PRINCIPAL SPECIAL MARKETS FUND INC, 485APOS, 1999-02-26

PRINCIPAL SPECIAL MARKETS FUND INC
485APOS, 1999-02-26

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Registration No. 33-59474

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
--------

POST-EFFECTIVE AMENDMENT NO. 9 TO

FORM N-1A

REGISTRATION STATEMENT

under

THE SECURITIES ACT OF 1933

and

REGISTRATION STATEMENT

under

THE INVESTMENT COMPANY ACT OF 1940
--------

PRINCIPAL SPECIAL MARKETS FUND, INC.
(Exact name of Registrant as specified in Charter)

The Principal Financial Group
Des Moines, Iowa 50392
(Address of principal executive offices)
--------

Telephone Number (515) 248-3842
--------

MICHAEL D. ROUGHTON Copy to:
The Principal Financial Group JOHN W. BLOUCH, L.L.P.
Des Moines, Iowa 50392 Jones & Blouch
Suite 405 West
1025 Thomas Jefferson Street, N.W.
Washington, DC 20007-0805

(Name and address of agent for service)
----------

It is proposed that this filing will become effective (check appropriate box)
immediately upon filing pursuant to paragraph (b)of Rule 485
on (date), pursuant to paragraph (b) of Rule 485
60 days after filing pursuant to paragraph (a)(1) of Rule 485
X on May 1, 1999, pursuant to paragraph (a)(1) of Rule 485
75 days after filing pursuant to paragraph (a)(2) of Rule 485
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.
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<PAGE>

PRINCIPAL SPECIAL MARKETS FUND, INC.

PORTFOLIOS OF THE FUND

International Emerging Markets Portfolio International SmallCap Portfolio
International Securities Portfolio Mortgage-Backed Securities Portfolio

This Prospectus describes mutual fund organized by Principal Life Insurance
Company. The Fund provides a choice of investment objectives through
International Growth-Oriented Porfolios and an Income-Oriented Portfolio.

The date of this Prospectus is _________________

Neither the Securities and Exchange Commission nor any State Securities
Commission has approved or disapproved of these securities or determined if this
prospectus is accurate or complete. Any representation to the contrary is a
criminal offense.

TABLE OF CONTENTS

Fund Description..........................................................3

International Growth-Oriented Portfolio

International Emerging Markets Portfolio..............................6

International Securities Portfolio....................................8

International SmallCap Portfolio.....................................10

Income-Oriented Portfolio

Mortgage-Backed Securities Portfolio.................................12

The Costs of Investing...................................................14

Certain Investment Strategies and Related Risks..........................14

Management, Organization and Capital Structure...........................17

Pricing of Fund Shares...................................................18

Dividend and Distributions...............................................18

To Buy Shares............................................................19

Offering Price of Shares ................................................20

To Sell Shares...........................................................20

General Information about a Fund Account.................................22

Financial Highlights.....................................................24

FUND DESCRIPTION

The Principal Special Markets Fund, Inc. (the "Fund") is a no-load, open-end
management investment company. It consists of four series ("Portfolios"):
International Emerging Markets Portfolio, International Securities Portfolio,
International SmallCap Portfolio and Mortgage-Backed Securities Portfolio. The
Portfolios and investment objectives are:

International Growth-Oriented Portfolios

International Emerging Markets Portfolio: Long-term growth of capital by
investing primarily in equity securities of issuers in emerging market
countries.

International Securities Portfolio: Long-term growth of capital by investing in
a portfolio of securities of companies domiciled in any of the nations of the
world.

International SmallCap Portfolio: Long-term growth of capital by investing
primarily in equity securities of non-United States companies with comparatively
smaller market capitalizations.

Income-Oriented Portfolio

Mortgage-Backed Securities Portfolio: A total investment return consisting of
current income and capital appreciation while maintaining liquidity and safety
of principal. The Portfolio seeks to achieve its objective through the purchase
of mortgage-backed securities and other obligations issued or guaranteed by the
United States Government or its agencies or instrumentalities. Portfolio shares
are not guaranteed by the United States Government.

In the description for each Portfolio, you will find important information about
the Portfolio's:

Primary investment strategy
This section summarizes how the Portfolio intends to achieve its investment
objective. It identifies the Portfolio's primary investment strategy including
the type or types of securities in which the Portfolio invests.

Annual operating expenses
The annual operating expenses for each Portfolio are deducted from its assets
(stated as a percentage of the portfolio's assets) and are shown as of the end
of the most recent fiscal year. The examples on the following pages are intended
to help you compare the cost of investing in a particular Portfolio with the
cost of investing in other mutual funds. The examples assume that 1) you invest
$10,000 in a Portfolio for the time periods indicated, 2) you sell all of your
shares at the end of those time periods, 3) that the investment has a 5% annual
return and 4) the Portfolio's operating expenses are the same as the most recent
fiscal year expenses. Although your actual costs may be higher or lower, based
on these assumptions, your costs would be as shown.

Day-to-day Portfolio management
The investment professionals who manage the assets of each Portfolio are listed
with each Portfolio. Backed by their staffs of experienced securities analysts,
they provide the Portfolios with professional investment management.

Principal Management Corporation serves as the manager for the Fund. It has
signed a contract with Invista Capital Management LLC. Under the contract,
Invista provides investment advisory services for the Portfolios (see
Management, Organization and Capital Structure).

Portfolio Performance
Included in each Portfolio's description is a set of tables and a bar chart.
Together, these provide an indication of the risks involved when you invest.

The bar chart shows changes in the Portfolio's performance from year to year.
One of the tables compares the Portfolio's average annual returns for 1, 5 and
10 years with a broad based securities market index (a broad measure of market
performance) and an average of mutual funds with a similar investment objective
and management style. The averages used are prepared by Lipper, Inc. (an
independent statistical service). The table shows how the Portfolio's
performance compares with the returns of an index and with funds having similar
investment objectives. The other table for each Portfolio provides the highest
and lowest quarterly return for that Portfolio since the inception of each
Portfolio.

A Portfolio's past performance is not necessarily an indication of how the
Portfolio will perform in the future.

NOTE: Investments in these Portfolios are not deposits of a bank and are not
insured or guaranteed by the Federal Deposit Insurance Corporation or
any other government agency.

This page left blank intentionally.

INTERNATIONAL GROWTH-ORIENTED PORTFOLIO

International Emerging Markets Portfolio

Main Strategies
The International Emerging Markets Portfolio seeks to achieve long-term growth
of capital by investing primarily in equity securities of issuers in emerging
market countries.

The International Emerging Markets Portfolio seeks to achieve its objective by
investing in common stocks of companies in emerging market countries. For this
Portfolio, the term "emerging market country" means any country which is
considered to be an emerging country by the international financial community
(including the International Bank for Reconstruction and Development (also known
as the World Bank) and the International Financial Corporation). These countries
generally include every nation in the world except the United States, Canada,
Japan, Australia, New Zealand and most nations located in Western Europe.
Investing in many emerging market countries is not feasible or may involve
unacceptable political risk. Invista, the Sub-Advisor, focuses on those emerging
market countries that it believes have strongly developing economies and markets
which are becoming more sophisticated.

Under normal conditions, at least 65% of the Portfolio's assets are invested in
emerging market country equity securities. The Portfolio invests in securities
of:
o companies with their principal place of business or principal office in
emerging market countries;
o companies for which the principal securities trading market is an
emerging market country; or
o companies, regardless of where its securities are traded, that derive
50% or more of their total revenue from either goods or services
produced in emerging market countries or sales made in emerging market
countries.

Main Risks
Investments in emerging market countries involve special risks. Certain emerging
market countries have historically experienced, and may continue to experience,
certain economic problems. These may include: high rates of inflation, high
interest rates, exchange rate fluctuations, large amounts of debt, balance of
payments and trade difficulties, and extreme poverty and unemployment. In
addition, there are risks involved with any investment in foreign securities
(See Foreign Securities).

Under unusual market or economic conditions, the Portfolio may invest in
securities issued by domestic corporations, governments or governmental
agencies, instrumentalities or political subdivisions. The securities may be
denominated in U. S. dollars or other currencies.

The International Emerging Markets Portfolio is generally a suitable investment
for investors seeking long-term growth who want to invest a portion of their
assets in securities of companies in emerging market countries. Because the
values of the Portfolio's assets are likely to rise or fall dramatically, when
shares of the Portfolio are sold they may be worth more or less than the amount
paid for them. This Portfolio is not an appropriate investment if you are
seeking either preservation of capital or high current income. You must be able
to assume the increased risks of higher price volatility and currency
fluctuations associated with investments in international stocks which trade in
non-U.S. currencies.

----------------------------------- ------------------------------------
Annual Total Returns Highest & lowest
----------------------------------- quarterly total return
during the last 1 year
1998 (14.76) ------------------------------------
Quarter Ended Quarterly Return
------------------------------------
12/31/98 14.06%
9/30/98 (19.25%)
------------------------------------
Calendar Year Ended December 31
-------------------------------------------------
Average annual total returns
for the period ending December 31, 1998
-------------------------------------------------
Past One Past Five
Year Years
-------- ---------
International Emerging Markets
Portfolio (17.21)%(14.76)%*
Morgan Stanley Capital
International EMF (27.52) (11.13)
Lipper Emerging Markets
Fund Average (26.83) (10.01)
-------------------------------------------------
* Period from November 26, 1997, date first
offered to the public, through December 31,
1998.

The year to date return as of December 31, 1998 is (17.21)%.

--------------------------------------------------
Portfolio Operating Expenses
--------------------------------------------------

Management Fees........................ 1.15%
Other Expenses*........................ _

Total Portfolio Operating Expenses 1.15%
--------------------------------------------------

* In addition to brokerage and extraordinary expenses, a Portfolio will pay
only taxes and interest expenses, which it is anticipated will be minimal
or nonexistent under normal circumstances.

--------------------------------------------------------
Examples**
--------------------------------------------------------

1 Year 3 Years 5 Years 10 Years
------ ------- -------- --------
$117 $365 $633 $1,398
--------------------------------------------------------

**The Examples assume 1) an investment of $10,000, 2) an annual return of
5%, and 3) expenses the same as the most recent fiscal year expenses.

Day-to-day Fund management:
Since May 1997 Manager: Kurtis D. Spieler, CFA. Portfolio Manager of
Invista since 1995.

INTERNATIONAL GROWTH-ORIENTED PORTFOLIO

Principal International Securities Portfolio

Main Strategies
The International Securities Portfolio seeks long-term growth of capital by
investing in a portfolio of securities of companies domiciled in any of the
nations of the world.

The International Securities Portfolio invests in common stocks of companies
established outside of the U. S. The Portfolio has no limitation on the
percentage of assets that are invested in any one country or denominated in any
one currency. However under normal market conditions, the Portfolio intends to
have at least 65% of its assets invested in companies in at least three
different countries. One of those countries may be the U. S. though currently
the Portfolio does not intend to invest in equity securities of U. S. companies.

Investments may be made anywhere in the world. Primary consideration is given to
securities of corporations of Western Europe, North America and Australasia
(Australia, Japan and Far East Asia). Changes in investments are made as
prospects change for particular countries, industries or companies.

In choosing investments for the Portfolio, Invista pays particular attention to
the long-term earnings prospects of the various companies under consideration.
Invista then weighs those prospects relative to the price of the security.

Main Risks
The values of the stocks owned by the Portfolio change on a daily basis. Stock
prices reflect the activities of individual companies as well as general market
and economic conditions. In the short term, stock prices and currencies can
fluctuate dramatically in response to these factors. In addition, there are
risks involved with any investment in foreign securities (see Foreign
Securities). Because the values of the Portfolio's assets may rise or fall, when
shares of the Portfolio are sold they may be worth more or less than the amount
paid for them.

The International Securities Portfolio is generally a suitable investment for
investors who seek long-term growth and who want to invest in non-U.S.
companies. This Portfolio is not an appropriate investment if you are seeking
either preservation of capital or high current income. Suitable investors must
be able to assume the increased risks of higher price volatility and currency
fluctuations associated with investments in international stocks which trade in
non-U.S. currencies.

Calendar Year Ended December 31

-------------------------------------------------------------
Average annual total returns
for the period ending December 31, 1998
-------------------------------------------------------------
Past One Past Five Ten
Year Years Years
-------- --------- --------
International Securities Portfolio 9.55% 9.91% 13.87%*
Morgan Stanley Capital
International EAFE
(Europe, Australia and
Far East) Index 20.00 9.19 5.54
Lipper International Fund
Average 13.02 7.87 9.39
--------------------------------------------------------------
* Period from May 7, 1993, date first offered to the public,
through December 31, 1998.

The year to date return as of December 31, 1998 is 9.55%.

--------------------------------------------------
Portfolio Operating Expenses
--------------------------------------------------

Management Fees........................ .90%
Other Expenses*........................ _

Total Portfolio Operating Expenses .90%
--------------------------------------------------

* In addition to brokerage and extraordinary expenses, a Portfolio will pay
only taxes and interest expenses, which it is anticipated will be minimal
or nonexistent under normal circumstances.

--------------------------------------------------------
Examples**
--------------------------------------------------------

1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
$92 $287 $498 $1,108
--------------------------------------------------------

**The Examples assume 1) an investment of $10,000, 2) an annual return of
5%, and 3) expenses the same as the most recent fiscal year expenses.

Day-to-day Fund management:
Since April, 1994 Manager: Scott D. Opsal, CFA. Executive Vice President
and Chief Investment Officer of Invista
since 1997.

INTERNATIONAL GROWTH-ORIENTED PORTFOLIO

Principal International SmallCap Portfolio

Main Strategies
The International SmallCap Portfolio seeks to achieve long-term growth of
capital by investing primarily in equity securities of non-United States
companies with comparatively smaller market capitalizations.

The International SmallCap Portfolio invests in stocks of non-U.S. companies
with comparatively smaller market capitalizations. Market capitalization is
defined as total current market value of a company's outstanding common stock.
Under normal market conditions, the Portfolio invests at least 65% of its assets
in securities of companies having market capitalizations of $1 billion or less.
Please review the sections of this prospectus which discuss the risks involved
with any investment in foreign securities (see Foreign Securities) and with
investments in companies with small market capitalizations (see Securities of
Smaller Companies).

Main Risks
The Portfolio diversifies its investments geographically. There is no limitation
of the percentage of assets that may be invested in one country or denominated
in any one currency. However, under normal market circumstances, the Portfolio
intends to have at least 65% of its assets invested in securities of companies
of at least three countries.

This Portfolio is not an appropriate investment if you are seeking either
preservation of capital or high current income. You must be able to assume the
increased risks of higher price volatility and currency fluctuations associated
with investments in international stocks which trade in non-U.S. currencies.

The International SmallCap Portfolio is generally a suitable investment for
investors seeking long-term growth who want to invest a portion of their assets
in smaller, non-U.S. companies. Because the values of the Portfolio's assets may
rise or fall, when shares of the Portfolio are sold they may be worth more or
less than the amount paid for them.

----------------------------------- ------------------------------------
Annual Total Returns Highest & lowest
----------------------------------- quarterly total return
during the last 1 year
1998 11.92 --------------------------------------
Quarter Ended Quarterly Return
--------------------------------------
3/31/98 21.10%
9/30/98 (20.68%)
--------------------------------------
Calendar Year Ended December 31
-------------------------------------------------
Average annual total returns
for the period ending December 31, 1998
-------------------------------------------------
Past One Past Five
Year Years
-------- ---------
International SmallCap Portfolio 11.92% 12.43%*
Morgan Stanley Capital
International EAFE
(Europe, Australia and
Far East) Index 20.00 9.19
Lipper International Small-Cap
Fund Average 13.02 6.10
-------------------------------------------------
* Period from November 26, 1997, date first
offered to the public, through December 31,
1998.

The year to date return as of December 31, 1998 is 11.92%.

--------------------------------------------------
Portfolio Operating Expenses
--------------------------------------------------

Management Fees........................ 1.00%
Other Expenses*........................ _

Total Portfolio Operating Expenses 1.00%
--------------------------------------------------

* In addition to brokerage and extraordinary expenses, a Portfolio will pay
only taxes and interest expenses, which it is anticipated will be minimal
or nonexistent under normal circumstances.

--------------------------------------------------------
Examples**
--------------------------------------------------------

1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
$102 $318 $552 $1,225
--------------------------------------------------------

**The Examples assume 1) an investment of $10,000, 2) an annual return of
5%, and 3) expenses the same as the most recent fiscal year expenses.

Day-to-day Fund management:
Since May 1997 Manager: Darren K. Sleister, CFA. Portfolio Manager of
Invista since 1995.

INCOME-ORIENTED PORTFOLIO

Mortgage-Backed Securities Portfolio

Main Strategies
The Mortgage-Backed Securities Portfolio seeks a high level of current income,
liquidity and safety of principal by purchasing obligations issued or guaranteed
by the United States Government or its agencies, with emphasis on Government
National Mortgage Associations Certificates. The guarantees by the United States
Government extends only to principal and interest. There are certain risks
unique to GNMA Certificates.

The Mortgage-Backed Securities Portfolio invests in U. S. Government securities,
which include obligations issued or guaranteed by the U. S. Government or its
agencies or instrumentalities. The Portfolio may invest in securities supported
by:
o full faith and credit of the U. S. Government (e.g. GNMA certificates);
or
o credit of the instrumentality (e.g. bonds issued by the Federal Home
Loan Mortgage Corp.).

Although some of the securities the Portfolio purchases are backed by the U.S.
government and its agencies, shares of the Portfolio are not guaranteed.
Generally, when interest rates fall, the value of the Portfolio's shares rises,
and when rates rise, the value declines. Because of the fluctuation in values of
the Portfolio's shares, when sold, shares of the Portfolio may be worth more or
less than the amount paid for them.

U.S. Government securities do not involve the degree of credit risk associated
with investments in lower quality fixed-income securities. As a result, the
yields available from U.S. Government securities are generally lower than the
yields available from many other fixed-income securities. Like other
fixed-income securities, the values of U.S. Government securities change as
interest rates fluctuate. Fluctuations in the value of the Portfolio's
securities do not effect interest income on securities already held by the
Portfolio, but are reflected in the Fund's price per share. Since the magnitude
of these fluctuation generally are greater at times when the Portfolio's average
maturity is longer, under certain market conditions the Portfolio may invest in
short term investments yielding lower current income rather than investing in
higher yielding longer term securities.

GNMA Certificates are mortgage backed securities representing an interest in a
pool of mortgage loans. Various lenders make the loans which are then insured
(by the Federal Housing Administration) or loans which are guaranteed (by
Veterans Administration or Farmers Home Administration). The lender or other
security issuer creates a pool of mortgages which it submits to GNMA for
approval.

The Portfolio invests in modified pass-through GNMA Certificates. Owners of
Certificates receive all interest and principal payments owed on the mortgages
in the pool, regardless of whether or not the mortgagor has made the payment.
Timely payment of interest and principal is guaranteed by the full faith and
credit of the U. S. Government.

Main Risks
Mortgage backed securities are subject to prepayment risk. Prepayments,
unscheduled principal payments, may result from voluntary prepayment,
refinancing or foreclosure of the underlying mortgage. When interest rates
decline, significant unscheduled prepayments may result. These prepayments must
then be reinvested at lower rates. Prepayments may also shorten the effective
maturities of these securities, especially during periods of declining interest
rates. On the other hand, during period of rising interest rates, a reduction in
prepayments may increase the effective maturities of these securities,
subjecting them to the risk of decline in market value in response to rising
interest and potentially increasing the volatility of the fund.

In addition, prepayments may cause losses on securities purchased at a premium
(dollar amount by which the price of the bond exceeds its face value). At times,
mortgage backed securities may have higher than market interest rates and are
purchased at a premium. Unscheduled prepayments are made at par and cause the
Portfolio to experience a loss of some or all of the premium.

The Mortgaged-Backed Securities Portfolio is generally a suitable investment for
investors who want monthly dividends to provide income or to be reinvested in
additional Portfolio shares to produce growth. Such investors prefer to have the
repayment of principal and interest on most of the securities in which the
Portfolio invests to be backed by the U.S. Government, its agencies or
instrumentalities.

Calendar Year Ended December 31

-------------------------------------------------------------
Average annual total returns
for the period ending December 31, 1998
-------------------------------------------------------------
Past One Past Five Ten
Year Years Years
-------- --------- --------
Mortgage-Backed Securities
Portfolio 7.74% 7.29% 7.25%*
Lehman Brothers Mortgage
Index 6.96 7.23 9.13
Lipper U.S. Mortgage Fund
Average 6.08 5.98 8.04
-------------------------------------------------------------
* Period from May 7, 1993, date first offered to the public,
through December 31, 1998.

The year to date return as of December 31, 1998 is 7.74%.

--------------------------------------------------
Portfolio Operating Expenses
--------------------------------------------------

Management Fees........................ .45%
Other Expenses*........................ _

Total Portfolio Operating Expenses .45%
--------------------------------------------------

* In addition to brokerage and extraordinary expenses, a Portfolio will pay
only taxes and interest expenses, which it is anticipated will be minimal
or nonexistent under normal circumstances.

--------------------------------------------------------
Examples**
--------------------------------------------------------

1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
$46 $144 $252 $567
--------------------------------------------------------

**The Examples assume 1) an investment of $10,000, 2) an annual return of
5%, and 3) expenses the same as the most recent fiscal year expenses.

Day-to-day Fund Management:
Since May 1985 Manager: Martin J. Schafer, CFA. Portfolio Manager of
Invista since 1992.

THE COSTS OF INVESTING

Sales charge:
There is no sales charge on purchases or sales of shares of the Portfolios.

Ongoing fees. The Fund pays ongoing operating fees to its Manager, Underwriter
and others who provide services to the Fund. They reduce the value of each share
you own. See MANAGEMENT, ORGANIZATION AND CAPITAL STRUCTURE.

CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS

The Statement of Additional Information (SAI) contains additional information
about investment strategies and their related risks.

Securities and Investment Practices
Equity Securities include common stocks, preferred stocks, convertible
securities and warrants. Common stocks, the most familiar type, represent an
equity (ownership) interest in a corporation. Although equity securities have a
history of long term growth in value, their prices fluctuate based on changes in
a company's financial condition and on overall market and economic conditions.
Smaller companies are especially sensitive to these factors.

Debt securities include bonds and other debt instruments that are used by
issuers to borrow money from investors. The issuer generally pays the investor a
fixed, variable or floating rate of interest. The amount borrowed must be repaid
at maturity. Some debt securities, such as zero coupon bonds, do not pay current
interest, but are sold at a discount from their face values.

Debt securities are sensitive to changes in interest rates. In general, bond
prices rise when interest rates fall and fall when interest rates rise. Longer
term bonds and zero coupon bonds are generally more sensitive to interest rate
changes.

Bond prices are also affected by the credit quality of the issuer. Investment
grade debt securities are medium and high quality securities. Some bonds may
have speculative characteristics and be particularly sensitive to economic
conditions and the financial condition of the issuers.

Repurchase Agreements and Loaned Securities
Each of the Fund's Portfolios may invest a portion of its assets in repurchase
agreements. Repurchase agreements typically involve the purchase of debt
securities from a financial institution such as a bank, savings and loan
association or broker-dealer. A repurchase agreement provides that the Portfolio
sells back to the seller and that the seller repurchases the underlying
securities at a specified price on a specific date. Repurchase agreements may be
viewed as loans by a Portfolio collateralized by the underlying securities. This
arrangement results in a fixed rate of return that is not subject to market
fluctuation while the Portfolio holds the security. In the event of a default or
bankruptcy by a selling financial institution, the affected Portfolio bears a
risk of loss. To minimize such risks, the Portfolio enters into repurchase
agreements only with large, well-capitalized and well-established financial
institutions. In addition, the value of the collateral underlying the repurchase
agreement is always at least equal to the repurchase price, including accrued
interest.

Each of the Fund's Portfolios may lend its portfolio securities to unaffiliated
broker-dealers and other unaffiliated qualified financial institutions.

Currency Contracts
The International Emerging Markets, International Securities and International
SmallCap Portfolios may each enter into forward currency contracts, currency
futures contracts and options, and options on currencies for hedging and other
non-speculative purposes. A forward currency contract involves a privately
negotiated obligation to purchase or sell a specific currency at a future date
at a price set in the contract. A Portfolio will not hedge currency exposure to
an extent greater than the aggregate market value of the securities held or to
be purchased by the Portfolio (denominated or generally quoted or currently
convertible into the currency).

Hedging is a technique used in an attempt to reduce risk. If a Portfolio's
Manager or Sub-Advisor hedges market conditions incorrectly or employs a
strategy that does not correlate well with the Portfolio's investment, these
techniques could result in a loss, regardless of whether the intent was to
reduce risk or to increase return. These techniques may increase the volatility
of a Portfolio and may involve a small investment of cash relative to the
magnitude of the risk assumed. In addition, these techniques could result in a
loss if the other party to the transaction does not perform as promised.
Additionally, there is the risk of government action through exchange controls
that would restrict the ability of the Portfolio to deliver or receive currency.

Warrants
Each of the Portfolios may invest up to 5% of its assets in warrants. Up to 2%
of a Portfolio's assets may be invested in warrants which are not listed on
either the New York or American Stock Exchanges. For the International,
International Emerging Markets and International SmallCap Funds, the 2%
limitation also applies to warrants not listed on the Toronto Stock and Chicago
Board Options Exchanges.

Options
Each of the Portfolios may buy and sell certain types of options. Each type is
more fully discussed in the SAI.

Foreign Securities
The International Emerging Markets, International Securities and International
SmallCap Portfolios each may invest in foreign securities (securities of
non-U.S. companies).

Investment in foreign securities presents certain risks including: fluctuations
in currency exchange rates, revaluation of currencies, the imposition of foreign
taxes, future political and economic developments including war, expropriations,
nationalization, the possible imposition of currency exchange controls and other
foreign governmental laws or restrictions. In addition, there may be reduced
availability of public information concerning issuers compared to domestic
issuers. Foreign issuers are not generally subject to uniform accounting,
auditing and financial reporting standards or to other regulatory practices and
requirements that apply to domestic issuers. Transactions in foreign securities
may be subject to higher costs. Each Portfolio's investment in foreign
securities may also result in higher custodial costs and the costs associated
with currency conversions.

Securities of many foreign issuers may be less liquid and their prices more
volatile than those of comparable domestic issuers. Foreign securities markets,
particularly those in emerging market countries, are known to experience long
delays between the trade and settlement dates of securities purchased and sold.
Such delays may result in a lack of liquidity and greater volatility in the
price of securities on those markets. As a result of these factors, the Board of
Directors of the Fund has adopted Daily Pricing and Valuation Procedures for the
Portfolios. These procedures outline the steps to be followed by the Manager and
Sub-Advisor to establish a reliable market or fair value if a reliable market
value is not available through normal market quotations. The Executive Committee
of the Board of Directors oversees this process.

Euro Conversion. A new European currency was introduced on January 1, 1999. The
new currency is called the "euro." It is expected to be utilized by eleven
European countries. The eleven countries are members of the European Economic
Monetary Union (EMU). The introduction of this currency may result in
uncertainty for European securities, security markets and international mutual
fund portfolios. Because of the euro's introduction, European securities will
undergo a redenomination period which may result in otherwise unlikely
accounting differences and tax consequences. Further uncertainty exists because
not all EMU members, including the United Kingdom, will officially implement the
euro on January 1, 1999. If the euro's introduction does not occur as planned,
then negative effects, such as severe currency fluctuations and market
disruptions, may result.

The Manager is actively working to address euro-related issues. The Manager has
successfully completed three conversion tests for the Portfolios potentially
effected by the euro's introduction. The Manager has paid costs of $31,500 for
preparation of the euro's introduction and subsequent conversions. Additional
costs are not expected. However, the precise impact is unknown. Any negative
effects to a Fund's portfolio holdings could decrease the Fund's performance.

Securities of Smaller Companies
The Portfolios may invest in securities of companies with small- or mid-sized
market capitalizations. Market capitalization is defined as total current market
value of a company's outstanding common stock. Investments in companies with
smaller market capitalizations may involve greater risks and price volatility
(wide, rapid fluctuations) than investments in larger, more mature companies.
Smaller companies may be less mature than older companies. At this earlier stage
of development, the companies may have limited product lines, reduced market
liquidity for their shares, limited financial resources or less depth in
management than larger or more established companies. Small companies also may
be less significant within their industries and may be at a competitive
disadvantage relative to their larger competitors. While smaller companies may
be subject to these additional risks, they may also realize more substantial
growth than larger or more established companies.

Unseasoned Issuers
The Portfolios may invest in the securities of unseasoned issuers. Unseasoned
issuers are companies with a record of less than three years continuous
operation, including the operation of predecessors and parents. Unseasoned
issuers by their nature have only a limited operating history which can be used
for evaluating the companies growth prospects. As a result, investment decisions
for these securities may place a greater emphasis on current or planned product
lines and the reputation and experience of the companies management and less
emphasis on fundamental valuation factors than would be the case for more mature
growth companies. In addition, many unseasoned issuers also may be small
companies and involve the risks and price volatility associated with smaller
companies.

Temporary Defensive Measures
For temporary defensive purposes in times of unusual or adverse market
conditions, the Portfolios, may invest without limit in cash and cash
equivalents. For this purpose, cash equivalents include: bank certificates of
deposit, bank acceptances, repurchase agreements, commercial paper, and
commercial paper master notes which are floating rate debt instruments without a
fixed maturity. In addition, a Portfolio may purchase U.S. Government
securities, preferred stocks and debt securities, whether or not convertible
into or carrying rights for common stock.

Portfolio Turnover
"Portfolio Turnover" is the term used in the industry for measuring the amount
of trading that occurs in a fund's portfolio during the year. For example, a
100% turnover rate means that on average every security in the portfolio has
been replaced once during the year.

Funds with high turnover rates (more than 100%) often have higher transaction
costs (which are paid by the fund) and may generate short-term capital gains (on
which you pay taxes even if you don't sell any of your shares during the year).
You can find the turnover rate for each Portfolio in the Portfolio's Financial
Highlights table.

Please consider all the factors when you compare the turnover rates of different
funds. A fund with consistently higher total returns and higher turnover rates
than another fund may actually be achieving better performance precisely because
the managers are active traders. You should also be aware that the "total
return" line in the Financial Highlights already includes portfolio turnover
costs.

MANAGEMENT, ORGANIZATION AND CAPITAL STRUCTURE

The Manager

Principal Management Corporation (the "Manager") serves as the manager for the
Fund. In its handling of the business affairs of each Portfolio, the Manager
provides clerical, recordkeeping and bookkeeping services, and keeps the
financial and accounting records required for the Fund. The Manager has signed
sub-advisory agreements with Invista for portfolio management functions for the
International Growth-Oriented Portfolios and the Income-Oriented Portfolio. The
Manager compensates Invista for its sub-advisory services as provided in the
Sub-Advisory Agreement between Invista and the Manager. The Manager may
periodically reallocate management fees between itself and Invista.

The Manager is a subsidiary of Principal Life Insurance Company. It has managed
mutual funds since 1969. As of December 31, 1998, the Funds it managed had
assets of approximately $6.0 billion. The Manager's address is Principal
Financial Group, Des Moines, Iowa 50392-0200.

Invista is also a subsidiary of Principal Life Insurance Company and is an
affiliate of the Manager. Invista has managed investments for institutional
investors, including Principal Life, since 1985. As of December 31, 1998, it
managed assets of approximately $31 billion. Invista's address is 1800 Hub
Tower, 699 Walnut, Des Moines, Iowa 50309.

The Manager or Invista provides the Board of Directors of the Fund a recommended
investment program for each of the four Portfolios. Each program must be
consistent with the Portfolio's investment objective and policies. Within the
scope of the approved investment program, the Manager or Invista advises each
Portfolio on its investment policies and determines which securities are bought
and sold, and in what amounts.

The Manager is paid a fee by each Portfolio for its services, which includes any
fee paid to Invista. The fee paid by each Portfolio (as a percentage of the
average daily net assets) is determined using the following rate:

<TABLE>
<CAPTION>
Fees Computed On Fees as a Percent of
Portfolio Net Asset Value of Portfolio Average Daily Net Assets
--------- ---------------------------- ------------------------
<S> <C> <C> <C>
International Emerging Markets Portfolio First $250 million 1.15%
Next $250 million 1.05%
Over $500 million 0.95%

International Securities Portfolio Entire Portfolio 0.90%

International SmallCap Portfolio First $250 million 1.00%
Next $250 million 0.90%
Over $500 million 0.80%

Mortgage-Backed Securities Portfolio Entire Portfolio 0.45%
</TABLE>

For the fiscal year ended December 31, 1998 the Management fee for each
Portfolio was:

International Emerging Markets Portfolio 1.15%
International Securities Portfolio .90%

International SmallCap Portfolio 1.00%
Mortgage-Backed Securities Portfolio .45%

PRICING OF FUND SHARES

Each Portfolio's shares are bought and sold at the current share price. The
share price of each Portfolio is calculated each day the New York Stock Exchange
is open. The share price is determined at the close of business of the Exchange
(normally at 3:00 p.m. Central Time). When Princor receive your order to buy or
sell shares, the share price used to fill the order is the next price calculated
after the order is placed.

For all Portfolios the share price is calculated by:
o taking the current market value of the total assets of the Portfolio
o subtracting liabilities of the Portfolio
o dividing the remainder by the total number of shares owned

NOTES:
o If current market values are not readily available for a security, its
fair value is determined using a policy adopted by the Fund's Board of
Directors.
o The Portfolio's securities may be traded on foreign securities markets
which generally complete trading at various times during the day prior
to the close of the New York Stock Exchange. The values of foreign
securities used in computing share price are determined at the time the
foreign market closes. Occasionally, events affecting the value of
foreign securities occur when the foreign market is closed and the New
York Stock Exchange is open. If the Manager believes the market value
is materially affected, the share price will be calculated using the
policy adopted by the Fund.
o Foreign securities markets may trade on days when the New York Stock
Exchange is closed (such as customary U.S. holidays) and the
Portfolio's share price is not calculated. As a result, the value of a
Portfolio's assets may be significantly affected by such trading on
days when you cannot purchase or sell shares of the Portfolio.

DIVIDENDS AND DISTRIBUTIONS

The International Growth-Oriented and Income-Oriented Portfolios pay most of
their net dividend income to you every year. The payment schedule is:

<TABLE>
<CAPTION>
Portfolios Record Date Payable Date
---------- ----------- ------------
<S> <C> <C> <C>
International Emerging Markets, three business days before December 24
International Securities and each payable date (or previous business day)
International SmallCap

Mortgage-Backed Securities three business days before last business day of each
each payable date month
</TABLE>
Net realized capital gain for each of the Portfolios, if any, are distributed
annually, on the 24th of December (or the preceding business day if the 24th is
not a business day) to shareholders of record three business days before the
payable date. Payments are made to shareholders of record on the third business
day prior to the payable date. Capital gains may be taxable at different rates,
depending on the length of time that the Portfolio holds it's assets.

You can authorize income dividend and capital gain distributions to be:
o invested in additional shares of the Portfolio you own; or
o paid in cash.

NOTE: Payment of income dividends and capital gains shortly after you buy
shares has the effect of reducing the share price by the amount of the
payment.

Distributions from a Portfolio, whether received in cash or reinvested in
additional shares, may be subject to federal (and state) income tax.

You should consult your tax advisor as to the federal, state and local
tax consequences of Portfolio ownership.

TO BUY SHARES

Each Portfolio requires:
o A minimum initial investment of $1,000,000 which may be invested over a
three month period. If the minimum investment has not been met within 3
months, we will send you a notice. If following the notice, we do not
receive sufficient funds within 30 days to meet the required minimum,
then we will redeem the account and send you the proceeds.
o You may combine your investment with those of your spouse, dependent
children and/or a trust for the benefit of such persons to meet the
requirement;
o Subsequent purchases are not subject to limitations.

Fill out the Principal Mutual Fund application* completely. You must include:
o the name(s) you want to appear on the account;
o the Portfolio(s) you want to invest in;
o the amount of the investment;
o your Social Security number or Taxpayer I.D. number;
o investor information (used to help your Registered Representative
confirm that your investment selection is consistent with your goals
and circumstances) ; and
o other required information (may include corporate resolutions, trust
agreements, etc.).

* An application is included with this prospectus.

Invest by mail:
o Send a check and completed application to:

Principal Special Markets Fund, Inc.
P. O. Box 10423
Des Moines Iowa 50306

o Make your check payable to Principal Special Markets Fund, Inc.
o Your purchase will be priced at the next share price calculated after
Fund receives your completed paperwork.

Order by telephone:
o Call us at 1-800-521-1502 between 7:00 a.m. and 7:00 p.m. Central Time
on any day that the New York Stock Exchange is open.
o To buy shares the same day, you need to call before 3:00 p.m. Central
Time.
o We must receive your payment for the order within three business days
(or the order will be canceled and you may be liable for any loss).
o For new accounts, you also need to send a completed application.

Wire money from your bank:
o Have your Registered Representative call Principal Mutual Funds
(1-800-521-1502) for an account number and wiring instructions.
o For both initial and subsequent purchases, federal funds should be
wired to:
Norwest Bank Iowa, N.A.
Des Moines, Iowa 50309
ABA No.: 073000228
For credit to: Principal Special Markets Fund
Account No.: 3000499968
For credit: Principal Special Markets Fund, Portfolios
Shareholder Account No. __________________
Shareholder Registration __________________

o Give the number and instructions to your bank (which may charge a wire
fee).
o To buy shares the same day, the wire must be received before 3:00 p.m.
Central Time.
o No wires are accepted on days when the New York Stock Exchange is
closed or when the Federal Reserve is closed (because the bank that
would receive your wire is closed).

OFFERING PRICE OF SHARES

The Fund offers shares of each Portfolio continuously through Princor Financial
Services Corporation which is the principal underwriter for the Fund and sells
shares as agent for the Fund. Shares are sold to the public at net asset value,
subject to the minimum investment requirements. In certain circumstances,
Princor Financial Services Corporation will compensate its registered
representatives or a selected dealer with whom it has entered into a selling
agreement for their efforts in distributing shares of the fund. Compensation is
an ongoing fee in an amount up to 0.10% on an annualized basis of the average
net asset value of shares held in your account the establishment of which is
attributable to the efforts of the registered representative or selected dealer.

TO SELL SHARES

After you place a sell order in proper form, shares are sold using the next
share price calculated. There is no charge for a sale. Generally, the sale
proceeds are sent out on 3 business days after the sell order has been placed.
At your request, the check will be sent overnight (a $15 overnight fee will be
deducted from your account unless other arrangements are made). The Fund can
only sell shares after your check making the Fund investment has cleared your
bank. To avoid the inconvenience of a delay in obtaining sale proceeds, shares
may be purchased with a cashier's check, money order or certified check. A sell
order from one owner is binding on all joint owners.

Selling shares may create a gain or a loss for federal (and state) income tax
purposes. You should maintain accurate records for use in preparing your income
tax returns.

Generally, sales proceeds checks are:
o payable to all owners on the account (as shown in the account
registration) and
o mailed to address on the account (if not changed within last month) or
previously authorized bank account.

For other payment arrangements, please call Principal Mutual Funds
(1-800-521-1502).

You should also call Principal Mutual Funds (1-800-521-1502) for special
instructions that may apply to sales from accounts:
o when an owner has died; or
o owned by corporations, partnerships, agents or fiduciaries.

The transaction is considered a sale for federal (and state) income tax purposes
even if the proceeds are reinvested. If a loss is realized on the sale, the
reinvestment may be subject to the "wash sale" rules resulting in the
postponement of the recognition of the loss for tax purposes.

Sell shares by mail
o Send a letter (signed by the owner of the account) to
Principal Mutual Funds
P. O. Box 10423
Des Moines Iowa 50306-9780

o Specify the Fund and account number.
o Specify the Portfolio(s).
o Specify the number of shares or the dollar amount to be sold.
o A signature guarantee* will be required if the:
o account address has been changed within three months of the sell
order; or
o check is payable to a party other than the account shareholder(s)
or Principal Life Insurance Company.
* If required, the signature(s) must be guaranteed by a commercial
bank, trust company, credit union, savings and loan, national
securities exchange member or brokerage firm. A signature
guaranteed by a notary public or savings bank is not acceptable.

Sell shares by telephone* (1-800-521-1502)
o Address on account must not have been changed within the last month and
telephone privileges must apply to the account from which the shares
are being sold.
o If our phone lines are busy, you may need to send in a written sell
order.
o To sell shares the same day, the order must be received before 3:00
p.m. Central Time.
o If previously authorized, checks can be sent to a shareholder's U.S.
bank account.
* The Fund and transfer agent reserve the right to refuse telephone
orders to sell shares. The shareholder is liable for a loss resulting
from a fraudulent telephone order that the Fund reasonably believes
is genuine. The Fund will use reasonable procedures to assure
instructions are genuine. If the procedures are not followed, the
Fund may be liable for loss due to unauthorized or fraudulent
transactions. The procedures include: recording all telephone
instructions, requesting personal identification information (name,
phone number, social security number, birth date, etc.) and sending
written confirmation to the address on the account.

Periodic withdrawal plans
You may set up a periodic withdrawal plan
o on a monthly, quarterly, semiannual or annual basis to:
o sell a fixed number of shares ($100 initial minimum amount),
o sell enough shares to provide a fixed amount of money ($100 initial
minimum amount).

You can set up a periodic withdrawal plan by:
o completing the applicable section of the application; or
o sending us your written instructions (and share certificate, if any,
issued for the account).

Your periodic withdrawal plan continues until:
o you instruct us to stop, or
o your Fund account is exhausted.

When you set up the withdrawal plan, you select which day you want the sale made
(if none selected, the sale will be made on the 15th of the month). If the
selected date is not a trading day, the sale will take place on the next trading
day (if that day falls in the month after your selected date, the transaction
will take place on the trading day before your selected date. If telephone
privileges apply to the account, you may change the date or amount by
telephoning us at 1-800-521-1502.

GENERAL INFORMATION ABOUT A FUND ACCOUNT

Statements
You will receive quarterly statements. The statements provide the number and
value of shares you own, transactions during the quarter, dividends declared or
paid and other information. The year end statement includes information for all
transactions that took place during the year. Please review your statement as
soon as your receive it. Keep your statements as you may need them for tax
reporting purposes.

Generally, each time you buy or sell shares between Portfolios, you will receive
a confirmation in the mail shortly thereafter. It summarizes all the key
information; what you bought or sold, the amount of the transaction, and other
vital data.

Certain purchases and sales are only included on your quarterly statement. These
include accounts
o when the only activity during the quarter:
o is purchase of shares from reinvested dividends and/or capital
gains; and
o sales under a periodic withdrawal plan; and

Signature Guarantees
Certain transactions require that your signature be guaranteed. If required, the
signature(s) must be guaranteed by a commercial bank, trust company, credit
union, savings and loan, national securities exchange member or brokerage firm.
A signature guaranteed by a notary public or savings bank is not acceptable.
Signature guarantees are required:
o if you sell more than $100,000;
o if a sales proceeds check is payable to other than the account
shareholder(s), Principal Life Insurance Company or one of its
affiliates;
o to change ownership of an account;
o to add telephone transaction services to an existing account;
o to change bank account information designated under an existing
telephone withdrawal plan;
o to have a sales proceeds check mailed to an address other than the
address on the account or to the address on the account if it has been
changed within the preceding month; and
o to add wire privileges to an existing account.

Special Plans
The Fund reserves the right to amend or terminate the special plans described in
this prospectus. Such plans include periodic withdrawal for certain purchasers.
You would be notified of any such action to the extent required by law.

Telephone Orders
The Fund reserves the right to refuse telephone orders to sell shares. You are
liable for a loss resulting from a fraudulent telephone order that we reasonably
believe is genuine. We will use reasonable procedures to assure instructions are
genuine. If the procedures are not followed, we may be liable for loss due to
unauthorized or fraudulent transactions. The procedures include: recording all
telephone instructions, requesting personal identification information (name,
phone number, social security number, birth date, etc.) and sending written
confirmation to the shareholder's address of record.

Year 2000 Problem
The business operations of the Fund depends on computer systems that contain
date fields. These systems include securities transfer agent operations and
securities pricing systems. Many of these systems were constructed using a two
digit date field to represent the date. Unless these systems are changed or
modified, they may not be able to distinguish the Year 1900 from the Year 2000
(commonly referred to as the Year 2000 Problem).

When the Year 2000 arrives, the Fund's operations could be adversely affected if
the computer systems used by the Manager, the service providers and other third
parties it does business with are not Year 2000 compliant. For example, the
Fund's portfolios and operational areas could be impacted, included securities
pricing, dividend and interest payments, shareholder account servicing and
reporting functions. In addition, a Portfolio could experience difficulties in
transactions if foreign broker-dealers or foreign markets are not Year 2000
compliant.

The Manager relies on public filings and other statements made by companies
about their Year 2000 readiness. Issuers in countries outside of the U.S.,
particularly in emerging countries, may not be required to make the same
disclosures about their readiness as are required in the U.S. It is likely that
if a company a Portfolio invests in is adversely affected by Year 2000 problems,
the price of its securities will also be negatively impacted. A decrease in
value of one or more of a Portfolio's securities will decrease that Portfolio's
share price.

In addition, the Manager and affiliated service providers are working to
identify their Year 2000 problems and taking steps they reasonably believe will
address these issues. This process began in 1996 with the identification of
product vendors and service providers as well as the internal systems that might
be impacted.

At this time, testing of internal systems has been completed. The Manager is now
participating in a corporate-wide initiative lead by senior management
representatives of Principal Life. Currently they are engaged in regression
testing of internal programs. They are also participating in development of
contingency plans in the event that Year 2000 problems develop and/or persist on
or after January 1, 2000. This plan is scheduled to be completed in March 1999.
The contingency plan calls for:
o identification of business risks;
o consideration of alternative approaches to critical business risks; and
o development of action plans to address problems.

Other important Year 2000 initiatives include:
o the service provider for our transfer agent system has renovated its
code. Client testing will occur in the first and second quarters of
1999. The service provider is also participating in a securities
industry wide testing program that is scheduled to be completed by the
end of April 1999;
o the securities pricing system we use has renovated its code and
conducted client testing in June 1998;
o Facilities Management of Principal Life has identified non-systems
issues (heat, lights, water, phone, etc.) and is working with these
service providers to ensure continuity of service; and
o the Manager and other areas of Principal Life have contacted all
vendors with which we do business to receive assurances that they are
able to deal with any Year 2000 problems. We continue to work with the
vendors to identify any areas of risk.

In its budget for 1999 and 2000, the Manager has estimated expenses of between
$100,000 and $500,000 to deal with Year 2000 issues.

Financial Statements
You will receive an annual financial statement for the Fund, examined by the
Fund's independent auditors, Ernst & Young LLP. That report is a part of this
prospectus. You will also receive a semiannual financial statement which is
unaudited. The following financial highlights are based on financial statements
which were audited by Ernst & Young LLP.

FINANCIAL HIGHLIGHTS

Selected data for a share of Capital Stock outstanding throughout each year
ended December 31 (except as noted):

INTERNATIONAL EMERGING
MARKETS PORTFOLIO 1998 1997(a)

Net Asset Value, Beginning of Period................... $10.14 $9.94
Income from Investment Operations:
Net Investment Income............................... .17 .01
Net Realized and Unrealized Gain (Loss) on Investments (1.91) .21

Total from Investment Operations (1.74) .22

Less Dividends and Distributions:
Dividends from Net Investment Income................ (.17) (.02)
Distributions from Capital Gains.................... (.02) --

Total Dividends and Distributions (.19) (.02)

Net Asset Value, End of Period......................... $8.21 $10.14

Total Return........................................... (17.21)% 1.40%(b)

Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $79,481 $32,488
Ratio of Expenses to Average Net Assets............. 1.15% 1.15%(c)
Ratio of Net Investment Income to Average Net Assets 2.11% .91%(c)

Portfolio Turnover Rate............................. 36.5% 12.3%(c)

<TABLE>
<CAPTION>
INTERNATIONAL SECURITIES PORTFOLIO 1998 1997 1996 1995 1994

<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period $14.45 $13.67 $11.70 $11.29 $12.87
Income from Investment Operations:
Net Investment Income............................... .24 .24 .31 .19 .13
Net Realized and Unrealized Gain (Loss) on Investments 1.12 1.46 2.46 1.11 (.95)

Total from Investment Operations 1.36 1.70 2.77 1.30 (.82)
Less Dividends and Distributions:

Dividends from Net Investment Income................ (.23) (.24) (.16) (.10) (.12)

Excess Distributions from Net Investment Income........ -- -- (.07) (.07) (.13)
Distributions from Capital Gains....................... (.68) (.68) (.57) (.72) (.51)

Total Dividends and Distributions (.91) (.92) (.80) (.89) (.76)

Net Asset Value, End of Period......................... $14.90 $14.45 $13.67 $11.70 $11.29

Total Return........................................... 9.55% 12.55% 24.12% 12.02% (6.45%)

Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $47,912 $37,684 $28,161 $17,251 $15,542
Ratio of Expenses to Average Net Assets................ .90% .90% .90% .90% .90%
Ratio of Net Investment Income to Average Net Assets... 1.60% 1.73% 1.90% 1.79% .94%
Portfolio Turnover Rate................................ 36.7% 30.8% 25.5% 46.0% 37.0%
</TABLE>

INTERNATIONAL SMALLCAP PORTFOLIO 1998 1997(a)

Net Asset Value, Beginning of Period................... $9.97 $9.86
Income from Investment Operations:
Net Investment Income............................... .07 .01
Net Realized and Unrealized Gain (Loss) on Investments 1.11 .12

Total from Investment Operations 1.18 .13

Less Dividends and Distributions:
Dividends from Net Investment Income................ (.07) (.02)
Distributions from Capital Gains.................... (.02) --

Total Dividends and Distributions (.09) (.02)

Net Asset Value, End of Period......................... $11.06 $9.97

Total Return........................................... 11.92% 1.59%(b)

Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $83,330 $31,968
Ratio of Expenses to Average Net Assets............. 1.00% 1.00%(c)
Ratio of Net Investment Income to Average Net Assets .78% .91%(c)
Portfolio Turnover Rate............................. 88.5% 30.3%(c)

<TABLE>
<CAPTION>
MORTGAGE-BACKED SECURITIES PORTFOLIO 1998 1997 1996 1995 1994

<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period $10.27 $9.93 $10.17 $9.11 $10.10
Income from Investment Operations:
Net Investment Income............................... .65 .64 .64 .65 .63
Net Realized and Unrealized Gain (Loss) on Investments. .12 .34 (.24) 1.06 (.99)

Total from Investment Operations .77 .98 .40 1.71 (.36)

Less Dividends from Net Investment Income (.65) (.64) (.64) (.65) (.63)

Net Asset Value, End of Period......................... $10.39 $10.27 $9.93 $10.17 $9.11

Total Return........................................... 7.74% 10.18% 4.20% 19.26% (3.60)%

Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $14,861 $13,796 $14,968 $14,253 $14,714
Ratio of Expenses to Average Net Assets................ .45% .45% .45% .45% .45%
Ratio of Net Investment Income to Average Net Assets... 6.28% 6.37% 6.51% 6.66% 6.56%
Portfolio Turnover Rate................................ 13.8% 15.5% 28.7% 41.8% 41.8%
</TABLE>

Notes to Financial Highlights

(a) Period from November 26, 1997, date shares first offered to the public,
through December 31, 1997. Net investment income, aggregating $.02 per
share for the International Emerging Markets Portfolio and $.01 per share
for the International SmallCap Portfolio for the period from the initial
purchase of shares on November 17, 1997 through November 25, 1997, was
recognized, none of which was distributed to the sole shareholder,
Principal Life Insurance Company. Additionally, the portfolios incurred
unrealized losses on investments of $.08 per share and $.15 per share
respectively, during the interim period. This represents activities of each
portfolio prior to the initial offering.

(b) Total return amounts have not been annualized.

Additional information about the Fund is available in the Statement of
Additional Information dated ___________ and which is part of this prospectus.
Information about the Fund's investments is also available in the Fund's annual
and semi-annual reports to shareholders. In the Fund's annual report, you will
find a discussion of the market conditions and investment strategies that
significantly affected the Fund's performance during its last fiscal year. The
Statement of Additional Information and annual and semi-annual reports can be
obtained free of charge by writing or telephoning Princor Financial Services
Corporation, P.O. Box 10423, Des Moines, IA 50306. Telephone 1-800-451-5447.

Information about the Fund can be reviewed and copied at the Securities and
Exchange Commission's Public Reference Room in Washington, D.C. Information on
the operation of the public reference room may be obtained by calling the
Commission at 800-SEC-0330. Reports and other information about the Fund are
available on the Commission's internet site at http://www.sec.gov. Copies of
this information may be obtained, upon payment of a duplicating fee, by writing
the Public Reference Section of the Commission, Washington, D.C. 20549-6009.

The U.S. Government does not insure or guarantee an investment in the Fund.

Shares of the Fund are not deposits or obligations of, or guaranteed or endorsed
by, any financial institution, nor are shares of the Fund federally insured by
the Federal Deposit Insurance Corporation, the Federal Reserve Board, or any
other agency.

Principal Special Markets Fund, Inc. SEC File 811-07572

PART B

PRINCIPAL SPECIAL MARKETS FUND, INC.
INTERNATIONAL EMERGING MARKETS PORTFOLIO
INTERNATIONAL SECURITIES PORTFOLIO
INTERNATIONAL SMALLCAP PORTFOLIO
MORTGAGE-BACKED SECURITIES PORTFOLIO

Statement of Additional Information

dated ________________

This Statement of Additional Information provides information about
each Portfolio in addition to the information that is contained in the
Prospectus, dated _________________.

This Statement of Additional Information is not a prospectus. It should
be read in conjunction with the Prospectus, a copy of which can be obtained free
of charge by writing or telephoning:

Princor Financial Services Corporation
P.O. Box 10423
Des Moines, Iowa 50306-0423
Telephone: 1-800-451-5447

FV 76 B-8

TABLE OF CONTENTS

Investment Policies and Restrictions ........................................ 2
Investments ................................................................. 4
Directors and Officers of the Fund........................................... 14
Manager and Sub-Advisor ..................................................... 16
Cost of Manager's Services .................................................. 17
Brokerage on Purchases and Sales of Securities .............................. 20
Offering Price .............................................................. 23
Determination of Net Asset Value ............................................ 23
Performance Calculation ..................................................... 24
Tax Treatment, Dividends and Distributions .................................. 26
Financial Statements......................................................... 27

INVESTMENT POLICIES AND RESTRICTIONS

The following information supplements the information provided in the
Prospectus under the caption "Certain Investment Strategies and Related Risks."

INVESTMENT RESTRICTIONS

In implementing the investment policies of the Portfolios, the Fund is
subject to fundamental and nonfundamental restrictions. Nonfundamental
restrictions may be changed by the Board of Directors without shareholder
approval. Fundamental restrictions may only be changed by a vote of the lesser
of (i) 67% or more 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. The required shareholder approval shall be effective with
respect to a Portfolio if a majority of the outstanding voting securities of
that Portfolio votes to approve the matter, notwithstanding that the matter has
not been approved by a majority of the outstanding voting securities of the Fund
or of any other Portfolio affected by the matter.

The investment objective and investment policies and restrictions of
each Portfolio discussed in the Prospectus and the Statement of Additional
Information, except for those investment restrictions identified below under the
caption "Fundamental Restrictions," are not fundamental and may be changed by
the Fund's Board of Directors without shareholder approval. Shareholders must be
given 30 days prior written notice before the investment objectives of the
Portfolios may be amended at the discretion of the Board of Directors.

All percentage limitations apply at the time of acquisition of a
security, and any subsequent change in any applicable percentage resulting from
changes in the values or nature of a Portfolio's assets will not require
elimination of the security from the Portfolio.

Fundamental Restrictions. Each of the following restrictions is
fundamental and may not be changed without shareholder approval. Each Portfolio
will not (unless specifically excepted):

(1) With respect to 75% of its total assets, purchase the securities
of any issuer if the purchase would cause more than 5% of the
total assets of the Portfolio to be invested in the securities of
any one issuer (other than securities issued or guaranteed by the
United States Government or its agencies or instrumentalities) or
cause more than 10% of the outstanding voting securities of any
one issuer to be held by the Portfolio.

(2) Borrow money, except (a) for temporary or emergency purposes in
an amount not to exceed 5% of the value of the Portfolio's total
assets at the time of the borrowing and (b) for any purpose from
banks in an amount not to exceed one-third of the Portfolio's
total assets (including the amount borrowed) less all liabilities
and indebtedness other than borrowings deemed to be senior
securities.

(3) Issue any senior securities as defined in the Investment Company
Act of 1940. For purposes of this restriction, purchasing and
selling securities, currency and futures contracts and options
and borrowing money in accordance with restrictions described
herein do not involve the issuance of a senior security.

(4) Act as an underwriter of securities, except to the extent the
Portfolio may be deemed to be an underwriter in connection with
the sale of securities held in its portfolio.

(5) Concentrate its investments in any particular industry or
industries, except that the Portfolio may invest not more than
25% of the value of its total assets in a single industry. For
purposes of this restriction, foreign government and
supranational issuers are not considered members of any industry.

(6) Invest in real estate, although it may invest in securities which
are secured by real estate and securities of issuers which invest
or deal in real estate.

(7) Invest in commodities or commodity contracts, but it may purchase
and sell currency and financial futures contracts and options on
such contracts.

(8) Make loans, except that the Portfolio may (i) purchase and hold
debt obligations in accordance with its investment objective and
policies, (ii) enter into repurchase agreements, and (iii) lend
its portfolio securities but not in excess of 33% of the value of
its total assets. The deposit of underlying securities and other
assets in escrow and other collateral arrangements in connection
with options, currency and futures transactions are not deemed to
be the making of loans.

Nonfundamental Restrictions. Each of the following restrictions is
nonfundamental and may be changed by the Board of Directors without shareholder
approval. Each Portfolio will not (unless specifically excepted):

(1) Invest more than 15% of its total assets in securities not
readily marketable and in repurchase agreements maturing in more
than seven days. The value of any options purchased in the
over-the-counter market are included as part of this 15%
limitation.

(2) Sell securities short (except where the Portfolio holds or has
the right to obtain at no added cost a long position in the
securities sold that equals or exceeds the securities sold short)
or purchase any securities on margin, except it may obtain such
short-term credits as are necessary for the clearance of
transactions. The deposit or payment of margin in connection with
options, currency and futures transactions is not considered the
purchase of securities on margin.

(3) Invest in companies for the purpose of exercising control or
management.

(4) Purchase puts, calls, straddles, spreads or any combination
thereof if by reason thereof the value of its aggregate
investment in such classes of securities will exceed 5% of its
total assets. Options will be used solely for hedging purposes;
not for speculation.

(5) Invest more than 5% of its assets in initial margin and premiums
on futures contracts and options on such contracts.

(6) Purchase securities of other investment companies if the purchase
would cause more than 10% of its total assets to be invested in
securities of other investment companies or more than 5% of its
total assets to be invested in the securities of any investment
company or would cause the Portfolio to own more than 3% of the
outstanding voting securities of any investment company. These
restrictions do not apply to purchases in connection with a
merger, consolidation, or plan of reorganization. [For purposes
of these restrictions, privately issued collateralized mortgage
obligations will not be treated as investment company securities
if issued by "Exemptive Issuers." Exemptive Issuers are defined
as unmanaged, fixed-asset issuers that (i) invest primarily in
mortgage-backed securities, (ii) do not issue redeemable
securities as defined in section 2(a)(32) of the Investment
Company Act of 1940, (iii) operate under general exemptive orders
exempting them from "all provisions of the Investment Company Act
of 1940," and (iv) are not registered or regulated under the
Investment Company Act of 1940 as investment companies.]

(7) Pledge, mortgage or hypothecate its assets, except to secure
permitted borrowings. The deposit of underlying securities and
other assets in escrow and other collateral arrangements in
connection with options, currency and futures transactions are
not deemed to be pledges or other encumbrances.

(8) Purchase warrants in excess of 5% of its total assets, of which
2% may be invested in warrants that are not listed on the New
York, American or Toronto Stock Exchanges or the Chicago Board
Options Exchange. This restriction does not apply to warrants
included in units or attached to other securities.

(9) Invest in interests in oil, gas or other mineral exploration or
development programs, although the Portfolio may invest in
securities of issuers which invest in or sponsor such programs.

(10) Purchase securities of any issuer having less than three years'
continuous operation (including operations of any predecessors)
if such purchase would cause the value of the Portfolio's
investments in all such issuers to exceed 5% of the value of its
total assets.

(11) Purchase or retain in its portfolio securities of any issuer if
those officers or directors of the Fund or its Manager owning
beneficially more than one-half of 1% (0.5%) of the securities of
the issuer together own beneficially more than 5% of such
securities.

(12) Invest in arbitrage transactions.

(13) Invest in mineral leases.

(14) Invest in real estate limited partnership interests.

(15) Invest more than 25% of the value of its total assets (i) in the
securities issued by a single foreign government; or (ii) in
securities issued by supranational issuers.

The Manager will waive its management fee on Portfolio assets invested
in securities of other open-end investment companies and will generally invest
only in those open-end investment companies that have investment policies
requiring investment in securities comparable to those in which the Portfolio
invests.

INVESTMENTS

The following information further supplements the discussion of the
investment objectives and policies in the Prospectus under the caption "Certain
Investment Strategies and Related Risks."

In making selections of equity securities, Invista will use an approach
described broadly as fundamental analysis. Fundamental analysis consists of
three steps. First is the continuing study of basic economic factors in an
effort to conclude what the future general economic climate is likely to be over
the next one to two years. Second, given some conviction as to the likely
economic climate, Invista attempts to identify the prospects for the major
industrial, commercial and financial segments of the economy, by looking at such
factors as demand for products, capacity to produce, operating costs, pricing
structure, marketing techniques, adequacy of raw materials and components,
domestic and foreign competition, and research productivity, to ascertain
prospects for each industry for the near and intermediate term. Finally, Invista
determines what the earnings prospects are for individual companies within each
industry by considering the same types of factors described above. Invista
evaluates these earnings prospects in relation to the current price of the
securities of each company.

Although each Portfolio may pursue the investment practices described
under the captions Restricted Securities, Foreign Securities, Spread
Transactions, Options on Securities and Securities Indices, and Futures
Contracts and Options on Futures Contracts, Currency Contracts, Repurchase
Agreements, Lending of Portfolio Securities and When-Issued and Delayed Delivery
Securities, none of the Portfolios currently intends to commit during the
present fiscal year more than 5% of its net assets to any of the practices, with
the exception that the Mortgage-Backed Securities Portfolio may commit more than
5% of its net assets in When-Issued and Delayed Delivery Securities. The
International Emerging Markets Portfolio, International Securities Portfolio and
International SmallCap Portfolio will each invest more than 5% of its net assets
in foreign securities. Each Portfolio may commit more than 5% of its assets to
Currency Contracts.

Restricted Securities

Each Portfolio is subject to an investment restriction that limits its
investments in illiquid securities to 15% of its net asset value. In computing
the Portfolio's net asset value per share, illiquid securities are valued at
their fair value as determined in good faith by or under the direction of the
Board of Directors.

Each Portfolio may acquire securities that are subject to legal or
contractual restrictions upon resale. Securities subject to such restrictions
("restricted securities") are frequently treated as illiquid for purposes of the
15% restriction. Such securities may be sold only in a public offering with
respect to which a registration statement is in effect under the Securities Act
of 1933 ("1933 Act") or in a transaction which is exempt from the registration
requirements of that act. One such exemption is provided by Rule 144A under the
1933 Act, pursuant to which certain restricted securities may be sold at a
readily ascertainable price. The Board of Directors has adopted procedures to
determine the liquidity of restricted securities qualifying for Rule 144A
treatment, and any such securities so determined to be liquid will be excluded
when applying the Portfolio's limitation on illiquid securities. To the extent
Rule 144A securities held by a Portfolio should become illiquid because of a
lack of interest on the part of qualified institutional investors, the overall
liquidity of the Portfolio could be adversely affected.

When registration of a restricted security is required, a Portfolio may
be obligated to pay all or a part of the registration expenses and a
considerable period may elapse between the time of the decision to sell and the
time the Portfolio may be permitted to sell the security under an effective
registration statement. If during such a period adverse market conditions were
to develop, the Portfolio might obtain a less favorable price than prevailed
when it decided to sell.

Foreign Securities

Investment in foreign securities presents certain risks, including those
resulting from fluctuations in currency exchange rates, revaluation of
currencies, the imposition of foreign taxes, the withholding of taxes on
dividends at the source, future political and economic developments including
war, expropriations, nationalization, the possible imposition of currency
exchange controls and other foreign governmental laws or restrictions, reduced
availability of public information concerning issuers, and the fact that foreign
issuers are not generally subject to uniform accounting, auditing and financial
reporting standards or to other regulatory practices and requirements comparable
to those applicable to domestic issuers. Moreover, securities of many foreign
issuers may be less liquid and their prices more volatile than those of
comparable domestic issuers. In addition, transactions in foreign securities may
be subject to higher costs, and the time for settlement of transactions in
foreign securities may be longer than the settlement period for domestic
issuers. A Portfolio's investment in foreign securities may also result in
higher custodial costs and the costs associated with currency conversions.

Securities of many foreign issuers may be less liquid and their prices
more volatile than those of comparable domestic issuers. In particular,
securities markets in emerging market countries are known to experience long
delays between the trade and settlement dates of securities purchased and sold,
potentially resulting in a lack of liquidity and greater volatility in the price
of securities on those markets. In addition, investments in smaller companies
may present greater opportunities for capital appreciation, but may also involve
greater risks than large, mature issuers. Such companies may have limited
product lines and financial resources. Their securities may trade in more
limited volume than larger companies and may therefore experience significantly
more price volatility and less liquidity than securities of larger companies. As
a result of these factors, the Boards of Directors of the Funds have adopted
Daily Pricing and Valuation Procedures for the Funds which set forth the steps
to be followed by the Manager and Sub-Advisor to establish a reliable market or
fair value if a reliable market value is not available through normal market
quotations. Oversight of this process is provided by the Executive Committee of
the Boards of Directors.

Spread Transactions, Options on Securities and Securities Indices, Futures
Contracts and Options on Futures Contracts, and Currency Contracts

Except as specifically indicated otherwise, each Portfolio may engage in
the practices described under this heading to attempt to hedge market value,
interest rate and currency risks and, in certain cases, to enhance its income.

Spread Transactions

A Portfolio may purchase from securities dealers covered spread options.
Such covered spread options are not presently exchange listed or traded. The
purchase of a spread option gives the Portfolio the right to put, or sell, a
security that it owns at a fixed dollar spread or fixed yield spread in
relationship to another security that the Portfolio does not own, but which is
used as a benchmark. The risk to the Portfolio in purchasing covered spread
options is the cost of the premium paid for the spread option and any
transaction costs. In addition, there is no assurance that closing transactions
will be available. The purchase of spread options can be used to protect the
Portfolio against adverse changes in prevailing credit quality spreads, i.e.,
the yield spread between high quality and lower quality securities. The security
covering the spread option will be maintained in a segregated account by the
Portfolio's custodian. A security covered by a spread option is not considered
to be "pledged" as that term is used in the Portfolio's policy limiting the
pledging or mortgaging of assets.

Options on Securities and Securities Indices

Each Portfolio may write (sell) and purchase call and put options on
securities in which it may invest and on securities indices based on securities
in which the Portfolio may invest. The Portfolio may write calland put options
to generate additional revenue, and may write and purchase call and put options
in seeking to hedge against a decline in the value of securities owned or an
increase in the price of securities which the Portfolio plans to purchase.

Writing Covered Call and Put Options. When a Portfolio writes a call
option, it gives the purchaser of the option, in return for the premium it
receives, the right to buy from the Portfolio the underlying security at a
specified price at any time before the option expires. When a Portfolio writes a
put option, it gives the purchaser of the option, in return for the premium it
receives, the right to sell to the Portfolio the underlying security at a
specified price at any time before the option expires.

The premium received by a Portfolio, when it writes a put or call
option, reflects, among other factors, the current market price of the
underlying security, the relationship of the exercise price to the market price,
the time period until the expiration of the option and interest rates. The
premium will generate additional income for the Portfolio if the option expires
unexercised or is closed out at a profit. By writing a call, a Portfolio limits
its opportunity to profit from any increase in the market value of the
underlying security above the exercise price of the option, but it retains the
risk of loss if the price of the security should decline. By writing a put, a
Portfolio assumes the risk that it may have to purchase the underlying security
at a price that may be higher than its market value at time of exercise.

The Portfolios write only covered options and will comply with
applicable regulatory and exchange cover requirements. A Portfolio will own the
underlying security covered by any outstanding call option that it has written
or will be able to acquire such security through the exercise of conversion
privileges on convertible securities or otherwise at no additional cost. With
respect to an outstanding put option that it has written, each Portfolio will
deposit and maintain with its custodian cash, U.S. Government securities or
other liquid securities with a value at least equal to the exercise price of the
option.

Once a Portfolio has written an option, it may terminate its obligation,
before the option is exercised, by effecting a closing transaction, which is
accomplished by the Portfolio's purchasing an option of the same series as the
option previously written. The Portfolio will have a gain or loss depending on
whether the premium received when the option was written exceeds the closing
purchase price plus related transaction costs.

Purchasing Call and Put Options. When a Portfolio purchases a call
option, it receives, in return for the premium it pays, the right to buy from
the writer of the option the underlying security at a specified price at any
time before the option expires. The Portfolio may purchase call options in
anticipation of an increase in the market value of securities that it intends
ultimately to buy. During the life of the call option, the Portfolio would be
able to buy the underlying security at the exercise price regardless of any
increase in the market price of the underlying security. In order for a call
option to result in a gain, the market price of the underlying security must
rise to a level that exceeds the sum of the exercise price, the premium paid and
transaction costs. If the option expires unexercised, the Portfolio will lose
the premium paid and any transaction costs incurred.

When a Portfolio purchases a put option, it receives, in return for the
premium it pays, the right to sell to the writer of the option the underlying
security at a specified price at any time before the option expires. The
Portfolio may purchase put options in anticipation of a decline in the market
value of the underlying security. During the life of the put option, the
Portfolio would be able to sell the underlying security at the exercise price
regardless of any decline in the market price of the underlying security. In
order for a put option to result in a gain, the market price of the underlying
security must decline, during the option period, below the exercise price
sufficiently to cover the premium and transaction costs.

Once a Portfolio has purchased an option, it may close out its position
by selling an option of the same series as the option previously purchased. The
Portfolio will have a gain or loss depending on whether the closing sale price
exceeds the initial purchase price plus related transaction costs.

Options on Securities Indices. Each Portfolio may purchase and sell put
and call options on any securities index based on securities in which the
Portfolio may invest. Securities index options are designed to reflect price
fluctuations in a group of securities or segment of the securities market rather
than price fluctuations in a single security. Options on securities indices are
similar to options on securities, except that the exercise of securities index
options requires cash payments and does not involve the actual purchase or sale
of securities. A Portfolio would engage in transactions in put and call options
on securities indices for the same purposes as it would engage in transactions
in options on securities. When a Portfolio writes call options on securities
indices, it will hold in its portfolio underlying securities which, in the
judgment of Invista, correlate closely with the securities index and which have
a value at least equal to the aggregate amount of the securities index options.

Risks Associated with Options Transactions. An options position may be
closed out only on an exchange which provides a secondary market for an option
of the same series. Although a Portfolio will generally purchase or write only
those options for which there appears to be an active secondary market, there is
no assurance that a liquid secondary market on an exchange will exist for any
particular option, or at any particular time. For some options, no secondary
market on an exchange or elsewhere may exist. If a Portfolio is unable to effect
closing sale transactions in options it has purchased, the Portfolio would have
to exercise its options in order to realize any profit and may incur transaction
costs upon the purchase or sale of underlying securities pursuant thereto. If a
Portfolio is unable to effect a closing purchase transaction for a covered
option that it has written, it will not be able to sell the underlying
securities, or dispose of the assets held in a segregated account, until the
option expires or is exercised. A Portfolio's ability to terminate option
positions established in the over-the-counter market may be more limited than
for exchange-traded options and may also involve the risk that broker-dealers
participating in such transactions might fail to meet their obligations.

A Portfolio's hedging strategy that employs options on a securities
index may be unsuccessful due to imperfect correlation between the securities in
the index and the securities owned by the Portfolio. In addition, if Invista is
incorrect in predicting the direction of stock prices, interest rates and other
economic factors, hedging through the use of options could result in a lower
return than if the Portfolio had not hedged its investments.

Futures Contracts and Options on Futures

Each Portfolio may purchase and sell financial futures contracts and
options on those contracts. Financial futures contracts are commodities
contracts based on financial instruments such as U.S. Treasury bonds or bills or
on securities indices such as the S&P 500 Index. Futures contracts, options on
futures contracts and the commodity exchanges on which they are traded are
regulated by the Commodity Futures Trading Commission ("CFTC"). Through the
purchase and sale of futures contracts and related options, a Portfolio may seek
to hedge against a decline in securities owned by the Portfolio or an increase
in the price of securities which the Portfolio plans to purchase.

Futures Contracts. When a Portfolio sells a futures contract based on a
financial instrument, the Portfolio becomes obligated to deliver that kind of
instrument at a specified future time for a specified price. When a Portfolio
purchases the futures contract, it becomes obligated to take delivery of the
instrument at a specified time and to pay the specified price. In most
instances, these contracts are closed out by entering into an offsetting
transaction before the settlement date, thereby canceling the obligation to make
or take delivery of specific securities. The Portfolio realizes a gain or loss
depending on whether the price of an offsetting purchase plus transaction costs
are less or more than the price of the initial sale or on whether the price of
an offsetting sale is more or less than the price of the initial purchase plus
transaction costs. Although a Portfolio will usually liquidate futures contracts
on financial instruments in this manner, it may instead make or take delivery of
the underlying securities whenever it appears economically advantageous to do
so.

A futures contract based on a securities index provides for the purchase
or sale of a group of securities at a specified future time for a specified
price. These contracts do not require actual delivery of securities, but result
in a cash settlement based upon the difference in value of the index between the
time the contract was entered into and the time it is liquidated, which may be
at its expiration or earlier if it is closed out by entering into an offsetting
transaction.

When a futures contract is purchased or sold a brokerage commission is
paid, but unlike the purchase or sale of a security or option, no price or
premium is paid or received. Instead, an amount of cash or U.S. Government
securities, which varies, but is generally about 5% of the contract amount, is
deposited by the Portfolio with its custodian for the benefit of the futures
commission merchant through which the Portfolio engages in the transaction. This
amount is known as "initial margin." It does not involve the borrowing of funds
by the Portfolio to finance the transaction, but instead represents a "good
faith" deposit assuring the performance of both the purchaser and the seller
under the futures contract. It is returned to the Portfolio upon termination of
the futures contract, if all the Portfolio's contractual obligations have been
satisfied.
Subsequent payments to and from the broker, known as "variation margin,"
are required to be made on a daily basis as the price of the futures contract
fluctuates, making the long or short positions in the futures contract more or
less valuable, a process known as "marking to market." If the position is closed
out by taking an opposite position prior to the settlement date of the futures
contract, a final determination of variation margin is made, additional cash is
required to be paid to or released by the broker, and the Portfolio realizes a
loss or gain.

In using futures contracts, a Portfolio will seek to establish more
certainly than would otherwise be possible the effective price of or rate of
return on portfolio securities or securities that the Portfolio proposes to
acquire. A Portfolio, for example, may sell futures contracts in anticipation of
a rise in interest rates which would cause a decline in the value of its debt
investments. When this kind of hedging is successful, the futures contracts
should increase in value when the Portfolio's debt securities decline in value
and thereby keep the Portfolio's net asset value from declining as much as it
otherwise would. A Portfolio may also sell futures contracts on securities
indices in anticipation of or during a stock market decline in an endeavor to
offset a decrease in the market value of its equity investments. When a
Portfolio is not fully invested and anticipates an increase in the cost of
securities it intends to purchase, it may purchase financial futures contracts.
When increases in the prices of equities are expected, a Portfolio may purchase
futures contracts on securities indices in order to gain rapid market exposure
that may partially or entirely offset increases in the cost of the equity
securities it intends to purchase.

Options on Futures. A Portfolio may also purchase and write call and put
options on futures contracts. A call option on a futures contract gives the
purchaser the right, in return for the premium paid, to purchase a futures
contract (assume a long position) at a specified exercise price at any time
before the option expires. A put option gives the purchaser the right, in return
for the premium paid, to sell a futures contract (assume a short position), for
a specified exercise price, at any time before the option expires.

Upon the exercise of a call, the writer of the option is obligated to
sell the futures contract (to deliver a long position to the option holder) at
the option exercise price, which will presumably be lower than the current
market price of the contract in the futures market. Upon exercise of a put, the
writer of the option is obligated to purchase the futures contract (deliver a
short position to the option holder) at the option exercise price, which will
presumably be higher than the current market price of the contract in the
futures market. However, as with the trading of futures, most options are closed
out prior to their expiration by the purchase or sale of an offsetting option at
a market price that will reflect an increase or a decrease from the premium
originally paid.

Options on futures can be used to hedge substantially the same risks as
might be addressed by the direct purchase or sale of the underlying futures
contracts. For example, if a Portfolio anticipated a rise in interest rates and
a decline in the market value of the debt securities in its portfolio, it might
purchase put options or write call options on futures contracts instead of
selling futures contracts.

If a Portfolio purchases an option on a futures contract, it may obtain
benefits similar to those that would result if it held the futures position
itself. But in contrast to a futures transaction, the purchase of an option
involves the payment of a premium in addition to transaction costs. In the event
of an adverse market movement, however, the Portfolio will not be subject to a
risk of loss on the option transaction beyond the price of the premium it paid
plus its transaction costs.

When a Portfolio writes an option on a futures contract, the premium
paid by the purchaser is deposited with the Portfolio's custodian, and the
Portfolio must maintain with its custodian all or a portion of the initial
margin requirement on the underlying futures contract. The Portfolio assumes a
risk of adverse movement in the price of the underlying futures contract
comparable to that involved in holding a futures position. Subsequent payments
to and from the broker, similar to variation margin payments, are made as the
premium and the initial margin requirement are marked to market daily. The
premium may partially offset an unfavorable change in the value of portfolio
securities, if the option is not exercised, or it may reduce the amount of any
loss incurred by the Portfolio if the option is exercised.

Risks Associated with Futures Transactions. There are a number of risks
associated with transactions in futures contracts and related options. A
Portfolio's successful use of futures contracts is subject to Invista's ability
to predict correctly the factors affecting the market values of the Portfolio's
portfolio securities. For example, if a Portfolio was hedged against the
possibility of an increase in interest rates which would adversely affect debt
securities held by the Portfolio and the prices of those debt securities instead
increased, the Portfolio would lose part or all of the benefit of the increased
value of its securities which it hedged because it would have offsetting losses
in its futures positions. Other risks include imperfect correlation between
price movements in the financial instrument or securities index underlying the
futures contract, on the one hand, and the price movements of either the futures
contract itself or the securities held by the Portfolio, on the other hand. If
the prices do not move in the same direction or to the same extent, the
transaction may result in trading losses.

Prior to exercise or expiration, a position in futures may be terminated
only by entering into a closing purchase or sale transaction. This requires a
secondary market on the relevant contract market. The Portfolio will enter into
a futures contract or related option only if there appears to be a liquid
secondary market. There can be no assurance, however, that such a liquid
secondary market will exist for any particular futures contract or related
option at any specific time. Thus, it may not be possible to close out a futures
position once it has been established. Under such circumstances, the Portfolio
would continue to be required to make daily cash payments of variation margin in
the event of adverse price movements. In such situations, if the Portfolio 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.
In addition, the Portfolio may be required to perform under the terms of the
futures contracts it holds. The inability to close out futures positions also
could have an adverse impact on a Portfolio's ability effectively to hedge its
portfolio.

Most United States futures exchanges limit the amount of fluctuation
permitted in futures contract prices during a single trading day. This daily
limit establishes the maximum amount that the price of a futures contract may
vary either up or down from the previous day's settlement price at the end of a
trading session. Once the daily limit has been reached in a particular type of
contract, no more trades may be made on that day at a price beyond that limit.
The daily limit governs only price movements during a particular trading day and
therefore does not limit potential losses because the limit may prevent the
liquidation of unfavorable positions. Futures contract prices have occasionally
moved to the daily limit for several consecutive trading days with little or no
trading, thereby preventing prompt liquidation of futures positions and
subjecting some futures traders to substantial losses.

Limitations on the Use of Futures and Options on Futures. The Fund
intends that each Portfolio will come within an exclusion from the definition of
"commodity pool operator" provided by CFTC regulations by complying with certain
limitations on the use of futures and related options prescribed by those
regulations.

No Portfolio will purchase or sell futures contracts or options thereon
if immediately thereafter the aggregate initial margin and premiums exceed 5% of
the fair market value of the Portfolio's assets, after taking into account
unrealized profits and unrealized losses on any such contracts it has entered
into (except that in the case of an option that is in-the-money at the time of
purchase, the in-the-money amount generally may be excluded in computing the
5%).

The Portfolios will enter into futures contracts and related options
transactions only for bona fide hedging purposes as permitted by the CFTC and
for other appropriate risk management purposes, if any, which the CFTC may deem
appropriate for mutual funds excluded from the regulations governing commodity
pool operators. A Portfolio is not permitted to engage in speculative futures
trading. Invista will determine that the price fluctuations in the futures
contracts and options on futures used for hedging or risk management purposes
for a Portfolio are substantially related to price fluctuations in securities
held by the Portfolio or which it expects to purchase. In pursuing traditional
hedging activities, each Portfolio will sell futures contracts or acquire puts
to protect against a decline in the price of securities that the Portfolio owns,
and each Portfolio will purchase futures contracts or calls on futures contracts
to protect the Portfolio against an increase in the price of securities the
Portfolio intends to purchase before it is in a position to do so.

When a Portfolio purchases a futures contract, or purchases a call
option on a futures contract, it will comply with applicable cover requirements,
such as maintaining an amount of cash, cash equivalents or short-term high grade
fixed income securities in a segregated account with the Portfolio's custodian,
so that the amount so segregated plus the amount of initial margin held for the
account of its broker equals the market value of the futures contract.

A Portfolio will not maintain open short positions in futures contracts,
call options written on futures contracts, and call options written on
securities indices if, in the aggregate, the value of the open positions (marked
to market) exceeds the current market value of that portion of its securities
portfolio being hedged by those futures and options plus or minus the unrealized
gain or loss on those open positions, adjusted for the historical volatility
relationship between that portion of the portfolio and the contracts (i.e., the
Beta volatility factor). To the extent a Portfolio has written call options on
specific securities in that portion of its portfolio, the value of those
securities will be deducted from the current market value of that portion of the
securities portfolio. If this limitation should be exceeded at any time, the
Portfolio will take prompt action to close out the appropriate number of open
short positions to bring its open futures and options positions within this
limitation.

Currency Contracts

The International Emerging Markets Portfolio, International Securities
Portfolio and International SmallCap Portfolio each may engage in currency
transactions with securities dealers, financial institutions or other parties
that are deemed credit worthy by Invista to hedge the value of portfolio
securities denominated in particular currencies against fluctuations in relative
value. Currency transactions include forward currency contracts, exchange-listed
currency futures contracts and options thereon and exchange-listed and
over-the-counter options on currencies. A forward currency contract involves a
privately negotiated obligation to purchase or sell (with delivery generally
required) a specific currency at a future date, which may be any fixed number of
days from the date of the contract agreed upon the parties, at a price set at
the time of the contract.

A Portfolio will engage in currency transactions only for hedging and
other non-speculative purposes, including transaction hedging and position
hedging. Transaction hedging is entering into a currency transaction with
respect to specific assets or liabilities of a Portfolio, which will generally
arise in connection with the purchase or sale of the Portfolio's portfolio
securities or the receipt of income from them. Position hedging is entering into
a currency transaction with respect to portfolio securities positions
denominated or generally quoted in that currency. A Portfolio will not enter
into a transaction to hedge currency exposure to an extent greater, after
netting all transactions intended wholly or partially to offset other
transactions, than the aggregate market value (at the time of entering into the
transaction) of the securities held by the Portfolio that are denominated or
generally quoted in or currently convertible into the currency, other than with
respect to proxy hedging as described below.

A Portfolio may cross-hedge currencies by entering into transactions to
purchase or sell one or more currencies that are expected to increase or decline
in value relative to other currencies to which the Portfolio has or in which the
Portfolio expects to have exposure. To reduce the effect of currency
fluctuations on the value of existing or anticipated holdings of its securities,
a Portfolio may also engage in proxy hedging. Proxy hedging is often used when
the currency to which a Portfolio's holding is exposed is difficult to hedge
generally or difficult to hedge against the dollar. Proxy hedging entails
entering into a forward contract to sell a currency, the changes in the value of
which are generally considered to be linked to a currency or currencies in which
some or all of a Portfolio's securities are or are expected to be denominated,
and to buy dollars. The amount of the contract would not exceed the market value
of the Portfolios's securities denominated in linked currencies.

Except when a Portfolio enters into a forward contract in connection
with the purchase or sale of a security denominated in a foreign currency or for
other non-speculative purposes, which requires no segregation, a currency
contract that obligates the Portfolio to buy or sell a foreign currency will
generally require the Portfolio to place any asset, including equity securities
and non-investment grade debt, in a segregated account, so long as the asset is
liquid and marked to the market daily. The amount so segregated shall be equal
to the amount of the Portfolio's obligation.

Currency hedging involves some of the same risks and considerations as
other transactions with similar instruments. Currency transactions can result in
losses to a Portfolio if the currency being hedged fluctuates in value to a
degree or in a direction that is not anticipated. Further, the risk exists that
the perceived linkage between various currencies may not be present or may not
be present during the particular time that a Portfolio is engaging in proxy
hedging. Currency transactions are also subject to risks different from those of
other portfolio transactions. Because currency control is of great importance to
the issuing governments and influences economic planning and policy, purchases
and sale of currency and related instruments can be adversely affected by
government exchange controls, limitations or restrictions on repatriation of
currency, and manipulations or exchange restrictions imposed by governments.
These forms of governmental actions can result in losses to a Portfolio if it is
unable to deliver or receive currency or monies in settlement of obligations and
could also cause hedges it has entered into to be rendered useless, resulting in
full currency exposure as well as incurring transaction costs. Currency exchange
rates may also fluctuate based on factors extrinsic to a country's economy.
Buyers and sellers of currency futures contracts are subject to the same risks
that apply to the use of futures contracts generally. Further, settlement of a
currency futures contract for the purchase of most currencies must occur at a
bank based in the issuing nation. Trading options on currency futures contracts
is relative new, and the ability to establish and close out positions on these
options is subject to the maintenance of a liquid market that may not always be
available.

Repurchase Agreements

Each Portfolio may invest in repurchase agreements. No Portfolio will
enter into repurchase agreements that do not mature within seven days if any
such investment, together with other illiquid securities held by the Portfolio,
would amount to more than 15% of its assets. Repurchase agreements will
typically involve the acquisition by the Portfolio of debt securities from a
selling financial institution such as a bank, savings and loan association or
broker-dealer. A repurchase agreement provides that the Portfolio will sell back
to the seller and that the seller will repurchase the underlying securities at a
specified price and at a fixed time in the future. Repurchase agreements may be
viewed as loans by a Portfolio collateralized by the underlying securities
("collateral"). This arrangement results in a fixed rate of return that is not
subject to market fluctuation during the Portfolio's holding period. Although
repurchase agreements involve certain risks not associated with direct
investments in debt securities, each Portfolio follows procedures established by
the Board of Directors which are designed to minimize such risks. These
procedures include entering into repurchase agreements only with large,
well-capitalized and well-established financial institutions, which have been
approved by the Board of Directors and which Invista believes present minimum
credit risks. In addition, the value of the collateral underlying the repurchase
agreement will always be at least equal to the repurchase price, including
accrued interest. In the event of a default or bankruptcy by a selling financial
institution, the affected Portfolio bears a risk of loss. In seeking to
liquidate the collateral, a Portfolio may be delayed in or prevented from
exercising its rights and may incur certain costs. Further to the extent that
proceeds from any sale upon a default of the obligation to repurchase were less
than the repurchase price, the Portfolio could suffer a loss.

Lending of Portfolio Securities

Each Portfolio may lend its portfolio securities. No Portfolio intends
to lend its portfolio securities if as a result the aggregate of such loans made
by the Portfolio would exceed 33% of its total assets. Portfolio securities may
be lent to unaffiliated broker-dealers and other unaffiliated qualified
financial institutions provided that such loans are callable at any time on not
more than five business days' notice and that cash or government securities
equal to at least 100% of the market value of the securities loaned, determined
daily, is deposited by the borrower with the Portfolio and is maintained each
business day in a segregated account. While such securities are on loan, the
borrower will pay the Portfolio any income accruing thereon, and the Portfolio
may invest any cash collateral, thereby earning additional income, or may
receive an agreed upon fee from the borrower. Borrowed securities must be
returned when the loan is terminated. Any gain or loss in the market price of
the borrowed securities which occurs during the term of the loan inures to the
Portfolio and its shareholders. A Portfolio may pay reasonable administrative,
custodial and other fees in connection with such loans and may pay a negotiated
portion of the interest earned on the cash or government securities pledged as
collateral to the borrower or placing broker. The Fund does not vote securities
that have been loaned, but it will call a loan of securities in anticipation of
an important vote.

When-Issued and Delayed Delivery Securities

Each of the Portfolios may from time to time purchase securities on a
when-issued basis and may purchase or sell securities on a delayed delivery
basis. The price of such a transaction is fixed at the time of the commitment,
but delivery and payment take place on a later settlement date, which may be a
month or more after the date of the commitment. No interest accrues to the
purchaser during this period, and the securities are subject to market
fluctuation, which involves the risk for the purchaser that yields available in
the market at the time of delivery may be higher than those obtained in the
transaction. Each Portfolio will only purchase securities on a when-issued or
delayed delivery basis for the purpose of acquiring the securities and not for
the purpose of investment leverage or to speculate on interest rate changes, but
a Portfolio may sell the securities before the settlement date, if such action
is deemed advisable. At the time a Portfolio makes the commitment to purchase
securities on a when-issued or delayed delivery basis, the Fund will record the
transaction and thereafter reflect the value, each day, of the securities in
determining the net asset value of the Portfolio. Each Portfolio will also
establish a segregated account with its custodian bank in which it will maintain
cash or cash equivalents, United States Government securities and other high
grade debt obligations equal in value to the Portfolio's commitments for such
when-issued or delayed delivery securities. The availability of liquid assets
for this purpose and the effect of asset segregation on a Portfolio's ability to
meet its current obligations, to honor requests for redemption and to have its
investment portfolio managed properly will limit the extent to which the
Portfolio may engage in forward commitment agreements. Except as may be imposed
by these factors, there is no limit on the percent of a Portfolio's total assets
that may be committed to transactions in such agreements.

Portfolio Turnover

Portfolio turnover will normally differ for each Portfolio, may vary
from year to year, as well as within a year, and may be affected by portfolio
sales necessary to meet cash requirements for redemptions of Portfolio shares.
The portfolio turnover rate for a Portfolio is calculated by dividing the lesser
of purchases or sales of its portfolio securities during the fiscal year by the
monthly average of the value of its portfolio securities (excluding from the
computation all securities, including options, with maturities at the time of
acquisition of one year or less). A high rate of portfolio turnover generally
involves correspondingly greater brokerage commission expenses, which must be
borne directly by the Portfolio.

The Mortgage-Backed Securities Portfolio intends to be active in the
forward commitment market when the return from holding forward positions appears
to be greater than the return from holding the actual securities. The Portfolio
will enter into forward commitment contracts to purchase securities for the
purpose of acquiring those securities and not for the purpose of investment
leverage or to speculate on interest rate changes, but as delivery dates
approach, a determination will be made whether to take delivery of a specific
forward position, or sell that position and purchase another forward position.
Because of this strategy, it is anticipated that its annual portfolio turnover
rate should generally exceed 100% and may be as much as 600% or more, although
this rate should not be construed as a limiting factor. The effect of a high
turnover rate would be to incur more transaction expenses than would be incurred
at a lower turnover rate, and there is no assurance that the additional
transactions that cause the higher turnover rate would result in gains for the
Portfolio or in sufficient gains to offset the increased transaction expenses.
The annualized portfolio turnover rates for each portfolio for its most recent
and immediately preceding fiscal year were as follows (annualized when reporting
period is less than one year): International Emerging Markets 36.5% and 12.3%
(for the period beginning November 26, 1997 and ending December 31, 1997);
International Securities 36.7% and 30.8%; International SmallCap Portfolio
88.5%% and 30.3% (for the period beginning November 26, 1997 and ending December
31, 1997); Mortgage-Backed Securities 13.8% and 15.5%.

DIRECTORS AND OFFICERS OF THE FUND

The following listing discloses the principal occupations and other
principal business affiliations of the Fund's Officers and Directors during the
past five years. All Directors and Officers listed here also hold similar
positions with each of the other mutual funds sponsored by Principal Life
Insurance Company. All mailing addresses are The Principal Financial Group, Des
Moines, Iowa 50392, unless otherwise indicated.

Michael W. Cumings, 47, Assistant Counsel. Counsel, Principal Life
Insurance Company.

@James D. Davis, 64, Director. 4940 Center Court, Bettendorf, Iowa.
Attorney. Vice President, Deere and Company, retired.

Pamela A. Ferguson, 55, Director, 4112 River Oaks Drive, Des Moines,
Iowa. Professor of Mathematics, Grinnell College since 1998. Prior thereto,
President, Grinnell College.

*&J. Barry Griswell, 49, Director and Chairman of the Board. President,
Principal Life Insurance Company, since 1998; Executive Vice President,
1996-1998, Senior Vice President, 1991-1996. Director and Chairman of the Board,
Principal Management Corporation and Princor Financial Services Corporation.

*&Stephan L. Jones, 63, Director and President. Vice President,
Principal Life Insurance Company. Director and President, Princor Financial
Services Corporation and Principal Management Corporation.

@&Barbara A. Lukavsky, 58, Director. 13731 Bay Hill Court, Clive, Iowa.
President and CEO, Barbican Enterprises, Inc. Since 1977. President and CEO, Lu
San ELITE USA, L.C., 1985-1998.

*Craig L. Bassett, 46, Treasurer. Treasurer, Principal Life Insurance
Company since 1996. Prior thereto, Associate Treasurer. Treasurer, Princor
Financial Services Corporation and Principal Management Corporation since 1996.

*Michael J. Beer, 38, Financial Officer. Executive Vice President and
Chief Operating Officer, Princor Financial Services Corporation and Principal
Management Corporation, since 1997. Prior thereto, Vice President and Chief
Operating Officer.

*Arthur S. Filean, 60, Vice President and Secretary. Vice President,
Princor Financial Services Corporation. Vice President, Principal Management
Corporation, since 1996.

*Ernest H. Gillum, 43, Assistant Secretary. Vice President-Compliance
and Product Development, Princor Financial Services Corporation and Principal
Management Corporation, since 1995. Prior thereto, Product Development and
Compliance Officer.

Jane E. Karli, 41, Assistant Treasurer. Assistant Treasurer, Principal
Life Insurance Company since 1998. Senior Accounting and Custody Administrator
1994-1998; Prior thereto, Senior Investment Cost Accountant 1993-1994.

*Michael D. Roughton, 47, Counsel. Counsel, Principal Life Insurance
Company, since 1994. Prior thereto Assistant Counsel. Counsel, Invista Capital
Management, Inc., Princor Financial Services Corporation, Principal Investors
Corporation and Principal Management Corporation.

@ Member of Audit and Nominating Committee.

* Affiliated with the Manager of the Fund or its parent and considered an
"Interested Persons," as defined in the Investment Company Act of 1940, as
amended.

& Member of the Executive Committee. The Executive Committee is elected by
the Board of Directors and may exercise all the powers of the Board of
Directors, with certain exceptions, when the Board is not in session and shall
report its actions to the Board.

COMPENSATION TABLE*
fiscal year ended December 31, 1998 Compensation
Director Compensation from the Fund from Fund Complex
-------- -------------------------- -----------------
<S> <C> <C> <C>
James D. Davis $ $
Pamela A. Ferguson
Barbara A. Lukavsky
<FN>
* The Fund does not provide retirement benefits for any of the the directors.
</FN>
</TABLE>

As of_______________________, Principal Life Insurance Company, a life
insurance company organized in 1879 under the laws of Iowa, its subsidiaries and
affiliates owned of record and beneficially the following number of shares or
percentage of the outstanding shares of each Portfolio:

- --------------------------------------------------------------------------------
% of Outstanding
Portfolio Shares
--------- ----------------
International Emerging Markets Portfolio %
International Securities Portfolio %
International SmallCap Portfolio %
Mortgage-Backed Securities Portfolio %

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

As of _________________, the Officers and Directors of the Fund as a
group owned less than 1% of the outstanding shares of any Portfolio of the Fund.
As of _______________, the following shareholders of the Fund owned 5% or
more of the outstanding shares of any Portfolio of the Fund:

- --------------------------------------------------------------------------------
Percentage
Name Address of Ownership
---- ------- ------------
International Emerging Markets Portfolio
%
International Securities Portfolio

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

MANAGER AND SUB-ADVISOR

The Manager of each Portfolio of the Fund is Principal Management
Corporation, a wholly-owned subsidiary of Princor Financial Services Corporation
which is a wholly-owned subsidiary of Principal Holding Company. Principal
Holding Company is a holding company which is a wholly-owned subsidiary of
Principal Life Insurance Company, a life insurance company organized in 1879
under the laws of the state of Iowa. The address of the Manager is The Principal
Financial Group, Des Moines, Iowa 50392-0200. The Manager was organized on
January 10, 1969 and since that time has managed various mutual funds sponsored
by Principal Life Insurance Company.

The Manager has executed an agreement with Invista Capital Management,
Inc. ("Invista") under which Invista has agreed to assume the obligations of the
Manager to provide investment advisory services for each Portfolio and to
reimburse the Manager for the other costs it incurs under the Management
Agreement. Invista, an indirectly wholly-owned subsidiary of Principal Life
Insurance Company and an affiliate of the Manager, was founded in 1985 and
manages investments for institutional investors, including Principal Life.
Assets under management at December 31, 1998 were approximately $31 billion.
Invista's address is 1800 Hub Tower, 699 Walnut, Des Moines, Iowa 50309.

Each of the persons affiliated with the Fund who is also an affiliated
person of the Manager or Invista is named below, together with the capacities in
which such person is affiliated with the Fund, Invista and the Manager:

<TABLE>
<CAPTION>
Office Held With Office Held With
Name Each Fund The Manager/Invista
---- ---------------- -------------------
<S> <C> <C>

Craig L. Bassett Treasurer Treasurer (Manager)
Michael J. Beer Financial Officer Executive Vice President and Chief
Operating Officer (Manager)
Arthur S. Filean Vice President and Vice President (Manager)
Secretary
Ernest H. Gillum Assistant Secretary Vice President - Compliance and
Product Development
J. Barry Griswell Director and Chairman Director and Chairman of
of the Board the Board (Manager)
Stephan L. Jones Director and Director and President
President (Manager)
Michael D. Roughton Counsel Counsel (Manager; Invista)
</TABLE>

COST OF MANAGER'S SERVICES

The Manager has entered into a Management Agreement with the Fund which
requires the Manager to act as investment adviser and manager of each Portfolio.
As compensation for its services and other responsibilities, the Manager
receives a fee computed and accrued daily and payable monthly. Under a
Sub-Advisory Agreement between Invista and the Manager, Invista performs all
investment advisory responsibilities of the Manger under the Management
Agreement and receive the full amount of the compensation paid by the Fund to
the Manager.

The Management Fees are computed at the following annual rates:

<TABLE>
<CAPTION>
Fees Computed On Fees as a Percent of
Portfolio Net Asset Value of Portfolio Average Daily Net Assets
--------- ---------------------------- ------------------------
<S> <C> <C> <C>
International Emerging
Markets Portfolio First $250 million 1.15%
Next $250 million 1.05%
Over $500 million 0.95%
International Securities
Portfolio Entire Portfolio 0.90%

International SmallCap
Portfolio First $250 million 1.00%
Next $250 million 0.90%
Over $500 million 0.80%
Mortgage-Backed Securities
Portfolio Entire Portfolio 0.45%
</TABLE>

The net assets of each portfolio on December 31, 1998 and the rate of
the fee for each portfolio for investment management services as provided in the
Management Agreement for the fiscal year then ended were as follows:

- --------------------------------------------------------------------------------
Management Fee for
Net Assets as of Fiscal Year Ended
Portfolio December 31, 1998 December 31, 1998
--------- ----------------- -----------------
International Emerging Markets $79,480,510 1.15%
International Securities 47,912,159 .90%
International SmallCap 82,329,857 1.00%
Mortgage Backed Securities 14,860,542 .45%

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

Fees paid for investment management services during the periods
indicated were as follows:

- --------------------------------------------------------------------------------
Management Fees for Fiscal
Portfolio Year Ended December 31
--------- ----------------------
1998 1997 1996
---- ---- ----
International Emerging Markets $856,612 $ 43,775 N/A
International 413,285 311,027 $185,375
Securities 731,367 37,932 N/A
International SmallCap 64,195 67,721 65,114
Mortgage-Backed Securities
- --------------------------------------------------------------------------------

In addition to investment advisory services, the responsibilities of
the Manager under the Management Agreement include various corporate and
administrative services, including furnishing the services of its officers and
employees that are elected to serve as officers or directors of the Fund;
furnishing office space and all necessary office facilities and equipment for
the general corporate functions of the Fund; furnishing the services of
supervisory and clerical personnel necessary to perform such functions;
determining the net asset value per share for the shares of each Portfolio;
acting as and performing the services of transfer and paying agent (including
preparing and distributing prospectuses, shareholder reports, tax information,
notices and proxy statements, making dividend payments, maintaining shareholder
records in an open account system and processing redemptions, repurchases and
remittances to shareholders); and qualifying Fund shares for sale in various
jurisdictions.

In addition, the Manager is responsible for all expenses of each
Portfolio except (i) the management fee paid to it by the Fund, (ii) taxes,
including in case of redeemed shares any initial transfer taxes, (iii) portfolio
brokerage fees and incidental brokerage expenses, (iv) interest and (v)
extraordinary expenses. Since brokerage fees are treated as part of the price
paid or received upon the purchase or sale of securities and since taxes,
interest and extraordinary expenses are expected to be minimal, the management
fee should tend to give shareholders an idea as to the expected level of
operating expenses of the Portfolios in which they invest. This arrangement is
different from the fee structures of most mutual funds where one fee is paid to
the investment adviser for advisory services and many or all other expenses
involved with the operation of the fund are paid directly by the fund.

Under the terms of the Sub-Advisory Agreement with the Manager, Invista
has agreed to reimburse the Manager for all of its costs in performing corporate
and administrative services and to pay all expenses of the Fund that the Manager
has undertaken to pay under the Management Agreement.

The Management Agreement and Sub-Advisory Agreement ("Agreements") were
last approved by the Fund's Board of Directors on September 14, 1998. Both kinds
of agreements provide that each will continue in effect as to any Portfolio from
year to year only so long such continuance is specifically approved at least
annually either by the Board of Directors of the Fund or by a vote of a majority
of the outstanding voting securities of the Fund and in either event by vote of
a majority of the directors of the Fund who are not interested persons of the
Manager, Principal Mutual Life Insurance Company, the Fund and, in the case of
the Sub-Advisory Agreement, Invista cast in person at a meeting called for the
purpose of voting on such approval. Each Agreement may, on sixty days' written
notice, be terminated at any time without the payment of any penalty, by the
Board of Directors of the Fund, by vote of a majority of the outstanding voting
securities of the Fund, as to any Portfolio by the vote of a majority of the
outstanding voting securities of that Portfolio, by the Manager, and in the case
of the Sub-Advisory Agreement by Invista. Each Agreement shall automatically
terminate in the event of its assignment.

The required shareholder approval of any continuance of either
Agreement shall be effective with respect to any Portfolio if a majority of the
outstanding voting securities of that Portfolio votes to approve the
continuance, notwithstanding that the amendment may not have been approved by a
majority of the outstanding voting securities of the Fund or of any other
Portfolio affected by the amendment. If the shareholders of any Portfolio of the
Fund fail to approve the continuance of either Agreement and that failure causes
the Agreement to be invalid with respect to that Portfolio, the Manager and
Invista will continue to act as investment adviser and sub-adviser with respect
to that Portfolio pending the required approval of the Agreement's continuance
or of a new contract or other definitive action, provided that the compensation
received by each of the Manager and Invista, in case of the invalidity of the
Management Agreement, or by Invista, in case of the invalidity of the
Sub-Advisory Agreement, in respect of that Portfolio during such period will be
no more than its actual costs incurred in furnishing services to that Portfolio
or the amount it would have received under the Agreement in respect of that
Portfolio, whichever is less.

The Management Agreement may be amended but such amendment will not be
effective until specifically approved by vote of the holders of a majority of
the Fund's outstanding voting securities and by vote of a majority of the
directors of the Fund who are not interested persons of the Manager, Principal
Mutual Life Insurance Company or the Fund cast in person at a meeting called for
the purpose of voting on such approval. The required shareholder approval of any
amendment to the Management Agreement shall be effective with respect to any
Portfolio if a majority of the outstanding voting securities of that Portfolio
votes to approve the amendment, notwithstanding that the amendment may not have
been approved by a majority of the outstanding voting securities of the Fund or
of any other Portfolio affected by the matter.

The Manager has entered into an Investment Service Agreement with
Principal Mutual Life Insurance Company ("Principal Mutual") whereby Principal
Mutual has agreed to provide on a part-time basis such employees as the parties
may agree are reasonably needed by the Manager and Invista in the performance of
investment advisory services (but not corporate or administrative services)
under the Management Agreement. Principal Mutual also agreed to permit such
employees, in performing services for the Manager and Invista, full access to
statistical and economic data, investment research reports and other
non-confidential materials in the files of its Investment Department. For the
services of Principal Mutual employees, the Manager will reimburse Principal
Mutual for the direct and indirect costs fairly attributable to their services
performed for the Manager, and the Manager will be reimbursed for such costs by
Invista. The Investment Service Agreement contains provisions on continuation
and termination comparable to those described above for the Management
Agreement. The Management Agreement was last approved by the Funds Board of
Directors on September 14, 1998.

BROKERAGE ON PURCHASES AND SALES OF SECURITIES

In distributing brokerage business arising out of the placement of
orders for the purchase and sale of securities for any Portfolio, Invista's
objective is to obtain the best overall terms. In pursuing this objective,
Invista considers all matters it deems relevant, including the breadth of the
market in the security, the price of the security, the financial condition and
executing capability of the broker or dealer and the reasonableness of the
commission, if any (for the specific transaction and on a continuing basis).
This may mean in some instances that Invista will pay a broker commissions that
are in excess of the amount of commission another broker might have charged for
executing the same transaction when Invista believes that such commissions are
reasonable in light of (a) the size and difficulty of transactions (b) the
quality of the execution provided and (c) the level of commissions paid relative
to commissions paid by other institutional investors. (Such factors are viewed
both in terms of that particular transaction and in terms of all transactions
that broker executes for accounts over which Invista exercises investment
discretion. Invista may purchase securities in the over-the-counter market,
utilizing the services of principal market matters, unless better terms can be
obtained by purchases through brokers or dealers, and may purchase securities
listed on the New York Stock Exchange from non-Exchange members in transactions
off the Exchange.) Invista gives consideration in the allocation of business to
services performed by a broker (e.g. the furnishing of statistical data and
research generally consisting of information of the following types: analyses
and reports concerning issuers, industries, economic factors and trends,
portfolio strategy and performance of client accounts). If any such allocation
is made, the primary criteria used will be to obtain the best overall terms for
such transactions. Invista may pay additional commission amounts for research
services but generally does not do so. Such statistical data and research
information received from brokers or dealers may be useful in varying degrees
and Invista may use it in servicing some or all of the accounts it manages. Some
statistical data and research information may not be useful to Invista in
managing the client account, brokerage for which resulted in Invista's receipt
of the statistical data and research information. However, in Invista's opinion,
the value thereof is not determinable and it is not expected that Invista's
expenses will be significantly raised since the receipt of such statistical data
and research information is only supplementary to Invista's own research
efforts. The Manager, or Sub-advisor, allocated portfolio transactions for the
International Emerging Markets, International Securities and International
SmallCap Portfolios to certain brokers during the fiscal year ended December 31,
1998 due to research services provided by such brokers. These portfolio
transactions resulted in commissions paid to such brokers by the Fund in the
amounts of $_______, $_______ and $_______, respectively.

Some products and services brokers provide to Invista (such as computer
hardware) may perform an administrative function (e.g. client accounting) as
well as a research function. In such cases, Invista makes a reasonable
allocation of the cost of the product or service according to Invista's use.
Invista pays for the portion of the product or service that consists of research
in commission dollars. Invista pays for the portion that provides it with
administrative or non-research assistance with its own money. Invista's
allocation of such products and services between research and non-research
functions poses a conflict of interest between Invista and its clients.

Annually the officers of Invista call a meeting to determine dollar
limits on business done with brokers who provide useful research information. A
list of products, research and services is kept in Invista's office.

Purchases and sales of debt securities and money market instruments
usually will be principal transactions and will normally be purchased directly
from the issuer or from an underwriter or marketmaker for the securities. Such
transactions are usually conducted on a net basis with a Portfolio paying no
brokerage commissions. Purchases from underwriters will include a commission or
concession paid by the issuer to the underwriter, and the purchases from dealers
serving as marketmakers will include the spread between the bid and asked
prices.

The following table shows the brokerage commissions paid during the
periods indicated. In each year, 100% of the commissions paid by each Fund went
to broker-dealers which provided research, statistical or other factual
information.

- --------------------------------------------------------------------------------
Total Brokerage Commissions
Portfolio Paid During Fiscal Year
Ended December 31
-----------------
1998 1997 1996
---- ---- ----
International Emerging Markets $373,096 $99,367 N/A
International Securities 101,586 78,786 $66,683
International SmallCap 417,318 80,568 N/A
Mortgage-Backed Securities -0- -0- -0-
- --------------------------------------------------------------------------------

Brokerage commissions paid to affiliates during the year ended December
31 were as follows:

Commissions Paid to Morgan Stanley & Co.
----------------------------------------
Percent of Dollar
Total Amount of
Dollar As Percent of Commissionable
Portfolio Amount Total Commissions Transactions
--------- ------ ----------------- ------------
<S> <C> <C> <C>
International Emerging Markets
1998 $20,062 5.38% 5.45%
1997 10,074 10.14 16.63
International Securities
1998 7,322 7.21 7.48
1997 1,394 1.77 1.99
1,655 2.02 2.10
1996
International SmallCap 24,089 5.77 9.80
1998
</TABLE>

Commissions Paid to Goldman Sachs
---------------------------------
Percent of Dollar
Total Amount of
Dollar As Percent of Commissionable
Portfolio Amount Total Commissions Transactions
--------- ------ ----------------- ------------
<S> <C> <C> <C>
International Emerging Markets
1998 $17,124 4.59% 6.15%
International Securities
1998 6,290 6.19 4.66
International SmallCap
1998 11,465 2.75 3.02
</TABLE>

Commissions Paid to J.P. Morgan Securities
------------------------------------------
Percent of Dollar
Total Amount of
Dollar As Percent of Commissionable
Portfolio Amount Total Commissions Transactions
--------- ------ ----------------- ------------
<S> <C> <C> <C>
International Emerging Markets
1998 $16,910 4.59% 6.15%
International Securities
1998 2,320 2.28 1.65
</TABLE>

Morgan Stanley and Co. is affiliated with Morgan Stanley Asset
Management, Inc., which acts as sub-advisor to two mutual funds included in the
Fund Complex. On December 1, 1998 Morgan Stanley Asset Management, Inc. changed
its name to Morgan Stanley Dean Witter Investment Management, Inc. but continues
to do business in certain instances using the name Morgan Stanley Asset
Management.

The Manager acts as investment advisor for other funds sponsored by
Principal Mutual Life Insurance Company. Invista furnishes certain personnel,
services and facilities required by the Manager to assist the Manager in
carrying out its investment advisory responsibilities to such other funds. If,
in carrying out the investment objectives of these entities, occasions arise
when purchases or sales of the same equity securities are to be made for two or
more of the entities at the same time, Invista may submit the orders to
purchase, or whenever possible, to sell, to a broker/dealer for execution on an
aggregate or "bunched" basis. Invista may create several aggregate or "bunched"
orders relating to a single security at different times during the same day. On
such occasion, Invista will employ a computer program to randomly order the
entities whose individual orders for purchase or sale make up each aggregate or
"bunched" order. Securities purchased or proceeds of sales received on each
trading day with respect to each such aggregate or "bunched" order shall be
allocated to the various entities whose individual orders for purchase or sale
make up the aggregate or "bunched" order. Securities purchased for entities
participating in an aggregate or "bunched" order will be placed into those
accounts, and where applicable, other client accounts at a price equal to the
average of the prices achieved in the course of filling the aggregate or
"bunched" order.

OFFERING PRICE

Each Portfolio offers its shares continuously through Princor Financial
Services Corporation which is principal underwriter for the Fund and sells
shares as agent for the Fund. Shares are sold at net asset value, without a
sales charge. In certain circumstances, Princor Financial Services Corporation
will compensate its registered representatives or a selected dealer with whom it
has entered into a selling agreement for their efforts in distributing shares
held in a customer account the establishment of which is attributable to the
efforts of the registered representatives or selected dealer.

DETERMINATION OF NET ASSET VALUE

The net asset value of the shares of each Portfolio is determined daily,
Monday through Friday, as of the close of trading on the New York Stock
Exchange, except on days on which changes in the value of a Portfolio's
portfolio securities will not materially affect the current net asset value of
that Portfolio's redeemable securities, on days during which a Portfolio
receives no order for the purchase or sale of its redeemable securities and no
tender of such a security for redemption, and on customary national business
holidays. The Portfolios treat as customary national business holidays those
days on which the New York Stock Exchange is closed for New Year's Day, Martin
Luther King, Jr. Day, Presidents' Day, Good Friday, Memorial Day, Independence
Day, Labor Day, Thanksgiving Day, and Christmas Day. The net asset value per
share for each Portfolio is determined by dividing the value of securities in
the Portfolio's investment portfolio plus all other assets, less all
liabilities, by the number of Portfolio shares outstanding. Securities for which
market quotations are readily available, including options and futures traded on
an exchange, are valued at market value, which is for exchanged-listed
securities, the closing sale price; for United Kingdom-listed securities, the
market-maker provided price; and for non-listed equity securities, the bid
price. Non-listed corporate debt securities and government securities are
usually valued using an evaluated bid price provided by a pricing service. If
closing prices are unavailable for exchange-listed securities, generally the bid
price, or in the case of debt securities an evaluated bid price, is used to
value such securities. When reliable market quotations are not considered to be
readily available, which may be the case, for example, with respect to certain
debt securities, preferred stocks, foreign securities and over-the-counter
options, the investments are valued by using market quotations, prices provided
by market makers, which may include dealers with which the Portfolio has
executed transactions, or estimates of market values obtained from yield data
and other factors relating to instruments or securities with similar
characteristics in accordance with procedures established in good faith by the
Board of Directors. Securities with remaining maturities of 60 days or less are
valued at amortized cost. Other assets are valued at fair value as determined in
good faith through procedures established by the Board of Directors.

Generally, trading in foreign securities is substantially completed each
day at various times prior to the close of the New York Stock Exchange. The
values of such securities used in computing net asset value per share are
usually determined as of such times. Occasionally, events which affect the
values of such securities and foreign currency exchange rates may occur between
the times at which they are generally determined and the close of the New York
Stock Exchange and would therefore not be reflected in the computation of the
net asset values of the Portfolios. If events materially affecting the value of
such securities occur during such period, then these securities will be valued
at their fair value as determined in good faith by the Manager or Invista under
procedures established and regularly reviewed by the Board of Directors. To the
extent the Portfolio invests in foreign securities listed on foreign exchanges
which trade on days on which the Portfolio does not determine its net asset
value, for example Saturdays and other customary national U.S. holidays, the
Portfolio's net asset value could be significantly affected on days when
shareholders have no access to the Portfolio.

PERFORMANCE CALCULATION

Each Portfolio may from time to time advertise its performance in terms
of total return or yield. The figures used for total return and yield are based
on the historical performance of a Portfolio, show the performance of a
hypothetical investment and are not intended to indicate future performance.
Total return and yield will vary from time to time depending upon market
conditions, the composition of a Portfolio's portfolio and operating expenses.
These factors and possible differences in the methods used in calculating
performance figures should be considered when comparing a Portfolio's
performance to the performance of some other kind of investment.

A Portfolio may also include in its advertisements performance rankings
and other performance-related information published by independent statistical
services or publishers, such as Lipper Analytical Services, Weisenberger
Investment Companies Services, Money Magazine, Forbes, The Wall Street Journal,
Baron's and Changing Times, and comparisons of the performance of a Portfolio to
that of various market indices, such as the S&P 500 Index, Dow Jones Industrials
Index, Morgan Stanley Capital International EAFE (Europe, Australia and Far
East) Index and World Index, Lehman Brothers GNMA Index and the Salomon Brothers
Investment Grade Bond Index.

Total Return

When advertising total return figures, each Portfolio will include its
average annual total return for each of the one, five and ten year periods (or
if shorter, the period during which its registration statement has been in
effect) that end on the last day of the most recent calendar quarter. Average
annual total return is computed by calculating the average annual compounded
rate of return over the stated period that would equate an initial $1,000
investment to the ending redeemable value assuming the reinvestment of all
dividends and capital gains distributions at net asset value. In its
advertising, a Portfolio may also include average annual total return for some
other period or cumulative total return for a specified period. Cumulative total
return is computed by dividing the difference between the ending redeemable
value (assuming the reinvestment of all dividends and capital gains
distributions) and the initial investment by the initial investment.

The following table shows as of December 31, 1998 average annual return
for each of the Portfolios for the periods indicated:

Portfolio 1-Year 5-Year 10-Year
--------- ------ ------ -------
International Emerging Markets (17.21)% (14.76)(1)
International Securities 9.55% 9.91% 13.87%(2)
International SmallCap Portfolio 11.92%) 12.73%(1) N/A
Mortgage-Backed Securities 7.74% 7.29% 7.25%(2)

(1) Period beginning November 26, 1997 and ending December 31, 1998. (2) Period
beginning May 7, 1993 and ending December 31, 1998.

Yield

The Mortgage-Backed Securities Portfolio calculates its yield by
determining its net investment income per share for a 30-day (or one month)
period, annualizing that figure (assuming semi-annual compounding) and dividing
the result by the net asset value per share for the last day of the same period.
The yield for the Mortgage-Backed Securities Portfolio as of December 31, 1998
was 6.73%.

A Portfolio may include in its advertisements the compounding effect of
reinvested dividends over an extended period of time as illustrated below.

The Power of Compounding

Shareholders who choose to reinvest their distributions get the advantage of
compounding. Here's what happens to a $10,000 investment with monthly income
reinvested at 6 percent, 8 percent and 10 percent over 20 years.

These figures assume no fluctuation in the value of principal. This chart is for
illustration purposes only and is not intended as an indication of the results a
shareholder may receive as a shareholder of a specific Portfolio. The return and
capital value of an investment in a Portfolio will fluctuate so that the value,
when redeemed, may be worth more or less than the original cost.

$67,275
$46,610
$32,071

0, 5, 10, 15 and 20

A Portfolio may also include in its advertisements an illustration of
the impact of income taxes and inflation on earnings from bank certificates of
deposit ("CD's"). The interest rate on the hypothetical CD will be based upon
average CD rates for a stated period as reported in the Federal Reserve
Bulletin. The illustrated annual rate of inflation will be the core inflation
rate as measured by the Consumer Price Index for the 12-month period ended as of
the most recent month prior to the advertisement's publication. The illustrated
income tax rate may include any federal income tax rate applicable to
individuals at the time the advertisement is published. Any such advertisement
will indicate that, unlike bank CD's, an investment in the Fund is not insured
nor is there any guarantee that the Fund's net asset value or any stated rate of
return will remain constant.

An example of a typical calculation included in such advertisements is
as follows: the after-tax and inflation-adjusted earnings on a bank CD, assuming
a $10,000 investment in a six-month bank CD with an annual interest rate of
4.99% (average six-month CD rate for the month of October, 1998, as reported in
the Federal Reserve Bulletin) and an inflation rate of 1.5% (rate of inflation
for the 12-month period ended October 31, 1998 as measured by the Consumer Price
Index) and an income tax bracket of 28% would be $(105).

($10,000 x 4.99%) / 2 = $250 Interest for six-month period
- 70 Federal income taxes (28%)
- 75 Inflation's impact on invested principal
($10,000 x 1.5%) / 2
($105) After-tax, inflation-adjusted earnings

TAX TREATMENT, DIVIDENDS AND DISTRIBUTIONS

It is the policy of each Portfolio to distribute substantially all net
investment income and net realized gains. Through such distributions, and by
satisfying certain other requirements, the Fund intends to qualify each
portfolio for the tax treatment accorded to regulated investment companies under
the applicable provisions of the Internal Revenue Code. This means that in each
year in which a Portfolio so qualifies, it will be exempt from federal income
tax upon the amount so distributed to investors. The Tax Reform Act of 1986
imposed an excise tax on mutual funds which fail to distribute net investment
income and capital gains by the end of the calendar year in accordance with the
provisions of the Act. Each Portfolio intends to comply with the Act's
requirements and to avoid this excise tax.

Distributions from the International Emerging Markets Portfolio,
International Securities Portfolio, International SmallCap Portfolio and
Mortgage-Backed Securities Portfolio will generally not be eligible for the 70%
corporate dividends received deduction. All taxable dividends and capital gains
are taxable in the year in which distributed, whether received in cash or
reinvested in additional shares. Dividends declared with a record date in
December and paid in January will be deemed to have been distributed to
shareholders in December. Each Portfolio will inform its shareholders of the
amount and nature of their taxable income dividends and capital gain
distributions. Dividends from a Portfolio's net income and distributions of
capital gains, if any, may also be subject to state and local taxation.

As previously discussed, a Portfolio may invest in futures contracts or
options thereon, index options or options traded on qualified exchanges. For
federal income tax purposes, capital gains and losses on futures contracts or
options thereon, index options or options traded on qualified exchanges are
generally treated as 60% long-term and 40% short-term. In addition, a Portfolio
must recognize any unrealized gains and losses on such positions held at the end
of the fiscal year. A Portfolio may elect out of such tax treatment, however,
for a futures or options position that is part of an "identified mixed straddle"
such as a put option purchased with respect to a portfolio security. Gains and
losses on futures and options included in an identified mixed straddle will be
considered 100% short-term and unrealized gain or loss on such positions will
not be realized at year end. The straddle provisions of the Code may require the
deferral of realized losses to the extent that a Portfolio has unrealized gains
in certain offsetting positions at the end of the fiscal year, and may also
require recharacterization of all or a part of losses on certain offsetting
positions from short-term to long-term, as well as adjustment of the holding
periods of straddle positions.

Each Portfolio is required by law under certain circumstances to
withhold 31% of dividends paid to investors who do not furnish their correct
taxpayer identification number (in the case of individuals, their social
security number).

Shareholders should consult their own tax advisors as to the federal,
state and local tax consequences of ownership of shares of the Portfolios in
their particular circumstances.

Special Tax Considerations

International Emerging Markets Portfolio, International Securities
Portfolio and International SmallCap Portfolio

When at the close of a fiscal year more than 50% of the value of a
Portfolio's total assets are invested in securities of foreign corporations, the
Fund may elect pursuant to Section 853 of the Code to permit its Shareholders to
take a credit (or a deduction) for foreign income taxes paid by the Portfolio.
In that case, Shareholders should include in their report of gross income in
their federal income tax returns both cash dividends received from the Portfolio
and also the amount which the Portfolio advises is their pro rata portion of
foreign income taxes paid with respect to, or withheld from, dividends and
interest paid to the Portfolio from its foreign investments. Shareholders would
then be entitled to subtract from their federal income taxes the amount of such
taxes withheld, or treat such foreign taxes as a deduction from gross income, if
that should be more advantageous. As in the case of individuals receiving income
directly from foreign sources, the above-described tax credit or tax deduction
is subject to certain limitations. Shareholders or prospective shareholders
should consult their tax advisors on how these provisions apply to them.

FINANCIAL STATEMENTS

The financial statements of the Fund for the year ended December 31,
1998 appearing in the Annual Report to Shareholders and the report thereon of
Ernst & Young LLP, independent auditors, appearing therein are incorporated by
reference in this Statement of Additional Information. The Annual Report will be
furnished without charge, to investors who request copies of the Statement of
Additional Information.

<PAGE>
PART C
OTHER INFORMATION

Item 24. Financial Statements and Exhibits

(a) Financial Statements included in the Registration Statement
(1) Part A:
To be filed by amendment

(2) Part B:
None

(b) Exhibits
(1a) Articles of Amendment and Restatement
(Filed 4/12/96)
(1b) Articles of Amendment (Filed 9/12/97)
(2) Bylaws
(5a) Management Agreement (Filed 9/12/97)
(5b) Investment Service Agreement (Filed 9/12/97)
(5c) Sub-Advisory Agreement (Filed 9/12/97)
(6a) Distribution Agreement (Filed 9/12/97)
(6b) Fund Application (Filed 11/21/97)
(8a) Domestic Custody Agreement (Filed 4/12/96)
(8b) Global Custody Agreement (Filed 4/12/96)
(9a) Dealer Selling Agreement (Filed 9/12/97)
(10) Opinion of Counsel (Filed 4/12/96)
(11) Consent of Independent Auditors*
(12) Audited Financial Statements as of December
31, 1998, including the Report of Ernst &
Young LLP, independent auditors for the
Registrant.*
(13) Investment Letter (Filed 4/12/96)
(16) Performance Quotations (Filed 4/12/96)

*To be filed by amendment.

Item 25. Persons Controlled by or Under Common Control with Depositor

Principal Life Insurance Company (an Iowa corporation)
a life group, pension and individual insurance company.

Sponsored the organization of the following mutual funds, some of
which it controls by virtue of owning voting securities:

Principal Balanced Fund, Inc.(a Maryland Corporation) 0.69% of
shares outstanding owned by Principal Life Insurance Company
(including subsidiaries and affiliates) on December 8, 1998.

Principal Blue Chip Fund, Inc.(a Maryland Corporation) 0.93% of
shares outstanding owned by Principal Life Insurance Company
(including subsidiaries and affiliates) on December 8, 1998.

Principal Bond Fund, Inc.(a Maryland Corporation) 1.14% of shares
outstanding owned by Principal Life Insurance Company (including
subsidiaries and affiliates) on December 8, 1998.

Principal Capital Value Fund, Inc. (a Maryland Corporation)
23.99% of outstanding shares owned by Principal Life Insurance
Company (including subsidiaries and affiliates) on December 8,
1998.

Principal Cash Management Fund, Inc. (a Maryland Corporation)
9.45% of outstanding shares owned by Principal Life Insurance
Company (including subsidiaries and affiliates) on December 8,
1998.

Principal Government Securities Income Fund, Inc. (a Maryland
Corporation) 0.38% of shares outstanding owned by Principal Life
Insurance Company (including subsidiaries and affiliates) on
December 8, 1998.

Principal Growth Fund, Inc. (a Maryland Corporation) 0.43% of
outstanding shares owned by Principal Life Insurance Company
(including subsidiaries and affiliates) on December 8, 1998.

Principal High Yield Fund, Inc. (a Maryland Corporation) 7.35%
of shares outstanding owned by Principal Life Insurance Company
(including subsidiaries and affiliates) on December 8, 1998.

Principal International Emerging Markets Fund, Inc. (a Maryland
Corporation) 48.93% of shares outstanding owned by Principal Life
Insurance Company (including subsidiaries and affiliates) on
December 8, 1998.

Principal International Fund, Inc. (a Maryland Corporation)
22.80% of shares outstanding owned by Principal Life Insurance
Company (including subsidiaries and affiliates) on December 8,
1998.

Principal International SmallCap Fund, Inc. (a Maryland
Corporation) 45.14% of shares outstanding owned by Principal Life
Insurance Company (including subsidiaries and affiliates) on
December 8, 1998.

Principal Limited Term Bond Fund, Inc. (a Maryland Corporation)
38.04% of shares outstanding owned by Principal Life Insurance
Company(including subsidiaries and affiliates) on December 8,
1998.

Principal MidCap Fund, Inc. (a Maryland Corporation) 0.63% of
shares outstanding owned by Principal Life Insurance Company
(including subsidiaries and affiliates) on December 8, 1998

Principal Real Estate Fund, Inc. (a Maryland Corporation) 72.27%
of shares outstanding owned by Principal Life Insurance Company
(including subsidiaries and affiliates) on December 8, 1998

Principal SmallCap Fund, Inc.(a Maryland Corporation) 25.85% of
shares outstanding owned by Principal Life Insurance
Company (including subsidiaries and affiliates) on December 8,
1998

Principal Special Markets Fund, Inc. (a Maryland Corporation)
83.04% of shares outstanding of the International Emerging
Markets Portfolio, 42.77% of the shares outstanding of the
International Securities Portfolio, 98.66% of shares outstanding
of the International SmallCap Portfolio and 100% of the shares
outstanding of the Mortgage-Backed Securities Portfolio were
owned by Principal Life Insurance Company (including subsidiaries
and affiliates) on December 8, 1998

Principal Tax-Exempt Bond Fund, Inc. (a Maryland Corporation)
0.54% of shares outstanding owned by Principal Life Insurance
Company (including subsidiaries and affiliates) on December 8,
1998.

Principal Tax-Exempt Cash Management Fund, Inc. (a Maryland
Corporation) 3.71% of shares outstanding owned by Principal Life
Insurance Company (including subsidiaries and affiliates) on
December 8, 1998.

Principal Utilities Fund, Inc. (a Maryland Corporation) 1.52% of
shares outstanding owned by Principal Life Insurance Company
(including subsidiaries and affiliates) on December 8, 1998.

Principal Variable Contracts Fund, Inc. (a Maryland Corporation)
100% of shares outstanding of the following Accounts owned by
Principal Life Insurance Company and its Separate Accounts on
December 8, 1998: Aggressive Growth, Asset Allocation, Balanced,
Bond, Capital Value, Government Securities, Growth, High Yield,
International, International SmallCap, MicroCap, MidCap, MidCap
Growth, Money Market, Real Estate, SmallCap, SmallCap Growth,
SmallCap Value and Utilities .

Subsidiaries organized and wholly-owned by Principal Life
Insurance Company:

a. Principal Holding Company (an Iowa Corporation) A holding
company wholly-owned by Principal Life Insurance
Company.

b. PT Asuransi Jiwa Principal Egalita Indonesia (an Indonesia
Corporation)

c. Principal Real Estate Services, LLC (a Delaware Corporation)
a limited liability company which acts as a property manager
and real estate service provider.

d. Principal Commercial Funding, LLC (a Delaware
Corporation) a correspondent lender and sevice provider for
loans.

Subsidiaries wholly-owned by Principal Holding Company:

a. Petula Associates, Ltd. (an Iowa Corporation) a real estate
development company.

b. Patrician Associates, Inc. (a California Corporation) a real
estate development company.

c. Principal Development Associates, Inc. (a California
Corporation) a real estate development company.

d. Princor Financial Services Corporation (an Iowa Corporation)
a registered broker-dealer.

e. Invista Capital Management, Inc. (an Iowa Corporation) a
registered investment adviser.

f. Principal Marketing Services, Inc. (a Delaware Corporation)
a corporation formed to serve as an interface between
marketers and manufacturers of financial services products.

g. The Principal Financial Group, Inc. (a Delaware corporation)
a general business corporation established in connection
with the new corporate identity. It is not currently active.

h. Delaware Charter Guarantee & Trust Company (a Delaware
Corporation) a nondepository trust company.

i. The Admar Group, Inc. (a Florida Corporation) a national
managed care service organization that developes and manages
preferred provider organizations.

j. Principal Health Care, Inc. (an Iowa Corporation) a
developer and administrator of managed care systems.

k. Principal Financial Advisors, Inc. (an Iowa Corporation) a
registered investment advisor.

l. Principal Asset Markets, Inc. (an Iowa Corporation) a
residential mortgage loan broker.

m. Principal Portfolio Services, Inc. (an Iowa Corporation) a
mortgage due diligence company.

n. Principal International, Inc. (an Iowa Corporation) a
company formed for the purpose of international business
development.

o. Principal Spectrum Associates, Inc. (a California
Corporation) a real estate development company.

p. Principal Commercial Advisors, Inc. (an Iowa Corporation) a
company that purchases, manages and sells commercial real
estate assets.

q. Principal FC, Ltd. (an Iowa Corporation) a limited purpose
investment corporation.

r. Principal Residential Mortgage, Inc. (an Iowa Corporation) a
residential mortgage loan broker.

s. Equity FC, Ltd. (an Iowa Corporation) engaged in investment
transactions including limited partnership and limited
liability companies.

t. Principal Bank (a Federal Corporation) a Federally chartered
direct delivery savings bank.

u. HealthRisk Resource Group, Inc. (an Iowa Corporation) a
management services organization.

v. Dental-Net, Inc. (an Arizona Corporation) holding company
of Employers Dental Services; a managed dental care services
organization. HMO and dental group practice.

Subsidiaries organized and wholly-owned by Princor Financial Services
Corporation:

a. Principal Management Corporation (an Iowa Corporation) a
registered investment advisor.

b. Principal Investors Corporation (a New Jersey Corporation) a
registered broker-dealer with the Securities Exchange
Commission. It is not currently active.

Subsidiary wholly owned by Delaware Charter Guarantee & Trust Company:

a. Trust Consultants, Inc. (a California Corporation) a
Consulting and Administration of Employee Benefit Plans.

Subsidiaries owned by The Admar Group, Inc.:

a. Admar Corporation (a California Corporation) a managed care
services organization.

b. Admar Insurance Marketing, Inc. (a California Corporation) a
managed care services organization.

c. Benefit Plan Administrators, Inc. (a Colorado Corporation) a
managed care services organization.

d. SelectCare Management Co., Inc. (a California Corporation) a
managed care services organization.

e. Image Financial & Insurance Services, Inc. (a California
Corporation) a managed care services organization.

f. WM. G. Hofgard & Co., Inc. (a California Corporation) a
managed care services organization.

Subsidiary owned by Petula Associates, Ltd.

a. Magnus Properties, Inc. (an Iowa Corporation) which owns
real estate.

Subsidiary owned by Principal Residential Mortgage, Inc.:

a. Reliastar Mortgage Corporation (an Iowa corporation) a
brokerage and servicer of residential mortgage loans

b. Principal JMC, Inc. (an Iowa Corporation) a brokerage
company that originates and sells loans; enters into the
business of organization and sale of real estate mortgages.

Subsidiaries owned by Delta-Net, Inc.

a. Employers Dental Services, Inc. (an Arizona corporation)
a prepaid dental plan organization.

Subsidiaries owned by Principal International, Inc.:

a. Principal Insurance Company (Hong Kong) Limited (a Hong Kong
Corporation) group life and group pension products.

b. Principal International Argentina, S.A. (an Argentina
services corporation).

c. Principal International Asia Limited (a Hong Kong
Corporation) a corporation operating as a regional
headquarters for Asia.

d. Principal International de Chile, S.A. (a Chile
Corporation) a holding company.

e. Principal International Espana, S.A. de Seguros de Vida (a
Spain Corporation) a life insurance company (individual
group), annuities and pension.

f. Principal Mexico Compania de Seguros, S.A. de C.V. (a Mexico
Corporation) a life insurance company (individual and
group), personal accidents.

g. Afore Confia-Principal, S.a. de C.V. (a Mexico Corporation),
pension.

h. Zao Principal International (a Russia Corporation) inactive.

i. Principal Trust Company (Asia) Limited (an Asia trust
company).

j. Principal Asset Management Company (Asia) Ltd. (Hong Kong)
a corporation which manages pension funds.

k. Afore Atlantico Promex, S.A. DE C.V. (a Mexico corporation)
a Mexico Pension Co.

l. Principal Consulting (India) Private Limited (an India
corporation) an India consulting company.

Subsidiaries owned by Principal International Argentina, S.A.:

a. Ethika Administradora de Fondos de Jubilaciones y Pensions
S.A. (an Argentina company) a pension company.

b. Principal Compania de Seguros de Retiro, S.A. (an Argentina
Corporation) an individual annuity/employee benefit company.

c. Principal Life Compania de Seguros, S.A. (an Argentina
Corporation) a life insurance company.

Subsidiary owned by Principal International de Chile, S.A.:

a. Principal Compania de Seguros de Vida Chile S.A. (a Chile
Corporation) life insurance and annuity company.

Subsidiary owned by Principal International Espana, S.A. de Seguros de
Vida:

a. Princor International Espana Sociedad Anonima de Agencia de
Seguros (a Spain Corporation) an insurance agency.

Subsidiary owned by Afore Confia-Principal, S.A. de C.V.:

a. Siefore Confia-Principal, S.A. de C.V. (a Mexico
Corporation) an investment fund company.

Subsidiary owned by Afore Atlantico Promex, S.A. DE C.V.:

a. Siefore A.P. Index S.A. de CV (a Mexico Corporation) a
pension investment fund

Item 26. Number of Holders of Securities - As of: January 31, 1999

(1) (2)
Title of Class Number of Holders
Principal Special Markets Fund, Inc.
Common - International Securities Portfolio 19
Common - Mortgage-Backed Securities Portfolio 1
Common - International Emerging Markets Portfolio 3
Common - International SmallCap Portfolio 2

Item 27. Indemnification

Under Section 2-418 of the Maryland General Corporation Law, with respect
to any proceedings against a present or former director, officer, agent or
employee (a "corporate representative") of the Registrant, the Registrant may
indemnify the corporate representative against judgments, fines, penalties, and
amounts paid in settlement, and against expenses, including attorneys' fees, if
such expenses were actually incurred by the corporate representative in
connection with the proceeding, unless it is established that:

(i) The act or omission of the corporate representative was
material to the matter giving rise to the proceeding; and

1. Was committed in bad faith; or

2. Was the result of active and deliberate dishonesty; or

(ii) The corporate representative actually received an improper
personal benefit in money, property, or services; or

(iii) In the case of any criminal proceeding, the corporate
representative had reasonable cause to believe that the act or
omission was unlawful.

If a proceeding is brought by or on behalf of the Registrant, however, the
Registrant may not indemnify a corporate representative who has been adjudged to
be liable to the Registrant. Under the Registrant's Articles of Incorporation
and Bylaws, directors and officers of Registrant are entitled to indemnification
by the Registrant to the fullest extent permitted under Maryland law and the
Investment Company Act of 1940. Reference is made to Article VI, Section 7 of
the Registrant's Articles of Incorporation, Article 12 of Registrant's Bylaws
and Section 2-418 of the Maryland General Corporation Law.

The Registrant has agreed to indemnify, defend and hold the Distributor,
its officers and directors, and any person who controls the Distributor within
the meaning of Section 15 of the Securities Act of 1933, free and harmless from
and against any and all claims, demands, liabilities and expenses (including the
cost of investigating or defending such claims, demands or liabilities and any
counsel fees incurred in connection therewith) which the Distributor, its
officers, directors or any such controlling person may incur under the
Securities Act of 1933, or under common law or otherwise, arising out of or
based upon any untrue statement of a material fact contained in the Registrant's
registration statement or prospectus or arising out of or based upon any alleged
omission to state a material fact required to be stated in either thereof or
necessary to make the statements in either thereof not misleading, except
insofar as such claims, demands, liabilities or expenses arise out of or are
based upon any such untrue statement or omission made in conformity with
information furnished in writing by the Distributor to the Registrant for use in
the Registrant's registration statement or prospectus: provided, however, that
this indemnity agreement, to the extent that it might require indemnity of any
person who is also an officer or director of the Registrant or who controls the
Registrant within the meaning of Section 15 of the Securities Act of 1933, shall
not inure to the benefit of such officer, director or controlling person unless
a court of competent jurisdiction shall determine, or it shall have been
determined by controlling precedent that such result would not be against public
policy as expressed in the Securities Act of 1933, and further provided, that in
no event shall anything contained herein be so construed as to protect the
Distributor against any liability to the Registrant or to its security holders
to which the Distributor would otherwise be subject by reason of willful
misfeasance, bad faith, or gross negligence, in the performance of its duties,
or by reason of its reckless disregard of its obligations under this Agreement.
The Registrant's agreement to indemnify the Distributor, its officers and
directors and any such controlling person as aforesaid is expressly conditioned
upon the Registrant being promptly notified of any action brought against the
Distributor, its officers or directors, or any such controlling person, such
notification to be given by letter or telegram addressed to the Registrant.

Item 28. Business or Other Connection of Investment Adviser

A complete list of the officers and directors of the investment adviser,
Principal Management Corporation, are set out below. This list includes some of
the same people (designated by an *), who are serving as officers and directors
of the Registrant. For these people the information as set out in the Statement
of Additional Information (See Part B) under the caption "Directors and Officers
of the Fund" is incorporated by reference.

John E. Aschenbrenner The Principal Senior Vice President
Director Financial Group Principal Life Insurance
Company

Craig R. Barnes Same President & Chief Executive
Vice President Officer, Invista Capital
Management, Inc.

*Craig L. Bassett Same See Part B
Treasurer

*Michael J. Beer Same See Part B
Executive Vice President
and Chief Operating
Officer

Mary L. Bricker Same Counsel and Assistant
Assistant Corporate Corporate Secretary
Secretary Principal Life
Insurance Company

David J. Drury Same Chief Executive Officer
Director and Chairman of the Board
Principal Life
Insurance Company

*Arthur S. Filean Same See Part B
Vice President

Paul N. Germain Same Vice President -
Vice President - Mutual Fund Operations
Mutual Fund Operations Princor Financial Services
Corporation

*Ernest H. Gillum Same See Part B
Vice President -
Compliance and Product
Development

Thomas J. Graf Same Senior Vice President
Director Principal Life
Insurance Company

*J. Barry Griswell Same See Part B
Chairman of the Board
and Director

Joyce N. Hoffman Same Vice President and
Vice President and Corporate Secretary
Corporate Secretary Principal Life
Insurance Company

*Stephan L. Jones Same See Part B
President and Director

Ellen Z. Lamale Same Vice President & Chief Actuary
Director Principal Life Insurance
Company

Gregg R. Narber Same Senior Vice President and
Director General Counsel
Principal Life
Insurance Company

Richard L. Prey Senior Vice President
Director Principal Life
Insurance Company

Layne A. Rasmussen Same Controller
Controller - Princor Financial Services
Mutual Funds Corporation

Elizabeth R. Ring Same Controller- Broker Dealer
Controller - Operations
Mutual Funds Princor Financial Services
Corporation

*Michael D. Roughton Same See Part B
Counsel

Jean B. Schustek Same Product Compliance Officer -
Product Compliance Officer - Princor Financial Services
Registered Products Corporation

Dewain A. Sparrgrove Same Vice President -
Vice President Investment Securities
Principal Life
Insurance Company

Principal Management Corporation serves as investment adviser and dividend
disbursing and transfer agent for, Principal Balanced Fund, Inc., Principal Blue
Chip Fund, Inc., Principal Bond Fund, Inc., Principal Capital Value Fund, Inc.,
Principal Cash Management Fund, Inc., Principal Government Securities Income
Fund, Inc., Principal Growth Fund, Inc., Principal High Yield Fund, Inc.,
Principal International Emerging Markets Fund, Inc., Principal International
Fund, Inc., Principal International SmallCap Fund, Inc., Principal Limited Term
Bond Fund, Inc., Principal MidCap Fund, Inc., Principal Real Estate Fund, Inc.,
Principal SmallCap Fund, Inc., Principal Special Markets Fund, Inc., Principal
Tax-Exempt Bond Fund, Inc., Principal Tax-Exempt Cash Management Fund, Inc.,
Principal Utilities Fund, Inc. and Principal Variable Contracts Fund, Inc. -
funds sponsored by Principal Life Insurance Company.

Item 29. Principal Underwriters

(a) Princor Financial Services Corporation, principal underwriter for
Registrant, acts as principal underwriter for, Principal Balanced Fund, Inc.,
Principal Blue Chip Fund, Inc., Principal Bond Fund, Inc., Principal Capital
Value Fund, Inc., Principal Cash Management Fund, Inc., Principal Government
Securities Income Fund, Inc., Principal Growth Fund, Inc., Principal High Yield
Fund, Inc., Principal International Emerging Markets Fund, Inc., Principal
International Fund, Inc., Principal International SmallCap Fund, Inc., Principal
Limited Term Bond Fund, Inc., Principal MidCap Fund, Inc., Principal Real Estate
Fund, Inc., Principal SmallCap Fund, Inc., Principal Special Markets Fund, Inc.,
Principal Tax-Exempt Bond Fund, Inc., Principal Tax-Exempt Cash Management Fund,
Inc., Principal Utilities Fund, Inc., Principal Variable Contracts Fund, Inc.
and for variable annuity contracts participating in Principal Life
Insurance Company Separate Account B, a registered unit investment trust for
retirement plans adopted by public school systems or certain tax-exempt
organizations pursuant to Section 403(b) of the Internal Revenue Code, Section
457 retirement plans, Section 401(a) retirement plans, certain non- qualified
deferred compensation plans and Individual Retirement Annuity Plans adopted
pursuant to Section 408 of the Internal Revenue Code, and for variable life
insurance contracts issued by Principal Life Insurance Company Variable
Life Separate Account, a registered unit investment trust.

(b) (1) (2) (3)
Positions
and offices Positions and
Name and principal with principal offices with
business address underwriter registrant

John E. Aschenbrenner Director None
The Principal
Financial Group
Des Moines, IA 50392

Robert W. Baehr Marketing Services None
The Principal Officer
Financial Group
Des Moines, IA 50392

Craig L. Bassett Treasurer Treasurer
The Principal
Financial Group
Des Moines, IA 50392

Michael J. Beer Executive Vice President and Financial Officer
The Principal Chief Operating Officer
Financial Group
Des Moines, IA 50392

Mary L. Bricker Assistant Corporate None
The Principal Secretary
Financial Group
Des Moines, IA 50392

Lynn A. Brones Vice President Sales, None
The Principal Princor Investment Network
Financial Group
Des Moines, IA 50392

David J. Drury Director None
The Principal
Financial Group
Des Moines, IA 50392

Arthur S. Filean Vice President Vice President
The Principal and Secretary
Financial Group
Des Moines, IA 50392

Paul N. Germain Vice President- None
The Principal Mutual Fund Operations
Financial Group
Des Moines, IA 50392

Ernest H. Gillum Vice President-Compliance Assistant
The Principal and Product Development Secretary
Financial Group
Des Moines, IA 50392

William C. Gordon Insurance License Officer None
The Principal
Financial Group
Des Moines, IA 50392

Thomas J. Graf Director None
The Principal
Financial Group
Des Moines, IA 50392

J. Barry Griswell Director and Director and
The Principal Chairman of the Chairman of the
Financial Group Board Board
Des Moines, IA 50392

Susan R. Haupts Marketing Officer None
The Principal
Financial Group
Des Moines, IA 50392

Joyce N. Hoffman Vice President and None
The Principal Corporate Secretary
Financial Group
Des Moines, IA 50392

Stephan L. Jones Director and Director and
The Principal President President
Financial Group
Des Moines, IA 50392

Kraig L. Kuhlers Marketing Officer None
The Principal
Financial Group
Des Moines, IA 50392

Ellen Z. Lamale Director None
The Principal
Financial Group
Des Moines, IA 50392

John R. Lepley Senior Vice None
The Principal President - Marketing
Financial Group and Distribution
Des Moines, IA 50392

Gregg R. Narber Director None
The Principal
Financial Group
Des Moines, IA 50392

Kelly A. Paul Systems & Technology None
The Principal Officer
Financial Group
Des Moines, IA 50392

Elise M. Pilkington Assistant Director - None
The Principal Retirement Consulting
Financial Group
Des Moines, IA 50392

Richard L. Prey Director None
The Principal
Financial Group
Des Moines, IA 50392

Layne A. Rasmussen Controller-Mutual Funds None
The Principal
Financial Group
Des Moines, IA 50392

Elizabeth R. Ring Controller None
The Principal
Financial Group
Des Moines, IA 50392

Martin R. Richardson Operations Office- None
The Principal Broker/Dealer Services
Financial Group
Des Moines, IA 50392

Michael D. Roughton Counsel Counsel
The Principal
Financial Group
Des Moines, IA 50392

Jean B. Schustek Product Compliance Officer- None
The Principal Registered Products
Financial Group
Des Moines, IA 50392

Kyle R. Selberg Vice President- None
The Principal Marketing
Financial Group
Des Moines, IA 50392

Minoo Spellerberg Compliance Officer None
The Principal
Financial Group
Des Moines, IA 50392

Roger C. Stroud Assistant Director- None
The Principal Marketing
Financial Group
Des Moines, IA 50392

Item 30. Location of Accounts and Records

All accounts, books or other documents of the Registrant are located at the
offices of the Registrant and its Investment Adviser in the Principal Mutual
Life Insurance Company home office building, The Principal Financial Group, Des
Moines, Iowa 50392.

Item 31. Management Services

Inapplicable.

Item 32. Undertakings

Indemnification

Reference is made to Item 27 above, which discusses circumstances under
which directors and officers of the Registrant shall be indemnified by the
Registrant against certain liabilities and expenses incurred by them by reason
of being a director or officer of the Registrant.

Notwithstanding the provisions of Registrant's Articles of Incorporation
and Bylaws, the Registrant hereby makes the following undertaking:

Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
Registrant, 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 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 director, officer or controlling person of the Registrant, in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person of the Registrant, in connection with
the securities 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 Act and will be governed by the
final adjudication of such issue

Shareholder Communications

Registrant hereby undertakes to call a meeting of shareholders for the
purpose of voting upon the question of removal of a director or directors when
requested in writing to do so by the holders of at least 10% of the Registrant's
outstanding shares of common stock and in connection with such meeting to comply
with the provisions of Section 16(c) of the Investment Company Act of 1940
relating to shareholder communications

Delivery of Annual Report to Shareholders

The registrant hereby undertakes to furnish each person to whom a
prospectus is delivered a copy of the registrant's latest annual report to
shareholders, upon request and without charge.
<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 requirments for effectiveness of this Registration Statement and has duly
caused this Amendment to the Registration Statement to be signed on its behalf
by the undersigned, thereunto duly authorized in the City of Des Moines and
State of Iowa, on the 26th day of February, 1999.

PRINCIPAL SPECIAL MARKETS FUND, INC.

(Registrant)

By /s/ S. L. JONES
______________________________________
S. L. Jones
President and Director

Attest:

/s/ E. H. GILLUM
______________________________________
E. H. Gillum
Assistant Secretary
<PAGE>
Pursuant to the requirement of the Securities Act of 1933, this Amendment
to the Registration Statement has been signed below by the following persons in
the capacities and on the dates indicated.

Signature Title Date

/s/ S. L. Jones
_____________________________ President and Director 2/26/99
S. L. Jones (Principal Executive Officer) __________

(J. B. Griswell)*
_____________________________ Director and 2/26/99
J. B. Griswell Chairman of the Board __________

/s/ M. J. Beer
_____________________________ Financial Officer (Principal 2/26/99
M. J. Beer Financial and Accounting Officer) __________

(J. D. Davis)*
_____________________________ Director 2/26/99
J. D. Davis __________

(P. A. Ferguson)*
_____________________________ Director 2/26/99
P. A. Ferguson __________

(B. A. Lukavsky)*
_____________________________ Director 2/26/99
B. A. Lukavsky __________

*By /s/ S. L. JONES
_____________________________________
S. L. Jones
President and Director

Pursuant to Powers of Attorney
Previously Filed or Included

POWER OF ATTORNEY

The undersigned hereby constitutes and appoints S. L. Jones, J. B. Griswell, M.
D. Roughton, E. H. Gillum and A. S. Filean and each of them (with full power to
each of them to act alone), the undersigned's true and lawful attorney-in-fact
and agent, with full power of substitution to each, for and on behalf and in the
name of the undersigned, to execute and file any documents relating to
registration under the Securities Act of 1933 and the Investment Company Act of
1940 with respect to open-end management investment companies currently
organized or to be organized in the future which are sponsored by Principal Life
Insurance Company, and any and all amendments thereto and reports thereunder
with all exhibits and all instruments necessary or appropriate in connection
therewith, each of said attorneys-in-fact and agents and his or their
substitutes being empowered to act with or without the others or other, and to
have full power and authority to do or cause to be done in the name and on
behalf of the undersigned each and every act and thing necessary or appropriate
to be done in order to effectuate the same, as fully to all intents and purposes
as the undersigned might or could do in person; hereby ratifying and confirming
all that said attorneys-in-fact and agents, or any of them, may do or cause to
be done by virtue hereof.

IN WITNESS WHEREOF, the undersigned has hereunto set his hand this 26th day of
February, 1999.

/s/J. D. Davis
________________
J. D. Davis

POWER OF ATTORNEY

IN WITNESS WHEREOF, the undersigned has hereunto set his hand this 26th day of
February, 1999.

/s/B. A. Lukavsky
________________
B. A. Lukavsky

POWER OF ATTORNEY

The undersigned hereby constitutes and appoints J. B. Griswell, M. D. Roughton,
E. H. Gillum and A. S. Filean and each of them (with full power to each of them
to act alone), the undersigned's true and lawful attorney-in-fact and agent,
with full power of substitution to each, for and on behalf and in the name of
the undersigned, to execute and file any documents relating to registration
under the Securities Act of 1933 and the Investment Company Act of 1940 with
respect to open-end management investment companies currently organized or to be
organized in the future which are sponsored by Principal Life Insurance Company,
and any and all amendments thereto and reports thereunder with all exhibits and
all instruments necessary or appropriate in connection therewith, each of said
attorneys-in-fact and agents and his or their substitutes being empowered to act
with or without the others or other, and to have full power and authority to do
or cause to be done in the name and on behalf of the undersigned each and every
act and thing necessary or appropriate to be done in order to effectuate the
same, as fully to all intents and purposes as the undersigned might or could do
in person; hereby ratifying and confirming all that said attorneys-in-fact and
agents, or any of them, may do or cause to be done by virtue hereof.

IN WITNESS WHEREOF, the undersigned has hereunto set his hand this 26th day of
February, 1999.

/s/S. L. Jones
________________
S. L. Jones

POWER OF ATTORNEY

IN WITNESS WHEREOF, the undersigned has hereunto set his hand this 26th day of
February, 1999.

/s/P. A. Ferguson
________________
P. A. Ferguson

POWER OF ATTORNEY

The undersigned hereby constitutes and appoints S. L. Jones, M. D. Roughton, E.
H. Gillum and A. S. Filean and each of them (with full power to each of them to
act alone), the undersigned's true and lawful attorney-in-fact and agent, with
full power of substitution to each, for and on behalf and in the name of the
undersigned, to execute and file any documents relating to registration under
the Securities Act of 1933 and the Investment Company Act of 1940 with respect
to open-end management investment companies currently organized or to be
organized in the future which are sponsored by Principal Life Insurance Company,
and any and all amendments thereto and reports thereunder with all exhibits and
all instruments necessary or appropriate in connection therewith, each of said
attorneys-in-fact and agents and his or their substitutes being empowered to act
with or without the others or other, and to have full power and authority to do
or cause to be done in the name and on behalf of the undersigned each and every
act and thing necessary or appropriate to be done in order to effectuate the
same, as fully to all intents and purposes as the undersigned might or could do
in person; hereby ratifying and confirming all that said attorneys-in-fact and
agents, or any of them, may do or cause to be done by virtue hereof.

IN WITNESS WHEREOF, the undersigned has hereunto set his hand this 26th day of
February, 1999.

/s/J. B. Griswell
________________
J. B. Griswell

BYLAWS

PRINCIPAL SPECIAL MARKETS FUND, INC.

ARTICLE 1

Name, Fiscal Year

1.01 The name of this corporation shall be Principal Special Markets
Fund, Inc., Inc. Except as otherwise from time to time provided by the board of
directors, the fiscal year of the corporation shall begin January 1 and end
December 31.

ARTICLE 2

Stockholders' Meetings

2.01 Place of Meetings. All meetings of the stockholders shall be held
at such place within or without the State of Maryland, as is stated in the
notice of meeting.

2.02 Annual Meetings. The Board of Directors of the Fund shall
determine whether or not an annual meeting of stockholders shall be held. In the
event that an annual meeting of stockholders is held, such meeting shall be held
on the first Tuesday after the first Monday of April in each year or on such
other day during the 31-day period following the first Tuesday after the first
Monday of April as the directors may determine.

2.03 Special Meetings. Special meetings of the stockholders shall be
held whenever called by the chairman of the board, the president or the board of
directors, or when requested in writing by 10% of the Fund's outstanding shares.

2.04 Notice of Stockholders' Meetings. Notice of each stockholders'
meeting stating the place, date and hour of the meeting and the purpose or
purposes for which the meeting is called shall be given by mailing such notice
to each stockholder of record at his address as it appears on the records of the
corporation not less than 10 nor more than 90 days prior to the date of the
meeting. Any meeting at which all stockholders entitled to vote are present
either in person or by proxy or of which those not present have waived notice in
writing shall be a legal meeting for the transaction of business notwithstanding
that notice has not been given as herein provided.

2.05 Quorum. Except as otherwise expressly required by law, these
bylaws or the Articles of Incorporation, as from time to time amended, at any
meeting of the stockholders the presence in person or by proxy of the holders of
one-third of the shares of capital stock of the Corporation issued and
outstanding and entitled to vote, shall constitute a quorum, but a lesser
interest may adjourn any meeting from time to time and the meeting may be held
as adjourned without further notice. When a quorum is present at any meeting a
majority of the stock represented thereat shall decide any question brought
before such meeting unless the question is one upon which by express provision
of law or of these bylaws or the Articles of Incorporation a larger or different
vote is required, in which case such express provision shall govern.

2.06 Proxies and Voting Stockholders of record may vote at any meeting
either in person or by written proxy signed by the stockholder or by the
stockholder's duly authorized attorney-in-fact dated not more than eleven months
before the date of exercise, which shall be filed with the Secretary of the
meeting before being voted. Each stockholder shall be entitled to one vote for
each share of stock held, and to a fraction of a vote equal to any fractional
share held."

2.07 Stock Ledger. The Corporation shall maintain at the office of the
stock transfer agent of the Corporation, or at the office of any successor
thereto as stock transfer agent of the Corporation, an original stock ledger
containing the names and addresses of all stockholders and the number of shares
of each class held by each stockholder. Such stock ledger may be in written form
or any other form capable of being converted into written form within a
reasonable time for visual inspection.

ARTICLE 3

Board of Directors

3.01 Number, Service. The Corporation shall have a Board of Directors
consisting of not less than two and no more than fifteen members. The number of
Directors to constitute the whole board within the limits above-stated shall be
fixed by the Board of Directors. The Directors may be chosen (i) by stockholders
at any annual meeting of stockholders held for the purpose of electing directors
or at any meeting held in lieu thereof, or at any special meeting called for
such purpose, or (ii) by the Directors at any regular or special meeting of the
Board to fill a vacancy on the Board as provided in these bylaws and Maryland
General Corporation Law. Each director should serve until the next annual
meeting of shareholders and until a successor is duly qualified and elected,
unless sooner displaced.

3.02 Powers. The board of directors shall be responsible for the entire
management of the business of the Corporation. In the management and control of
the property, business and affairs of the Corporation the board of directors is
hereby vested with all the powers possessed by the corporation itself so far as
this designation of authority is not inconsistent with the laws of the State of
Maryland, but subject to the limitations and qualifications contained in the
Articles of Incorporation and in these bylaws.

3.03 Executive Committee and Other Committees. The board of directors
may elect from its members an executive committee of not less than three which
may exercise certain powers of the board of directors when the board is not in
session pursuant to Maryland law. The executive committee may make rules for the
holding and conduct of its meetings and keeping the records thereof, and shall
report its action to the board of directors.

The board of directors may elect from its members such other
committees from time to time as it may desire. The number composing such
committees and the powers conferred upon them shall be determined by the board
of directors at its own discretion.

3.04 Meetings. Regular meetings of the board of directors may be held
in such places within or without the State of Maryland, and at such times as the
board may from time to time determine, and if so determined, notices thereof
need not be given. Special meetings of the board of directors may be held at any
time or place whenever called by the president or a majority of the directors,
notice thereof being given by the secretary or the president, or the directors
calling the meeting, to each director. Special meetings of the board of
directors may also be held without formal notice provided all directors are
present or those not present have waived notice thereof.

3.05 Quorum. A majority of the members of the board of directors from
time to time in office but in no event not less than one-third of the number
constituting the whole board shall constitute a quorum for the transaction of
business provided, however, that where the Investment Company Act of 1940
requires a different quorum to transact business of a specific nature, the
number of directors so required shall constitute a quorum for the transaction of
such business.

A lesser number may adjourn a meeting from time to time and
the meeting may be held without further notice. When a quorum is present at any
meeting a majority of the members present thereat shall decide any question
brought before such meeting except as otherwise expressly required by law, the
Articles of Incorporation or these bylaws.

3.06 Action by Directors Other than at a Meeting. Any action required
or permitted to be taken at any meeting of the Board of Directors, or of any
committee thereof, may be taken without a meeting, if a written consent to such
action is signed by all members of the Board of Directors or such committee, as
the case may be, and such written consent is filed with the minutes of
proceedings of the Board of Directors or committee.

3.07 Holding of Meetings by Conference Telephone Call. At any regular
or special meeting, members of the Board of Directors or any committee thereof
may participate by conference telephone or similar communications equipment by
means of which all persons participating in the meeting can hear each other.
Participation in a meeting pursuant to this Section shall constitute presence in
person at such meeting.

ARTICLE 4

Officers

4.01 Selection. The officers of the corporation shall be a president,
one or more vice presidents, a secretary and a treasurer. The board of directors
may, if it so determines, also elect a chairman of the board. All officers shall
be elected by the board of directors and shall serve at the pleasure of the
board. The same person may hold more than one office except the offices of
president and vice president.

4.02 Eligibility. The chairman of the board, if any, and the president
shall be directors of the corporation. Other officers need not be directors.

4.03 Additional Officers and Agents. The board of directors may appoint
one or more assistant treasurers, one or more assistant secretaries and such
other officers or agents as it may deem advisable, and may prescribe the duties
thereof.

4.04 Chairman of the Board of Directors. The chairman of the board, if
any, shall preside at all meetings of the board of directors at which he is
present. He shall have such other authority and duties as the board of directors
shall from time to time determine.

4.05 The President. The president shall be the chief executive officer
of the corporation; he shall have general and active management of the business,
affairs and property of the corporation, and shall see that all orders and
resolutions of the board of directors are carried into effect. He shall preside
at meetings of stockholders, and of the board of directors unless a chairman of
the board has been elected and is present.
4.06 The Vice Presidents. The vice presidents shall respectively have
such powers and perform such duties as may be assigned to them by the board of
directors or the president. In the absence or disability of the president, the
vice presidents, in the order determined by the board of directors, shall
perform the duties and exercise the powers of the president.

4.07 The Secretary. The secretary shall keep accurate minutes of all
meetings of the stockholders and directors, and shall perform all duties
commonly incident to his office and as provided by law and shall perform such
other duties and have such other powers as the board of directors shall from
time to time designate. In his absence an assistant secretary or secretary pro
tempore shall perform his duties.

4.08 The Treasurer. The treasurer shall, subject to the order of the
board of directors and in accordance with any arrangements for performance of
services as custodian, transfer agent or disbursing agent approved by the board,
have the care and custody of the money, funds, securities, valuable papers and
documents of the corporation, and shall have and exercise under the supervision
of the board of directors all powers and duties commonly incident to his office
and as provided by law. He shall keep or cause to be kept accurate books of
account of the corporation's transactions which shall be subject at all times to
the inspection and control of the board of directors. He shall deposit all funds
of the corporation in such bank or banks, trust company or trust companies or
such firm or firms doing a banking business as the board of directors shall
designate. In his absence, an assistant treasurer shall perform his duties.

ARTICLE 5

Vacancies

5.01 Removals. The stockholders may at any meeting called for the
purpose, by vote of the holders of a majority of the capital stock issued and
outstanding and entitled to vote, remove from office any director and, unless
the number of directors constituting the whole board is accordingly decreased,
elect a successor. To the extent consistent with the Investment Company Act of
1940, the board of directors may by vote of not less than a majority of the
directors then in office remove from office any director, officer or agent
elected or appointed by them and may for misconduct remove any thereof elected
by the stockholders.

5.02 Vacancies. If the office of any director becomes or is vacant by
reason of death, resignation, removal, disqualification, an increase in the
authorized number of directors or otherwise, the remaining directors may by vote
of a majority of said directors choose a successor or successors who shall hold
office for the unexpired term; provided that vacancies on the board of directors
may be so filled only if, after the filling of the same, at least two-thirds of
the directors then holding office would be directors elected to such office by
the stockholders at a meeting or meetings called for the purpose. In the event
that at any time less than a majority of the directors were so elected by the
stockholders, a special meeting of the stockholders shall be called forthwith
and held as promptly as possible and in any event within sixty days for the
purpose of electing an entire new board of directors.

ARTICLE 6

Certificates of Stock

6.01 Certificates. The board of directors may adopt a policy of not
issuing certificates except in extraordinary situations as may be authorized
from time to time by an officer of the Corporation. If such a policy is adopted,
a stockholder may obtain a certificate or certificates of the capital stock of
the Corporation owned by such stockholder only if the stockholder demonstrates a
specific reason for needing a certificate. If issued, the certificate shall be
in such form as shall, in conformity to law, be prescribed from time to time by
the board of directors. Such certificates shall be signed by the chairman of the
board of directors or the president or a vice president and by the treasurer or
an assistant treasurer or the secretary or an assistant secretary. If such
certificates are countersigned by a transfer agent or registrar other than the
Corporation or an employee of the Corporation, the signatures of the
aforementioned officers upon such certificates may be facsimile. In case any
officer or officers who have signed, or whose facsimile signature or signatures
have been used on, any such certificate or certificates shall cease to be such
officer or officers of the Corporation, whether because of death, resignation or
otherwise, before such certificate or certificates have been delivered by the
Corporation, such certificate or certificates may nevertheless be adopted by the
Corporation and be issued and delivered as though the person or persons who
signed such certificate or certificates or whose facsimile signature or
signatures have been used thereon had not ceased to be such officer or officers
of the Corporation.

6.02 Replacement of Certificates. The board of directors may direct a
new certificate or certificates to be issued in place of any certificate or
certificates theretofore issued by the corporation alleged to have been lost or
destroyed. When authorizing such issue of a new certificate or certificates, the
board of directors may, in its discretion and as a condition precedent to the
issuance thereof, require the owner of such lost or destroyed certificate or
certificates, or its legal representative, to advertise the same in such manner
as it shall require and/or to give the corporation a bond in such sum as it may
direct as indemnity against any claim that may be made against the corporation
with respect to the certificate alleged to have been lost or destroyed.

6.03 Stockholder Open Accounts. The corporation may maintain or cause
to be maintained for each stockholder a stockholder open account in which shall
be recorded such stockholder's ownership of stock and all changes therein, and
certificates need not be issued for shares so recorded in a stockholder open
account unless requested by the stockholder and such request is approved by an
officer.

6.04 Transfers. Transfers of stock for which certificates have been
issued will be made only upon surrender to the Corporation or the transfer agent
of the Corporation of a certificate for shares duly endorsed or accompanied by
proper evidence of succession, assignment or authority to transfer, whereupon
the Corporation will issue a new certificate to the person entitled thereto,
cancel the old certificate and record the transaction on its books. Transfers of
stock evidenced by open account authorized by Section 6.03 will be made upon
delivery to the Corporation or the transfer agent of the Corporation of
instructions for transfer or evidence of assignment or succession, in each case
executed in such manner and with such supporting evidence as the Corporation or
transfer agent may reasonably require.

6.05 Closing Transfer Books. The transfer books of the stock of the
corporation may be closed for such period (not to exceed 20 days) from time to
time in anticipation of stockholders' meetings or the declaration of dividends
as the directors may from time to time determine.

6.06 Record Dates. The board of directors may fix in advance a date,
not exceeding ninety days preceding the date of any meeting of stockholders, or
the date for the payment of any dividend, or the date for the allotment of
rights, or the date when any change or conversion or exchange of capital stock
shall go into effect, or a date in connection with obtaining any consent or for
any other lawful purpose, as a record date for the determination of the
stockholders entitled to notice of, and to vote at, any such meeting, and any
adjournment thereof, or entitled to receive payment of any such dividend, or to
any such allotment of rights, or to exercise the rights in respect of any such
change, conversion or exchange of capital stock, or to give such consent, and in
such case such stockholders and only such stockholders as shall be stockholders
of record on the date as fixed shall be entitled to such notice of, and to vote
at, such meeting, and any adjournment thereof, or to receive payment of such
dividend, or to receive such allotment of rights, or to exercise such rights, or
to give such consent, as the case may be, notwithstanding any transfer of any
stock on the books of the Corporation after any such record date fixed as
aforesaid.

6.07 Registered Ownership. The Corporation shall be entitled to
recognize the exclusive right of a person registered on its books as the owner
of shares to receive dividends, and to vote as such owner and shall not be bound
to recognize any equitable or other claim to or interest in such share or shares
on the part of any other person, whether or not it shall have express or other
notice thereof, except as otherwise provided by the laws of the State of
Maryland.

ARTICLE 7

Notices

7.01 Manner of Giving. Whenever under the provisions of the statutes or
of the Articles of Incorporation or of these bylaws notice is required to be
given to any director, committee member, officer or stockholder, it shall not be
construed to mean personal notice, but such notice may be given, in the case of
stockholders, in writing, by mail, by depositing the same in a United States
post office or letter box, in a postpaid sealed wrapper, addressed to each
stockholder at such address as it appears on the books of the corporation, or,
in default to other address, to such stockholder at the General Post Office in
the City of Baltimore, Maryland, and, in the case of directors, committee
members and officers, by telephone, or by mail or by telegram to the last
business address known to the secretary of the corporation, and such notice
shall be deemed to be given at the time when the same shall be thus mailed or
telegraphed or telephoned.

7.02 Waiver. Whenever any notice is required to be given under the
provisions of the statutes or of the Articles of Incorporation or of these
bylaws, a waiver thereof in writing, signed by the person or persons entitled to
said notice, whether before or after the time stated therein, shall be deemed
equivalent thereto.
ARTICLE 8

General Provisions

8.01 Disbursement of Funds. All checks, drafts, orders or instructions
for the payment of money and all notes of the corporation shall be signed by
such officer or officers or such other person or persons as the board of
directors may from time to time designate.

8.02 Voting of Stock in Other Corporations. Unless otherwise ordered by
the board of directors, any officer or, at the direction of any such officer,
any Manager shall have full power and authority to attend and act and vote at
any meeting of stockholders of any corporation in which this Corporation may
hold stock, at of any such meeting may exercise any and all the rights and
powers incident to the ownership of such stock. Any officer of this corporation
or, at the direction of any such officer, any Manager may execute proxies to
vote shares of stock of other corporations standing in the name of this
Corporation."

8.03 Execution of Instruments. Except as otherwise provided in these
bylaws, all deeds, mortgages, bonds, contracts, stock powers and other
instruments of transfer, reports and other instruments may be executed on behalf
of the corporation by the president or any vice president or by any other
officer or agent authorized to act in such matters, whether by law, the Articles
of Incorporation, these bylaws, or any general or special authorization of the
board of directors. If the corporate seal is required, it shall he affixed by
the secretary or an assistant secretary.

8.04 Seal. The corporate seal shall have inscribed thereon the name of
the corporation, the year of its incorporation and the words "Corporate Seal,
Maryland." The seal may be used by causing it or a facsimile thereof to be
impressed or affixed or reproduced or otherwise.

ARTICLE 9

Regulations

9.01 Investment and Related Matters. The Corporation shall not purchase
or hold securities in violation of the investment restrictions enumerated in its
then current prospectus and the registration statement or statements filed with
the Securities and Exchange Commission pursuant to the Securities Act of 1933
and the Investment Company Act of 1940, as amended, nor shall the Corporation
invest in securities the purchase of which would cause the Corporation to
forfeit its rights to continue to publicly offer its shares under the laws,
rules or regulations of any state in which it may become authorized to so offer
its shares unless, by specific resolution of the board of directors, the
Corporation shall elect to discontinue the sale of its shares in such state.

9.02 Other Matters. When used in this section the following words shall
have the following meanings: "Sponsor" shall mean any one or more corporations,
firms or associations which have distributor's contracts in effect with this
Corporation. "Manager" shall mean any corporation, firm or association which may
at the time have an investment advisory contract with this Corporation.

(a) Limitation of Holdings by this Corporation of Certain
Securities and of Dealings with Officers or Directors. This Corporation shall
not purchase or retain securities of any issuer if those officers and directors
of the Fund or its Manager owning beneficially more than one-half of one per
cent (0.5%) of the shares or securities of such issuer together own beneficially
more than five per cent (5%) of such shares or securities; and each officer and
director of this Corporation shall keep the treasurer of this Corporation
informed of the names of all issuers (securities of which are held in the
portfolio of this Corporation) in which such officer or director owns as much as
one-half of one percent (1/2 of 1%) of the outstanding shares or securities and
(except in the case of a holding by the treasurer) this Corporation shall not be
charged with knowledge of any such security holding in the absence of notice
given if as aforesaid if this Corporation has requested such information not
less often than quarterly. The Corporation will not lend any of its assets to
the Sponsor or Manager or to any officer or director of the Sponsor or Manager
or of this Corporation and shall not permit any officer or director, and any
officer or director of the Sponsor or Manager, to deal for or on behalf of the
Corporation with himself as principal agent, or with any partnership,
association or corporation in which he has a financial interest. Nothing
contained herein shall prevent (1) officers and directors of the Corporation
from buying, holding or selling shares in the Corporation, or from being
partners, officers or directors of or otherwise financially interested in the
Sponsor or the Manager or any company controlling the Sponsor or the Manager;
(2) employment of legal counsel, registrar, transfer agent, dividend disbursing
agent or custodian who is, or has a partner shareholder, officer or director who
is, an officer or director of the Corporation, if only customary fees are
charged for services to the Corporation; (3) sharing statistical and research
expenses and office hire and expenses with any other investment company in which
an officer or director of the Corporation is an officer or director or otherwise
financially interested.

(b) Limitation Concerning Participating by Interested Persons
in Investment Decisions. In any case where an officer or director of the
Corporation or of the Manager, or a member of an advisory committee or portfolio
committee of the Corporation, is also an officer or a director of another
corporation, and the purchase or sale of shares issued by that other corporation
is under consideration, the officer or director or committee member concerned
will abstain from participating in any decision made on behalf of the
Corporation to purchase or sell any securities issued by such other corporation.

(c) Limitation on Dealing in Securities of this Corporation by
certain Officers, Directors, Sponsor or Manager. Neither the Sponsor nor
Manager, nor any officer or director of this Corporation or of the Sponsor or
Manager shall take long or short positions in securities issued by this
Corporation, provided, however, that:

(1) The Sponsor may purchase from this Corporation
shares issued by this Corporation if the
orders to purchase from this Corporation are entered with this Corporation by
the Sponsor upon receipt by the Sponsor of purchase orders for shares of this
Corporation and such purchases are not in excess of purchase orders received by
the Sponsor.

(2) The Sponsor may in the capacity of agent for this
Corporation buy securities issued by
this Corporation offered for sale by other persons.

(3) Any officer or director of this Corporation or of
the Sponsor or Manager or any Company
controlling the Sponsor or Manager may at any time, or from time to time,
purchase from this Corporation or from the Sponsor shares issued by this
Corporation at a price not lower than the net asset value of the shares, no such
purchase to be in contravention of any applicable state or federal requirement.

(d) Securities and Cash of this Corporation to be held by
Custodian subject to certain Terms and Conditions.

(1) All securities and cash owned by this Corporation
shall as hereinafter provided, be held
by or deposited with a bank or trust company having (according to its last
published report) not less than two million dollars ($2,000,000) aggregate
capital, surplus and undivided profits (which bank or trust company is hereby
designated as "Custodian"), provided such a Custodian can be found ready and
willing to act.

(2) This Corporation shall enter into a written
contract with the Custodian regarding the
powers, duties and compensation of the Custodian with respect to the cash and
securities of this Corporation held by the Custodian. Said contract and all
amendments thereto shall be approved by the board of directors of this
Corporation.

(3) This Corporation shall upon the resignation or
inability to serve of its Custodian or upon
change of the Custodian:

(aa) in case of such resignation or
inability to serve, use its best efforts to obtain a successor Custodian;

(bb) require that the cash and
securities owned by this Corporation be delivered directly to the successor
Custodian; and

(cc) In the event that no successor
Custodian can be found, submit to the stockholders, before permitting delivery
of the cash and securities owned by this Corporation otherwise than to a
successor Custodian, the question whether or not this Corporation shall be
liquidated or shall function without a Custodian.

(e) Amendment of Investment Advisory Contract. Any investment
advisory contract entered into by this Corporation shall not be subject to
amendment except by (1) affirmative vote at a shareholders meeting, of the
holders of a majority of the outstanding stock of this Corporation, or (2) a
majority of such Directors who are not interested persons (as the term is
defined in the Investment Company Act of 1940) of the Parties to such
agreements, cast in person at a board meeting called for the purpose of voting
on such amendment.

(f) Reports relating to Certain Dividends. Dividends paid from
net profits from the sale of securities shall be clearly revealed by this
Corporation to its shareholders and the basis of calculation shall be set forth.

(g) Maximum Sales Commission. The Corporation shall, in any
distribution contract with respect to its shares of common stock entered into by
it, provide that the maximum sales commission to be charged upon any sales of
such shares shall not be more than nine per cent (9%) of the offering price to
the public of such shares. As used herein, "offering price to the public" shall
mean net asset value per share plus the commission charged adjusted to the
nearest cent.

ARTICLE 10

Purchases and Redemption of Shares:
Suspension of Sales

10.01 Purchase by Agreement. The Corporation may purchase its shares by
agreement with the owner at a price not exceeding the net asset value next
computed following the time when the purchase or contract to purchase is made.

10.02 Redemption. The Corporation shall redeem such shares as are
offered by any stockholder for redemption upon the presentation of a written
request therefor, duly executed by the record owner, to the office or agency
designated by the corporation. If the shareholder has received stock
certificates, the request must be accompanied by the certificates, duly endorsed
for transfer, in acceptable form; and the Corporation will pay therefor the net
asset value of the shares next effective following the time at which the
request, in acceptable form, is so presented. Payment for said shares shall
ordinarily be made by the Corporation to the stockholder within seven days after
the date on which the shares are presented.

10.03 Suspension of Redemption. The obligations set out in Section
10.02 may be suspended (i) for any period during which the New York Stock
Exchange, Inc. is closed other than customary week-end and holiday closings, or
during which trading on the New York Stock Exchange, Inc. is restricted, as
determined by the rules and regulations of the Securities and Exchange
Commission or any successor thereto; (ii) for any period during which an
emergency, as determined by the rules and regulations of the Securities and
Exchange Commission or any successor thereto, exists as a result of which
disposal by the Corporation of securities owned by it is not reasonably
practicable or as a result of which it is not reasonably practicable for the
Corporation to fairly determine the value of its net assets; or (iii) for such
other periods as the Securities and Exchange Commission or any successor thereto
may by order permit for the protection of security holders of the Corporation.
Payment of the redemption or purchase price may be made in cash or, at the
option of the Corporation, wholly or partly in such portfolio securities of the
Corporation as the Corporation may select.

10.04 Suspension of Sales. The Corporation reserves the right to
suspend sales of its shares if, in the judgment of the majority of the board of
directors or a majority of the executive committee of its Board, if such
committee exists, it is in the best interest of the Corporation to do so, such
suspension to continue for such period as may be determined by such majority.

ARTICLE 11

Fractional Shares

11.01 The board of directors may authorize the issue from time to time
of shares of the capital stock of the corporation in fractional denominations,
provided that the transactions in which and the terms upon which shares in
fractional denominations may be issued may from time to time be determined and
limited by or under authority of the board of directors.

ARTICLE 12

Indemnification

12.01 (a) Every person who is or was a director, officer or employee of
this Corporation or of any other corporation which he served at the request of
this Corporation and in which this Corporation owns or owned shares of capital
stock or of which it is or was a creditor shall have a right to be indemnified
by this Corporation against all liability and reasonable expenses incurred by
him in connection with or resulting from a claim, action, suit or proceeding in
which he may become involved as a party or otherwise by reason of his being or
having been a director, officer or employee of this Corporation or such other
corporation, provided (1) said claim, action, suit or proceeding shall be
prosecuted to a final determination and he shall be vindicated on the merits, or
(2) in the absence of such a final determination vindicating him on the merits,
the board of directors shall determine that he acted in good faith and in a
manner he reasonably believed to be in the best interest of the Corporation in
the case of conduct in the director's official capacity with the Corporation and
in all other cases, that the conduct was at least not opposed to the best
interest of the Corporation, and, with respect to any criminal action or
proceeding, had no reasonable cause to believe his conduct was unlawful; said
determination to be made by the board of directors acting through a quorum of
disinterested directors, or in its absence on the opinion of counsel.

(b) For purposes of the preceding subsection: (1) "liability
and reasonable expenses" shall include hut not be limited to reasonable counsel
fees and disbursements, amounts of any judgment, fine or penalty, and reasonable
amounts paid in settlement; (2) "claim, action, suit or proceeding" shall
include every such claim, action, suit or proceeding, whether civil or criminal,
derivative or otherwise, administrative, judicial or legislative, any appeal
relating thereto, and shall include any reasonable apprehension or threat of
such a claim, action, suit or proceeding; (3) the termination of any proceeding
by judgment, order, settlement, conviction or upon a plea of nolo contendere or
its equivalent creates a rebuttable presumption that the director did not meet
the standard of conduct set forth in subsection (a)(2), supra.

(c) Notwithstanding the foregoing, the following limitations
shall apply with respect to any action by or in the right of the Corporation:
(1) no indemnification shall be made in respect of claim, issue or matter as to
which the person seeking indemnification shall have been adjudged to be liable
for negligence or misconduct in the performance of his duty to the Corporation
unless and only to the extent that the Court of Chancery of the State of
Maryland or the court in which such action or suit was brought shall determine
upon application that despite the adjudication of liability but in view of all
the circumstances of the case, such person is fairly and reasonably entitled to
indemnity for such expenses which the Court of Chancery or such other court
shall deem proper; and (2) indemnification shall extend only to reasonable
expenses, including reasonable counsel's fees and disbursements.

(d) The right of indemnification shall extend to any person
otherwise entitled to it under this bylaw whether or not that person continues
to be a director, officer or employee of this Corporation or such other
corporation at the time such liability or expense shall be incurred. The right
of indemnification shall extend to the legal representative and heirs of any
person otherwise entitled to indemnification. If a person meets the requirements
of this bylaw with respect to some matters in a claim, action suit, or
proceeding, but not with respect to others, he shall be entitled to
indemnification as to the former. Advances against liability and expenses may be
made by the Corporation on terms fixed by the board of directors subject to an
obligation to repay if indemnification proves unwarranted.

(e) This bylaw shall not exclude any other rights of
indemnification or other rights to which any director, officer or employee may
be entitled to by contract, vote of the stockholders or as a matter of law.

If any clause, provision or application of this section shall
be determined to be invalid, the other clauses, provisions or applications of
this section shall not be affected but shall remain in full force and effect.
The provisions of this bylaw shall be applicable to claims, actions, suits or
proceedings made or commenced after the adoption hereof, whether arising from
acts or omissions to act occurring before or after the adoption hereof.

(f) Nothing contained in this bylaw shall be construed to
protect any director or officer of the Corporation against any liability to the
Corporation or its security holders to which he would otherwise be subject by
reason of willful misfeasance, bad faith, gross negligence or reckless disregard
of the duties involved in the conduct of his office.

ARTICLE 13

Amendments

13.01 These bylaws may be amended or added to, altered or repealed at
any annual or special meeting of the stockholders by the affirmative vote of the
holders of a majority of the shares of capital stock issued and outstanding and
entitled to vote, provided notice of the general purport of the proposed
amendment, addition, alteration or repeal is given in the notice of said
meeting, or, at any meeting of the board of directors by vote of a majority of
the directors then in office, except that the board of directors may not amend
Article 5 to permit removal by said board without cause of any director elected
by the stockholders.