As Filed with the Securities and Exchange Commission on November 28, 2000
File No. 811-7848
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM N-1A
REGISTRATION STATEMENT
UNDER
THE INVESTMENT COMPANY ACT OF 1940
AMENDMENT NO. 10
THE TAX EXEMPT BOND PORTFOLIO
(Exact Name of Registrant as Specified in Charter)
60 State Street, Suite 1300, Boston, Massachusetts 02109
(Address of Principal Executive Offices)
Registrant's Telephone Number, Including Area Code: (617) 557-0700
Margaret W. Chambers, c/o Funds Distributor, Inc.,
60 State Street, Suite 1300, Boston, Massachusetts 02109
(Name and Address of Agent for Service)
Copy to: John Baumgardner, Jr., Esq.
Sullivan & Cromwell
125 Broad Street
New York, NY 10004
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EXPLANATORY NOTE
This Registration Statement has been filed by the Registrant pursuant
to Section 8(b) of the Investment Company Act of 1940, as amended. However,
beneficial interests in the Registrant are not being registered under the
Securities Act of 1933, as amended (the "1933 Act"), because such interests will
be issued solely in private placement transactions that do not involve any
"public offering" within the meaning of Section 4(2) of the 1933 Act.
Investments in the Registrant may only be made by other investment companies,
insurance company separate accounts, common or commingled trust funds or similar
organizations or entities that are "accredited investors" within the meaning of
Regulation D under the 1933 Act. This Registration Statement does not constitute
an offer to sell, or the solicitation of an offer to buy, any beneficial
interests in the Registrant.
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A-11
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PART A
Responses to Items 1,2,3,5 and 9 have been omitted pursuant to paragraph
2(b) of Instruction B of the General Instructions to Form N-1A.
Item 4. Investment Objectives, Principal Investment Strategies, and Related
Risks for the Tax Exempt Bond Portfolio (the "Portfolio").
INVESTMENT OBJECTIVE
The Portfolio's investment objective is to provide a high level of
current income that is exempt from federal income tax consistent with moderate
risk of capital.
PORTFOLIO MANAGER
The portfolio management team is led by Benjamin Thompson, vice
president, who joined the team in June 1999, Robert W. Meiselas, vice president
who joined the team in June 1997 and has been at J.P. Morgan since 1987, and
Kingsley Wood, Jr., vice president who has been on the team since January 2000.
Prior to joining J.P. Morgan, Mr. Thompson was a senior fixed income portfolio
manager at Goldman Sachs, and Mr. Wood was a senior at Mercantile Bank & Trust.
Prior to joining Mercantile in July of 1998, Mr. Wood was an institutional
tax-exempt trader at ABN-AMRO and Kemper Securities.
PRINCIPAL INVESTMENT STRATEGIES AND RELATED RISKS
INVESTMENT APPROACH
The Portfolio invests primarily in high quality municipal securities
that it believes have the potential to provide current income that is free from
federal personal income tax. While the Portfolio's goal is high tax-exempt
income, the Portfolio may invest to a limited extent in taxable securities,
including U.S. government, government agency, corporate, or taxable municipal
securities. The Portfolio's securities may be on any maturity, but under normal
market conditions the Portfolio's duration will generally range between four and
seven years, similar to that of the Lehman Brothers Intermediate Competitive
Municipal Bond Index (1-17 Year Maturity) (currently 5.4 years). At least 90% of
assets must be invested in securities that, at the time of purchase, are rated
investment-grade (BBB/Baa or better) or are the unrated equivalent. No more than
10% of assets may be invested in securities rated B or BB.
PRINCIPAL RISKS
The Portfolio's share price and total return will vary in response to
changes in interest rates. How well the Portfolio's performance compares to that
of similar tax-exempt portfolios will depend on the success of the investment
process.
Investors should be prepared for higher share price volatility than
from a tax-exempt fund of shorter duration. The Portfolio's performance could be
affected by market reaction to proposed tax legislation. To the extent that the
Portfolio seeks higher returns by investing in non-investment-grade bonds, often
called junk bonds, it takes on additional risks, since these bonds are more
sensitive to economic news and their issuers have a less secure financial
position.
INVESTMENT PROCESS
J.P. Morgan seeks to generate an information advantage through the
depth of its global fixed-income research and the sophistication of its
analytical systems. Using a team-oriented approach, J.P. Morgan seeks to gain
insights in a broad range of distinct areas and takes positions in many
different areas, helping the Portfolio to limit exposure to concentrated sources
of risk.
In managing the Portfolio, J.P. Morgan employs a three-step process
that combines sector allocation, fundamental research for identifying portfolio
securities, and duration management.
Sector Allocation: The sector allocation team meets monthly, analyzing the
fundamentals of a broad range of sectors in which the Portfolio may invest. The
team seeks to enhance performance and manage risk by underweighting or
overweighting sectors.
Security Selection: Relying on the insights of different specialists, including
credit analysts, quantitative researchers, and dedicated fixed income traders,
the portfolio managers make buy and sell decisions according to the Portfolio's
goal and strategy.
Duration Management: Forecasting teams use fundamental economic factors to
develop strategic forecasts of the direction of interest rates. Based on these
forecasts, strategists establish the Portfolio's target duration, a common
measurement of a security's sensitivity to interest rate movements. For
securities owned by the Portfolio, duration measures the average time needed to
receive the present value of all principal and interest payments by analyzing
cash flows and interest rate movements. The Portfolio's duration is generally
shorter than the Portfolio's average maturity because the maturity of a security
only measures the time until final payment is due. The Portfolio's target
duration typically remains relatively close to the duration of the market as a
whole, as represented by the Portfolio's benchmark. The strategists closely
monitor the Portfolios and make tactical adjustments as necessary.
INVESTMENTS
This table discusses the customary types of securities which can be held by the
Portfolio. In each case the principal types of risk (along with their
definitions) are listed.
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ASSET-BACKED SECURITIES Interests in a stream of payments from specific assets,
such as auto or credit card receivables.
Risk: credit, interest rate, market, prepayment
Permitted, but not typically used.
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BANK OBLIGATIONS Negotiable certificates of deposit, time deposits and bankers'
acceptances.
Risk: credit, liquidity, political
Permitted, but not typically used (Domestic only)
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COMMERCIAL PAPER Unsecured short term debt issued by banks or corporations.
These securities are usually discounted and are rated by S&P or Moody's.
Risk: credit, interest rate, liquidity, market, political
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MORTGAGES (DIRECTLY HELD) Domestic debt instrument which gives the lender a lien
on property as security for the loan payment.
Risk: credit, currency, extension, interest rate, leverage, market,
political, repayment
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PRIVATE
PLACEMENTS Bonds or other investments that are sold directly to an institutional
investor.
Risk: credit, interest rate, liquidity, market, valuation
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REPURCHASE AGREEMENTS Contracts whereby the portfolio agrees to purchase a
security and resell it to the seller on a particular date and at a specific
price.
Risk: credit
Permitted, but not typically used
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REVERSE
REPURCHASE AGREEMENTS Contracts whereby the portfolio sells a security and
agrees to repurchase it from the buyer on a particular date and at a specific
price. Considered a form of borrowing.
Risk: credit All forms of borrowing (including securities lending and
reverse repurchase agreements) in the aggregate may not exceed 33 1/3 of the
portfolio's total assets. Permitted, but not typically used
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SWAPS Contractual whereby a party agrees to exchange periodic payments with a
counterparty segregated accounts are used to offset leverage risk it.
Risk: credit, interest rate, leverage, market, political
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SYNTHETIC
VARIABLE RATE INSTRUMENTS Debt instruments whereby the issuer agrees to exchange
one security for another in order to change the maturity or quality of a
security in the Portfolio.
Risk: credit, interest rate, leverage, liquidity, market
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TAX EXEMPT MUNICIPAL SECURITIES Securities, generally issued as general
obligation and revenue bonds, whose interest is exempt from federal taxation and
state and/or local taxes in the state where the securities were issued.
Risk: credit, interest rate, market, natural event, political At least 80%
of assets must be in tax exempt securities.
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U.S. GOVERNMENT SECURITIES Debt instruments (Treasury bills, notes, and bonds)
guaranteed by the U.S. government for the timely payment of principal and
interest.
Risk: interest rate
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ZERO COUPON, PAY-IN-KIND, AND DEFERRED PAYMENT SECURITIES Securities offering
non-cash or delayed-cash payment. Their prices are typically more volatile than
those of some other debt instruments and involve certain special tax
considerations.
Risk: credit, interest rate, liquidity, market, political, valuation
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RISK RELATED TO CERTAIN SECURITIES HELD BY THE NEW YORK TAX EXEMPT BOND
PORTFOLIO:
CREDIT RISK The risk a financial obligation will not be met by the issuer of a
security or the counterparty to a contract, resulting in a loss to the
purchaser.
ENVIRONMENTAL RISK The risk that an owner or operator of real estate may be
liable for the costs associated with hazardous or toxic substances located on
the property.
EXTENSION RISK The risk a rise in interest rates will extend the life of a
mortgage (directly held) to a date later than the anticipated prepayment date,
causing the value of the investment to fall.
INTEREST RATE RISK The risk a change in interest rates will adversely affect the
value of an investment. The value of fixed income securities generally moves in
the opposite direction of interest rates (decreases when interest rates rise and
increases when interest rates fall).
LEVERAGE RISK The risk of gains or losses disproportionately higher than
the amount invested
LIQUIDITY RISK The risk the holder may not be able to sell the security at the
time or price it desires.
MARKET RISK The risk that when the market as a whole declines, the value of a
specific investment will decline proportionately. This systematic risk is common
to all investments and the mutual funds that purchase them.
NATURAL EVENT RISK The risk of a natural disaster, such as a hurricane or
similar event, will cause severe economic losses and default in payments by the
issuer of the security.
POLITICAL RISK The risk governmental policies or other political actions will
negatively impact the value of the investment.
PREPAYMENT RISK The risk declining interest rates will result in unexpected
prepayments, causing the value of the investment to fall.
VALUATION RISK The risk the estimated value of a security does not match the
actual amount that can be realized if the security is sold.
RISK AND REWARD ELEMENTS
This table discusses the main elements that make up the Portfolio's
overall risk characteristics. It also outlines the Portfolio's policies toward
various securities, including those that are designed to help the Portfolio
manage risk.
POTENTIAL RISKS OLICIES TO BALANCE RISK AND REWARD
MARKET CONDITIONS
-The Portfolio's price, yield and total return will -Under normal circumstances
the Portfolio plans to fluctuate in response to bond market movements remain
fully invested in bonds and other fixed income
securities
-The value of most bonds will fall when interest rates -The Portfolio seeks to
limit risk and enhance yields rise; the longer a bond's maturity and the lower
its through careful management, sector allocation, credit quality, the more its
value typically falls individual securities selection and duration management
-Adverse market conditions -During severe market downturns, the Portfolio has
the may from time to time cause option of investing up to 100% of assets in the
Portfolio to take temporary defensive positions that investment-grade short-term
securities are inconsistent with its principal investment strategies and may
hinder the portfolio from achieving its investment objective
-J.P. Morgan monitors interest rate trends, as well as
geographic and demographic information related to
mortgage prepayments
MANAGEMENT CHOICES
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-The Portfolio could underperform its -J.P. Morgan focuses its active management on those
benchmark due to its sector, securities, or duration areas where it believes its commitment to research can
choices most enhance returns and manage risks in a consistent
way
CREDIT QUALITY
-The default of an issuer would leave the Portfolio with -The Portfolio
maintains its own policies for balancing unpaid interest or principal credit
quality against potential yields and gains in
light of its investment goals
-Junk bonds (those rated BB/Ba or lower) have a higher -J.P. Morgan develops its own ratings of unrated
risk of default, tend to be less liquid, and may be more securities and makes a credit quality determination for
difficult to value unrated securities
DERIVATIVES
-Derivatives such as futures, options, & swaps that are -The Portfolio uses
derivatives, such as futures, used for hedging the Portfolio or specific
securities may options and swaps for hedging and for risk not fully offset the
underlying positions (1) and this management(i.e., to adjust duration or yield
curve could result in losses to the Portfolio that would not exposure, or to
establish or adjust exposure to have otherwise occurred. particular securities,
markets, or currencies); risk
management may include management of the Portfolio's
-Derivatives used for risk management may not have the exposure relative to its benchmark; the Portfolio is
intended effects permitted to enter into futures, options, and swap
and may result in losses or missed opportunities transactions, however, these transactions result in
taxable gains or losses so it is expected that the
-The counterparty to a derivatives contract could default Portfolio will utilize them infrequently
-Derivatives that involve
leverage could
magnify losses -The
Portfolio only
establishes hedges
that it expects
will be highly
correlated with
underlying
positions
-Certain types of derivatives involve costs to the -While the Portfolio may use derivatives that
Portfolio which can reduce returns incidentally involve leverage, it does not use them for
the
specific purpose of leveraging
the
Portfolio
SECURITIES LENDING
- When the Portfolio lends a security, there is a - J.P. Morgan maintains a list of all approved
risk that the loaned securities may not be returned borrowers
if the borrower defaults
- The Portfolio receives collateral equal to at
- The collateral will be subject to the risks of least 100% of the current value of securities
the securities in which it is invested loaned
- The lending agents indemnify the Portfolio
against borrower default
- JP Morgan's collateral investment guidelines
limit the quality and duration of collateral
investment to minimize losses
- Upon recall, the borrower must return the
securities loaned within the normal settlement
period.
ILLIQUID HOLDINGS
-The Portfolio could have difficulty valuing holdings -The Portfolio may not invest more than 15% of net
precisely assets in illiquid holdings
-The Portfolio could be unable to sell these holdings at -To maintain adequate
liquidity to meet redemptions, the time or price desired the Portfolio may hold
investment-grade short-term
securities (including repurchase
agreements and
reverse repurchase
agreements) and,
for temporary or
extraordinary
purposes, may
borrow from banks
up to 33 1/3% of
the value of its
total assets
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WHEN-ISSUED AND DELAYED
DELIVERY SECURITIES
-When the Portfolio buys securities before issue or for -The Portfolio uses
segregated accounts to offset delayed delivery, it could be exposed to leverage
risk if leverage risk it does not use segregated accounts
SHORT-TERM TRADING
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-Increased trading would raise the Portfolio transaction -The Portfolio may use short-term trading to take
costs advantage of attractive or unexpected opportunities or
to meet demands generated by shareholder activity. The
Portfolio turnover rate for the fiscal year ended
-Increased short-term capital gains 7/31/00 was 84%.
distributions would raise investors' income tax liability
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(1) A futures contract is an agreement to buy or sell a set quantity of an
underlying instrument at a future date, or to make or receive a cash
payment based on changes in the value of a securities index. An option
is the right to buy or sell a set quantity of an underlying instrument
at a predetermined price. A swap is a privately negotiated agreement to
exchange one stream of payments for another.
Item 6. MANAGEMENT, ORGANIZATION AND CAPITAL STRUCTURE.
BUSINESS STRUCTURE
The Tax Exempt Bond Portfolio (the "Portfolio") is a diversified
open-end management investment company which was organized as a trust under the
laws of the State of New York on January 29, 1993. Beneficial interests in the
Portfolio are issued solely in private placement transactions that do not
involve any "public offering" within the meaning of Section 4(2) of the
Securities Act of 1933, as amended (the "1933 Act"). Investments in the
Portfolio may only be made by other investment companies, insurance company
separate accounts, common or commingled trust funds or similar organizations or
entities that are "accredited investors" within the meaning of Regulation D
under the 1933 Act. This Registration Statement does not constitute an offer to
sell, or the solicitation of an offer to buy, any "security" within the meaning
of the 1933 Act.
MANAGEMENT AND ADMINISTRATION
The Board of Trustees provides broad supervision over the affairs of the
Portfolio. The Portfolio has retained the services of J.P. Morgan Investment
Management, Inc. ("JPMIM" or the "Advisor") as investment adviser and Guaranty
Trust Company of New York ("Morgan") as administrative services agent. The
Portfolio has retained the services of Funds Distributor, Inc. ("FDI") as
co-administrator (the "Co-Administrator").
The Portfolio has not retained the services of a principal underwriter
or distributor, since interests in the Portfolio are offered solely in private
placement transactions. FDI, acting as exclusive placement agent of interests in
the Portfolio. FDI receives no additional compensation for serving in this
capacity.
The Portfolio has entered into an Amended and Restated Portfolio Fund
Services Agreement, dated July 11, 1996, with Pierpont Group, Inc. ("Pierpont
Group") to assist the Trustees in exercising their overall supervisory
responsibilities for the Portfolio. The fees to be paid under the agreement
approximate the reasonable cost of Pierpont Group in providing these services to
the Portfolio, the Portfolio and certain other registered investment companies
subject to similar agreements with Pierpont Group, Inc. Pierpont Group was
organized in 1989 at the request of the Trustees of the J.P. Morgan Family of
Funds (formerly The Pierpont Family of Funds) for the purpose of providing these
services at cost to those funds. See Item 14 in Part B. The principal offices of
Pierpont Group are located at 461 Fifth Avenue, New York, New York 10017.
------------------------------------------------------- Advisory services
0.30% of the portfolio's average net assets Administrative services (fee shared
with Funds Portfolio's pro-rata portions of 0.09% of the first Distributor,
Inc.) $7 billion of average net assets in J.P. Morgan-advised portfolios, plus
0.04% of average net assets over $7 billion
J.P. Morgan may pay fees to certain firms and professionals for providing
recordkeeping or other services in connection with investments in a fund.
Item 7. Shareholder Information
INVESTING
Beneficial interests in the Portfolio are issued solely in private
placement transactions that do not involve any "public offering" within the
meaning of Section 4(2) of the 1933 Act. Investments in the Portfolio may only
be made by other investment companies, insurance company separate accounts,
common or commingled trust funds, or similar organizations or entities which are
"accredited investors" as defined in Rule 501 under the 1933 Act. This
Registration Statement does not constitute an offer to sell, or the solicitation
of an offer to buy, any "security" within the meaning of the 1933 Act.
An investment in the Portfolio may be made without a sales load. All
investments are made at net asset value next determined after an order is
received in "good order" by the Portfolio. The net asset value of the Portfolio
is determined on each Portfolio Business Day.
There is no minimum initial or subsequent investment in the Portfolio.
However, because the Portfolio intends to be as fully invested at all times as
is reasonably practicable in order to enhance the yield on its assets,
investments must be made in federal funds (i.e., monies credited to the account
of the Custodian by a Federal Reserve Bank).
The Portfolio may, at its own option, accept securities in payment for
investments in its beneficial interest. The securities delivered in kind are
valued by the method described in Item 19 as of the business day prior to the
day the Portfolio receives the securities. Securities may be accepted in payment
for beneficial interests only if they are, in the judgment of the Advisor,
appropriate investments for the Portfolio. In addition, securities accepted in
payment for beneficial interests must: (i) meet the investment objective and
policies of the Portfolio; (ii) be acquired by the Portfolio for investment and
not for resale; (iii) be liquid securities which are not restricted as to
transfer either by law or liquidity of market; and (iv) if stock, have a value
which is readily ascertainable as evidenced by a listing on a stock exchange,
over-the-counter market or by readily available market quotations from a dealer
in such securities. The Portfolio reserves the right to accept or reject at its
own option any and all securities offered in payment for beneficial interests.
The Portfolio and FDI reserve the right to cease accepting investments
at any time or to reject any investment order.
ADDING TO YOUR ACCOUNT
Each investor in the Portfolio may add to or reduce its investment in
the Portfolio on each Portfolio Business Day. At the Valuation Time on each such
day, the value of each investor's beneficial interest in the Portfolio will be
determined by multiplying the net asset value of the Portfolio by the
percentage, effective for that day, which represents that investor's share of
the aggregate beneficial interests in the Portfolio. Any additions or
reductions, which are to be effected at the Valuation Time on such day, will
then be effected. The investor's percentage of the aggregate beneficial
interests in the Portfolio will then be recomputed as the percentage equal to
the fraction (i) the numerator of which is the value of such investor's
investment in the Portfolio as of the Valuation Time on such day plus or minus,
as the case may be, the amount of net additions to or reductions in the
investor's investment in the Portfolio effective as of the Valuation Time, and
(ii) the denominator of which is the aggregate net asset value of the Portfolio
as of the Valuation Time on such day, plus or minus, as the case may be, the
amount of net additions to or reductions in the aggregate investments in the
Portfolio by all investors in the Portfolio. The percentage so determined will
then be applied to determine the value of the investor's interest in the
Portfolio as of the Valuation Time on the following Portfolio Business Day.
SELLING SHARES
An investor in the Portfolio may reduce all or any portion of its
investment at the net asset value next determined after a request in "good
order" is furnished by the investor to the Portfolio. The proceeds of a
reduction will be paid by the Portfolio in federal funds normally on the next
Portfolio Business Day after the reduction is effected, but in any event within
seven days.
Investments in the Portfolio may not be transferred.
The right of any investor to receive payment with respect to any
reduction may be suspended or the payment of the proceeds therefrom postponed
during any period in which the New York Stock Exchange (the "NYSE") is closed
(other than weekends or holidays) or trading on the NYSE is restricted or, to
the extent otherwise permitted by the 1940 Act, if an emergency exists.
REDEMPTION IN KIND
The Portfolio reserves the right under certain circumstances, such as
accommodating requests for substantial withdrawals or liquidations, to pay
distributions in kind to investors (i.e., to distribute portfolio securities as
opposed to cash). If securities are distributed, an investor could incur
brokerage, tax or other charges in converting the securities to cash. In
addition, distribution in kind may result in a less diversified portfolio of
investments or adversely affect the liquidity of the Portfolio or the investor's
portfolio, as the case may be.
ACCOUNT AND TRANSACTION POLICIES
Business Hours and NAV Calculation
The net asset value of the Portfolio is determined each business day
other than the holidays listed in Part B ("Portfolio Business Day"). This
determination is made once each Portfolio Business Day at the close of trading
on the New York Stock Exchange (normally 4:00 p.m.) (the "Valuation Time").
DIVIDENDS AND DISTRIBUTIONS
It is intended that the Portfolio's assets, income and distributions
will be managed in such a way that an investor in the Portfolio will be able to
satisfy the requirements of Subchapter M of the Code, assuming that the investor
invested all of its assets in the Portfolio.
Investor inquiries may be directed to FDI at 60 State Street, Suite
1300, Boston, Massachusetts 02109, (617) 557-0700.
TAX CONSIDERATIONS
Under the anticipated method of operation of the Portfolio, the
Portfolio will not be subject to any income tax. However, each investor in the
Portfolio will be taxable on its share (as determined in accordance with the
governing instruments of the Portfolio) of the Portfolio's ordinary income and
capital gain in determining its income tax liability. The determination of such
share will be made in accordance with the Internal Revenue Code of 1986, as
amended (the "Code"), and regulations promulgated thereunder.
Item 8. DISTRIBUTION ARRANGEMENTS
Not applicable.
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B-25
PART B
Item 10. COVER PAGE.
Not applicable.
Item 11. TABLE OF CONTENTS.
Page
General Information and History B-2
Investment Objective and Policies B-2
Management of the Portfolio B-22
Control Persons and Principal Holder of Securities B-27
Investment Advisory and Other Services B-27
Brokerage Allocation and Other Practices B-30
Capital Stock and Other Securities B-31
Purchase, Redemption and Pricing of Securities Being Offered B-32
Tax Status B-34
Underwriters B-35
Calculations of Performance Data B-35
Financial Statements B-35
Appendix A Appendix A-1
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Item 12. GENERAL INFORMATION AND HISTORY.
Not applicable.
Item 13. INVESTMENT OBJECTIVE AND POLICIES.
The investment objective of The Tax Exempt Bond Portfolio (the
"Portfolio") is to provide a high level of current income that is exempt from
federal income tax consistent with moderate risk of capital and maintenance of
liquidity. The Portfolio attempts to achieve its investment objective by
investing primarily in securities of states, territories and possessions of the
United States and their political subdivisions, agencies and instrumentalities,
the interest of which is exempt from federal income tax in the opinion of bond
counsel for the issuer, but it may invest up to 20% of its total assets in
taxable obligations. The Portfolio seeks to maintain a current yield that is
greater than that obtainable from a portfolio of short term tax exempt
obligations, subject to certain quality and diversification restrictions. See
"Quality and Diversification Requirements."
The Portfolio is advised by J.P. Morgan Investment Management Inc. ("JPMIM"
or the "Advisor").
The following discussion supplements the information regarding the
investment objective of the Portfolio and the policies to be employed to achieve
this objective as set forth above and in Part A.
TAX EXEMPT OBLIGATIONS
As discussed in Part A, the Portfolio may invest in tax exempt obligations
to the extent consistent with the Portfolio's investment objective and policies.
A description of the various types of tax exempt obligations which may be
purchased by the Portfolio appears in Part A and below. See "Quality and
Diversification Requirements."
MUNICIPAL BONDS. Municipal bonds are debt obligations issued by the states,
territories and possessions of the United States and the District of Columbia,
by their political subdivisions and by duly constituted authorities and
corporations. For example, states, territories, possessions and municipalities
may issue municipal bonds to raise funds for various public purposes such as
airports, housing, hospitals, mass transportation, schools, water and sewer
works. They may also issue municipal bonds to refund outstanding obligations and
to meet general operating expenses. Public authorities issue municipal bonds to
obtain funding for privately operated facilities, such as housing and pollution
control facilities, for industrial facilities or for water supply, gas,
electricity or waste disposal facilities.
Municipal bonds may be general obligation or revenue bonds. General
obligation bonds are secured by the issuer's pledge of its full faith, credit
and taxing power for the payment of principal and interest. Revenue bonds are
payable from revenues derived from particular facilities, from the proceeds of a
special excise tax or from other specific revenue sources. They are not
generally payable from the general taxing power of a municipality.
MUNICIPAL NOTES. The Portfolio may also invest in municipal notes of various
types, including notes issued in anticipation of receipt of taxes, the proceeds
of the sale of bonds, other revenues or grant proceeds, as well as municipal
commercial paper and municipal demand obligations such as variable rate demand
notes and master demand obligations. The interest rate on variable demand notes
is adjustable at periodic intervals as specified in the notes. Master demand
obligations permit the investment of fluctuating amounts at periodically
adjusted interest rates. They are governed by agreements between the municipal
issuer and Morgan Guaranty Trust Company of New York ("Morgan"), an affiliate of
the Advisor, acting as agent, for no additional fee. Although master demand
obligations are not marketable to third parties, the Fund considers them to be
liquid because they are payable on demand. There is no specific percentage
limitation on these investments. Municipal notes are subdivided into three
categories of short-term obligations: municipal notes, municipal commercial
paper and municipal demand obligations.
Municipal notes are short-term obligations with a maturity at the time
of issuance ranging from six months to five years. The principal types of
municipal notes include tax anticipation notes, bond anticipation notes, revenue
anticipation notes, grant anticipation notes and project notes. Notes sold in
anticipation of collection of taxes, a bond sale, or receipt of other revenues
are usually general obligations of the issuing municipality or agency.
Commercial paper typically consists of very short-term, unsecured
negotiable promissory notes that are sold to meet seasonal working capital or
interim construction financing needs of a municipality or agency. While these
obligations are intended to be paid from general revenues or refinanced with
long-term debt, they frequently are backed by letters of credit, lending
agreements, note repurchase agreements or other credit facility agreements
offered by banks or institutions.
Municipal demand obligations are subdivided into two types: variable rate
demand notes and master demand obligations.
Variable rate demand notes are tax exempt municipal obligations or
participation interests that provide for a periodic adjustment in the interest
rate paid on the notes. They permit the holder to demand payment of the notes,
or to demand purchase of the notes at a purchase price equal to the unpaid
principal balance, plus accrued interest either directly by the issuer or by
drawing on a bank letter of credit or guaranty issued with respect to such note.
The issuer of the municipal obligation may have a corresponding right to prepay
at its discretion the outstanding principal of the note plus accrued interest
upon notice comparable to that required for the holder to demand payment. The
variable rate demand notes in which the Portfolio may invest are payable, or are
subject to purchase, on demand usually on notice of seven calendar days or less.
The terms of the notes provide that interest rates are adjustable at intervals
ranging from daily to six months, and the adjustments are based upon the prime
rate of a bank or other appropriate interest rate index specified in the
respective notes. Variable rate demand notes are valued at amortized cost; no
value is assigned to the right of the Portfolio to receive the par value of the
obligation upon demand or notice.
Master demand obligations are tax exempt municipal obligations that
provide for a periodic adjustment in the interest rate paid and permit daily
changes in the amount borrowed. The interest on such obligations is, in the
opinion of counsel for the borrower, excluded from gross income for federal
income tax purposes. For a description of the attributes of master demand
obligations, see "Money Market Instruments" above. Although there is no
secondary market for master demand obligations, such obligations are considered
by the Portfolio to be liquid because they are payable upon demand. The
Portfolio has no specific percentage limitations on investments in master demand
obligations.
Premium Securities. During a period of declining interest rates, many
municipal securities in which the Portfolio invests likely will bear coupon
rates higher than current market rates, regardless of whether the securities
were initially purchased at a premium. In general, such securities have market
values greater than the principal amounts payable on maturity, which would be
reflected in the net asset value of the Portfolio. The values of such "premium"
securities tend to approach the principal amount as they near maturity.
PUTS. The Portfolio may purchase without limit municipal bonds or notes
together with the right to resell the bonds or notes to the seller at an agreed
price or yield within a specified period prior to the maturity date of the bonds
or notes. Such a right to resell is commonly known as a "put." The aggregate
price for bonds or notes with puts may be higher than the price for bonds or
notes without puts. Consistent with the Portfolio's investment objective and
subject to the supervision of the Trustees, the purpose of this practice is to
permit the Portfolio to be fully invested in tax exempt securities while
preserving the necessary liquidity to purchase securities on a when-issued
basis, to meet unusually large redemptions, and to purchase at a later date
securities other than those subject to the put. The principal risk of puts is
that the writer of the put may default on its obligation to repurchase. The
Advisor will monitor each writer's ability to meet its obligations under puts.
Puts may be exercised prior to the expiration date in order to fund
obligations to purchase other securities or to meet redemption requests. These
obligations may arise during periods in which proceeds from sales of interests
in the Portfolio and from recent sales of portfolio securities are insufficient
to meet obligations or when the funds available are otherwise allocated for
investment. In addition, puts may be exercised prior to the expiration date in
order to take advantage of alternative investment opportunities or in the event
the Advisor revises its evaluation of the creditworthiness of the issuer of the
underlying security. In determining whether to exercise puts prior to their
expiration date and in selecting which puts to exercise, the Advisor considers
the amount of cash available to the Portfolio, the expiration dates of the
available puts, any future commitments for securities purchases, alternative
investment opportunities, the desirability of retaining the underlying
securities in the Portfolio and the yield, quality and maturity dates of the
underlying securities.
The Portfolio values any municipal bonds and notes subject to puts with
remaining maturities of less than 60 days by the amortized cost method. If the
Portfolio were to invest in municipal bonds and notes with maturities of 60 days
or more that are subject to puts separate from the underlying securities, the
puts and the underlying securities would be valued at fair value as determined
in accordance with procedures established by the Board of Trustees. The Board of
Trustees would, in connection with the determination of the value of a put,
consider, among other factors, the creditworthiness of the writer of the put,
the duration of the put, the dates on which or the periods during which the put
may be exercised and the applicable rules and regulations of the Securities and
Exchange Commission (the "SEC"). Prior to investing in such securities, the
Portfolio, if deemed necessary based upon the advice of counsel, will apply to
the SEC for an exemptive order, which may not be granted, relating to the
amortized valuation of such securities.
Since the value of the put is partly dependent on the ability of the
put writer to meet its obligation to repurchase, the Portfolio's policy is to
enter into put transactions only with municipal securities dealers who are
approved by the Advisor. Each dealer will be approved on its own merits, and it
is the Portfolio's general policy to enter into put transactions only with those
dealers which are determined to present minimal credit risks. In connection with
such determination, the Advisor reviews regularly the list of approved dealers,
taking into consideration, among other things, the ratings, if available, of
their equity and debt securities, their reputation in the municipal securities
markets, their net worth, their efficiency in consummating transactions and any
collateral arrangements, such as letters of credit, securing the puts written by
them. Commercial bank dealers normally will be members of the Federal Reserve
System, and other dealers will be members of the National Association of
Securities Dealers, Inc. or members of a national securities exchange. Other put
writers will have outstanding debt rated Aa or better by Moody's Investors
Service, Inc. ("Moody's") or AA or better by Standard & Poor's Ratings Group
("Standard & Poor's"), or will be of comparable quality in the Advisor's opinion
or such put writers' obligations will be collateralized and of comparable
quality in the Advisor's opinion. The Trustees have directed the Advisor not to
enter into put transactions with any dealer which in the judgment of the Advisor
becomes more than a minimal credit risk. In the event that a dealer should
default on its obligation to repurchase an underlying security, the Portfolio is
unable to predict whether all or any portion of any loss sustained could
subsequently be recovered from such dealer.
Entering into a put with respect to a tax exempt security may be
treated, depending upon the terms of the put, as a taxable sale of the tax
exempt security by the Portfolio with the result that, while the put is
outstanding, the Portfolio will no longer be treated as the owner of the
security and the interest income derived with respect to the security will be
treated as taxable income to the Portfolio.
Non-Municipal Securities
The Portfolio may invest in bonds and other debt securities of domestic
issuers to the extent consistent with its investment objective and policies. The
Portfolio may invest in U.S. Government, bank and corporate debt obligations, as
well as asset-backed securities and repurchase agreements. The Portfolio will
purchase such securities only when the Advisor believes that they would enhance
the after tax returns of a shareholder of the Fund in the highest federal income
tax brackets. Under normal circumstances, the Portfolio's holdings of
non-municipal securities will not exceed 20% of its total assets. A description
of these investments appears below. See "Quality and Diversification
Requirements." For information on short-term investments in these securities,
see "Money Market Instruments."
Zero Coupon, Pay-in-Kind and Deferred Payment Securities. Zero coupon securities
are securities that are sold at a discount to par value and on which interest
payments are not made during the life of the security. Upon maturity, the holder
is entitled to receive the par value of the security. Pay-in-kind securities are
securities that have interest payable by delivery of additional securities. Upon
maturity, the holder is entitled to receive the aggregate par value of the
securities. The Portfolio accrues income with respect to zero coupon and
pay-in-kind securities prior to the receipt of cash payments. Deferred payment
securities are securities that remain zero coupon securities until a
predetermined date, at which time the stated coupon rate becomes effective and
interest becomes payable at regular intervals. While interest payments are not
made on such securities, holders of such securities are deemed to have received
"phantom income." Because the Portfolio will distribute "phantom income" to
shareholders, to the extent that shareholders elect to receive dividends in cash
rather than reinvesting such dividends in additional shares, the Portfolio will
have fewer assets with which to purchase income producing securities. Zero
coupon, pay-in-kind and deferred payment securities may be subject to greater
fluctuation in value and lesser liquidity in the event of adverse market
conditions than comparably rated securities paying cash interest at regular
interest payment periods.
Asset-Backed Securities. Asset-backed securities directly or indirectly
represent a participation interest in, or are secured by and payable from, a
stream of payments generated by particular assets such as motor vehicle or
credit card receivables or other asset-backed securities collateralized by such
assets. Payments of principal and interest may be guaranteed up to certain
amounts and for a certain time period by a letter of credit issued by a
financial institution unaffiliated with the entities issuing the securities. The
asset-backed securities in which the Portfolio may invest are subject to the
Portfolio's overall credit requirements. However, asset-backed securities, in
general, are subject to certain risks. Most of these risks are related to
limited interests in applicable collateral. For example, credit card debt
receivables are generally unsecured and the debtors are entitled to the
protection of a number of state and federal consumer credit laws, many of which
give such debtors the right to set off certain amounts on credit card debt
thereby reducing the balance due. Additionally, if the letter of credit is
exhausted, holders of asset-backed securities may also experience delays in
payments or losses if the full amounts due on underlying sales contracts are not
realized. Because asset-backed securities are relatively new, the market
experience in these securities is limited and the market's ability to sustain
liquidity through all phases of the market cycle has not been tested.
MONEY MARKET INSTRUMENTS
The Portfolio will invest in money market instruments, to the extent
consistent with its investment objective and policies, that meet the quality
requirements described below except that short-term municipal obligations of New
York State issuers may be rated MIG-2 by Moody's or SP-2 by Standard & Poor's.
Under normal circumstances, the Portfolio will purchase these securities to
invest temporary cash balances or to maintain liquidity to meet withdrawals. As
discussed in Part A, the Portfolio may invest in money market instruments to the
extent consistent with its investment objective and policies. A description of
the various types of money market instruments that may be purchased by the
Portfolio appears below. Also see "Quality and Diversification Requirements"
below.
U.S. TREASURY SECURITIES. The Portfolio may invest in direct obligations of
the U.S. Treasury, including Treasury bills, notes and bonds, all of which are
backed as to principal and interest payments by the full faith and credit of the
United States.
Additional U.S. Government Obligations. The Fund may invest in
obligations issued or guaranteed by U.S. Government agencies or
instrumentalities. These obligations may or may not be backed by the "full faith
and credit" of the United States. Securities which are backed by the full faith
and credit of the United States include obligations of the Government National
Mortgage Association, the Farmers Home Administration, and the Export-Import
Bank. In the case of securities not backed by the full faith and credit of the
United States, the Fund must look principally to the federal agency issuing or
guaranteeing the obligation for ultimate repayment and may not be able to assert
a claim against the United States itself in the event the agency or
instrumentality does not meet its commitments. Securities in which the Fund may
invest that are not backed by the full faith and credit of the United States
include, but are not limited to: (i) obligations of the Tennessee Valley
Authority, the Federal Home Loan Mortgage Corporation, the Federal Home Loan
Banks and the U.S. Postal Service, each of which has the right to borrow from
the U.S. Treasury to meet its obligations; (ii) securities issued by the Federal
National Mortgage Association, which are supported by the discretionary
authority of the U.S. Government to purchase the agency's obligations; and (iii)
obligations of the Federal Farm Credit System and the Student Loan Marketing
Association, each of whose obligations may be satisfied only by the individual
credits of the issuing agency.
BANK OBLIGATIONS. The Portfolio, unless otherwise noted in Part A or
below, may invest in negotiable certificates of deposit, time deposits and
bankers' acceptances of (i) banks, savings and loan associations and savings
banks which have more than $2 billion in total assets and are organized under
the laws of the United States or any state, (ii) foreign branches of these banks
of equivalent size (Euros) and (iii) U.S. branches of foreign banks of
equivalent size (Yankees). The Portfolio may not invest in obligations of
foreign branches of foreign banks. The Portfolio will not invest in obligations
for which the Advisor, or any of its affiliated persons, is the ultimate obligor
or accepting bank.
COMMERCIAL PAPER. The Portfolio may invest in commercial paper
including master demand obligations. Master demand obligations are obligations
that provide for a periodic adjustment in the interest rate paid and permit
daily changes in the amount borrowed. Master demand obligations are governed by
agreements between the issuer and Morgan acting as agent, for no additional fee.
The monies loaned to the borrower come from accounts managed by the Advisor or
its affiliates, pursuant to arrangements with such accounts. Interest and
principal payments are credited to such accounts. Morgan has the right to
increase or decrease the amount provided to the borrower under an obligation.
The borrower has the right to pay without penalty all or any part of the
principal amount then outstanding on an obligation together with interest to the
date of payment. Since these obligations typically provide that the interest
rate is tied to the Federal Reserve commercial paper composite rate, the rate on
master demand obligations is subject to change. Repayment of a master demand
obligation to participating accounts depends on the ability of the borrower to
pay the accrued interest and principal of the obligation on demand which is
continuously monitored by Morgan. Since master demand obligations typically are
not rated by credit rating agencies, the Portfolio may invest in such unrated
obligations only if at the time of an investment the obligation is determined by
the Advisor to have a credit quality which satisfies the Portfolio's quality
restrictions. See "Quality and Diversification Requirements." Although there is
no secondary market for master demand obligations, such obligations are
considered by the Portfolio to be liquid because they are payable upon demand.
It is possible that the issuer of a master demand obligation could be a client
of Morgan to whom Morgan, in its capacity as a commercial bank, has made a loan.
REPURCHASE AGREEMENTS. The Portfolio may enter into repurchase
agreements with brokers, dealers or banks that meet the Advisor's credit
guidelines. In a repurchase agreement, the Portfolio buys a security from a
seller that has agreed to repurchase the same security at a mutually agreed upon
date and price. The resale price normally is in excess of the purchase price,
reflecting an agreed upon interest rate. This interest rate is effective for the
period of time the Portfolio is invested in the agreement and is not related to
the coupon rate on the underlying security. A repurchase agreement may also be
viewed as a fully collateralized loan of money by the Portfolio to the seller.
The period of these repurchase agreements will usually be short, from overnight
to one week, and at no time will the Portfolio invest in repurchase agreements
for more than 13 months. The securities which are subject to repurchase
agreements, however, may have maturity dates in excess of 13 months from the
effective date of the repurchase agreement. The Portfolio will always receive
securities as collateral whose market value is, and during the entire term of
the agreement remains, at least equal to 100% of the dollar amount invested by
the Portfolio in each agreement plus accrued interest, and the Portfolio will
make payment for such securities only upon physical delivery or upon evidence of
book entry transfer to the account of the Portfolio's custodian (the
"Custodian"). If the seller defaults, the Portfolio might incur a loss if the
value of the collateral securing the repurchase agreement declines and might
incur disposition costs in connection with liquidating the collateral. In
addition, if bankruptcy proceedings are commenced with respect to the seller of
the security, realization upon disposal of the collateral by the Portfolio may
be delayed or limited.
The Portfolio may make investments in other debt securities including
without limitation corporate and foreign bonds, asset-backed securities and
other obligations described in Part A or this Part B. The Portfolio may not
invest in foreign bonds or asset-backed securities.
ADDITIONAL INVESTMENTS
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES. The Portfolio may purchase
securities on a when-issued or delayed delivery basis. For example, delivery of
and payment for these securities can take place a month or more after the date
of the purchase commitment. The purchase price and the interest rate payable, if
any, on the securities are fixed on the purchase commitment date or at the time
the settlement date is fixed. The value of such securities is subject to market
fluctuation and for money market instruments and other fixed income securities
no interest accrues to the Portfolio until settlement takes place. At the time
the Portfolio makes the commitment to purchase securities on a when-issued or
delayed delivery basis, it will record the transaction, reflect the value each
day of such securities in determining its net asset value and, if applicable,
calculate the maturity for the purposes of average maturity from that date. At
the time of settlement a when-issued security may be valued at less than the
purchase price. To facilitate such acquisitions, the Portfolio will maintain
with the custodian a segregated account with liquid assets, consisting of cash,
U.S. Government securities or other appropriate securities, in an amount at
least equal to such commitments. On delivery dates for such transactions, the
Portfolio will meet its obligations from maturities or sales of the securities
held in the segregated account and/or from cash flow. If the Portfolio chooses
to dispose of the right to acquire a when-issued security prior to its
acquisition, it could, as with the disposition of any other portfolio
obligation, incur a gain or loss due to market fluctuation. Also, the Portfolio
may be disadvantaged if the other party to the transaction defaults. It is the
current policy of the Portfolio not to enter into when-issued commitments
exceeding in the aggregate 15% of the market value of the Portfolio's total
assets, less liabilities other than the obligations created by when-issued
commitments.
INVESTMENT COMPANY SECURITIES. Securities of other investment companies
may be acquired by the Portfolio to the extent permitted under the 1940 Act or
any order pursuant thereto. These limits currently require that, as determined
immediately after a purchase is made, (i) not more than 5% of the value of the
Portfolio's total assets will be invested in the securities of any one
investment company, (ii) not more than 10% of the value of its total assets will
be invested in the aggregate in securities of investment companies as a group,
and (iii) not more than 3% of the outstanding voting stock of any one investment
company will be owned by the Portfolio. As a shareholder of another investment
company, the Portfolio would bear, along with other shareholders, its pro rata
portion of the other investment company's expenses, including advisory fees.
These expenses would be in addition to the advisory and other expenses that the
Portfolio bears directly in connection with its own operations.
The Securities and Exchange Commission ("SEC") has granted the Portfolio an
exemptive order permitting it to invest its uninvested cash in any of the
following affiliated money market funds: J.P. Morgan Institutional Prime Money
Market Fund, J.P. Morgan Institutional Tax Exempt Money Market Fund, J.P. Morgan
Institutional Federal Money Market Fund and J.P. Morgan Institutional Treasury
Money Market Fund. The order sets the following conditions: (1) the Portfolio
may invest in one or more of the permitted money market funds up to an aggregate
limit of 25% of its assets; and (2) the Advisor will waive and/or reimburse its
advisory fee from the Portfolio in an amount sufficient to offset any doubling
up of investment advisory and shareholder servicing fees.
REVERSE REPURCHASE AGREEMENTS. The Portfolio may enter into reverse
repurchase agreements. In a reverse repurchase agreement, the Portfolio sells a
security and agrees to repurchase the same security at a mutually agreed upon
date and price, refleting the interest rate effective for the term of the
agreement. For purposes of the 1940 Act, a reverse repurchase agreement is also
considered as the borrowing of money by the Portfolio and, therefore, a form of
leverage. Leverage may cause any gains or losses for the Portfolio to be
magnified. The Portfolio will invest the proceeds of borrowings under reverse
repurchase agreements. In addition, the Portfolio will enter into a reverse
repurchase agreement only when the interest income to be earned from the
investment of the proceeds is greater than the interest expense of the
transaction. The Portfolio will not invest the proceeds of a reverse repurchase
agreement for a period which exceeds the duration of the reverse repurchase
agreement. The Portfolio will establish and maintain with the custodian a
separate account with a segregated portfolio of securities in an amount at least
equal to its purchase obligations under its reverse repurchase agreements. All
forms of borrowing (including reverse repurchase agreements and securities
lending) are limited in the aggregate and may not exceed 33 1/3% of the
Portfolio's total assets.
LOANS OF PORTFOLIO SECURITIES. The Portfolio may lend its securities if such
loans are secured continuously by cash or equivalent collateral or by a letter
of credit in favor of the Portfolio at least equal at all times to 100% of the
market value of the securities loaned, plus accrued interest. While such
securities are on loan, the borrower will pay the Portfolio any income accruing
thereon. Loans will be subject to termination by the Portfolio in the normal
settlement time, generally three business days after notice, or by the borrower
on one day's notice. Borrowed securities must be returned when the loan is
terminated. Any gain or loss in the market price of the borrowed securities
which occurs during the term of the loan inures to the Portfolio and its
investors. The Portfolio may pay reasonable finders' and custodial fees in
connection with a loan. In addition, the Portfolio will consider all facts and
circumstances including the creditworthiness of the borrowing financial
institution, and the Portfolio will not make any loans in excess of one year.
The Portfolio will not lend its securities to any officer, Trustee, Members of
the Advisory Board, Director, employee or other affiliate of the Portfolio, the
Advisor or placement agent, unless otherwise permitted by applicable law. All
forms of borrowing (including reverse repurchase agreements and securities
lending) are limited in the aggregate and may not exceed 33 1/3% of the
Portfolio's total assets.
ILLIQUID INVESTMENTS; PRIVATELY PLACED AND CERTAIN UNREGISTERED
SECURITIES. T he Fund may not acquire any illiquid securities if, as a result
thereof, more than 15% of the Fund's net assets would be in illiquid
investments. Subject to this non-fundamental policy limitation, the Fund may
acquire investments that are illiquid or have limited liquidity, such as private
placements or investments that are not registered under the Securities Act of
1933, as amended (the "1933 Act"), and cannot be offered for public sale in the
United States without first being registered under the 1933 Act. An illiquid
investment is any investment that cannot be disposed of within seven days in the
normal course of business at approximately the amount at which it is valued by
the Portfolio. The price the Fund pays for illiquid securities or receives upon
resale may be lower than the price paid or received for similar securities with
a more liquid market. Accordingly the valuation of these securities will reflect
any limitations on their liquidity.
The Fund may also purchase Rule 144A securities sold to institutional
investors without registration under the 1933 Act. These securities may be
determined to be liquid in accordance with guidelines established by the Advisor
and approved by the Trustees. The Trustees will monitor the Advisor's
implementation of these guidelines on a periodic basis.
As to illiquid investments, the Fund is subject to a risk that should
the Fund decide to sell them when a ready buyer is not available at a price the
Fund deems representative of their value, the value of the Fund's net assets
could be adversely affected. Where an illiquid security must be registered under
the 1933 Act, before it may be sold, the Fund may be obligated to pay all or
part of the registration expenses, and a considerable period may elapse between
the time of the decision to sell and the time the Fund may be permitted to sell
a security under an effective registration statement. If, during such a period,
adverse market conditions were to develop, the Fund might obtain a less
favorable price than prevailed when it decided to sell.
Synthetic Variable Rate Instruments. The Fund may invest in certain
synthetic variable rate instruments. Such instruments generally involve the
deposit of a long-term tax exempt bond in a custody or trust arrangement and the
creation of a mechanism to adjust the long-term interest rate on the bond to a
variable short-term rate and a right (subject to certain conditions) on the part
of the purchaser to tender it periodically to a third party at par. Morgan will
review the structure of synthetic variable rate instruments to identify credit
and liquidity risks (including the conditions under which the right to tender
the instrument would no longer be available) and will monitor those risks. In
the event that the right to tender the instrument is no longer available, the
risk to the Fund will be that of holding the long-term bond. In the case of some
types of instruments credit enhancement is not provided, and if certain events,
which may include (a) default in the payment of principal or interest on the
underlying bond, (b) downgrading of the bond below investment grade or (c) a
loss of the bond's tax exempt status, occur, then (i) the put will terminate and
(ii) the risk to the Fund will be that of holding a long-term bond.
Options and Futures Transactions
The Portfolio may purchase and sell (a) exchange traded and
over-the-counter ("OTC") put and call options on fixed income securities,
indexes of fixed income securities and futures contracts on fixed income
securities and indexes of fixed income securities and (b) futures contracts on
fixed income securities and indexes of fixed income securities. Each of these
instruments is a derivative instrument as its value derives from the underlying
asset or index.
The Portfolio may use futures contracts and options for hedging and
risk management purposes. The Portfolio may not use futures and options for
speculation.
The Portfolio may utilize options and futures contracts to manage its
exposure to changing interest rates and/or security prices. Some options and
futures strategies, including selling futures contracts and buying puts, tend to
hedge the Portfolio's investments against price fluctuations. Other strategies,
including buying futures contracts, writing puts and calls and buying calls,
tend to increase market exposure. Options and futures contracts may be combined
with each other or with forward contracts in order to adjust the risk and return
characteristics of the Portfolio's overall strategy in a manner deemed
appropriate to the Advisor and consistent with the Portfolio's objective and
policies. Because combined options positions involve multiple trades, they
result in higher transaction costs and may be more difficult to open and close
out.
The use of options and futures is a highly specialized activity which
involves investment strategies and risks different from those associated with
ordinary portfolio securities transactions, and there can be no guarantee that
their use will increase the Portfolio's return. While the use of these
instruments by the Portfolio may reduce certain risks associated with owning its
portfolio securities, these techniques themselves entail certain other risks. If
the Advisor applies a strategy at an inappropriate time or judges market
conditions or trends incorrectly, options and futures strategies may lower the
Portfolio's return. Certain strategies limit the Portfolio's possibilities to
realize gains as well as limiting its exposure to losses. The Portfolio could
also experience losses if the prices of its options and futures positions were
poorly correlated with its other investments, or if it could not close out its
positions because of an illiquid secondary market. In addition, the Portfolio
will incur transaction costs, including trading commissions and option premiums,
in connection with its futures and options transactions and these transactions
could significantly increase the Portfolio's turnover rate.
The Portfolio may purchase put and call options on securities, indexes
of securities and futures contracts, or purchase and sell futures contracts,
only if such options are written by other persons and if (i) the aggregate
premiums paid on all such options which are held at any time do not exceed 20%
of the Portfolio's net assets, and (ii) the aggregate margin deposits required
on all such futures or options thereon held at any time do not exceed 5% of the
Portfolio's total assets. In addition, the Portfolio will not purchase or sell
(write) futures contracts, options on futures contracts or commodity options for
risk management purposes if, as a result, the aggregate initial margin and
options premiums required to establish these positions exceed 5% of the net
asset value of the Portfolio.
Options
Purchasing Put and Call Options. By purchasing a put option, the
Portfolio obtains the right (but not the obligation) to sell the instrument
underlying the option at a fixed strike price. In return for this right, the
Portfolio pays the current market price for the option (known as the option
premium). Options have various types of underlying instruments, including
specific securities, indexes of securities, indexes of securities prices, and
futures contracts. The Portfolio may terminate its position in a put option it
has purchased by allowing it to expire or by exercising the option. The
Portfolio may also close out a put option position by entering into an
offsetting transaction, if a liquid market exits. If the option is allowed to
expire, the Portfolio will lose the entire premium it paid. If the Portfolio
exercises a put option on a security, it will sell the instrument underlying the
option at the strike price. If the Portfolio exercises an option on an index,
settlement is in cash and does not involve the actual sale of securities. If an
option is American style, it may be exercised on any day up to its expiration
date. A European style option may be exercised only on its expiration date.
The buyer of a typical put option can expect to realize a gain if the
underlying instrument falls substantially. However, if the price of the
instrument underlying the option does not fall enough to offset the cost of
purchasing the option, a put buyer can expect to suffer a loss (limited to the
amount of the premium paid, plus related transaction costs).
The features of call options are essentially the same as those of put
options, except that the purchaser of a call option obtains the right to
purchase, rather than sell, the instrument underlying the option at the option's
strike price. A call buyer typically attempts to participate in potential price
increases of the instrument underlying the option with risk limited to the cost
of the option if security prices fall. At the same time, the buyer can expect to
suffer a loss if security prices do not rise sufficiently to offset the cost of
the option.
Selling (Writing) Put and Call Options. When the Portfolio writes a put option,
it takes the opposite side of the transaction from the option's purchaser. In
return for the receipt of the premium, the Portfolio assumes the obligation to
pay the strike price for the instrument underlying the option if the other party
to the option chooses to exercise it. The Portfolio may seek to terminate its
position in a put option it writes before exercise by purchasing an offsetting
option in the market at its current price. If the market is not liquid for a put
option the Portfolio has written, however, the Portfolio must continue to be
prepared to pay the strike price while the option is outstanding, regardless of
price changes, and must continue to post margin as discussed below.
If the price of the underlying instrument rises, a put writer would
generally expect to profit, although its gain would be limited to the amount of
the premium it received. If security prices remain the same over time, it is
likely that the writer will also profit, because it should be able to close out
the option at a lower price. If security prices fall, the put writer would
expect to suffer a loss. This loss should be less than the loss from purchasing
and holding the underlying instrument directly, however, because the premium
received for writing the option should offset a portion of the decline.
Writing a call option obligates the Portfolio to sell or deliver the
option's underlying instrument in return for the strike price upon exercise of
the option. The characteristics of writing call options are similar to those of
writing put options, except that writing calls generally is a profitable
strategy if prices remain the same or fall. Through receipt of the option
premium a call writer offsets part of the effect of a price decline. At the same
time, because a call writer must be prepared to deliver the underlying
instrument in return for the strike price, even if its current value is greater,
a call writer gives up some ability to participate in security price increases.
The writer of an exchange traded put or call option on a security, an
index of securities or a futures contract is required to deposit cash or
securities or a letter of credit as margin and to make mark to market payments
of variation margin as the position becomes unprofitable.
Options on Indexes. The Portfolio may purchase or sell put and call
options on any securities index based on securities in which the Portfolio may
invest. Options on securities indexes are similar to options on securities,
except that the exercise of securities index options is settled by cash payment
and does not involve the actual purchase or sale of securities. In addition,
these options are designed to reflect price fluctuations in a group of
securities or segment of the securities market rather than price fluctuations in
a single security. The Portfolio, in purchasing or selling index options, is
subject to the risk that the value of its portfolio securities may not change as
much as index because the Portfolio's investments generally will not match the
composition of an index.
For a number of reasons, a liquid market may not exist and thus the
Portfolio may not be able to close out an option position that it has previously
entered into. When the Portfolio purchases an OTC option, it will be relying on
its counterparty to perform its obligations, and the Portfolio may incur
additional losses if the counterparty is unable to perform.
Exchange Traded and OTC Options. All options purchased or sold by the Portfolio
will be traded on a securities exchange or will be purchased or sold by
securities dealers (OTC options) that meet creditworthiness standards approved
by the Advisor. While exchange-traded options are obligations of the Options
Clearing Corporation, in the case of OTC options, the Portfolio relies on the
dealer from which it purchased the option to perform if the option is exercised.
Thus, when the Portfolio purchases an OTC option, it relies on the dealer from
which it purchased the option to make or take delivery of the underlying
securities. Failure by the dealer to do so would result in the loss of the
premium paid by the Portfolio as well as loss of the expected benefit of the
transaction.
Provided that the Portfolio has arrangements with certain qualified
dealers who agree that the Portfolio may repurchase any option it writes for a
maximum price to be calculated by a predetermined formula, the Portfolio may
treat the underlying securities used to cover written OTC options as liquid. In
these cases, the OTC option itself would only be considered illiquid to the
extent that the maximum repurchase price under the formula exceeds the intrinsic
value of the option.
Futures Contracts
The Portfolio may purchase and sell futures contracts. When the
Portfolio purchases a futures contract, it agrees to purchase a specified
quantity of an underlying instrument at a specified future date or to make a
cash payment based on the value of a securities index. When the Portfolio sells
a futures contract, it agrees to sell a specified quantity of the underlying
instrument at a specified future date or to receive a cash payment based on the
value of a securities index. The price at which the purchase and sale will take
place is fixed when the Portfolio enters into the contract. Futures can be held
until their delivery dates or the position can be (and normally is) closed out
before then. There is no assurance, however, that a liquid market will exist
when the Portfolio wishes to close out a particular position.
When the Portfolio purchases a futures contract, the value of the
futures contract tends to increase and decrease in tandem with the value of its
underlying instrument. Therefore, purchasing futures contracts will tend to
increase the Portfolio's exposure to positive and negative price fluctuations in
the underlying instrument, much as if it had purchased the underlying instrument
directly. When the Portfolio sells a futures contract, by contrast, the value of
its futures position will tend to move in a direction contrary to the value of
the underlying instrument. Selling futures contracts, therefore, will tend to
offset both positive and negative market price changes, much as if the
underlying instrument had been sold.
The purchaser or seller of a futures contract is not required to
deliver or pay for the underlying instrument unless the contract is held until
the delivery date. However, when the Portfolio buys or sells a futures contract
it will be required to deposit "initial margin" with its Custodian in a
segregated account in the name of its futures broker, known as a futures
commission merchant (FCM). Initial margin deposits are typically equal to a
small percentage of the contract's value. If the value of either party's
position declines, that party will be required to make additional "variation
margin" payments equal to the change in value on a daily basis. The party that
has a gain may be entitled to receive all or a portion of this amount. The
Portfolio may be obligated to make payments of variation margin at a time when
it is disadvantageous to do so. Furthermore, it may not always be possible for
the Portfolio to close out its futures positions. Until it closes out a futures
position, the Portfolio will be obligated to continue to pay variation margin.
Initial and variation margin payments do not constitute purchasing on margin for
purposes of the Portfolio's investment restrictions. In the event of the
bankruptcy of an FCM that holds margin on behalf of the Portfolio, the Portfolio
may be entitled to return of margin owed to it only in proportion to the amount
received by the FCM's other customers, potentially resulting in losses to the
Portfolio.
The Portfolio will segregate liquid assets in connection with its use
of options and futures contracts to the extent required by the staff of the
Securities and Exchange Commission. Securities held in a segregated account
cannot be sold while the futures contract or option is outstanding. Unless they
are replaced with other suitable assets. As a result, there is a possibility
that segregation of a large percentage of the Portfolio's assets could impede
portfolio management or the Portfolio's ability to meet redemption requests or
other current obligations.
Options on Futures Contracts. The Portfolio may purchase and sell (write) put
and call options, including put and call options on futures contracts. Futures
contracts obligate the buyer to take and the seller to make delivery at a future
date of a specified quantity of a financial instrument or an amount of cash
based on the value of a securities index. Currently, futures contracts are
available on various types of fixed income securities, including but not limited
to U.S. Treasury bonds, notes and bills, Eurodollar certificates of deposit and
on indexes of fixed income securities.
Unlike a futures contract, which requires the parties to buy and sell a
security or make a cash settlement payment based on changes in a financial
instrument or securities index on an agreed date, an option on a futures
contract entitles its holder to decide on or before a future date whether to
enter into such a contract. If the holder decides not to exercise its option,
the holder may close out the option position by entering into an offsetting
transaction or may decide to let the option expire and forfeit the premium
thereon. The purchaser of an option on a futures contract pays a premium for the
option but makes no initial margin payments or daily payments of cash in the
nature of "variation" margin payments to reflect the change in the value of the
underlying contract as does a purchaser or seller of a futures contract.
The seller of an option on a futures contract receives the premium paid
by the purchaser and may be required to pay initial margin. Amounts equal to the
initial margin and any additional collateral required on any options on futures
contracts sold by the Portfolio are paid by the Portfolio into a segregated
account, in the name of the FCM, as required by the 1940 Act and the SEC's
interpretations thereunder.
Combined Positions. The Portfolio may purchase and write options in combination
with each other, or in combination with futures or forward contracts, to adjust
the risk and return characteristics of the overall position. For example, the
Portfolio may purchase a put option and write a call option on the same
underlying instrument, in order to construct a combined position whose risk and
return characteristics are similar to selling a futures contract. Another
possible combined position would involve writing a call option at one strike
price and buying a call option at a lower price, in order to reduce the risk of
the written call option in the event of a substantial price increase. Because
combined options positions involve multiple trades, they result in higher
transaction costs and may be more difficult to open and close out.
Correlation of Price Changes. Because there are a limited number of types of
exchange-traded options and futures contracts, it is likely that the
standardized options and futures contracts available will not match the
Portfolio's current or anticipated investments exactly. The Portfolio may invest
in options and futures contracts based on securities with different issuers,
maturities, or other characteristics from the securities in which it typically
invests, which involves a risk that the options or futures position will not
track the performance of the Portfolio's other investments.
Options and futures contracts prices can also diverge from the prices
of their underlying instruments, even if the underlying instruments match the
Portfolio's investments well. Options and futures contracts prices are affected
by such factors as current and anticipated short term interest rates, changes in
volatility of the underlying instrument, and the time remaining until expiration
of the contract, which may not affect security prices the same way. Imperfect
correlation may also result from differing levels of demand in the options and
futures markets and the securities markets, from structural differences in how
options and futures and securities are traded, or from imposition of daily price
fluctuation limits or trading halts. The Portfolio may purchase or sell options
and futures contracts with a greater or lesser value than the securities it
wishes to hedge or intends to purchase in order to attempt to compensate for
differences in volatility between the contract and the securities, although this
may not be successful in all cases. If price changes in the Portfolio's options
or futures positions are poorly correlated with its other investments, the
positions may fail to produce anticipated gains or result in losses that are not
offset by gains in other investments.
Liquidity of Options and Futures Contracts. There is no assurance that a liquid
market will exist for any particular option or futures contract at any
particular time even if the contract is traded on an exchange. In addition,
exchanges may establish daily price fluctuation limits for options and futures
contracts and may halt trading if a contract's price moves up or down more than
the limit in a given day. On volatile trading days when the price fluctuation
limit is reached or a trading halt is imposed, it may be impossible for the
Portfolio to enter into new positions or close out existing positions. If the
market for a contract is not liquid because of price fluctuation limits or
otherwise, it could prevent prompt liquidation of unfavorable positions, and
could potentially require the Portfolio to continue to hold a position until
delivery or expiration regardless of changes in its value. As a result, the
Portfolio's access to other assets held to cover its options or futures
positions could also be impaired. (See "Exchange Traded and OTC Options" above
for a discussion of the liquidity of options not traded on an exchange.)
Position Limits. Futures exchanges can limit the number of futures and options
on futures contracts that can be held or controlled by an entity. If an adequate
exemption cannot be obtained, the Portfolio or the Advisor may be required to
reduce the size of its futures and options positions or may not be able to trade
a certain futures or options contract in order to avoid exceeding such limits.
Asset Coverage for Futures Contracts and Options Positions. Although the
Portfolio will not be a commodity pool, certain derivatives subject the
Portfolio to the rules of the Commodity Futures Trading Commission which limit
the extent to which the Portfolio can invest in such derivatives. The Portfolio
may invest in futures contracts and options with respect thereto for hedging
purposes without limit. However, the Portfolio may not invest in such contracts
and options for other purposes if the sum of the amount of initial margin
deposits and premiums paid for unexpired options with respect to such contracts,
other than for bona fide hedging purposes, exceeds 5% of the liquidation value
of the Portfolio's assets, after taking into account unrealized profits and
unrealized losses on such contracts and options; provided, however, that in the
case of an option that is in-the-money at the time of purchase, the in-the-money
amount may be excluded in calculating the 5% limitation.
In addition, the Portfolio will comply with guidelines established by
the SEC with respect to coverage of options and futures contracts by mutual
Portfolios, and if the guidelines so require, will set aside appropriate liquid
assets in a segregated custodial account in the amount prescribed. Securities
held in a segregated account cannot be sold while the futures contract or option
is outstanding, unless they are replaced with other suitable assets. As a
result, there is a possibility that segregation of a large percentage of the
Portfolio's assets could impede portfolio management or a Portfolio's ability to
meet redemption requests or other current obligations.
Swaps and Related Swap Products. The Portfolio may engage in swap transactions,
including, but not limited to, interest rate, currency, securities index,
basket, specific security and commodity swaps, interest rate caps, floors and
collars and options on interest rate swaps (collectively defined as "swap
transactions").
The Portfolio may enter into swap transactions for any legal purpose
consistent with its investment objective and policies, such as for the purpose
of attempting to obtain or preserve a particular return or spread at a lower
cost than obtaining that return or spread through purchases and/or sales of
instruments in cash markets, to protect against currency fluctuations, as a
duration management technique, to protect against any increase in the price of
securities the Portfolio anticipates purchasing at a later date, or to gain
exposure to certain markets in the most economical way possible. The Portfolio
will not sell interest rate caps, floors or collars if it does not own
securities with coupons which provide the interest that a Portfolio may be
required to pay.
Swap agreements are two-party contracts entered into primarily by
institutional counterparties for periods ranging from a few weeks to several
years. In a standard swap transaction, two parties agree to exchange the returns
(or differentials in rates of return) that would be earned or realized on
specified notional investments or instruments. The gross returns to be exchanged
or "swapped" between the parties are calculated by reference to a "notional
amount," i.e., the return on or increase in value of a particular dollar amount
invested at a particular interest rate, in a particular foreign currency or
commodity, or in a "basket" of securities representing a particular index. The
purchaser of an interest rate cap or floor, upon payment of a fee, has the right
to receive payments (and the seller of the cap is obligated to make payments) to
the extent a specified interest rate exceeds (in the case of a cap) or is less
than (in the case of a floor) a specified level over a specified period of time
or at specified dates. The purchaser of an interest rate collar, upon payment of
a fee, has the right to receive payments (and the seller of the collar is
obligated to make payments) to the extent that a specified interest rate falls
outside an agreed upon range over a specified period of time or at specified
dates. The purchaser of an option on an interest rate swap, upon payment of a
fee (either at the time of purchase or in the form of higher payments or lower
receipts within an interest rate swap transaction) has the right, but not the
obligation, to initiate a new swap transaction of a pre-specified notional
amount with pre-specified terms with the seller of the option as the
counterparty.
The "notional amount" of a swap transaction is the agreed upon basis
for calculating the payments that the parties have agreed to exchange. For
example, one swap counterparty may agree to pay a floating rate of interest
(e.g., 3 month LIBOR) calculated based on a $10 million notional amount on a
quarterly basis in exchange for receipt of payments calculated based on the same
notional amount and a fixed rate of interest on a semi-annual basis. In the
event the Portfolio is obligated to make payments more frequently than it
receives payments from the other party, it will incur incremental credit
exposure to that swap counterparty. This risk may be mitigated somewhat by the
use of swap agreements which call for a net payment to be made by the party with
the larger payment obligation when the obligations of the parties fall due on
the same date. Under most swap agreements entered into by the Portfolio,
payments by the parties will be exchanged on a "net basis", and the Portfolio
will receive or pay, as the case may be, only the net amount of the two
payments.
The amount of the Portfolio's potential gain or loss on any swap
transaction is not subject to any fixed limit. Nor is there any fixed limit on
the Portfolio's potential loss if it sells a cap or collar. If the Portfolio
buys a cap, floor or collar, however, the Portfolio's potential loss is limited
to the amount of the fee that it has paid. When measured against the initial
amount of cash required to initiate the transaction, which is typically zero in
the case of most conventional swap transactions, swaps, caps, floors and collars
tend to be more volatile than many other types of instruments.
The use of swap transactions, caps, floors and collars involves
investment techniques and risks which are different from those associated with
portfolio security transactions. If the Advisor is incorrect in its forecasts of
market values, interest rates, and other applicable factors, the investment
performance of the Portfolio will be less favorable than if these techniques had
not been used. These instruments are typically not traded on exchanges.
Accordingly, there is a risk that the other party to certain of these
instruments will not perform its obligations to the Portfolio or that the
Portfolio may be unable to enter into offsetting positions to terminate its
exposure or liquidate its position under certain of these instruments when it
wishes to do so. Such occurrences could result in losses to the Portfolio.
The Advisor will, however, consider such risks and will enter into swap
and other derivatives transactions only when it believes that the risks are not
unreasonable.
The Portfolio will maintain cash or liquid assets in a segregated
account with its custodian in an amount sufficient at all times to cover its
current obligations under its swap transactions, caps, floors and collars. If
the Portfolio enters into a swap agreement on a net basis, it will segregate
assets with a daily value at least equal to the excess, if any, of the
Portfolio's accrued obligations under the swap agreement over the accrued amount
the Portfolio is entitled to receive under the agreement. If the Portfolio
enters into a swap agreement on other than a net basis, or sells a cap, floor or
collar, it will segregate assets with a daily value at least equal to the full
amount of a Portfolio's accrued obligations under the agreement.
The Portfolio will not enter into any swap transaction, cap, floor, or
collar, unless the counterparty to the transaction is deemed creditworthy by the
Advisor. If a counterparty defaults, the Portfolio may have contractual remedies
pursuant to the agreements related to the transaction. The swap markets in which
many types of swap transactions are traded have grown substantially in recent
years, with a large number of banks and investment banking firms acting both as
principals and as agents utilizing standardized swap documentation. As a result,
the markets for certain types of swaps (e.g., interest rate swaps) have become
relatively liquid. The markets for some types of caps, floors and collars are
less liquid.
The liquidity of swap transactions, caps, floors and collars will be as
set forth in guidelines established by the Advisor and approved by the Trustees
which are based on various factors, including (1) the availability of dealer
quotations and the estimated transaction volume for the instrument, (2) the
number of dealers and end users for the instrument in the marketplace, (3) the
level of market making by dealers in the type of instrument, (4) the nature of
the instrument (including any right of a party to terminate it on demand) and
(5) the nature of the marketplace for trades (including the ability to assign or
offset the Portfolio's rights and obligations relating to the instrument). Such
determination will govern whether the instrument will be deemed within the 15%
restriction on investments in securities that are not readily marketable.
During the term of a swap, cap, floor or collar, changes in the value
of the instrument are recognized as unrealized gains or losses by marking to
market to reflect the market value of the instrument. When the instrument is
terminated, the Portfolio will record a realized gain or loss equal to the
difference, if any, between the proceeds from (or cost of) the closing
transaction and a Portfolio's basis in the contract.
The federal income tax treatment with respect to swap transactions,
caps, floors, and collars may impose limitations on the extent to which a
Portfolio may engage in such transactions.
QUALITY AND DIVERSIFICATION REQUIREMENTS
The Portfolio intends to meet the diversification requirements of the
1940 Act. Current 1940 Act diversification requirements require that with
respect to 75% of the assets of the Portfolio: (1) the Portfolio may not invest
more than 5% of its total assets in the securities of any one issuer, except
obligations of the U.S. Government, its agencies and instrumentalities, and (2)
the Portfolio may not own more than 10% of the outstanding voting securities of
any one issuer. As for the other 25% of the Portfolio's assets not subject to
the limitation described above, there is no limitation on investment of these
assets under the 1940 Act, so that all of such assets may be invested in
securities of any one issuer. Investments not subject to the limitations
described above could involve an increased risk to the Portfolio should an
issuer, or a state or its related entities, be unable to make interest or
principal payments or should the market value of such securities decline.
The Portfolio will comply with the diversification requirements imposed
by the Internal Revenue Code of 1986, as amended (the "Code"), for qualification
as a regulated investment company. See "Taxes."
For purposes of diversification and concentration under the 1940 Act,
identification of the issuer of municipal bonds or notes depends on the terms
and conditions of the obligation. If the assets and revenues of an agency,
authority, instrumentality or other political subdivision are separate from
those of the government creating the subdivision and the obligation is backed
only by the assets and revenues of the subdivision, such subdivision is regarded
as the sole issuer. Similarly, in the case of an industrial development revenue
bond or pollution control revenue bond, if the bond is backed only by the assets
and revenues of the nongovernmental user, the nongovernmental user is regarded
as the sole issuer. If in either case the creating government or another entity
guarantees an obligation, the guaranty is regarded as a separate security and
treated as an issue of such guarantor. Since securities issued or guaranteed by
states or municipalities are not voting securities, there is no limitation on
the percentage of a single issuer's securities which the Portfolio may own so
long as it does not invest more than 5% of its total assets that are subject to
the diversification limitation in the securities of such issuer, except
obligations issued or guaranteed by the U.S. Government. Consequently, the
Portfolio may invest in a greater percentage of the outstanding securities of a
single issuer than would an investment company which invests in voting
securities. See "Investment Restrictions."
It is the current policy of the Portfolio that under normal
circumstances at least 90% of total assets will consist of securities that at
the time of purchase are rated Baa or better by Moody's or BBB or better by
Standard & Poor's. The remaining 10% of total assets may be invested in
securities that are rated B or better by Moody's or Standard & Poor's. See
"Below Investment Grade Debt" below. In each case, the Portfolio may invest in
securities which are unrated, if in the Advisor's opinion, such securities are
of comparable quality. Securities rated Baa by Moody's or BBB by Standard &
Poor's are considered investment grade, but have some speculative
characteristics. Securities rated Ba or B by Moody's and BB or B by Standard &
Poor's are below investment grade and considered to be speculative with regard
to payment of interest and principal. These standards must be satisfied at the
time an investment is made. If the quality of the investment later declines, the
Portfolio may continue to hold the investment.
The Portfolio invests principally in a diversified portfolio of
"investment grade" tax exempt securities. On the date of investment, with
respect to at least 90% of its total assets, (i) municipal bonds must be rated
within the four highest ratings of Moody's, currently Aaa, Aa, A and Baa, or of
Standard & Poor's, currently AAA, AA, A and BBB, (ii) municipal notes must be
rated MIG-1 by Moody's or SP-1 by Standard & Poor's (or, in the case of New York
State municipal notes, MIG-1 or MIG-2 by Moody's or SP-1 or SP-2 by Standard &
Poor's) and (iii) at the time the Portfolio invests in any commercial paper,
bank obligation, repurchase agreement, or any other money market instruments,
the investment must have received a short term rating of investment grade or
better (currently Prime-3 or better by Moody's or A-3 or better by Standard &
Poor's) or the investment must have been issued by an issuer that received a
short term investment grade rating or better with respect to a class of
investments or any investment within that class that is comparable in priority
and security with the investment being purchased by the Portfolio. If no such
ratings exists, the investment must be of comparable investment quality in the
Advisor's opinion, but will not be eligible for purchase if the issuer or its
parent has long term outstanding debt rated below BBB. With respect to the
remaining 10% of its assets, any investment must be rated B or better by Moody's
or Standard & Poor's, or of comparable quality. The Portfolio may invest in
other tax exempt securities which are not rated if, in the opinion of the
Advisor, such securities are of comparable quality to the rated securities
discussed above. In addition, at the time the Portfolio invests in any
commercial paper, bank obligation or repurchase agreement, the issuer must have
outstanding debt rated A or higher by Moody's or Standard & Poor's, the issuer's
parent corporation, if any, must have outstanding commercial paper rated Prime-1
by Moody's or A-1 by Standard & Poor's, or if no such ratings are available, the
investment must be of comparable quality in the Advisor's opinion.
Below Investment Grade Debt. Certain lower rated securities purchased
by the Portfolio, such as those rated Ba or B by Moody's or BB or B by Standard
& Poor's (commonly known as junk bonds), may be subject to certain risks with
respect to the issuing entity's ability to make scheduled payments of principal
and interest and to greater market fluctuations. While generally providing
greater income than investments in higher quality securities, lower quality
fixed income securities involve greater risk of loss of principal and income,
including the possibility of default or bankruptcy of the issuers of such
securities, and have greater price volatility, especially during periods of
economic uncertainty or change. These lower quality fixed income securities tend
to be affected by economic changes and short-term corporate and industry
developments to a greater extent than higher quality securities, which react
primarily to fluctuations in the general level of interest rates. To the extent
that the Portfolio invests in such lower quality securities, the achievement of
its investment objective may be more dependent on the Advisor's own credit
analysis.
Lower quality fixed income securities are affected by the market's
perception of their credit quality, especially during times of adverse
publicity, and the outlook for economic growth. Economic downturns or an
increase in interest rates may cause a higher incidence of default by the
issuers of these securities, especially issuers that are highly leveraged. The
market for these lower quality fixed income securities is generally less liquid
than the market for investment grade fixed income securities. It may be more
difficult to sell these lower rated securities to meet redemption requests, to
respond to changes in the market, or to value accurately the Portfolio's
securities for purposes of determining the Portfolio's net asset value. See
Appendix A for more detailed information on these ratings.
Risk Management
The Portfolio may employ non-hedging risk management techniques.
Examples of such strategies include synthetically altering the duration of its
portfolio or the mix of securities in its portfolio. For example, if the Advisor
wishes to extend maturities in a fixed income portfolio in order to take
advantage of an anticipated decline in interest rates, but does not wish to
purchase the underlying long term securities, it might cause the portfolio to
purchase futures contracts on long term debt securities. Such non-hedging risk
management techniques are not speculative, but because they involve leverage
include, as do all leveraged transactions, the possibility of losses as well as
gains that are greater than if these techniques involved the purchase and sale
of the securities themselves rather than their synthetic derivatives.
INVESTMENT RESTRICTIONS
The investment restrictions below have been adopted by the Portfolio.
Except where otherwise noted, these investment restrictions are "fundamental"
policies which, under the 1940 Act, may not be changed without the vote of a
"majority of the outstanding voting securities" (as defined in the 1940 Act) of
the Portfolio. A "majority of the outstanding voting securities" is defined in
the 1940 Act as the lesser of (a) 67% or more of the voting securities present
at a security holders meeting if the holders of more than 50% of the outstanding
voting securities are present or represented by proxy, or (b) more than 50% of
the outstanding voting securities. The percentage limitations contained in the
restrictions below apply at the time of the purchase of securities.
The Portfolio:
1. May not make any investment inconsistent with the Portfolio's classification
as a diversified investment company under the Investment Company Act of 1940.
2. May not purchase any security which would cause the Portfolio to concentrate
its investments in the securities of issuers primarily engaged in any particular
industry except as permitted by the SEC;
3. May not issue senior securities, except as permitted under the Investment
Company Act of 1940 or any rule, order or interpretation thereunder;
4. May not borrow money, except to the extent permitted by applicable law;
5. May not underwrite securities of other issuers, except to the extent that the
Portfolio, in disposing of portfolio securities, may be deemed an underwriter
within the meaning of the 1933 Act; 6. May not purchase or sell real estate,
except that, to the extent permitted by applicable law, the Portfolio may (a)
invest in securities or other instruments directly or indirectly secured by real
estate, (b) invest in securities or other instruments issued by issuers that
invest in real estate and (c) make direct investments in mortgages;
7. May not purchase or sell commodities or commodity contracts unless acquired
as a result of ownership of securities or other instruments issued by persons
that purchase or sell commodities or commodities contracts; but this shall not
prevent the Portfolio from purchasing, selling and entering into financial
futures contracts (including futures contracts on indices of securities,
interest rates and currencies), options on financial futures contracts
(including futures contracts on indices of securities, interest rates and
currencies), warrants, swaps, forward contracts, foreign currency spot and
forward contracts or other derivative instruments that are not related to
physical commodities; and
8. May make loans to other persons, in accordance with the Portfolio's
investment objective and policies and to the extent permitted by applicable law.
Non-Fundamental Investment Restrictions. The investment restriction
described below is not a fundamental policy of the Portfolio and may be changed
by the Trustees. This non-fundamental investment policy requires that the
Portfolio:
(i) May not acquire any illiquid securities, such as repurchase agreements with
more than seven days to maturity or fixed time deposits with a duration of over
seven calendar days, if as a result thereof, more than 15% of the market value
of the Portfolio's net assets would be in investments which are illiquid;
(ii) May not purchase securities on margin, make short sales of securities, or
maintain a short position, provided that this restriction shall not be deemed to
be applicable to the purchase or sale of when-issued or delayed delivery
securities, or to short sales that are covered in accordance with SEC rules; and
(iii) May not acquire securities of other investment companies, except as
permitted by the 1940 Act or any order pursuant thereto.
There will be no violation of any investment restriction if that
restriction is complied with at the time the relevant action is taken
notwithstanding a later change in market value of an investment, in net or total
assets, in the securities rating of the investment, or any other later change.
Item 14. MANAGEMENT OF THE PORTFOLIO.
The Trustees of the Portfolio, principal occupations during the past
five years and dates of birth are set forth below. The mailing address of the
Trustees is c/o Pierpont Group, Inc., 461 Fifth Avenue, New York, New York
10017.
Frederick S. Addy - Trustee; Retired; Former Executive Vice President
and Chief Financial Officer Amoco Corporation. His date of birth is January 1,
1932.
William G. Burns - Trustee; Retired; Former Vice Chairman and Chief
Financial Officer, NYNEX. His date of birth is November 2, 1932.
Arthur C. Eschenlauer - Trustee; Retired; Former Senior Vice President,
Morgan Guaranty Trust Company of New York. His date of birth is May 23, 1934.
Matthew Healey* - Trustee; Chairman and Chief Executive Officer; Chairman,
Pierpont Group, Inc. ("Pierpont Group ") since prior to 1993. His date of birth
is August 23, 1937.
Michael P. Mallardi - Trustee; Retired; Prior to April 1996, Senior Vice
President, Capital Cities/ABC, Inc. and President, Broadcast Group. His date of
birth is March 17, 1934.
----------------------
* Mr. Healey is an "interested person" of the
Portfolio as that term is defined in the 1940 Act.
Each Trustee is currently paid an annual fee of $75,000 for serving as
Trustee of the Master Portfolios (as defined below), J.P. Morgan Funds, J.P.
Morgan Institutional Funds and J.P. Morgan Series Trust and is reimbursed for
expenses incurred in connection with service as a Trustee. The Trustees may hold
various other directorships unrelated to the Portfolio.
<PAGE>
Trustee compensation expenses accrued by the Portfolio for the calendar
year ended December 31, 1999 is set forth below.
---------------------------------------- --------------------------------- -----
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
TOTAL TRUSTEE COMPENSATION ACCRUED BY
THE MASTER PORTFOLIOS(*), J.P. MORGAN
AGGREGATE TRUSTEE COMPENSATION INSTITUTIONAL FUNDS AND J.P. MORGAN
ACCRUED BY THE PORTFOLIO DURING FUNDS DURING 1999(**)
NAME OF TRUSTEE 1999
---------------------------------------- --------------------------------- -----------------------------------------
---------------------------------------- --------------------------------- -----------------------------------------
Frederick S. Addy, $1,460 $75,000
Trustee
---------------------------------------- --------------------------------- -----------------------------------------
---------------------------------------- --------------------------------- -----------------------------------------
William G. Burns, $1,460 $75,000
Trustee
---------------------------------------- --------------------------------- -----------------------------------------
---------------------------------------- --------------------------------- -----------------------------------------
Arthur C. Eschenlauer, $1,460 $75,000
Trustee
---------------------------------------- --------------------------------- -----------------------------------------
---------------------------------------- --------------------------------- -----------------------------------------
Matthew Healey, $1,460 $75,000
Trustee(***), Chairman
and Chief Executive
Officer
---------------------------------------- --------------------------------- -----------------------------------------
---------------------------------------- --------------------------------- -----------------------------------------
Michael P. Mallardi, $1,460 $75,000
Trustee
---------------------------------------- --------------------------------- -----------------------------------------
</TABLE>
(*) Includes the Portfolio and 18 other portfolios (collectively, the
"Master Portfolios") for which JPMIM acts as investment advisor.
(**) No investment company within the fund complex has a pension or
retirement plan. Currently there are 22 investment companies (comprised of 19
investment companies comprising the Master Portfolios, J.P. Morgan Funds, J.P.
Morgan Institutional Funds and J.P. Morgan Series Trust) in the fund complex.
(***) During 1999, Pierpont Group, Inc. paid Mr. Healey, in his role as
Chairman of Pierpont Group, Inc., compensation in the amount of $153,800,
contributed $23,100 to a defined contribution plan on his behalf and paid
$17,300 in insurance premiums for his benefit.
The Trustees of the Portfolio are the same as the Trustees of each of
the other Master Portfolios, the J.P. Morgan Funds, the J.P. Morgan
Institutional Funds and J.P. Morgan Series Trust. In accordance with applicable
state requirements, a majority of the disinterested Trustees have adopted
written procedures reasonably appropriate to deal with potential conflicts of
interest arising from the fact that the same individuals are Trustees of the
Master Portfolios, the J.P. Morgan Funds and the J.P. Morgan Institutional
Funds, up to and including creating a separate board of trustees.
The Trustees decide upon matters of general policies and are
responsible for overseeing the Trust's and the Portfolio's business affairs. The
Portfolio has entered into a Portfolio Fund Services Agreement with Pierpont
Group to assist the Trustees in exercising their overall supervisory
responsibilities over the affairs of the Portfolio. Pierpont Group was organized
in July 1989 to provide services for the J.P. Morgan Family of Funds (formerly
The Pierpont Family of Funds). The Portfolio has agreed to pay Pierpont Group a
fee in an amount representing its reasonable costs in performing these services.
These costs are periodically reviewed by the Trustees.
The aggregate fees paid to Pierpont Group by the Portfolio during the
fiscal year ended August 31, 1998, for the eleven months ended July 31, 1999 and
for the fiscal year ended July 31, 2000: $21,294, $17,915 and $12,760,
respectively. The Portfolio has no employees; its executive officers (listed
below), other than the Chief Executive Officer, are provided and compensated by
Funds Distributor, Inc. ("FDI"), a wholly owned indirect subsidiary of Boston
Institutional Group, Inc. The Portfolio's officers conduct and supervise the
business operations of the Portfolio.
MEMBERS OF THE ADVISORY BOARD
The Trustees determined as of January 26, 2000 to establish an advisory
board and appoint four members ("Members of the Advisory Board") thereto. Each
member serves at the pleasure of the Trustees. The advisory board is distinct
from the Trustees and provides advice to the Trustees as to investment,
management and operations of the Trust; but has no power to vote upon any matter
put to a vote of the Trustees. The advisory board and the members thereof also
serve each of J.P. Morgan Funds, J.P. Morgan Series Trusts, and collectively,
together with the Trust (the "Trusts") and the Master Portfolios. It is also the
current intention of the Trustees that the Members of the Advisory Board will be
proposed at the next shareholders' meeting, expected to be held within a year
from the date hereof, for election as Trustees of the Trusts and the Master
Portfolios. The creation of the Advisory Board and the appointment of the
members thereof was designed so that the Board of Trustees will continuously
consist of persons able to assume the duties of Trustees and be fully familiar
with the business and affairs of each of the Trusts and the Master Portfolios,
in anticipation of the current Trustees reaching the mandatory retirement age of
seventy. Each member of the Advisory Board is paid an annual fee of $75,000 for
serving in this capacity for the Trust, each of the Master Portfolios, the J.P.
Morgan Funds and the J.P. Morgan Series Trust and is reimbursed for expenses
incurred in connection for such service. The members of the Advisory Board may
hold various other directorships unrelated to these funds. The mailing address
of the Members of the Advisory Board is c/o Pierpont Group, Inc., 461 Fifth
Avenue, New York, New York 10017. Their names, principal occupations during the
past five years and dates of birth are set forth below:
Ann Maynard Gray; Former President, Diversified Publishing Group and Vice
President, Capital Cities/ABC, Inc. Her date of birth is August 22, 1945.
John R. Laird; Retired; Former Chief Executive Officer, Shearson Lehman
Brothers and The Boston Company. His date of birth is June 21, 1942.
Gerard P. Lynch; Retired; Former Managing Director, Morgan Stanley Group and
President and Chief Operating Officer, Morgan Stanley Services, Inc. His date of
birth is October 5, 1936.
James J. Schonbachler; Retired; Prior to September, 1998, Managing Director,
Bankers Trust Company and Chief Executive Officer and Director, Bankers Trust
A.G., Zurich and BT Brokerage Corp. His date of birth is January 26, 1943.
Officers
The officers of the Portfolio, their principal occupations during the
past five years and dates of birth are set forth below. The business address of
each of the officers unless otherwise noted is 60 State Street, Suite 1300,
Boston, Massachusetts 02109.
MATTHEW HEALEY. Chief Executive Officer; Chairman, Pierpont Group, since
prior to 1993. His address is c/o Pierpont Group, Inc., 461 Fifth Avenue, New
York, New York 10017. His date of birth is August 23, 1937.
MARGARET W. CHAMBERS. Vice President and Secretary. Senior Vice President
and General Counsel of FDI since April, 1998. From August 1996 to March 1998,
Ms. Chambers was Vice President and Assistant General Counsel for Loomis, Sayles
& Company, L.P. From January 1986 to July 1996, she was an associate with the
law firm of Ropes & Gray. Her date of birth is October 12, 1959.
MARIE E. CONNOLLY. Vice President and Assistant Treasurer. President, Chief
Executive Officer, Chief Compliance Officer and Director of FDI, Premier Mutual
Fund Services, Inc., an affiliate of FDI ("Premier Mutual") and an officer of
certain investment companies distributed or administered by FDI, since prior to
1995. Her date of birth is August 1, 1957.
DOUGLAS C. CONROY. Vice President and Assistant Treasurer. Assistant Vice
President and Assistant Department Manager of Treasury Services and
Administration of FDI and an officer of certain investment companies distributed
or administered by FDI. Prior to April 1997, Mr. Conroy was Supervisor of
Treasury Services and Administration of FDI. His date of birth is March 31,
1969.
KAREN JACOPPO-WOOD. Vice President and Assistant Secretary. Vice President
and Senior Counsel of FDI and an officer of certain investment companies
distributed or administered by FDI. From June 1994 to January 1996, Ms.
Jacoppo-Wood was a Manager of SEC Registration at Scudder, Stevens & Clark, Inc.
Her date of birth is December 29, 1966.
CHRISTOPHER J. KELLEY. Vice President and Assistant Secretary. Vice
President and Senior Associate General Counsel of FDI and Premier Mutual and an
officer of certain investment companies distributed or administered by FDI. From
April 1994 to July 1996, Mr. Kelley was Assistant Counsel at Forum Financial
Group. His date of birth is December 24, 1964.
KATHLEEN K. MORRISEY. Vice President and Assistant Secretary. Vice
President and Assistant Secretary of FDI. Manager of Treasury Services
Administration and an officer of certain investment companies advised or
administered by Montgomery Asset Management, L.P. and Dresdner RCM Global
Investors, Inc., and their respective affiliates. From July 1994 to November
1995, Ms. Morrisey was a Fund Accountant II for Investors Bank & Trust Company.
Her date of birth is July 5, 1972.
MARY A. NELSON. Vice President and Assistant Treasurer. Vice President and
Manager of Treasury Services and Administration of FDI and Premier Mutual and an
officer of certain investment companies distributed or administered by FDI. Her
date of birth is April 22, 1964.
MARY JO PACE. Assistant Treasurer. Vice President, Morgan Guaranty Trust
Company of New York since 1990. Ms. Pace serves in the Funds Administration
group as a Manager for the Budgeting and Expense Processing Group. Prior to
September 1995, Ms. Pace served as a Fund Administrator for Morgan Guaranty
Trust Company of New York. Her address is 60 Wall Street, New York, New York
10260. Her date of birth is March 13, 1966.
GEORGE A. RIO. President and Treasurer. Executive Vice President and Client
Service Director of FDI since April 1998. From June 1995 to March 1998, Mr. Rio
was Senior Vice President and Senior Key Account Manager for Putnam Mutual
Funds. From May 1994 to June 1995, Mr. Rio was Director of Business Development
for First Data Corporation. His date of birth is January 2, 1955.
CHRISTINE ROTUNDO; Assistant Treasurer. Vice President, Morgan Guaranty
Trust Company of New York. Ms. Rotundo serves as Manager of the Funds
Infrastructure group and is responsible for the management of special projects.
Prior to January 2000, she served as Manager of the Tax Group in the Funds
Administration group and was responsible for U.S. mutual fund tax matters. Her
address is 60 Wall Street, New York, New York 10260. Her date of birth is
September 26, 1965.
ELBA VASQUEZ; Vice President and Assistant Secretary. Vice President of FDI
since February 1999. Ms. Vasquez served as a Sales Associate for FDI from May
1996. Prior to that she served in various mutual fund sales and marketing
positions for U.S. Trust Company of New York. Her date of birth is December 14,
1961.
The Portfolio's Declaration of Trust provides that it will indemnify
its Trustees and officers against liabilities and expenses incurred in
connection with litigation in which they may be involved because of their
offices with the Portfolio, unless, as to liability to the Portfolio or its
investors, it is finally adjudicated that they engaged in willful misfeasance,
bad faith, gross negligence or reckless disregard of the duties involved in
their offices, or unless with respect to any other matter it is finally
adjudicated that they did not act in good faith in the reasonable belief that
their actions were in the best interests of the Portfolio. In the case of
settlement, such indemnification will not be provided unless it has been
determined by a court or other body approving the settlement or other
disposition, or by a reasonable determination, based upon a review of readily
available facts, by vote of a majority of disinterested Trustees or in a written
opinion of independent counsel, that such officers or Trustees have not engaged
in willful misfeasance, bad faith, gross negligence or reckless disregard of
their duties.
CODES OF ETHICS
The Trust, FDI and the Advisor have adopted codes of ethics pursuant to
Rule 17j-1 under the 1940 Act. Each of these codes permits personnel subject to
such code to invest in securities, including securities that may be purchased or
held by the Portfolio. Such purchases, however, are subject to procedures
reasonably necessary to prevent access persons from engaging in any unlawful
conduct set forth in Rule 17j-1.
Item 15. CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES.
As of July 31, 2000, J.P. Morgan Institutional Tax Exempt Bond Fund and
J.P. Morgan Tax Exempt Bond Fund, series of the J.P. Morgan Funds and the J.P.
Morgan Institutional Funds, respectively, owned 47% and 53%, respectively, of
the outstanding beneficial interests in the Portfolio. So long as J.P. Morgan
Tax Exempt Bond Fund controls the Portfolio, it may take actions without the
approval of any other holder of beneficial interests in the Portfolio.
The officers and Trustees of the Portfolio own none of the outstanding
beneficial interests in the Portfolio.
Item 16. INVESTMENT ADVISORY AND OTHER SERVICES.
INVESTMENT ADVISOR. The investment advisor to the Portfolio is JPMIM, a
wholly-owned subsidiary of J.P. Morgan. Subject to the supervision of the
Portfolio's Trustees, the Advisor makes the Portfolio's day-to-day investment
decisions, arranges for the execution of Portfolio transactions and generally
manages the Portfolio's investments. Prior to October 28, 1998, Morgan was the
Investment Advisor. JPMIM, a wholly owned subsidiary of J.P. Morgan & Co.
Incorporated ("J.P. Morgan"), is a registered investment adviser under the
Investment Advisers Act of 1940, as amended, and manages employee benefit funds
of corporations, labor unions and state and local governments and the accounts
of other institutional investors, including investment companies. Certain of the
assets of employee benefit accounts under its management are invested in
commingled pension trust funds for which Morgan serves as trustee.
J.P. Morgan, through the Advisor and other subsidiaries, acts as
investment advisor to individuals, governments, corporations, employee benefit
plans, mutual funds and other institutional investors with combined assets under
management of approximately $373 billion.
Morgan, whose principal offices are at 60 Wall Street, New York, New
York 10260, is a New York trust company which conducts a general banking and
trust business. Morgan is subject to regulation by the New York State Banking
Department and is a member bank of the Federal Reserve System. Through offices
in New York City and abroad, Morgan offers a wide range of services, primarily
to governmental, institutional, corporate and high net worth individual
customers in the United States and throughout the world. The firm, through its
predecessor firms, has been in business for over a century and has been managing
investments since 1913. Morgan is also a wholly-owned subsidiary of J.P. Morgan,
a bank holding company organized under the laws of the State of Delaware.
The basis of the Advisor's investment process is fundamental investment
research as the firm believes that fundamentals should determine an asset's
value over the long term. J.P. Morgan currently employs approximately 415
research analysts, capital market researchers, portfolio managers and traders
and has one of among the largest research staffs in the money management
industry. The Advisor has investment management divisions located in New York,
London, Tokyo, Frankfurt and Singapore to cover companies, industries and
countries on site. The Advisor's fixed income investment process is based on
analysis of real rates, sector diversification and quantitative and credit
analysis.
The investment advisory services the Advisor provides to the Portfolio
are not exclusive under the terms of the Advisory Agreement. The Advisor is free
to and does render similar investment advisory services to others. The Advisor
serves as investment advisor to personal investors and other investment
companies and acts as fiduciary for trusts, estates and employee benefit plans.
Certain of the assets of trusts and estates under management are invested in
common trust funds for which the Advisor serves as trustee. The accounts which
are managed or advised by the Advisor have varying investment objectives and the
Advisor invests assets of such accounts in investments substantially similar to,
or the same as, those which are expected to constitute the principal investments
of the Portfolio. Such accounts are supervised by officers and employees of the
Advisor who may also be acting in similar capacities for the Portfolio. See Item
17 below.
Sector weightings are generally similar to a benchmark with the
emphasis on security selection as the method to achieve investment performance
superior to the benchmark. The benchmark Portfolio is the Lehman Brothers
Intermediate Competitive Municipal Bond Index (1-17 Year Maturity), an unmanaged
index that measures municipal bond market performance and is more widely
disseminated than the Lehman Brothers 1-16 Year Blended Municipal Bond Index,
previously used by the Portfolio.
The Portfolio is managed by officers of the Advisor who, in acting for
their customers, including the Portfolio, do not discuss their investment
decisions with any personnel of J.P. Morgan or any personnel of other divisions
of the Advisor or with any of its affiliated persons, with the exception of
certain other investment management affiliates of J.P. Morgan.
As compensation for the services rendered and related expenses such as
salaries of advisory personnel borne by the Advisor under the Investment
Advisory Agreement, the Portfolio has agreed to pay the Advisor a fee, which is
computed daily and may be paid monthly, equal to the annual rate of 0.30% of the
Portfolio's average daily net assets. For the fiscal year ended August 31, 1998,
for the eleven months ended July 31, 1999 and for the fiscal year ended July 31,
2000, the advisory fees paid by the Portfolio were $2,017,415, $2,295,351 and
$2,365,565, respectively.
The Investment Advisory Agreement provides that it will continue in
effect for a period of two years after execution only if specifically approved
annually thereafter (i) by a vote of the holders of a majority of the
Portfolio's outstanding securities or by its Trustees and (ii) by a vote of a
majority of the Trustees who are not parties to the Advisory Agreement or
"interested persons" as defined by the 1940 Act cast in person at a meeting
called for the purpose of voting on such approval. The Investment Advisory
Agreement will terminate automatically if assigned and is terminable at any time
without penalty by a vote of a majority of the Trustees of the Portfolio or by a
vote of the holders of a majority of the Portfolio's voting securities on 60
days' written notice to the Advisor and by the Advisor on 90 days' written
notice to the Portfolio.
CO-ADMINISTRATOR. Under the Portfolio's Co-Administration Agreement
dated August 1, 1996, FDI serves as the Portfolio's Co-Administrator. The
Co-Administration Agreement may be renewed or amended by the Trustees without an
investor vote. The Co-Administration Agreement is terminable at any time without
penalty by a vote of a majority of the Trustees of the Portfolio on not more
than 60 days' written notice nor less, subject to the consent of the Trustees of
the Portfolio, than 30 days' written notice to the other party. The
Co-Administrator may, subject to the consent of the Trustees of the Portfolio,
subcontract for the performance of its obligations, provided, however, that
unless the Portfolio expressly agrees in writing, the Co-Administrator shall be
fully responsible for the acts and omissions of any subcontractor as it would
for its own acts or omissions. See "Administrative Services Agent" below.
For its services under the Co-Administration Agreement, the Portfolio
has agreed to pay FDI fees equal to its allocable share of an annual
complex-wide charge of $425,000 plus FDI's out-of-pocket expenses. The amount
allocable to the Portfolio is based on the ratio of its net assets to the
aggregate net assets of J.P. Morgan Funds, J.P. Morgan Institutional Funds, the
Master Portfolios and J.P. Morgan Series Trust. For the fiscal year ended August
31, 1998, for the eleven months ended July 31, 1999 and for the fiscal year
ended July 31, 2000 the Co-Administration fees paid by the Portfolio: $9,832,
$7,665 and $5,677, respectively.
ADMINISTRATIVE SERVICES AGENT. The Portfolio has entered into a
Restated Administrative Services Agreement (the "Services Agreement") with
Morgan, pursuant to which Morgan is responsible for certain administrative and
related services provided to the Portfolio.
Under the Services Agreements, Morgan provides certain administrative
and related services to the Fund and the Portfolio, including services related
to tax compliance, preparation of financial statements, calculation of
performance data, oversight of service providers and certain regulatory and
Board of Trustee matters.
Under the Services Agreement, the Portfolio has agreed to pay Morgan
fees equal to its allocable share of an annual complex-wide charge. This charge
is calculated daily based on the aggregate net assets of the Master Portfolios
and J.P. MORGAN Series Trust in accordance with the following annual schedule:
0.09% of the first $7 billion of their aggregate average daily net assets and
0.04% of their average daily net assets in excess of $7 billion, less the
complex-wide fees payable to FDI. The portion of this charge payable by the
Portfolio is determined by the proportionate share that its net assets bear to
the total net assets of the J.P. Morgan Funds, the J.P. Morgan Institutional
Funds, the Master Portfolios, the other investors in the Master Portfolios for
which Morgan provides similar services and J.P. Morgan Series Trust.
For the fiscal year ended August 31, 1998, for the eleven months ended
July 31, 1999 and for the fiscal year ended July 31, 2000 the Portfolio paid
Morgan: $198,156, $203,283 and $194,913, respectively, in administrative
services fees.
See "Expenses" below for applicable expense limitations.
CUSTODIAN. The Bank of New York ("BONY"), One Wall Street, New York,
New York 10286, serves as the Trust's custodian and fund accounting agent.
Pursuant to the Custodian Contract and Fund Accounting Agreement with the Trust,
BONY is responsible for holding portfolio securities and cash and maintaining
the books of account and records of the Fund's portfolio transactions.
INDEPENDENT ACCOUNTANTS. The independent accountants of the Portfolio
are PricewaterhouseCoopers LLP, 1177 Avenue of the Americas, New York, New York
10036. PricewaterhouseCoopers LLP conducts an annual audit of the financial
statements of the Portfolio, assists in the preparation and/or review of each of
the Portfolio's federal and state income tax returns and consults with the
Portfolio as to matters of accounting and federal and state income taxation.
EXPENSES. In addition to the fees payable to the service providers
identified above, the Portfolio is responsible for usual and customary expenses
associated with its operations. Such expenses include organization expenses,
legal fees, accounting and audit expenses, insurance costs, the compensation and
expenses of the Trustees, registration fees under federal securities laws, and
extraordinary expenses, applicable to the Portfolio. Such expenses also include
brokerage expenses.
Item 17. BROKERAGE ALLOCATION AND OTHER PRACTICES.
The Advisor places orders for the Portfolio for all purchases and sales
of portfolio securities, enters into repurchase agreements, and may enter into
reverse repurchase agreements and execute loans of portfolio securities on
behalf of the Portfolio.
See Item 13 above.
Fixed income and debt securities and municipal bonds and notes are
generally traded at a net price with dealers acting as principal for their own
accounts without a stated commission. The price of the security usually includes
profit to the dealers. In underwritten offerings, securities are purchased at a
fixed price which includes an amount of compensation to the underwriter,
generally referred to as the underwriter's concession or discount. On occasion,
certain securities may be purchased directly from an issuer, in which case no
commissions or discounts are paid.
In connection with portfolio transactions for the Portfolio, the
Advisor intends to seek the best price and execution on a competitive basis for
both purchases and sales of securities. For the fiscal year ended August 31,
1998, for the eleven months ended July 31, 1999 and for the fiscal year ended
July 31, 2000, the portfolio turnover rates were: 16%, 29% and 84%,
respectively.
Portfolio transactions for the Portfolio will be undertaken principally
to accomplish the Portfolio's objective in relation to expected movements in the
general level of interest rates. The Portfolio may engage in short term trading
consistent with its objective.
In selecting a broker, the Advisor considers a number of factors
including: the price per unit of the security; the broker's reliability for
prompt, accurate confirmations and on-time delivery of securities; the firm's
financial condition. The Trustees of the Portfolio review regularly the
reasonableness of commissions and other transaction costs incurred by the
Portfolio in light of facts and circumstances deemed relevant from time to time,
and, in that connection, will receive reports from the Advisor and published
data concerning transaction costs incurred by institutional investors generally.
Research services provided by brokers to which the Advisor has allocated
brokerage business in the past include economic statistics and forecasting
services, industry and company analyses, portfolio strategy services,
quantitative data, and consulting services from economists and political
analysts. Research services furnished by brokers are used for the benefit of all
the Advisor's clients and not solely or necessarily for the benefit of the
Portfolio. The Advisor believes that the value of research services received is
not determinable and does not significantly reduce its expenses. The Portfolio
does not reduce its fee to the Advisor by any amount that might be attributable
to the value of such services.
Subject to the overriding objective of obtaining the best possible
execution of orders, the Advisor may allocate a portion of the Portfolio's
portfolio brokerage transactions to affiliates of the Advisor. In order for
affiliates of the Advisor to effect any portfolio transactions for the
Portfolio, the commissions, fees or other remuneration received by such
affiliates must be reasonable and fair compared to the commissions, fees, or
other remuneration paid to other brokers in connection with comparable
transactions involving similar securities being purchased or sold on a
securities exchange during a comparable period of time. Furthermore, the
Trustees of the Portfolio, including a majority of the Trustees who are not
"interested persons," have adopted procedures which are reasonably designed to
provide that any commissions, fees, or other remuneration paid to such
affiliates are consistent with the foregoing standard.
The Portfolio's portfolio securities will not be purchased from or
through or sold to or through the Exclusive Placement Agent or Advisor or any
other "affiliated person" (as defined in the 1940 Act), of the Exclusive
Placement Agent or Advisor when such entities are acting as principals, except
to the extent permitted by law. In addition, the Portfolio will not purchase
securities during the existence of any underwriting group relating thereto of
which the Advisor or an affiliate of the Advisor is a member, except to the
extent permitted by law.
On those occasions when the Advisor deems the purchase or sale of a
security to be in the best interests of the Portfolio as well as other
customers, including other Portfolios, the Advisor, to the extent permitted by
applicable laws and regulations, may, but is not obligated to, aggregate the
securities to be sold or purchased for the Portfolio with those to be sold or
purchased for other customers in order to obtain best execution, including lower
brokerage commissions if appropriate. In such event, allocation of the
securities so purchased or sold as well as any expenses incurred in the
transaction will be made by the Advisor in the manner it considers to be most
equitable and consistent with its fiduciary obligations to the Portfolio. In
some instances, this procedure might adversely affect the Portfolio.
If the Portfolio effects a closing purchase transaction with respect to
an option written by it, normally such transaction will be executed by the same
broker-dealer who executed the sale of the option. The writing of options by the
Portfolio will be subject to limitations established by each of the exchanges
governing the maximum number of options in each class which may be written by a
single investor or group of investors acting in concert, regardless of whether
the options are written on the same or different exchanges or are held or
written in one or more accounts or through one or more brokers. The number of
options which the Portfolio may write may be affected by options written by the
Advisor for other investment advisory clients. An exchange may order the
liquidation of positions found to be in excess of these limits, and it may
impose certain other sanctions.
Item 18. CAPITAL STOCK AND OTHER SECURITIES.
Under the Declaration of Trust, the Trustees are authorized to issue
beneficial interests in the Portfolio. Investors are entitled to participate pro
rata in distributions of taxable income, loss, gain and credit of the Portfolio.
Upon liquidation or dissolution of the Portfolio, investors are entitled to
share pro rata in the Portfolio's net assets available for distribution to its
investors. Investments in the Portfolio have no reference, preemptive,
conversion or similar rights and are fully paid and nonassessable, except as set
forth below. Investments in the Portfolio may not be transferred. Certificates
representing an investor's beneficial interest in the Portfolio are issued only
upon the written request of an investor.
Each investor is entitled to a vote in proportion to the amount of its
investment in the Portfolio. Investors in the Portfolio do not have cumulative
voting rights, and investors holding more than 50% of the aggregate beneficial
interest in the Portfolio may elect all of the Trustees if they choose to do so
and in such event the other investors in the Portfolio would not be able to
elect any Trustee. The Portfolio is not required and has no current intention to
hold annual meetings of investors but the Portfolio will hold special meetings
of investors when in the judgment of the Portfolio's Trustees it is necessary or
desirable to submit matters for an investor vote. No material amendment may be
made to the Portfolio's Declaration of Trust without the affirmative majority
vote of investors (with the vote of each being in proportion to the amount of
its investment).
The Portfolio may enter into a merger or consolidation, or sell all or
substantially all of its assets, if approved by the vote of two thirds of its
investors (with the vote of each being in proportion to its percentage of the
beneficial interests in the Portfolio), except that if the Trustees recommend
such sale of assets, the approval by vote of a majority of the investors (with
the vote of each being in proportion to its percentage of the beneficial
interests of the Portfolio) will be sufficient. The Portfolio may also be
terminated (i) upon liquidation and distribution of its assets if approved by
the vote of two thirds of its investors (with the vote of each being in
proportion to the amount of its investment) or (ii) by the Trustees by written
notice to its investors.
The Portfolio is organized as a trust under the laws of the State of
New York. Investors in the Portfolio will be held personally liable for its
obligations and liabilities, subject, however, to indemnification by the
Portfolio in the event that there is imposed upon an investor a greater portion
of the liabilities and obligations of the Portfolio than its proportionate
beneficial interest in the Portfolio. The Declaration of Trust also provides
that the Portfolio shall maintain appropriate insurance (for example, fidelity
bonding and errors and omissions insurance) for the protection of the Portfolio,
its investors, Trustees, officers, employees and agents covering possible tort
and other liabilities. Thus, the risk of an investor incurring financial loss on
account of investor liability is limited to circumstances in which both
inadequate insurance existed and the Portfolio itself was unable to meet its
obligations.
The Portfolio's Declaration of Trust further provides that obligations
of the Portfolio are not binding upon the Trustees individually but only upon
the property of the Portfolio and that the Trustees will not be liable for any
action or failure to act, but nothing in the Declaration of Trust protects a
Trustee against any liability to which he would otherwise be subject by reason
of willful misfeasance, bad faith, gross negligence, or reckless disregard of
the duties involved in the conduct of his office.
Item 19. PURCHASE, REDEMPTION AND PRICING OF SECURITIES BEING OFFERED.
Beneficial interests in the Portfolio are issued solely in private
placement transactions that do not involve any "public offering" within the
meaning of Section 4(2) of the 1933 Act.
The Portfolio computes its net asset value once daily on Monday through
Friday at the time described in Part A. The net asset value will not be computed
on the days the following legal holidays are observed: New Year's Day, Martin
Luther King, Jr. Day, President's Day, Good Friday, Memorial Day, Independence
Day, Labor Day, Thanksgiving Day, and Christmas Day. On days when the U.S.
trading markets close early, the Portfolio will close for purchases and
redemptions at the same time. The Portfolio may also close for purchases and
redemptions at such other times as may be determined by the Board of Trustees to
the extent permitted by applicable law. The days on which net asset value is
determined are the Portfolio's business days.
Listed options on debt securities traded on U.S. option exchanges shall
be valued at their closing price on such exchanges. Futures on debt securities
and related options traded on commodities exchanges shall be valued at their
closing price as of the close of such commodities exchanges, which is currently
4:15 p.m., New York time. Options and future traded on foreign exchanges shall
be valued at the last sale or close price available prior to the calculation of
the Funds' net asset value. Non-listed OTC options and swaps shall be valued at
the closing price provided by a counterparty or third-party broker.
Fixed income securities with a maturity of 60 days or more are
generally valued using bid quotations readily available from and supplied daily
by pricing services or brokers. If such prices are generally not readily
available from the Fund's pricing services or brokers, such securities are
priced in accordance with fair value procedures adopted by the Trustees. Such
fair value procedures include the use of pricing services, which use prices
based upon yields or prices of securities of comparable quality, coupon,
maturity and type; indications as to values from dealers; and general market
conditions. Fixed income securities with a remaining maturity of less than 60
days are valued by the amortized cost method.
If the Portfolio determines that it would be detrimental to the best
interest of the remaining investors in the Portfolio to make payment wholly or
partly in cash, payment of the redemption price may be made in whole or in part
by a distribution in kind of securities from the Portfolio, in lieu of cash, in
conformity with the applicable rule of the SEC. If interests are redeemed in
kind, the redeeming investor might incur transaction costs in converting the
assets into cash. The method of valuing portfolio securities is described above
and such valuation will be made as of the same time the redemption price is
determined. The Portfolio has elected to be governed by Rule 18f-1 under the
1940 Act pursuant to which the Portfolio is obligated to redeem interests solely
in cash up to the lesser of $250,000 or 1% of the net asset value of the
Portfolio during any 90 day period for any one investor. The Portfolio will not
redeem in kind except in circumstances in which an investor is permitted to
redeem in kind.
Item 20. TAX STATUS.
The Portfolio is organized as a New York trust. The Portfolio is not
subject to any income or franchise tax in the State of New York or the
Commonwealth of Massachusetts. However, each investor in the Portfolio will be
subject to U.S. Federal income tax in the manner described below on its share
(as determined in accordance with the governing instruments of the Portfolio) of
the Portfolio's ordinary income and capital gain in determining its income tax
liability. The determination of such share will be made in accordance with the
Internal Revenue Service Code of 1986, as amended (the "Code"), and regulations
promulgated thereunder.
Although, as described above, the Portfolio will not be subject to
federal income tax, it will file appropriate income tax returns.
It is intended that the Portfolio's assets will be managed in such a
way that an investor in the Portfolio will be able to satisfy the requirements
of Subchapter M of the Code. To ensure that investors will be able to satisfy
the requirements of subchapter M, the Portfolio must satisfy certain gross
income and diversification requirements, including, among other things, a
requirement that the Portfolio derive less than 30% of its gross income from the
sale of stock, securities, options, futures or forward contracts held less than
three months.
The Portfolio intends to qualify to allocate tax exempt interest to its
investors by having, at the close of each quarter of its taxable year, at least
50% of the value of its total assets consist of tax exempt securities. Tax
exempt interest is that part of income earned by the Portfolio which consists of
interest received by the Portfolio on tax exempt securities. In view of the
Portfolio's investment policies, it is expected that a substantial portion of
all income will be tax exempt income, although the Portfolio may from time to
time realize net short-term capital gains and may invest limited amounts in
taxable securities under certain circumstances.
Gains or losses on sales of portfolio securities will be treated as
long-term capital gains or losses if the securities have been held by it for
more than one year except in certain cases where, if applicable, a put option is
acquired or a call option is written thereon. Other gains or losses on the sale
of securities will be short-term capital gains or losses. Gains and losses on
the sale, lapse or other termination of options on securities will be treated as
gains and losses from the sale of securities. If an option written by the
Portfolio lapses or is terminated through a closing transaction, such as a
repurchase by the Portfolio of the option from its holder, the Portfolio will
realize a short-term capital gain or loss, depending on whether the premium
income is greater or less than the amount paid by the Portfolio in the closing
transaction. If securities are purchased by the Portfolio pursuant to the
exercise of a put option written by it, the Portfolio will subtract the premium
received from its cost basis in the securities purchased.
Options and futures contracts entered into by the Portfolio may create
"straddles" for U.S. federal income tax purposes and this may affect the
character and timing of gains or losses realized by the Portfolio on forward
currency contracts, options and futures contracts or on the underlying
securities. Straddles may also result in the loss of the holding period of
underlying securities for purposes of the 30% of gross income test described
above, and therefore, the Portfolio's ability to enter into forward currency
contracts, options and futures contracts may be limited.
Certain options and futures held by a Portfolio at the end of each fiscal
year will be required to be "marked to market" for federal income tax purposes
-- i.e., treated as having been sold at market value. For options and futures
contracts, 60% of any gain or loss recognized on these deemed sales and on
actual dispositions will be treated as long-term capital gain or loss, and the
remainder will be treated as short-term capital gain or loss regardless of how
long the Portfolio has held such options or futures. Any gain or loss recognized
on foreign currency contracts will be treated as ordinary income.
STATE AND LOCAL TAXES. The Portfolio may be subject to state or local
taxes in jurisdictions in which the Portfolio is deemed to be doing business. In
addition, the treatment of the Portfolio and its investors in those states which
have income tax laws might differ from treatment under the federal income tax
laws. Investors should consult their own tax advisors with respect to any state
or local taxes.
OTHER TAXATION. The investment by an investor in the Portfolio does not
cause the investor to be liable for any income or franchise tax in the State of
New York. Investors are advised to consult their own tax advisors with respect
to the particular tax consequences to them of an investment in the Portfolio.
Item 21. UNDERWRITERS.
The exclusive placement agent for the Portfolio is FDI, which receives
no additional compensation for serving in this capacity. Investment companies,
insurance company separate accounts, common and commingled trust funds and
similar organizations and entities may continuously invest in the Portfolio.
Item 22. CALCULATIONS OF PERFORMANCE DATA.
Not applicable.
Item 23. FINANCIAL STATEMENTS.
The Portfolio's July 31, 2000 annual report filed with the SEC pursuant
to Section 30(b) of the 1940 Act and Rule 30b2-1 thereunder is incorporated
herein by reference filed on October 11, 2000 (Accession Number
0000912057-00-044450).
<PAGE>
Appendix A-3
APPENDIX A
DESCRIPTION OF SECURITY RATINGS
STANDARD & POOR'S
CORPORATE AND MUNICIPAL BONDS
AAA - Debt rated AAA has the highest ratings assigned by Standard & Poor's
to a debt obligation. 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 a small degree.
A - Debt rated A has a strong capacity to pay interest and repay
principal although it is somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than debt
in higher rated categories.
BBB - Debt rated BBB is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate
protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to pay
interest and repay principal for debt in this category than for debt in
higher rated categories.
BB - Debt rated BB is regarded as having less near-term vulnerability to
default than other speculative issues. 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 payments.
B - An obligation rated B is more vulnerable to nonpayment than
obligations rated BB, but the obligor currently has the capacity to
meet its financial commitment on the obligation. Adverse business,
financial, or economic conditions will likely impair the obligor's
capacity or willingness to meet its financial commitment on the
obligation.
CCC - An obligation rated CCC is currently vulnerable to nonpayment, and is
dependent upon favorable business, financial, and economic conditions
for the obligor to meet its financial commitment on the obligation. In
the event of adverse business, financial, or economic conditions, the
obligor is not likely to have the capacity to meet its financial
commitment on the obligation.
CC - An obligation rated CC is currently highly vulnerable to nonpayment.
C - The C rating may be used to cover a situation where a bankruptcy
petition has been filed or similar action has been taken, but payments on this
obligation are being continued.
COMMERCIAL PAPER, INCLUDING TAX EXEMPT
A - Issues assigned this highest rating are regarded as having the
greatest capacity for timely payment. Issues in this category are
further refined with the designations 1, 2, and 3 to indicate the
relative degree of safety.
A-1 - This designation indicates that the degree of safety regarding timely
payment is very strong.
SHORT-TERM TAX-EXEMPT NOTES
SP-1 - The short-term tax-exempt note rating of SP-1 is the highest
rating assigned by Standard & Poor's and has a very strong or
strong capacity to pay principal and interest. Those issues
determined to possess overwhelming safety characteristics are
given a "plus" (+) designation.
SP-2 - The short-term tax-exempt note rating of SP-2 has a satisfactory
capacity to pay principal and interest.
MOODY'S
CORPORATE AND MUNICIPAL BONDS
Aaa - Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred
to as "gilt edge." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be
visualized are most unlikely to impair the fundamentally strong
position of such issues.
Aa - Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally
known as high grade bonds. They are rated lower than the best bonds
because margins of protection may not be as large as in Aaa securities
or fluctuation of protective elements may be of greater amplitude or
there may be other elements present which make the long term risks
appear somewhat larger than in Aaa securities.
A - Bonds which are rated A possess many favorable investment attributes
and are to be considered as upper medium grade obligations. Factors
giving security to principal and interest are considered adequate but
elements may be present which suggest a susceptibility to impairment
sometime in the future.
Baa - Bonds which are rated Baa are considered as medium grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest
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 which are rated Ba are judged to have speculative elements;
their future cannot be considered as well-assured. Often the protection
of interest and principal payments may be very moderate, and thereby
not well safeguarded during both good and bad times over the future.
Uncertainty of position characterizes bonds in this class.
B - Bonds which are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or
of maintenance of other terms of the contract over any long period of
time may be small.
Caa - Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal or
interest.
Ca - Bonds which are rated Ca represent obligations which are speculative
in a high degree. Such issues are often in default or have other marked
shortcomings.
C - Bonds which are rated C are the lowest rated class of bonds and issues
so rated can be regarded as having extremely poor prospects of ever attaining
any real investment standing.
COMMERCIAL PAPER, INCLUDING TAX EXEMPT
Prime-1 - 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.
SHORT-TERM TAX EXEMPT NOTES
MIG-1 The short-term tax-exempt note rating MIG-1 is the highest
rating assigned by Moody's for notes judged to be the best
quality. Notes with this rating enjoy strong protection from
established cash flows of funds for their servicing or from
established and broad-based access to the market for
refinancing, or both.
MIG-2 - MIG-2 rated notes are of high quality but with margins of
protection not as large as MIG-1.
<PAGE>
C-4
PART C
ITEM 23 EXHIBITS
(a) Declaration of Trust, as amended, of the Registrant.
Incorporated herein by reference from Amendment No. 5 to
Registrant's Registration Statement on Form N-1A as filed with
the Securities and Exchange Commission (SEC) on December 24,
1996 (Accession Number 0001016964-96-000047).
(a) (b) Restated By-Laws of the Registrant.
Incorporated herein by reference from Amendment No. 5 to
Registrant's Registration Statement on Form N-1A as filed with
the SEC on December 24, 1996 (Accession Number 0001016964-96-
000047).
(c ) None
(d) Investment Advisory Agreement between the Registrant and
Morgan Guaranty Trust Company of New York ("Morgan").
Incorporated herein by reference from Amendment No. 5 to
Registrant's Registration Statement on Form N-1A as filed with
the SEC on December 24, 1996 (Accession Number 0001016964-96-
000047).
(e) None
(f) N/A
(g) Custodian Contract between the Registrant and State Street
Bank and Trust Company ("State Street"). Incorporated herein
by reference from Amendment No. 5 to Registrant's Registration
Statement on Form N-1A as filed with the SEC on December 24,
1996 (Accession Number 0001016964-96-000047).
(h) Co-Administration Agreement between the Registrant and Funds
Distributor, Inc. dated August 1, 1996 ("Co-Administration
Agreement"). Incorporated herein by reference from Amendment
No.4 to Registrant's Registration Statement on Form N-1A as
filed with the SEC on October 7, 1996 (Accession Number
0000912057-96-022171).
(h)(i) Amended Exhibit I to Co-Administration Agreement.
Incorporated herein by reference from Amendment No. 5 to
Registrant's Registration Statement on Form N-1A as filed with
the SEC on December 24, 1996 Accession Number 0001016964-96-
000047).
(h)(1) Transfer Agency and Service Agreement between the Registrant
and State Street. Incorporated herein by reference from Amendment No. 5 to
Registrant's Registration Statement on Form N-1A as filed with the SEC on
December 24, 1996 (Accession Number 0001016964-96-000047).
(h)(2) Restated Administrative Services Agreement between the Registrant
and Morgan dated August 1, 1996 ("Administrative Services Agreement").
Incorporated herein by reference from Amendment No. 4 to Registrant's
Registration Statement on Form N-1A as filed with the SEC on October 7, 1996
(Accession Number 0000912057-96-022171).
(h)(2)(i) Amended Exhibit I to Administrative Services Agreement.
Incorporated herein by reference from Amendment No. 5 to
Registrant's Registration Statement on Form N-1A as filed with
the SEC on December 24, 1996 (Accession Number 0001016964-96-
000047).
(h)(3) Amended and Restated Portfolio Fund Services Agreement between
the Registrant and Pierpont Group, Inc. dated July 11, 1996.
Incorporated herein by reference from Amendment No. 4 to
Registrant's Registration Statement on Form N-1A as
filed with the SEC on October 7, 1996 (Accession Number 0000912057-96-
022171).
(a) (h)(4) Investment representation letters of initial investors.
Incorporated herein by reference from Amendment No. 5 to
Registrant's Registration Statement on Form N-1A as filed with
the SEC on December 24, 1996 (Accession Number 0001016964-96-
000047).
(i) None
(j) None
(k) N/A
(l) N/A
(m) N/A
(n) N/A
(o) None
(p) Code of Ethics filed herewith.
<PAGE>
Item 25. INDEMNIFICATION.
Reference is hereby made to Article V of the Registrant's Declaration
of Trust, filed as an Exhibit hereto.
The Trustees and officers of the Registrant and the personnel of the
Registrant's co-administrator are insured under an errors and omissions
liability insurance policy. The Registrant and its officers are also insured
under the fidelity bond required by Rule 17g-1 under the Investment Company Act
of 1940, as amended.
Item 26. BUSINESS AND OTHER CONNECTIONS OF INVESTMENT ADVISER.
The business of J.P. Morgan is summarized in the Prospectus constituting
Part A of this Registration Statement, which is incorporated herein by
reference. The business or other connections of each director and officer of J.
P. Morgan is currently listed in the investment advisor registration on Form ADV
for J.P. Morgan (File No. 801-21011).
Item 27. PRINCIPAL UNDERWRITERS.
Not applicable.
Item 28. LOCATION OF ACCOUNTS AND RECORDS.
The accounts and records of the Registrant are located, in whole or in
part, at the office of the Registrant and the following locations:
J.P. Morgan Investment Management Inc. and Morgan Guaranty Trust Company of
New York, 522 Fifth Avenue, New York, New York 10036 and/or 60 Wall Street, New
York, New York 10260-0060 (records relating to its functions as investment
adviser and administrative services agent).
The Bank of New York, 1 Wall Street New York, New York 10086, (records
relating to its functions as fund accountant and custodian).
Funds Distributor, Inc., 60 State Street, Suite 1300, Boston,
Massachusetts 02109 (records relating to its functions as co-administrator and
exclusive placement agent).
Pierpont Group, Inc., 461 Fifth Avenue, New York, New York 10017
(records relating to its assisting the Trustees in carrying out their duties in
supervising the Registrant's affairs).
Item 29. MANAGEMENT SERVICES.
Not applicable.
Item 30. UNDERTAKINGS.
Not applicable.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Investment Company Act of 1940, as
amended, The Tax Exempt Bond Portfolio has duly caused this amendment to its
registration statement to be signed on its behalf by the undersigned, thereto
duly authorized, in the City of New York, State of New York, on the 28th day of
November, 2000.
THE TAX EXEMPT BOND PORTFOLIO
By:
---------------------
Christopher Kelley
Vice President and Assistant Secretary
<PAGE>
INDEX TO EXHIBIT
EXHIBIT NO: DESCRIPTION OF EXHIBITS
Ex. 99 Code of Ethics for Funds Distributor, Inc.
Code of Ethics for J.P. Morgan Funds
Code of Ethics for J.P. Morgan Investment Management
