Prospectus
[Merrill Lynch Logo Appears Here]
Merrill Lynch Utility Income Fund, Inc.
December 29, 1998
This prospectus contains information you should know before
investing, including information about risks. Please read
it before you invest and keep it for future reference.
The Securities and Exchange Commission has not approved or
disapproved these Securities or passed
upon the adequacy of this Prospectus. Any representation to
the contrary is a criminal offense.
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Table of Contents
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PAGE
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KEY FACTS
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The Merrill Lynch Utility Income Fund at a Glance......3
Risk/Return Bar Chart..................................5
Fees and Expenses......................................6
[GRAPHIC APPEARS HERE]
DETAILS ABOUT THE FUND
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How the Fund Invests...................................8
Investment Risks.......................................9
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YOUR ACCOUNT
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Merrill Lynch Select Pricing(SM) System.................16
How to Buy, Sell, Transfer and Exchange Shares........20
Participation in Merrill Lynch Fee-Based Programs.....24
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MANAGEMENT OF THE FUND
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Merrill Lynch Asset Management........................27
Financial Highlights..................................28
[GRAPHIC APPEARS HERE]
FOR MORE INFORMATION
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Shareholder Reports...........................Back Cover
Statement of Additional Information...........Back Cover
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MERRILL LYNCH UTILITY INCOME FUND, INC.
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Key Facts [GRAPHIC APPEARS HERE]
THE MERRILL LYNCH UTILITY INCOME FUND AT A GLANCE
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In an effort to help you better understand the many concepts involved in making
an investment decision, we have defined the highlighted terms in this
prospectus in the sidebar.
UTILITY COMPANIES -- The Fund considers companies that are primarily engaged in
the ownership or operation of facilities used to generate, transmit or
distribute electricity, telecommunications, gas or water to be utility
companies.
COMMON STOCKS -- shares of ownership of a corporation.
BONDS -- debt obligations issued by corporations or governments.
PREFERRED STOCKS -- usually pays dividends at specified rates and have
preference over common stock in dividend payments and liquidation of assets.
WHAT ARE THE FUND'S OBJECTIVE AND GOAL?
The investment objective of the Fund is to seek high current income through
investment of at least 65% of its total assets in equity and debt securities
issued by companies that are, in the opinion of the Investment Adviser,
primarily engaged in the ownership or operation of facilities used to generate,
transmit or distribute electricity, telecommunications, gas or water. In other
words, the Fund's goal is to provide high current income. The Fund cannot
guarantee that it will achieve its investment objective.
WHAT ARE THE FUND'S MAIN INVESTMENT STRATEGIES?
The Fund tries to achieve its goal by investing in a diversified portfolio of
securities issued by UTILITY COMPANIES. The Fund invests primarily in
securities that pay above-average dividends or yields. In selecting
investments, Fund management emphasizes COMMON STOCKS, BONDS and PREFERRED
STOCKS that it believes have the ability to continue paying above-average
dividends or yields. The Fund may also invest up to 20% of its assets in
securities issued by foreign companies.
WHAT ARE THE MAIN RISKS OF INVESTING IN THE FUND?
As with any mutual fund, the value of the Fund's investments, and therefore the
value of your Fund shares, may fluctuate. These changes may occur because the
markets in general are rising or falling. At other times, there are specific
factors that may affect the value of a particular investment. If the value of
the Fund's investments go down, you may lose money. The Fund is also subject to
the risk that the investments that Fund management selects will underperform
the stock market or other funds with similar investment objectives and
investment strategies.
As a sector fund that invests in utility companies, the Fund is subject to the
risks associated with this sector. This makes the Fund more vulnerable to price
changes of utility companies and factors that affect the utilities industry
than a more broadly diversified mutual fund. The prices of securities issued by
utility companies may change in response to interest rate changes. Generally
when interest rates go up, the value of securities issued by utility companies
goes down. Conversely, when interest rates go down, the value of securities
issued by utility companies generally go up. There is no guarantee that this
relationship will continue in the future. Deregulation of the utilities
industry has resulted in increased competition and reduced profitability for
certain companies.
Foreign investing involves special risks -- including foreign currency risk and
the possibility of substantial volatility due to adverse political, economic or
other developments.
MERRILL LYNCH UTILITY INCOME FUND, INC.
3
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[GRAPHIC APPEARS HERE] Key Facts
THE MERRILL LYNCH UTILITY INCOME FUND AT A GLANCE
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WHO SHOULD INVEST?
The Fund may be an appropriate investment for you if you:
o Are seeking current income.
o Want to diversify your portfolio to include exposure to utility
companies.
o Want a professionally managed and diversified portfolio.
MERRILL LYNCH UTILITY INCOME FUND, INC.
4
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RISK/RETURN BAR CHART
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The bar chart and table shown below provide an indication of the risks of
investing in the Fund. The bar chart shows changes in the Fund's performance
for Class B shares from year to year since the Fund's inception. Sales charges
are not reflected in the bar chart. If these amounts were reflected, returns
would be less than those shown. The table compares the average annual total
returns for each class of the Fund's shares for the periods shown with those of
the S&P 500 Index and the Composite Index. How the Fund performed in the past
is not necessarily an indication of how the Fund will perform in the future.
[Bar Chart Appears Here]
1994 -11%
1995 27%
1996 0%
1997 23%
During the period shown in the bar chart, the highest return for a quarter was
14.99% (quarter ended December 31, 1997) and the lowest return for a quarter
was -9.77% (quarter ended March 31, 1994). The year-to-date return as of
September 30, 1998 was 6.94%.
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS
(AS OF THE CALENDAR YEAR ENDED) PAST
DECEMBER 31, 1997 ONE YEAR SINCE INCEPTION
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<S> <C> <C>
Merrill Lynch
Utility Income Fund*A 19.41% 7.76 %+
B 19.42% 8.00 %+
C 22.43% 16.03 %++
D 19.20% 15.28 %++
S&P 500** 33.36% 21.97%/28.74% **
Composite Index# 22.01% 8.04%/16.20 %#
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</TABLE>
* Includes sales charge.
** This unmanaged broad-based index is comprised of common stocks. Past
performance is not predictive of future performance. Since inception total
returns are from October 29, 1993 to December 31, 1997 and from October
21, 1994 to December 31, 1997, respectively, to correspond to the
inception dates of the Fund's different classes.
# This unmanaged market value-weighted composite Index is comprised of the S&P
Electric Utility Index (75%), representing 25 electric utility companies
and the Merrill Lynch C5GO High and Medium Quality Utilities Index (25%),
representing US corporate utility and phone bonds maturing in 1-10 years.
Past performance is not predictive of future performance. Since inception
total returns are from October 29, 1993 to December 31, 1997 and October
31, 1994 to December 31, 1997, respectively, to correspond to the inception
dates of the Fund's different classes. + Inception date is October 29, 1993.
This performance does not reflect the effect of the conversion of Class B
shares to Class D shares after approximately 10 years.
++ Inception date is October 21, 1994.
MERRILL LYNCH UTILITY INCOME FUND, INC.
5
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[GRAPHIC APPEARS HERE] Key Facts
FEES AND EXPENSES
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UNDERSTANDING EXPENSES
Fund investors pay various fees and expenses, either directly or indirectly.
Listed below are some of the main types of expenses, which all mutual funds may
charge:
EXPENSES PAID DIRECTLY BY THE SHAREHOLDER:
SHAREHOLDER FEES -- these include sales charges which you may pay when you buy
or sell shares of the Fund.
EXPENSES PAID INDIRECTLY BY THE SHAREHOLDER:
ANNUAL FUND OPERATING
EXPENSES -- expenses that cover the costs of operating the Fund.
MANAGEMENT FEE -- a fee paid to the Investment Adviser for managing the Fund.
DISTRIBUTION FEES -- fees used to support the Fund's marketing and distribution
efforts, such as compensating Financial Consultants.
SERVICE (ACCOUNT MAINTENANCE) FEES -- fees used to compensate securities
dealers for account maintenance activities.
The Fund offers four different classes of shares. Although your money will be
invested the same way no matter which class of shares you buy, there are
differences among the fees and expenses associated with each class. Not
everyone is eligible to buy every class. After determining which classes you
are eligible to buy, decide which class best suits your needs. Your Merrill
Lynch Financial Consultant can help you with this decision.
This table shows the different fees and expenses that you may pay if you buy
and hold the different classes of shares of the Fund. Future expenses may be
greater or less than those indicated below.
<TABLE>
<CAPTION>
SHAREHOLDER FEES:
(FEES PAID DIRECTLY FROM YOUR INVESTMENT) Class A Class B(a) Class C Class D
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<S> <C> <C> <C> <C>
Maximum Sales Charge (Load) imposed on
purchases (as a percentage of offering
price) 4.00%(b) None None 4.00%(b)
Maximum Deferred Sales Charge (Load) (as
a percentage of original purchase price or
redemption proceeds, whichever is lower) None(c) 4.0%(b) 1.0%(b) None(c)
Maximum Sales Charge (Load) imposed on
Dividend Reinvestments None None None None
Redemption Fee None None None None
Exchange Fee None None None None
Maximum Account Fee None None None None
ANNUAL FUND OPERATING EXPENSES (EXPENSES
THAT ARE DEDUCTED FROM FUND ASSETS):
MANAGEMENT FEE(D)(G) 0.55% 0.55% 0.55% 0.55%
DISTRIBUTION AND/OR SERVICE (12B-1) FEES(e) None 0.75% 0.80% 0.25%
Other Expenses (including transfer agency
fees)(f) 0.74% 0.76% 0.73% 0.74%
Total Annual Fund Operating Expenses(g) 1.29% 2.06% 2.08% 1.54%
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(a) Class B shares automatically convert to Class D shares about ten years
after you buy them and will no longer be subject to distribution fees.
(b) Some investors may qualify for reductions in the sales charge (load).
(c) You may pay a deferred sales charge if you purchase $1 million or more and
you redeem within one year.
(d) The Fund pays the Investment Adviser a fee at the annual rate of 0.55% of
the average daily net assets of the Fund.
(e) The Fund calls the Service Fee an "Account Maintenance Fee." Account
Maintenance Fee is the term used elsewhere in this Prospectus and in other
materials. If you hold Class B or Class C shares for a long time, it may
cost you more in distribution (12b-1) fees than the maximum sales charge
that you would have paid if you had bought one of the other classes.
(f) The Fund pays the Transfer Agent $11.00 for each Class A and Class D
shareholder account and $14.00 for each Class B and Class C shareholder
account and reimburses the Transfer Agent's out-of-pocket expenses. The
Fund pays a 0.10% fee for certain accounts that participate in the Merrill
Lynch Mutual Fund Advisor program. The Fund also pays a $0.20 monthly
closed account charge, which is assessed upon all accounts that close
during the year. This fee begins the month following the month the account
is closed and ends at the end of the calendar year. For the fiscal year
ended August 31, 1998, the Fund paid the Transfer Agent fees totaling
$52,572. The investment adviser provides accounting services to the Fund
at its cost. For the fiscal year ended August 31, 1998, the Fund
reimbursed the Investment Adviser $47,814 for these services.
(g) In addition, Merrill Lynch may charge clients a processing fee (currently
$5.35) when a client buys or redeems shares. As of August 31, 1998, the
Investment Adviser was voluntarily waiving all of its management fees due
from the Fund and voluntarily reimbursing the Fund for a portion of other
expenses (excluding Rule 12b-1 Fees). The Fee Table includes expense
amounts that would have been incurred absent expense reimbursement or fee
waiver arrangements. During the fiscal year ended August 31, 1998, the
Investment Adviser waived management fees and reimbursed expenses totaling
0.70% for Class A shares, 0.69% for Class B shares, 0.68% for Class C
shares and 0.70% for Class D shares after which the Fund's total expense
ratio was 0.59% for Class A shares, 1.37% for Class B shares, 1.40% for
Class C shares and 0.84% for Class D shares. The investment adviser may
discontinue or reduce the expense reimbursement or fee waiver arrangement at
any time without notice.
MERRILL LYNCH UTILITY INCOME FUND, INC.
6
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[GRAPHIC APPEARS HERE] Key Facts
EXAMPLES:
These examples are intended to help you compare the cost of investing in the
Fund with the cost of investing in other mutual funds.
These examples assume that you invest $10,000 in the Fund for the time periods
indicated, that your investment has a 5% return each year, that you pay the
sales charges, if any, that apply to the particular class and that the Fund's
operating expenses remain the same. This assumption is not meant to indicate
you will receive a 5% annual rate of return. Your annual return may be more or
less than the 5% used in this example. Although your actual costs may be higher
or lower, based on these assumptions your costs would be:
EXPENSES IF YOU DID REDEEM YOUR SHARES:
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<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
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<S> <C> <C> <C> <C>
Class A $526 $793 $1,079 $1,894
Class B $609 $846 $1,108 $2,390
Class C $311 $652 $1,119 $2,410
Class D $550 $867 $1,206 $2,161
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EXPENSES IF YOU DID NOT REDEEM YOUR SHARES:
<TABLE>
<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
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<S> <C> <C> <C> <C>
Class A $526 $793 $1,079 $1,894
Class B $209 $646 $1,108 $2,390
Class C $211 $652 $1,119 $2,410
Class D $550 $867 $1,206 $2,161
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MERRILL LYNCH UTILITY INCOME FUND, INC.
7
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Details About the Fund [GRAPHIC APPEARS HERE]
ABOUT THE
PORTFOLIO MANAGER
Walter D. Rogers is a Senior Vice President and the portfolio manager of the
Fund. Mr. Rogers has been a First Vice President of Merrill Lynch Asset
Management since 1997 and a Vice President of Merrill Lynch Asset Management
from 1987 to 1997. Mr. Rogers has been primarily responsible for the management
of the Fund's portfolio since 1993.
ABOUT THE
INVESTMENT ADVISER
The Fund is managed by Merrill Lynch Asset Management.
HOW THE FUND INVESTS
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The Fund's goal is high current income. The Fund tries to achieve its goal by
investing in a diversified portfolio of securities issued by utility companies.
Except during temporary defensive periods, the Fund invests at least 65% of its
assets in securities issued by utility companies. The Fund may invest in common
stocks, bonds and preferred stock. Fund management adjusts the mix of
securities in its portfolio as it sees appropriate to seek to meet the Fund's
objective.
In selecting securities, Fund management emphasizes securities of utility
companies that have strong financial characteristics and are paying above-
average dividends or yields. Fund management analyzes the dividend that a
utility stock pays and whether the company has the ability to continue paying
the dividend in the future. Similarly, when selecting bonds, Fund management
considers the yield a bond provides and whether the company has the ability to
continue paying that yield. Fund management assesses the financial strength of
the utility company by considering factors such as financial resources, quality
of management and overall business prospects.
The Fund also looks for utility companies that may prosper in a deregulated
environment. Historically, utility companies have been highly regulated. There
is a growing movement in the United States to deregulate utility companies,
particularly electric utility and telecommunication companies, and permit
greater competition. Deregulation may allow utility companies to increase their
earnings at a faster rate than was allowed in a regulated environment.
Deregulation presents both opportunities and risks for investors.
The bonds the Fund invests in generally are limited to those rated investment
grade, though the Fund may invest up to 5% of its total assets in junk bonds.
The Fund may invest up to 20% of its total assets in securities of foreign
issuers. (American Depositary Receipts are not included in this 20% limit). The
Fund may also invest in European Depositary Receipts, convertible securities,
when-issued securities, illiquid securities and may engage in securities
lending.
The Fund may or may not choose to use derivatives, such as options and futures,
to hedge against movements in interest rates, currencies and market movements.
The Fund may also write covered call options to enhance income.
MERRILL LYNCH UTILITY INCOME FUND, INC.
8
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The Fund may invest up to 35% of its assets in securities of companies that are
not utility companies. These investments will be selected to meet the Fund's
investment objective.
The Fund will normally invest a portion of its assets in short-term debt
securities, such as commercial paper. Except during temporary defensive
periods, the Fund's investment in short-term securities will not exceed 20% of
its total assets. During temporary defensive periods, the Fund may invest more
heavily in these securities, without limitation. Therefore, the Fund may not
achieve its investment objective. The Fund may also increase its investments in
these securities when Fund management is unable to find enough attractive
long-term investments, to reduce exposure to equities when management believes
it is advisable to do so or to meet redemptions. Investments in short-term debt
securities can be sold easily and have limited risk of loss but earn only
limited returns.
INVESTMENT RISKS
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This section contains a summary discussion of the general risks of investing in
the Fund. As with any mutual fund, there can be no guarantee that the Fund will
meet its goals or that the Fund's performance will be positive for any period
of time.
SECTOR RISK -- Sector risk is the risk that the Fund's concentration in the
securities of utility companies will expose the Fund to the price movements of
companies in one industry more than a more broadly diversified mutual fund.
Because the Fund invests primarily in one sector, there is the risk that the
Fund will perform poorly during a downturn in that sector. The Fund should be
considered a vehicle for diversification and should not be considered a
balanced investment program by itself.
MERRILL LYNCH UTILITY INCOME FUND, INC.
9
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[GRAPHIC APPEARS HERE] Details About the Fund
When interest rates go up, the value of securities issued by utility companies
generally goes down. Although the average dividend yield of utility industry
stocks historically has been higher than those of industrial companies, the
total return of utility industry securities has historically underperformed
those of industrial companies. In most countries and localities, the utilities
industry is regulated by government entities, which can increase costs and
delays for new projects and make it difficult to pass increased costs on to
consumers. In certain areas, deregulation of utilities has resulted in
increased competition and reduced profitability for certain companies. Reduced
profitability as well as new uses of funds (such as for expansion, operations
or stock buybacks) could result in reduced dividend payout rates for utility
companies. In addition, utility companies face the risk of increases in the
cost and reduced availability of fuel (such as oil, coal, nuclear or natural
gas) and high interest costs for borrowing to finance new projects.
STOCK MARKET AND SELECTION RISK -- Stock market risk is the risk that the
stock market will go down in value, including the possibility that the market
will go down sharply and unpredictably. Selection risk is the risk that the
investments that Fund management selects will underperform the stock market or
other funds with similar investment objectives and investment strategies.
INTEREST RATE RISK -- Interest rate risk is the risk that prices of bonds
generally increase when interest rates decline and decrease when interest rates
increase. Prices of longer term securities generally change more in response to
interest rate changes than prices of shorter term securities.
CREDIT RISK -- Credit risk is the risk that the issuer will be unable to pay
the interest or principal when due. The degree of credit risk depends on both
the financial condition of the issuer and the terms of the obligation.
FOREIGN MARKET RISK -- Since the Fund may invest in foreign securities, it
offers the potential for more diversification than an investment only in the
United States. This is because stocks traded on foreign markets have often
(though not always) performed differently than stocks in the United States.
However, such investments involve special risks not present in U.S. investments
that can increase the chances that the Fund will lose money. In particular,
investment in foreign securities involves the following risks, which are
generally greater for investments in emerging markets.
MERRILL LYNCH UTILITY INCOME FUND, INC.
10
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o The economies of certain foreign markets often do not compare favorably
with that of the United States in areas such as growth of gross
national product, reinvestment of capital, resources and balance of
payments. Some of these economies may rely heavily on particular
industries or foreign capital and are more vulnerable to diplomatic
developments, the imposition of economic sanctions against a
particular country or countries, changes in international trading
patterns, trade barriers, and other protectionist or retaliatory
measures.
o Investments in foreign markets may be adversely affected by governmental
actions such as the imposition of capital controls, nationalization
of companies or industries, expropriation of assets, or the
imposition of punitive taxes.
o The governments of certain countries may prohibit or impose substantial
restrictions on foreign investing in their capital markets or in
certain industries. Any of these actions could severely affect
security prices, impair the Fund's ability to purchase or sell
foreign securities or transfer the Fund's assets or income back into
the United States, or otherwise adversely affect the Fund's
operations.
o Other foreign market risks include foreign exchange controls,
difficulties in pricing securities, defaults on foreign government
securities, difficulties in enforcing favorable legal judgments in
foreign courts, and political and social instability. Legal remedies
available to investors in certain foreign countries may be less
extensive than those available to investors in the United States or
other foreign countries.
o Because there are generally fewer investors on foreign exchanges and a
smaller number of shares traded each day, it may be difficult for
the Fund to buy and sell securities on those exchanges. In addition,
prices of foreign securities may go up and down more than prices of
securities traded in the United States.
MERRILL LYNCH UTILITY INCOME FUND, INC.
11
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[GRAPHIC APPEARS HERE] Details About the Fund
o Non-U.S. markets have different clearance and settlement procedures. In
certain markets settlements may be unable to keep pace with the
volume of securities transactions, which may cause delays. If there
is a settlement delay, the Fund's assets may be uninvested and not
earning returns. The Fund may miss investment opportunities or be
unable to dispose of a security because of these delays.
EUROPEAN ECONOMIC AND MONETARY UNION ("EMU") -- A number of European countries
have agreed to enter into EMU in an effort to reduce trade barriers between
themselves and eliminate fluctuations in their currencies. EMU establishes a
single European currency (the euro), which will be introduced on January 1,
1999 and is expected to replace the existing national curriencies of all
initial EMU participants by July 1, 2002. Upon introduction of the euro,
certain securities (beginning with government and corporate bonds) will be
redenominated in the euro. Thereafter, these securities will trade and make
dividend and other payments only in euros. Like other investment companies and
business organizations, including the companies in which the Fund invests, the
Fund could be adversely affected:
o If the euro, or EMU as a whole, does not take effect as planned.
o If a participating country withdraws from EMU.
o If the computing, accounting and trading systems used by the Fund's
service providers, or by other entities with which the Fund or its
service providers do business, are not capable of recognizing the
euro as a distinct currency beginning with euro conversion.
CONVERTIBLES -- Convertibles are generally debt securities or preferred stocks
that may be converted into common stock. Convertibles typically pay current
income, as either interest (debt security convertibles) or dividends (preferred
stocks). A convertible's value usually reflects both the stream of current
income payments and the value of the underlying common stock. The market value
of a convertible performs like regular debt securities; that is, if market
interest rates rise, the value of a convertible usually falls. Since it is
convertible into common stock, the convertible also has the same types of
market and issuer risk as the value of the underlying common stock.
MERRILL LYNCH UTILITY INCOME FUND, INC.
12
<PAGE>
DERIVATIVES -- Derivatives allow the Fund to increase or decrease its risk
exposure more quickly and efficiently than other types of instruments. The Fund
may use the following types of derivative instruments including: Futures,
Forwards and Options.
Derivatives are volatile and involve significant risks, including:
o Leverage risk -- the risk associated with certain types of investments
or trading strategies (such as borrowing money to increase the
amount of investments) that relatively small market movements may
result in large changes in the value of an investment. Certain
investments or trading strategies that involve leverage can result
in losses that greatly exceed the amount originally invested.
o Credit risk -- the risk that the counterparty (the party on the other
side of the transaction) on a derivative transaction will be unable
to honor its financial obligation to the Fund.
o Currency risk -- the risk that changes in the exchange rate between
currencies will adversely affect the value (in U.S. dollar terms) of
an investment.
o Liquidity Risk -- the risk that certain securities may be difficult or
impossible to sell at the time that the seller would like or at the
price that the seller believes the security is currently worth.
The Fund may use derivatives, including anticipatory hedges, for hedging
purposes. The Fund may also write covered call options to enhance income.
Hedging is a strategy in which the Fund uses a derivative is used to offset the
risk that other Fund holdings may decrease in value. While hedging can reduce
losses, it can also reduce or eliminate gains if the market moves in a
different manner than anticipated by the Fund or if the cost of the derivative
outweighs the benefit of the hedge. Hedging also involves the risk that changes
in the value of the derivative will not match those of the holdings being
hedged as expected by the Fund, in which case any losses on the holdings being
hedged may not be reduced. There can be no assurance that the Fund's hedging
strategy will reduce risk or that hedging transactions will be either available
or cost effective. The Fund is not required to use hedging and may choose not
to do so.
MERRILL LYNCH UTILITY INCOME FUND, INC.
13
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[GRAPHIC APPEARS HERE] Details About the Fund
BORROWING AND LEVERAGE -- The Fund may borrow for temporary emergency purposes
including to meet redemptions. Borrowing may exaggerate changes in the net
asset value of Fund shares and in the yield on the Fund's portfolio. Borrowing
will cost the Fund interest expense and other fees. The cost of
borrowing may reduce the Fund's return.
Certain securities that the Fund buys may create leverage, including, for
example, when-issued securities, forward commitments and options.
STATEMENT OF ADDITIONAL INFORMATION
If you would like further information about the Fund, including how it invests,
please see the Statement of Additional Information.
MERRILL LYNCH UTILITY INCOME FUND, INC.
14
<PAGE>
Your Account [GRAPHIC APPEARS HERE]
MERRILL LYNCH SELECT PRICING(SM) SYSTEM
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The Fund offers four share classes, each with its own sales charge and expense
structure, allowing you to invest in the way that best suits your needs. Each
share class represents an ownership interest in the same investment portfolio.
When you choose your class of shares you should consider the size of your
investment and how long you plan to hold your shares. Your Merrill Lynch
Financial Consultant can help you determine which share class is best suited to
your personal financial goals.
For example, if you select Class A or D shares, you generally pay a sales
charge at the time of purchase. If you buy Class D shares, you also pay an
ongoing account maintenance fee of 0.25%. You may be eligible for a sales
charge waiver.
If you select Class B or C shares, you will invest the full amount of your
purchase price, but you will be subject to distribution fees of 0.50% for Class
B shares and 0.55% for Class C shares and account maintenance of 0.25% for both
Class B and Class C shares. Because these fees are paid out of the Fund's
assets on an ongoing basis, over time these fees increase the cost of your
investment and may cost you more than paying an initial sales charge. In
addition, you may be subject to a deferred sales charge when you sell Class B
or C shares.
The Fund's shares are distributed by Merrill Lynch Funds Distributor, a
division of Princeton Funds Distributor, Inc., an affiliate of Merrill Lynch.
MERRILL LYNCH UTILITY INCOME FUND, INC.
15
<PAGE>
[GRAPHIC APPEARS HERE] Your Account
The table below summarizes key features of the Merrill Lynch Select Pricing(SM)
System.
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C CLASS D
------------------------ ---------------------- ---------------------- ----------------------
<S> <C> <C> <C> <C>
Availability Limited to certain Generally available Generally available Generally available
investors including: through Merrill through Merrill through Merrill
o Current Class A Lynch. Limited Lynch. Limited Lynch. Limited
shareholders availability through availability through availability through
o Certain Retirement other securities other securities other securities
Plans dealers. dealers. dealers.
o Participants in
certain Merrill
Lynch sponsored
programs
o Certain affiliates of
Merrill Lynch.
Initial Sales Charge? Yes. Payable at time No. Entire purchase No. Entire purchase Yes. Payable at time
of purchase. Lower price is invested in price is invested in of purchase. Lower
sales charges shares of the Fund. shares of the Fund. sales charges
available for larger available for larger
investments. investments.
Deferred Sales No. (May be charged Yes. Payable if you Yes. Payable if you No. (May be charged
Charge? for purchases over redeem within four redeem within one for purchases over
$1 million that are years of purchase. year of purchase. $1 million that are
redeemed within redeemed within
one year.) one year.)
Account No. 0.25% Account 0.25% Account 0.25% Account
Maintenance and Maintenance Fee Maintenance Fee Maintenance Fee
Distribution Fees? 0.50% Distribution 0.55% Distribution No Distribution Fee.
Fee. Fee.
Conversion to No. Yes, automatically No. No.
Class D shares? after approximately
ten years.
</TABLE>
MERRILL LYNCH UTILITY INCOME FUND, INC.
16
<PAGE>
RIGHT OF ACCUMULATION --
permits you to pay the sales charge that would apply to the cost or value
(whichever is higher) of all shares you own in the Merrill Lynch mutual funds
that offer Select Pricing options.
LETTER OF INTENT -- permits you to pay the sales charge that would be
applicable if you add up all shares of Merrill Lynch Select Pricing System
funds that you agree to buy within a 13 month period. Certain restrictions
apply.
CLASS A AND CLASS D SHARES -- INITIAL SALES CHARGE OPTIONS
If you select Class A or Class D shares, you will pay a sales charge at the
time of purchase.
<TABLE>
<CAPTION>
DEALER
COMPENSATION
AS A % OF AS A % OF AS A % OF
YOUR INVESTMENT OFFERING PRICE YOUR INVESTMENT* OFFERING PRICE
- ------------------------- ---------------- ------------------ ---------------
<S> <C> <C> <C>
Less than $25,000 4.00% 4.17% 3.75%
$25,000 but less than
$50,000 3.75% 3.90% 3.50%
$50,000 but less than
$100,000 3.25% 3.36% 3.00%
$100,000 but less
than $250,000 2.50% 2.56% 2.25%
$250,000 but less
than
$1,000,000 1.50% 1.52% 1.25%
$1,000,000 and
over** 0.00% 0.00% 0.00%
- ----------- ---- ---- ----
</TABLE>
* Rounded to the nearest one-hundredth percent.
** If you invest $1,000,000 or more in Class A or Class D shares, you may not
pay an initial sales charge. However, if you redeem your shares within one
year after purchase, you may be charged a deferred sales charge. This
charge is 1% of the lesser of the original cost of the shares being
redeemed or your redemption proceeds. A sales charge of 0.75% will be
charged on purchases of $1,000,000 or more of Class A or Class D shares by
certain employer sponsored retirement or savings plans.
No initial sales charge applies to Class A or Class D shares that you buy
through reinvestment of dividends or distributions.
A reduced or waived sales charge on a purchase of Class A or Class D shares may
apply for:
o Purchases under a RIGHT OF ACCUMULATION or LETTER OF INTENT.
o Merrill Lynch Blueprint(SM) Program participants.
o TMA(SM) Managed Trusts.
o Certain Merrill Lynch investment or central asset accounts.
o Certain employer-sponsored retirement or savings plans.
o Purchases using proceeds from the sale of certain Merrill Lynch
closed-end funds under certain circumstances.
MERRILL LYNCH UTILITY INCOME FUND, INC.
17
<PAGE>
[GRAPHIC APPEARS HERE] Your Account
o Certain investors, including directors of Merrill Lynch mutual funds and
Merrill Lynch employees.
o Certain Merrill Lynch fee-based programs.
Only certain investors are eligible to buy Class A shares. Your Merrill Lynch
Financial Consultant can help you determine whether you are eligible to buy
Class A shares or to participate in any of these programs.
If you decide to buy shares under the initial sales charge alternative and you
are eligible to buy both Class A and Class D shares, you should buy Class A
since Class D shares are subject to an account maintenance fee, while Class A
shares are not.
If you redeem Class A or Class D shares and within 30 days buy new shares of
the same class, you will not pay a sales charge on the new purchase amount. The
amount eligible for this "Reinstatement Privilege" may not exceed the amount of
your redemption proceeds. To exercise the privilege, contact your Merrill Lynch
Financial Consultant or the Fund's Transfer Agent at 1-800-MER-FUND.
CLASS B AND CLASS C SHARES -- DEFERRED SALES CHARGE OPTIONS
If you select Class B or Class C shares, you do not pay an initial sales charge
at the time of purchase. However, if you redeem your Class B shares within four
years after purchase or your Class C shares within one year after purchase, you
may be required to pay a deferred sales charge. You will also pay distribution
fees of 0.50% for Class B shares and 0.55% for Class C shares and account
maintenance fees of 0.25% for both Class B and Class C shares each year under a
distribution plan that the Fund has adopted under Rule 12b-1. Because these
fees are paid out of the Fund's assets on an ongoing basis, over time these
fees increase the cost of your investment and may cost you more than paying an
initial sales charge. The Distributor uses the money that it receives from the
deferred sales charges and the distribution fees to cover the costs of
marketing, advertising and compensating the Merrill Lynch Financial Consultant
or other securities dealer who assists you in purchasing Fund shares.
CLASS B SHARES
If you redeem Class B shares within four years after purchase, you may be
charged a deferred sales charge. The amount of the charge gradually
MERRILL LYNCH UTILITY INCOME FUND, INC.
18
<PAGE>
decreases as you hold your shares over time, according to the following
schedule:
<TABLE>
<CAPTION>
YEARS SINCE PURCHASE SALES CHARGE*
- ----------------------------- --------------
<S> <C>
0 - 1 4.00%
1 - 2 3.00%
2 - 3 2.00%
3 - 4 1.00%
4 and thereafter 0.00%
- ----------------------------- ----
</TABLE>
* The percentage charge will apply to the lesser of the original cost of the
shares being redeemed or the proceeds of your redemption. Shares acquired
through reinvestment of dividends or distributions are not subject to a
deferred sales charge. Not all Merrill Lynch funds have identical deferred
sales charge schedules. If you exchange your shares for shares of another
fund, the higher charge will apply.
The deferred sales charge relating to Class B shares may be reduced or waived
in certain circumstances, such as:
o Certain post-retirement withdrawals from an IRA or other retirement plan
if you are over 59 1/2 years old.
o Redemption by certain eligible 401(a) and 401(k) plans and group plans
participating in the Merrill Lynch Blueprint Program and certain
retirement plan rollovers.
o Redemption in connection with participation in certain Merrill Lynch
fee-based programs.
o Withdrawals resulting from shareholder death or disability as long as
the waiver request is made within one year of death or disability
or, if later, reasonably promptly following completion of probate,
or in connection with involuntary termination of an account in which
Fund shares are held.
o Withdrawal through the Merrill Lynch Systematic Withdrawal Plan of up to
10% per year of your Class B account value at the time the plan is
established.
Your Class B shares convert automatically into Class D shares approximately ten
years after purchase. Any Class B shares received through reinvestment of
dividends or distributions paid on converting shares will also convert at that
MERRILL LYNCH UTILITY INCOME FUND, INC.
19
<PAGE>
time. Class D shares are subject to lower annual expenses than Class B shares.
The conversion of Class B to Class D shares is not a taxable event for federal
income tax purposes.
Different conversion schedules apply to Class B shares of different Merrill
Lynch mutual funds. For example, Class B shares of a fixed-income fund convert
approximately ten years after purchase compared to approximately eight years
for equity funds. If you acquire your Class B shares in an exchange from
another fund with a shorter conversion schedule, the Fund's ten year conversion
schedule will apply. If you exchange your Class B shares in the Fund for Class
B shares of a fund with a longer conversion schedule, the other fund's
conversion schedule will apply. The length of time that you hold both the
original and exchanged Class B shares in both funds will count toward the
conversion schedule. The conversion schedule may be modified in certain other
cases as well.
CLASS C SHARES
If you redeem Class C shares within one year after purchase, you may be charged
a deferred sales charge of 1.00%. The charge will apply to the lesser of the
original cost of the shares being redeemed or the proceeds of your redemption.
You will not be charged a deferred sales charge when you redeem shares that you
acquire through reinvestment of Fund dividends or distributions. The deferred
sales charge relating to Class C shares may be reduced or waived in connection
with participation in certain Merrill Lynch fee-based programs, involuntary
termination of an account in which Fund shares are held and withdrawals through
the Merrill Lynch Systematic Withdrawal Plan.
Class C shares do not offer a conversion privilege.
HOW TO BUY, SELL, TRANSFER AND EXCHANGE SHARES
- --------------------------------------------------------------------
The chart below summarizes how to buy, sell, transfer and exchange shares
through Merrill Lynch or other securities dealers. You may also buy shares
through the Transfer Agent. To learn more about buying shares through the
Transfer Agent, call 1-800-MER-FUND. Because the selection of a mutual fund
involves many considerations, your Merrill Lynch Financial Consultant may help
you with this decision.
MERRILL LYNCH UTILITY INCOME FUND, INC.
20
<PAGE>
<TABLE>
<CAPTION>
IF YOU WANT TO YOUR CHOICES INFORMATION IMPORTANT FOR YOU TO KNOW
- -------------------- ------------------------------- ------------------------------------------------------------------------
<S> <C> <C>
Buy Shares First, select the share class Refer to the Merrill Lynch Select Pricing table on page 17. Be sure to
appropriate for you read this prospectus carefully.
------------------------------- ------------------------------------------------------------------------
Next, determine the amount The minimum initial investment for the Fund is $1,000 for all
of your investment accounts except:
o $500 for Employee Access(SM) Accounts
o $250 for certain Merrill Lynch fee-based programs
o $100 for Merrill Lynch Blueprint(SM) Program
o $100 for retirement plans
(The minimums for initial investments may be waived or reduced
under certain circumstances.)
------------------------------- ------------------------------------------------------------------------
Have your Merrill Lynch The price of your shares is based on the next calculation of net asset
Financial Consultant or value after your order is placed. Any purchase orders placed within
securities dealer submit your fifteen minutes after the close of business on the New York Stock
purchase order Exchange will be priced at the net asset value determined that day.
Purchase orders placed after that time will be priced at the net asset
value determined on the next business day. The Fund may reject any
order to buy shares and may suspend the sale of shares at any time.
Merrill Lynch may charge a processing fee to confirm a purchase.
This fee is currently $5.35.
------------------------------- ------------------------------------------------------------------------
Or contact the Transfer Agent You can purchase shares by calling the Transfer Agent to request an
application and making a purchase order directly to the Transfer
Agent at the address on the inside back cover of this prospectus.
- -------------------- ------------------------------- ------------------------------------------------------------------------
Add to Your Purchase additional shares The minimum investment for additional purchases is $50 for all
Investment accounts except that retirement plans have a minimum additional
purchase of $1.
(The minimums for additional purchases may be waived under
certain circumstances.)
------------------------------- ------------------------------------------------------------------------
Acquire additional shares All dividends and capital gains distributions are automatically
through the automatic reinvested without a sales charge.
dividend reinvestment plan
Participate in the automatic You may invest a specific amount on a periodic basis through certain
investment plan Merrill Lynch investment or central asset accounts.
- -------------------- ------------------------------- ------------------------------------------------------------------------
Transfer Shares to Transfer to a participating You may transfer your Fund shares only to another securities dealer
Another Securities securities dealer that has entered into an agreement with Merrill Lynch. All
Dealer shareholder services will be available for the transferred shares. You
may only purchase additional shares of funds previously owned
before the transfer. All future trading of these assets must be
coordinated by the receiving firm.
------------------------------------------------------------------------
</TABLE>
MERRILL LYNCH UTILITY INCOME FUND, INC.
21
<PAGE>
[GRAPHIC APPEARS HERE] Your Account
<TABLE>
<CAPTION>
IF YOU WANT TO YOUR CHOICES INFORMATION IMPORTANT FOR YOU TO KNOW
- --------------------- ------------------------------- ------------------------------------------------------------------------
<S> <C> <C>
Transfer Shares Transfer to a You must either:
to Another non-participating securities o Transfer your shares to an account with the Transfer Agent; or
Securities Dealers dealer o Sell your shares.
(continued)
- --------------------- ------------------------------- ------------------------------------------------------------------------
Sell Your Shares Have your Merrill Lynch The price of your shares is based on the next calculation of net asset
Financial Consultant or value after your order is placed. For your redemption request to be
securities dealer submit your priced at the net asset value on the day of your request, you must
sales order submit your request to your dealer within fifteen minutes after that
day's close of business on the New York Stock Exchange (the New
York Stock Exchange generally closes at 4:00 p.m. Eastern time). Any
redemption request placed after that time will be priced at the net
asset value at the close of business on the next business day. Dealers
must submit redemption requests to the Fund not more than thirty
minutes after the close of business on the New York Stock Exchange
on the day the request was received.
Securities dealers, including Merrill Lynch, may charge a fee to
process a redemption of shares. Merrill Lynch currently charges a fee
of $5.35. No processing fee is charged if you redeem shares directly
through the Transfer Agent.
The Fund may reject an order to sell shares under certain
circumstances.
------------------------------- ------------------------------------------------------------------------
Sell through the Transfer You may sell shares held at the Transfer Agent by writing to the
Agent Transfer Agent at the address on the inside back cover of this
prospectus. All shareholders on the account must sign the letter and
signatures must be guaranteed. If you hold stock certficiates, return
the certificates with the letter. The Transfer Agent will normally mail
redemption proceeds within seven days following receipt of a
properly completed request. If you make a redemption request
before the Fund has collected payment for the purchase of shares,
the Fund or the Transfer Agent may delay mailing your proceeds.
This delay will usually not exceed ten days.
If you hold share certificates, they must be delivered to the Transfer
Agent before they can be converted. Check with the Transfer Agent
or your Merrill Lynch Financial Consultant for details.
- --------------------- ------------------------------- -------------------------------------------------------------------------
</TABLE>
MERRILL LYNCH UTILITY INCOME FUND, INC.
22
<PAGE>
<TABLE>
<CAPTION>
IF YOU WANT TO YOUR CHOICES INFORMATION IMPORTANT FOR YOU TO KNOW
- ---------------- ---------------------------- -----------------------------------------------------------------------
<S> <C> <C>
Sell Shares Participate in the Fund's You can choose to receive systematic payments from your Fund
Systematically Systematic Withdrawal Plan account either by check or through direct deposit to your bank
account on a monthly or quarterly basis. If you have a Merrill Lynch
CMA(R), CBA(R) or Retirement Account you can arrange for systematic
redemptions of a fixed dollar amount on a monthly, bi-monthly,
quarterly, semi-annual or annual basis, subject to certain conditions.
Under either method you must have dividends and other
distributions automatically reinvested. For Class B and C shares your
total annual withdrawals cannot be more than 10% per year of the
value of your shares at the time your plan is established. The
deferred sales charge is waived for systematic redemptions. Ask your
Merrill Lynch Financial Consultant for details.
- --------------- -------------------------- -----------------------------------------------------------------------
Exchange Your Select the fund into which You can exchange your shares of the Fund for shares of many other
Shares you want to exchange. Be Merrill Lynch mutual funds. You must have held the shares used in
sure to read that fund's the exchange for at least 15 calendar days before you can exchange
prospectus to another fund.
Each class of Fund shares is generally exchangeable for shares of the
same class of another fund. If you own Class A shares and wish to
exchange into a fund in which you have no Class A shares, you will
exchange into Class D shares.
Some of the Merrill Lynch mutual funds impose a different initial or
deferred sales charge schedule. If you exchange Class A or D shares
for shares of a fund with a higher initial sales charge than you
originally paid, you will be charged the difference at the time of
exchange. If you exchange Class B shares for shares of a fund with a
different deferred sales charge schedule, the higher schedule will
apply. The time you hold Class B or C shares in both funds will count
when determining your holding period for calculating a deferred
sales charge at redemption. If you exchange Class A or D shares for
money market fund shares, you will receive Class A shares of Summit
Cash Reserves Fund. Class B or C shares of the Fund will be
exchanged for Class B shares of Summit.
Although there is currently no limit on the number of exchanges
that you can make, the exchange privilege may be modified or
terminated at any time in the future.
- ------------- ----------------------------- -----------------------------------------------------------------------
</TABLE>
MERRILL LYNCH UTILITY INCOME FUND, INC.
23
<PAGE>
[GRAPHIC APPEARS HERE] Your Account
NET ASSET VALUE -- the market value of the Fund's total assets after deducting
liabilities, divided by the number of shares outstanding.
HOW SHARES ARE PRICED
- --------------------------------------------------------------------------------
When you buy shares, you pay the NET ASSET VALUE, plus any applicable sales
charge. This is the offering price. Shares are also redeemed at their net asset
value, minus any applicable deferred sales charge. The Fund calculates its net
asset value (generally by using market quotations) each day the New York Stock
Exchange is open, fifteen minutes after the close of business on the Exchange
(the Exchange generally closes at 4:00 p.m. Eastern time). The net asset value
used in determining your price is the next one calculated after your purchase
or redemption order is placed. Foreign securities owned by the Fund may trade
on weekends or other days when the Fund does not price its shares. As a result,
the Fund's net asset value may change on days when you will not be able to
purchase or redeem the Fund's shares. If an event occurs after the close of a
foreign exchange that is likely to significantly affect the Fund's net asset
value, "fair value" pricing may be used. This means that the Fund may value its
foreign holdings at prices other than their last closing prices, and the Fund's
net asset value will reflect this.
Generally, Class A shares will have the highest net asset value because that
class has the lowest expenses, and Class D shares will have a higher net asset
value than Class B or Class C shares. Also dividends paid on Class A and Class
D shares will generally be higher than dividends paid on Class B and Class C
shares because Class A and Class D shares have lower expenses.
PARTICIPATION IN MERRILL LYNCH FEE-BASED PROGRAMS
- --------------------------------------------------------------------
If you participate in certain fee-based programs offered by Merrill Lynch, you
may be able to buy Class A shares at net asset value, including by exchanges
from other share classes. Sales charges on the shares being exchanged may be
reduced or waived under certain circumstances.
You generally cannot transfer shares held through a fee-based program into
another account. Instead, you will have to redeem your shares held through the
program and purchase shares of another class, which may be subject to
distribution and account maintenance fees. This may be a taxable event and you
will pay any applicable sales charges.
If you leave one of these programs, your shares may be redeemed or
automatically exchanged into another class of Fund shares or into a money
market fund. The class you receive may be the class you originally owned
MERRILL LYNCH UTILITY INCOME FUND, INC.
24
<PAGE>
DIVIDENDS -- income paid to shareholders. Dividends may be reinvested in
additional Fund shares as they are paid.
DISTRIBUTIONS -- capital gains paid to shareholders. Distributions may be
reinvested in additional Fund shares as they are paid.
when you entered the program, or in certain cases, a different class. If the
exchange is into Class B shares, the period before conversion to Class D shares
may be modified. Any redemption or exchange will be at net asset value.
However, if you participate in the program for less than a specified period,
you may be charged a fee in accordance with the terms of the program.
Details about these features and the relevant charges are included in the
client agreement for each fee-based program and are available from your Merrill
Lynch Financial Consultant.
DIVIDENDS, CAPITAL GAINS AND TAXES
- --------------------------------------------------------------------
The Fund will distribute net investment income on a monthly basis. The Fund
attempts to pay a stable monthly dividend. As a result, some months the Fund
will pay a dividend of less than the full amount of investment income earned
during the particular month, while other months the Fund will pay a dividend
out of accumulated but previously undistributed investment income. The Fund
intends to distribute all of its investment income earned each fiscal year. The
Fund will distribute any net realized long or short-term capital gains
annually. The Fund may also pay a special distribution at the end of the
calendar year to comply with federal tax requirements. If your account is with
Merrill Lynch and you would like to receive DIVIDENDS and DISTRIBUTIONS in
cash, contact your Merrill Lynch Financial Consultant. If your account is with
the Transfer Agent and you would like to receive dividends and distributions in
cash, contact the Transfer Agent.
You will pay tax on dividends and distributions from the Fund whether you
receive them in cash or additional shares. If you redeem Fund shares or
exchange them for shares of another fund, any gain on the transaction may be
subject to
MERRILL LYNCH UTILITY INCOME FUND, INC.
25
<PAGE>
[GRAPHIC APPEARS HERE] Your Account
"BUYING A DIVIDEND"
Unless your investment is in a tax-deferred account, you may want to avoid
buying shares shortly before the Fund pays a dividend or distribution. The
reason? If you buy shares when a fund has realized but not yet distributed
income or capital gains, you will pay the full price for the shares and then
receive a portion of the price back in the form of a taxable distribution.
Before investing you may want to consult your tax adviser.
tax. The Fund intends to make distributions that will either be taxed as
ordinary income or capital gains. Capital gains are taxed at different rates
than ordinary income.
If you are neither a lawful permanent resident nor a citizen of the U.S. or if
you are a foreign entity, the Fund's ordinary income dividends (which include
distributions of net short-term capital gains) will generally be subject to a
30% U.S. withholding tax, unless a lower treaty rate applies.
Dividends and interest received by the Fund may give rise to withholding and
other taxes imposed by foreign countries. Tax conventions between certain
countries and the United States may reduce or eliminate such taxes.
By law, the Fund must withhold 31% of your distributions and proceeds if you
have not provided a taxpayer identification number or social security number.
This section summarizes some of the consequences under current federal tax law
of an investment in the Fund. It is not a substitute for personal tax advice.
Consult your personal tax adviser about the potential tax consequences of an
investment in the Fund under all applicable tax laws.
MERRILL LYNCH UTILITY INCOME FUND, INC.
26
<PAGE>
Management of the Fund [Compass Icon Appears Here]
MERRILL LYNCH ASSET MANAGEMENT
- --------------------------------------------------------------------------------
Merrill Lynch Asset Management, the Fund's Investment Adviser, manages the
Fund's investments and its business operations under the overall supervision of
the Fund's Board of Directors. The Investment Adviser has the responsibility
for making all investment decisions for the Fund. The Investment Adviser has a
sub-advisory agreement with Merrill Lynch Asset Management U.K. Limited, an
affiliate, under which the Investment Adviser may pay a fee for services it
receives. For the fiscal year ended August 31, 1998 the Investment Adviser
received a fee equal to 0.55% of the Fund's average daily net assets, all of
which was voluntarily waived.
Merrill Lynch Asset Management is part of the Asset Management Group, which had
approximately $499 billion in investment company and other portfolio assets
under management as of November 1998. This amount includes assets managed for
Merrill Lynch affiliates.
A NOTE ABOUT YEAR 2000
Many computer systems were designed using only two digits to designate years.
These systems may not be able to distinguish the Year 2000 from the Year 1900
(commonly known as the "Year 2000 Problem"). The Fund could be adversely
affected if the computer systems used by the Fund's management or other Fund
service providers do not properly address this problem before January 1, 2000.
The Fund's management expects to have addressed this problem before then, and
does not anticipate that the services it provides will be adversely affected.
The Fund's other service providers have told the Fund's management that they
also expect to resolve the Year 2000 Problem, and the Fund's management will
continue to monitor the situation as the Year 2000 approaches. However, if the
problem has not been fully addressed, the Fund could be negatively affected.
The Year 2000 Problem could also have a negative impact on the companies in
which the Fund invests, and this could hurt the Fund's investment returns.
MERRILL LYNCH UTILITY INCOME FUND, INC.
27
<PAGE>
[GRAPHIC APPEARS HERE] Management of the Fund
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------
The Financial Highlights table is intended to help you understand the Fund's
financial performance for the period October 29, 1993 to August 31, 1998 (Class
A and Class B shares) and for the period October 21, 1994 to August 31, 1998
(Class C and Class D shares). Certain information reflects financial results
for a single Fund share. The total returns in the table represent the rate that
an investor would have earned on an investment in the Fund (assuming
reinvestment of all dividends and distributions.) This information has been
audited by Deloitte & Touche LLP, whose report, along with the Fund's financial
statements, are included in the Fund's annual report to shareholders, which is
available upon request.
<TABLE>
<CAPTION>
CLASS A
-----------------------------------------------------------
FOR THE
PERIOD
OCTOBER 29,
FOR THE YEAR ENDED AUGUST 31, 1993+ TO
INCREASE (DECREASE) IN ------------------------------------------- AUGUST 31,
NET ASSET VALUE: 1998++ 1997++ 1996 1995 1994
- ------------------------------------------- ---------- ---------- ---------- ---------- ---------------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year $ 9.46 $ 9.17 $ 9.15 $ 8.44 $ 10.00
Investment income -- net .57 .55 .60 .60 .40
Realized and unrealized gain (loss) on
investments and foreign currency
transactions -- net 1.60 .29 .02 .59 ( 1.57)
Total from investment operations 2.17 .84 .62 1.19 ( 1.17)
Less dividends from investment
income -- net (.59) ( .55) ( .60) ( .48) ( .39)
Net asset value, end of year $ 11.04 $ 9.46 $ 9.17 $ 9.15 $ 8.44
TOTAL INVESTMENT RETURN:**
Based on net asset value per share 23.30% 9.36% 6.61% 14.68% (11.84)%#
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of reimbursement .59% .59% .56% .49% .44%*
Expenses 1.29% 1.51% 1.52% 1.87% 1.58%*
Investment income -- net 5.26% 5.79% 5.56% 6.60% 5.92%*
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands) $ 2,110 $1,376 $ 2,108 $ 3,253 $ 4,238
Portfolio turnover 13.36% 5.50% 25.98% 12.59% 8.50%
- ------------------------------------------- ------- ------ ------- ------- ----------
<CAPTION>
CLASS B
----------------------------------------------------------------
FOR THE
PERIOD
OCTOBER 29,
FOR THE YEAR ENDED AUGUST 31, 1993+ TO
INCREASE (DECREASE) IN ----------------------------------------------- AUGUST 31,
NET ASSET VALUE: 1998++ 1997++ 1996 1995 1994
- ------------------------------------------- ----------- ----------- ----------- ----------- ---------------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year $ 9.45 $ 9.17 $ 9.15 $ 8.44 $ 10.00
Investment income -- net .49 .47 .46 .49 .35
Realized and unrealized gain (loss) on
investments and foreign currency
transactions -- net 1.60 .28 .09 .63 ( 1.57)
Total from investment operations 2.09 .75 .55 1.12 ( 1.22)
Less dividends from investment
income -- net ( .51) ( .47) ( .53) ( .41) ( .34)
Net asset value, end of year $ 11.03 $ 9.45 $ 9.17 $ 9.15 $ 8.44
TOTAL INVESTMENT RETURN:**
Based on net asset value per share 22.38% 8.39% 5.86% 13.72% (12.34)%#
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of reimbursement 1.37% 1.36% 1.34% 1.27% 1.21%*
Expenses 2.06% 2.28% 2.29% 2.66% 2.35%*
Investment income -- net 4.52% 5.00% 4.79% 5.75% 5.22%*
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands) $32,540 $27,259 $35,702 $37,498 $ 27,395
Portfolio turnover 13.36% 5.50% 25.98% 12.59% 8.50%
- ------------------------------------------- ------- ------- ------- ------- ----------
</TABLE>
+ Commencement of operations.
++ Based on average shares outstanding.
# Aggregate total investment return.
* Annualized.
** Total investment returns exclude the effects of sales loads.
MERRILL LYNCH UTILITY INCOME FUND, INC.
28
<PAGE>
FINANCIAL HIGHLIGHTS (concluded)
- --------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS C
-------------------------------------------------
FOR THE PERIOD
OCTOBER 21,
FOR THE YEAR ENDED AUGUST 31, 1994+
INCREASE (DECREASE) IN -------------------------------- TO AUGUST 31,
NET ASSET VALUE: 1998++ 1997++ 1996 1995
- --------------------------------------------- ---------- ---------- ---------- ----------------
<S> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year $ 9.44 $ 9.15 $ 9.14 $ 8.17
Investment income -- net .48 .47 .43 .42
Realized and unrealized gain on investments
and foreign currency transactions -- net 1.59 .29 .10 .90
Total from investment operations 2.07 .76 .53 1.32
Less dividends from investment
income -- net ( .50) ( .47) ( .52) ( .35)
Net asset value, end of year $ 11.01 $ 9.44 $ 9.15 $ 9.14
TOTAL INVESTMENT RETURN:**
Based on net asset value per share 22.19% 8.48% 5.65% 16.50%#
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of reimbursement 1.40% 1.42% 1.40% 1.32%*
Expenses 2.08% 2.30% 2.34% 2.77%*
Investment income -- net 4.39% 4.79% 4.75% 5.56%*
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands) $ 2,846 $4,104 $ 2,107 $ 1,377
Portfolio turnover 13.36% 5.50% 25.98% 12.59%
- --------------------------------------------- ------- ------ ------- ---------
<CAPTION>
CLASS D
-------------------------------------------------
FOR THE PERIOD
OCTOBER 21,
FOR THE YEAR ENDED AUGUST 31, 1994+
INCREASE (DECREASE) IN -------------------------------- TO AUGUST 31,
NET ASSET VALUE: 1998++ 1997++ 1996 1995
- --------------------------------------------- ---------- ---------- ---------- ---------------
<S> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year $ 9.47 $ 9.18 $ 9.15 $ 8.17
Investment income -- net .54 .52 .47 .51
Realized and unrealized gain on investments
and foreign currency transactions -- net 1.61 .29 .13 .85
Total from investment operations 2.15 .81 .60 1.36
Less dividends from investment
income -- net ( .56) ( .52) ( .57) ( .38)
Net asset value, end of year $ 11.06 $ 9.47 $ 9.18 $ 9.15
TOTAL INVESTMENT RETURN:**
Based on net asset value per share 23.08% 9.08% 6.46% 17.03%#
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of reimbursement .84% .84% .82% .74%*
Expenses 1.54% 1.76% 1.75% 2.10%*
Investment income -- net 4.97% 5.47% 5.37% 6.14%*
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands) $ 2,362 $1,633 $ 1,416 $ 558
Portfolio turnover 13.36% 5.50% 25.98% 12.59%
- --------------------------------------------- ------- ------ ------- ---------
</TABLE>
+ Commencement of operations.
++ Based on average shares outstanding.
# Aggregate total investment return.
* Annualized.
** Total investment returns exclude the effects of sales loads.
MERRILL LYNCH UTILITY INCOME FUND, INC.
29
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(THIS PAGE INTENTIONALLY LEFT BLANK)
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
POTENTIAL
INVESTORS
OPEN AN ACCOUNT (TWO OPTIONS).
1 2
MERRILL LYNCH TRANSFER AGENT
FINANCIAL CONSULTANT
OR SECURITIES DEALER FINANCIAL DATA SERVICES, INC.
P.O. Box 45289
ADVISES SHAREHOLDERS ON THEIR FUND INVESTMENTS. Jacksonville, Florida 32232-5289
PERFORMS RECORDKEEPING AND REPORTING SERVICES.
DISTRIBUTOR
MERRILL LYNCH FUNDS DISTRIBUTOR,
A DIVISION OF PRINCETON FUNDS DISTRIBUTOR, INC.
P.O. Box 9081
Princeton, New Jersey 08543-9081
ARRANGES FOR THE SALE OF FUND SHARES.
COUNSEL CUSTODIAN
SWIDLER BERLIN THE FUND STATE STREET BANK AND
SHEREFF FRIEDMAN, LLP TRUST COMPANY
919 Third Avenue THE BOARD OF DIRECTORS One Heritage Drive P2N
New York, New York 10022 OVERSEES THE FUND. North Quincy, Massachusetts 02171
PROVIDES LEGAL ADVICE TO THE FUND. HOLDS THE FUND'S ASSETS FOR SAFEKEEPING.
INDEPENDENT AUDITORS INVESTMENT ADVISER
DELOITTE & TOUCHE LLP MERRILL LYNCH ASSET MANAGEMENT, L.P.
117 Campus Drive
Princeton, New Jersey 08540-6400 ADMINISTRATIVE OFFICES
800 Scudders Mill Road
AUDITS THE FINANCIAL Plainsboro, New Jersey 08536
STATEMENTS OF THE FUND ON BEHALF OF
THE SHAREHOLDERS. MAILING ADDRESS
P.O. Box 9011
Princeton, New Jersey 08543-9011
MANAGES THE FUND'S DAY-TO-DAY ACTIVITIES.
</TABLE>
MERRILL LYNCH UTILITY INCOME FUND, INC.
<PAGE>
For More Information [GRAPHIC APPEARS HERE]
SHAREHOLDER REPORTS
Additional information about the Fund's investments is 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. You
may obtain these reports at no cost by calling 1-800-MER-FUND.
The Fund will send you one copy of each shareholder report and certain other
mailings, regardless of the number of Fund accounts you have. To receive
separate shareholder reports for each account, call your Merrill Lynch
Financial Consultant or write to the Transfer Agent at its mailing address.
Include your name, address, tax identification number and Merrill Lynch
brokerage or mutual fund account number. If you have any questions, please call
your Merrill Lynch Financial Consultant or the Transfer Agent at
1-800-MER-FUND.
STATEMENT OF ADDITIONAL INFORMATION
The Fund's Statement of Additional Information contains further information
about the Fund and is incorporated by reference (legally considered to be part
of this prospectus). You may request a free copy by writing the Fund at
Financial Data Services, Inc., P.O. Box 45289, Jacksonville, Florida 32232-5289
or by calling 1-800-MER-FUND.
Contact your Merrill Lynch Financial Consultant or the Fund at the telephone
number or address indicated above, if you have any questions.
Information about the Fund (including the Statement of Additional Information)
can be reviewed and copied at the SEC's Public Reference Room in Washington,
D.C. Call 1-800-SEC-0330 for information on the operation of the public
reference room. This information is also available on the SEC's Internet site
at http://www.sec.gov and copies may be obtained upon payment of a duplicating
fee by writing the Public Reference Section of the SEC, Washington, D.C.
20549-6009.
You should rely only on the information contained in this Prospectus. No one is
authorized to provide you with information that is different.
Investment Company Act file #811-7071
Code #16855-1298
(c)Merrill Lynch Asset Management, L.P.
[Merrill Lynch Logo Appears Here]
Prospectus
Merrill Lynch Utility
Income Fund, Inc.
December 29, 1998
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
MERRILL LYNCH UTILITY INCOME FUND, INC.
P.O. Box 9011, Princeton, New Jersey 08543-9011 o Phone No. (609) 282-2800
----------------
Merrill Lynch Utility Income Fund, Inc. (the "Fund") is a diversified
mutual fund seeking high current income through investment of at least 65% of
its total assets in equity and debt securities issued by companies which are,
in the opinion of Merrill Lynch Asset Management, L.P. (the "Investment
Adviser" or "MLAM"), primarily engaged in the ownership or operation of
facilities used to generate, transmit or distribute electricity,
telecommunications, gas or water. There can be no assurance that the Fund's
investment objective will be achieved.
Pursuant to Merrill Lynch Select Pricing(SM) System, the Fund offers four
classes of shares each with a different combination of sales charges, ongoing
fees and other features. The Merrill Lynch Select Pricing(SM) System permits an
investor to choose the method of purchasing shares that the investor believes
is most beneficial given the amount of the purchase, the length of time the
investor expects to hold the shares and other relevant circumstances.
----------------
This Statement of Additional Information of the Fund is not a prospectus
and should be read in conjunction with the Prospectus of the Fund, dated
December 29, 1998 (the "Prospectus"), which has been filed with the Securities
and Exchange Commission (the "Commission") and can be obtained, without charge,
by calling (800) 637-3863 or by writing the Fund at the above address. The
Prospectus is incorporated by reference into this Statement of Additional
Information, and this Statement of Additional Information has been incorporated
by reference into the Prospectus. The Fund's audited financial statements are
incorporated in this Statement of Additional Information by reference to its
1998 annual report to shareholders. You may request a copy of the annual report
at no charge by calling (800) 456-4587 ext. 789 between 8:00 a.m. and 8:00 p.m.
on any business day.
----------------
MERRILL LYNCH ASSET MANAGEMENT -- INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR -- DISTRIBUTOR
----------------
The date of this Statement of Additional Information is December 29, 1998.
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
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<S> <C>
Investment Objective and Policies ....................................................... 3
Other Investment Policies, Practices, and Risk Factors ................................ 4
Portfolio Strategies Involving Options, Futures and Foreign Exchange Transactions ..... 13
Investment Restrictions ............................................................... 18
Portfolio Turnover .................................................................... 19
Management of the Fund .................................................................. 20
Directors and Officers ................................................................ 20
Compensation of Directors ............................................................. 21
Management and Advisory Arrangements .................................................. 21
Code of Ethics ........................................................................ 23
Purchase of Shares ...................................................................... 24
Initial Sales Charge Alternatives -- Class A and Class D Shares ....................... 24
Reduced Initial Sales Charges ......................................................... 26
Deferred Sales Charge Alternatives -- Class B and Class C Shares ...................... 29
Distribution Plans .................................................................... 32
Limitations on the Payment of Deferred Sales Charges .................................. 34
Redemption of Shares .................................................................... 35
Redemption ............................................................................ 35
Repurchase ............................................................................ 35
Reinstatement Privilege -- Class A and Class D Shares ................................. 36
Pricing of Shares ....................................................................... 36
Determination of Net Asset Value ...................................................... 36
Computation of Offering Price Per Share ............................................... 37
Portfolio Transactions and Brokerage .................................................... 38
Transactions in Portfolio Securities .................................................. 38
Shareholder Services .................................................................... 39
Investment Account .................................................................... 39
Exchange Privilege .................................................................... 40
Fee-Based Programs .................................................................... 42
Retirement Plans ...................................................................... 42
Automatic Investment Plans ............................................................ 42
Automatic Dividend Reinvestment Plan .................................................. 43
Systematic Withdrawal Plans ........................................................... 43
Distributions and Taxes ................................................................. 44
Distributions and Taxes ............................................................... 44
Taxes ................................................................................. 45
Tax Treatment of Options and Futures Transactions ..................................... 47
Special Rules for Certain Foreign Currency Transactions ............................... 47
Performance Data ........................................................................ 48
General Information ..................................................................... 50
Description of Shares ................................................................. 50
Independent Auditors .................................................................. 51
Custodian ............................................................................. 51
Transfer Agent ........................................................................ 51
Legal Counsel ......................................................................... 51
Reports to Shareholders ............................................................... 51
Shareholder Inquiries ................................................................. 51
Additional Information ................................................................ 51
Financial Statements .................................................................... 51
Appendix ................................................................................ A-1
</TABLE>
2
<PAGE>
INVESTMENT OBJECTIVE AND POLICIES
The Fund is a diversified, open-end management investment company. The
Fund's investment objective is to seek high current income through investment
of at least 65% of its total assets in equity and debt securities issued by
companies that are, in the opinion of the Investment Adviser, primarily engaged
in the ownership or operation of facilities used to generate, transmit or
distribute electricity, telecommunications, gas or water. This objective is a
fundamental policy, which the Fund may not change without a vote of a majority
of the Fund's outstanding voting securities, as defined in the Investment
Company Act of 1940, as amended (the "Investment Company Act"). There can be no
assurance that the Fund's investment objective will be achieved.
The Fund at all times, except during temporary defensive periods, will
maintain at least 65% of its total assets invested in equity and debt
securities issued by companies in the utilities industries. The Fund is
permitted to invest up to 35% of its assets in the securities of issuers that
are outside the utilities industries. The Fund reserves the right to hold, as a
temporary defensive measure or as a reserve for redemptions, short-term U.S.
Government securities, money market securities, including repurchase
agreements, or cash in such proportions as, in the opinion of the Investment
Adviser, prevailing market or economic conditions warrant. Except during
temporary defensive periods, such securities or cash will not exceed 20% of its
total assets.
The Fund will invest in common stocks (including preferred or debt
securities convertible into common stocks), preferred stocks and debt
securities. The relative weightings among common stocks, debt securities and
preferred stocks will vary from time to time based upon the Investment
Adviser's judgment of the extent to which investments in each category will
contribute to meeting the Fund's investment objective. Fixed income securities
in which the Fund will invest generally will be limited to those rated
investment grade, that is, rated in one of the four highest rating categories
by Standard & Poor's ("S&P") or Moody's Investors Service, Inc. ("Moody's")
(I.E., securities rated at least BBB by S&P or Baa by Moody's), or deemed to be
of equivalent quality in the judgment of the Investment Adviser. Securities
rated Baa by Moody's are described by it as having speculative characteristics
and, according to S&P, fixed income securities rated BBB normally exhibit
adequate protection parameters, although adverse economic conditions or
changing circumstances are more likely to lead to a weakened capacity to pay
interest and repay principal. The Fund's commercial paper investments at the
time of purchase will be rated "A-1" or "A-2" by S&P or "Prime-1" or "Prime-2"
by Moody's or, if not rated, will be of comparable quality as determined by the
Investment Adviser. The Fund may also invest up to 5% of its total assets at
the time of the purchase in fixed income securities having a minimum rating no
lower than Caa by Moody's or CCC by S&P. The Fund may, but need not, dispose of
any security if it is subsequently downgraded. For a description of ratings of
debt securities see the Appendix.
The Fund may invest in the securities of foreign issuers in the form of
American Depositary Receipts ("ADRs"), European Depositary Receipts ("EDRs") or
other securities convertible into securities of foreign issuers. These
securities may not necessarily be denominated in the same currency as the
securities into which they may be converted. ADRs are receipts typically issued
by an American bank or trust company that evidence ownership of underlying
securities issued by a foreign corporation. EDRs are receipts issued in Europe
that evidence a similar ownership arrangement. Generally, ADRs, which are
issued in registered form, are designed for use in the United States securities
markets, and EDRs, which are issued in bearer form, are designed for use in
European securities markets. The Fund may invest in ADRs and EDRs through both
sponsored and unsponsored arrangements. In a sponsored ADR or EDR arrangement,
the foreign issuer assumes the obligation to pay some or all of the
depository's transaction fees, whereas in an unsponsored arrangement the
foreign issuer assumes no obligations and the depository's transaction fees are
paid by the ADR or EDR holders. Foreign issuers in respect of whose securities
unsponsored ADRs or EDRs have been issued are not necessarily obligated to
disclose material information in the markets in which the unsponsored ADRs or
EDRs are traded and, therefore, there may not be a correlation between such
information and the market value of such securities.
A change in prevailing interest rates is likely to affect the Fund's net
asset value because prices of debt and equity securities of utility companies
tend to increase when interest rates decline and decrease when interest rates
rise.
3
<PAGE>
The Fund may engage in various portfolio strategies to hedge its portfolio
against movements in the securities markets and exchange rates between
currencies by the use of options, futures and options thereon. Utilization of
options and futures transactions involves the risk of imperfect correlation in
movements in the price of options and futures and movements in the price of the
securities or currencies which are the subject of the hedge. There can be no
assurance that a liquid secondary market for options and futures contracts will
exist at any specific time. See "Portfolio Strategies Involving Options and
Futures."
Because of its emphasis on securities of companies in the utilities
industries, the Fund should be considered as a vehicle for diversification and
not as a balanced investment program. The suitability for any particular
investor of a purchase of shares of the Fund will depend upon, among other
things, such investor's investment objectives and such investor's ability to
accept the risks of investing in such securities including the risk of a loss
of principal.
OTHER INVESTMENT POLICIES, PRACTICES, AND RISK FACTORS
UTILITY INDUSTRIES
Under normal circumstances, the Fund will invest at least 65% of its total
assets in common stock (including preferred or debt securities convertible into
common stocks), debt securities and preferred stocks or companies in the
utility industries. To meet its objective of high current income, the Fund may
invest in utility companies that pay higher than average dividends, but have a
lesser potential for capital appreciation. The average dividend yields of
common stocks issued by domestic utility companies historically have exceeded
those of industrial companies' common stocks. For certain periods, the total
return of utility companies' securities has underperformed that of industrial
companies' securities. There can be no assurance that positive relative returns
on utility securities will occur in the future.
The utility companies in which the Fund will invest include companies
which are, in the opinion of the Investment Adviser, primarily engaged in the
ownership or operation of facilities used to generate, transmit or distribute
electricity, telecommunications, gas or water.
Risks that are intrinsic to the utility industries include difficulty in
obtaining an adequate return on invested capital, difficulty in financing large
construction programs during an inflationary period, restrictions on operations
and increased cost and delays attributable to environmental considerations and
regulation, difficulty in raising capital in adequate amounts on reasonable
terms in periods of high inflation and unsettled capital markets, technological
innovations that may render existing plants, equipment or products obsolete,
the potential impact of natural or man-made disasters, increased costs and
reduced availability of certain types of fuel, occasionally reduced
availability and high costs of natural gas for resale, the effects of energy
conservation, the effects of a national energy policy and lengthy delays and
greatly increased costs and other problems associated with the design,
construction, licensing, regulation and operation of nuclear facilities for
electric generation, including, among other considerations, the problems
associated with the use of radioactive materials and the disposal of
radioactive wastes. There are substantial differences between the regulatory
practices and policies of various jurisdictions, and any given regulatory
agency may make major shifts in policy from time to time. There is no assurance
that regulatory authorities will, in the future, grant rate increases or that
such increases will be adequate to permit the payment of dividends on common
stocks. Additionally, existing and possible future regulatory legislation may
make it even more difficult for these utilities to obtain adequate relief.
Certain of the issuers of securities held in the Fund's portfolio may own or
operate nuclear generating facilities. Governmental authorities may from time
to time review existing policies, and impose additional requirements governing
the licensing, construction and operation of nuclear power plants. Prolonged
changes in climatic conditions can also have a significant impact on both the
revenues of an electric and gas utility as well as the expenses of a utility,
particularly a hydro-based electric utility.
Utility companies are generally subject to regulation. Most utility
companies are regulated by state and/or federal authorities. Such regulation is
intended to ensure appropriate standards of service and adequate capacity to
meet public demand. Generally, prices are also regulated with the intention of
protecting the public while ensuring that the rate of return earned by utility
companies is sufficient to allow them to attract capital in order
4
<PAGE>
to grow and continue to provide appropriate services. There can be no assurance
that such pricing policies or rates of return will continue in the future.
The nature of regulation of the utility industries is evolving. In recent
years, changes in regulation increasingly have allowed utility companies to
provide services and products outside their traditional geographic areas and
lines of business, creating new areas of competition within the industries. In
some instances, utility companies are operating on an unregulated basis.
Because of trends toward deregulation and the evolution of independent power
producers as well as new entrants to the field of telecommunications,
non-regulated providers of utility services have become a significant part of
their respective industries. The Investment Adviser believes that the emergence
of competition and deregulation will result in certain utility companies being
able to earn more than their traditional regulated rates of return, while
others may be forced to defend their core business from increased competition
and may be less profitable. Reduced profitability, as well as new uses of funds
(such as for expansion, operations or stock buybacks) could result in cuts in
dividend payout rates. The Investment Adviser seeks to take advantage of
favorable investment opportunities that may arise from these structural
changes. Of course, there can be no assurance that favorable developments will
occur in the future.
The revenues of utility companies generally reflect the economic growth
and development in the geographic areas in which they do business. The
Investment Adviser will take into account anticipated economic growth rates and
other economic developments when selecting securities of utility companies.
ELECTRIC. The electric utility industry consists of companies that are
engaged principally in the generation, transmission and sale of electric
energy, although many also provide other energy-related services. In the past,
electric utility companies, in general, have been favorably affected by lower
fuel and financing costs and the full or near completion of major construction
programs. In addition, many of these companies have generated cash flows in
excess of current operating expenses and construction expenditures, permitting
some degree of diversification into unregulated businesses. Some electric
utilities have also taken advantage of the right to sell power outside of their
traditional geographic areas. Electric utility companies have historically been
subject to the risks associated with increases in fuel and other operating
costs, high interest costs on borrowings needed for capital construction
programs, costs associated with compliance with environmental and safety
regulations and changes in the regulatory climate. As interest rates declined,
many utilities refinanced high cost debt and in doing so improved their fixed
charges coverage. Regulators, however, lowered allowed rates of return as
interest rates declined and thereby caused the benefits of the rate declines to
be shared wholly or in part with customers.
The construction and operation of nuclear power facilities is subject to
increased scrutiny by, and evolving regulations of, the Nuclear Regulatory
Commission and state agencies having comparable jurisdiction. Increased
scrutiny might result in higher operating costs and higher capital
expenditures, with the risk that the regulators may disallow inclusion of these
costs in rate authorizations or the risk that a company may not be permitted to
operate or complete construction of a facility. In addition, operators of
nuclear power plants may be subject to significant costs for disposal of
nuclear fuel and for decommissioning such plants.
In October 1993, S&P stiffened its debt-ratings formula for the electric
utility industry, stating that the industry is in long-term decline. In
addition, Moody's stated that it expected a drop in the next three years in its
average credit ratings for the industry. Reasons set forth for these outlooks
included slowing demand and increasing cost pressures as a result of
competition from rival providers. Subsequent to that time, these rating
agencies have noted that, as a whole, electric utility companies have been
taking positive steps to reduce costs through operational efficiencies, limits
on capital expenditures and the use of excess cash flow to reduce debt.
Nevertheless, both agencies indicate that the changes occurring in the industry
present pressures on credit quality from the uncertainties that exist or are
increasing.
Currently, several states are considering deregulation proposals. The
introduction of competition into the industry as a result of deregulation may
result in lower revenue, lower credit ratings, increased default risk, and
lower electric utility security prices. Such increased competition may also
cause long-term contracts, which electric utilities previously entered into to
buy power, to become "stranded assets" which have no economic value. Any loss
associated with such contracts must be absorbed by ratepayers and investors. In
addition, in anticipation of increasing competition, some electric utilities
have acquired electric utilities overseas to diversify, enhance earnings and
gain experience in operating in a deregulated environment. In some instances,
such acquisitions
5
<PAGE>
have involved significant borrowings, which have burdened the acquirer's
balance sheet. There is no assurance that current deregulation proposals will
be adopted. However, deregulation in any form could significantly impact the
electric utilities industry.
TELECOMMUNICATIONS. The telecommunications industry today includes both
traditional telephone companies, with a history of broad market coverage and
highly regulated businesses, and cable companies, which began as small, lightly
regulated businesses focused on limited markets. Today these two historically
different businesses are converging in an industry which is trending toward
larger, competitive, national and international markets with an emphasis on
deregulation. Companies that distribute telephone services and provide access
to the telephone networks still comprise the greatest portion of this segment,
but non-regulated activities such as cellular telephone services, paging, data
processing, equipment retailing, computer software and hardware services are
becoming increasingly significant components as well. The presence of
unregulated companies in this industry and the entry of traditional telephone
companies into unregulated or less regulated businesses provide significant
investment opportunities with companies which may increase their earnings at
faster rates than had been allowed in traditional regulated businesses. Still,
increasing competition, technological innovations and other structural changes
could adversely affect the profitability of such utilities and the growth rate
of their dividends. Given mergers, certain marketing tests currently underway
and proposed legislation and enforcement changes, it is likely that both
traditional telephone companies and cable companies will soon provide a greatly
expanded range of utility services, including two-way video and informational
services to both residential, corporate and governmental customers.
In February 1996, the Telecommunications Act of 1996 became law. The Act
removed regulatory restrictions on entry that prevented local and long-distance
telephone companies and cable television companies from competing against one
another. The Act also removed most cable rate controls and allows broadcasters
to own more radio and television stations.
GAS. Gas transmission companies and gas distribution companies are also
undergoing significant changes. Interstate transmission companies are regulated
by the Federal Energy Regulatory Commission, which is reducing its regulation
of the industry. Many companies have diversified into oil and gas exploration
and development, making returns more sensitive to energy prices. In the recent
decade, gas utility companies have been adversely affected by disruptions in
the oil industry and have also been affected by increased concentration and
competition. In the opinion of the Investment Adviser, however, environmental
considerations could improve the gas industry outlook in the future. For
example, natural gas is the cleanest of the hydrocarbon fuels, and this may
result in incremental shifts in fuel consumption toward natural gas and away
from oil and coal, even for electricity generation.
WATER. Water supply utilities are companies that collect, purify,
distribute and sell water. The industry is highly fragmented because most of
the supplies are owned by local authorities. Companies in this industry are
generally mature and are experiencing little or no per capita volume growth. In
the opinion of the Investment Adviser, there may be opportunities for certain
companies to acquire other water utility companies and for foreign acquisition
of domestic companies. The Investment Adviser believes that favorable
investment opportunities may result from consolidation of this segment.
There can be no assurance that the positive developments noted above will
occur or that risk factors other than those noted above will not develop in the
future.
INVESTMENT OUTSIDE THE UTILITY INDUSTRIES
As noted above, the Fund is permitted to invest up to 35% of its assets in
securities of issuers that are outside the utility industries. Such investments
may include common stocks, debt securities or preferred stocks and will be
selected to meet the Fund's investment objective of high current income. Some
of these issuers may be in industries related to utility industries and,
therefore, may be subject to similar risks. Securities that are issued by
foreign companies or are denominated in foreign currencies are subject to the
risks outlined below.
The Fund is also permitted to invest in securities issued or guaranteed by
the U.S. Government, its agencies or instrumentalities ("U.S. Government
Securities"). Such investments may be backed by the "full faith and
6
<PAGE>
credit" of the United States, including U.S. Treasury bills, notes and bonds as
well as certain agency securities and mortgage-backed securities issued by the
Government National Mortgage Associates ("GNMA"). The guarantees on these
securities do not extend to the securities' yield or value or to the yield or
value of the Fund's shares. Other investments in agency securities are not
necessarily backed by the "full faith and credit" of the United States, such as
certain securities issued by the Federal National Mortgage Association
("FNMA"), the Federal Home Loan Mortgage Corporation, the Student Loan
Marketing Association, and the Farm Credit Bank.
CONVERTIBLE SECURITIES
Convertible securities entitle the holder to receive interest payments
paid on corporate debt securities or the dividend preference on a preferred
stock until such time as the convertible security matures or is redeemed or
until the holder elects to exercise the conversion privilege.
The characteristics of convertible securities include the potential for
capital appreciation as the value of the underlying common stock increases, the
relatively high yield received from dividend or interest payments as compared
to common stock dividends and decreased risks of decline in value relative to
the underlying common stock due to their fixed-income nature. As a result of
the conversion feature, however, the interest rate or dividend preference on a
convertible security is generally less than would be the case if the securities
were issued in nonconvertible form.
In analyzing convertible securities, the Investment Adviser will consider
both the yield on the convertible security and the potential capital
appreciation that is offered by the underlying common stock.
Convertible securities are issued and traded in a number of securities
markets. Even in cases where a substantial portion of the convertible
securities held by the Fund are denominated in United States dollars, the
underlying equity securities may be quoted in the currency of the country where
the issuer is domiciled. With respect to convertible securities denominated in
a currency different from that of the underlying equity securities, the
conversion price may be based on a fixed exchange rate established at the time
the security is issued. As a result, fluctuations in the exchange rate between
the currency in which the debt security is denominated and the currency in
which the share price is quoted will affect the value of the convertible
security.
Apart from currency considerations, the value of convertible securities is
influenced by both the yield of nonconvertible securities of comparable issuers
and by the value of the underlying common stock. The value of a convertible
security viewed without regard to its conversion feature (I.E., strictly on the
basis of its yield) is sometimes referred to as its "investment value." To the
extent interest rates change, the investment value of the convertible security
typically will fluctuate. However, at the same time, the value of the
convertible security will be influenced by its "conversion value," which is the
market value of the underlying common stock that would be obtained if the
convertible security were converted. Conversion value fluctuates directly with
the price of the underlying common stock. If, because of a low price of the
common stock the conversion value is substantially below the investment value
of the convertible security, the price of the convertible security is governed
principally by its investment value.
To the extent the conversion value of a convertible security increases to
a point that approximates or exceeds its investment value, the price of the
convertible security will be influenced principally by its conversion value. A
convertible security will sell at a premium over the conversion value to the
extent investors place value on the right to acquire the underlying common
stock while holding a fixed-income security.
Holders of convertible securities generally have a claim on the assets of
the issuer prior to the common stockholders but may be subordinated to other
debt securities of the same issuer. A convertible security may be subject to
redemption at the option of the issuer at a price established in the charter
provision, indenture or other governing instrument pursuant to which the
convertible security was issued. If a convertible security held by the Fund is
called for redemption, the Fund will be required to redeem the security,
convert it into the underlying common stock or sell it to a third party.
Certain convertible debt securities may provide a put option to the holder
which entitles the holder to cause the security to be redeemed by the issuer at
a premium over the stated principal amount of the debt security under certain
circumstances.
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FOREIGN INVESTMENT RISKS
FOREIGN MARKET RISK. Because the Fund may invest up to 20% of its total
assets in foreign securities, the Fund offers you more diversification than an
investment only in the United States since prices of securities traded on
foreign markets have often, though not always, moved counter to prices in the
United States. Foreign security investment, however, involves special risks not
present in U.S. investments that can increase the chances that the Fund will
lose money. In particular, the Fund is subject to the risk that because there
are generally fewer investors on foreign exchanges and a smaller number of
shares traded each day, it may be difficult for the Fund to buy and sell
securities on those exchanges. In addition, prices of foreign securities may
fluctuate more than prices of securities traded in the United States.
FOREIGN ECONOMY RISK. The economies of certain foreign markets often do
not compare favorably with that of the United States with respect to such
issues as growth of gross national product, reinvestment of capital, resources,
and balance of payments position. Certain such economies may rely heavily on
particular industries or foreign capital and are more vulnerable to diplomatic
developments, the imposition of economic sanctions against a particular country
or countries, changes in international trading patterns, trade barriers, and
other protectionist or retaliatory measures. Investments in foreign markets may
also be adversely affected by governmental actions such as the imposition of
capital controls, nationalization of companies or industries, expropriation of
assets, or the imposition of punitive taxes. In addition, the governments of
certain countries may prohibit or impose substantial restrictions on foreign
investing in their capital markets or in certain industries. Any of these
actions could severely affect security prices, impair the Fund's ability to
purchase or sell foreign securities or transfer the Fund's assets or income
back into the United States, or otherwise adversely affect the Fund's
operations. Other foreign market risks include foreign exchange controls,
difficulties in pricing securities, defaults on foreign government securities,
difficulties in enforcing favorable legal judgments in foreign courts, and
political and social instability. Legal remedies available to investors in
certain foreign countries may be less extensive than those available to
investors in the United States or other foreign countries.
CURRENCY RISK AND EXCHANGE RISK. Securities in which the Fund invests may
be denominated or quoted in currencies other than the U.S. dollar. Changes in
foreign currency exchange rates will affect the value of the securities of the
Fund. Generally, when the U.S. dollar rises in value against a foreign
currency, your investment in a security denominated in that currency loses
value because the currency is worth fewer U.S. dollars. Similarly when the U.S.
dollar decreases in value against a foreign currency, your investment in a
security denominated in that currency gains value because the currency is worth
more U.S. dollars. This risk is generally known as "currency risk" which is the
possibility that a stronger U.S. dollar will reduce returns for U.S. investors
investing overseas and a weak U.S. dollar will increase returns for U.S.
investors investing overseas.
GOVERNMENTAL SUPERVISION AND REGULATION/ACCOUNTING STANDARDS. Many foreign
governments supervise and regulate stock exchanges, brokers and the sale of
securities less than the United States does. Other countries may not have laws
to protect investors the way that the United States' securities laws do. For
example, some foreign countries may have no laws or rules against insider
trading (this is when a person buys or sells a company's securities based on
"inside" non-public information about that company). Accounting standards in
other countries are not necessarily the same as in the United States. If the
accounting standards in another country do not require as much detail as U.S.
accounting standards, it may be harder for the Fund's portfolio manager to
completely and accurately determine a company's financial condition. Also,
brokerage commissions and other costs of buying or selling securities often are
higher in foreign countries than they are in the United States. This reduces
the amount the Fund can earn on its investments.
CERTAIN RISKS OF HOLDING FUND ASSETS OUTSIDE THE UNITED STATES. The Fund
generally holds the foreign securities and cash in which it invests outside the
United States in foreign banks and securities depositories. Certain of such
foreign banks and securities depositories may be recently organized or new to
the foreign custody business and/or may have operations subject to limited or
no regulatory oversight. Also, the laws of certain countries may put limits on
the Fund's ability to recover its assets if a foreign bank or depository or
issuer of a security or any or their agents goes bankrupt. In addition, it can
be expected that it will be more expensive for the Fund to buy, sell, and hold
securities in certain foreign markets than in the U.S. market due to higher
brokerage, transaction, custody and/or other costs. The increased expense to
invest in foreign market reduces the
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amount the Fund can earn on its investments and typically results in a higher
operating expense ratio for the Fund than investment companies invested only in
the U.S.
Settlement and clearance procedures in certain foreign markets differ
significantly from those in the United States. Foreign settlement procedures
and trade regulations also may involve certain risks (such as delays in payment
for or delivery of securities) not typically generated by the settlement of
U.S. investments. Communications between the United States and emerging market
countries may be unreliable, increasing the risk of delayed settlements or
losses of security certificates. Settlements in certain foreign countries at
times have not kept pace with the number of securities transactions; these
problems may make it difficult for the Fund to carry out transactions. If the
Fund cannot settle or is delayed in settling a purchase of securities, it may
miss attractive investment opportunities and certain of its assets may be
uninvested with no return earned thereon for some period. If the Fund cannot
settle or is delayed in settling a sale of securities, it may lose money if the
value of the security then declines or, if it has contracted to sell the
security to another party, the Fund could be liable to that party for any
losses incurred.
Dividends or interest on, or proceeds from the sale of, foreign securities
may be subject to foreign withholding taxes, and special U.S. tax
considerations may apply.
EUROPEAN ECONOMIC AND MONETARY UNION ("EMU"). For a number of years,
certain European countries have been seeking economic unification that would,
among other things, reduce barriers between countries, increase competition
among companies, reduce government subsidies in certain industries, and reduce
or eliminate currency fluctuations among these European countries. The Treaty
on European Union (the "Maastricht Treaty") seeks to set out a framework for
the European Economic and Monetary Union ("EMU") among the countries that
comprise the European Union ("EU"). Among other things, EMU establishes a
single common European currency (the "euro") that will be introduced on January
1, 1999 and is expected to replace the existing national currencies of all EMU
participants by July 1, 2002. EMU is scheduled to take effect for the initial
EMU participants as of January 1, 1999, and will be implemented over the
weekend January 1, 1999 through January 3, 1999 ("conversion weekend"). Upon
implementation of EMU, certain securities issued in participating EU countries
(beginning with government and corporate bonds) will be redenominated in the
euro, and thereafter, will be listed, traded, and make dividend and other
payments only in euros.
No assurance can be given that EMU will take effect, that the changes
planned for the EU can be successfully implemented, or that these changes will
result in the economic and monetary unity and stability intended. There is a
possibility that EMU will not be implemented, will be implemented but not
completed, or will be completed but then partially or completely unwound.
Because any participating country may opt out of EMU within the first three
years, it is also possible that a significant participant could choose to
abandon EMU, which would diminish its credibility and influence. Any of these
occurrences could have adverse effects on the markets of both participating and
non-participating countries, including sharp appreciation or depreciation of
the participants' national currencies and a significant increase in exchange
rate volatility, a resurgence in economic protectionism, an undermining of
confidence in the European markets, an undermining of European economic
stability, the collapse or slowdown of the drive toward European economic
unity, and/or reversion of the attempts to lower government debt and inflation
rates that were introduced in anticipation of EMU. Also, withdrawal from EMU at
any time after the conversion weekend by an initial participant could cause
disruption of the financial markets as securities redenominated in euros are
transferred back into that country's national currency, particularly if the
withdrawing country is a major economic power. Such developments could have an
adverse impact on the Fund's investments in Europe generally or in specific
countries participating in EMU. Gains or losses resulting from the euro
conversion may be taxable to Fund shareholders under foreign or, in certain
limited circumstances, U.S. tax laws.
In addition, computer, accounting, and trading systems must be capable of
recognizing the euro as a distinct currency immediately after the conversion
weekend. Like other investment companies and business organizations, the Fund
could be adversely affected if the computer, accounting, and trading systems
used by the Investment Adviser, the Fund's service providers, or other entities
with which the Fund or its service providers do business do not properly
address this issue prior to January 4, 1999.
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WHEN-ISSUED SECURITIES AND FORWARD COMMITMENTS. The Fund may purchase or
sell securities that it is entitled to receive on a when-issued basis. The Fund
may also purchase or sell securities through a forward commitment. These
transactions involve the purchase or sale of securities by the Fund at an
established price with payment and delivery taking place in the future. The
Fund enters into these transactions to obtain what is considered an
advantageous price to the Fund at the time of entering into the transaction.
The Fund has not established any limit on the percentage of its assets that may
be committed in connection with these transactions. When the Fund is purchasing
securities in these transactions, the Fund maintains a segregated account with
its custodian of cash, cash equivalents, U.S. Government securities or other
liquid securities in an amount equal to the amount of its purchase commitments.
There can be no assurance that a security purchased on a when-issued basis
will be issued, or a security purchased or sold through a forward commitment
will be delivered. The value of securities in these transactions on the
delivery date may be more or less than the Fund's purchase price. The Fund may
bear the risk of a decline in the value of the security in these transactions
and may not benefit from an appreciation in the value of the security during
the commitment period.
ILLIQUID OR RESTRICTED SECURITIES. The Fund may invest up to 15% of its
net assets in securities that lack an established secondary trading market or
otherwise are considered illiquid. Liquidity of a security relates to the
ability to dispose easily of the security and the price to be obtained upon
disposition of the security, which may be less than would be obtained for a
comparable more liquid security. Illiquid securities may trade at a discount
from comparable, more liquid investments. Investment of the Fund's assets in
illiquid securities may restrict the ability of the Fund to dispose of its
investments in a timely fashion and for a fair price as well as its ability to
take advantage of market opportunities. The risks associated with illiquidity
will be particularly acute where the Fund's operations require cash, such as
when the Fund redeems shares or pays dividends, and could result in the Fund
borrowing to meet short-term cash requirements or incurring capital losses on
the sale of illiquid investments.
The Fund may invest in securities that are not registered ("restricted
securities.") under the Securities Act of 1933, as amended (the "Securities
Act"). Restricted securities may be sold in private placement transactions
between the issuers and their purchasers and may be neither listed on an
exchange nor traded in other established markets. In many cases, privately
placed securities may not be freely transferable under the laws of the
applicable jurisdiction or due to contractual restrictions on resale. As a
result of the absence of a public trading market, privately placed securities
may be less liquid and more difficult to value than publicly traded securities.
To the extent that privately placed securities may be resold in privately
negotiated transactions, the prices realized from the sales, due to
illiquidity, could be less than those originally paid by the Fund or less than
their fair market value. In addition, issuers whose securities are not publicly
traded may not be subject to the disclosure and other investor protection
requirements that may be applicable if their securities were publicly traded.
If any privately placed securities held by the Fund are required to be
registered under the securities laws of one or more jurisdictions before being
resold, the Fund may be required to bear the expenses of registration. Certain
of the Fund's investments in private placements may consist of direct
investments and may include investments in smaller, less-seasoned issuers,
which may involve greater risks. These issuers may have limited product lines,
markets or financial resources, or they may be dependent on a limited
management group. In making investments in such securities, the Fund may obtain
access to material nonpublic information which may restrict the Fund's ability
to conduct portfolio transactions in such securities.
144A SECURITIES. The Fund may purchase restricted securities that can be
offered and sold to "qualified institutional buyers" under Rule 144A under the
Securities Act. The Board of Directors has determined to treat as liquid Rule
144A securities that are either (i) freely tradable in their primary markets
offshore or (ii) non-investment grade debt securities that the Fund's
management determines are as liquid as publicly registered non-investment grade
debt securities. The Board of Directors has adopted guidelines and delegated to
the Fund's management the daily function of determining and monitoring
liquidity of restricted securities. The Board of Directors, however, will
retain sufficient oversight and be ultimately responsible for the
determinations. Since it is not possible to predict with assurance exactly how
this market for restricted securities sold and offered under Rule 144A will
continue to develop, the Board of Directors will carefully monitor the Fund's
investments in
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these securities. This investment practice could have the effect of increasing
the level of illiquidity in the Fund to the extent that qualified institutional
buyers become for a time uninterested in purchasing these securities.
STANDBY COMMITMENT AGREEMENTS. The Fund may enter into standby commitment
agreements. These agreements commit the Fund, for a stated period of time, to
purchase a stated amount of securities that may be issued and sold to the Fund
at the option of the issuer. The price of the security is fixed at the time of
the commitment. At the time of entering into the agreement the Fund is paid a
commitment fee, regardless of whether or not the security is ultimately issued.
The Fund will enter into such agreements for the purpose of investing in the
security underlying the commitment at a price that is considered advantageous
to the Fund. The Fund will not enter into a standby commitment with a remaining
term in excess of 45 days and will limit its investment in such commitments so
that the aggregate purchase price of securities subject to such commitments,
together with the value of portfolio securities subject to legal restrictions
on resale that affect their marketability, will not exceed 15% of its net
assets taken at the time of the commitment. The Fund will maintain a segregated
account with its custodian of cash, cash equivalents, U.S. Government
securities or other liquid securities in an aggregate amount equal to the
purchase price of the securities underlying the commitment.
There can be no assurance that the securities subject to a standby
commitment will be issued and the value of the security, if issued, on the
delivery date may be more or less than its purchase price. Since the issuance
of the security underlying the commitment is at the option of the issuer, the
Fund may bear the risk of a decline in the value of such security and may not
benefit from an appreciation in the value of the security during the commitment
period.
The purchase of a security subject to a standby commitment agreement and
the related commitment fee will be recorded on the date on which the security
can reasonably be expected to be issued, and the value of the security will
thereafter be reflected in the calculation of the Fund's net asset value. The
cost basis of the security will be adjusted by the amount of the commitment
fee. In the event the security is not issued, the commitment fee will be
recorded as income on the expiration date of the standby commitment.
REPURCHASE AGREEMENTS. The Fund may invest in securities pursuant to
repurchase agreements. Repurchase agreements may be entered into only with a
member bank of the Federal Reserve System or primary dealer in U.S. Government
securities or an affiliate thereof. Under such agreements, the bank or primary
dealer or an affiliate thereof agrees, upon entering into the contract, to
repurchase the security at a mutually agreed upon time and price, thereby
determining the yield during the term of the agreement. This insulates the Fund
from fluctuations in the market value of the underlying security during such
period, although, to the extent the repurchase agreement is not denominated in
U.S. dollars, the Fund's return may be affected by currency fluctuations. The
Fund may not invest more than 15% of its net assets in repurchase agreements
maturing in more than seven days (together with other illiquid securities).
Repurchase agreements may be construed to be collateralized loans by the
purchaser to the seller secured by the securities transferred to the purchaser.
The Fund will require the seller to provide additional collateral if the market
value of the securities falls below the repurchase price at any time during the
term of the repurchase agreement. In the event of default by the seller under a
repurchase agreement construed to be a collateralized loan, the underlying
securities are not owned by the Fund but only constitute collateral for the
seller's obligation to pay the repurchase price. Therefore, the Fund may suffer
time delays and incur costs or possible losses in connection with the
disposition of the collateral. In the event of a default under such a
repurchase agreement, instead of the contractual fixed rate of return, the rate
of return to the Fund shall be dependent upon intervening fluctuations of the
market value of such security and the accrued interest on the security. In such
event, the Fund would have rights against the seller for breach of contract
with respect to any losses arising from market fluctuations following the
failure of the seller to perform.
SECURITIES LENDING. The Fund may lend securities with a value not
exceeding 33 1/3% of its total assets. In return, the Fund receives collateral
in an amount equal to at least 100% of the current market value of the loaned
securities in cash or securities issued or guaranteed by the U.S. Government.
If cash collateral is received by the Fund, it is invested in short-term money
market securities, and a portion of the yield received in respect of such
investment is retained by the Fund. Alternatively, if securities are delivered
to the Fund as collateral, the Fund and the borrower negotiate a rate for the
loan premium to be received by the Fund for lending its portfolio securities.
In either event, the total yield on the Fund's portfolio is increased by loans
of its portfolio securities. The
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Fund may receive a flat fee for its loans. The loans are terminable at any time
and the borrower, after notice, is required to return borrowed securities
within five business days. The Fund may pay reasonable finder's, administrative
and custodial fees in connection with its loans. In the event that the borrower
defaults on its obligation to return borrowed securities because of insolvency
or for any other reason, the Fund could experience delays and costs in gaining
access to the collateral and could suffer a loss to the extent the value of the
collateral falls below the market value of the borrowed securities.
JUNK BONDS. Fixed income securities in which the Fund will invest
generally will be limited to those rated investment grade; that is, rated in
one of the four highest rating categories by S&P or Moody's (I.E., securities
rated at least BBB by S&P or Baa by Moody's), or deemed to be of equivalent
quality in the judgment of the Investment Adviser. The Fund is authorized to
invest up to 5% of its total assets at the time of purchase in junk bonds.
Junk bonds are debt securities that are rated below investment grade by
the major rating agencies or are unrated securities that the fund management
believes are of comparable quality. Although junk bonds generally pay higher
rates of interest than investment grade bonds, they are high-risk investments
that may cause income and principal losses for the Fund. The major risk in junk
bond investments include:
Junk bonds may be issued by less creditworthy companies. These securities
are vulnerable to adverse changes in the issuer's industry and to general
economic conditions. Issuers of junk bonds may be unable to meet their interest
or principal payment obligations because of an economic downturn, specific
issuer developments or the unavailability of additional financing.
The issuers of junk bonds may have a larger amount of outstanding debt
relative to their assets than issuers of investment grade bonds. If the issuer
experiences financial stress, it may be unable to meet its debt obligations.
The issuer's ability to pay its debt obligations also may be lessened by
specific issuer developments, or the unavailability of additional financing.
Junk bonds are frequently ranked junior in claims by other creditors. If
the issuer cannot meet its obligations, the senior obligations are generally
paid off before the junior obligations.
Junk bonds frequently have redemption features that permit an issuer to
repurchase the security from the Fund before it matures. If the issuer redeemed
the junk bonds the Fund may have to invest the proceeds in bonds with lower
yields and may lose income.
Prices of junk bonds are subject to extreme price fluctuations. Negative
economic developments may have a greater impact on the prices of junk bonds
than on other higher rated fixed-income securities.
Junk bonds may be less liquid than higher rated fixed-income securities
even under normal economic conditions. There are fewer dealers in the junk bond
market, and there may be significant differences in the prices quoted for junk
bonds by the dealers. Because they are less liquid judgment may play a greater
role in valuing certain of the Fund's portfolio securities than in the case
with securities trading in a more liquid market.
The Fund may incur expenses to the extent necessary to seek recovery upon
default or to negotiate a new terms with a defaulting issuer.
Investments in junk bonds will be made only when, in the judgment of the
Investment Adviser, such securities provide attractive total return potential,
relative to the risk of such securities, as compared to higher quality debt
securities. The Fund will not invest in debt securities in the lowest rating
categories (CC or lower for S&P or Ca or lower for Moody's) unless the
Investment Adviser believes that the financial condition of the issuer or the
protection afforded the particular securities is stronger than would otherwise
be indicated by such low ratings.
BORROWING AND LEVERAGE. The use of leverage by the Fund creates an
opportunity for greater total return, but, at the same time, creates special
risks. For example, leveraging may exaggerate changes in the net asset value of
Fund shares and in the yield on the Fund's portfolio. Although the principal of
such borrowings will be fixed, the Fund's assets may change in value during the
time the borrowings are outstanding. Borrowings will
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create interest expenses for the Fund which can exceed the income from the
assets purchased with the borrowings. To the extent the income or capital
appreciation derived from securities purchased with borrowed funds exceeds the
interest the Fund will have to pay on the borrowings, the Fund's return will be
greater than if leverage had not been used. Conversely, if the income or
capital appreciation from the securities purchased with such borrowed funds is
not sufficient to cover the cost of borrowing, the return to the Fund will be
less than if leverage had not been used, and therefore the amount available for
distribution to shareholders as dividends and other distributions will be
reduced. In the latter case, the Investment Adviser in its best judgment
nevertheless may determine to maintain the Fund's leveraged position if it
expects that the benefits to the Fund's shareholders of maintaining the
leveraged position will outweigh the current reduced return.
Certain types of borrowings by the Fund may result in the Fund being
subject to covenants in credit agreements relating to asset coverage, portfolio
composition requirements and other matters. It is not anticipated that
observance of such covenants would impede the Investment Adviser from managing
the Fund's portfolio in accordance with the Fund's investment objectives and
policies. However, a breach of any such covenants not cured within the
specified cure period may result in acceleration of outstanding indebtedness
and require the Fund to dispose of portfolio investments at a time when it may
be disadvantageous to do so.
The Fund at times may borrow from affiliates of the Investment Adviser,
provided that the terms of such borrowings are no less favorable than those
available from comparable sources of funds in the marketplace.
PORTFOLIO STRATEGIES INVOLVING OPTIONS, FUTURES AND FOREIGN EXCHANGE
TRANSACTIONS
The Fund is authorized to use certain derivative instruments, including
options and futures, and to purchase and sell foreign exchange, as described
below.
Although certain risks are involved in options and futures transactions
(as discussed below in "Risk Factors in Options, Futures and Currency
Instruments"), the Investment Adviser believes that, because the Fund will (i)
use derivatives to enhance income only through writing covered options on
portfolio securities and (ii) engage in any other options and futures
transactions only for hedging purposes, the options and futures portfolio
strategies of the Fund will not subject the Fund to the risks frequently
associated with the speculative use of options and futures transactions. While
the Fund's use of hedging strategies is intended to reduce the volatility of
the net asset value of Fund shares, the Fund's net asset value will fluctuate.
There can be no assurance that the Fund's hedging transactions will be
effective. Furthermore, the Fund will only engage in hedging activities from
time to time and may not necessarily be engaging in hedging activities when
movements in the equity, debt or currency markets occur.
OPTIONS ON SECURITIES AND SECURITIES INDICES
PURCHASING OPTIONS. The Fund is authorized to purchase put options on
securities held in its portfolio or securities indices the performance of which
is substantially replicated by securities held in its portfolio for hedging
purposes. The Fund may also purchase put options on U.S. Treasury Securities
for the purpose of hedging its portfolio of interest rate sensitive equity
securities against the adverse effects of anticipated movements in interest
rates. When the Fund purchases a put option, in consideration for an upfront
payment (the "option premium") the Fund acquires a right to sell to another
party specified securities owned by the Fund at a specified price (the
"exercise price") on or before a specified date (the "expiration date"), in the
case of an option on securities, or to receive from another party a payment
based on the amount a specified securities index declines below a specified
level on or before the expiration date, in the case of an option on a
securities index. The purchase of a put option limits the Fund's risk of loss
in the event of a decline in the market value of the portfolio holdings
underlying the put option prior to the option's expiration date. If the market
value of the portfolio holdings associated with the put option increases rather
than decreases, however, the Fund will lose the option premium and will
consequently realize a lower return on the portfolio holdings than would have
been realized without the purchase of the put. The Fund will not purchase put
options on securities or securities indices if, as a result of such purchase,
the aggregate cost of all outstanding options on securities and securities
indices held by the Fund would exceed 5% of the market value of the Fund's
total assets.
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The Fund is also authorized to purchase call options on securities held in
its portfolio on which it has written call options, securities it intends to
purchase or securities indices the performance of which substantially
replicates the performance of the types of securities it intends to purchase.
When the Fund purchases a call option, in consideration for the option premium
the Fund acquires a right to purchase from another party specified securities
at the exercise price on or before the expiration date, in the case of an
option on securities, or to receive from another party a payment based on the
amount a specified securities index increases beyond a specified level on or
before the expiration date, in the case of an option on a security index. The
purchase of a call option may protect the Fund from having to pay more for a
security as a consequence of increases in the market value for the security
during a period when the Fund is contemplating its purchase, in the case of an
option on a security, or attempting to identify specific securities in which to
invest in a market the Fund believes to be attractive, in the case of an option
on an index (an "anticipatory hedge"). In the event the Fund determines not to
purchase a security underlying a call option, however, the Fund may lose the
entire option premium.
The Fund is also authorized to purchase put or call options in connection
with closing out put or call options it has previously sold.
WRITING COVERED OPTIONS. The Fund is authorized to write (I.E., sell) call
options on securities held in its portfolio or securities indices the
performance of which is substantially correlated to securities held in its
portfolio. When the Fund writes a call option, in return for an option premium
the Fund gives another party the right to buy specified securities owned by the
Fund at the exercise price on or before the expiration date, in the case of an
option on securities, or agrees to pay to another party an amount based on any
gain in a specified securities index beyond a specified level on or before the
expiration date, in the case of an option securities index. The Fund may write
call options on securities to earn income, through the receipt of option
premiums; the Fund may write call options on securities indices for hedging
purposes. In the event the party to which the Fund has written an option fails
to exercise its rights under the option because the value of the underlying
securities is less than the exercise price, the Fund will partially offset any
decline in the value of the underlying securities through the receipt of the
option premium. By writing a call option, however, the Fund limits its ability
to sell the underlying securities, and gives up the opportunity to profit from
any increase in the value of the underlying securities beyond the exercise
price, while the option remains outstanding.
The Fund may also write put options on securities or securities indices.
When the Fund writes a put option, in return for an option premium the Fund
gives another party the right to sell to the Fund a specified security at the
exercise price on or before the expiration date, in the case of an option on a
security, or agrees to pay to another party an amount based on any decline in a
specified securities index below a specified level on or before the expiration
date, in the case of an option on a securities index. The Fund may write put
options to earn income, through the receipt of option premiums. In the event
the party to which the Fund has written an option fails to exercise its rights
under the option because the value of the underlying securities is greater than
the exercise price, the Fund will profit by the amount of the option premium.
By writing a put option, however, the Fund will be obligated to purchase the
underlying security at a price that may be higher than the market value of the
security at the time of exercise as long as the put option is outstanding, in
the case of an option on a security, or make a cash payment reflecting any
decline in the index, in the case of an option on an index. Accordingly, when
the Fund writes a put option it is exposed to a risk of loss in the event the
value of the underlying securities falls below the exercise price, which loss
potentially may substantially exceed the amount of option premium received by
the Fund for writing the put option. The Fund will write a put option on a
security or a securities index only if the Fund would be willing to purchase
the security at the exercise price for investment purposes (in the case of an
option on a security) or is writing the put in connection with trading
strategies involving combinations of options -- for example, the sale and
purchase of options with identical expiration dates on the same security or
index but different exercise prices (a technique called a "spread"). The Fund
will not write put options if the aggregate value of the obligations underlying
all outstanding puts shall exceed 50% of the Fund's net assets.
The Fund is also authorized to sell call options in connection with
closing out call options it has previously purchased.
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Other than with respect to closing transactions, the Fund will write only
call options that are "covered." A call option will be considered covered if
the Fund has segregated assets with respect to such option in the manner
described in "Risk Factors in Options, Futures and Currency Instruments" below.
A call option will also be considered covered if the Fund owns the securities
it would be required to deliver upon exercise of the option (or, in the case of
option on a securities index, securities which substantially replicate the
performance of such index) or owns a call option, warrant or convertible
instrument which is immediately exercisable for, or convertible into, such
security. The Fund will not write covered put options or covered call options
on any stock index if the cash, cash equivalents, liquid securities, or other
assets used at cover for such options have an aggregate value of greater than
50% of the Fund's net assets.
TYPES OF OPTIONS. The Fund may engage in transactions in the options on
securities or securities indices described above on U.S. and foreign exchanges
and in the over-the-counter ("OTC") markets. In general, exchange-traded
options have standardized exercise prices and expiration dates and require the
parties to post margin against their obligations, and the performance of the
parties' obligations in connection with such options is guaranteed by the
exchange or a related clearing corporation. OTC options have more flexible
terms negotiated between the buyer and seller, but generally do not require the
parties to post margin and are subject to greater risk of counterparty default.
See "Additional Risk Factors of OTC Transactions" below.
FUTURES
The Fund may engage in transactions in futures and options thereon.
Futures are standardized, exchange-traded contracts that obligate a purchaser
to take delivery, and a seller to make delivery, of a specific amount of a
commodity at a specified future date at a specified price. No price is paid
upon entering into a futures contract. Rather, upon purchasing or selling a
futures contract the Fund is required to deposit collateral ("margin") equal to
a percentage (generally less than 10%) of the contract value. Each day
thereafter until the futures position is closed, the Fund will pay additional
margin representing any loss experienced as a result of the futures position
the prior day or be entitled to a payment representing any profit experienced
as a result of the futures position the prior day.
The sale of a futures contract limits the Fund's risk of loss through a
decline in the market value of portfolio holdings correlated with the futures
contract prior to the futures contract's expiration date. In the event the
market value of the portfolio holdings correlated with the futures contract
increases rather than decreases, however, the Fund will realize a loss on the
futures position and a lower return on the portfolio holdings than would have
been realized without the purchase of the futures contract.
The purchase of a futures contract may protect the Fund from having to pay
more for securities as a consequence of increases in the market value for such
securities during a period when the Fund was attempting to identify specific
securities in which to invest in a market the Fund believes to be attractive.
In the event that such securities decline in value or the Fund determines not
to complete an anticipatory hedge transaction relating to a futures contract,
however, the Fund may realize a loss relating to the futures position.
The Fund will limit transactions in futures and options on futures to
financial futures contracts (I.E., contracts for which the underlying commodity
is a currency or securities or interest rate index) purchased or sold for
hedging purposes (including anticipatory hedges). The Fund will further limit
transactions in futures and options on futures to the extent necessary to
prevent the Fund from being deemed a "commodity pool operator" under
regulations of the Commodity Futures Trading Commission.
FOREIGN EXCHANGE TRANSACTIONS
The Fund may engage in spot and forward foreign exchange transactions,
purchase and sell options on currencies and purchase and sell currency futures
and related options thereon (collectively, "Currency Instruments") for purposes
of hedging against possible variations in foreign exchange rates. Such
transactions may be effected with respect to hedges on non-U.S. dollar
denominated securities owned by the Fund, sold by the Fund but not yet
delivered, or committed or anticipated to be purchased by the Fund.
15
<PAGE>
Forward foreign exchange transactions are OTC contracts to purchase or
sell a specified amount of a specified currency or multinational currency unit
at a price and future date set at the time of the contract. Spot foreign
exchange transactions are similar but require current, rather than future,
settlement. The Fund will enter into foreign exchange transactions only for
purposes of hedging either a specific transaction or a portfolio position. The
Fund may enter into a foreign exchange transaction for purposes of hedging a
specific transaction by, for example, purchasing a currency needed to settle a
security transaction or selling a currency in which the Fund has received or
anticipates receiving a dividend or distribution. The Fund may enter into a
foreign exchange transaction for purposes of hedging a portfolio position by
selling forward a currency in which a portfolio position of the Fund is
denominated or by purchasing a currency in which the Fund anticipates acquiring
a portfolio position in the near future.
The Fund may also hedge against the decline in the value of a currency
against the U.S. dollar through use of currency futures or options thereon.
Currency futures are similar to forward foreign exchange transactions except
that futures are standardized, exchange-traded contracts. See "Futures" above.
The Fund may also hedge against the decline in the value of a currency
against the U.S. dollar through the use of currency options. Currency options
are similar to options on securities, but in consideration for an option
premium the writer of a currency option is obligated to sell (in the case of a
call option) or purchase (in the case of a put option) a specified amount of a
specified currency on or before the expiration date for a specified amount of
another currency. The Fund may engage in transactions in options on currencies
either on exchanges or OTC markets. See "Types of Options" above and
"Additional Risk Factors of OTC Transactions" below.
The Fund will not speculate in Currency Instruments. Accordingly, the Fund
will not hedge a currency in excess of the aggregate market value of the
securities which it owns (including receivables for unsettled securities
sales), or has committed to or anticipates purchasing, which are denominated in
such currency. The Fund may, however, hedge a currency by entering into a
transaction in a Currency Instrument denominated in a currency other than the
currency being hedged (a "cross-hedge"). The Fund will enter into a cross hedge
only if the Investment Adviser believes that (i) there is a demonstrable high
correlation between the currency in which the cross-hedge is denominated and
the currency being hedged, and (ii) executing a cross-hedge through the
currency in which the cross-hedge is denominated will be significantly more
cost-effective or provide substantially greater liquidity than executing a
similar hedging transaction by means of the currency being hedged. The Fund may
not incur potential net liabilities with respect to currency or securities
positions, including net liabilities with respect to cross-currency hedges, of
more than 20% of its total assets from foreign currency options, futures or
related options and forward currency transactions. The Fund will not
necessarily attempt to hedge all of its foreign portfolio positions.
RISK FACTORS IN HEDGING FOREIGN CURRENCY RISKS. While the Fund's use of
Currency Instruments to effect hedging strategies is intended to reduce the
volatility of the net asset value of the Fund's shares, the net asset value of
the Fund's shares will fluctuate. Moreover, although Currency Instruments will
be used with the intention of hedging against adverse currency movements,
transactions in Currency Instruments involve the risk that anticipated currency
movements will not be accurately predicted and that the Fund's hedging
strategies will be ineffective. To the extent that the Fund hedges against
anticipated currency movements which do not occur, the Fund may realize losses,
and decrease its total return, as the result of its hedging transactions.
Furthermore, the Fund will only engage in hedging activities from time to time
and may not be engaging in hedging activities when movements in currency
exchange rates occur. It may not be possible for the Fund to hedge against
currency exchange rate movements, even if correctly anticipated, in the event
that (i) the currency exchange rate movement is so generally anticipated that
the Fund is not able to enter into a hedging transaction at an effective price,
or (ii) the currency exchange rate movement relates to a market with respect to
which Currency Instruments are not available (such as certain developing
markets) and it is not possible to engage in effective foreign currency
hedging.
16
<PAGE>
RISK FACTORS IN OPTIONS, FUTURES AND CURRENCY INSTRUMENTS
Use of derivatives for hedging purposes involves the risk of imperfect
correlation in movements in the value of the derivatives and the value of the
instruments being hedged. If the value of the derivatives moves more or less
than the value of the hedged instruments the Fund will experience a gain or
loss which will not be completely offset by movements in the value of the
hedged instruments. This risk applies particularly to the Fund's use of
cross-hedging, which means that the security which is the subject of the hedged
transaction is different from the security being hedged.
The Fund intends to enter into transactions involving derivatives only if
there appears to be a liquid secondary market for such instruments or, in the
case of illiquid instruments traded in OTC transactions, such instruments
satisfy the criteria set forth below under "Additional Risk Factors of OTC
Transactions." However, there can be no assurance that, at any specific time,
either a liquid secondary market will exist for a Strategic Instrument or the
Fund will otherwise be able to sell such instrument at an acceptable price. It
may therefore not be possible to close a position in a Strategic Instrument
without incurring substantial losses, if at all.
Certain transactions in derivatives (E.G., forward foreign exchange
transactions, futures transactions, sales of put options) may expose the Fund
to potential losses which exceed the amount originally invested by the Fund in
such instruments. When the Fund engages in such a transaction, the Fund will
deposit in a segregated account at its custodian liquid securities with a value
at least equal to the Fund's exposure, on a mark-to-market basis, to the
transaction (as calculated pursuant to requirements of the Securities and
Exchange Commission). Such segregation will ensure that the Fund has assets
available to satisfy its obligations with respect to the transaction, but will
not limit the Fund's exposure to loss.
ADDITIONAL RISK FACTORS OF OTC TRANSACTIONS; LIMITATIONS ON THE USE OF OTC
DERIVATIVES
Certain derivatives traded in OTC markets, including indexed securities
and OTC options may be substantially less liquid than other instruments in
which the Fund may invest. The absence of liquidity may make it difficult or
impossible for the Fund to sell such instruments promptly at an acceptable
price. The absence of liquidity may also make it more difficult for the Fund to
ascertain a market value for such instruments. The Fund will therefore acquire
illiquid OTC instruments (i) if the agreement pursuant to which the instrument
is purchased contains a formula price at which the instrument may be terminated
or sold, or (ii) for which the Manager anticipates the Fund can receive on each
business day at least two independent bids or offers, unless a quotation from
only one dealer is available, in which case that dealer's quotation may be
used.
The staff of the Securities and Exchange Commission has taken the position
that purchased OTC options and the assets underlying written OTC options are
illiquid securities. The Fund has therefore adopted an investment policy
pursuant to which it will not purchase or sell OTC options (including OTC
options on futures contracts) if, as a result of such transactions, the sum of
the market value of OTC options currently outstanding which are held by the
Fund, the market value of the securities underlying OTC call options currently
outstanding which have been sold by the Fund and margin deposits on the Fund's
outstanding OTC options exceeds 15% of the total assets of the Fund, taken at
market value, together with all other assets of the Fund which are deemed to be
illiquid or are otherwise not readily marketable. However, if an OTC option is
sold by the Fund to a dealer in U.S. government securities recognized as a
"primary dealer" by the Federal Reserve Bank of New York and the Fund has the
unconditional contractual right to repurchase such OTC option at a
predetermined price, then the Fund will treat as illiquid such amount of the
underlying securities as is equal to the repurchase price less the amount by
which the option is "in-the-money" (I.E., current market value of the
underlying security minus the option's exercise price).
Because Strategic Instruments traded in OTC markets are not guaranteed by
an exchange or clearing corporation and generally do not require payment of
margin, to the extent that the Fund has unrealized gains in such instruments or
has deposited collateral with its counterparty, the Fund is at risk that its
counterparty will become bankrupt or otherwise fail to honor its obligations.
The Fund will attempt to minimize the risk that a counterparty will become
bankrupt or otherwise fail to honor its obligations by engaging in transactions
in Strategic Instruments traded in OTC markets only with financial institutions
which have substantial capital or which have provided the Fund with a
third-party guaranty or other credit enhancement.
17
<PAGE>
ADDITIONAL LIMITATIONS ON THE USE OF DERIVATIVES
The Fund may not use any derivative to gain exposure to an asset or class
of assets that it would be prohibited by its investment restrictions from
purchasing directly.
INVESTMENT RESTRICTIONS
The Fund has adopted the following restrictions and policies relating to
the investment of its assets and its activities, which are fundamental policies
and may not be changed without the approval of the holders of a majority of the
Fund's outstanding voting securities (which for this purpose and under the
Investment Company Act means the lesser of (i) 67% of the shares represented at
a meeting at which more than 50% of the outstanding shares are represented or
(ii) more than 50% of the outstanding shares). The Fund may not:
1. Make any investment inconsistent with the Fund's classification as a
diversified company under the Investment Company Act.
2. Invest more than 25% of its assets, taken at market value, in the
securities of issuers in any particular industry (excluding the U.S.
Government and its agencies and instrumentalities) except that, under
normal circumstances, the Fund will invest more than 25% of its total
assets in the securities of issuers in the utilities industry.
3. Make investments for the purpose of exercising control or management.
4. Purchase or sell real estate, except that, to the extent permitted by
law, the Fund may invest in securities directly or indirectly secured by
real estate or interests therein or issued by companies which invest in
real estate or interests therein.
5. Make loans to other persons, except that the acquisition of bonds,
debentures or other corporate debt securities and investment in government
obligations, commercial paper, pass-through instruments, certificates of
deposit, bankers acceptances, repurchase agreements or any similar
instruments shall not be deemed to be the making of a loan, and except
further that the Fund may lend its portfolio securities, provided that the
lending of portfolio securities may be made only in accordance with
applicable law and the guidelines set forth in the Fund's Prospectus and
Statement of Additional Information, as they may be amended from time to
time.
6. Issue senior securities to the extent such issuance would violate
applicable law.
7. Borrow money, except that (i) the Fund may borrow from banks (as
defined in the Investment Company Act) in amounts up to 33 1/3% of its
total assets (including the amount borrowed), (ii) the Fund may borrow up
to an additional 5% of its total assets for temporary purposes, (iii) the
Fund may obtain such short-term credit as may be necessary for the
clearance of purchases and sales of portfolio securities and (iv) the Fund
may purchase securities on margin to the extent permitted by applicable
law. The Fund may not pledge its assets other than to secure such
borrowings or, to the extent permitted by the Fund's investment policies as
set forth in its Prospectus and Statement of Additional Information, as
they may be amended from time to time, in connection with hedging
transactions, short sales, when-issued and forward commitment transactions
and similar investment strategies.
8. Underwrite securities of other issuers except insofar as the Fund
technically may be deemed an underwriter under the Securities Act in
selling portfolio securities.
9. Purchase or sell commodities or contracts on commodities, except to
the extent that the Fund may do so in accordance with applicable law and
the Fund's Prospectus and Statement of Additional Information, as they may
be amended from time to time, and without registering as a commodity pool
operator under the Commodity Exchange Act.
The Fund has also adopted certain non-fundamental investment restrictions,
which may be changed by the Directors without approval by the shareholders.
Under the non-fundamental investment restrictions, the Fund may not:
18
<PAGE>
a. Purchase securities of other investment companies, except to the
extent such purchases are permitted by applicable law. As a matter of
policy, however, the Fund will not purchase shares of any registered
open-end investment company or registered unit investment trust, in
reliance on Section 12(d)(1)(F) or (G) (the "fund of funds" provisions) of
the Investment Company Act at any time the Fund's shares are owned by
another investment company that is part of the same group of investment
companies as the Fund.
b. Make short sales of securities or maintain a short position, except
to the extent permitted by applicable law.
c. Invest in securities which cannot be readily resold because of legal
or contractual restrictions or which cannot otherwise be marketed, redeemed
or put to the issuer or a third party, if at the time of acquisition more
than 15% of its net assets would be invested in such securities. This
restriction shall not apply to securities which mature within seven days or
securities which the Board of Directors of the Fund has otherwise
determined to be liquid pursuant to applicable law. Securities purchased in
accordance with Rule 144A under the Securities Act (a "Rule 144A security")
and determined to be liquid by the Fund's Board of Directors are not
subject to the limitations set forth in this investment restriction.
d. Notwithstanding fundamental restriction (7) above, borrow amounts in
excess of 10% of its total assets, taken at market value (including the
amount borrowed), and then only from banks as a temporary measure for
extraordinary or emergency purposes such as the redemption of Fund shares.
In addition, the Fund will not purchase securities while borrowings exceed
5% of its total assets.
In addition, to comply with tax requirements for qualification as a
"regulated investment company," the Fund's investments will be limited in a
manner such that, at the close of each quarter of each fiscal year, (a) no more
than 25% of the Fund's total assets are invested in the securities of a single
issuer, and (b) with regard to at least 50% of the Fund's total assets, no more
than 5% of its total assets are invested in the securities of a single issuer.
For purposes of this restriction, the Fund will regard each state and each
political subdivision, agency or instrumentality of such state and each
multi-state agency of which such state is a member and each public authority
which issues securities on behalf of a private entity as a separate issuer,
except that if the security is backed only by the assets and revenues of a
non-government entity then the entity with the ultimate responsibility for the
payment of interest and principal may be regarded as the sole issuer. These
tax-related limitations may be changed by the Board of Directors of the Fund to
the extent necessary to comply with changes to the Federal tax requirements.
Notwithstanding the provisions of Investment Restriction (b) above, the
Fund does not currently intend to engage in short sales.
Because of the affiliation of Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("Merrill Lynch") with the Investment Adviser, the Fund is
prohibited from engaging in certain transactions involving Merrill Lynch,
"Merrill Lynch", or its affiliates except for brokerage transactions permitted
under the Investment Company Act involving only usual and customary commissions
or transactions pursuant to an exemptive order under the Investment Company
Act. See "Portfolio Transactions and Brokerage." Without such an exemptive
order, the Fund is prohibited from engaging in portfolio transactions with
Merrill Lynch or its affiliates acting as principal and from purchasing
securities in public offerings that are not registered under the Securities Act
in which such firms or any of their affiliates participate as an underwriter or
dealer.
PORTFOLIO TURNOVER
While the Fund generally does not expect to engage in trading for
short-term gains, the Investment Adviser will effect portfolio transactions
without regard to a holding period, if, in its judgment, such transactions are
advisable in light of a change in circumstance in general market, economic or
financial conditions. As a result of its investment policies, the Fund may
engage in a substantial number of portfolio transactions. Accordingly, while
the Fund anticipates that its annual turnover rate should not exceed 100% under
normal conditions, it is impossible to predict portfolio turnover rates. The
portfolio turnover rate is calculated by dividing the lesser of the Fund's
annual sales or purchases of portfolio securities (exclusive of purchases or
sales of securities whose maturities at the time of acquisition were one year
or less) by the monthly average value of the securities in the
19
<PAGE>
portfolio during the year. High portfolio turnover involves correspondingly
greater transaction costs in the form of dealer spreads and brokerage
commissions, which are borne directly by the Fund.
MANAGEMENT OF THE FUND
DIRECTORS AND OFFICERS
The Directors, executive officers and portfolio Investment Adviser of the
Fund, their ages and their principal occupations for at least the last five
years are set forth below. Unless otherwise noted, the address of the portfolio
Investment Adviser and of each executive officer and Director is P.O. Box 9011,
Princeton, New Jersey 08543-9011.
ARTHUR ZEIKEL (66) -- PRESIDENT AND DIRECTOR (1)(2) -- Chairman of the
Investment Adviser and Fund Asset Management, L.P. ("FAM") (which terms as used
herein includes their corporate predecessors) since 1997; President of the
Investment Adviser and FAM from 1977 to 1997; Chairman of Princeton Services,
Inc. ("Princeton Services") since 1997 and Director thereof since 1993;
President of Princeton Services from 1993 to 1997; Executive Vice President of
Merrill Lynch & Co., Inc. ("ML & Co.") since 1990.
RONALD W. FORBES (58) -- DIRECTOR (2) -- 1400 Washington Avenue, Albany,
New York 12222. Professor of Finance, School of Business, State University of
New York at Albany, since 1989.
CYNTHIA A. MONTGOMERY (46) -- DIRECTOR (2) -- Harvard Business School,
Soldiers Field Road, Boston, Massachusetts 02163. Professor, Harvard Business
School since 1989; Associate Professor, J.L. Kellogg Graduate School of
Management, Northwestern University from 1985 to 1989; Assistant Professor,
Graduate School of Business Administration, The University of Michigan from
1979 to 1985; Director, UNUM Corporation since 1990 and Director of Newell Co.
since 1995.
CHARLES C. REILLY (67) -- DIRECTOR (2) -- 9 Hampton Harbor Road, Hampton
Bays, New York 11946. Self-employed financial consultant since 1990; President
and Chief Investment Officer of Verus Capital, Inc. from 1979 to 1990; Senior
Vice President of Arnhold and S. Bleichroeder, Inc. from 1973 to 1990; Adjunct
Professor, Columbia University Graduate School of Business, from 1990 to 1991;
Adjunct Professor, Wharton School, The University of Pennsylvania from 1989 to
1990; Partner, Small Cities Cable Television from 1986 to 1997.
KEVIN A. RYAN (66) -- DIRECTOR (2) -- 127 Commonwealth Avenue, Chestnut
Hill, Massachusetts 02167. Founder and current Director of The Boston
University Center for the Advancement of Ethics and Character; Professor of
Education at Boston University since 1982; formerly taught on the faculties of
The University of Chicago, Stanford University and Ohio State University.
RICHARD R. WEST (60) -- DIRECTOR (2) -- Box 604, Genoa, Nevada 89411.
Professor of Finance since 1984, and Dean from 1984 to 1993, and currently Dean
Emeritus of New York University, Leonard N. Stern School of Business
Administration; Director of Bowne & Co., Inc. (financial printers), Vornado
Realty Trust, Inc. (real estate holding company) and Alexander's Inc. (real
estate company).
TERRY K. GLENN (58) -- EXECUTIVE VICE PRESIDENT (1)(2) -- Executive Vice
President of the Investment Adviser and FAM since 1983; Executive Vice
President and Director of Princeton Services since 1993; President of Merrill
Lynch Funds Distributor ("MLFD" or the "Distributor"), a division of Princeton
Funds Distributor, Inc. since 1986 and Director thereof since 1991; President
of Princeton Administrators, L.P. since 1988.
NORMAN R. HARVEY (65) -- SENIOR VICE PRESIDENT (1)(2) -- Senior Vice
President of the Investment Adviser and FAM since 1982; Senior Vice President
of Princeton Services since 1993.
WALTER D. ROGERS (56) -- SENIOR VICE PRESIDENT AND PORTFOLIO INVESTMENT
ADVISER (1)(2) -- First Vice President of the Investment Adviser since 1997;
Vice President of the Investment Adviser since 1987.
DONALD C. BURKE (38) -- VICE PRESIDENT (1)(2) -- First Vice President of
the Investment Adviser since 1997; Vice President of the Investment Adviser
from 1990 to 1997; Director of Taxation of the Investment Adviser since 1990.
20
<PAGE>
GERALD M. RICHARD (49) -- TREASURER (1)(2) -- Senior Vice President and
Treasurer of the Investment Adviser and FAM since 1984; Senior Vice President
and Treasurer of Princeton Services since 1993; Vice President of Princeton
Funds Distributor, Inc. since 1981 and Treasurer thereof since 1984.
THOMAS D. JONES, III (33) -- SECRETARY (1) -- Attorney with the Investment
Adviser since 1992; Lawyer in private practice from 1990 to 1992.
- ----------
(1) Interested person, as defined in the Investment Company Act, of the Fund.
(2) Such Director or officer is a director, trustee or officer of other
investment companies for which the Investment Adviser or FAM acts as
investment adviser or manager.
As of October 1, 1998, the officers and Directors of the Fund as a group
(12 persons) owned an aggregate of less than 1% of the outstanding shares of
Common Stock of ML & Co., and owned an aggregate of less than 1% of the
outstanding shares of the Fund.
COMPENSATION OF DIRECTORS
Pursuant to the terms of the management agreement with the Fund, the
Investment Adviser pays all compensation of officers of the Fund as well as the
fees of all Directors who are affiliated persons of the Investment Adviser. The
Fund pays each non-interested Director a fee of $1,000 per year plus $400 per
meeting attended. The Fund also compensates members of its Audit and Nominating
Committee (the "Committee"), which consists of all of the non-interested
Directors, a fee of $400 per year. The Fund pays the Chairman of the Committee
an additional fee of $1,000 per year. The Fund reimburses each non-interested
Director for his out-of-pocket expenses relating to attendance at Board and
Committee meetings.
The following table sets forth the compensation earned by non-affiliated
Directors from the Fund for the fiscal year ended August 31, 1998 and the
aggregate compensation paid to non-affiliated Directors from all registered
investment companies advised by MLAM and its affiliate FAM, ("MLAM/FAM Advised
Funds") for the calendar year ended December 31, 1997.
<TABLE>
<CAPTION>
TOTAL COMPENSATION
PENSION OR FROM FUND AND
AGGREGATE RETIREMENT BENEFIT MLAM/FAM
COMPENSATION ACCRUED AS PART OF ADVISED FUNDS
DIRECTOR FROM THE FUND FUND EXPENSE PAID TO DIRECTOR(1)
- ------------------------------- --------------- -------------------- --------------------
<S> <C> <C> <C>
Ronald W. Forbes .............. $3,000 None 153,500
Cynthia A. Montgomery ......... $3,000 None 153,500
Charles C. Reilly ............. $4,000 None 313,000
Kevin A. Ryan ................. $3,000 None 153,500
Richard R. West ............... $3,000 None 299,000
</TABLE>
- ----------
(1) The Directors serve on the boards of MLAM/FAM Advised Funds as follows: Mr.
Forbes (35 registered investment companies consisting of 48 portfolios);
Ms. Montgomery (35 registered investment companies consisting of 48
portfolios); Mr. Reilly (54 registered investment companies consisting of
67 portfolios); Mr. Ryan (35 registered investment companies consisting of
48 portfolios); and Mr. West (56 registered investment companies
consisting of 81 portfolios).
Directors of the Fund, members of the Boards of other MLAM/FAM advised
Funds, ML & Co. and its subsidiaries (the term "subsidiaries,"when used herein
with respect to ML & Co., includes MLAM, the Investment Adviser and certain
other entities directly or indirectly wholly owned and controlled by ML & Co.)
and their directors and employees, and any trust, pension, profit-sharing or
other benefit plan for such persons may purchase Class A shares of the Fund at
net asset value.
MANAGEMENT AND ADVISORY ARRANGEMENTS
MANAGEMENT SERVICES. The Investment Adviser provides the Fund with
investment advisory and management services. Subject to the supervision of the
Board of Directors, the Investment Adviser is responsible for the actual
management of the Fund's portfolio and constantly reviews the Fund's holdings
in light of its own research
21
<PAGE>
analysis and that from other relevant sources. The responsibility for making
decisions to buy, sell or hold a particular security rests with the Investment
Adviser. The Investment Adviser performs certain of the other administrative
services and provides all the office space, facilities, equipment and necessary
personnel for management of the Fund.
Securities held by the Fund may also be held by, or be appropriate
investments for, other funds or investment advisory clients for which the
Investment Adviser or its affiliates act as an adviser. Because of different
objectives or other factors, a particular security may be bought for one or
more clients when one or more clients are selling the same security. If
purchases or sales of securities by the Investment Adviser for the Fund or
other funds for which it acts as investment adviser or for its advisory clients
arise for consideration at or about the same time, transactions in such
securities will be made, insofar as feasible, for the respective funds and
clients in a manner deemed equitable to all. To the extent that transactions on
behalf of more than one client of the Investment Adviser or its affiliates
during the same period may increase the demand for securities being purchased
or the supply of securities being sold there may be an adverse effect on price.
MANAGEMENT FEE. The Fund has entered into a management agreement with the
Investment Adviser (the "Management Agreement"). As discussed in the
Prospectus, the Investment Adviser receives for its services to the Fund
monthly compensation at the annual rate of 0.55% of the Fund's average daily
net assets. The table below sets forth information about the total investment
advisory fees paid by the Fund to the Investment Adviser for the periods
indicated, all of which were voluntarily waived.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED AUGUST 31, INVESTMENT ADVISORY FEE
- ------------------------------ ------------------------
<S> <C>
1998 ....................... $213,013
1997 ....................... $207,552
1996 ....................... $255,399
</TABLE>
PAYMENT OF FUND EXPENSES. The Management Agreement obligates the
Investment Adviser to provide investment advisory services and to pay all
compensation of and furnish office space for officers and employees of the Fund
connected with investment and economic research, trading and investment
management of the Fund, as well as the fees of all Directors of the Fund who
are affiliated persons of the Investment Adviser or any of their affiliates.
The Fund pays all other expenses incurred in the operation of the Fund,
including, among other things, taxes; expenses for legal and auditing services;
costs of printing proxies, stock certificates, shareholder reports and
prospectuses and statements of additional information (except to the extent
paid by the Distributor); charges of the Custodian, any Sub-custodian and
Transfer Agent; expenses of redemption of shares; Securities and Exchange
Commission fees; expenses of registering the shares under Federal, state or
foreign laws; fees and expenses of unaffiliated Directors; accounting and
pricing costs (including the daily calculation of net asset value); insurance,
interest, brokerage costs, litigation and other extraordinary or non-recurring
expenses, and other expenses properly payable by the Fund. Accounting services
are provided to the Fund by the Investment Adviser and the Fund reimburses the
Investment Adviser for its costs in connection with such services on a
semi-annual basis. As required by the Distribution Agreements, the Distributor
will pay certain of the expenses of the Fund incurred in connection with the
offering of its shares. See "Purchase of Shares -- Deferred Sales Charge
Alternatives -- Class B and Class C Shares."
ORGANIZATION OF THE INVESTMENT ADVISER. The Investment Adviser is a
limited partnership, the partners of which are ML & Co. and Princeton Services.
ML & Co. and Princeton Services are "controlling persons" of the Investment
Adviser as defined under the Investment Company Act because of their ownership
of its voting securities or their power to exercise a controlling influence
over its management or policies. Similarly, the following entities may be
considered "controlling persons" of MLAM U.K.: Merrill Lynch Europe PLC (MLAM
U.K.'s parent), a subsidiary of Merrill Lynch International Holdings, Inc., a
subsidiary of Merrill Lynch International, Inc., a subsidiary of ML & Co.
The Investment Adviser has entered into a sub-advisory agreement (the
"Sub-Advisory Agreement") with MLAM U.K., an indirect, wholly-owned subsidiary
of ML & Co., and an affiliate of the Investment Adviser, pursuant to which the
Investment Adviser pays MLAM U.K. a fee for providing investment advisory
services to
22
<PAGE>
the Investment Adviser with respect to the Fund in an amount to be determined
from time to time by the Investment Adviser and MLAM U.K. but in no event in
excess of the amount that the Investment Adviser actually receives for
providing services to the Fund pursuant to the Management Agreement.
DURATION AND TERMINATION. Unless earlier terminated as described below,
the Management Agreement will remain in effect from year to year if approved
annually (a) by the Board of Directors or by a majority of the outstanding
shares of the Fund and (b) by a majority of the Directors who are not parties
to such contract or interested persons (as defined in the Investment Company
Act) of any such party. Such contracts are not assignable and may be terminated
without penalty on 60 days' written notice at the option of either party
thereto or by the vote of the shareholders of the Fund.
TRANSFER AGENCY SERVICES. Financial Data Services, Inc. (the "Transfer
Agent"), a subsidiary of ML & Co., acts as the Fund's transfer agent pursuant
to a Transfer Agency, Dividend Disbursing Agency and Shareholder Servicing
Agency Agreement (the "Transfer Agency Agreement"). Pursuant to the Transfer
Agency Agreement, the Transfer Agent is responsible for the issuance, transfer
and redemption of shares and the opening and maintenance of shareholder
accounts. Pursuant to the Transfer Agency Agreement, the Transfer Agent
receives a fee of $11.00 per Class A or Class D account and $14.00 per Class B
or Class C account and is entitled to reimbursement for certain transaction
charges and out-of-pocket expenses incurred by the Transfer Agent under the
Transfer Agency Agreement. Additionally, a $.20 monthly closed account charge
will be assessed on all accounts which close during the calendar year.
Application of the fee will commence the month following the month the account
is closed. At the end of the calendar year, no further fee will be due. For
purposes of the Transfer Agency Agreement, the term "account" includes a
shareholder account maintained directly by the Transfer Agent and any other
account representing the beneficial interest of a person in the relevant share
class on a record keeping system, provided the record keeping system is
maintained by a subsidiary of ML & Co.
DISTRIBUTION EXPENSES. The Fund has entered into four separate
distribution agreements with the Distributor in connection with the continuous
offering of each class of shares of the Fund (the "Distribution Agreements").
The Distribution Agreements obligate the Distributor to pay certain expenses in
connection with the offering of each class of shares of the Fund. After the
prospectuses, statements of additional information and periodic reports have
been prepared, set in type and mailed to shareholders, the Distributor pays for
the printing and distribution of copies thereof used in connection with the
offering to dealers and investors. The Distributor also pays for other
supplementary sales literature and advertising costs. The Distribution
Agreements are subject to the same renewal requirements and termination
provisions as the Management Agreement described above.
CODE OF ETHICS
The Board of Directors of the Fund has adopted a Code of Ethics under Rule
17j-1 of the Investment Company Act which incorporates the Code of Ethics of
the Investment Adviser (together, the "Codes"). The Codes significantly
restrict the personal investing activities of all employees of the Investment
Adviser and, as described below, impose additional, more onerous, restrictions
on fund investment personnel.
The Codes require that all employees of the Investment Adviser pre-clear
any personal securities investment (with limited exceptions, such as government
securities). The pre-clearance requirement and associated procedures are
designed to identify any substantive prohibition or limitation applicable to
the proposed investment. The substantive restrictions applicable to all
employees of the Investment Adviser include a ban on acquiring any securities
in a "hot" initial public offering and a prohibition from profiting on
short-term trading in securities. In addition, no employee may purchase or sell
any security that at the time is being purchased or sold (as the case may be),
or to the knowledge of the employee is being considered for purchase or sale,
by any fund advised by the Investment Adviser. Furthermore, the Codes provide
for trading "blackout periods" which prohibit trading by investment personnel
of the Fund within periods of trading by the Fund in the same (or equivalent)
security (15 or 30 days depending upon the transaction).
23
<PAGE>
PURCHASE OF SHARES
Reference is made to "How to Buy, Sell, Transfer and Exchange Shares" in
the Prospectus for certain information as to the purchase of Fund shares.
The Fund offers four classes of shares under the Merrill Lynch Select
Pricing System: shares of Class A and Class D shares are sold to investors
choosing the initial sales charge alternatives and shares of Class B and Class
C are sold to investors choosing the deferred sales charge alternatives. Each
Class A, Class B, Class C and Class D share of the Fund represents identical
interests in the investment portfolio of the Fund, and has the same rights,
except that Class B, Class C and Class D shares bear the expenses of the
ongoing account maintenance fees and Class B and Class C shares bear the
expenses of the ongoing distribution fees and the additional incremental
transfer agency costs resulting from the deferred sales charge arrangements.
Class B, Class C and Class D shares each have exclusive voting rights with
respect to the Rule 12b-1 plan adopted with respect to such class pursuant to
which the account maintenance and/or distribution fees are paid (except that
Class B shareholders may vote upon any material changes to expenses charged
under the Class D Distribution Plan). Each class has different exchange
privileges. See "Shareholder Services -- Exchange Privilege."
Investors should understand that the purpose and function of the initial
sales charges with respect to the Class A and Class D shares are the same as
those of the CDSCs and distribution fees with respect to the Class B and Class
C shares in that the sales charges and distribution fees applicable to each
class provide for the financing of the distribution of the shares of the Fund.
The distribution-related revenues paid with respect to a class will not be used
to finance the distribution expenditures of another class. Sales personnel may
receive different compensation for selling different classes of shares.
The Merrill Lynch Select Pricing(SM) System is used by more than 50
registered investment companies advised by the Investment Adviser or its
affiliate, FAM. Funds advised by the Investment Adviser or FAM that use the
Merrill Lynch Select Pricing(SM) System are referred to herein as "Select
Pricing Funds."
The Fund or the Distributor may suspend the continuous offering of the
Fund's shares of any class at any time in response to conditions in the
securities markets or otherwise and may thereafter resume such offering from
time to time. Neither the Distributor nor the dealers are permitted to withhold
placing orders to benefit themselves by a price change. Merrill Lynch may
charge its customers a processing fee (presently $5.35) to confirm a sale of
shares to such customers. Purchases made directly through the Transfer Agent
are not subject to the processing fee.
Dividends paid by the Fund for each class of shares are calculated in the
same manner at the same time and differ only to the extent that account
maintenance and distribution fees and any incremental transfer agency costs
relating to a particular class are borne exclusively by that class. Each class
has different exchange privileges. See "Shareholder Services -- Exchange
Privilege."
INITIAL SALES CHARGE ALTERNATIVES -- CLASS A AND CLASS D SHARES
Investors who prefer an initial sales charge alternative may elect to
purchase Class D shares or, if an eligible investor, Class A shares. Investors
choosing the initial sales charge alternative who are eligible to purchase
Class A shares should purchase Class A shares rather than Class D shares
because there is an account maintenance fee imposed on Class D shares.
Investors qualifying for significantly reduced initial sales charges may find
the initial sales charge alternative particularly attractive because similar
sales charge reductions are not available with respect to the deferred sales
charges imposed in connection with purchases of Class B or Class C shares.
Investors not qualifying for reduced initial sales charges who expect to
maintain their investment for an extended period of time also may elect to
purchase Class A or Class D shares, because over time the accumulated ongoing
account maintenance and distribution fees on Class B or Class C shares may
exceed the initial sales charge and, in the case of Class D shares, the account
maintenance fee. Although some investors who previously purchased Class A
shares may no longer be eligible to purchase Class A shares of other Select
Pricing Funds, those previously purchased Class A shares, together with Class
B, Class C and Class D share holdings, will count toward a right of
accumulation which may qualify the investor for reduced initial sales charge on
new initial sales charge purchases. In addition, the ongoing Class B and Class
C account maintenance and distribution fees
24
<PAGE>
will cause Class B and Class C shares to have higher expense ratios, pay lower
dividends and have lower total returns than the initial sales charge shares.
The ongoing Class D account maintenance fees will cause Class D shares to have
a higher expense ratio, pay lower dividends and have a lower total return than
Class A shares.
The term "purchase," as used in the Prospectus and this Statement of
Additional Information in connection with an investment in Class A and Class D
shares of the Fund, refers to a single purchase by an individual, or to
concurrent purchases, which in the aggregate are at least equal to the
prescribed amounts, by an individual, his spouse and their children under the
age of 21 years purchasing shares for his or their own account and to single
purchases by a trustee or other fiduciary purchasing shares for a single trust
estate or single fiduciary account although more than one beneficiary is
involved. The term "purchase" also includes purchases by any "company," as that
term is defined in the Investment Company Act of 1940, but does not include
purchases of any such company which has not been in existence for at least six
months or which has no purpose other than the purchase of shares of the Fund or
shares of other registered investment companies at a discount; provided,
however, that it shall not include purchases by any group of individuals whose
sole organizational nexus is that the participants therein are credit
cardholders of a company, policyholders of an insurance company, customers of
either a bank or broker-dealer or clients of an investment adviser.
ELIGIBLE CLASS A INVESTORS
Class A shares are offered to a limited group of investors and also will
be issued upon reinvestment of dividends on outstanding Class A shares.
Investors who currently own Class A shares, including participants in the
Merrill Lynch Blueprint(SM) Program, are entitled to purchase additional Class A
shares of the Fund in that account. Certain Employer Sponsored Retirement or
Savings Plans, including eligible 401(k) plans, may purchase Class A shares at
net asset value provided such plans meet the required minimum number of
eligible employees or required amount of assets advised by MLAM or any of its
affiliates. Class A shares are available at net asset value to corporate
warranty insurance reserve fund programs provided that the program has $3
million or more initially invested in Select Pricing Funds. Also eligible to
purchase Class A shares at net asset value are participants in certain
investment programs including TMA(SM) Managed Trusts to which Merrill Lynch
Trust Company provides discretionary trustee services, collective investment
trusts for which Merrill Lynch Trust Company serves as trustee and certain
purchases made in connection with certain fee-based programs. In addition, Class
A shares are offered at net asset value to ML & Co. and its subsidiaries and
their directors and employees and to members of the Boards of MLAM/FAM advised
Funds. Certain persons who acquired shares of certain MLAM-advised closed-end
funds in their initial offerings who wish to reinvest the net proceeds from a
sale of their closed-end fund shares of common stock in shares of the Fund also
may purchase Class A shares of the Fund if certain conditions are met. In
addition, Class A shares of the Fund and certain other Select Pricing Funds are
offered at net asset value to shareholders of Merrill Lynch Senior Floating Rate
Fund, Inc. and, if certain conditions are met, to shareholders of Merrill Lynch
Municipal Strategy Fund, Inc. and Merrill Lynch High Income Municipal Bond Fund,
Inc. who wish to reinvest the net proceeds form a sale of certain of their
shares of common stock pursuant to a tender offer conducted by such funds in
shares of the Fund and certain other Select Pricing Funds.
Investors are advised that only Class A and Class D shares may be
available for purchase through securities dealers, other than Merrill Lynch,
that are eligible to sell shares.
25
<PAGE>
CLASS A AND CLASS D SALES CHARGE INFORMATION
<TABLE>
<CAPTION>
CLASS A SHARES
- -----------------------------------------------------------------------------------------------
FOR THE FISCAL YEAR GROSS SALES SALES CHARGES SALES CHARGES CDSCS RECEIVED ON
ENDED CHARGES RETAINED BY PAID TO REDEMPTION OF
AUGUST 31 COLLECTED DISTRIBUTOR MERRILL LYNCH LOAD-WAIVED SHARES
- --------------------- ------------- --------------- --------------- -------------------
<S> <C> <C> <C> <C>
1998 $ 855 $ 79 $ 776 0
1997 $1,730 $119 $1,611 0
1996 $1,299 $104 $1,195 0
</TABLE>
<TABLE>
<CAPTION>
CLASS D SHARES
- -----------------------------------------------------------------------------------------------
FOR THE FISCAL YEAR GROSS SALES SALES CHARGES SALES CHARGES CDSCS RECEIVED ON
ENDED CHARGES RETAINED BY PAID TO REDEMPTION OF
AUGUST 31 COLLECTED DISTRIBUTOR MERRILL LYNCH LOAD-WAIVED SHARES
- --------------------- ------------- --------------- --------------- -------------------
<S> <C> <C> <C> <C>
1998 $ 7,828 $735 $ 7,093 0
1997 $ 6,613 $446 $ 6,167 0
1996 $13,029 $976 $12,053 0
</TABLE>
The Distributor may reallow discounts to selected dealers and retain the
balance over such discounts. At times the Distributor may reallow the entire
sales charge to such dealers. Since securities dealers selling Class A and
Class D shares of the Fund will receive a concession equal to most of the sales
charge, they may be deemed to be underwriters under the Securities Act.
REDUCED INITIAL SALES CHARGES
REINVESTED DIVIDENDS AND CAPITAL GAINS. No initial sales charges are
imposed upon Class A and Class D shares issued as a result of the automatic
reinvestment of dividends or capital gains distributions.
RIGHT OF ACCUMULATION. Reduced sales charges are applicable through a
right of accumulation under which eligible investors are permitted to purchase
shares of the Fund subject to an initial sales charge at the offering price
applicable to the total of (a) the public offering price of the shares then
being purchased plus (b) an amount equal to the then current net asset value or
cost, whichever is higher, of the purchaser's combined holdings of all classes
of shares of the Fund and of other Select Pricing Funds. For any such right of
accumulation to be made available, the Distributor must be provided at the time
of purchase, by the purchaser or the purchaser's securities dealer, with
sufficient information to permit confirmation of qualification. Acceptance of
the purchase order is subject to such confirmation. The right of accumulation
may be amended or terminated at any time. Shares held in the name of a nominee
or custodian under pension, profit-sharing, or other employee benefit plans may
not be combined with other shares to qualify for the right of accumulation.
LETTER OF INTENT. Reduced sales charges are applicable to purchases
aggregating $25,000 or more of Class A or Class D shares of the Fund or any
other Select Pricing Funds made within a 13-month period starting with the
first purchase pursuant to a Letter of Intent. The Letter of Intent is
available only to investors whose accounts are maintained at the Fund's
Transfer Agent. The Letter of Intent is not available to employee benefit plans
for which Merrill Lynch provides plan participant record keeping services. The
Letter of Intent is not a binding obligation to purchase any amount of Class A
or Class D shares; however, its execution will result in the purchaser paying a
lower sales charge at the appropriate quantity purchase level. A purchase not
originally made pursuant to a Letter of Intent may be included under a
subsequent Letter of Intent executed within 90 days of such purchase if the
Distributor is informed in writing of this intent within such 90-day period.
The value of Class A and Class D shares of the Fund and of other Select Pricing
Funds presently held, at cost or maximum offering price (whichever is higher),
on the date of the first purchase under the Letter of Intent, may be included
as a credit toward the completion of such Letter, but the reduced sales charge
applicable to the amount covered by such Letter will be applied only to new
purchases. If the total amount of shares does not equal the amount stated in
the Letter of Intent (minimum of $25,000), the investor will be notified and
must pay, within 20 days of the expiration of such Letter, the difference
between the sales charge on the Class A or Class D shares purchased at the
reduced rate and the sales charge applicable to the shares actually purchased
through the Letter. Class A or Class D shares equal to at least five percent of
the intended amount will be held in escrow during
26
<PAGE>
the 13-month period (while remaining registered in the name of the purchaser)
for this purpose. The first purchase under the Letter of Intent must be at
least five percent of the dollar amount of such Letter. If a purchase during
the term of such Letter would otherwise be subject to a further reduced sales
charge based on the right of accumulation, the purchaser will be entitled on
that purchase and subsequent purchases to the reduced percentage sales charge
which would be applicable to a single purchase equal to the total dollar value
of the Class A shares then being purchased under such Letter, but there will be
no retroactive reduction of the sales charges on any previous purchase. The
value of any shares redeemed or otherwise disposed of by the purchaser prior to
termination or completion of the Letter of Intent will be deducted from the
total purchases made under such Letter. An exchange from the Summit Cash
Reserves Fund ("Summit") into the Fund that creates a sales charge will count
toward completing a new or existing Letter of Intent from the Fund.
MERRILL LYNCH BLUEPRINT(SM) PROGRAM. Class D shares of the Fund are offered
to participants in the Merrill Lynch Blueprint(SM) Program ("Blueprint"). In
addition, participants in Blueprint who own Class A shares of the Fund may
purchase additional Class A shares of the Fund through Blueprint. Blueprint is
directed to small investors, group IRAs and participants in certain affinity
groups such as credit unions, trade associations and benefit plans. Investors
placing orders to purchase Class A or Class D shares of the Fund through
Blueprint will acquire the Class A or Class D shares at net asset value plus a
sales charge calculated in accordance with the Blueprint sales charge schedule
(I.E., up to $300 at 4.25%, from $300.01 to $5,000 at 3.25% plus $3.00 and
$5,000.01 or more at the standard sales charge rates disclosed in the
Prospectus). In addition, Class A or Class D shares of the Fund are being
offered at net asset value plus a sales charge of 0.50% for corporate or group
IRA programs placing orders to purchase their Class A or Class D shares through
Blueprint. Services, including the exchange privilege, available to Class A and
Class D investors through Blueprint, however, may differ from those available
to other investors in Class A or Class D shares.
Class A and Class D shares are offered at net asset value to Blueprint
participants through the Merrill Lynch Directed IRA Rollover Program ("IRA
Rollover Program") available from Merrill Lynch Business Financial Services, a
business unit of Merrill Lynch. The IRA Rollover Program is available to
custodian rollover assets from employer sponsored retirement and savings plans
(as defined below) whose trustee and/or plan sponsor has entered into an IRA
Rollover Program Service Agreement.
Orders for purchases and redemptions of Class A or Class D shares of the
Fund may be grouped for execution purposes which, in some circumstances, may
involve the execution of such orders two business days following the day such
orders are placed. The minimum initial purchase price is $100, with a $50
minimum for subsequent purchases through Blueprint. There are no minimum
initial or subsequent purchase requirements for participants who are part of an
automatic investment plan. Additional information concerning purchases through
Blueprint, including any annual fees and transaction charges, is available from
Merrill Lynch, Pierce, Fenner & Smith Incorporated, The Blueprint(SM) Program,
P.O. Box 30441, New Brunswick, New Jersey 08989-0441.
TMA(SM) MANAGED TRUSTS. Class A shares are also offered to TMA(SM) Managed
Trusts to which Merrill Lynch Trust Company provides discretionary trustee
services at net asset value.
EMPLOYEE ACCESS(SM) ACCOUNTS. Provided applicable threshold requirements
are met, either Class A or Class D shares are offered at net asset value to
Employee Access(SM) Accounts available through authorized employers. The initial
minimum for such accounts is $500, except that the initial minimum for shares
purchased for such accounts pursuant to the Automatic Investment Program is
$50.
EMPLOYER-SPONSORED RETIREMENT OR SAVINGS PLANS AND CERTAIN OTHER
ARRANGEMENTS. Certain employer-sponsored retirement or savings plans and
certain other arrangements may purchase Class A or Class D shares at net asset
value, based on the number of employees or number of employees eligible to
participate in the plan, the aggregate amount invested by the plan in specified
investments and/or the services provided by Merrill Lynch to the plan.
Additional information regarding purchases by employer-sponsored retirement or
savings plans and certain other arrangements is available toll-free from
Merrill Lynch Business Financial Services at (800) 237-7777.
PURCHASE PRIVILEGES OF CERTAIN PERSONS. Directors of the Fund, members of
the Boards of other MLAM/
FAM advised Funds, ML & Co., and its subsidiaries and their directors and
employees and any trust, pension, profit-sharing or other benefit plan for such
persons, may purchase Class A shares of the Fund at net asset value.
27
<PAGE>
Class D shares of the Fund are offered at net asset value, without a sales
charge, to an investor who has a business relationship with a Financial
Consultant who joined Merrill Lynch from another investment firm within six
months prior to the date of purchase by such investor, if the following
conditions are satisfied: first, the investor must advise Merrill Lynch that it
will purchase Class D shares of the Fund with proceeds from a redemption of a
mutual fund that was sponsored by the Financial Consultant's previous firm and
was subject to a sales charge either at the time of purchase or on a deferred
basis; and second, the investor must establish that such redemption had been
made within 60 days prior to the investment in the Fund and the proceeds from
the redemption had been maintained in the interim in cash or a money market
fund.
Class D shares of the Fund are also offered at net asset value, without
sales charge, to an investor who has a business relationship with a Merrill
Lynch Financial Consultant and who has invested in a mutual fund sponsored by a
non-Merrill Lynch company for which Merrill Lynch has served as a selected
dealer and where Merrill Lynch has either received or given notice that such
arrangement will be terminated ("notice") if the following conditions are
satisfied: first, the investor must purchase Class D shares of the Fund with
proceeds from a redemption of shares of such other mutual fund and the shares
of such other fund were subject to a sales charge either at the time of
purchase or on a deferred basis; second, such purchase of Class D shares must
be made within 90 days after such notice.
Class D shares of the Fund are also offered at net asset value, without
sales charge, to an investor who has a business relationship with a Merrill
Lynch Financial Consultant and who has invested in a mutual fund for which
Merrill Lynch has not served as a selected dealer if the following conditions
are satisfied: first, the investor must advise Merrill Lynch that it will
purchase Class D shares of the Fund with proceeds from a redemption of shares
of such other mutual funds and that such shares have been outstanding for a
period of no less than 6 months; and second, such purchase of Class D shares
must be made within 60 days after the redemption and the proceeds from the
redemption must be maintained in the interim in cash or a money market fund.
CLOSED-END FUND INVESTMENT OPTION. Class A shares of the Fund and certain
other Select Pricing Funds ("Eligible Class A shares") are offered at net asset
value to shareholders of certain closed-end funds advised by the Investment
Adviser who purchased such closed-end fund shares prior to October 21, 1994
(the date the Merrill Lynch Select Pricing(SM) System commenced operations) and
wish to reinvest the net proceeds from a sale of their closed-end fund shares
of common stock in Eligible Class A shares, if the conditions set forth below
are satisfied. Alternatively, closed-end fund shareholders who purchased such
shares on or after October 21, 1994 and wish to reinvest the net proceeds from
a sale of their closed-end fund shares are offered Class A shares (if eligible
to buy Class A shares) or Class D shares of the Fund and other Select Pricing
Funds ("Eligible Class D shares"), if the following conditions are met. First,
the sale of closed-end fund shares must be made through Merrill Lynch, and the
net proceeds therefrom must be immediately reinvested in Eligible Class A or
Eligible Class D shares. Second, the closed-end fund shares must either have
been acquired in the initial public offering or be shares representing
dividends from shares of common stock acquired in such offering. Third, the
closed-end fund shares must have been continuously maintained in a Merrill
Lynch securities account. Fourth, there must be a minimum purchase of $250 to
be eligible for the investment option.
Shareholders of certain MLAM-advised continuously offered closed-end funds
may reinvest at net asset value the net proceeds from a sale of certain shares
of common stock of such funds in shares of the Fund. Upon exercise of this
investment option, shareholders of Merrill Lynch Senior Floating Rate Fund,
Inc. will receive Class A shares of the Fund and shareholders of Merrill Lynch
Municipal Strategy Fund, Inc. and Merrill Lynch High Income Municipal Bond
Fund, Inc. will receive Class D shares of the Fund, except that shareholders
already owning Class A shares of the Fund will be eligible to purchase
additional Class A shares pursuant to this option, if such additional Class A
shares will be held in the same account as the existing Class A shares and the
other requirements pertaining to the reinvestment privilege are met. In order
to exercise this investment option, a shareholder of one of the
above-referenced continuously offered closed-end funds (an "eligible fund")
must sell his or her shares of common stock of the eligible fund (the "eligible
shares") back to the fund in connection with a tender offer conducted by the
eligible fund and reinvest the proceeds immediately in the designated class of
shares of the Fund. This investment option is available only with respect to
eligible shares as to which no Early Withdrawal Charge or CDSC (each as defined
in the eligible fund's prospectus) is applicable. Purchase orders from eligible
fund shareholders wishing to exercise this investment option will be accepted
only on the
28
<PAGE>
day that the related tender offer terminates and will be effected at the net
asset value of the designated class of the Fund on such day.
ACQUISITION OF CERTAIN INVESTMENT COMPANIES. The public offering price of
Class D shares may be reduced to the net asset value per Class D share in
connection with the acquisition of the assets of or merger or consolidation
with a personal holding company or a public or private investment company. The
value of the assets or company acquired in a tax-free transaction may be
adjusted in appropriate cases to reduce possible adverse tax consequences to
the Fund that might result from an acquisition of assets having net unrealized
appreciation that is disproportionately higher at the time of acquisition than
the realized or unrealized appreciation of the Fund. The issuance of Class D
shares for consideration other than cash is limited to bona fide
reorganizations, statutory mergers or other acquisitions of portfolio
securities that (i) meet the investment objectives and policies of the Fund;
(ii) are acquired for investment and not for resale (subject to the
understanding that the disposition of the Fund's portfolio securities shall at
all times remain within its control); and (iii) are liquid securities, the
value of which is readily ascertainable, which are not restricted as to
transfer either by law or liquidity of market (except that the Fund may acquire
through such transactions restricted or illiquid securities to the extent the
Fund does not exceed the applicable limits on acquisition of such securities
set forth under "Investment Objective and Policies" herein).
Reductions in or exceptions from the imposition of a sales load are due to
the nature of the investors and/or the reduced sales efforts that will be
needed in obtaining such investments.
DEFERRED SALES CHARGE ALTERNATIVES -- CLASS B AND CLASS C SHARES
Investors choosing the deferred sales charge alternatives should consider
Class B shares if they intend to hold their shares for an extended period of
time and Class C shares if they are uncertain as to the length of time they
intend to hold their assets in Select Pricing Funds.
The public offering price of Class B and Class C shares for investors
choosing the deferred sales charge alternatives is the next determined net
asset value per share without the imposition of a sales charge at the time of
purchase. See "Pricing of Shares -- Determination of Net Asset Value" below.
Because no initial sales charges are deducted at the time of purchase,
Class B and Class C shares provide the benefit of putting all of the investor's
dollars to work from the time the investment is made. The deferred sales charge
alternatives may be particularly appealing to investors that do not qualify for
the reduction in initial sales charges. Both Class B and Class C shares are
subject to ongoing account maintenance fees and distribution fees; however, the
ongoing account maintenance and distribution fees potentially may be offset to
the extent any return is realized on the additional funds initially invested in
Class B or Class C shares. In addition, Class B shares will be converted into
Class D shares of the Fund after a conversion period of approximately ten
years, and thereafter investors will be subject to lower ongoing fees.
CONTINGENT DEFERRED SALES CHARGES -- CLASS B SHARES
Class B shares that are redeemed within four years of purchase may be
subject to a CDSC at the rates set forth below charged as a percentage of the
dollar amount subject thereto. In determining whether a CDSC is applicable to a
redemption, the calculation will be determined in the manner that results in
the lowest applicable rate being charged. The charge will be assessed on an
amount equal to the lesser of the proceeds of redemption or the cost of the
shares being redeemed. Accordingly, no CDSC will be imposed on increases in net
asset value above the initial purchase price. In addition, no CDSC will be
assessed on shares derived from reinvestment of dividends or capital gains
distributions. It will be assumed that the redemption is first of shares held
for over four years or shares acquired pursuant to reinvestment of dividends or
distributions and then of shares held longest during the four-year period. A
transfer of shares from a shareholder's account to another account will be
assumed to be made in the same order as a redemption.
29
<PAGE>
The following table sets forth the Class B CDSC:
<TABLE>
<CAPTION>
CDSC AS A PERCENTAGE
OF DOLLAR AMOUNT
YEAR SINCE PURCHASE PAYMENT MADE SUBJECT TO CHARGE
- ----------------------------------- ---------------------
<S> <C>
0-1 ............................. 4.0%
1-2 ............................. 3.0%
2-3 ............................. 2.0%
3-4 ............................. 1.0%
4 and thereafter ................ None
</TABLE>
To provide an example, assume an investor purchased 100 shares at $10 per
share (at a cost of $1,000) and in the third year after purchase, the net asset
value per share is $12 and, during such time, the investor has acquired 10
additional shares upon dividend reinvestment. If at such time the investor
makes his or her first redemption of 50 shares (proceeds of $600), 10 shares
will not be subject to a CDSC because of dividend reinvestment. With respect to
the remaining 40 shares, the charge is applied only to the original cost of $10
per share and not to the increase in net asset value of $2 per share.
Therefore, $400 of the $600 redemption proceeds will be charged at a rate of
2.0% (the applicable rate in the third year after purchase).
As discussed in the prospectus under "Merrill Lynch Select Pricing(SM)
System -- Class B Shares", while Class B shares redeemed within four years of
purchase and subject to a CDSC under most circumstances, the charge is reduced
or waived in certain instances, such as: (a) any partial or complete
redemptions in connection with a distribution following retirement under a
tax-deferred retirement plan or attaining age 59 1/2 in the case of an IRA or
other retirement plan, or part of a series of equal periodic payments (not less
frequently than annually) made for life (or life expectancy), or any redemption
resulting from the tax free return of an excess contribution to an IRA; (b) any
partial or complete redemption following the death or disability (as defined in
the Internal Revenue Code of 1986, as amended (the "Code")) of a Class B
shareholder (including one who owns the Class B shares as joint tenant with his
or her spouse), provided the redemption is requested within one year of the
death or initial determination of disability; (c) redemptions of shares by
certain eligible 401(a) and eligible 401(k) plans and in connection with
certain group plans placing orders through the Merrill Lynch Blueprint(SM)
Program; (d) any Class B shares that are purchased by eligible 401(k) or
eligible 401(a) plans that are rolled over into a Merrill Lynch or Merrill
Lynch Trust Company custodied IRA and held in such account at the time of
redemption and for any Class B shares that were acquired and held at the time
of the redemption in an Employee Access(SM) Account available through employers
providing eligible 401(k) plans; (e) any Class B shares that are purchased by a
Merrill Lynch rollover IRA that was funded by a rollover from a terminated
401(k) plan managed by the MLAM Private Portfolio Group and held in such
account at the time of redemption; (f) any Class B shares purchased within
qualifying Employee Access(SM) Accounts; (g) redemptions in connection with
participation in certain fee-based programs (see "Shareholder Services --
Fee-Based Programs"); or (h) withdrawals through the Merrill Lynch Systematic
Withdrawal Plan up to 10% per year of the shareholder's Class B account value
at the time the plan is established.
EMPLOYER-SPONSORED RETIREMENT OR SAVINGS PLANS AND CERTAIN OTHER
ARRANGEMENTS. Certain employer-sponsored retirement or savings plans and
certain other arrangements may purchase Class B shares with a waiver of the
CDSC upon redemption, based on the number of employees or number of employees
eligible to participate in the plan, the aggregate amount invested by the plan
in specified investments and/or the services provided by Merrill Lynch to the
plan. Such Class B shares will convert into Class D shares approximately ten
years after the plan purchases the first share of any Select Pricing Fund.
Minimum purchase requirements may be waived or varied for such plans.
Additional information regarding purchases by employer-sponsored retirement or
savings plans and certain other arrangements is available toll-free from
Merrill Lynch Business Financial Services at (800) 237-7777.
MERRILL LYNCH BLUEPRINT(SM) PROGRAM. Class B shares are offered to certain
participants in Blueprint. Blueprint is directed to small investors, group IRAs
and participants in certain affinity groups such as trade associations, credit
unions and benefit plans. Class B shares of the Fund are offered through
Blueprint only to members of certain affinity groups. The CDSC is waived in
connection with purchase orders placed through Blueprint.
30
<PAGE>
Services, including the exchange privilege, available to Class B investors
through Blueprint, however, may differ from those available to other Class B
investors. Orders for purchases and redemptions of Class B shares of the Fund
may be grouped for execution purposes which, in some circumstances, may involve
the execution of such orders two business days following the day such orders
are placed. The minimum initial purchase price is $100, with a $50 minimum for
subsequent purchases through Blueprint. There is no minimum initial or
subsequent purchase requirement for investors who are part of a Blueprint
automatic investment plan. Additional information concerning these Blueprint
programs, including any annual fees or transaction charges is available from
Merrill Lynch, Pierce, Fenner & Smith Incorporated, The Blueprint(SM) Program,
P.O. Box 30441, New Brunswick, New Jersey 08989-0441.
CONVERSION OF CLASS B SHARES TO CLASS D SHARES. After approximately ten
years (the "Conversion Period"), Class B shares will be converted automatically
into Class D shares of the Fund. Class D shares are subject to an ongoing
account maintenance fee of 0.25% of net assets but are not subject to the
distribution fee that is borne by Class B shares. Automatic conversion of Class
B shares into Class D shares will occur at least once each month (on the
"Conversion Date") on the basis of the relative net asset value of the shares
of the two classes on the Conversion Date, without the imposition of any sales
load, fee or other charge. Conversion of Class B shares to Class D shares will
not be deemed a purchase or sale of the shares for Federal income tax purposes.
In addition, shares purchased through reinvestment of dividends on Class B
shares also will convert automatically to Class D shares. The Conversion Date
for dividend reinvestment shares will be calculated taking into account the
length of time the shares underlying such dividend reinvestment shares were
outstanding. If at the Conversion Date the conversion of Class B shares to
Class D shares of the Fund in a single account will result in less than $50
worth of Class B shares being left in the account, all of the Class B shares of
the Fund held in the account on the Conversion Date will be converted to Class
D shares of the Fund.
In general, Class B shares of equity Select Pricing Funds will convert
approximately eight years after initial purchase and Class B shares of taxable
and tax-exempt fixed income Select Pricing Funds will convert approximately ten
years after the initial purchase. If, during the Conversion Period, a
shareholder exchanges Class B shares with an eight-year Conversion Period for
Class B shares with a ten-year Conversion Period, or vice versa, the Conversion
Period applicable to the Class B shares acquired in the exchange will apply and
the holding period for the shares exchanged will be tacked on to the holding
period for the shares acquired. The conversion period also may be modified for
investors that participate in certain fee-based programs. See "Shareholder
Services -- Fee-Based Programs."
Class B shareholders of the Fund exercising the exchange privilege
described under "Shareholder Services -- Exchange Privilege" will continue to
be subject to the Fund's CDSC schedule if such schedule is higher than the CDSC
schedule relating to the Class B shares acquired as a result of the exchange.
The Conversion Period is modified for shareholders who purchased Class B
shares through certain retirement plans that qualified for a waiver of the CDSC
normally imposed or purchases of Class B shares ("Class B Retirement Plans").
When the first share of any Select Pricing Fund purchased by a Class B
Retirement Plan has been held for ten years (I.E., ten years from the date the
relationship between Select Pricing Funds and the Class B Retirement Plan was
established), all Class B shares of all Select Pricing Funds held in that Class
B Retirement Plan will be converted into Class D shares of the appropriate
funds. Subsequent to such conversion, that Class B Retirement Plan will be sold
Class D shares of the appropriate funds at net asset value per share.
Share certificates for Class B shares of the Fund to be converted must be
delivered to the Transfer Agent at least one week prior to the Conversion Date
applicable to those shares. In the event such certificates are not received by
the Transfer Agent at least one week prior to the Conversion Date, the related
Class B shares will convert to Class D shares on the next scheduled Conversion
Date after such certificates are delivered.
CONTINGENT DEFERRED SALES CHARGES -- CLASS C SHARES
Class C shares that are redeemed within one year of purchase may be
subject to a 1.0% CDSC charged as a percentage of the dollar amount subject
thereto. In determining whether a Class C CDSC is applicable to a
31
<PAGE>
redemption, the calculation will be determined in the manner that results in
the lowest possible rate being charged. The charge will be assessed on an
amount equal to the lesser of the proceeds of redemption or the cost of the
shares being redeemed. Accordingly, no Class C CDSC will be imposed on
increases in net asset value above the initial purchase price. In addition, no
Class C CDSC will be assessed on shares derived from reinvestment of dividends
or capital gains distributions. It will be assumed that the redemption is first
of shares held for over one year or shares acquired pursuant to reinvestment of
dividends or distributions and then of shares held longest during the one-year
period. A transfer of shares from a shareholder's account to another account
will be assumed to be made in the same order as a redemption. The Class C CDSC
may be waived in connection with certain fee-based programs. See "Shareholder
Services -- Fee-Based Programs."
CLASS B AND CLASS C SALES CHARGE INFORMATION
<TABLE>
<CAPTION>
CLASS B SHARES*
- ---------------------------------------------------------
FOR THE FISCAL YEAR CDSCS RECEIVED CDSCS PAID TO
ENDED AUGUST 31 BY DISTRIBUTOR MERRILL LYNCH
- --------------------- ---------------- --------------
<S> <C> <C>
1998 $ 44,814 $ 44,814
1997 $109,154 $109,154
1996 $159,510 $159,510
</TABLE>
- ----------
* Additional Class B CDSCs payable to the Distributor with respect to the
fiscal years ended August 31, 1997 and 1998 may have been waived or
converted to a contingent obligation in connection with a shareholder's
participation in certain fee-based programs.
<TABLE>
<CAPTION>
CLASS C SHARES
- ---------------------------------------------------------
FOR THE FISCAL YEAR CDSCS RECEIVED CDSCS PAID TO
ENDED AUGUST 31 BY DISTRIBUTOR MERRILL LYNCH
- --------------------- ---------------- --------------
<S> <C> <C>
1998 $18,888 $18,888
1997 $ 669 $ 669
1996 $ 2,585 $ 2,585
</TABLE>
Merrill Lynch compensates its Financial Consultants for selling Class B
and Class C shares at the time of purchase from its own funds. Proceeds from
the CDSC and the ongoing distribution fee are paid to the Distributor and are
used in whole or in part by the Distributor to defray the expenses of dealers
(including Merrill Lynch) related to providing distribution-related services to
the Fund in connection with the sale of the Class B and Class C shares, such as
the payment of compensation to financial consultants for selling Class B and
Class C shares, from the dealers' own funds. The combination of the CDSC and
the ongoing distribution fee facilitates the ability of the Fund to sell the
Class B and Class C shares without a sales charge being deducted at the time of
purchase. See "Distribution Plans" below. Imposition of the CDSC and the
distribution fee on Class B and Class C shares is limited by the NASD
asset-based sales charge rule. See "Limitations on the Payment of Deferred
Sales Charges" below.
DISTRIBUTION PLANS
Reference is made to "Fees and Expenses" in the Prospectus for certain
information with respect to the separate distribution plans for Class B, Class
C and Class D shares pursuant to Rule 12b-1 under the Investment Company Act
(each a "Distribution Plan") with respect to the account maintenance and/or
distribution fees paid by the Fund to the Distributor with respect to such
classes.
The Distribution Plans for Class B, Class C and Class D shares each
provides that the Fund pays the Distributor an account maintenance fee relating
to the shares of the relevant class, accrued daily and paid monthly, at the
annual rate of 0.25% of the average daily net assets of the Fund attributable
to shares of the relevant class in order to compensate the Distributor and
Merrill Lynch (pursuant to a sub-agreement) in connection with account
maintenance activities with respect to Class B, Class C and Class D shares.
Each of those classes has exclusive voting rights with respect to the
Distribution Plan adopted with respect to such class pursuant to which account
maintenance and/or distribution fees are paid (except that Class B shareholders
may vote upon any material changes to expenses charged under the Class D
Distribution Plan).
32
<PAGE>
The Distribution Plans for Class B and Class C shares each provides that
the Fund also pays the Distributor a distribution fee relating to the shares of
the relevant class, accrued daily and paid monthly, at the annual rate of 0.50%
and 0.55% respectively, of the average daily net assets of the Fund
attributable to the shares of the relevant class in order to compensate the
Distributor and Merrill Lynch (pursuant to a sub-agreement) for providing
shareholder and distribution services and bearing certain distribution-related
expenses of the Fund, including payments to Financial Consultants for selling
Class B and Class C shares of the Fund. The Distribution Plans relating to
Class B and Class C shares are designed to permit an investor to purchase Class
B and Class C shares through dealers without the assessment of an initial sales
charge and at the same time permit the dealer to compensate its financial
consultants in connection with the sale of the Class B and Class C shares.
The Fund's Distribution Plans are subject to the provisions of Rule 12b-1
under the Investment Company Act. In their consideration of each Distribution
Plan, the Directors must consider all factors they deem relevant, including
information as to the benefits of the Distribution Plan to the Fund and each
related class of shareholders. Each Distribution Plan further provides that, so
long as the Distribution Plan remains in effect, the selection and nomination
of Independent Directors shall be committed to the discretion of the
Independent Directors then in office. In approving each Distribution Plan in
accordance with Rule 12b-1, the Independent Directors concluded that there is
reasonable likelihood that each Distribution Plan will benefit the Fund and its
related class of shareholders. Each Distribution Plan can be terminated at any
time, without penalty, by the vote of a majority of the Independent Directors
or by the vote of the holders of a majority of the outstanding related class of
voting securities of the Fund. A Distribution Plan cannot be amended to
increase materially the amount to be spent by the Fund without the approval of
the related class of shareholders and all material amendments are required to
be approved by the vote of Directors, including a majority of the Independent
Directors who have no direct or indirect financial interest in the Distribution
Plan, cast in person at a meeting called for that purpose. Rule 12b-1 further
requires that the Fund preserve copies of the Distribution Plan and any report
made pursuant to such plan for a period of not less than six years from the
date of the Distribution Plan or such report, the first two years in an easily
accessible place.
Among other things, each Distribution Plan provides that the Distributor
shall provide and the Directors shall review quarterly reports of the
disbursement of the account maintenance and/or distribution fees paid to the
Distributor. Payments under the Distribution Plans are based on a percentage of
average daily net assets attributable to the shares regardless of the amount of
expenses incurred and, accordingly, distribution-related revenues from the
Distribution Plans may be more or less than distribution-related expenses.
Information with respect to the distribution-related revenues and expenses is
presented to the Directors for their consideration in connection with their
deliberations as to the continuance of the Class B and Class C Distribution
Plans annually, as of December 31 of each year, on a "fully allocated accrual"
basis and quarterly on a "direct expense and revenue/cash" basis. On the fully
allocated accrual basis, revenues consist of the account maintenance fees,
distribution fees, the CDSCs and certain other related revenues, and expenses
consist of financial consultant compensation, branch office and regional
operation center selling and transaction processing expenses, advertising,
sales promotion and marketing expenses, corporate overhead and interest
expense. On the direct expense and revenue/cash basis, revenues consist of the
account maintenance fees, distribution fees and CDSCs and the expenses consist
of financial consultant compensation.
As of December 31, 1997, the last date for which fully allocated accrual
data is available, the fully allocated accrual expenses incurred by the
Distributor and Merrill Lynch for the period since the commencement of
operations of Class B shares exceeded fully allocated accrual revenues by
approximately $570,000 (1.74% of Class B net assets at that date). As of August
31, 1998, direct cash revenues for the period since the commencement of
operations of Class B shares exceeded direct cash expenses by $771,062 (2.37%
of Class B net assets at that date). As of December 31, 1997, the fully
allocated accrual expenses incurred by the Distributor and Merrill Lynch for
the period since the commencement of operations of Class C shares exceeded the
fully allocated revenues by approximately $32,000 (0.64% of Class C net assets
at that date). As of August 31, 1998, direct cash revenues for the period since
the commencement of operations of Class C shares exceeded direct cash expenses
by $61,508 (2.16% of Class C net assets at that date).
For the fiscal year ended August 31, 1998, the Fund paid the Distributor
$231,489 pursuant to the Class B Distribution Plan (based on average daily net
assets subject to such Class B Distribution Plan of approximately
33
<PAGE>
$30.7 million), all of which was paid to Merrill Lynch for providing account
maintenance and distribution-related activities and services in connection with
Class B shares. For the fiscal year ended August 31, 1998, the Fund paid the
Distributor $31,990 pursuant to the Class C Distribution Plan (based on average
daily net assets subject to such Class C Distribution Plan of approximately
$4.0 million), all of which was paid to Merrill Lynch for providing account
maintenance and distribution-related activities and services in connection with
Class C shares. For the fiscal year ended August 31, 1998, the Fund paid the
Distributor $4,873 pursuant to the Class D Distribution Plan (based on average
daily net assets subject to such Class D Distribution Plan of approximately
$1.9 million), all of which was paid to Merrill Lynch for providing account
maintenance activities in connection with Class D shares.
LIMITATIONS ON THE PAYMENT OF DEFERRED SALES CHARGES
The maximum sales charge rule in the Conduct Rules of the NASD imposes a
limitation on certain asset-based sales charges such as the distribution fee
and the CDSC borne by the Class B and Class C shares, but not the account
maintenance fee. The maximum sales charge rule is applied separately to each
class. As applicable to the Fund, the maximum sales charge rule limits the
aggregate of distribution fee payments and CDSCs payable by the Fund to (1)
6.25% of eligible gross sales of Class B shares and Class C shares, computed
separately (defined to exclude shares issued pursuant to dividend reinvestments
and exchanges), plus (2) interest on the unpaid balance for the respective
class, computed separately, at the prime rate plus 1% (the unpaid balance being
the maximum amount payable minus amounts received from the payment of the
distribution fee and the CDSC). In connection with the Class B shares, the
Distributor has voluntarily agreed to waive interest charges on the unpaid
balance in excess of 0.50% of eligible gross sales. Consequently, the maximum
amount payable to the Distributor (referred to as the "voluntary maximum") in
connection with the Class B shares is 6.75% of eligible gross sales. The
Distributor retains the right to stop waiving the interest charges at any time.
To the extent payments would exceed the voluntary maximum, the Fund will not
make further payments of the distribution fee with respect to Class B shares,
and any CDSCs will be paid to the Fund rather than to the Distributor; however,
the Fund will continue to make payments of the account maintenance fee. In
certain circumstances the amount payable pursuant to the voluntary maximum may
exceed the amount payable under the NASD formula. In such circumstances payment
in excess of the amount payable under the NASD formula will not be made.
The following table sets forth comparative information as of August 31,
1998 with respect to the Class B and Class C shares of the Fund indicating the
maximum allowable payments that can be made under the NASD maximum sales charge
rule, and with respect to Class B shares only, the Distributor's voluntary
maximum. Class C Shares have no Distributor's voluntary maximum.
<TABLE>
<CAPTION>
DATA CALCULATED AS OF AUGUST 31, 1998
----------------------------------------
(IN THOUSANDS)
ALLOWABLE
ELIGIBLE INTEREST ON
GROSS AGGREGATE UNPAID
SALES(1) SALES CHARGES BALANCE(2)
---------- --------------- -------------
<S> <C> <C> <C>
CLASS B SHARES
Under NASD Rule as Adopted ................... $59,194 $3,699 $1,208
Under Distributor's Voluntary Waiver ......... $59,194 $3,699 $ 296
CLASS C SHARES
Under NASD Rule as Adopted ................... $ 6,291 $ 393 $ 69
<CAPTION>
DATA CALCULATED AS OF AUGUST 31, 1998
-----------------------------------------------------------
(IN THOUSANDS)
ANNUAL
DISTRIBUTION
MAXIMUM AMOUNTS FEE AT
AMOUNT PREVIOUSLY AGGREGATE CURRENT NET
PAYABLE TO PAID TO UNPAID ASSET
DISTRIBUTOR(3) DISTRIBUTOR(3) BALANCE LEVEL(4)
---------------- ---------------- ----------- -------------
<S> <C> <C> <C> <C>
CLASS B SHARES
Under NASD Rule as Adopted ................... $4,907 $1,333 $3,574 $163
Under Distributor's Voluntary Waiver ......... $3,995 $1,333 $2,662 $163
CLASS C SHARES
Under NASD Rule as Adopted ................... $ 462 $ 72 $ 390 $ 16
</TABLE>
- ----------
(1) Purchase price of all eligible Class B shares sold since October 29, 1993
(commencement of operations) and all eligible Class C shares sold since
October 21, 1994 (commencement of operations) other than shares acquired
through dividend reinvestment and the exchange privilege.
(2) Interest is computed on a monthly basis based upon the prime rate, as
reported in The Wall Street Journal, plus 1.0% as permitted under the NASD
Rule.
(3) Consists of CDSC payments, distribution fee payments and accruals. See
"What are the Fund's fees and expenses?" in the Prospectus. This figure
may include CDSCs that were deferred when a shareholder redeemed shares
prior to the expiration of the applicable CDSC period and invested the
proceeds, without the imposition of a sales charge, in Class A shares in
conjunction with the shareholder's participation in the Merrill Lynch
Mutual Fund Advisor (Merrill Lynch MFA(SM)) Program (the "MFA Program"). The
CDSC is booked as a contingent obligation that may be payable if the
shareholder terminates participation in the MFA Program.
(4) Provided to illustrate the extent to which the current level of
distribution fee payments (not including any CDSC payments) is amortizing
the unpaid balance. No assurance can be given that payments of the
distribution fee will reach either the voluntary maximum (with respect to
Class B shares) or the NASD maximum (with respect to Class B and Class C
shares).
34
<PAGE>
REDEMPTION OF SHARES
Reference is made to "How to Buy, Sell, Transfer and Exchange Shares" in
the Prospectus for certain information as to the redemption and repurchase of
Fund shares.
The Fund is required to redeem for cash all shares of the Fund upon
receipt of a written request in proper form. The redemption price is the net
asset value per share next determined after the initial receipt of proper
notice of redemption. Except for any CDSC that may be applicable, there will be
no charge for redemption if the redemption request is sent directly to the
Transfer Agent. Shareholders liquidating their holdings will receive upon
redemption all dividends reinvested through the date of redemption. The value
of shares at the time of redemption may be more or less than the shareholder's
cost, depending on the market value of the securities held by the Fund at any
such time.
The right to redeem shares or to receive payment with respect to any such
redemption may be suspended for more than seven days only for periods during
which trading on the NYSE is restricted as determined by the Commission or
during which the NYSE is closed (other than customary weekend and holiday
closings), for any period during which an emergency exists as defined by the
Commission as a result of which disposal of portfolio securities or
determination of the net asset value of the Fund is not reasonably practicable,
and for such other periods as the Commission may by order permit for the
protection of shareholders of the Fund.
Shares are redeemable at the option of the Fund, if in the opinion of the
Fund, ownership of the shares has or may become concentrated to the extent that
would cause the Fund to be deemed a personal holding company within the meaning
of the Code.
REDEMPTION
A shareholder wishing to redeem shares held with the Transfer Agent may do
so without charge by tendering the shares directly to the Transfer Agent at
Financial Data Services, Inc., P.O. Box 45289, Jacksonville, Florida
32232-5289. Redemption requests delivered other than by mail should be
delivered to Financial Data Services, Inc. 4800 Deer Lake Drive East,
Jacksonville, Florida 32246-6484. Proper notice of redemption in the case of
shares deposited with the Transfer Agent may be accomplished by a written
letter requesting redemption. Proper notice of redemption in the case of shares
for which certificates have been issued may be accomplished by a written letter
as noted above accompanied by certificates for the shares to be redeemed.
Redemption requests should not be sent to the Fund. The redemption request in
either event requires the signature(s) of all persons in whose name(s) the
shares are registered, signed exactly as such name(s) appear(s) on the Transfer
Agent's register. The signature(s) on the redemption requests must be
guaranteed by an "eligible guarantor institution" as such is defined in Rule
17Ad-15 under the Securities Exchange Act of 1934, as amended (the "Exchange
Act"), the existence and validity of which may be verified by the Transfer
Agent through the use of industry publications. Notarized signatures are not
sufficient. In certain instances, the Transfer Agent may require additional
documents such as, but not limited to, trust instruments, death certificates,
appointments as executor or administrator, or certificates of corporate
authority. For shareholders redeeming directly with the Transfer Agent,
payments will be mailed within seven days of receipt of a proper notice of
redemption.
At various times the Fund may be requested to redeem shares for which it
has not yet received good payment (E.G., cash, Federal funds or certified check
drawn on a United States bank). The Fund may delay or cause to be delayed the
mailing of a redemption check until such time as it has assured itself that
good payment (E.G., cash, Federal funds or certified check drawn on a United
States bank) has been collected for the purchase of such Fund shares, which
will not exceed 10 days.
REPURCHASE
The Fund also will repurchase Fund shares through a shareholder's listed
securities dealer. The Fund normally will accept orders to repurchase Fund
shares by wire or telephone from dealers for their customers at the net asset
value next computed after the order is placed. Shares will be priced at the net
asset value calculated on the day the request is received, provided that the
request for repurchase is submitted to the dealer prior to
35
<PAGE>
fifteen minutes after the regular close of business on the NYSE (generally, the
NYSE closes at 4:00 p.m., Eastern time) on the day received, and such request
is received by the Fund from such dealer not later than 30 minutes after the
close of business on the NYSE on the same day. Dealers have the responsibility
of submitting such repurchase requests to the Fund not later than 30 minutes
after the close of business on the NYSE, in order to obtain that day's closing
price.
The foregoing repurchase arrangements are for the convenience of
shareholders and do not involve a charge by the Fund (other than any applicable
CDSC). Securities firms that do not have selected dealer agreements with the
Distributor, however, may impose a transaction charge on the shareholder for
transmitting the notice of repurchase to the Fund. Merrill Lynch may charge its
customers a processing fee (presently $5.35) to confirm a repurchase of shares
to such customers. Repurchases made directly through the Transfer Agent on
accounts held at the Transfer Agent are not subject to the processing fee. The
Fund reserves the right to reject any order for repurchase, which right of
rejection might adversely affect shareholders seeking redemption through the
repurchase procedure. However, a shareholder whose order for repurchase is
rejected by the Fund may redeem Fund shares as set forth above.
REINSTATEMENT PRIVILEGE -- CLASS A AND CLASS D SHARES
Shareholders who have redeemed their Class A or Class D shares of the Fund
have a privilege to reinstate their accounts by purchasing Class A or Class D
shares, as the case may be, of the Fund at net asset value without a sales
charge up to the dollar amount redeemed. The reinstatement privilege may be
exercised by sending a notice of exercise along with a check for the amount to
be reinstated to the Transfer Agent within 30 days after the date the request
for redemption was accepted by the Transfer Agent or the Distributor.
Alternatively, the reinstatement privilege may be exercised through the
investor's Merrill Lynch Financial Consultant within 30 days after the date the
request for redemption was accepted by the Transfer Agent or the Distributor.
The reinstatement will be made at the net asset value per share next determined
after the notice of reinstatement is received and cannot exceed the amount of
the redemption proceeds.
PRICING OF SHARES
DETERMINATION OF NET ASSET VALUE
Reference is made to "How Shares are Priced" in the Prospectus.
The net asset value of the shares of all classes of the Fund is determined
once daily Monday through Friday as of 15 minutes after the close of business
on the NYSE on each day the NYSE is open for trading. The NYSE generally closes
at 4:00 p.m., Eastern time. Any assets or liabilities initially expressed in
terms of non-U.S. dollar currencies are translated into U.S. dollars at the
prevailing market rates as quoted by one or more banks or dealers on the day of
valuation. The NYSE is not open for trading on New Year's Day, Martin Luther
King, Jr. Day, Presidents' Day, Good Friday, Memorial Day, Independence Day,
Labor Day, Thanksgiving Day, and Christmas Day.
Net asset value per share is computed by dividing the market value of the
securities held by the Fund plus any cash or other assets (including interest
and dividends accrued but not yet received) minus all liabilities (including
accrued expenses) by the total number of shares outstanding at such time,
rounded to the nearest cent. Expenses, including the fees payable to the
Investment Adviser and Distributor are accrued daily.
The per share net asset value of Class B, Class C and Class D shares
generally will be lower than the per share net asset value of Class A shares,
reflecting the daily expense accruals of the account maintenance, distribution
and higher transfer agency fees applicable with respect to Class B and Class C
shares, and the daily expense accruals of the account maintenance fees
applicable with respect to the Class D shares; moreover, the per share net
asset value of the Class B and Class C shares generally will be lower than the
per share net asset value of Class D shares reflecting the daily expense
accruals of the distribution fees and higher transfer agency fees applicable
with respect to Class B and Class C shares of the Fund. It is expected,
however, that the per share net asset value of the four classes will tend to
converge (although not necessarily meet) immediately after the
36
<PAGE>
payment of dividends or distributions, which will differ by approximately the
amount of the expense accrual differentials between the classes.
Portfolio securities that are traded on stock exchanges are valued at the
last sale price (regular way) on the exchange on which such securities are
traded as of the close of business on the day the securities are being valued
or, lacking any sales, at the last available bid price for long positions and
at the last available ask price for short positions. In cases where securities
are traded on more than one exchange, the securities are valued on the exchange
designated by or under the authority of the Directors as the primary market.
Long positions in securities traded in the OTC market are valued at the last
available bid price in the OTC market prior to the time of valuation. Portfolio
securities that are traded both in the OTC market and on a stock exchange are
valued according to the broadest and most representative market. Short
positions in securities traded in the OTC market are valued at the last
available ask price in the OTC market prior to the time of valuation. When the
Fund writes an option, the amount of the premium received is recorded on the
books of the Fund as an asset and an equivalent liability. The amount of the
liability is subsequently valued to reflect the current market value of the
option written, based upon the last sale price in the case of exchange-traded
options or, in the case of options traded in the OTC market, the last asked
price. Options purchased by the Fund are valued at their last sale price in the
case of exchange-traded options or, in the case of options traded in the OTC
market, the last bid price. Other investments, including financial futures
contracts and related options, are stated at market value. Securities and
assets for which market quotations are not readily available are valued at fair
value as determined in good faith by or under the direction of the Directors of
the Fund, including valuations furnished by a pricing service retained by the
Fund. Such valuations and procedures will be reviewed periodically by the
Directors.
Generally, trading in non-U.S. securities, as well as U.S. Government
securities and money market instruments, is substantially completed each day at
various times prior to the close of business on the NYSE. The values of such
securities used in computing the net asset value of the Fund's shares are
determined as of such times. Foreign currency exchange rates are also generally
determined prior to the close of business on the NYSE. Occasionally, events
affecting the values of such securities and such exchange rates may occur
between the times at which they are determined and the close of business on the
NYSE that will not be reflected in the computation of the Fund's net asset
value. 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 Directors.
COMPUTATION OF OFFERING PRICE PER SHARE
The offering price for Class A, Class B, Class C and Class D shares of the
Fund based on the value of the Fund's net assets and number of shares
outstanding as of August 31, 1998, is calculated as set forth below.
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C CLASS D
--------------- ---------------- --------------- ---------------
<S> <C> <C> <C> <C>
Net Assets ........................................ $ 2,109,611 $ 32,540,580 $ 2,846,280 $ 2,361,600
=========== ============ =========== ===========
Number of Shares Outstanding ...................... 191,156 2,949,299 258,480 213,609
=========== ============ =========== ===========
Net Asset Value Per Share (net assets divided by
number of shares outstanding) ................... $ 11.04 $ 11.03 $ 11.01 $ 11.06
Sales Charge (for Class A and Class D shares: 4.00%
of offering price (4.17% of net asset value per
share))* ........................................ 0.46 ** ** 0.46
----------- ------------- ------------ -----------
Offering Price .................................... $ 11.50 $ 11.03 $ 11.01 $ 11.52
=========== ============ =========== ===========
</TABLE>
- ----------
* Rounded to the nearest one-hundredth percent; assumes maximum sales charge is
applicable.
** Class B and Class C shares are not subject to an initial sales charge but
may be subject to a CDSC on redemption. See "Purchase of Shares -- Merrill
Lynch Select Pricing(SM) System" and "Deferred Sales Charge Alternatives --
Contingent Deferred Sales Charges -- Class B Shares" and "Contingent
Deferred Sales Charges -- Class C Shares" herein.
37
<PAGE>
PORTFOLIO TRANSACTIONS AND BROKERAGE
TRANSACTIONS IN PORTFOLIO SECURITIES
Subject to policies established by the Board of Directors, the Investment
Adviser is primarily responsible for the execution of the Fund's portfolio
transactions and the allocation of brokerage. The Fund has no obligation to
deal with any dealer or group of dealers in the execution of transactions in
portfolio securities of the Fund. Where possible, the Fund deals directly with
the dealers who make a market in the securities involved except in those
circumstances where better prices and execution are available elsewhere. It is
the policy of the Fund to obtain the best results in conducting portfolio
transactions for the Fund, taking into account such factors as price (including
the applicable dealer spread or commission), the size, type and difficulty of
the transaction involved, the firm's general execution and operations
facilities and the firm's risk in positioning the securities involved. The
portfolio securities of the Fund generally are traded on a principal basis and
normally do not involve either brokerage commissions or transfer taxes. The
cost of portfolio securities transactions of the Fund primarily consists of
dealer or underwriter spreads. While reasonable competitive spreads or
commissions are sought, the Fund will not necessarily be paying the lowest
spread or commission available. Transactions with respect to the securities of
small and emerging growth companies in which the Fund may invest may involve
specialized services on the part of the broker or dealer and thereby entail
higher commissions or spreads than would be the case with transactions
involving more widely trading securities.
Subject to obtaining the best price and execution, broker-dealers who
provide supplemental investment research (such as assessments and analyses of
the business or prospects of a company, industry or economic sector) to the
Investment Adviser may receive orders for transactions by the Fund. Information
so received will be in addition to and not in lieu of the services required to
be performed by the Investment Adviser under its Management Agreement and the
expense of the Investment Adviser will not necessarily be reduced as a result
of the receipt of such supplemental information. If in the judgment of the
Investment Adviser the Fund will be benefitted by supplemental research
services, the Investment Adviser is authorized to pay brokerage commissions to
a broker-dealer furnishing such services which are in excess of commissions
which another broker-dealer may have charged for effecting the same
transaction. Supplemental investment research obtained from such broker-dealers
might be used by the Investment Adviser in servicing all of its accounts and
all such research might not be used by the Investment Adviser in connection
with the Fund. Consistent with the Conduct Rules of the NASD and policies
established by the Directors of the Fund, the Investment Adviser may consider
sales of shares of the Fund as a factor in the selection of brokers or dealers
to execute portfolio transactions for the Fund.
For the fiscal year ended August 31, 1998, brokerage commissions paid to
Merrill Lynch aggregated $2,874 which comprised 10.66% of the Fund's aggregate
brokerage commissions paid and involved 9.62% of the Fund's aggregate dollar
amount of transactions involving the payment of commissions effected through
Merrill Lynch during the year. For the fiscal year ended August 31, 1997,
brokerage commissions paid to Merrill Lynch aggregated $690, which comprised
2.98% of the Fund's aggregate brokerage commissions paid and involved 3.24% of
the Fund's aggregate dollar amount of transactions involving the payment of
commissions effected through Merrill Lynch during the year. For the fiscal year
ended August 31, 1996, no brokerage commissions were paid to Merrill Lynch.
Aggregate brokerage commissions paid by the Fund are set forth in the following
table:
<TABLE>
<CAPTION>
BROKERAGE
FISCAL YEAR COMMISSIONS
ENDED AUGUST 31 PAID
- ----------------- ------------
<S> <C>
1998 $26,951
1997 $23,190
1996 $49,682
</TABLE>
Under the Investment Company Act, persons affiliated with the Fund and
persons who are affiliated with such persons are prohibited from dealing with
the Fund as principal in the purchase and sale of securities unless a
permissive order allowing such transactions is obtained from the Commission.
Since transactions in the OTC market usually involve transactions with dealers
acting as principal for their own accounts, affiliated persons of the Fund,
including Merrill Lynch and any of its affiliates, will not serve as the Fund's
dealer in such transactions. However, affiliated persons of the Fund may serve
as its broker in listed or OTC transactions conducted
38
<PAGE>
on an agency basis provided that, among other things, the fee or commission
received by such affiliated broker is reasonable and fair compared to the fee
or commission received by non-affiliated brokers in connection with comparable
transactions. In addition, the Fund may not purchase securities during the
existence of any underwriting syndicate for such securities of which Merrill
Lynch is a member or in a private placement in which Merrill Lynch serves as
placement agent except pursuant to procedures adopted by the Board of Directors
of the Fund that either comply with rules adopted by the Commission or with
interpretations of the Commission staff.
Certain court decisions have raised questions as to the extent to which
investment companies should seek exemptions under the Investment Company Act in
order to seek to recapture underwriting and dealer spreads from affiliated
entities. The Directors have considered all factors deemed relevant and have
made a determination not to seek such recapture at this time. The Directors
will reconsider this matter from time to time.
Section 11(a) of the Exchange Act generally prohibits members of the U.S.
national securities exchanges from executing exchange transactions for their
affiliates and institutional accounts that they manage unless the member (i)
has obtained prior express authorization from the account to effect such
transactions, (ii) at least annually furnishes the account with a statement
setting forth the aggregate compensation received by the member in effecting
such transactions, and (iii) complies with any rules the Commission has
prescribed with respect to the requirements of clauses (i) and (ii). To the
extent Section 11(a) would apply to Merrill Lynch acting as a broker for the
Fund in any of its portfolio transactions executed on any such securities
exchange of which it is a member, appropriate consents have been obtained from
the Fund and annual statements as to aggregate compensation will be provided to
the Fund. Securities may be held by, or be appropriate investments for, the
Fund as well as other funds or investment advisory clients of the Investment
Adviser or FAM.
Because of different objectives or other factors, a particular security
may be bought for one or more clients of the Investment Adviser or an affiliate
when one or more clients of the Investment Adviser or an affiliate are selling
the same security. If purchases or sales of securities arise for consideration
at or about the same time that would involve the Fund or other clients or funds
for which the Investment Adviser or an affiliate acts as manager, transactions
in such securities will be made, insofar as feasible, for the respective funds
and clients in a manner deemed equitable to all. To the extent that
transactions on behalf of more than one client of the Investment Adviser or an
affiliate during the same period may increase the demand for securities being
purchased or the supply of securities being sold, there may be an adverse
effect on price.
SHAREHOLDER SERVICES
The Fund offers a number of shareholder services and investment plans
described below that are designed to facilitate investment in its shares of the
Fund. Full details as to each of such services and copies of the various plans
and instructions as to how to participate in the various services or plans, or
how to change options with respect thereto, can be obtained from the Fund, by
calling the telephone number on the cover page hereof, or from the Distributor
or Merrill Lynch. Certain of these services are available only to United States
investors.
INVESTMENT ACCOUNT
Each shareholder whose account is maintained at the Transfer Agent has an
Investment Account and will receive statements, at least quarterly, from the
Transfer Agent. These statements will serve as transaction confirmations for
automatic investment purchases and the reinvestment of ordinary income
dividends, and capital gains distributions. The statements will also show any
other activity in the account since the preceding statement. Shareholders will
receive separate confirmations for each purchase or sale transaction other than
automatic investment purchases and the reinvestment of ordinary income
dividends and capital gains distributions. A shareholder with an account held
at the Transfer Agent may make additions to his or her Investment Account at
any time by mailing a check directly to the Transfer Agent. A shareholder may
also maintain an account through Merrill Lynch. Upon the transfer of shares out
of a Merrill Lynch brokerage account, an Investment Account in the transferring
shareholder's name may be opened automatically at the Transfer Agent.
39
<PAGE>
Share certificates are issued only for full shares and only upon the
specific request of a shareholder who has an Investment Account. Issuance of
certificates representing all or only part of the full shares in an Investment
Account may be requested by a shareholder directly from the Transfer Agent.
Shareholders considering transferring their Class A or Class D shares from
Merrill Lynch to another brokerage firm or financial institution should be
aware that, if the firm to which the Class A or Class D shares are to be
transferred will not take delivery of shares of the Fund, a shareholder either
must redeem the Class A or Class D shares (paying any applicable CDSC) so that
the cash proceeds can be transferred to the account at the new firm or continue
to maintain an Investment Account at the Transfer Agent for those Class A or
Class D shares. Shareholders interested in transferring their Class B or Class
C shares from Merrill Lynch who do not wish to have an Investment Account
maintained for such shares at the Transfer Agent may request their new
brokerage firm to maintain such shares in an account registered in the name of
the brokerage firm for the benefit of the shareholder at the Transfer Agent. If
the new brokerage firm is willing to accommodate the shareholder in this
manner, the shareholder must request that he or she be issued certificates for
his or her shares and then must turn the certificates over to the new firm for
re-registration in the new brokerage firm's name.
EXCHANGE PRIVILEGE
U.S. shareholders of each class of shares of the Fund have an exchange
privilege with certain other Select Pricing Funds and Summit Cash Reserves Fund
("Summit"), a series of Financial Institutions Series Trust, which is a Merrill
Lynch-sponsored money market fund specifically designated for exchange by
holders of Class A, Class B, Class C and Class D shares of Select Pricing
Funds. Shares with a net asset value of at least $100 are required to qualify
for the exchange privilege and any shares utilized in an exchange must have
been held by the shareholder for at least 15 days. Before effecting an
exchange, shareholders should obtain a currently effective prospectus of the
fund into which the exchange is to be made. Exercise of the exchange privilege
is treated as a sale of the exchanged shares and a purchase of the acquired
shares for Federal income tax purposes.
EXCHANGES OF CLASS A AND CLASS D SHARES. Under the Merrill Lynch Select
Pricing(SM) System, Class A shareholders may exchange Class A shares of the Fund
for Class A shares of a second Select Pricing Fund if the shareholder holds any
Class A shares of the second fund in his or her account in which the exchange
is made at the time of the exchange or is otherwise eligible to purchase Class
A shares of the second fund. If the Class A shareholder wants to exchange Class
A shares for shares of a second Select Pricing Fund, but does not hold Class A
shares of the second fund in his or her account at the time of the exchange and
is not otherwise eligible to acquire Class A shares of the second fund, the
shareholder will receive Class D shares of the second fund as a result of the
exchange. Class D shares also may be exchanged for Class A shares of a second
Select Pricing Fund at any time as long as, at the time of the exchange, the
shareholder holds Class A shares of the second fund in the account in which the
exchange is made or is otherwise eligible to purchase Class A shares of the
second fund. Class D shares are exchangeable with shares of the same class of
other Select Pricing Funds.
Exchanges of Class A or Class D shares outstanding ("outstanding Class A
or Class D shares") for Class A or Class D shares of other Select Pricing Funds
or Class A shares of Summit, a series of Financial Institution Series Trust, a
money market fund ("new Class A or Class D shares") are transacted on the basis
of relative net asset value per Class A or Class D share, respectively, plus an
amount equal to the difference, if any, between the sales charge previously
paid on the outstanding Class A or Class D shares and the sales charge payable
at the time of the exchange on the new Class A or Class D shares. With respect
to outstanding Class A or Class D shares as to which previous exchanges have
taken place, the "sales charge previously paid" shall include the aggregate of
the sales charges paid with respect to such Class A or Class D shares in the
initial purchase and any subsequent exchange. Class A or Class D shares issued
pursuant to dividend reinvestment are sold on a no-load basis in each of the
funds offering Class A or Class D shares. For purposes of the exchange
privilege, Class A or Class D shares acquired through dividend reinvestment
shall be deemed to have been sold with a sales charge equal to the sales charge
previously paid on the Class A or Class D shares on which the dividend was
paid. Based on this formula, Class A and Class D shares generally may be
exchanged into the Class A or Class D shares, respectively, of the other funds
with a reduced sales charge or without a sales charge.
40
<PAGE>
EXCHANGES OF CLASS B AND CLASS C SHARES. Each Select Pricing Fund with
Class B and Class C shares outstanding ("outstanding Class B or Class C
shares") offers to exchange its Class B or Class C shares for Class B or Class
C shares, respectively, of another Select Pricing Fund or for Class B shares of
Summit ("new Class B or Class C Shares") on the basis of relative net asset
value per Class B or Class C share, without the payment of any CDSC that might
otherwise be due on redemption of the outstanding shares. Class B shareholders
of the Fund exercising the exchange privilege will continue to be subject to
the Fund's CDSC schedule if such schedule is higher than the CDSC schedule
relating to the new Class B or Class C shares acquired through use of the
exchange privilege. In addition, Class B shares of the Fund acquired through
use of the exchange privilege will be subject to the Fund's CDSC schedule if
such schedule is higher than the CDSC schedule relating to the Class B shares
of the fund from which the exchange has been made. For purposes of computing
the CDSC that may be payable on a disposition of the new Class B or Class C
shares, the holding period for the outstanding Class B or Class C shares is
"tacked" to the holding period of the new Class B or Class C shares. For
example, an investor may exchange Class B or Class C shares of the Fund for
those of Merrill Lynch Special Value Fund, Inc. ("Special Value Fund") after
having held the Fund's Class B shares for two and a half years. The 2% CDSC
that generally would apply to a redemption would not apply to the exchange.
Three years later the investor may decide to redeem the Class B shares of
Special Value Fund and receive cash. There will be no CDSC due on this
redemption, since by "tacking" the two and a half year holding period of the
Fund's Class B shares to the three year holding period for the Special Value
Fund Class B shares, the investor will be deemed to have held the new Special
Value Fund Class B shares for more than five years.
EXCHANGES FOR SHARES OF A MONEY MARKET FUND. Class A and Class D shares
are exchangeable for Class A shares of Summit and Class B and Class C shares
are exchangeable for Class B shares of Summit. Class A shares of Summit have an
exchange privilege back into Class A or Class D shares of Select Pricing Funds;
Class B shares of Summit have an exchange privilege back into Class B or Class
C shares of Select Pricing Funds and, in the event of such an exchange, the
period of time that Class B shares of Summit are held will count toward
satisfaction of the holding period requirement for purposes of reducing any
CDSC and toward satisfaction of any Conversion Period with respect to Class B
shares. Class B shares of Summit will be subject to a distribution fee at an
annual rate of 0.75% of average daily net assets of such Class B shares. This
exchange privilege does not apply with respect to certain Merrill Lynch
fee-based programs for which alternative exchange arrangements may exist.
Please see your Merrill Lynch Financial Consultant for further information.
Prior to October 12, 1998, exchanges from the Fund and other Select
Pricing Funds into a money market fund were directed to certain Merrill
Lynch-sponsored money market funds other than Summit. Shareholders who have
exchanged Select Pricing Fund shares for shares of such other money market
funds and subsequently wish to exchange those money market fund shares for
shares of the Fund will be subject to the CDSC schedule applicable to such Fund
shares, if any. The holding period for the money market fund shares will not
count toward satisfaction of the holding period requirement for reduction of
the CDSC imposed on such shares, if any, and, with respect to Class B shares,
toward satisfaction of the Conversion Period. However, the holding period for
Class B or Class C shares received in exchange for such money market fund
shares will be aggregated with the holding period for the original shares for
purposes of reducing the CDSC or satisfying the Conversion Period.
EXCHANGES BY PARTICIPANTS IN THE MFA PROGRAM. The exchange privilege is
modified with respect to certain retirement plans which participate in the MFA
program. Such retirement plans may exchange Class B, Class C or Class D shares
that have been held for at least one year for Class A shares of the same fund
on the basis of relative net asset values in connection with commencement of
participation in the MFA program, I.E., no CDSC will apply. The one year
holding period does not apply to shares acquired through reinvestment of
dividends. Upon termination of participation in the MFA program. Class A shares
will be re-exchanged for the class of shares originally held. For purposes of
computing any CDSC that may be payable upon redemption of Class B or Class C
shares so reacquired, or the Conversion Period for Class B shares so
reacquired, the holding period for the Class A shares will be "tacked" to the
holding period for the Class B or Class C shares originally held. The Fund's
exchange privilege is also modified with respect to purchases of Class A and
Class D shares by non-retirement plan investors under the MFA program. First,
the initial allocation of assets is made under the MFA program. Then, any
subsequent exchange under the MFA program of Class A or Class D shares of a
Select Pricing Fund for Class A or Class D shares of the Fund will be made
solely on the basis of the relative net asset
41
<PAGE>
values of the shares being exchanged. Therefore, there will not be a charge for
any difference between the sales charge previously paid on the shares of the
other Select Pricing Fund and the sales charge payable on the shares of the
Fund being acquired in the exchange under the MFA program.
EXERCISE OF THE EXCHANGE PRIVILEGE. To exercise the exchange privilege,
shareholders should contact their Merrill Lynch Financial Consultant, who will
advise the Fund of the exchange. Shareholders of the Fund, and shareholders of
the other MLAM-advised mutual funds with shares for which certificates have not
been issued, may exercise the exchange privilege by wire through their
securities dealers. The Fund reserves the right to require a properly completed
Exchange Application. This exchange privilege may be modified or terminated in
accordance with the rules of the Commission. The Fund reserves the right to
limit the number of times an investor may exercise the exchange privilege.
Certain funds may suspend the continuous offering of their shares to the
general public at any time and may thereafter resume such offering from time to
time. The exchange privilege is available only to U.S. shareholders in states
where the exchange legally may be made. It is contemplated that the exchange
privilege may be applicable to other new mutual funds whose shares may be
distributed by the Distributor.
FEE-BASED PROGRAMS
Certain Merrill Lynch fee-based programs, including pricing alternatives
for securities transactions (each referred to in this paragraph as a
"Program"), may permit the purchase of Class A shares at net asset value. Under
specified circumstances, participants in certain Programs may deposit other
classes of shares which will be exchanged for Class A shares. Initial or
deferred sales charges otherwise due in connection with such exchanges may be
waived or modified, as may the Conversion Period applicable to the deposited
shares. Termination of participation in a Program may result in the redemption
of shares held therein or the automatic exchange thereof to another class at
net asset value, which may be shares of a money market fund. In addition, upon
termination of participation in a Program, shares that have been held for less
than specified periods within such Program may be subject to a fee based upon
the current value of such shares. These Programs also generally prohibit such
shares from being transferred to another account at Merrill Lynch, to another
broker-dealer or to the Transfer Agent. Except in limited circumstances (which
may also involve an exchange as described above), such shares must be redeemed
and another class of shares purchased (which may involve the imposition of
initial or deferred sales charges and distribution and account maintenance
fees) in order for the investment not to be subject to Program fees. Additional
information regarding a specific Program (including charges and limitations on
transferability applicable to shares that may be held in such Program) is
available in such Program's client agreement and from the Transfer Agent at
(1-800-MER-FUND) or 1-(800)-637-3863.
RETIREMENT PLANS
Individual retirement accounts and other retirement plans are available
from Merrill Lynch. Under these plans, investments may be made in the Fund and
certain of the other mutual funds sponsored by Merrill Lynch as well as in
other securities. Merrill Lynch charges an initial establishment fee and an
annual custodial fee for each account. Information with respect to these plans
is available on request from Merrill Lynch. The minimum initial purchase to
establish any such plan is $100, and the minimum subsequent purchase is $1.
Shareholders considering transferring a tax-deferred retirement account
such as an individual retirement account from Merrill Lynch to another
brokerage firm or financial institution should be aware that if the firm to
which the retirment account is being transferred will not take delivery of
shares of the Fund, the shareholder must either redeem the shares (paying any
applicable CDSC) so that the cash proceeds can be transferred to the account at
the new firm, or continue to maintain a retirement account at Merrill Lynch for
those shares.
AUTOMATIC INVESTMENT PLANS
A shareholder may make additions to an Investment Account at any time by
purchasing Class A shares (if he or she is an eligible Class A investor) or
Class B, Class C, or Class D shares at the applicable public offering price.
These purchases may be made either through the shareholder's securities dealer,
or by mail directly to the Transfer Agent, acting as agent for such securities
dealer. Voluntary accumulation also can be made through a service known as the
Fund's Automatic Investment Plan. The Fund would be authorized, on a regular
basis,
42
<PAGE>
to provide systematic additions to the Investment Account of such shareholder
through charges of $50 or more to the regular bank account of the shareholder
by either pre-authorized checks or automated clearing house debits. For
investors who buy shares of the Fund through Blueprint, no minimum charge to
the investor's bank account is required. Alternatively, an investor that
maintains a CMA(R) or CBA(R) account may arrange to have periodic investments
of amounts of $100 or more ($1 or more for retirement accounts), made in the
fund through the CMA(R) or CBA(R) Automatic Investment Program from his or her
CMA(R) or CBA(R) account or from certain related accounts.
AUTOMATIC DIVIDEND REINVESTMENT PLAN
Unless specific instructions are given as to the method of payment,
dividends and capital gains distributions will be automatically reinvested,
without sales charge, in additional full and fractional shares of the Fund.
Such reinvestment will be at the net asset value of shares of the Fund as of
the close of business on the NYSE on the monthly payment date for such
dividends and distributions. No CDSC will be imposed upon redemption of shares
issued as a result of the automatic reinvestment of dividends or capital gains
distributions.
Shareholders may, at any time, by written notification to Merrill Lynch if
the shareholder's account is maintained with Merrill Lynch, or by written
notification or by telephone (1-800-MER-FUND) to the Transfer Agent, if the
shareholder's account is maintained with the Transfer Agent, elect to have
subsequent dividends or capital gains distributions, or both, paid in cash,
rather than reinvested, in which event payment will be mailed on or about the
payment date (provided that, in the event that a payment on an account
maintained at the Transfer Agent would amount to $10.00 or less, a shareholder
will not receive such payment in cash and such payment will be automatically
reinvested in additional shares). Cash payments can also be directly deposited
to the shareholder's bank account. No CDSC will be imposed on redemptions of
shares issued as a result of the automatic reinvestment of dividends or capital
gains distributions. Commencing ten days after the receipt by the Transfer
Agent of such notice, those instructions will be effected. The Fund is not
responsible for any failure of delivery to the shareholder's address of record
and no interest will accrue on amounts represented by uncashed distribution or
redemption checks.
SYSTEMATIC WITHDRAWAL PLAN
A shareholder may elect to receive systematic withdrawals from his or her
Investment Account of Class A, Class B, Class C or Class D shares by check or
through automatic payment by direct deposit to his or her bank account on
either a monthly or quarterly basis as provided below. Quarterly withdrawals
are available for shareholders that have acquired shares of the Fund having a
value, based on cost or the current offering price, of $5,000 or more, and
monthly withdrawals are available for shareholders with shares having a value
of $10,000 or more.
At the time of each withdrawal payment, sufficient shares are redeemed
from those on deposit in the shareholder's account to provide the withdrawal
payment specified by the shareholder. The shareholder may specify the dollar
amount and the class of shares to be redeemed. With respect to shareholders who
hold accounts directly at the Transfer Agent, redemptions will be made at net
asset value as determined 15 minutes after the close of business on the NYSE
(generally, 4:00 p.m., Eastern time) on the 24th day of each month or the 24th
day of the last month of each quarter, whichever is applicable. With respect to
shareholders who hold accounts with their broker-dealer, redemptions will be
made at net asset value as determined 15 minutes after the close of business on
the NYSE on the first, second, third, or fourth Monday of each month or the
first, second, third, or fourth Monday of the last month of each quarter,
whichever is applicable. If the NYSE is not open for business on such date, the
shares will be redeemed at the close of business on the following business day.
The check for the withdrawal payment will be made, on the next business day
following redemption. When a shareholder is making systematic withdrawals,
dividends and distributions on all shares in the Investment Account are
reinvested automatically in shares of the Fund. A shareholder's Systematic
Withdrawal Plan may be terminated at any time, without charge or penalty, by
the shareholder, the Fund, the Transfer Agent or the Distributor.
With respect to redemptions of Class B or Class C shares pursuant to a
systematic withdrawal plan, the maximum number of Class B or Class C shares
that can be redeemed from an account annually shall not exceed
43
<PAGE>
10% of the value of shares of such class in that account at the time the
election to join the systematic withdrawal plan was made. Any CDSC that
otherwise might be due on such redemption of Class B or Class C shares will be
waived. Shares redeemed pursuant to a systematic withdrawal plan will be
redeemed in the same order as Class B or Class C shares are otherwise redeemed.
See "Purchase of Shares -- Deferred Sales Charge Alternatives -- Contingent
Deferred Sales Charges -- Class B Shares" and " -- Contingent Deferred Sales
Charges -- Class C Shares." Where the systematic withdrawal plan is applied to
Class B shares, upon conversion of the last Class B shares in an account to
Class D shares, a shareholder must make a new election to join the systematic
withdrawal plan with respect to the Class D shares. See "Purchase of Shares --
Deferred Sales Charge Alternatives -- Conversion of Class B Shares to Class D
Shares." If an investor wishes to change the amount being withdrawn in a
systematic withdrawal plan the investor should contact his or her Financial
Consultant.
Withdrawal payments should not be considered as dividends. Each withdrawal
is a taxable event. If periodic withdrawals continuously exceed reinvested
dividends, the shareholder's original investment may be reduced
correspondingly. Purchases of additional shares concurrent with withdrawals are
ordinarily disadvantageous to the shareholder because of sales charges and tax
liabilities. The Fund will not knowingly accept purchase orders for shares of
the Fund from investors that maintain a Systematic Withdrawal Plan unless such
purchase is equal to at least one year's scheduled withdrawals or $1,200,
whichever is greater. Automatic investments may not be made into an Investment
Account in which the shareholder has elected to make systematic withdrawals.
Alternatively, a shareholder whose shares are held within a CMA(R), CBA(R)
Account or Retirement Account may elect to have shares redeemed on a monthly,
bimonthly, quarterly, semiannual or annual basis through the CMA(R) or CBA(R)
Systematic Redemption Program. The minimum fixed dollar amount redeemable is
$50. The proceeds of systematic redemptions will be posted to the shareholder's
account three business days after the date the shares are redeemed. All
redemptions are made at net asset value. A shareholder may elect to have his or
her shares redeemed on the first, second, third or fourth Monday of each month,
in the case of monthly redemptions, or of every other month, in the case of
bimonthly redemptions. For quarterly, semiannual or annual redemptions, the
shareholder may select the month in which the shares are to be redeemed and may
designate whether the redemption is to be made on the first, second, third, or
fourth Monday of the month. If the Monday selected is not a business day, the
redemption will be processed at net asset value on the next business day. The
CMA(R) or CBA(R) Systematic Redemption Program is not available if Fund shares
are being purchased within the account pursuant to the Automated Investment
Program. For more information on the CMA(R) or CBA(R) Systematic Redemption
Program, eligible shareholders should contact their Financial Consultant.
Capital gains and ordinary income received in each of the retirement plans
referred to above are exempt from Federal taxation until distributed from the
plans. Investors considering participation in any such plan should review
specific tax laws relating thereto and should consult their attorneys or tax
advisers with respect to the establishment and maintenance of any such plan.
DISTRIBUTIONS AND TAXES
DISTRIBUTIONS AND TAXES
All or a portion of the Fund's net investment income will be declared and
paid as dividends monthly. The Fund may at times pay out less than the entire
amount of net investment income earned in any particular period and may at
times pay out such accumulated undistributed income in addition to net
investment income earned in any particular period in order to permit the Fund
to maintain a more stable level of distributions. As a result, the distribution
paid by the Fund for any particular period may be more or less than the amount
of net investment income earned by the Fund during such period. However, it is
the Fund's intention to distribute during any fiscal year all its net
investment income. Shares will accrue dividends as long as they are issued and
outstanding. Shares are issued and outstanding as of the settlement date of a
purchase order to the settlement date of a redemption order. All net realized
capital gains, if any, will be distributed to the Fund's shareholders at least
annually. From time to time, the Fund may declare a special distribution at or
about the end of the calendar year in order to comply with a Federal income tax
requirement that certain percentages of its ordinary income and capital gains
be distributed during the taxable year. Premiums from expired call options
written by the Fund and
44
<PAGE>
net gains from closing purchase transactions are treated as short-term capital
gains for Federal income tax purposes. See "Shareholder Services -- Automatic
Dividends Program for information concerning the manner in which dividends and
distributions may be reinvested automatically in shares of the Fund.
Shareholders may elect in writing to receive any such dividends or
distributions, or both, in cash. Dividends and distributions are taxable to
shareholders as described below whether they are invested in shares of the Fund
or received in cash. The per share dividends and distributions on Class B and
Class C shares will be lower than the per share dividends and distributions on
Class A and Class D shares as a result of the account maintenance, distribution
and higher transfer agency fees applicable with respect to the Class B and
Class C shares; similarly, the per share dividends and distributions on Class D
shares will be lower than the per share dividends and distributions on Class A
shares as a result of the account maintenance fees applicable with respect to
the Class D shares. See "Determination of Net Asset Value."
TAXES
The Fund intends to continue to qualify for the special tax treatment
afforded regulated investment companies ("RICs") under the Internal Revenue
Code of 1986, as amended (the "Code"). As long as it so qualifies, the Fund
(but not its shareholders) will not be subject to Federal income tax on the
part of its net ordinary income and net realized capital gains which it
distributes to Class A, Class B, Class C and Class D shareholders (together,
the "shareholders"). The Fund intends to distribute substantially all of such
income.
In order to qualify, the Fund must among other things, (i) derive at least
90% of its gross income from dividends, interest, payments with respect to
certain securities loans, gains from the sale of securities, certain gains from
foreign currencies, or other income (including but not limited to gains from
options, futures or forward contracts) derived with respect to its business of
investing in such stock, securities or currencies; (ii) solely with respect to
tax years beginning on or before August 5, 1997, derive less than 30% of its
gross income from gains from the sale or other disposition of stock,
securities, options, futures, forward contracts and certain investments in
foreign currencies held for less than three months; (iii) distribute at least
90% of its dividend, interest and certain other taxable income each year; (iv)
at the end of each fiscal quarter maintain at least 50% of the value of its
total assets in cash, government securities, securities of other RICs, and
other securities of issuers which represent, with respect to each issuer, no
more than 5% of the value of the Fund's total assets and 10% of the outstanding
voting securities of such issuer; and (v) at the end of each fiscal quarter
have no more than 25% of its assets invested in the securities (other than
those of the government or other RICs) of any one issuer or of two or more
issuers which the Fund controls and which are engaged in the same, similar or
related trades and businesses.
Dividends paid by the Fund from its ordinary income and distributions of
the Fund's net realized short-term capital gains (together referred to
hereafter as "ordinary income dividends") are taxable to shareholders as
ordinary income. Distributions made from the Fund's net realized capital gains
(including long-term gains from certain transactions in futures and options)
are taxable to shareholders as long-term capital gains, regardless of the
length of time the shareholder has owned Fund shares.
Any net capital gains (I.E., the excess of net capital gains from the sale
of assets held for more than 12 months over net short-term capital losses, and
including such gains from certain transactions in futures and options)
distributed to shareholders will be taxable as long-term capital gains to the
shareholders, whether or not reinvested and regardless of the length of time a
shareholder has owned his or her shares. Under the Code, there are certain
categories of capital gains, applicable to individuals, which are taxable at
different rates. Generally not later than 60 days after the close of its
taxable year, the Fund will provide its shareholders with a written notice
designating the amounts of any ordinary income dividends or capital gain
dividends, as well as the amount of capital gain dividends in the different
categories of capital gain referred to above. The maximum capital gains rate
for corporate shareholders currently is the same as the maximum tax rate for
ordinary income.
The portion of the Fund's ordinary income dividends which is attributable
to dividends received by the Fund from U.S. corporations may be eligible for
the dividends received deduction allowed to corporations under the Code, if
certain requirements are met. For this purpose, the Fund will allocate
dividends eligible for the dividends received deduction between the Class A,
Class B, Class C and Class D shareholders according to a method
45
<PAGE>
(which it believes is consistent with the Securities and Exchange Commission
exemptive order permitting the issuance and sale of multiple classes of stock)
that is based upon the gross income that is allocable to the Class A, Class B,
Class C and Class D shareholders during the taxable year, or such other method
as the Internal Revenue Service may prescribe. If the Fund pays a dividend in
January which was declared in the previous October, November or December to
shareholders of record on a date in such a month, then such dividend or
distribution will be treated for tax purposes as being paid on December 31, and
will be taxable to its shareholders on December 31 of the year in which the
dividend was declared.
Under certain provisions of the Code, some shareholders may be subject to
a 31% withholding tax on ordinary income dividends, capital gains distributions
and redemption payments ("backup withholding"). Generally, shareholders subject
to backup withholding will be those for whom a certified taxpayer
identification number is not on file with the Fund or who, to the Fund's
knowledge, have furnished an incorrect number. When establishing an account, an
investor must certify under penalty of perjury that such number is correct and
that such shareholder is not otherwise subject to backup withholding taxes.
Pursuant to the investment objectives of the Fund, the Fund may invest in
foreign securities. Foreign taxes may be paid by the Fund as a result of tax
laws of countries in which the Fund may invest. Because the Fund limits its
investments in foreign securities, shareholders will not be entitled to claim
foreign tax credits with respect to their share of foreign taxes paid by the
Fund on income from investments in foreign securities held by the Fund.
Ordinary income dividends paid by the Fund to shareholders who are
non-resident aliens or foreign entities generally will be subject to a 30%
United States withholding tax under existing provisions of the Code applicable
to foreign individuals and entities unless a reduced rate of withholding or a
withholding exemption is provided under applicable treaty law. Non-resident
shareholders are urged to consult their own tax advisers concerning the
applicability of the United States withholding tax.
No gain or loss will be recognized by Class B shareholders on the
conversion of their Class B shares for Class D shares. A shareholder's basis in
the Class D shares acquired will be the same as such shareholder's basis in the
Class B shares converted, and the holding period of the acquired Class D shares
will include the holding period of the converted Class B shares.
Upon a sale or exchange of its shares, a shareholder will realize a
taxable gain or loss depending on its basis in the shares. Such gain or loss
will be treated as capital gain or loss if the shares are capital assets in the
shareholder's hands. In the case of an individual, any such capital gain will
be treated as short-term capital loss if the shares were held for not more than
12 months and long-term capital gain taxable at the maximum rate of 20% if such
shares were held for more than 12 months. In the case of a corporation, any
such capital gain will be treated as long-term capital gain, taxable at the
same rates as ordinary income, if such shares were held for more than 12
months. Generally, any loss realized on a sale or exchange will be disallowed
to the extent shares disposed of are replaced (whether through the automatic
reinvestment of dividends or otherwise) within a period of 61 days beginning 30
days before and ending 30 days after the shares are disposed of. In such a
case, the basis of the shares acquired will be adjusted to reflect the
disallowed loss. Any loss realized by a shareholder on the sale of shares of
the Fund held by the shareholder for six months or less will be treated for tax
purposes as long-term capital loss to the extent of any distributions of net
capital gains received by the shareholder with respect to such shares.
Distributions in excess of the Fund's earnings and profits will first reduce
the adjusted tax basis of a holder's shares and, after such adjusted tax basis
is reduced to zero, will constitute capital gains to such holder (assuming the
shares are held as a capital asset). If a shareholder exercises his exchange
privilege within 90 days of acquiring Class A shares of the Fund to acquire
shares in a second fund ("New Fund"), then the loss he can recognize on the
exchange will be reduced (or the gain increased) to the extent the charge paid
to the Fund reduces any charge he would have owed upon purchase of the shares
of the New Fund in the absence of the exchange privilege. Instead, such charge
will be treated as an amount paid for the New Fund shares.
The Code requires a RIC to pay a nondeductible 4% excise tax to the extent
the RIC does not distribute, during each calendar year, 98% of its ordinary
income, determined on a calendar basis, and 98% of its capital gains,
determined, in general, on an October 31 year end, plus certain undistributed
amounts from previous years.
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<PAGE>
While the Fund intends to distribute its income and capital gains in the manner
necessary to avoid imposition of the 4% excise tax, there can be no assurance
that sufficient amounts of the Fund's taxable income and capital gains will be
distributed to avoid entirely the imposition of the tax. In such event, the
Fund will be liable for the tax only on the amount by which it does not meet
the foregoing distribution requirements.
TAX TREATMENT OF OPTIONS AND FUTURES TRANSACTIONS
The Fund may purchase or sell options or futures. Options and futures
contracts that are "Section 1256 contracts" will be "marked to market" for
Federal income tax purposes at the end of each taxable year, I.E., each option
or futures contract will be treated as sold for its fair market value on the
last day of the taxable year. Unless such contract is a forward foreign
exchange contract, or is a non-equity option or a regulated futures contract
for a non-U.S. currency for which the Fund elects to have gain or loss treated
as ordinary gain or loss under Code Section 988 (as described below), gain or
loss from Section 1256 contracts will be 60% long-term and 40% short-term
capital gain or loss. The mark-to-market rules outlined above, however, will
not apply to certain transactions entered into by the Fund solely to reduce the
risk of changes in price or interest rates with respect to its investments.
Code Section 1092, which applies to certain "straddles," may affect the
taxation of the Fund's transactions in options and futures contracts. Under
Section 1092, the Fund may be required to postpone recognition for tax purposes
of losses incurred in certain closing transactions in options and futures.
Similarly, Code Section 1091, which deals with "wash sales," may cause the Fund
to postpone recognition of certain losses for tax purposes; Code Section 1258,
which deals with "conversion transactions," may apply to recharacterize certain
capital gains as ordinary income for tax purposes, and Code Section 1259, which
deals with "constructive sales" of appreciated financial positions (E.G.,
stock), may treat the Fund as having recognized income before the time that
such income is economically recognized by the Fund.
One of the requirements for qualification as a RIC is that less than 30%
of the Fund's gross income may be derived from gains from the sale or other
disposition of securities held for less than three months. Accordingly, the
Fund may be restricted in effecting closing transactions within three months
after entering into an option or futures contract. Under recently enacted
legislation, this requirement will no longer apply to the Fund after its fiscal
year ending August 31, 1998.
SPECIAL RULES FOR CERTAIN FOREIGN CURRENCY TRANSACTIONS
In general, gains from "foreign currencies" and from foreign currency
options, foreign currency futures and forward foreign exchange contracts
relating to investments in stock, securities or foreign currencies will be
qualifying income for purposes of determining whether the Fund qualifies as a
RIC. It is currently unclear, however, who will be treated as the issuer of a
foreign currency instrument or how foreign currency options, foreign currency
futures and forward foreign exchange contracts will be valued for purposes of
the RIC diversification requirements applicable to the Fund.
Under Code Section 988, special rules are provided for certain
transactions in a foreign currency other than the taxpayer's functional
currency (I.E., unless certain special rules apply, currencies other than the
U.S. dollar). In general, foreign currency gains or losses from certain forward
contracts not traded in the interbank market, from futures contracts that are
not "regulated futures contracts," and from unlisted options will be treated as
ordinary income or loss under Code Section 988. In certain circumstances, the
Fund may elect capital gain or loss treatment for such transactions. In
general, however, Code Section 988 gains or losses will increase or decrease
the amount of the Fund's investment company taxable income available to be
distributed to shareholders as ordinary income, rather than increasing or
decreasing the amount of the Fund's net capital gain. Additionally, if Code
Section 988 losses exceed other investment company taxable income during a
taxable year, the Fund would not be able to make any ordinary dividend
distributions, and any distributions made before the losses were realized but
in the same taxable year would be treated as a return of capital to
shareholders, thereby reducing each shareholder's basis in his Fund shares.
----------------
47
<PAGE>
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code and Treasury regulations presently in effect, and does
not address state and local taxation. For the complete provisions, reference
should be made to the pertinent Code sections and the Treasury regulations
promulgated thereunder. The Code and the Treasury regulations are subject to
change by legislative or administrative action either prospectively or
retroactively.
Dividends and capital gains distributions and gains on the sale or
exchange of shares in the Fund may also be subject to state and local taxes.
Shareholders are urged to consult their own tax advisers regarding
specific questions as to Federal, state, local or foreign taxes. Foreign
investors should consider applicable foreign taxes in their evaluation of an
investment in the Fund.
PERFORMANCE DATA
From time to time the Fund may include its average annual total return and
other total return data, as well as yield, in advertisements or information
furnished to present or prospective shareholders. Total return and yield
figures are based on the Fund's historical performance and are not intended to
indicate future performance. Average annual total return and yield are
determined separately for Class A, Class B, Class C and Class D shares in
accordance with a formula specified by the Commission.
Average annual total return quotations for the specified periods are
computed by finding the average annual compounded rates of return (based on net
investment income and any realized and unrealized capital gains or losses on
portfolio investments over such periods) that would equate the initial amount
invested to the redeemable value of such investment at the end of each period.
Average annual total return is computed assuming all dividends and
distributions are reinvested and taking into account all applicable recurring
and nonrecurring expenses, including the maximum sales charge in the case of
Class A and Class D shares and the CDSC that would be applicable to a complete
redemption of the investment at the end of the specified period in the case of
Class B and Class C shares.
The Fund also may quote annual, average annual and annualized total return
and aggregate total return performance data for various periods other than
those noted below. Such data will be computed as described above, except that
(1) as required by the periods of the quotations, actual annual, annualized or
aggregate data, rather than average annual data, may be quoted and (2) the
maximum applicable sales charges will not be included with respect to annual or
annualized rates of return calculations.
Aside from the impact on the performance data calculations of including or
excluding the maximum applicable sales charges, actual annual or annualized
total return data generally will be lower than average annual total return data
since the average rates of return reflect compounding of return; aggregate
total return data generally will be higher than average annual total return
data since the aggregate rates of return reflect compounding over a longer
period of time. In order to reflect the reduced sales charges in the case of
Class A or Class D shares or the waiver of the CDSC in the case of Class B or
Class C shares applicable to certain investors, as described under "Purchase of
Shares" the total return data quoted by the Fund in advertisements directed to
such investors may take into account the reduced, and not the maximum, sales
charge or may not take into account the waiver of the CDSC and therefore may
reflect greater total return since, due to the reduced sales charges or the
waiver of sales charges, a lower amount of expenses may be deducted. The Fund's
total return may be expressed either as a percentage or as a dollar amount in
order to illustrate such total return on a hypothetical $1,000 investment in
the Fund at the beginning of each specified period.
Yield quotations will be computed based on a 30-day period by dividing (a)
the net income based on the yield of each security earned during the period by
(b) the average number of shares outstanding during the period that were
entitled to receive dividends multiplied by the maximum offering price per
share on the last day of the period.
The Fund's total return and yield will vary depending on market
conditions, the securities comprising the Fund's portfolio, the Fund's
operating expenses and the amount of realized and unrealized net capital gains
or
48
<PAGE>
losses during the period. The value of an investment in the Fund will fluctuate
and investor's shares, when redeemed, may be worth more or less than their
original cost.
On occasion, the Fund may compare its performance to the Financial Times
- -- Actuaries Utility Index, Standard & Poor's 500 Index, the Value Line
Composite Index or the Dow Jones Industrial Average, other market indices, to
data contained in publications such as Lipper Analytical Services, Inc., or
performance data published by Morningstar Publications, Inc., MONEY MAGAZINE,
U.S. NEWS AND WORLD REPORT, BUSINESS WEEK, CDA INVESTMENT TECHNOLOGY, INC.,
FORBES MAGAZINE and FORTUNE MAGAZINE or other industry publications. When
comparing its performance to a market index, the Fund may refer to various
statistical measures derived from the historic performances of the Fund and the
index, such as standard deviation and beta. From time to time, the Fund may
include the Fund's Morningstar risk-adjusted performance ratings in
advertisements or supplemental sales literature. As with other performance
data, performance comparisons should not be considered indicative of the Fund's
relative performance for any future period.
Set forth below is total return and yield information for Class A, Class
B, Class C, and Class D shares of the Fund for the periods indicated.
<TABLE>
<CAPTION>
CLASS A SHARES CLASS B SHARES
----------------------------------------- ----------------------------------------
EXPRESSED AS REDEEMABLE VALUE EXPRESSED AS REDEEMABLE VALUE
A PERCENTAGE OF A HYPOTHETICAL A PERCENTAGE OF A HYPOTHETICAL
BASED ON A $1,000 INVESTMENT BASED ON A $1,000 INVESTMENT
HYPOTHETICAL AT THE END OF HYPOTHETICAL AT THE END OF
PERIOD $1,000 INVESTMENT THE PERIOD $1,000 INVESTMENT THE PERIOD
- ---------------------------------------- ------------------- ------------------- ------------------- ------------------
AVERAGE ANNUAL TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGES)
<S> <C> <C> <C> <C>
One Year Ended August 31, 1998 ......... 18.37% $ 1,183.70 18.38% $ 1,183.80
Inception (October 29, 1993) to
August 31, 1998 ...................... 7.13% $ 1,395.40 7.20% $ 1,399.80
ANNUAL TOTAL RETURN
Year Ended August 31, (EXCLUDING MAXIMUM APPLICABLE SALES CHARGES)
1998 ................................... 23.30% $ 1,233.00 22.38% $ 1,223.80
1997 ................................... 9.36% $ 1,093.60 8.39% $ 1,083.90
1996 ................................... 6.61% $ 1,066.10 5.86% $ 1,058.60
1995 ................................... 14.68% $ 1,146.80 13.72% $ 1,137.20
Inception (October 29, 1993) to
August 31, 1994 ...................... -11.84% $ 881.60 -12.34% $ 876.60
AGGREGATE TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGES)
Inception (October 29, 1993) to
August 31, 1998 ...................... 39.54% $ 1,395.40 39.98% $ 1,399.80
YIELD
30 Days Ended August 31, 1998 .......... 4.78% 4.22%
</TABLE>
49
<PAGE>
<TABLE>
<CAPTION>
CLASS C SHARES CLASS D SHARES
----------------------------------------- ----------------------------------------
EXPRESSED AS REDEEMABLE VALUE EXPRESSED AS REDEEMABLE VALUE
A PERCENTAGE OF A HYPOTHETICAL A PERCENTAGE OF A HYPOTHETICAL
BASED ON A $1,000 INVESTMENT BASED ON A $1,000 INVESTMENT
HYPOTHETICAL AT THE END OF HYPOTHETICAL AT THE END OF
PERIOD $1,000 INVESTMENT THE PERIOD $1,000 INVESTMENT THE PERIOD
- ---------------------------------------- ------------------- ------------------- ------------------- ------------------
AVERAGE ANNUAL TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGES)
<S> <C> <C> <C> <C>
One Year Ended August 31, 1998 ......... 21.19% $ 1,211.90 18.16% $ 1,181.60
Inception (October 21, 1994) to
August 31, 1998 ...................... 13.5% $ 1,631.40 13.04% $ 1,605.80
ANNUAL TOTAL RETURN
Year Ended August 31, (EXCLUDING MAXIMUM APPLICABLE SALES CHARGES)
1998 ................................... 22.19% $ 1,221.90 23.08% $ 1,230.80
1997 ................................... 8.48% $ 1,084.80 9.08% $ 1,090.80
1996 ................................... 5.65% $ 1,056.50 6.46% $ 1,064.60
Inception (October 21, 1994) to
August 31, 1995 ...................... 16.50% $ 1,165.00 17.03% $ 1,170.30
AGGREGATE TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGES)
Inception (October 21, 1994) to
August 31, 1998 ...................... 63.14% $ 1,631.40 60.58% $ 1,605.86
YIELD
30 Days Ended August 31, 1998 .......... 4.16% 4.54%
</TABLE>
GENERAL INFORMATION
DESCRIPTION OF SHARES
The Fund was incorporated under Maryland law on July 14, 1993. It has an
authorized capital of 400,000,000 shares of Common Stock, par value $0.10 per
share, divided into four classes, designated Class A, Class B, Class C and
Class D Common Stock, each of which consists of 100,000,000 shares. Class A,
Class B, Class C and Class D Common Stock represent an interest in the same
assets of the Fund and are identical in all respects except that the Class B,
Class C and Class D shares bear certain expenses relating the distribution of
such shares and the account maintenance fee and have exclusive voting rights
with respect to matters relating to such account maintenance and/or
distribution expenditures. The Board of Directors of the Fund may classify and
reclassify the shares of the Fund into additional classes of Common Stock at a
future date.
Shareholders are entitled to one vote for each share held and fractional
votes for fractional shares held and will vote on the election of Directors and
any other matter submitted to a shareholder vote. The Fund does not intend to
hold meetings of shareholders in any year in which the Investment Company Act
does not require shareholders to act upon any of the following matters: (i)
election of Directors; (ii) approval of an investment advisory agreement; (iii)
approval of a distribution agreement; and (iv) ratification of selection of
independent accountants. Also, the by-laws of the Fund require that a special
meeting of stockholders be held upon the written request of at least 10% of the
outstanding shares of the Fund entitled to vote at such meeting. Voting rights
for Directors are not cumulative. Shares issued are fully paid and
non-assessable and have no preemptive rights. Redemption and conversion rights
are discussed elsewhere herein and in the Prospectus. Each share is entitled to
participate equally in dividends and distributions declared by the Fund and in
the net assets of the Fund upon liquidation or dissolution after satisfaction
of outstanding liabilities. Stock certificates are issued by the transfer agent
only on specific request. Certificates for fractional shares are not issued in
any case.
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<PAGE>
INDEPENDENT AUDITORS
Deloitte & Touche LLP, 117 Campus Drive, Princeton, New Jersey 08540 has
been selected as the independent auditors of the Fund. The independent auditors
are responsible for auditing the annual financial statements of the Fund.
CUSTODIAN
State Street Bank and Trust Company, One Heritage Drive P2N, North Quincy,
Massachusetts 02171, acts as the Custodian of the Fund's assets. Under its
contract with the Fund, the Custodian is authorized to establish separate
accounts in foreign currencies and to cause foreign securities owned by the
Fund to be held in its offices outside the United States and with certain
foreign banks and securities depositories. The Custodian is responsible for
safeguarding and controlling the Fund's cash and securities, handling the
receipt and delivery of securities and collecting interest and dividends on the
Fund's investments.
TRANSFER AGENT
Financial Data Services, Inc., 4800 Deer Lake Drive East, Jacksonville,
Florida 32246-6484, acts as the Fund's Transfer Agent. The Transfer Agent is
responsible for the issuance, transfer and redemption of shares and the
opening, maintenance and servicing of shareholder accounts. See "How to Buy,
Sell, Transfer and Exchange Shares" in the Prospectus.
LEGAL COUNSEL
Swidler Berlin Shereff Friedman, LLP, 919 Third Avenue, New York, New York
10022, is counsel for the Fund.
REPORTS TO SHAREHOLDERS
The fiscal year of the Fund ends on August 31 of each year. The Fund sends
to its shareholders at least quarterly reports showing the Fund's portfolio and
other information. An annual report, containing financial statements audited by
independent auditors, is sent to shareholders each year. After the end of each
year shareholders will receive Federal income tax information regarding
dividends and capital gains distributions.
SHAREHOLDER INQUIRIES
Shareholder inquiries may be addressed to the Fund at the address or
telephone number set forth on the cover page of this Statement of Additional
Information.
ADDITIONAL INFORMATION
The Prospectus and this Statement of Additional Information do not contain
all the information set forth in the Registration Statement and the exhibits
relating thereto, which the Fund has filed with the Securities and Exchange
Commission, Washington, D.C., under the Securities Act and the Investment
Company Act of 1940, to which reference is hereby made.
To the knowledge of the Fund, no person or entity owned beneficially 5% or
more of any class of the Fund's shares on December 1, 1998.
FINANCIAL STATEMENTS
The Fund's audited financial statements are incorporated in this Statement
of Additional Information by reference to its 1998 annual report to
shareholders. You may request a copy of the annual report at no charge by
calling (800) 456-4587 Ext. 789 between 8:00 a.m. and 8:00 p.m. on any business
day.
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APPENDIX
RATINGS OF FIXED INCOME SECURITIES
DESCRIPTION OF MOODY'S INVESTORS SERVICE INC.'S ("MOODY'S") CORPORATE RATINGS
Aaa Bonds that are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred
to as "gilt edge." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be
visualized are most unlikely to impair the fundamentally strong position
of such issues.
Aa Bonds that are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally
known as high grade bonds. They are rated lower than the best bonds
because margins of protection may not be as large as in Aaa securities
or fluctuation of protective elements may be of greater amplitude or
there may be other elements present which make the long-term risks
appear somewhat larger than in Aaa securities.
A Bonds that are rated A possess many favorable investment attributes and
are to be considered as upper medium grade obligations. Factors giving
security to principal and interest are considered adequate, but elements
may be present which suggest a susceptibility to impairment sometime in
the future.
Baa Bonds that are rated Baa are considered as medium grade obligations;
I.E., they are neither highly protected nor poorly secured. Interest
payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding
investment characteristics and in fact have speculative characteristics
as well.
Ba Bonds that are rated Ba are judged to have speculative elements; their
future cannot be considered as well assured. Often the protection of
interest and principal payments may be very moderate, and therefore not
well safeguarded during both good and bad times over the future.
Uncertainty of position characterizes bonds in this class.
B Bonds that are rated B generally lack characteristics of desirable
investments. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any long period of time
may be small.
Caa Bonds that are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to
principal or interest.
Ca Bonds that are rated Ca represent obligations which are speculative in a
high degree. Such issues are often in default or have other marked
shortcomings.
C Bonds that are rated C are the lowest rated class of bonds, and issues
so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
NOTE. Moody's may apply numerical modifiers 1, 2 and 3 in each generic
rating classification from Aa through B in its corporate bond rating system.
The modifier I indicates that the security ranks in the higher end of its
generic rating category; the modifier 2 indicates a mid-range ranking; and the
modifier 3 indicates that the issue ranks in the lower end of its generic
rating category.
DESCRIPTION OF MOODY'S COMMERCIAL PAPER RATINGS
The term "commercial paper" as used by Moody's means promissory
obligations not having an original maturity in excess of nine months. Moody's
makes no representations as to whether such commercial paper is by any other
definition "commercial paper" or is exempt from registration under the
Securities Act of 1933, as amended.
Moody's commercial paper ratings are opinions of the ability of issuers to
repay punctually promissory obligations not having an original maturity in
excess of nine months. Moody's makes no representation that such obligations
are exempt from registration under the Securities Act of 1933, nor does it
represent that any specific
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note is a valid obligation of a rated issuer or issued in conformity with any
applicable law. Moody's employs the following three designations, all judged to
be investment grade, to indicate the relative repayment capacity of rated
issuers:
Issuers rated PRIME-1 (or related supporting institutions) have a superior
capacity for repayment of short-term promissory obligations. PRIME-1 repayment
capacity will normally be evidenced by the following characteristics:
-- Leading market positions in well established industries
-- High rates of return on funds employed
-- Conservative capitalization structures with moderate reliance on debt
and ample asset protection
-- Broad margins in earnings coverage of fixed financial charges and
high internal cash generation.
-- Well established access to a range of financial markets and assured
sources of alternate liquidity.
Issuers rated PRIME-2 (or related supporting institutions) have a strong
capacity for repayment of short-term promissory obligations. This will normally
be evidenced by many of the characteristics cited above but to a lesser degree.
Earnings trends and coverage ratios, while sound, will be more subject to
variation. Capitalization characteristics, while still appropriate, may be more
affected by external conditions. Ample alternate liquidity is maintained.
Issuers rated PRIME-3 (or related supporting institutions) have an
acceptable capacity for repayment of short-term promissory obligations. The
effect of industry characteristics and market composition may be more
pronounced. Variability in earnings and profitability may result in changes in
level of debt protection measurements and the requirement for relatively high
financial leverage. Adequate alternate liquidity is maintained.
Issuers rated NOT PRIME do not fall within any of the Prime rating
categories.
If an issuer represents to Moody's that its commercial paper obligations
are supported by the credit of another entity or entities, then the name or
names of such supporting entity or entities are listed within parentheses
beneath the name of the issuer, or there is a footnote referring the reader to
another page for the name or names of the supporting entity or entities. In
assigning ratings to such issuers, Moody's evaluates the financial strength of
the indicated affiliated corporations, commercial banks, insurance companies,
foreign governments or other entities, but only as one factor in the total
rating assessment. Moody's makes no representation and gives no opinion on the
legal validity or enforceability of any support arrangement. You are cautioned
to review with your counsel any questions regarding particular support
arrangements.
DESCRIPTION OF MOODY'S PREFERRED STOCK RATINGS
Because of the fundamental differences between preferred stocks and bonds,
a variation of the bond rating symbols is being used in the quality ranking of
preferred stocks. The symbols, presented below, are designed to avoid
comparison with bond quality in absolute terms. It should always be borne in
mind that preferred stocks occupy a junior position to bonds within a
particular capital structure and that these securities are rated within the
universe of preferred stocks.
Preferred stock rating symbols and their definitions are as follows:
aaa An issue that is rated "aaa" is considered to be a top-quality preferred
stock. This rating indicates good asset protection and the least risk of
dividend impairment within the universe of preferred stocks.
aa An issue that is rated "aa" is considered a high-grade preferred stock.
This rating indicates that there is reasonable assurance that earnings
and asset protection will remain relatively well maintained in the
foreseeable future.
a An issue that is rated "a" is considered to be an upper-medium grade
preferred stock. While risks are judged to be somewhat greater than in
the "aaa" and "aa" classifications, earnings and asset protection are,
nevertheless, expected to be maintained at adequate levels.
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baa An issue that is rated "baa" is considered to be medium grade, neither
highly protected nor poorly secured. Earnings and asset protection
appear adequate at present but may be questionable over any great length
of time.
ba An issue that is rated "ba" is considered to have speculative elements
and its future cannot be considered well assured. Earnings and asset
protection may be very moderate and not well safeguarded during adverse
periods. Uncertainty of position characterizes preferred stocks in this
class.
b An issue that is rated "b" generally lacks the characteristics of a
desirable investment. Assurance of dividend payments and maintenance of
other terms of the issue over any long period of time may be small.
caa An issue that is rated "caa" is likely to be in arrears on dividend
payments. This rating designation does not purport to indicate the
future status of payments.
ca An issue that is rated "ca" is speculative in a high degree and is
likely to be in arrears on dividends with little likelihood of eventual
payment.
c This is the lowest rated class of preferred or preference stock. Issues
so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
NOTE: Moody's may apply numerical modifiers 1, 2 and 3 in each rating
classification from "aa" through "b" in its preferred stock rating system. The
modifier 1 indicates that the security ranks in the higher end of its generic
rating category; the modifier 2 indicates a mid-range ranking; and the modifier
3 indicates that the issue ranks in the lower end of its generic rating
category.
DESCRIPTION OF STANDARD & POOR'S ("STANDARD & POOR'S") CORPORATE DEBT RATINGS
A Standard & Poor's corporate or municipal rating is a current assessment
of the creditworthiness of an obligor with respect to a specific obligation.
This assessment may take into consideration obligors such as guarantors,
insurers, or lessees.
The debt rating is not a recommendation to purchase, sell or hold a
security, inasmuch as it does not comment as to market price or suitability for
a particular investor.
The ratings are based on current information furnished by the issuer or
obtained by Standard & Poor's from other sources it considers reliable.
Standard & Poor's does not perform an audit in connection with any rating and
may, on occasion, rely on unaudited financial information. The ratings may be
changed, suspended or withdrawn as a result of changes in, or unavailability
of, such information or for other reasons.
The ratings are based, in varying degrees, on the following
considerations: (1) likelihood of default-capacity and willingness of the
obligor as to the timely payment of interest and repayment of principal in
accordance with the terms of the obligation; (2) nature of and provisions of
the obligation; and (3) protection afforded by, and relative position of, the
obligation in the event of bankruptcy, reorganization or other arrangement
under the laws of bankruptcy and other laws affecting creditors' rights.
AAA Debt rated AAA has the highest rating assigned by Standard & Poor's.
Capacity to pay interest and repay principal is extremely strong.
AA Debt rated AA has a very strong capacity to pay interest and repay
principal and differs from the highest-rated issues only in small
degree.
A Debt rated A has a strong capacity to pay interest and repay principal
although it is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in
higher-rated categories.
BBB Debt rated BBB is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate
protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to pay
interest and repay principal for debt in this category than for debt in
higher-rated categories.
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Debt rated BB, B, CCC, CC and C are regarded as having predominantly
speculative characteristics with respect to capacity to pay interest
and repay principal. BB indicates the least degree of speculation and C
the highest degree of speculation. While such debt will likely have
some quality and protective characteristics, these are outweighed by
large uncertainties or major risk exposures to adverse conditions.
BB Debt rated BB has less near-term vulnerability to default than other
speculative grade debt. However, it faces major ongoing uncertainties or
exposure to adverse business, financial or economic conditions which
could lead to inadequate capacity to meet timely interest and principal
payment. The BB rating category is also used for debt subordinated to
senior debt that is assigned an actual or implied BBB-rating.
B Debt rated B has a greater vulnerability to default but presently has
the capacity to meet interest payments and principal repayments. Adverse
business, financial or economic conditions would likely impair capacity
or willingness to pay interest and repay principal. The B rating
category is also used for debt subordinated to senior debt that is
assigned an actual or implied BB or BB-rating.
CCC Debt rated CCC has a current identifiable vulnerability to default, and
is dependent upon favorable business, financial and economic conditions
to meet timely payments of interest and repayments of principal. In the
event of adverse business, financial or economic conditions, it is not
likely to have the capacity to pay interest and repay principal. The CCC
rating category is also used for debt subordinated to senior debt that
is assigned an actual or implied B or B-rating.
CC The rating CC is typically applied to debt subordinated to senior debt
which is assigned an actual or implied CCC rating.
C The rating C is typically applied to debt subordinated to senior debt
which is assigned an actual or implied CCC-debt rating. The C rating may
be used to cover a situation where a bankruptcy petition has been filed
but debt service payments are continued.
CI The rating CI is reserved for income bonds on which no interest is being
paid.
D Debt rated D is in default. The D rating is assigned on the day an
interest or principal payment is missed. The D rating also will be used
upon the filing of a bankruptcy petition if debt service payments are
jeopardized.
Plus (+) or minus ( - ): The ratings from AA to CCC may be modified by the
addition of a plus or minus sign to show relative standing within the major
ratings categories.
Provisional ratings: The letter "p" indicates that the rating is
provisional. A provisional rating assumes the successful completion of the
project being financed by the debt being rated and indicates that payment of
debt service requirements is largely or entirely dependent upon the successful
and timely completion of the project. This rating, however, while addressing
credit quality subsequent to completion of the project, makes no comment on the
likelihood or risk of default upon failure of such completion. The investor
should exercise judgment with respect to such likelihood and risk.
L The letter "L" indicates that the rating pertains to the principal
amount of those bonds to the extent that the underlying deposit
collateral is insured by the Federal Savings & Loan Insurance Corp. or
the Federal Deposit Insurance Corp. and interest is adequately
collateralized.
* Continuance of the rating is contingent upon Standard & Poor's receipt
of an executed copy of the escrow agreement or closing documentation
confirming investments and cash flows.
NR Indicates that no rating has been requested, that there is insufficient
information on which to base a rating or that Standard & Poor's does not
rate a particular type of obligation as a matter of policy.
Debt obligations of issuers outside the United States and its territories
are rated on the same basis as domestic corporate and municipal issues. The
ratings measure the creditworthiness of the obligor but do not take into
account currency exchange and related uncertainties.
Bond Investment Quality Standards: Under present commercial bank
regulations issued by the Comptroller of the Currency, bonds rated in the top
four categories ("AAA," "AA," "A," "BBB," commonly known as
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"investment grade" ratings) are generally regarded as eligible for bank
investment. In addition, the laws of various states governing legal investments
impose certain rating or other standards for obligations eligible for
investment by savings banks, trust companies, insurance companies and
fiduciaries generally.
DESCRIPTION OF STANDARD & POOR'S COMMERCIAL PAPER RATINGS
A Standard & Poor's commercial paper rating is a current assessment of the
likelihood of timely payment of debt having an original maturity of no more
than 365 days. Ratings are graded into four categories, ranging from "A" for
the highest quality obligations to "D" for the lowest. The four categories are
as follows:
A Issues assigned this highest rating are regarded as having the greatest
capacity for timely payment. Issues in this category are delineated with
the numbers 1, 2 and 3 to indicate the relative degree of safety.
A-l This designation indicates that the degree of safety regarding timely
payment is either overwhelming or very strong. Those issues determined
to possess overwhelming safety characteristics are denoted with a plus
(+) sign designation.
A-2 Capacity for timely payment on issues with this designation is strong.
However, the relative degree of safety is not as high as for issues
designated "A-l."
A-3 Issues carrying this designation have a satisfactory capacity for timely
payment. They are however, somewhat more vulnerable to the adverse
effects of changes in circumstances than obligations carrying the higher
designations.
B Issues rated "B" are regarded as having only adequate capacity for
timely payment. However, such capacity may be damaged by changing
conditions or short-term adversities.
C This rating is assigned to short-term debt obligations with a doubtful
capacity for payment.
D This rating indicates that the issue is either in default or is expected
to be in default upon maturity.
The commercial paper rating is not a recommendation to purchase or sell a
security. The ratings are based on current information furnished to Standard &
Poor's by the issuer or obtained from other sources it considers reliable. The
ratings may be changed, suspended, or withdrawn as a result of changes in or
unavailability of such information.
DESCRIPTION OF STANDARD & POOR'S PREFERRED STOCK RATINGS
A Standard & Poor's preferred stock rating is an assessment of the
capacity and willingness of an issuer to pay preferred stock dividends and any
applicable sinking fund obligations. A preferred stock rating differs from a
bond rating inasmuch as it is assigned to an equity issue, which issue is
intrinsically different from, and subordinated to, a debt issue. Therefore, to
reflect this difference, the preferred stock rating symbol will normally not be
higher than the bond rating symbol assigned to, or that would be assigned to,
the senior debt of the same issuer.
The preferred stock ratings are based on the following considerations:
I. Likelihood of payment -- capacity and willingness of the issuer to
meet the timely payment of preferred stock dividends and any
applicable sinking fund requirements in accordance with the terms of
the obligation.
II. Nature of, and provisions of, the issue.
III. Relative position of the issue in the event of bankruptcy,
reorganization, or other arrangements affecting creditors' rights.
AAA This is the highest rating that may be assigned by Standard & Poor's to
a preferred stock issue and indicates an extremely strong capacity to
pay the preferred stock obligations.
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AA A preferred stock issue rated "AA" also qualifies as a high-quality
fixed income security. The capacity to pay preferred stock obligations
is very strong, although not as overwhelming as for issues rated "AAA."
A An issue rated "A" is backed by a sound capacity to pay the preferred
stock obligations, although it is somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions.
BBB An issue rated "BBB" is regarded as backed by an adequate capacity to
pay the preferred stock obligations. Whereas it normally exhibits
adequate protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to make
payments for a preferred stock in this category than for issues in the
"A" category.
BB, Preferred stock rated "BB," "B," and "CCC" are regarded, on balance, as
B, predominantly B, speculative with respect to the issuer's capacity to pay
CCC preferred stock obligations. "BB" indicates the lowest degree of
speculation and "CCC" the highest degree of speculation. While such
issues will likely have some quality and protection characteristics,
these are outweighed by large uncertainties or major risk exposures to
adverse conditions.
CC The rating "CC" is reserved for a preferred stock issue in arrears on
dividends or sinking fund payments but that is currently paying.
C A preferred stock rated "C" is a non-paying issue.
D A preferred stock rated "D" is a non-paying issue with the issuer in
default on debt instruments.
NR indicates that no rating has been requested, that there is insufficient
information on which to base a rating, or that S&P does not rate a particular
type of obligation as a matter of policy.
Plus (+) or minus ( - ): To provide more detailed indications of preferred
stock quality, the ratings from "AA" to "CCC" may be modified by the addition
of a plus or minus sign to show relative standing within the major rating
categories.
The preferred stock ratings are not a recommendation to purchase or sell a
security, inasmuch as market price is not considered in arriving at the rating.
Preferred stock ratings are wholly unrelated to Standard Poor's earnings and
dividend rankings for common stocks.
The ratings are based on current information furnished to Standard &
Poor's by the issuer, and obtained by Standard & Poor's from other sources it
considers reliable. The ratings may be changed, suspended, or withdrawn as a
result of changes in, or unavailability of, such information.
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Code # 16857-1298
(c)Merrill Lynch Asset Management, L.P.
