aaa 2,000 RITR, 8.795% due 11/01/2026 (d)(e) 2,375
AAA Aaa 2,000 Series B, 6.625% due 8/01/2019 (b) 2,167
AAA Aaa 2,000 Los Angeles, California, Wastewater Systems Revenue Bonds, Series D,
6.70% due 12/01/2000 (d)(g) 2,193
AAA Aaa 1,000 Mesa, California, Consolidated Water District, COP (Water Project), 6.375%
due 3/15/2012 (c) 1,072
AAA Aaa 2,140 Mount Diablo, California, Unified School District, Community Facilities
-- Special District Tax No. 1, 6.30% due 8/01/2022 (b) 2,319
AAA Aaa 2,500 Mountain View, California, Capital Improvements Financing Authority Revenue
Bonds (City Hall Community Theatre), 6.50% due 8/01/2016 (d) 2,715
</TABLE>
64
<PAGE>
<TABLE>
<CAPTION>
August 31, 1997
Merrill Lynch California Insured Municipal Bond Fund (in Thousands)
Value
SCHEDULE OF INVESTMENTS (concluded) (Note 1a)
Sep Moody's Face
Ratings Ratings Amount Issue
<C> <C> <C> <S> <C>
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) 3,778
AAA Aaa 3,000 Orchard, California, School District, GO, UT, Series A, 6.50% due 8/01/2019
(c) 3,342
AAA Aaa 1,500 Rancho, California, Water District Financing Authority, Revenue Refunding
Bonds, 6.25% due 8/01/2012 (c) 1,607
Sacramento, California, Municipal Utility District, Electric Revenue Bonds:
AAA Aaa 2,000 INFLOS, 8.868% due 8/15/2018 (c)(e) 2,307
AAA Aaa 3,000 Series B, 6.375% due 8/15/2002 (d)(g) 3,333
San Diego, California, Public Facilities Financing Authority, Sewer Revenue
Bonds (c):
AAA Aaa 2,000 5% due 5/15/2020 1,876
AAA Aaa 1,500 Series B, 5.25% due 5/15/2027 1,445
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) 4,090
AAA Aaa 2,500 Second Issue, 6.75% due 5/01/2020 (d) 2,784
AAA Aaa 2,000 Santa Rosa, California, Wastewater Revenue Refunding Bonds (Subregional
Water Project), Series A, 5% due 9/01/2022 (c) 1,878
Stockton, California, Revenue, COP (Wastewater Treatment Plant Expansion),
Series A (c):
AAA Aaa 2,500 6.70% due 9/01/2014 2,790
AAA Aaa 2,500 6.80% due 9/01/2024 2,795
AAA Aaa 2,000 Truckee - Donner, California, Public Utility District, COP (Water System
Improvement Project), 6.75% due 11/15/2001 (d)(g) 2,233
AAA Aaa 3,685 University of California Revenue Bonds (Multiple Purpose Projects),
Series D, 6.30% due 9/01/2015 (d) 3,997
AAA Aaa 1,100 University of California Revenue Bonds, RITR, Series 13, 9.17% due
9/01/2019 (d)(e) 1,283
Total Investments (Cost -- $83,789) -- 96.3% 88,627
Variation Margin on Financial Futures Contracts** -- 0.0% (24)
Other Assets Less Liabilities -- 3.7% 3,455
---------
Net Assets -- 100.0% $92,058
=========
</TABLE>
(a) The interest rate is subject to change periodically based upon
prevailing market rates. The interest rate shown is the rate is
effect at August 31, 1997.
(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, 1997.
(f) FSA Insured.
(g) Prerefunded.
(h) All or a portion of security held as collateral in connection with
open financial futures contracts.
* Not Rated.
** Financial futures contracts purchased as of August 31, 1997
were as follows:
(in Thousands)
Value
Number of Expiration (Notes
Contracts Issue Date 1a & 1b)
40 Municipal Bond Index December 1997 $4,713
Total Financial Futures Contracts Purchased
(Total Contract Price -- $4,689) $4,713
=======
Ratings of issues shown have not been audited by Deloitte & Touche LLP.
<TABLE>
<CAPTION>
PORTFOLIO ABBREVIATIONS
........................................................................
<S> <C> <C>
To simplify the listings of Merrill Lynch AMT Alternative Minimum Tax (subject to)
California Insured Municipal Bond Fund's COP Certificate of Participation
portfolio holdings in the Schedule GO General Obligation Bonds
of Investments, we have abbreviated the HFA Housing Finance Agency
names of many of the securities according INFLOS Inverse Floating Rate Municipal Bands
to the list at right. PCR Pollution Control Revenue Bonds
RITES Residual Interest Tax-Exempt Securities
RITR Residual Interest Trust Receipts
UT Unlimited Tax
VRDN Variable Rate Demand Notes
</TABLE>
See Notes to Financial Statements.
65
<PAGE>
FINANCIAL INFORMATION
Statement of Assets and Liabilities as of August 31, 1997
<TABLE>
<S> <C> <C> <C>
Assets: Investments, at value (identified cost -- $83,789,452) (Note 1a) $88,626,832
Cash 48,072
Receivables:
Securities sold $3,983,670
Interest 1,354,911
Beneficial interest sold 115,004 5,453,585
-----------
Deferred organization expenses (Note 1e) 5,580
Prepaid registration and other assets (Note 1e) 40,551
------------
Total assets 94,174,620
------------
Liabilities: Payables:
Securities purchased 1,692,972
Beneficial interest redeemed 115,633
Dividends to shareholders (Note 1f) 78,557
Investment adviser (Note 2) 35,972
Distributor (Note 2) 33,837
Variation margin (Note 1b) 23,750 1,980,721
-----------
Accrued expenses and other liabilities 136,094
------------
Total liabilities 2,116,815
------------
Net Assets: Net assets $92,057,805
============
Net Assets Class A Shares of beneficial interest, $.10 par value, unlimited
Consist of: number of shares authorized $121,365
Class B Shares of beneficial interest, $.10 par value, unlimited
number of shares authorized 676,343
Class C Shares of beneficial interest, $.10 par value, unlimited
number of shares authorized 52,334
Class D Shares of beneficial interest, $.10 par value, unlimited
number of shares authorized 48,155
Paid-in capital in excess of par 89,111,616
Accumulated realized capital losses on investments -- net (Note 5) (2,813,138)
Unrealized appreciation on investments -- net 4,861,130
------------
Net assets $92,057,805
============
Net Asset Value: Class A -- Based on net assets of $12,437,427 and 1,213,650 shares of
beneficial interest outstanding $10.25
============
Class B -- Based on net assets of $69,320,188 and 6,763,433 shares of
beneficial interest outstanding $10.25
============
Class C -- Based on net assets of $5,361,183 and 523,342 shares of
beneficial interest outstanding $10.24
============
Class D -- Based on net assets of $4,939,007 and 481,550 shares of
beneficial interest outstanding $10.26
============
</TABLE>
See Notes to Financial Statements.
66
<PAGE>
<TABLE>
<CAPTION>
FINANCIAL INFORMATION (continued)
Statement of Operations
For the Year Ended
August 31, 1997
<S> <C> <C> <C>
Investment Income Interest and amortization of premium and discount earned $5,411,269
(Note 1d):
Expenses: Investment advisory fees (Note 2) $525,625
Account maintenance and distribution fees -- Class B (Note 2) 359,250
Accounting services (Note 2) 86,203
Registration fees (Note 1e) 80,516
Professional fees 51,573
Printing and shareholder reports 38,488
Account maintenance and distribution fees -- Class C (Note 2) 31,088
Transfer agent fees -- Class B (Note 2) 22,281
Custodian fees 13,474
Amortization of organization expenses (Note 1e) 11,443
Pricing fees 7,061
Account maintenance fees -- Class D (Note 2) 4,693
Transfer agent fees -- Class A (Note 2) 3,385
Trustees' fees and expenses 3,149
Transfer agent fees -- Class C (Note 2) 1,585
Transfer agent fees -- Class D (Note 2) 1,143
Other 4,850
----------
Total expenses before reimbursement 1,245,807
Reimbursement of expenses (Note 2) (238,835)
----------
Total expenses after reimbursement 1,006,972
----------
Investment income -- net 4,404,297
----------
Realized & Realized gain on investments -- net 1,351,724
Unrealized Gain on Change in unrealized appreciation on investments -- net 2,532,891
Investments -- Net ----------
(Notes 1b, 1d & 3): Net Increase in Net Assets Resulting from Operations $8,288,912
==========
</TABLE>
See Notes to Financial Statements.
67
<PAGE>
<TABLE>
<CAPTION>
FINANCIAL INFORMATION (continued)
Statements of Changes in Net Assets
For the Year Ended August 31,
Increase (Decrease) in Net Assets: 1997 1996
<S> <C> <C> <C>
Operations: Investment income -- net $4,404,297 $4,511,142
Realized gain on investments -- net 1,351,724 605,747
Change in unrealized appreciation on investments -- net 2,532,891 1,181,849
----------- -----------
Net increase in net assets resulting from operations 8,288,912 6,298,738
----------- -----------
Dividends to Investment income -- net:
Shareholders Class A (695,974) (752,385)
(Note 1f): Class B (3,248,319) (3,437,910)
Class C (228,905) (161,469)
Class D (231,099) (159,378)
----------- -----------
Net decrease in net assets resulting from dividends to shareholders (4,404,297) (4,511,142)
----------- -----------
Beneficial Interest Net increase (decrease) in net assets derived from beneficial
Transactions interest transactions (8,506,453) 5,394,929
(Note 4): ----------- -----------
Net Assets: Total increase (decrease) in net assets (4,621,838) 7,182,525
Beginning of year 96,679,643 89,497,118
----------- -----------
End of year $92,057,805 $96,679,643
=========== ===========
</TABLE>
See Notes to Financial Statements.
68
<PAGE>
<TABLE>
<CAPTION>
FINANCIAL INFORMATION (continued)
Financial Highlights
Class A
For the
Period
Feb. 26,
The following per share data and ratios have been derived 1993+ to
from information provided in the financial statements. For the Year Ended August 31, Aug. 31,
1997 1996 1995 1994 1993
Increase (Decrease) in Net Asset Value:
<S> <C> <C> <C> <C> <C> <C>
Per Share Net asset value, beginning of period $9.84 $9.65 $9.54 $10.23 $10.00
Operating --------- --------- --------- --------- ---------
Performance: Investment income -- net .50 .52 .52 .51 .24
Realized and unrealized gain (loss) on
investments -- net .41 .19 .11 (.65) .23
--------- --------- --------- --------- ---------
Total from investment operations .91 .71 .63 (.14) .47
--------- --------- --------- --------- ---------
Less dividends and distributions:
Investment income -- net (.50) (.52) (.52) (.51) (.24)
In excess of realized gain on
investments -- net -- -- -- (.04) --
--------- --------- --------- --------- ---------
Total dividends and distributions (.50) (.52) (.52) (.55) (.24)
--------- --------- --------- --------- ---------
Net asset value, end of period $10.25 $9.84 $9.65 $9.54 $10.23
========= ========= ========= ========= =========
Total Investment Based on net asset value per share 9.50% 7.44% 6.94% (1.44%) 4.81%++++
Return:** ========= ========= ========= ========= =========
Ratios to Average Expenses, net of reimbursement .63% .49% .47% .33% .14%*
Net Assets: ========= ========= ========= ========= =========
Expenses .89% .85% .87% .96% 1.06%*
========= ========= ========= ========= =========
Investment income -- net 5.03% 5.20% 5.53% 5.16% 4.80%*
========= ========= ========= ========= =========
Supplemental Net assets, end of period
Data: (in thousands) $12,438 $14,183 $14,204 $15,946 $17,105
========= ========= ========= ========= =========
Portfolio turnover 67.28% 87.77% 61.53% 93.04% 74.26%
========= ========= ========= ========= =========
* Annualized.
** Total investment returns exclude the effects of sales loads.
+ Commencement of Operations.
++++ Aggregate total investment return.
See Notes to Financial Statements.
</TABLE>
69
<PAGE>
<TABLE>
<CAPTION>
FINANCIAL INFORMATION (continued)
Class B
For the
Period
Feb. 26,
The following per share data and ratios have been derived 1993+ to
from information provided in the financial statements. For the Year Ended August 31, Aug. 31,
1997 1996 1995 1994 1993
Increase (Decrease) in Net Asset Value:
<S> <C> <C> <C> <C> <C> <C>
Per Share Net asset value, beginning of period $9.84 $9.65 $9.54 $10.23 $10.00
Operating --------- --------- --------- --------- ---------
Performance:
Investment income -- net .45 .47 .48 .46 .22
Realized and unrealized gain (loss) on
investments -- net .41 .19 .11 (.65) .23
--------- --------- --------- --------- ---------
Total from investment operations .86 .66 .59 (.19) .45
--------- --------- --------- --------- ---------
Less dividends and distributions:
Investment income -- net (.45) (.47) (.48) (.46) (.22)
In excess of realized gain on
investments -- net -- -- -- (.04) --
--------- --------- --------- --------- ---------
Total dividends and distributions (.45) (.47) (.48) (.50) (.22)
--------- --------- --------- --------- ---------
Net asset value, end of period $10.25 $9.84 $9.65 $9.54 $10.23
========= ========= ========= ========= =========
Total Investment Based on net asset value per share 8.95% 6.89% 6.38% (1.93%) 4.56%++++
Return:** ========= ========= ========= ========= =========
Ratios to Average Expenses, net of reimbursement 1.14% .99% .97% .83% .64%*
Net Assets: ========= ========= ========= ========= =========
Expenses 1.39% 1.36% 1.38% 1.48% 1.56%*
========= ========= ========= ========= =========
Investment income -- net 4.52% 4.69% 5.02% 4.67% 4.31%*
========= ========= ========= ========= =========
Supplemental Net assets, end of period
Data: (in thousands) $69,320 $73,292 $71,670 $74,982 $72,861
========= ========= ========= ========= =========
Portfolio turnover 67.28% 87.77% 61.53% 93.04% 74.26%
========= ========= ========= ========= =========
* Annualized.
** Total investment returns exclude the effects of sales loads.
+ Commencement of Operations.
++++ Aggregate total investment return.
</TABLE>
See Notes to Financial Statements.
70
<PAGE>
<TABLE>
<CAPTION>
FINANCIAL INFORMATION (concluded)
Class C Class D
For the For the
Period Period
For the Oct 21, For the Oct. 21,
The following per share data and ratios have been derived Year Ended 1994+ to Year Ended 1994+ to
from information provided in the financial statements. August 31, Aug. 31, August 31, Aug. 31,
1997 1996 1995 1997 1996 1995
Increase (Decrease) in Net Asset Value:
<S> <C> <C> <C> <C> <C> <C> <C>
Per Share Net asset value, beginning of period $9.84 $9.64 $9.19 $9.85 $9.65 $9.19
Operating --------- --------- --------- --------- --------- ---------
Performance:
Investment income -- net .44 .46 .39 .49 .51 .44
Realized and unrealized gain on
investments -- net .40 .20 .45 .41 .20 .46
--------- --------- --------- --------- --------- ---------
Total from investment operations .84 .66 .84 .90 .71 .90
--------- --------- --------- --------- --------- ---------
Less dividends from investment
income -- net (.44) (.46) (.39) (.49) (.51) (.44)
--------- --------- --------- --------- --------- ---------
Net asset value, end of period $10.24 $9.84 $9.64 $10.26 $9.85 $9.65
========= ========= ========= ========= ========= =========
Total Investment Based on net asset value per share 8.74% 6.90% 9.38%++++ 9.39% 7.44% 9.99%++++
Return:** ========= ========= ========= ========= ========= =========
Ratios to Average Expenses, net of reimbursement 1.24% 1.10% 1.09%* .74% .59% .57%*
Net Assets: ========= ========= ========= ========= ========= =========
Expenses 1.49% 1.46% 1.49%* .98% .95% .97%*
========= ========= ========= ========= ========= =========
Investment income -- net 4.42% 4.59% 4.76%* 4.92% 5.09% 5.33%*
========= ========= ========= ========= ========= =========
Supplemental Net assets, end of period
Data: (in thousands) $5,361 $4,901 $1,778 $4,939 $4,304 $1,845
========= ========= ========= ========= ========= =========
Portfolio turnover 67.28% 87.77% 61.53% 67.28% 87.77% 61.53%
========= ========= ========= ========= ========= =========
* 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>
Merrill Lynch California Insured Municipal Bond Fund August 31, 1997
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 Pricingsm 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.
[bullet] Financial futures contracts -- The Fund may purchase or sell
interest rate futures contracts and options on such futures contracts
for the purpose of hedging the market risk on existing securities or the
intended purchase of securities. Futures contracts are contracts for
delayed delivery of securities at a specific future date and at a
specific price or yield. Upon entering into a contract, the Fund
deposits and maintains as collateral such initial margin as required by
the exchange on which the transaction is effected. Pursuant to the
contract, the Fund agrees to receive from or pay to the broker an amount
of cash equal to the daily fluctuation in value of the contract. Such
receipts or payments are known as variation margin and are recorded by
the Fund as unrealized gains or losses. When the contract is closed, the
Fund records a realized gain or loss equal to the difference between the
value of the contract at the time it was opened and the value at the
time it was closed.
(c) Income taxes -- It is the Fund's policy to comply with the
requirements of the Internal Revenue Code applicable to regulated
investment companies and to distribute substantially all of its taxable
income to its shareholders. Therefore, no Federal income tax provision
is required.
(d) Security transactions and investment income -- Security transactions
are recorded on the dates the transactions are entered into (the trade
dates). Interest income is recognized on the accrual basis. Discounts
and market premiums are amortized into interest income. Realized gains
and losses on security transactions are determined on the identified
cost basis.
(e) Deferred organization expenses and prepaid registration fees --
Deferred organization expenses are charged to expense on a straight-line
basis over a five-year period. Prepaid registration fees are charged to
expense as the related shares are issued.
(f) Dividends and distributions -- Dividends from net investment income
are declared daily and paid monthly. Distributions of capital gains are
recorded on the ex-dividend date.
72
<PAGE>
NOTES TO FINANCIAL STATEMENTS (concluded)
2. Investment Advisory Agreement and Transactions with Affiliates:
The Fund has entered into an Investment Advisory Agreement with Fund
Asset Management, L.P. ("FAM"). The general partner of FAM is Princeton
Services, Inc. ("PSI"), an indirect wholly-owned subsidiary of Merrill
Lynch & Co., Inc. ("ML & Co."), which is the limited partner. The Fund
has also entered into a Distribution Agreement and Distribution Plans
with Merrill Lynch Funds Distributor, Inc. ("MLFD" or "Distributor"), a
wholly-owned subsidiary of Merrill Lynch Group, Inc.
FAM is responsible for the management of the Fund's portfolio and
provides the necessary personnel, facilities, equipment and certain
other services necessary to the operations of the Fund. For such
services, the Fund pays a monthly fee based upon the average daily value
of the Fund's net assets at the following annual rates: 0.55% of the
Fund's average daily net assets not exceeding $500 million; 0.525% of
average daily net assets in excess of $500 million but not exceeding $1
billion; and 0.50% of average daily net assets in excess of $1 billion.
For the year ended August 31, 1997, FAM earned fees of $525,625, of
which $238,835 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 Incorporated ("MLPF&S"), a subsidiary of ML & Co., also
provides account maintenance and distribution services to the Fund. The
ongoing account maintenance fee compensates the Distributor and MLPF&S
for providing account maintenance services to Class B, Class C
and Class D shareholders. The ongoing distribution fee compensates the
Distributor and MLPF&S for providing shareholder and distribution-
related services to Class B and Class C shareholders.
For the year ended August 31, 1997, 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 $150 $1,335
Class D $503 $3,096
For the year ended August 31, 1997, MLPF&S received contingent deferred
sales charges of $133,241 and $1,735 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.
Certain officers and/or trustees of the Fund are officers and/or
directors of FAM, PSI, MLFDS, MLFD, and/or ML & Co.
3. Investments:
Purchases and sales of investments, excluding short-term securities, for
the year ended August 31, 1997 were $60,586,252 and $68,143,623,
respectively.
Net realized and unrealized gains as of August 31, 1997 were as follows:
Realized Unrealized
Gains Gains
Long-term investments $1,327,093 $4,837,380
Financial futures contracts 24,631 23,750
----------- -----------
Total $1,351,724 $4,861,130
=========== ===========
As of August 31, 1997, net unrealized appreciation for Federal income
tax purposes aggregated $4,837,380, of which $4,866,392 related to
appreciated securities and $29,012 related to depreciated securities.
The aggregate cost of investments at August 31, 1997 for Federal income
tax purposes was $83,789,452.
73
<PAGE>
4. Beneficial Interest Transactions:
Net increase (decrease) in net assets derived from beneficial interest
transactions was $(8,506,453) and $5,394,929 for the years ended August
31, 1997 and August 31, 1996, respectively.
Transactions in shares of beneficial interest for each class were as
follows:
Class A Shares for the Year Dollar
Ended August 31, 1997 Shares Amount
Shares sold 167,842 $1,721,861
Shares issued to shareholders
in reinvestment of dividends 26,473 266,230
----------- -----------
Total issued 194,315 1,988,091
Shares redeemed (422,075) (4,313,656)
----------- -----------
Net decrease (227,760) $(2,325,565)
=========== ===========
Class A Shares for the Year Dollar
Ended August 31, 1996 Shares Amount
Shares sold 192,761 $1,890,855
Shares issued to shareholders
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 B Shares for the Year Dollar
Ended August 31, 1997 Shares Amount
Shares sold 925,806 $9,285,667
Shares issued to shareholders
in reinvestment of dividends 132,283 1,330,133
----------- -----------
Total issued 1,058,089 10,615,800
Automatic conversion
of shares (30,435) (307,865)
Shares redeemed (1,712,394) (17,203,405)
----------- -----------
Net decrease (684,740) $(6,895,470)
=========== ===========
Class B Shares for the Year Dollar
Ended August 31, 1996 Shares Amount
Shares sold 1,369,886 $13,477,417
Shares issued to shareholders
in reinvestment of dividends 155,360 1,531,776
----------- -----------
Total issued 1,525,246 15,009,193
Automatic conversion
of shares (35,131) (353,395)
Shares redeemed (1,469,919) (14,486,720)
----------- -----------
Net increase 20,196 $169,078
=========== ===========
Class C Shares for the Year Dollar
Ended August 31, 1997 Shares Amount
Shares sold 252,747 $2,537,534
Shares issued to shareholders
in reinvestment of dividends 14,024 140,882
----------- -----------
Total issued 266,771 2,678,416
Shares redeemed (241,739) (2,416,566)
----------- -----------
Net increase 25,032 $261,850
=========== ===========
Class C Shares for the Year Dollar
Ended August 31, 1996 Shares Amount
Shares sold 424,343 $4,215,073
Shares issued to shareholders
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
=========== ===========
Class D Shares for the Year Dollar
Ended August 31, 1997 Shares Amount
Shares sold 59,711 $601,386
Automatic conversion of shares 30,417 307,865
Shares issued to shareholders
in reinvestment of dividends 15,575 156,681
----------- -----------
Total issued 105,703 1,065,932
Shares redeemed (61,225) (613,200)
----------- -----------
Net increase 44,478 $452,732
=========== ===========
Class D Shares for the Year Dollar
Ended August 31, 1996 Shares Amount
Shares sold 263,889 $2,602,675
Automatic conversion
of shares 35,107 353,395
Shares issued to shareholders
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
=========== ===========
5. Capital Loss Carryforward:
At August 31, 1997, the Fund had a net capital loss carryforward of
approximately $2,594,000, of which $1,578,000 expires in 2003 and
$1,016,000 expires in 2004. This amount will be available to offset
like amounts of any future taxable gains.
74
<PAGE>
[THIS PAGE INTENTIONALLY LEFT BLANK]
<PAGE>
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.................................................... 14
Management of the Trust.................................................... 16
Trustees and Officers..................................................... 16
Compensation of Trustees.................................................. 18
Management and Advisory Arrangements...................................... 18
Purchase of Shares......................................................... 20
Initial Sales Charge Alternatives--Class A and Class D Shares............. 20
Reduced Initial Sales Charges............................................. 22
Distribution Plans........................................................ 24
Limitations on the Payment of Deferred Sales Charges...................... 25
Redemption of Shares....................................................... 26
Deferred Sales Charges--Class B and Class C Shares........................ 26
Portfolio Transactions..................................................... 26
Determination of Net Asset Value........................................... 28
Shareholder Services....................................................... 29
Investment Account........................................................ 29
Automatic Investment Plans................................................ 29
Automatic Reinvestment of Dividends and Capital Gains Distributions....... 30
Systematic Withdrawal Plans............................................... 30
Exchange Privilege........................................................ 31
Distributions and Taxes.................................................... 33
Tax Treatment of Options and Futures Transactions......................... 36
Performance Data........................................................... 37
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................................................ 55
Appendix III
Portfolio Insurance....................................................... 62
Independent Auditors' Report............................................... 63
Financial Statements....................................................... 64
</TABLE>
Code #16576-1197
[LOGO] MERRILL LYNCH
Merrill Lynch
California Insured
Municipal Bond Fund
Merrill Lynch California
Municipal Series Trust
[Art]
STATEMENT OF
ADDITIONAL
INFORMATION
November 26, 1997
Distributor:
Merrill Lynch
Funds Distributor, Inc.
<PAGE>
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 four-year period
ended August 31, 1997 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, 1997.
Statement of Assets and Liabilities as of August 31, 1997.
Statement of Operations for the year ended August 31, 1997.
Statements of Changes in Net Assets for each of the years in the two-
year period ended August 31, 1997.
Financial Highlights for each of the years in the four-year period
ended August 31, 1997 and for the period February 26, 1993
(commencement of operations) to August 31, 1993.
(B) EXHIBITS:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
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.
</TABLE>
C-1
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
11 --Consent of Deloitte & Touche LLP, independent auditors for the
Registrant.
12 --None.
13 --Certificate of Fund Asset Management, Inc.(a)
14 --None.
15(a) --Amended and Restated Class B Distribution Plan and Class B
Distribution Plan Sub-Agreement.(d)
(b) --Form of Class C Distribution Plan and Class C Distribution Plan Sub-
Agreement of the Registrant.(e)
(c) --Form of Class D Distribution Plan and Class D 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 Pricing SM 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 the 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; 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>
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 OCTOBER 31, 1997*
-------------- -----------------
<S> <C>
Class A shares of beneficial interest, par value $0.10 per
share...................................................... 180
Class B shares of beneficial interest, par value $0.10 per
share...................................................... 1,395
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...................................................... 80
</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>
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 registered 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
registered investment companies: Apex Municipal Fund, Inc., Corporate High
Yield Fund, Inc., Corporate High Yield Fund II, Inc., Debt Strategies Fund,
Inc., Income Opportunities Fund 1999, Inc., Income Opportunities Fund 2000,
Inc., Merrill Lynch Municipal Strategy Fund, Inc., MuniAssets Fund Inc.,
MuniEnhanced Fund, Inc., MuniHoldings California Insured Fund, Inc.,
MuniHoldings Florida Insured Fund, MuniHoldings Fund, Inc., MuniHoldings New
York Insured Fund, Inc., MuniInsured Fund, Inc., MuniVest Fund, Inc., MuniVest
Fund II, Inc., MuniVest Florida Fund, MuniVest Michigan Insured Fund, Inc.,
MuniVest New Jersey 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 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 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 registered
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 Convertible 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.,
C-4
<PAGE>
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 Intermediate Government Bond 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., Hotchkis and Wiley Funds (advised
by Hotchkis and Wiley, a division of MLAM); and the following closed-end
registered investment companies: Merrill Lynch High Income Municipal Bond
Fund, Inc. and Merrill Lynch Senior Floating Rate Fund, Inc. MLAM also acts as
sub-adviser to Merrill Lynch World Strategy Portfolio and Merrill Lynch Basic
Value Equity Portfolio, two investment portfolios of EQ Advisory Trust.
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 Intermediate Government Bond
Fund is One Financial Center, 23rd 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, 1995 for his, her 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, 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
---- ------------------------ ----------------------------------
<C> <S> <C>
ML & Co................... Limited Partner Financial Services Holding Company;
Limited Partner of MLAM
Princeton Services, Inc... General Partner General Partner of MLAM
Arthur Zeikel............. President President of MLAM; President and
Director of Princeton Services;
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.
Linda L. Federici......... Senior Vice President Senior Vice President of MLAM;
Senior Vice President of Princeton
Services
</TABLE>
C-5
<PAGE>
<TABLE>
<CAPTION>
OTHER SUBSTANTIAL BUSINESS,
NAME POSITION(S) WITH MANAGER PROFESSION, VOCATION OR EMPLOYMENT
---- ------------------------ ----------------------------------
<C> <S> <C>
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
Philip L. Kirstein...... Senior Vice President, Senior Vice President, General
General Counsel and Counsel and Secretary of MLAM;
Secretary Senior Vice President, General
Counsel, Secretary and Director of
Princeton Services
Ronald M. Kloss......... Senior Vice President Senior Vice President and Controller
and Controller of MLAM; Senior Vice President and
Controller of Princeton Services
Debra Landsman-Yaros.... Senior Vice President Senior Vice President of MLAM; Vice
President of MLFD; Senior Vice
President 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 First Vice President of MLAM; First
Vice President of Princeton
Services; Director of MLFD
Gerald M. Richard....... Senior Vice President Senior Vice President of MLAM; Vice
and Treasurer President and Treasurer of MLFD
Gregory Upah............ Senior Vice President Senior Vice President of MLAM; Vice
President of MLFD; Senior Vice
President of Princeton Services
Ronald L. Welburn....... 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>
(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 02111-2665.
<TABLE>
<CAPTION>
POSITION(S) AND OFFICES POSITIONS AND OFFICES
NAME WITH MLFD WITH REGISTRANT
---- ----------------------- ---------------------
<S> <C> <C>
Terry K. Glenn.......... President and Director Executive Vice President
Richard L. Reller....... Director None
Thomas J. Verage........ Director None
William E. Aldrich...... Senior Vice President None
Robert W. Crook......... Senior Vice President None
Michael J. Brady........ Vice President None
William M. Breen........ Vice President None
Michael G. Clark........ 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>
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 Post-Effective Amendment to its 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
25th day of November, 1997.
Merrill Lynch California Municipal Series
Trust
(Registrant)
/s/ Gerald M. Richard
By _________________________________________
(Gerald M. Richard, Treasurer)
Pursuant to the requirements of the Securities Act of 1933, this Post-
Effective Amendment to its Registration Statement has been signed below by the
following persons in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
Arthur Zeikel* President and
- ------------------------------------- Trustee (Principal
(Arthur Zeikel) Executive Officer)
Treasurer (Principal
Gerald M. Richard* Financial and
- ------------------------------------- Accounting Officer)
(Gerald M. Richard)
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)
/s/ Gerald M. Richard
*By _________________________________ November 25,
(Gerald M. Richard, Attorney-in- 1997
Fact)
C-8
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
-------
<C> <S> <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>
APPENDIX FOR GRAPHIC AND IMAGE MATERIAL
Pursuant to Rule 304 of Regulation S-T, the following table presents
fair and accurate narrative descriptions of graphic and image material omitted
from this EDGAR Submission file due to ASCII-incompatibility and cross-
references this material to the location of each occurrence in the text.
DESCRIPTION OF OMITTED LOCATION OF GRAPHIC
GRAPHIC OR IMAGE OR IMAGE IN TEXT
- ---------------------- -------------------
Compass plate, circular Back cover of Prospectus and
graph paper and Merrill Lynch back cover of Statement of
logo including stylized market Additional Information
bull
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 6
<SERIES>
<NUMBER> 001
<NAME> MERRILL LYNCH CALIFORNIA INSURED MUNICIPAL BOND FUND - CLASS A SHARES
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> AUG-31-1997
<PERIOD-START> SEP-01-1996
<PERIOD-END> AUG-31-1997
<INVESTMENTS-AT-COST> 83789452
<INVESTMENTS-AT-VALUE> 88626832
<RECEIVABLES> 5453585
<ASSETS-OTHER> 94203
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 94174620
<PAYABLE-FOR-SECURITIES> 1692972
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 423843
<TOTAL-LIABILITIES> 2116815
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 90009813
<SHARES-COMMON-STOCK> 1213650
<SHARES-COMMON-PRIOR> 1441410
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> (2813138)
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 4861130
<NET-ASSETS> 12437427
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 5411269
<OTHER-INCOME> 0
<EXPENSES-NET> (1006972)
<NET-INVESTMENT-INCOME> 4404297
<REALIZED-GAINS-CURRENT> 1351724
<APPREC-INCREASE-CURRENT> 2532891
<NET-CHANGE-FROM-OPS> 8288912
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (695974)
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 167842
<NUMBER-OF-SHARES-REDEEMED> (422075)
<SHARES-REINVESTED> 26473
<NET-CHANGE-IN-ASSETS> (4621838)
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> (4164862)
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 525625
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 1245807
<AVERAGE-NET-ASSETS> 13882195
<PER-SHARE-NAV-BEGIN> 9.84
<PER-SHARE-NII> .50
<PER-SHARE-GAIN-APPREC> .41
<PER-SHARE-DIVIDEND> (.50)
<PER-SHARE-DISTRIBUTIONS> 0
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 10.25
<EXPENSE-RATIO> .89
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 6
<SERIES>
<NUMBER> 002
<NAME> MERRILL LYNCH CALIFORNIA INSURED MUNICIPAL BOND FUND - CLASS B SHARES
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> AUG-31-1997
<PERIOD-START> SEP-01-1996
<PERIOD-END> AUG-31-1997
<INVESTMENTS-AT-COST> 83789452
<INVESTMENTS-AT-VALUE> 88626832
<RECEIVABLES> 5453585
<ASSETS-OTHER> 94203
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 94174620
<PAYABLE-FOR-SECURITIES> 1692972
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 423843
<TOTAL-LIABILITIES> 2116815
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 90009813
<SHARES-COMMON-STOCK> 6763433
<SHARES-COMMON-PRIOR> 7448173
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> (2813138)
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 4861130
<NET-ASSETS> 69320188
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 5411269
<OTHER-INCOME> 0
<EXPENSES-NET> (1006972)
<NET-INVESTMENT-INCOME> 4404297
<REALIZED-GAINS-CURRENT> 1351724
<APPREC-INCREASE-CURRENT> 2532891
<NET-CHANGE-FROM-OPS> 8288912
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (3248319)
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 925806
<NUMBER-OF-SHARES-REDEEMED> (1742829)
<SHARES-REINVESTED> 132283
<NET-CHANGE-IN-ASSETS> (4621838)
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> (4164862)
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 525625
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 1245807
<AVERAGE-NET-ASSETS> 72048012
<PER-SHARE-NAV-BEGIN> 9.84
<PER-SHARE-NII> .45
<PER-SHARE-GAIN-APPREC> .41
<PER-SHARE-DIVIDEND> (.45)
<PER-SHARE-DISTRIBUTIONS> 0
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 10.25
<EXPENSE-RATIO> 1.39
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 6
<SERIES>
<NUMBER> 003
<NAME> MERRILL LYNCH CALIFORNIA INSURED MUNICIPAL BOND FUND - CLASS C SHARES
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> AUG-31-1997
<PERIOD-START> SEP-01-1996
<PERIOD-END> AUG-31-1997
<INVESTMENTS-AT-COST> 83789452
<INVESTMENTS-AT-VALUE> 88626832
<RECEIVABLES> 5453585
<ASSETS-OTHER> 94203
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 94174620
<PAYABLE-FOR-SECURITIES> 1692972
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 423843
<TOTAL-LIABILITIES> 2116815
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 90009813
<SHARES-COMMON-STOCK> 523342
<SHARES-COMMON-PRIOR> 498310
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> (2813138)
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 4861130
<NET-ASSETS> 5361183
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 5411269
<OTHER-INCOME> 0
<EXPENSES-NET> (1006972)
<NET-INVESTMENT-INCOME> 4404297
<REALIZED-GAINS-CURRENT> 1351724
<APPREC-INCREASE-CURRENT> 2532891
<NET-CHANGE-FROM-OPS> 8288912
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (228905)
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 252747
<NUMBER-OF-SHARES-REDEEMED> (241739)
<SHARES-REINVESTED> 14024
<NET-CHANGE-IN-ASSETS> (4621838)
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> (4164862)
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 525625
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 1245807
<AVERAGE-NET-ASSETS> 5195558
<PER-SHARE-NAV-BEGIN> 9.84
<PER-SHARE-NII> .44
<PER-SHARE-GAIN-APPREC> .40
<PER-SHARE-DIVIDEND> (.44)
<PER-SHARE-DISTRIBUTIONS> 0
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 10.24
<EXPENSE-RATIO> 1.49
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 6
<SERIES>
<NUMBER> 004
<NAME> MERRILL LYNCH CALIFORNIA INSURED MUNICIPAL BOND FUND - CLASS D SHARES
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> AUG-31-1997
<PERIOD-START> SEP-01-1996
<PERIOD-END> AUG-31-1997
<INVESTMENTS-AT-COST> 83789452
<INVESTMENTS-AT-VALUE> 88626832
<RECEIVABLES> 5453585
<ASSETS-OTHER> 94203
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 94174620
<PAYABLE-FOR-SECURITIES> 1692972
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 423843
<TOTAL-LIABILITIES> 2116815
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 90009813
<SHARES-COMMON-STOCK> 481550
<SHARES-COMMON-PRIOR> 437072
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> (2813138)
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 4861130
<NET-ASSETS> 4939007
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 5411269
<OTHER-INCOME> 0
<EXPENSES-NET> (1006972)
<NET-INVESTMENT-INCOME> 4404297
<REALIZED-GAINS-CURRENT> 1351724
<APPREC-INCREASE-CURRENT> 2532891
<NET-CHANGE-FROM-OPS> 8288912
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (231099)
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 90128
<NUMBER-OF-SHARES-REDEEMED> (61225)
<SHARES-REINVESTED> 15575
<NET-CHANGE-IN-ASSETS> (4621838)
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> (4164862)
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 525625
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 1245807
<AVERAGE-NET-ASSETS> 4705650
<PER-SHARE-NAV-BEGIN> 9.85
<PER-SHARE-NII> .49
<PER-SHARE-GAIN-APPREC> .41
<PER-SHARE-DIVIDEND> (.49)
<PER-SHARE-DISTRIBUTIONS> 0
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 10.26
<EXPENSE-RATIO> .98
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
<PAGE>
EXHIBIT 99.11
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. 6 to Registration
Statement No. 33-55864 of our report dated October 7, 1997 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.
/s/ Deloitte & Touche LLP
Deloitte & Touche LLP
Princeton, New Jersey
November 25, 1997
