<PAGE>
PROSPECTUS
OCTOBER 21, 1994
MERRILL LYNCH COLORADO MUNICIPAL BOND FUND
MERRILL LYNCH MULTI-STATE MUNICIPAL SERIES TRUST
P.O. BOX 9011, PRINCETON, NEW JERSEY 08543-9011 - PHONE NO. (609) 282-2800
-------------------
Merrill Lynch Colorado Municipal Bond Fund (the "Fund") is a mutual fund
seeking to provide shareholders with as high a level of income exempt from
Federal and Colorado income taxes as is consistent with prudent investment
management. The Fund invests primarily in a portfolio of long-term, investment
grade obligations, the interest on which, in the opinion of bond counsel to the
issuer, is exempt from Federal and Colorado income taxes ("Colorado Municipal
Bonds"). The Fund may invest in certain tax-exempt securities classified as
"private activity bonds" that may subject certain investors in the Fund to an
alternative minimum tax. At times, the Fund may seek to hedge its portfolio
through the use of futures transactions and options. There can be no assurance
that the investment objective of the Fund will be realized.
Pursuant to the Merrill Lynch Select Pricing-SM- System, the Fund offers
four classes of shares, each with a different combination of sales charges,
ongoing fees and other features. The Merrill Lynch Select Pricing-SM- System
permits an investor to choose the method of purchasing shares that the investor
believes is most beneficial given the amount of the purchase, the length of time
the investor expects to hold the shares and other relevant circumstances. See
"Merrill Lynch Select Pricing-SM- System" on page 4.
Shares may be purchased directly from Merrill Lynch Funds Distributor, Inc.
(the "Distributor"), P.O. Box 9011, Princeton, New Jersey 08543-9011 [(609)
282-2800], or from securities dealers that have entered into selected dealer
agreements with the Distributor, including Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("Merrill Lynch"). The minimum initial purchase is $1,000 and the
minimum subsequent purchase is $50. Merrill Lynch may charge its customers a
processing fee (presently $4.85) for confirming purchases and repurchases.
Purchases and redemptions directly through the Fund's Transfer Agent are not
subject to the processing fee. See "Purchase of Shares" and "Redemption of
Shares".
-------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS.
ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
-------------------
This Prospectus is a concise statement of information about the Fund that is
relevant to making an investment in the Fund. This Prospectus should be retained
for future reference. A statement containing additional information about the
Fund, dated October 21, 1994 (the "Statement of Additional Information"), has
been filed with the Securities and Exchange Commission and is available, without
charge, by calling or by writing Merrill Lynch Multi-State Municipal Series
Trust (the "Trust") at the above telephone number or address. The Statement of
Additional Information is hereby incorporated by reference into this Prospectus.
The Fund is a separate series of the Trust, an open-end management investment
company organized as a Massachusetts business trust.
-------------------
FUND ASSET MANAGEMENT--MANAGER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC.--DISTRIBUTOR
<PAGE>
FEE TABLE
A general comparison of the sales arrangements and other nonrecurring and
recurring expenses applicable to shares of the Fund follows:
<TABLE>
<CAPTION>
CLASS A(A) CLASS B(B) CLASS C(C) CLASS D(C)
------------ ------------------------------ ------------ ----------
<S> <C> <C> <C> <C>
SHAREHOLDER TRANSACTION EXPENSES:
Maximum Sales Charge Imposed on Purchases
(as a percentage of offering price)........ 4.00%(d) None None 4.00%(d)
Sales Charge Imposed on Dividend
Reinvestments.............................. None None None None
Deferred Sales Charge (as a percentage of
original purchase price or redemption
proceeds, whichever is lower).............. None(e) 4.0% during the first year, 1% for one None(e)
decreasing 1.0% annually year
thereafter to 0.0% after the
fourth year
Exchange Fee................................. None None None None
ANNUAL FUND OPERATING EXPENSES (AS A PERCENTAGE
OF AVERAGE NET ASSETS)(F):...................
Investment Advisory Fees(g).................. 0.55% 0.55% 0.55% 0.55%
12b-1 Fees(h):
Account Maintenance Fees................... None 0.25% 0.25% 0.10%
Distribution Fees.......................... None 0.25% 0.35% None
(Class B shares convert to
Class D shares automatically
after approximately ten years,
cease being subject to
distribution fees and are
subject to lower account
maintenance fees)
Other Expenses:
Custodial Fees............................... .04% .04% .04% .04%
Shareholder Servicing Costs(i)............... .05% .06% .06% .05%
Other........................................ .88% .88% .88% .88%
-------- -------- -------- --------
Total Other Expenses..................... .97% .98% .98% .97%
-------- -------- -------- --------
Total Fund Operating Expenses.................. 1.52% 2.03% 2.13% 1.62%
-------- -------- -------- --------
-------- -------- -------- --------
<FN>
- ------------
(a) Class A shares are sold to a limited group of investors including existing
Class A shareholders and certain investment programs. See "Purchase of
Shares -- Initial Sales Charge Alternatives -- Class A and Class D Shares"
-- page 22.
(b) Class B shares convert to Class D shares automatically approximately ten
years after initial purchase. See "Purchase of Shares -- Deferred Sales
Charge Alternatives -- Class B and Class C Shares" -- page 24.
(c) Prior to the date of this Prospectus, the Fund has not offered its Class C
or Class D shares to the public.
(d) Reduced for purchases of $25,000 and over. Class A or Class D purchases of
$1,000,000 or more may not be subject to an initial sales charge. See
"Purchase of Shares -- Initial Sales Charge Alternatives -- Class A and
Class D Shares" -- page 22.
(e) Class A and Class D shares are not subject to a contingent deferred sales
charge ("CDSC"), except that purchases of $1,000,000 or more which may not
be subject to an initial sales charge may instead be subject to a CDSC of
1.0% of amounts redeemed within the first year of purchase.
(f) Information under "Other Expenses" for all classes of shares is estimated
for the fiscal year ending July 31, 1995.
(g) See "Management of the Trust -- Management and Advisory Arrangements" --
page 19.
(h) See "Purchase of Shares -- Distribution Plans" -- page 27.
(i) See "Management of the Trust -- Transfer Agency Services" -- page 20.
</TABLE>
2
<PAGE>
As of July 31, 1994, the Manager was voluntary waiving all of its management
fee and voluntarily reimbursing the Fund for a portion of other expenses
(excluding 12b-1 fees). The fee table has been restated to assume the absence of
any waiver or reimbursement because the Manager may discontinue or reduce such
waiver and assumption of expenses at any time without notice. During the period
November 26, 1993 (commencement of operations) to July 31, 1994, the Manager
waived management fees and reimbursed expenses totaling 1.49% for Class A shares
and 1.49% for Class B shares after which the Fund's total expense ratio was
0.03% for Class A shares and 0.54% for Class B shares. Class C and Class D
shares were not offered during that period.
<TABLE>
<CAPTION>
EXAMPLE:
CUMULATIVE EXPENSES PAID FOR THE
PERIOD OF:
-----------------------------------
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
An investor would pay the following expenses on a $1,000
investment including the maximum $40 initial sales charge
(Class A and Class D shares only) and assuming (1) the
Total Fund Operating Expense for each class set forth
above, (2) a 5% annual return throughout the periods and
(3) redemption at the end of the period:
Class A................................................. $ 55 $ 86 $ 120 $ 214
Class B................................................. $ 61 $ 84 $ 109 $ 236
Class C................................................. $ 32 $ 67 $ 114 $ 246
Class D................................................. $ 56 $ 89 $ 125 $ 225
An investor would pay the following expenses on the same
$1,000 investment assuming no redemption at the end of the
period:
Class A................................................. $ 55 $ 86 $ 120 $ 214
Class B................................................. $ 21 $ 64 $ 109 $ 236
Class C................................................. $ 22 $ 67 $ 114 $ 246
Class D................................................. $ 56 $ 89 $ 125 $ 225
</TABLE>
The foregoing Fee Table is intended to assist investors in understanding the
costs and expenses that a shareholder in the Fund will bear directly or
indirectly. The expenses set forth under "Other Expenses" are based on estimated
amounts through the end of the Fund's first fiscal year on an annualized basis.
The Example set forth above assumes reinvestment of all dividends and
distributions and utilizes a 5% annual rate of return as mandated by Securities
and Exchange Commission (the "Commission") regulations. THE EXAMPLE SHOULD NOT
BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE EXPENSES OR ANNUAL RATES OF
RETURN, AND ACTUAL EXPENSES OR ANNUAL RATES OF RETURN MAY BE MORE OR LESS THAN
THOSE ASSUMED FOR PURPOSES OF THE EXAMPLE. Class B and Class C shareholders who
hold their shares for an extended period of time may pay more in Rule 12b-1
distribution fees than the economic equivalent of the maximum front-end sales
charges permitted under the Rules of Fair Practice of the National Association
of Securities Dealers, Inc. ("NASD"). Merrill Lynch may charge its customers a
processing fee (presently $4.85) for confirming purchases and repurchases.
Purchases and redemptions directly through the Fund's Transfer Agent are not
subject to the processing fee. See "Purchase of Shares" and "Redemption of
Shares".
3
<PAGE>
The Manager of the Fund, Fund Asset Management, L.P. (the "Manager" or
"FAM"), has voluntarily agreed to assume the entire operating expenses of the
Fund. The Manager may discontinue or reduce such assumption of expenses at any
time without notice.
MERRILL LYNCH SELECT PRICING-SM- SYSTEM
The Fund offers four classes of shares under the Merrill Lynch Select
Pricing-SM- System. The shares of each class may be purchased at a price equal
to the next determined net asset value per share subject to the sales charges
and ongoing fee arrangements described below. Shares of Class A and Class D are
sold to investors choosing the initial sales charge alternatives, and shares of
Class B and Class C are sold to investors choosing the deferred sales charge
alternatives. The Merrill Lynch Select Pricing-SM- System is used by more than
50 mutual funds advised by Merrill Lynch Asset Management, L.P. ("MLAM") or FAM,
an affiliate of MLAM. Funds advised by MLAM or FAM are referred to herein as
"MLAM-advised mutual funds".
Each Class A, Class B, Class C or Class D share of the Fund represents an
identical interest in the investment portfolio of the Fund and has the same
rights, except that Class B, Class C and Class D shares bear the expenses of the
ongoing account maintenance fees and Class B and Class C shares bear the
expenses of the ongoing distribution fees and the additional incremental
transfer agency costs resulting from the deferred sales charge arrangements. The
deferred sales charges and account maintenance fees that are imposed on Class B
and Class C shares, as well as the account maintenance fees that are imposed on
the Class D shares, will be imposed directly against those classes and not
against all assets of the Fund and, accordingly, such charges will not affect
the net asset value of any other class or have any impact on investors choosing
another sales charge option. Dividends paid by the Fund for each class of shares
will be calculated in the same manner at the same time and will differ only to
the extent that account maintenance and distribution fees and any incremental
transfer agency costs relating to a particular class are borne exclusively by
that class. Each class has different exchange privileges. See "Shareholder
Services -- Exchange Privilege".
Investors should understand that the purpose and function of the initial
sales charges with respect to the Class A and Class D shares are the same as
those of the deferred sales charges with respect to the Class B and Class C
shares in that the sales charges applicable to each class provide for the
financing of the distribution of the shares of the Fund. The
distribution-related revenues paid with respect to a class will not be used to
finance the distribution expenditures of another class. Sales personnel may
receive different compensation for selling different classes of shares.
The following table sets forth a summary of the distribution arrangements
for each class of shares under the Merrill Lynch Select Pricing-SM- System,
followed by a more detailed description of each class and a discussion of the
factors that investors should consider in determining the method of purchasing
shares under the Merrill Lynch Select Pricing-SM- System that the investor
believes is most beneficial under his particular circumstances. More detailed
information as to each class of shares is set forth under the "Purchase of
Shares".
4
<PAGE>
<TABLE>
<CAPTION>
ACCOUNT
MAINTENANCE DISTRIBUTION
CLASS SALES CHARGE(1) FEE FEE CONVERSION FEATURE
<C> <S> <C> <C> <C>
A Maximum 4.00% initial sales charge(2)(3) No No No
B CDSC for a period of 4 years, at a rate 0.25% 0.25% B shares convert to D shares
of 4.0% during the first year, automatically after
decreasing 1.0% annually to 0.0% approximately ten years(4)
C 1.0% CDSC for one year 0.25% 0.35% No
D Maximum 4.00% initial sales charge(3) 0.10% No No
<FN>
- ---------
(1) Initial sales charges are imposed at the time of purchase as a percentage
of the offering price. Contingent deferred sales charges ("CDSCs") are
imposed if the redemption occurs within the applicable CDSC time period.
The charge will be assessed on an amount equal to the lesser of the
proceeds of redemption or the cost of the shares being redeemed.
(2) Offered only to eligible investors. See "Purchase of Shares -- Initial
Sales Charge Alternatives -- Class A and Class D Shares -- Eligible Class A
Investors".
(3) Reduced for purchases of $25,000 or more. Class A and Class D share
purchases of $1,000,000 or more may not be subject to an initial sales
charge but instead will be subject to a 1.0% CDSC for one year. See "Class
A" and "Class D" below.
(4) The conversion period for dividend reinvestment shares is modified. Also,
Class B shares of certain other MLAM-advised mutual funds into which
exchanges may be made have an eight-year conversion period. If Class B
shares of the Fund are exchanged for Class B shares of another MLAM-advised
mutual fund, the conversion period applicable to the Class B shares
acquired in the exchange will apply, and the holding period for the shares
exchanged will be tacked onto the holding period for the shares acquired.
</TABLE>
<TABLE>
<S> <C>
CLASS A: Class A shares incur an initial sales charge when they are purchased and bear no
ongoing distribution or account maintenance fees. Class A shares are offered to a
limited group of investors and also will be issued upon reinvestment of dividends
on outstanding Class A shares. Investors that currently own Class A shares in a
shareholder account are entitled to purchase additional Class A shares in that
account. In addition, Class A shares will be offered to Merrill Lynch & Co., Inc.
("ML&Co.") and its subsidiaries (the term "subsidiaries", when used herein with
respect to ML&Co. includes MLAM, the Manager and certain other entities directly
or indirectly wholly-owned and controlled by ML&Co.) and their directors and
employees and to members of the Boards of MLAM-advised mutual funds. The maximum
initial sales charge is 4.00%, which is reduced for purchases of $25,000 and over.
Purchases of $1,000,000 or more are not subject to an initial sales charge but if
the initial sales charge is waived, such purchases may be subject to a CDSC of
1.0% if the shares are redeemed within one year after purchase. Sales charges also
are reduced under a right of accumulation which takes into account the investor's
holdings of all classes of all MLAM-advised mutual funds. See "Purchase of Shares
-- Initial Sales Charge Alternatives -- Class A and Class D Shares".
</TABLE>
5
<PAGE>
<TABLE>
<S> <C>
CLASS B: Class B shares do not incur a sales charge when they are purchased, but they are
subject to an ongoing account maintenance fee of 0.25%, an ongoing distribution
fee of 0.25% of the Fund's average net assets attributable to the Class B shares,
and a CDSC if they are redeemed within four years of purchase. Approximately ten
years after issuance, Class B shares will convert automatically into Class D
shares of the Fund, which are subject to a lower account maintenance fee of 0.10%
and no distribution fee; Class B shares of certain other MLAM-advised mutual funds
into which exchanges may be made convert into Class D shares automatically after
approximately eight years. If Class B shares of the Fund are exchanged for Class B
shares of another MLAM-advised mutual fund, the conversion period applicable to
the Class B shares acquired in the exchange will apply, as will the Class D
account maintenance fee of the acquired fund upon the conversion, and the holding
period for the shares exchanged will be tacked onto the holding period for the
shares acquired. Automatic conversion of Class B shares into Class D shares will
occur at least once a month on the basis of the relative net asset values of the
shares of the two classes on the conversion date, without the imposition of any
sales load, fee or other charge. Conversion of Class B shares to Class D shares
will not be deemed a purchase or sale of the shares for Federal income tax
purposes. Shares purchased through reinvestment of dividends on Class B shares
also will convert automatically to Class D shares. The conversion period for
dividend reinvestment shares is modified as described under "Purchase of Shares --
Deferred Sales Charge Alternatives -- Class B and Class C Shares -- Conversion of
Class B Shares to Class D Shares".
CLASS C: Class C shares do not incur a sales charge when they are purchased, but they are
subject to an ongoing account maintenance fee of 0.25% and an ongoing distribution
fee of 0.35% of the Fund's average net assets attributable to Class C shares.
Class C shares are also subject to a CDSC if they are redeemed within one year of
purchase. Although Class C shares are subject to a 1.0% CDSC for only one year (as
compared to four years for Class B), Class C shares have no conversion feature
and, accordingly, an investor that purchases Class C shares will be subject to
distribution fees that will be imposed on Class C shares for an indefinite period
subject to annual approval by the Fund's Board of Directors and regulatory
limitations.
CLASS D: Class D shares incur an initial sales charge when they are purchased and are
subject to an ongoing account maintenance fee of 0.10% of average net assets
attributable to Class D shares. Class D shares are not subject to an ongoing
distribution fee or any CDSC when they are redeemed. Purchases of $1,000,000 or
more may not be subject to an initial sales charge, but if the initial sales
charge is waived, such purchase will be subject to a CDSC of 1.0% if the shares
are redeemed within one year after purchase. The schedule of initial sales charges
and reductions for the Class D shares is the same as the schedule for Class A
shares. Class D shares also will be issued upon conversion of Class B shares as
described above under "Class B". See "Purchase of Shares -- Initial Sales Charge
Alternatives -- Class A and Class D Shares".
</TABLE>
The following is a discussion of the factors that investors should consider
in determining the method of purchasing shares under the Merrill Lynch Select
Pricing-SM- System that the investor believes is most beneficial under his
particular circumstances.
6
<PAGE>
INITIAL SALES CHARGE ALTERNATIVES. Investors who prefer an initial sales
charge alternative may elect to purchase Class D shares or, if an eligible
investor, Class A shares. Investors choosing the initial sales charge
alternative who are eligible to purchase Class A shares should purchase Class A
shares rather than Class D shares because of the account maintenance fee imposed
on Class D shares. Investors qualifying for significantly reduced initial sales
charges may find the initial sales charge alternative particularly attractive
because similar sales charge reductions are not available with respect to the
deferred sales charges imposed in connection with purchases of Class B or Class
C shares. Investors not qualifying for reduced initial sales charges who expect
to maintain their investment for an extended period of time also may elect to
purchase Class A or Class D shares, because over time the accumulated ongoing
account maintenance and distribution fees on Class B or Class C shares may
exceed the initial sales charge and, in the case of Class D shares, the account
maintenance fee. Although some investors that previously purchased Class A
shares may no longer be eligible to purchase Class A shares of other
MLAM-advised mutual funds, those previously purchased Class A shares, together
with Class B, Class C and Class D share holdings, will count toward a right of
accumulation which may qualify the investor for reduced initial sales charges on
new initial sales charge purchases. In addition, the ongoing Class B and Class C
account maintenance and distribution fees will cause Class B and Class C shares
to have higher expense ratios, pay lower dividends and have lower total returns
than the initial sales charge shares. The ongoing Class D account maintenance
fees will cause Class D shares to have a higher expense ratio, pay lower
dividends and have a lower total return than Class A shares.
DEFERRED SALES CHARGE ALTERNATIVES. Because no initial sales charges are
deducted at the time of purchase, Class B and Class C shares provide the benefit
of putting all of the investor's dollars to work from the time the investment is
made. The deferred sales charge alternatives may be particularly appealing to
investors who do not qualify for a reduction in initial sales charges. Both
Class B and Class C shares are subject to ongoing account maintenance fees and
distribution fees; however, the ongoing account maintenance and distribution
fees potentially may be offset to the extent any return is realized on the
additional funds initially invested in Class B or Class C shares. In addition,
Class B shares will be converted into Class D shares of the Fund after a
conversion period of approximately ten years, and thereafter investors will be
subject to lower ongoing fees.
Certain investors may elect to purchase Class B shares if they determine it
to be most advantageous to have all their funds invested initially and intend to
hold their shares for an extended period of time. Investors in Class B shares
should take into account whether they intend to redeem their shares within the
CDSC period and, if not, whether they intend to remain invested until the end of
the conversion period and thereby take advantage of the reduction in ongoing
fees resulting from the conversion into Class D shares. Other investors,
however, may elect to purchase Class C shares if they determine that it is
advantageous to have all their assets invested initially and they are uncertain
as to the length of time they intend to hold their assets in MLAM-advised mutual
funds. Although Class C shareholders are subject to a shorter CDSC period at a
lower rate, they are subject to higher distribution fees and forgo the Class B
conversion feature, making their investment subject to account maintenance and
distribution fees for an indefinite period of time. In addition, while both
Class B and Class C distribution fees are subject to the limitations on
asset-based sales charges imposed by the NASD, the Class B distribution fees are
further limited under a voluntary waiver of asset-based sales charges. See
"Purchase of Shares -- Limitations on the Payment of Deferred Sales Charges".
7
<PAGE>
FINANCIAL HIGHLIGHTS
The financial information in the table below has been audited in conjunction
with the annual audit of the financial statements of the Fund by Deloitte &
Touche LLP, independent auditors. Financial statements for the period November
26, 1993 (commencement of operations) to July 31, 1994 and the independent
auditors' report thereon are included in the Statement of Additional
Information. The following per share data and ratios have been derived from
information provided in the Fund's audited financial statements. Financial
information is not presented for Class C or Class D shares since no shares of
those classes are publicly issued as of the date of this Prospectus. Further
information about the performance of the Fund is contained in the Fund's most
recent annual report to shareholders which may be obtained, without charge, by
calling or by writing the Fund at the telephone number or address on the front
cover of this Prospectus.
<TABLE>
<CAPTION>
FOR THE PERIOD FOR THE PERIOD
NOVEMBER 26, 1993+ NOVEMBER 26, 1993+
TO JULY 31, 1994 TO JULY 31, 1994
------------------ ------------------
CLASS A CLASS B
<S> <C> <C>
INCREASE (DECREASE) IN NET ASSET VALUE:
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period..................................... $ 10.00 $ 10.00
------- -------
Investment income -- net............................................... .34 .31
Realized and unrealized loss on investments -- net..................... (.62) (.62)
------- -------
Total from investment operations......................................... (.28) (.31)
------- -------
Less dividends:
Investment income -- net............................................... (.34) (.31)
------- -------
Net asset value, end of period........................................... $ 9.38 $ 9.38
------- -------
------- -------
TOTAL INVESTMENT RETURN:++
Based on net asset value per share..................................... (2.83%)(#) (3.16%)(#)
------- -------
------- -------
RATIOS TO AVERAGE NET ASSETS:
Expenses, excluding distribution fees and net of reimbursement........... .03%* .04%*
------- -------
------- -------
Expenses, net of reimbursement........................................... .03%* .54%*
------- -------
------- -------
Expenses................................................................. 1.52%* 2.03%*
------- -------
------- -------
Investment income -- net................................................. 5.36%* 4.73%*
------- -------
------- -------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands)................................. $ 10,634 $ 14,522
------- -------
------- -------
Portfolio turnover....................................................... 82.71% 82.71%
------- -------
------- -------
<FN>
- ---------
* Annualized.
+ Commencement of operations.
++ Total investment returns exclude the effects of sales loads.
(#) Aggregate total investment return.
</TABLE>
8
<PAGE>
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to provide shareholders with as high
a level of income exempt from Federal and Colorado income taxes as is consistent
with prudent investment management. The Fund seeks to achieve its objective
while providing investors with the opportunity to invest in a portfolio of
securities consisting primarily of long-term obligations issued by or on behalf
of the State of Colorado, its political subdivisions, agencies and
instrumentalities and obligations of other qualifying issuers, such as issuers
located in Puerto Rico, the Virgin Islands and Guam, which pay interest exempt,
in the opinion of bond counsel to the issuer, from Federal and Colorado income
taxes. Obligations exempt from Federal income taxes are referred to herein as
"Municipal Bonds" and obligations exempt from both Federal and Colorado income
taxes are referred to as "Colorado Municipal Bonds". Unless otherwise indicated,
references to Municipal Bonds shall be deemed to include Colorado Municipal
Bonds. The investment objective of the Fund as set forth in the first sentence
of this paragraph is a fundamental policy of the Fund which may not be changed
without a vote of a majority of the outstanding shares of the Fund. The Fund at
all times, except during temporary defensive periods, will maintain at least 65%
of its total assets invested in Colorado Municipal Bonds. The investment
objective of the Fund as set forth in the first sentence of this paragraph is a
fundamental policy and may not be changed without shareholder approval. At
times, the Fund may seek to hedge its portfolio through the use of futures
transactions to reduce volatility in the net asset value of Fund shares.
Municipal Bonds may include several types of bonds. The risks and special
considerations involved in investments in Municipal Bonds vary with the types of
instruments being acquired. Investments in Non-Municipal Tax-Exempt Securities,
as defined herein, may present similar risks, depending on the particular
product. Certain instruments in which the Fund may invest may be characterized
as derivative instruments. See "Description of Municipal Bonds" and "Financial
Futures Transactions and Options". The interest on Municipal Bonds may bear a
fixed rate or be payable at a variable or floating rate. At least 80% of the
Municipal Bonds purchased by the Fund primarily will be what are commonly
referred to as "investment grade" securities, which are obligations rated at the
time of purchase within the four highest quality ratings as determined by either
Moody's Investors Service, Inc. ("Moody's") (currently Aaa, Aa, A and Baa),
Standard & Poor's Corporation ("Standard & Poor's") (currently AAA, AA, A and
BBB) or Fitch Investors Service, Inc. ("Fitch") (currently AAA, AA, A and BBB).
If Municipal Bonds are unrated, such securities will possess creditworthiness
comparable, in the opinion of the manager of the Fund, Fund Asset Management,
L.P. (the "Manager"), to obligations in which the Fund may invest. Municipal
Bonds rated in the fourth highest rating category, while considered "investment
grade", have certain speculative characteristics and are more likely to be
downgraded to non-investment grade than obligations rated in one of the top
three rating categories. See Appendix II -- "Ratings of Municipal Bonds" -- in
the Statement of Additional Information for more information regarding ratings
of debt securities. An issue of rated Municipal Bonds may cease to be rated or
its rating may be reduced below "investment grade" subsequent to its purchase by
the Fund. If an obligation is downgraded below investment grade, the Manager
will consider factors such as price, credit risk, market conditions, financial
condition of the issuer and interest rates to determine whether to continue to
hold the obligation in the Fund's portfolio.
The Fund may invest up to 20% of its total assets in Municipal Bonds that
are rated below Baa by Moody's or below BBB by Standard & Poor's or Fitch, or
which in the Manager's judgment, possess similar
9
<PAGE>
credit characteristics. Such securities, sometimes referred to as "high-yield"
or "junk" bonds, are predominantly speculative with respect to the capacity to
pay interest and repay principal in accordance with the terms of the security
and generally involve a greater volatility of price than securities in higher
rating categories. The market prices of high-yielding, lower-rated securities
may fluctuate more than higher-rated securities and may decline significantly in
periods of general economic difficulty, which may follow periods of rising
interest rates. In purchasing such securities, the Fund will rely on the
Manager's judgment, analysis and experience in evaluating the creditworthiness
of the issuer of such securities. The Manager will take into consideration,
among other things, the issuer's financial resources, its sensitivity to
economic conditions and trends, its operating history, the quality of its
management and regulatory matters. See "Investment Objective and Policies" in
the Statement of Additional Information for a more detailed discussion of the
pertinent risk factors involved in investing in "high yield" or "junk" bonds and
Appendix II-"Ratings of Municipal Bonds"-in the Statement of Additional
Information for additional information regarding ratings of debt securities. The
Fund does not intend to purchase debt securities that are in default or which
the Manager believes will be in default.
Certain Municipal Bonds may be entitled to the benefits of letters of credit
or similar credit enhancements issued by financial institutions. In such
instances, the Trustees and the Manager will take into account in assessing the
quality of such bonds not only the creditworthiness of the issuer of such bonds
but also the creditworthiness of the financial institution.
The Fund's investments may also include variable rate demand obligations
("VRDOs") and VRDOs in the form of participation interests ("Participating
VRDOs") in variable rate tax-exempt obligations held by a financial institution.
The VRDOs in which the Fund will invest are tax-exempt obligations which contain
a floating or variable interest rate adjustment formula and an unconditional
right of demand on the part of the holder thereof to receive payment of the
unpaid principal balance plus accrued interest on a short notice period not to
exceed seven days. Participating VRDOs provide the Fund with a specified
undivided interest (up to 100%) of the underlying obligation and the right to
demand payment of the unpaid principal balance plus accrued interest on the
Participating VRDOs from the financial institution on a specified number of
days' notice, not to exceed seven days. There is, however, the possibility that
because of a default or insolvency, the demand feature of VRDOs or Participating
VRDOs may not be honored. The Fund has been advised by its counsel that the Fund
should be entitled to treat the income received on Participating VRDOs as
interest from tax-exempt obligations.
VRDOs that contain an unconditional right of demand to receive payment of
the unpaid principal balance plus accrued interest on a notice period exceeding
seven days may be deemed illiquid securities. A VRDO with a demand notice period
exceeding seven days will therefore be subject to the Fund's restriction on
illiquid investments unless, in the judgement of the Trustees, such VRDO is
liquid. The Trustees may adopt guidelines and delegate to the Manager the daily
function of determining and monitoring liquidity of such VRDOs. The Trustees,
however, will retain sufficient oversight and be ultimately responsible for such
determinations.
The Fund ordinarily does not intend to realize investment income not exempt
from Federal and Colorado income taxes. However, to the extent that suitable
Colorado Municipal Bonds are not available for investment by the Fund, the Fund
may purchase Municipal Bonds issued by other states, their agencies and
instrumentalities, the interest income on which is exempt, in the opinion of
bond counsel, from Federal, but not Colorado, taxation. The Fund also may invest
in securities not issued by or on behalf of a state or
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territory or by an agency or instrumentality thereof, if the Fund nevertheless
believes such securities to be exempt from Federal income taxation
("Non-Municipal Tax-Exempt Securities"). Non-Municipal Tax-Exempt Securities may
include securities issued by other investment companies that invest in municipal
bonds, to the extent such investments are permitted by the Investment Company
Act of 1940, as amended (the "1940 Act"). Other Non-Municipal Tax-Exempt
Securities could include trust certificates or other derivative evidencing
interests in one or more Municipal Bonds.
Under normal circumstances, except when acceptable securities are
unavailable as determined by the Manager, the Fund will invest at least 65% of
its total assets in Colorado Municipal Bonds. For temporary defensive periods or
to provide liquidity, the Fund has the authority to invest as much as 35% of its
total assets in tax-exempt or taxable money market obligations with a maturity
of one year or less (such short-term obligations being referred to herein as
"Temporary Investments"), except that taxable Temporary Investments shall not
exceed 20% of the Fund's net assets. The Temporary Investments, VRDOs and
Participating VRDOs in which the Fund may invest also will be in the following
rating categories at the time of purchase; MIG-1/VMIG-1 through MIG-4/VMIG-4 for
notes and VRDOs and Prime-1 through Prime-3 for commercial paper (as determined
by Moody's), SP-1 and SP-2 for notes and A-1 through A-3 for VRDOs and
commercial paper (as determined by Standard & Poor's), or F-1 through F-3 for
notes, VRDOs and commercial paper (as determined by Fitch) or, if unrated, of
comparable quality in the opinion of the Manager. The Fund at all times will
have at least 80% of its net assets invested in securities the interest on which
is exempt from Federal taxation. However, interest received on certain otherwise
tax-exempt securities which are classified as "private activity bonds" (in
general, bonds that benefit non-governmental entities), may be subject to a
Federal alternative minimum tax. The percentage of the Fund's net assets
invested in "private activity bonds" will vary during the year. See
"Distributions and Taxes". In addition, the Fund reserves the right to invest
temporarily a greater portion of its assets in Temporary Investments for
defensive purposes, when, in the judgment of the Manager, market conditions
warrant. The investment objective of the Fund is a fundamental policy of the
Fund which may be not changed without a vote of a majority of the outstanding
shares of the Fund. The Fund's hedging strategies, which are described in more
detail under "Financial Futures Transactions and Options", are not fundamental
policies and may be modified by the Trustees of the Trust without the approval
of the Fund's shareholders.
POTENTIAL BENEFITS
Investment in shares of the Fund offers several benefits. The Fund offers
investors the opportunity to receive income exempt from Federal and Colorado
income taxes by investing in a professionally managed portfolio consisting
primarily of long-term Colorado Municipal Bonds. The Fund also provides
liquidity because of its redemption features and relieves the investor of the
burdensome administrative details involved in managing a portfolio of tax-exempt
securities. The benefits of investing in the Fund are at least partially offset
by the expenses involved in operating an investment company. Such expenses
primarily consist of the management fee and operational costs, and in the case
of certain classes of shares, account maintenance and distribution costs.
SPECIAL AND RISK CONSIDERATIONS RELATING TO COLORADO MUNICIPAL BONDS
The Fund ordinarily will invest at least 65% of its total assets in Colorado
Municipal Bonds, and therefore it is more susceptible to factors adversely
affecting issuers of Colorado Municipal Bonds than is a tax-exempt mutual fund
that is not concentrated in issuers of Colorado Municipal Bonds to this degree.
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Colorado's economic climate is currently more favorable than many other
areas of the country. Retail sales, population, personal income and net new jobs
all showed increases in 1993. See Appendix I, "Economic and Financial Conditions
in Colorado" in the Statement of Additional Information.
In November 1992, Colorado voters approved a constitutional amendment (the
"Amendment") which became effective December 31, 1992 and could restrict the
ability of Colorado state and local governments to increase revenues and impose
taxes. Among other provisions, the Amendment requires voter approval prior to
tax increases, creation of debt or mill levy or valuation for assessment ratio
increases, and the Amendment limits increases in government spending and
property tax revenues to specified percentages. The provisions of the Amendment
are unclear and will probably require judicial interpretation. See Appendix I,
"Economic and Financial Conditions in Colorado" in the Statement of Additional
Information.
The Manager does not believe that the current economic conditions in
Colorado or other factors described above will have a significant adverse effect
on the Fund's ability to invest in high quality Colorado Municipal Bonds.
Because the Fund's portfolio will be comprised primarily of investment grade
securities, the Fund is expected to be less subject to market and credit risks
than a fund that invests primarily in lower quality Colorado Municipal Bonds.
See Appendix I to the Statement of Additional Information.
DESCRIPTION OF MUNICIPAL BONDS
Municipal Bonds include debt obligations issued to obtain funds for various
public purposes, including construction and equipping of a wide range of public
facilities (including water, sewer, gas, electricity, solid waste, health care,
transportation, education and housing facilities), refunding of outstanding
obligations and obtaining funds for general operating expenses and loans to
other public institutions and facilities. In addition, certain types of bonds
are issued by or on behalf of public authorities to finance various privately
operated facilities, including certain facilities for the local furnishing of
electric energy or gas, sewage facilities, solid waste disposal facilities and
other specialized facilities. For purposes of this Prospectus, such obligations
are referred to as Municipal Bonds if the interest paid thereon is exempt from
Federal income tax, and, as Colorado Municipal Bonds if the interest thereon is
exempt from Federal and Colorado income taxes, even though such bonds may be
"private activity bonds" as discussed below.
The two principal classifications of Municipal Bonds are "general
obligation" bonds and "revenue" bonds which latter category includes industrial
development bonds ("IDBs") and, for bonds issued after August 15, 1986, private
activity bonds. General obligation bonds are secured by the issuer's pledge of
its faith, credit and taxing power for the payment of principal and interest.
The taxing power of any governmental entity may be limited, however, by
provisions of state constitutions or laws, and an entity's creditworthiness will
depend on many factors, including potential erosion of the tax base due to
population declines, natural disasters, declines in the state's industrial base
or inability to attract new industries, economic limits on the ability to tax
without eroding the tax base, state legislative proposals or voter initiatives
to limit ad valorem real property taxes and the extent to which the entity
relies on Federal or state aid, access to capital markets or other factors
beyond the state or entity's control. Accordingly, the capacity of the issuer of
a general obligation bond as to the timely payment of interest and the repayment
of principal when due is affected by the issuer's maintenance of its tax base.
Revenue bonds are payable only from the revenues derived from a particular
facility or class of facilities or, in some cases, from the proceeds of a
special excise tax or other specific revenue source such as payments from the
user of the facility being financed; accordingly, the timely payment of interest
and the repayment of
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principal in accordance with the terms of the revenue or special obligation bond
is a function of the economic viability of such facility or such revenue source.
The Fund does not presently intend to invest more than 5% of its total assets
(taken at market value at the time of each investment) in industrial revenue
bonds where the entity supplying the revenues from which the issuer is paid,
including predecessors, has a record of less than three years of continuous
business operations. Investments involving entities with less than three years
of continuous business operations may pose somewhat greater risks due to the
lack of a substantial operating history for such entities. The Manager believes,
however, that the political benefits of such investments outweigh the potential
risks, particularly given the Fund's limitations on such investments.
The Fund may purchase IDBs and private activity bonds. IDBs and private
activity bonds are tax-exempt securities issued by states, municipalities or
public authorities to provide funds, usually through a loan or lease
arrangement, to a private entity for the purpose of financing construction or
improvement of a facility to be used by the entity. Such bonds are secured
primarily by revenues derived from loan repayments or lease payments due from
the entity which may or may not be guaranteed by a parent company or otherwise
secured. Neither IDBs nor private activity bonds are secured by a pledge of the
taxing power of the issuer of such bonds. Therefore, an investor should be aware
that repayment of such bonds depends on the revenues of a private entity and be
aware of the risks that such an investment may entail. Continued ability of an
entity to generate sufficient revenues for the payment of principal and interest
on such bonds will be affected by many factors including the size of the entity,
capital structure, demand for its products or services, competition, general
economic conditions, governmental regulation and the entity's dependence on
revenues for the operation of the particular facility being financed. The Fund
may also invest in so-called "moral obligation" bonds. If an issuer of such
bonds is unable to meet its obligations, repayment of such bonds becomes a moral
commitment, but not a legal obligation, of the issuer.
The Fund may invest in Municipal Bonds (and Non-Municipal Tax-Exempt
Securities) the return on which is based on a particular index of value or
interest rates. For example, the Fund may invest in Municipal Bonds that pay
interest based on an index of Municipal Bond interest rates or based on the
value of gold or some other commodity. The principal amount payable upon
maturity of certain Municipal Bonds also may be based on the value of an index.
To the extent the Fund invests in these types of Municipal Bonds, the Fund's
return on such Municipal Bonds will be subject to risk with respect to the value
of the particular index. Also, the Fund may invest in so-called "inverse
floating obligations" or "residual interest bonds" on which the interest rates
typically decline as market rates increase and increase as market rates decline.
To the extent the Fund invests in these types of Municipal Bonds, the Fund's
return on such Municipal Bonds will be subject to risk with respect to the value
of the particular index. Such securities have the effect of providing a degree
of investment leverage, since they may increase or decrease in value in response
to changes, as an illustration, in market interest rates at a rate which is a
multiple (typically two) of the rate at which fixed-rate long-term tax exempt
securities increase or decrease in response to such changes. As a result, the
market values of such securities will generally be more volatile than the market
values of fixed-rate tax exempt securities. To seek to limit the volatility of
these securities, the Fund may purchase inverse floating obligations with
shorter term maturities or which contain limitations on the extent to which the
interest rate may vary. The Manager believes that indexed and inverse floating
obligations represent a flexible portfolio management instrument for the Fund
which allows the Manager to vary the degree of investment leverage relatively
efficiently under different market conditions. Certain investments in such
obligations may be illiquid. The Fund may not invest in such illiquid
obligations if such investments, together with other illiquid investments, would
exceed 15% of the Fund's net assets.
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Also included within the general category of Municipal Bonds are
participation certificates issued by government authorities or entities to
finance the acquisition or construction of equipment, land and/or facilities.
The certificates represent participations in a lease, an installment purchase
contract or a conditional sales contract (hereinafter collectively called "lease
obligations") relating to such equipment, land or facilities. Although lease
obligations do not constitute general obligations of the issuer for which the
issuer's unlimited taxing power is pledged, a lease obligation frequently is
backed by the issuer's covenant to budget for, appropriate and make the payments
due under the lease obligation. However, certain lease obligations contain
"non-appropriation" clauses which provide that the issuer has no obligation to
make lease or installment purchase payments in future years unless money is
appropriated for such purpose on a yearly basis. Although "non-appropriation"
lease obligations are secured by the leased property, disposition of the
property in the event of foreclosure might prove difficult. These securities
represent a type of financing that has not yet developed the depth of
marketability associated with more conventional securities. Certain investments
in lease obligations may be illiquid. The Fund may not invest in illiquid lease
obligations if such investments, together with other illiquid investments, would
exceed 15% of the Fund's net assets. The Fund may, however, invest without
regard to such limitation in lease obligations which the Manager, pursuant to
guidelines which have been adopted by the Board of Trustees and subject to the
supervision of the Board, determines to be liquid. The Manager will deem lease
obligations liquid if they are publicly offered and have received an investment
grade rating of Baa or better by Moody's, or BBB or better by Standard & Poor's
or Fitch. Unrated lease obligations, or those rated below investment grade, will
be considered liquid if the obligations come to the market through an
underwritten public offering and at least two dealers are willing to give
competitive bids. In reference to the latter, the Manager must, among other
things, also review the creditworthiness of the municipality obligated to make
payment under the lease obligation and make certain specified determinations
based on such factors as the existence of a rating or credit enhancement such as
insurance, the frequency of trades or quotes for the obligation and the
willingness of dealers to make a market in the obligation.
Federal tax legislation has limited the types and volume of bonds the
interest on which qualifies for a Federal income tax exemption. As a result,
this legislation and legislation which may be enacted in the future may affect
the availability of Municipal Bonds for investment by the Fund.
WHEN-ISSUED SECURITIES AND DELAYED DELIVERY TRANSACTIONS
The Fund may purchase or sell Municipal Bonds on a delayed delivery basis or
a when-issued basis at fixed purchase terms. These transactions arise when
securities are purchased or sold by the Fund with payment and delivery taking
place in the future. The purchase will be recorded on the date the Fund enters
into the commitment and the value of the obligation will thereafter be reflected
in the calculation of the Fund's net asset value. The value of the obligation on
the delivery date may be more or less than its purchase price. A separate
account of the Fund will be established with its custodian consisting of cash,
cash equivalents or high grade, liquid Municipal Bonds having a market value at
all times at least equal to the amount of the forward commitment.
CALL RIGHTS
The Fund may purchase a Municipal Bond issuer's right to call all or a
portion of such Municipal Bond for mandatory tender for purchase (a "Call
Right"). A holder of a Call Right may exercise such right to require a mandatory
tender for the purchase of related Municipal Bonds, subject to certain
conditions. A Call Right that is not exercised prior to the maturity of the
related Municipal Bond will expire without value.
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The economic effect to holding both the Call Right and the related Municipal
Bond is identical to holding a Municipal Bond as a non-callable security.
Certain investments in such obligations may be illiquid. The Fund may not invest
in such illiquid obligations if such investments, together with other illiquid
investments, would exceed 15% of the Fund's net assets.
FINANCIAL FUTURES TRANSACTIONS AND OPTIONS
The Fund is authorized to purchase and sell certain exchange traded
financial futures contracts ("financial futures contracts") solely for the
purpose of hedging its investments in Municipal Bonds against declines in value
and to hedge against increases in the cost of securities it intends to purchase.
However, any transactions involving financial futures or options (including puts
and calls associated therewith) will be in accordance with the Fund's investment
policies and limitations. A financial futures contract obligates the seller of a
contract to deliver and the purchaser of a contract to take delivery of the type
of financial instrument covered by the contract, or in the case of index-based
futures contracts to make and accept a cash settlement, at a specific future
time for a specified price. A sale of financial futures contracts may provide a
hedge against a decline in the value of portfolio securities because such
depreciation may be offset, in whole or in part, by an increase in the value of
the position in the financial futures contracts. A purchase of financial futures
contracts may provide a hedge against an increase in the cost of securities
intended to be purchased, because such appreciation may be offset, in whole or
in part, by an increase in the value of the position in the futures contracts.
Distributions, if any, of net long-term capital gains from certain transactions
in futures or options are taxable at long-term capital gains rates for Federal
income tax purposes, regardless of the length of time the shareholder has owned
Fund shares. See "Distributions and Taxes -- Taxes".
The Fund deals in financial futures contracts traded on the Chicago Board of
Trade based on The Bond Buyer Municipal Bond Index, a price-weighted measure of
the market value of 40 large, recently issued tax-exempt bonds. There can be no
assurance, however, that a liquid secondary market will exist to terminate any
particular financial futures contract at any specific time. If it is not
possible to close a financial futures position entered into by the Fund, the
Fund would continue to be required to make daily cash payments of variation
margin in the event of adverse price movements. In such a situation, if the Fund
has insufficient cash, it may have to sell portfolio securities to meet daily
variation margin requirements at a time when it may be disadvantageous to do so.
The inability to close financial futures positions also could have an adverse
impact on the Fund's ability to hedge effectively. There is also the risk of
loss by the Fund of margin deposits in the event of bankruptcy of a broker with
whom the Fund has an open position in a financial futures contract.
The Fund may purchase and sell financial futures contracts on U.S.
Government securities and write and purchase put and call options on such
futures contracts as a hedge against adverse changes in interest rates as
described more fully in the Statement of Additional Information. With respect to
U.S. Government securities, currently there are financial futures contracts
based on long-term U.S. Treasury bonds, Treasury notes, Government National
Mortgage Association ("GNMA") Certificates and three-month U.S. Treasury bills.
Subject to policies adopted by the Trustees, the Fund also may engage in
other financial futures contracts transactions and options thereon, such as
financial futures contracts or options on other municipal bond indexes which may
become available if the Manager of the Fund and the Trustees of the Trust should
determine that there is normally a sufficient correlation between the prices of
such futures contracts and the Municipal Bonds in which the Fund invests to make
such hedging appropriate.
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Utilization of futures transactions and options thereon involves the risk of
imperfect correlation in movements in the price of futures contracts and
movements in the price of the security which is the subject of the hedge. If the
price of the futures contract moves more or less than the price of the security
that is the subject of the hedge, the Fund will experience a gain or loss which
will not be completely offset by movements in the price of such security. There
is a risk of imperfect correlation where the securities underlying futures
contracts have different maturities, ratings or geographic mixes than the
security being hedged. In addition, the correlation may be affected by additions
to or deletions from the index which serves as a basis for a financial futures
contract. Finally, in the case of futures contracts on U.S. Government
securities and options on such futures contracts, the anticipated correlation of
price movements between the U.S. Government securities underlying the futures or
options and Municipal Bonds may be adversely affected by economic, political,
legislative or other developments which have a disparate impact on the
respective markets for such securities.
Under regulations of the Commodity Futures Trading Commission, the futures
trading activities described herein will not result in the Fund being deemed to
be a "commodity pool", as defined under such regulations, provided that the Fund
adheres to certain restrictions. In particular, the Fund may purchase and sell
futures contracts and options thereon (i) for bona fide hedging purposes, and
(ii) for non-hedging purposes, if the aggregate initial margins and premiums
required to establish positions in such contracts and options does not exceed 5%
of the liquidation value of the Fund's portfolio assets after taking into
account unrealized profits and unrealized losses on any such contracts and
options. (However, as stated above, the Fund intends to engage in options and
futures transactions only for hedging purposes.) Margin deposits may consist of
cash or securities acceptable to the broker and the relevant contract market.
When the Fund purchases a futures contract, or writes a put option or
purchases a call option thereon, it will maintain an amount of cash, cash
equivalents (e.g., high grade commercial paper and daily tender adjustable
notes) or short-term, high-grade, fixed-income securities in a segregated
account with the Fund's custodian, so that the amount so segregated plus the
amount of initial and variation margin held in the account of its broker equals
the market value of the futures contracts, thereby ensuring that the use of such
futures contract is unleveraged. It is not anticipated that transactions in
futures contracts will have the effect of increasing portfolio turnover.
Although certain risks are involved in options and futures transactions, the
Manager believes that, because the Fund will engage in futures transactions only
for hedging purposes, the futures portfolio strategies of the Fund will not
subject the Fund to certain risks frequently associated with speculation in
futures transactions. The Fund must meet certain Federal income tax requirements
under the Internal Revenue Code of 1986, as amended (the "Code"), in order to
qualify for the special tax treatment afforded regulated investment companies,
including a requirement that less than 30% of its gross income be derived from
the sale or other disposition of securities held for less than three months.
Additionally, the Fund is required to meet certain diversification requirements
under the Code.
The liquidity of a secondary market in a futures contract may be adversely
affected by "daily price fluctuation limits" established by commodity exchanges
which limit the amount of fluctuation in a futures contract price during a
single trading day. Once the daily limit has been reached in the contract, no
trades may be entered into at a price beyond the limit, thus preventing the
liquidation of open futures positions. Prices have in the past moved beyond the
daily limit on a number of consecutive trading days.
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The successful use of transactions in futures also depends on the ability of
the Manager to forecast correctly the direction and extent of interest rate
movements within a given time frame. To the extent these rates remain stable
during the period in which a futures contract is held by the Fund or moves in a
direction opposite to that anticipated, the Fund may realize a loss on the
hedging transaction which is not fully or partially offset by an increase in the
value of portfolio securities. As a result, the Fund's total return for such
period may be less than if it had not engaged in the hedging transaction.
Furthermore, the Fund will only engage in hedging transactions from time to time
and may not necessarily be engaging in hedging transactions when movements in
interest rates occur.
Reference is made to the Statement of Additional Information for further
information on financial futures contracts and certain options thereon.
REPURCHASE AGREEMENTS
As Temporary Investments, the Fund may invest in securities pursuant to
repurchase agreements. Repurchase agreements may be entered into only with a
member bank of the Federal Reserve System or a primary dealer or an affiliate
thereof in U.S. Government securities. Under such agreements, the seller agrees,
upon entering into the contract, to repurchase the security from the Fund at a
mutually agreed upon time and price, thereby determining the yield during the
term of the agreement. This results in a fixed rate of return insulated from
market fluctuations during such period. The Fund may not invest in repurchase
agreements maturing in more than seven days if such investments, together with
the Fund's other illiquid investments, would exceed 15% of the Fund's net
assets. In the event of default by the seller under a repurchase agreement, the
Fund may suffer time delays and incur costs or possible losses in connection
with the disposition of the underlying securities.
INVESTMENT RESTRICTIONS
CURRENT INVESTMENT RESTRICTIONS. The Fund has adopted a number of
restrictions and policies relating to the investment of the Fund's assets and
its activities, which are fundamental policies of the Fund and may not be
changed without the approval of the holders of a majority of the Fund's
outstanding voting securities, as defined in the 1940 Act. Among the more
significant restrictions, the Fund may not: (i) purchase any securities other
than securities referred to under "Investment Objective and Policies" herein;
(ii) purchase securities of other investment companies, except in connection
with certain specified transactions and with respect to investments of up to 10%
of the Fund's total assets in securities of closed-end investment companies;
(iii) borrow amounts in excess of 20% of its total assets taken at market value
(including the amount borrowed), and then only from banks as a temporary measure
for extraordinary or emergency purposes [The Fund will not purchase securities
while borrowings are outstanding]; (iv) mortgage, pledge, hypothecate or in any
manner transfer as security for indebtedness any securities owned or held by the
Fund except in connection with certain specified transactions; (v) invest in
securities which cannot be readily resold because of legal or contractual
restrictions or which are not readily marketable, including individually
negotiated loans that constitute illiquid investments and illiquid lease
obligations, and in repurchase agreements and purchase and sale contracts
maturing in more than seven days, if, regarding all such securities taken
together, more than 15% of its net assets (taken at market value at the time of
each investment) would be invested in such securities; (vi) invest more than 10%
of its total assets (taken at market value at the time of each investment) in
industrial revenue bonds where the entity supplying the revenues from which the
issue is to be paid, and the guarantor of the obligation, including
predecessors, each have a record of less than three years' continuous business
operation; and (vii) invest more than 25% of its total assets (taken at market
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value at the time of each investment) in securities of issuers in any particular
industry (other than United States Government securities or Government agency
securities, Municipal Bonds and Non-Municipal Tax-Exempt Securities).
The Board of Trustees of the Trust, at a meeting held on August 4, 1994,
approved certain changes to the fundamental and non-fundamental investment
restrictions of the Fund. These changes were proposed in connection with the
creation of a set of standard fundamental and non-fundamental investment
restrictions that would be adopted, subject to shareholder approval, by all of
the non-money market mutual funds advised by MLAM or FAM. The proposed uniform
investment restrictions are designed to provide each of these funds, including
the Fund, with as much investment flexibility as possible under the 1940 Act and
applicable state securities regulations, help promote operational efficiencies
and facilitate monitoring of compliance. The investment objectives and policies
of the Fund will be unaffected by the adoption of the proposed investment
restrictions.
The full text of the proposed investment restrictions is set forth under
"Investment Objective and Policies -- Proposed Uniform Investment Restrictions"
in the Statement of Additional Information. Shareholders of the Fund are
currently considering whether to approve the proposed revised investment
restrictions. If such shareholder approval is obtained, the Fund's current
investment restrictions will be replaced by the proposed restrictions, and the
Fund's Prospectus and Statement of Additional Information will be supplemented
to reflect such change.
The Fund is classified as non-diversified within the meaning of the 1940
Act, which means that the Fund is not limited by the 1940 Act in the proportion
of its assets that it may invest in obligations of a single issuer. However, the
Fund's investments will be limited so as to qualify as a "regulated investment
company" for purposes of the Internal Revenue Code. See "Taxes". To qualify,
among other requirements, the Trust will limit the Fund's investments so that,
at the close of each quarter of the taxable year, (i) not more than 25% of the
market value of the Fund's total assets will be invested in the securities of a
single issuer, and (ii) with respect to 50% of the market value of its total
assets, not more than 5% of the market value of its total assets will be
invested in the securities of a single issuer and the Fund will not own more
than 10% of the outstanding voting securities of a single issuer. [For purposes
of this restriction, the Fund will regard each state and each political
subdivision, agency or instrumentality of such state and each multi-state agency
of which such state is a member and each public authority which issues
securities on behalf of a private entity as a separate issuer, except that if
the security is backed only by the assets and revenues of a non-government
entity then the entity with the ultimate responsibility for the payment of
interest and principal may be regarded as the sole issuer.] These tax-related
limitations may be changed by the Trustees of the Trust to the extent necessary
to comply with changes to the Federal tax requirements. A fund which elects to
be classified as "diversified" under the 1940 Act must satisfy the foregoing 5%
and 10% requirements with respect to 75% of its total assets. To the extent that
the Fund assumes large positions in the obligations of a small number of
issuers, the Fund's total return may fluctuate to a greater extent than that of
a diversified company as a result of changes in the financial condition or in
the market's assessment of the issuers.
Investors are referred to the Statement of Additional Information for a
complete description of the Fund's investment restrictions.
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MANAGEMENT OF THE TRUST
TRUSTEES
The Trustees of the Trust consist of six individuals, five of whom are not
"interested persons" of the Trust as defined in the 1940 Act. The Trustees are
responsible for the overall supervision of the operations of the Trust and the
Fund and perform the various duties imposed on the directors or trustees of
investment companies by the 1940 Act.
The Trustees are:
ARTHUR ZEIKEL* -- President and Chief Investment Officer of Fund Asset
Management, L.P. and Merrill Lynch Asset Management, L.P. ("MLAM"); President
and Director of Princeton Services, Inc.; Executive Vice President of Merrill
Lynch & Co., Inc. ("ML&Co.") since 1990 and of Merrill Lynch, and Director of
the Distributor.
KENNETH S. AXELSON -- Former Executive Vice President and Director, J.C.
Penney Company, Inc.
HERBERT I. LONDON -- John M. Olin Professor of Humanities, New York
University.
ROBERT R. MARTIN -- Chairman, WTC Industries, Inc. and former Chairman and
Chief Executive Officer, Kinnard Investments, Inc.
JOSEPH L. MAY -- Attorney in private practice.
ANDRE F. PEROLD -- Professor, Harvard Business School.
- ---------
* Interested person, as defined in the 1940 Act, of the Trust.
MANAGEMENT AND ADVISORY ARRANGEMENTS
The Manager, which is owned and controlled by ML&Co., a financial services
holding company, acts as the manager for the Fund and provides the Fund with
management services. The Manager or MLAM acts as the investment adviser for more
than 100 other registered investment companies. MLAM also provides investment
advisory services to individual and institutional accounts. As of August 31,
1994, the Manager and MLAM had a total of approximately $165.7 billion in
investment company and other portfolio assets under management, including
accounts of certain affiliates of MLAM.
Subject to the direction of the Trustees, the Manager is responsible for the
actual management of the Fund's portfolio and constantly reviews the Fund's
holdings in light of its own research analysis and that from other relevant
sources. The responsibility for making decisions to buy, sell or hold a
particular security rests with the Manager. The Manager performs certain of the
other administrative services and provides all the office space, facilities,
equipment and necessary personnel for management of the Fund.
Vincent R. Giordano and Kenneth A. Jacob are the Portfolio Managers for the
Fund. Vincent R. Giordano has been a Portfolio Manager of the Manager and MLAM
since 1977 and a Senior Vice President of the Manager and MLAM since 1984.
Kenneth A. Jacob has been a Vice President of the Manager and MLAM since 1984.
Pursuant to the management agreement between the Manager and the Trust on
behalf of the Fund (the "Management Agreement"), the Manager is entitled to
receive from the Fund a monthly fee based upon the
19
<PAGE>
average daily net assets of the Fund at the following annual rates: 0.55% of the
average daily net assets not exceeding $500 million; 0.525% of the average daily
net assets exceeding $500 million but not exceeding $1.0 billion; and 0.50% of
the average daily net assets exceeding $1.0 billion. For the period November 26,
1993 (commencement of operations) through July 31, 1994, the total fee paid by
the Fund to the Manager was $78,643, all of which was voluntarily waived (based
on average net assets of approximately $21 million).
The Management Agreement obligates the Fund to pay certain expenses incurred
in the Fund's operations, including, among other things, the management fee,
legal and audit fees, unaffiliated Trustees' fees and expenses, registration
fees, custodian and transfer agency fees, accounting and pricing costs, and
certain of the costs of printing proxies, shareholder reports, prospectuses and
statements of additional information. Accounting services are provided to the
Fund by the Manager, and the Fund reimburses the Manager for its costs in
connection with such services. The Manager may waive all or a portion of its
management fee and may voluntarily assume all or a portion of the Fund's
expenses. For the period November 26, 1993 (commencement of operations) through
July 31, 1994, the Fund paid the Manager $18,821 for accounting services, all of
which was voluntarily waived. For the year ended July 31, 1994, the ratio of
total expenses, excluding distribution fees and net of reimbursement, to average
net assets was .03% for the Class A shares and .04% for the Class B shares; no
Class C shares or Class D shares had been issued during that period.
TRANSFER AGENCY SERVICES
Financial Data Services, Inc. (the "Transfer Agent"), which is a
wholly-owned subsidiary of ML&Co., acts as the Trust's transfer agent pursuant
to a transfer agency, dividend disbursing agency and shareholder servicing
agency agreement (the "Transfer Agency Agreement"). Pursuant to the Transfer
Agency Agreement, the Transfer Agent is responsible for the issuance, transfer
and redemption of shares and the opening and maintenance of shareholder
accounts. Pursuant to the Transfer Agency Agreement, the Fund pays the Transfer
Agent an annual fee of $11.00 per Class A or Class D shareholder account and
$14.00 per Class B or Class C shareholder account, and the Transfer Agent is
entitled to reimbursement from the Fund for out-of-pocket expenses incurred by
the Transfer Agent under the Transfer Agency Agreement. For the period November
26, 1993 (commencement of operations) through July 31, 1994, the Fund paid the
Transfer Agent a total fee of $7,368 pursuant to the Transfer Agency Agreement
for providing transfer agency services.
PURCHASE OF SHARES
Merrill Lynch Funds Distributor, Inc. (the "Distributor"), an affiliate of
both MLAM and Merrill Lynch, acts as the distributor of the shares of the Fund.
Shares of the Fund are offered continuously for sale by the Distributor and
other eligible securities dealers (including Merrill Lynch). Shares of the Fund
may be purchased from securities dealers or by mailing a purchase order directly
to the Transfer Agent. The minimum initial purchase is $1,000 and the minimum
subsequent purchase is $50.
The Fund is offering its shares in four classes at a public offering price
equal to the next determined net asset value per share plus sales charges
imposed either at the time of purchase or on a deferred basis, depending upon
the class of shares selected by the investor under the Merrill Lynch Select
Pricing System, as described below. The applicable offering price for purchase
orders is based upon the net asset value of the Fund next determined after
receipt of the purchase orders by the Distributor. As to purchase orders
received
20
<PAGE>
by securities dealers prior to 4:15 P.M., New York time, which includes orders
received after the determination of the net asset value on the previous day, the
applicable offering price will be based on the net asset value determined as of
4:15 P.M. on the day the orders are placed with the Distributor, provided the
orders are received by the Distributor prior to 4:30 P.M., New York time, on
that day. If the purchase orders are not received prior to 4:30 P.M., New York
time, such orders shall be deemed received on the next business day. The Fund or
the Distributor may suspend the continuous offering of the Fund's shares of any
class at any time in response to conditions in the securities markets or
otherwise and may thereafter resume such offering from time to time. Any order
may be rejected by the Distributor or the Trust. Neither the Distributor nor the
dealers are permitted to withhold placing orders to benefit themselves by a
price change. Merrill Lynch may charge its customers a processing fee (presently
$4.85) to confirm a sale of shares to such customers. Purchases directly through
the Fund's Transfer Agent are not subject to the processing fee.
On November 26, 1993, the Fund completed the subscription offering of its
shares by issuing 260,207 Class A shares for net proceeds to the Fund of
$2,602,070 and 870,452 Class B shares for net proceeds to the Fund of
$8,704,520. In connection with such subscription offering, the Distributor
received $75,139, all of which was paid to Merrill Lynch as selected dealer.
The Fund issues four classes of shares under the Merrill Lynch Select
Pricing-SM- System, which permits each investor to choose the method of
purchasing shares that the investor believes is most beneficial given the amount
of the purchase, the length of time the investor expects to hold the shares and
other relevant circumstances. Shares of Class A and Class D are sold to
investors choosing the initial sales charge alternatives and shares of Class B
and Class C are sold to investors choosing the deferred sales charge
alternatives. Investors should determine whether under their particular
circumstances it is more advantageous to incur an initial sales charge or to
have the entire initial purchase price invested in the Fund with the investment
thereafter being subject to a contingent deferred sales charge and ongoing
distribution fees. A discussion of the factors that investors should consider in
determining the method of purchasing shares under the Merrill Lynch Select
Pricing-SM- System is set forth under "Merrill Lynch Select Pricing-SM- System"
on page 4.
Each Class A, Class B, Class C and Class D share of the Fund represents
identical interests in the investment portfolio of the Fund and has the same
rights, except that Class B, Class C and Class D shares bear the expenses of the
ongoing account maintenance fees, and Class B and Class C shares bear the
expenses of the ongoing distribution fees and the additional incremental
transfer agency costs resulting from the deferred sales charge arrangements. The
deferred sales charges and account maintenance fees that are imposed on Class B
and Class C shares, as well as the account maintenance fees that are imposed on
Class D shares, will be imposed directly against those classes and not against
all assets of the Fund and, accordingly, such charges will not affect the net
asset value of any other class or have any impact on investors choosing another
sales charge option. Dividends paid by the Fund for each class of shares will be
calculated in the same manner at the same time and will differ only to the
extent that account maintenance and distribution fees and any incremental
transfer agency costs relating to a particular class are borne exclusively by
that class. Class B, Class C and Class D shares each have exclusive voting
rights with respect to the Rule 12b-1 distribution plan adopted with respect to
such class pursuant to which account maintenance and/or distribution fees are
paid. See "Distribution Plans" below. Each class has different exchange
privileges. See "Shareholder Services -- Exchange Privilege".
21
<PAGE>
Investors should understand that the purpose and function of the initial
sales charges with respect to Class A and Class D shares are the same as those
of the deferred sales charges with respect to Class B and Class C shares in that
the sales charges applicable to each class provide for the financing of the
distribution of the shares of the Fund. The distribution-related revenues paid
with respect to a class will not be used to finance the distribution
expenditures of another class. Sales personnel may receive different
compensation for selling different classes of shares. Investors are advised that
only Class A and Class D shares may be available for purchase through securities
dealers, other than Merrill Lynch, which are eligible to sell shares.
The following table sets forth a summary of the distribution arrangements
for each class of shares under the Merrill Lynch Select Pricing-SM- System.
<TABLE>
<CAPTION>
ACCOUNT
MAINTENANCE DISTRIBUTION
CLASS SALES CHARGE(1) FEE FEE CONVERSION FEATURE
<C> <S> <C> <C> <C>
A Maximum 4.00% initial sales No No No
charge(2)(3)
B CDSC for a period of 4 years, at a rate 0.25% 0.25% B shares convert to D shares
of 4.0% during the first year, automatically after
decreasing 1.0% annually to 0.0% approximately ten years(4)
C 1.0% CDSC for one year 0.25% 0.35% No
D Maximum 4.00% initial sales 0.10% No No
charge(3)
<FN>
- ---------
(1) Initial sales charges are imposed at the time of purchase as a percentage
of the offering price. CDSCs may be imposed if the redemption occurs within
the applicable CDSC time period. The charge will be assessed on an amount
equal to the lesser of the proceeds of redemption or the cost of the shares
being redeemed.
(2) Offered only to eligible investors. See "Initial Sales Charge Alternatives
-- Class A and Class D Shares -- Eligible Class A Investors".
(3) Reduced for purchases of $25,000 or more. Class A and Class D share
purchases of $1,000,000 or more may not be subject to an initial sales
charge but instead may be subject to a 1.0% CDSC for one year.
(4) The conversion period for dividend reinvestment shares is modified. Also,
Class B shares of certain other MLAM-advised mutual funds into which
exchanges may be made have an eight-year conversion period. If Class B
shares of the Fund are exchanged for Class B shares of another MLAM-advised
mutual fund, the conversion period applicable to the Class B shares
acquired in the exchange will apply, and the holding period for the shares
exchanged will be tacked onto the holding period for the shares acquired.
</TABLE>
INITIAL SALES CHARGE ALTERNATIVES--CLASS A AND CLASS D SHARES
INVESTORS CHOOSING THE INITIAL SALES CHARGE ALTERNATIVES WHO ARE ELIGIBLE TO
PURCHASE CLASS A SHARES SHOULD PURCHASE CLASS A SHARES RATHER THAN CLASS D
SHARES BECAUSE THERE IS AN ACCOUNT MAINTENANCE FEE IMPOSED ON CLASS D SHARES.
22
<PAGE>
The public offering price of Class A shares for purchasers choosing the
initial sales charge alternative is the next determined net asset value plus
varying sales charges (i.e., sales loads), as set forth below.
<TABLE>
<CAPTION>
SALES CHARGE SALES CHARGE AS DISCOUNT TO SELECTED
AS PERCENTAGE PERCENTAGE* DEALERS AS
OF OFFERING OF THE NET PERCENTAGE OF THE
AMOUNT OF PURCHASE PRICE AMOUNT INVESTED OFFERING PRICE
- ------------------------------------------------------------ ------------- --------------- --------------------
<S> <C> <C> <C>
Less than $25,000........................................... 4.00% 4.17% 3.75%
$25,000 but less than $50,000............................... 3.75 3.90 3.50
$50,000 but less than $100,000.............................. 3.25 3.36 3.00
$100,000 but less than $250,000............................. 2.50 2.56 2.25
$250,000 but less than $1,000,000........................... 1.50 1.52 1.25
$1,000,000 and over**....................................... 0.00 0.00 0.00
<FN>
- ---------
* Rounded to the nearest one-hundredth percent.
** Class A and Class D purchases of $1,000,000 or more made on or after October
21, 1994 will be subject to a CDSC of 1.0% if the shares are redeemed within
one year after purchase. Class A purchases made prior to October 21, 1994 may
be subject to a CDSC if the shares are redeemed within one year of purchase
at the following rates: 0.75% on purchases of $1,000,000 to $2,500,000; 0.40%
on purchases of $2,500,001 to $3,500,000; 0.25% on purchases of $3,500,001 to
$5,000,000; and 0.20% on purchases of more than $5,000,000 in lieu of paying
an initial sales charge. The charge will be assessed on an amount equal to
the lesser of the proceeds of redemption or the cost of the shares being
redeemed.
</TABLE>
The Distributor may reallow discounts to selected dealers and retain the
balance over such discounts. At times the Distributor may reallow the entire
sales charge to such dealers. Since securities dealers selling Class A and Class
D shares of the Fund will receive a concession equal to most of the sales
charge, they may be deemed to be underwriters under the Securities Act. During
the period November 26, 1993 (commencement of operations) to July 31, 1994, the
Fund sold 1,233,303 Class A shares for aggregate net proceeds of $12,258,088.
The gross sales charges for the sale of Class A shares of the Fund for that
period were $120,789, of which $2,080 and $118,709 were received by the
Distributor and Merrill Lynch, respectively. For the period November 26, 1993
(commencement of operations) to July 31, 1994, the Fund incurred no CDSCs for
Class A redemptions.
ELIGIBLE CLASS A INVESTORS. Class A shares are offered to a limited group of
investors and also will be issued upon reinvestment of dividends on outstanding
Class A shares. Investors that currently own Class A shares in a shareholder
account are entitled to purchase additional Class A shares in that account.
Class A shares are available at net asset value to corporate warranty insurance
reserve fund programs provided that the program has $3 million or more initially
invested in MLAM-advised mutual funds. Also eligible to purchase Class A shares
at net asset value are participants in certain investment programs including
TMA-SM- Managed Trusts to which Merrill Lynch Trust Company provides
discretionary trustee services and certain purchases made in connection with the
Merrill Lynch Mutual Fund Adviser program. In addition, Class A shares will be
offered at net asset value to ML&Co. and its subsidiaries and their directors
and employees and to members of the Boards of MLAM-advised investment companies,
including the Fund. Certain persons who acquired shares of certain MLAM-advised
closed-end funds who wish to reinvest the net proceeds from a sale of their
closed-end fund shares of common stock in shares of the Fund also may purchase
Class A shares of the Fund if certain conditions set forth in the Statement of
Additional Information are met. For example, Class A shares of the Fund and
certain other MLAM-advised mutual funds are
23
<PAGE>
offered at net asset value to shareholders of Merrill Lynch Senior Floating Rate
Fund, Inc. who wish to reinvest the net proceeds from a sale of certain of their
shares of common stock of Merrill Lynch Senior Floating Rate Fund, Inc. in
shares of such funds.
REDUCED INITIAL SALES CHARGES. No initial sales charges are imposed upon
Class A and Class D shares issued as a result of the automatic reinvestment of
dividends or capital gains distributions. Class A and Class D sales charges also
may be reduced under a Right of Accumulation and a Letter of Intention.
Class A shares are offered at net asset value to certain eligible Class A
investors as set forth above under "Eligible Class A Investors".
Class D shares are offered at net asset value, without sales charge, to an
investor who has a business relationship with a Merrill Lynch financial
consultant if certain conditions set forth in the Statement of Additional
Information are met. Class D shares may be offered at net asset value in
connection with the acquisition of assets of other investment companies.
Additional information concerning these reduced initial sales charges is set
forth in the Statement of Additional Information.
DEFERRED SALES CHARGE ALTERNATIVES--CLASS B AND CLASS C SHARES
INVESTORS CHOOSING THE DEFERRED SALES CHARGE ALTERNATIVES SHOULD CONSIDER
CLASS B SHARES IF THEY INTEND TO HOLD THEIR SHARES FOR AN EXTENDED PERIOD OF
TIME AND CLASS C SHARES IF THEY ARE UNCERTAIN AS TO THE LENGTH OF TIME THEY
INTEND TO HOLD THEIR ASSETS IN MLAM-ADVISED MUTUAL FUNDS.
The public offering price of Class B and Class C shares for investors
choosing the deferred sales charge alternatives is the next determined net asset
value per share without the imposition of a sales charge at the time of
purchase. As discussed below, Class B shares are subject to a four year CDSC,
while Class C shares are subject only to a one year 1.0% CDSC. On the other
hand, approximately ten years after Class B shares are issued, such Class B
shares, together with shares issued upon dividend reinvestment with respect to
those shares, are automatically converted into Class D shares of the Fund and
thereafter will be subject to lower continuing fees. See "Conversion of Class B
Shares to Class D Shares" below. Both Class B and Class C shares are subject to
an account maintenance fee of 0.25% of net assets and Class B and Class C shares
are subject to distribution fees of 0.25% and 0.35%, respectively, of net assets
as discussed below under "Distribution Plans".
Class B and Class C shares are sold without an initial sales charge so that
the Fund will receive the full amount of the investor's purchase payment.
Merrill Lynch compensates its financial consultants for selling Class B and
Class C shares at the time of purchase from its own funds. See "Distribution
Plans" below. The proceeds from the account maintenance fees are used to
compensate Merrill Lynch for providing continuing account maintenance
activities.
Proceeds from the CDSC and the distribution fee are paid to the Distributor
and are used in whole or in part by the Distributor to defray the expenses of
dealers (including Merrill Lynch) related to providing distribution-related
services to the Fund in connection with the sale of the Class B and Class C
shares, such as the payment of compensation to financial consultants for selling
Class B and Class C shares, from its own funds. The combination of the CDSC and
the ongoing distribution fee facilitates the ability of the Fund to sell the
Class B and Class C shares without a sales charge being deducted at the time of
purchase.
24
<PAGE>
Approximately ten years after issuance, Class B shares will convert
automatically into Class D shares of the Fund, which are subject to an account
maintenance fee but no distribution fee; Class B shares of certain other
MLAM-advised mutual funds into which exchanges may be made convert into Class D
shares automatically after approximately eight years. If Class B shares of the
Fund are exchanged for Class B shares of another MLAM-advised mutual fund, the
conversion period applicable to the Class B shares acquired in the exchange will
apply, and the holding period for the shares exchanged will be tacked onto the
holding period for the shares acquired.
Imposition of the CDSC and the distribution fee on Class B and Class C
shares is limited by the NASD asset-based sales charge rule. See "Limitations on
the Payment of Deferred Sales Charges" below. The proceeds from the ongoing
account maintenance fee are used to compensate Merrill Lynch for providing
continuing account maintenance activities. Class B shareholders of the Fund
exercising the exchange privilege described under "Shareholder Services --
Exchange Privilege" will continue to be subject to the Fund's CDSC schedule if
such schedule is higher than the CDSC schedule relating to the Class B shares
acquired as a result of the exchange.
CONTINGENT DEFERRED SALES CHARGES -- CLASS B SHARES. Class B shares which
are redeemed within four years of purchase may be subject to a CDSC at the rates
set forth below charged as a percentage of the dollar amount subject thereto.
The charge will be assessed on an amount equal to the lesser of the proceeds of
redemption or the cost of the shares being redeemed. Accordingly, no CDSC will
be imposed on increases in net asset value above the initial purchase price. In
addition, no CDSC will be assessed on shares derived from reinvestment of
dividends or capital gains distributions.
The following table sets forth the rates of the Class B CDSC:
<TABLE>
<CAPTION>
CLASS B
CDSC AS A
PERCENTAGE OF
DOLLAR AMOUNT
SUBJECT TO
YEAR SINCE PURCHASE PAYMENT MADE CHARGE
- -------------------------------------------------------------------------- -----------------
<S> <C>
0-1....................................................................... 4.00%
1-2....................................................................... 3.00%
2-3....................................................................... 2.00%
3-4....................................................................... 1.00%
4 and thereafter.......................................................... 0.00%
</TABLE>
For the fiscal period ended July 31, 1994, the Distributor received CDSCs of
$16,384 with respect to redemptions of Class B shares, all of which were paid to
Merrill Lynch.
In determining whether a CDSC is applicable to a redemption, the calculation
will be determined in the manner that results in the lowest possible applicable
rate being charged. Therefore, it will be assumed that the redemption is first
of shares held for over four years or shares acquired pursuant to reinvestment
of dividends or distributions and then of shares held longest during the
four-year period. The charge will not be applied to dollar amounts representing
an increase in the net asset value since the time of purchase. A transfer of
shares from a shareholder's account to another account will be assumed to be
made in the same order as a redemption.
25
<PAGE>
To provide an example, assume an investor purchased 100 Class B shares at
$10 per share (at a cost of $1,000) and in the third year after purchase, the
net asset value per share is $12 and, during such time, the investor has
acquired 10 additional shares upon dividend reinvestment. If at such time the
investor makes his or her first redemption of 50 shares (proceeds of $600), 10
shares will not be subject to charge because of dividend reinvestment. With
respect to the remaining 40 shares, the CDSC is applied only to the original
cost of $10 per share and not to the increase in net asset value of $2 per
share. Therefore, $400 of the $600 redemption proceeds will be charged at a rate
of 2.0% (the applicable rates in the third year after purchase).
The Class B CDSC is waived on redemptions of shares following the death or
disability (as defined in the Internal Revenue Code of 1986, as amended) of a
shareholder. Additional information concerning the waiver of the Class B CDSC is
set forth in the Statement of Additional Information.
CONTINGENT DEFERRED SALES CHARGES -- CLASS C SHARES. Class C shares which
are redeemed within one year after purchase may be subject to a 1.0% CDSC
charged as a percentage of the dollar amount subject thereto. The charge will be
assessed on an amount equal to the lesser of the proceeds of redemption or the
cost of the shares being redeemed. Accordingly, no Class C CDSC will be imposed
on increases in net asset value above the initial purchase price. In addition,
no Class C CDSC will be assessed on shares derived from reinvestment of
dividends or capital gains distributions.
In determining whether a Class C CDSC is applicable to a redemption, the
calculation will be determined in the manner that results in the lowest possible
rate being charged. Therefore, it will be assumed that the redemption is first
of shares held for over one year or shares acquired pursuant to reinvestment of
dividends or distributions and then of shares held longest during the one-year
period. The charge will not be applied to dollar amounts representing an
increase in the net asset value since the time of purchase. A transfer of shares
from a shareholder's account to another account will be assumed to be made in
the same order as a redemption.
CONVERSION OF CLASS B SHARES TO CLASS D SHARES. After approximately ten
years (the "Conversion Period"), Class B shares will be converted automatically
into Class D shares of the Fund. Class D shares are subject to an ongoing
account maintenance fee of 0.10% of net assets but are not subject to the
distribution fee that is borne by Class B shares. Automatic conversion of Class
B shares into Class D shares will occur at least once each month (on the
"Conversion Date") on the basis of the relative net asset values of the shares
of the two classes on the Conversion Date, without the imposition of any sales
load, fee or other charge. Conversion of Class B shares to Class D shares will
not be deemed a purchase or sale of the shares for Federal income tax purposes.
In addition, shares purchased through reinvestment of dividends on Class B
shares also will convert automatically to Class D shares. The Conversion Date
for dividend reinvestment shares will be calculated taking into account the
length of time the shares underlying such dividend reinvestment shares were
outstanding. If at a Conversion Date the conversion of Class B shares to Class D
shares of the Fund in a single account will result in less than $50 worth of
Class B shares being left in the account, all of the Class B shares of the Fund
held in the account on the Conversion Date will be converted to Class D shares
of the Fund.
26
<PAGE>
Share certificates for Class B shares of the Fund to be converted must be
delivered to the Transfer Agent at least one week prior to the Conversion Date
applicable to those shares. In the event such certificates are not received by
the Transfer Agent at least one week prior to the Conversion Date, the related
Class B shares will convert to Class D shares on the next scheduled Conversion
Date after such certificates are delivered.
In general, Class B shares of equity MLAM-advised mutual funds will convert
approximately eight years after initial purchase, and Class B shares of taxable
and tax-exempt fixed income MLAM-advised mutual funds will convert approximately
ten years after initial purchase. If, during the Conversion Period, a
shareholder exchanges Class B shares with an eight-year Conversion Period for
Class B shares with a ten-year Conversion Period, or vice versa, the Conversion
Period applicable to the Class B shares acquired in the exchange will apply, and
the holding period for the shares exchanged will be tacked onto the holding
period for the shares acquired.
DISTRIBUTION PLANS
The Fund has adopted separate distribution plans for Class B, Class C and
Class D shares pursuant to Rule 12b-1 under the Investment Company Act (each a
"Distribution Plan") with respect to the account maintenance and/or distribution
fees paid by the Fund to the Distributor with respect to such classes. The Class
B and Class C Distribution Plans provide for the payment of account maintenance
fees and distribution fees, and the Class D Distribution Plan provides for the
payment of account maintenance fees.
The Distribution Plans for Class B, Class C and Class D shares each provide
that the Fund pays the Distributor an account maintenance fee relating to the
shares of the relevant class, accrued daily and paid monthly, at the annual
rates of 0.25%, 0.25% and 0.10%, respectively, of the average daily net assets
of the Fund attributable to shares of the relevant class in order to compensate
the Distributor and Merrill Lynch (pursuant to a sub-agreement) in connection
with account maintenance activities.
The Distribution Plans for Class B and Class C shares each provide that the
Fund also pays the Distributor a distribution fee relating to the shares of the
relevant class, accrued daily and paid monthly, at the annual rates of 0.25% and
0.35%, respectively, of the average daily net assets of the Fund attributable to
the shares of the relevant class in order to compensate the Distributor and
Merrill Lynch (pursuant to a sub-agreement) for providing shareholder and
distribution services, and bearing certain distribution-related expenses of the
Fund, including payments to financial consultants for selling Class B and Class
C shares of the Fund. The Distribution Plans relating to Class B and Class C
shares are designed to permit an investor to purchase Class B and Class C shares
through dealers without the assessment of an initial sales charge and at the
same time permit the dealer to compensate its financial consultants in
connection with the sale of the Class B and Class C shares. In this regard, the
purpose and function of the ongoing distribution fees and the CDSC are the same
as those of the initial sales charge with respect to the Class A and Class D
shares of the Fund in that the deferred sales charges provide for the financing
of the distribution of the Fund's Class B and Class C shares.
For the period November 26, 1993 (commencement of operations) to July 31,
1994, the Fund paid the Distributor account maintenance fees of $21,847 and
distribution fees of $21,847 under the Class B Distribution Plan. The Fund did
not begin to offer shares of Class C or Class D publicly until the date of this
Prospectus. Accordingly, no payments have been made pursuant to the Class C or
Class D Distribution Plans prior to the date of this Prospectus.
27
<PAGE>
The payments under the Distribution Plans are based on a percentage of
average daily net assets attributable to the shares regardless of the amount of
expenses incurred, and, accordingly, distribution-related revenues from the
Distribution Plans may be more or less than distribution-related expenses.
Information with respect to the distribution-related revenues and expenses is
presented to the Trustees for their consideration in connection with their
deliberations as to the continuance of the Class B and Class C Distribution
Plans. This information is presented annually as of December 31 of each year on
a "fully allocated accrual" basis and quarterly on a "direct expense and
revenue/cash" basis. On the fully allocated accrual basis, revenues consist of
the account maintenance fees, distribution fees, the CDSC and certain other
related revenues, and expenses consist of financial consultant compensation,
branch office and regional operation center selling and transaction processing
expenses, advertising, sales promotion and market expenses, corporate overhead
and interest expense. On the direct expense and revenue/cash basis, revenues
consist of the account maintenance fees, distribution fees and CDSCs, and the
expenses consist of financial consultant compensation. As of December 31, 1993,
the fully allocated accrual expenses incurred by the Distributor and Merrill
Lynch exceeded fully allocated accrual revenues for such period by approximately
$298,000 (2.8% of Class B net assets at that date). As of December 31, 1993,
direct cash expenses for the period since the commencement of operations
exceeded direct cash revenues by $149,620 (1.4% of Class B net assets at that
date). As of July 31, 1994, direct cash expenses for the period since the
commencement of operations exceeded directed cash revenues by approximately
$160,225 (1.1% of Class B net assets at that date).
The Fund has no obligation with respect to distribution and/or account
maintenace-related expenses incurred by the Distributor and Merrill Lynch in
connection with the Class B, Class C and Class D shares, and there is no
assurance that the Trustees of the Trust will approve the continuance of the
Distribution Plans from year to year. However, the Distributor intends to seek
annual continuation of the Distribution Plans. In their review of the
Distribution Plans, the Trustees will be asked to take into consideration
expenses incurred in connection with the account maintenance and/or distribution
of each class of shares separately. The initial sales charges, the account
maintenance fee, the distribution fee and/or the CDSCs received with respect to
one class will not be used to subsidize the sale of shares of another class.
Payments of the distribution fee on Class B shares will terminate upon
conversion of those Class B shares into Class D shares as set forth under
"Deferred Sales Charge Alternatives--Class B and Class D Shares--Conversion of
Class B Shares to Class D Shares".
LIMITATIONS ON THE PAYMENT OF DEFERRED SALES CHARGES
The maximum sales charge rule in the Rules of Fair Practice of the NASD
imposes a limitation on certain asset-based sales charges such as the
distribution fee and the CDSC borne by the Class B and Class C shares but not
the account maintenance fee. The maximum sales charge rule is applied separately
to each class. As applicable to the Fund, the maximum sales charge rule limits
the aggregate of distribution fee payments and CDSCs payable by the Fund to (1)
6.25% of eligible gross sales of Class B shares and Class C shares, computed
separately (defined to exclude shares issued pursuant to dividend reinvestments
and exchanges) plus (2) interest on the unpaid balance for the respective class,
computed separately at the prime rate plus 1% (the unpaid balance being the
maximum amount payable minus amounts received from the payment of the
distribution fee and the CDSC). In connection with the Class B shares, the
Distributor has voluntarily agreed to waive interest charges on the unpaid
balance in excess of 0.50% of eligible gross sales. Consequently, the maximum
amount payable to the Distributor (referred to as the "voluntary maximum") in
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connection with the Class B shares is 6.75% of eligible gross sales. The
Distributor retains the right to stop waiving the interest charges at any time.
To the extent payments would exceed the voluntary maximum, the Fund will not
make further payments of the distribution fee with respect to Class B shares,
and any CDSCs will be paid to the Fund rather than to the Distributor; however,
the Fund will continue to make payments of the account maintenance fee. In
certain circumstances the amount payable pursuant to the voluntary maximum may
exceed the amount payable under the NASD formula. In such circumstances payments
in excess of the amount payable under the NASD formula will not be made.
The Fund has no obligation with respect to distribution and/or account
maintenance-related expenses incurred by the Distributor and Merrill Lynch in
connection with Class B, Class C and Class D shares, and there is no assurance
that the Trustees of the Trust will approve the continuance of the Distribution
Plans from year to year. However, the Distributor intends to seek annual
continuation of the Distribution Plans. In their review of the Distribution
Plans, the Trustees will be asked to take into consideration expenses incurred
in connection with the account maintenance and/or distribution of each class of
shares separately. The initial sales charges, the account maintenance fee, the
distribution fee and/or the CDSCs received with respect to one class will not be
used to subsidize the sale of shares of another class. Payments of the
distribution fee on Class B shares will terminate upon conversion of those Class
B shares into Class D shares as set forth under "Deferred Sales Charge
Alternatives -- Conversion of Class B Shares to Class D Shares".
REDEMPTION OF SHARES
The Trust is required to redeem for cash all shares of the Fund upon receipt
of a written request in proper form. The redemption price is the net asset value
per share next determined after the initial receipt of proper notice of
redemption. Except for any CDSC which may be applicable, there will be no charge
for redemption if the redemption request is sent directly to the Transfer Agent.
Shareholders liquidating their holdings will receive upon redemption all
dividends reinvested through the date of redemption. The value of shares at the
time of redemption may be more or less than the shareholder's cost, depending on
the market value of the securities held by the Fund at such time.
REDEMPTION
A shareholder wishing to redeem shares may do so without charge by tendering
the shares directly to the Transfer Agent, Financial Data Services, Inc.,
Transfer Agency Mutual Fund Operations, P.O. Box 45289, Jacksonville, Florida
32232-5289. Redemption requests delivered other than by mail should be delivered
to Financial Data Services, Inc., Transfer Agency Mutual Fund Operations, 4800
Deer Lake Drive East, Jacksonville, Florida 32246-6484. Proper notice of
redemption in the case of shares deposited with the Transfer Agent may be
accomplished by a written letter requesting redemption. Proper notice of
redemption in the case of shares for which certificates have been issued may be
accomplished by a written letter as noted above accompanied by certificates for
the shares to be redeemed. Redemption requests should not be sent to the Trust.
The notice in either event requires the signature(s) of all persons in whose
name(s) the shares are registered, signed exactly as such name(s) appear(s) on
the Transfer Agent's register. The signature(s) on the redemption request must
be guaranteed by an "eligible guarantor institution" as such term is defined in
Rule 17Ad-15 under the Securities Exchange Act of 1934, as amended, the
existence and validity of which may be verified by the Transfer Agent through
the use of industry publications. Notarized signatures are not sufficient. In
certain instances, the Transfer Agent may require additional documents such as,
but not limited to, trust instruments, death certificates, appointments as
executor or administrator, or certificates of corporate authority. For
shareholders redeeming directly with the Transfer Agent, payments will be mailed
within seven days of receipt of a proper notice of redemption.
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At various times the Trust may be requested to redeem Fund shares for which
it has not yet received good payment (e.g., cash, Federal funds or certified
check drawn on a United States bank). The Trust may delay or cause to be delayed
the mailing of a redemption check until such time as it has assured itself that
good payment has been collected for the purchase of such Fund shares, which will
not exceed 10 days.
REPURCHASE
The Trust also will repurchase Fund shares through a shareholder's listed
securities dealer. The Trust normally will accept orders to repurchase Fund
shares by wire or telephone from dealers for their customers at the net asset
value next computed after receipt of the order by the dealer, provided that the
request for repurchase is received by the dealer prior to the close of business
on the New York Stock Exchange on the day received and is received by the Fund
from such dealer not later than 4:30 P.M., New York time, on the same day.
Dealers have the responsibility of submitting such repurchase requests to the
Trust not later than 4:30 P.M., New York time, in order to obtain that day's
closing price.
The foregoing repurchase arrangements are for the convenience of
shareholders and do not involve a charge by the Trust (other than any applicable
CDSC). Securities firms which do not have selected dealer agreements with the
Distributor, however, may impose a charge on the shareholder for transmitting
the notice of repurchase to the Trust. Merrill Lynch may charge its customers a
processing fee (presently $4.85) to confirm a repurchase of shares by such
customers. Redemptions directly through the Transfer Agent are not subject to
the processing fee. The Trust reserves the right to reject any order for
repurchase, which right of rejection might adversely affect shareholders seeking
redemption through the repurchase procedure. However, a shareholder whose order
for repurchase is rejected by the Trust may redeem Fund shares as set forth
above.
REINSTATEMENT PRIVILEGE--CLASS A AND CLASS D SHARES
Shareholders who have redeemed their Class A or Class D shares have a
one-time privilege to reinstate their accounts by purchasing Class A or Class D
shares, as the case may be, of the Fund at net asset value without a sales
charge up to the dollar amount redeemed. The reinstatement privilege may be
exercised by sending a notice of exercise along with a check for the amount to
be reinstated to the Transfer Agent within 30 days after the date the request
for redemption was accepted by the Transfer Agent or the Distributor. The
reinstatement will be made at the net asset value per share next determined
after the notice of reinstatement is received and cannot exceed the amount of
the redemption proceeds. The reinstatement is a one-time privilege and may be
exercised by the Class A or Class D shareholder only the first time such
shareholder makes a redemption.
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SHAREHOLDER SERVICES
The Trust offers a number of shareholder services and investment plans
designed to facilitate investment in shares of the Fund. Full details as to each
of such services, copies of the various plans described below and instructions
as to how to participate in the various services or plans, or to change options
with respect thereto can be obtained from the Trust by calling the telephone
number on the cover page hereof or from the Distributor or Merrill Lynch.
Included in such services are the following:
INVESTMENT ACCOUNT
Each shareholder whose account (an "Investment Account") is maintained at
the Transfer Agent has an Investment Account and will receive statements, at
least quarterly, from the Transfer Agent. These statements will serve as
transaction confirmations for automatic investment purchases and the
reinvestment of ordinary income dividends and long-term capital gain
distributions. These statements will also show any other activity in the account
since the preceding statement. Shareholders will receive separate transaction
confirmations for each purchase or sale transaction other than automatic
investment purchases and the reinvestment of ordinary income dividends and
long-term capital gain distributions. A shareholder may make additions to his
Investment Account at any time by mailing a check directly to the Transfer
Agent. Shareholders may also maintain their accounts through Merrill Lynch. Upon
the transfer of shares out of a Merrill Lynch brokerage account, an Investment
Account in the transferring shareholder's name will be opened automatically,
without charge, at the Transfer Agent. Shareholders considering transferring
their Class A or Class D shares from Merrill Lynch to another brokerage firm or
financial institution should be aware that, if the firm to which the Class A or
Class D shares are to be transferred will not take delivery of shares of the
Fund, a shareholder either must redeem the Class A or Class D shares (paying any
applicable CDSC) so that the cash proceeds can be transferred to the account at
the new firm or such shareholder must continue to maintain an Investment Account
at the Transfer Agent for those Class A or Class D shares. Shareholders
interested in transferring their Class B or Class C shares from Merrill Lynch
and who do not wish to have an Investment Account maintained for such shares at
the Transfer Agent may request their new brokerage firm to maintain such shares
in an account registered in the name of the brokerage firm for the benefit of
the shareholder at the Transfer Agent.
EXCHANGE PRIVILEGE
Shareholders of each class of shares of the Fund each have an exchange
privilege with certain other MLAM-advised mutual funds. There is currently no
limitation on the number of times a shareholder may exercise the exchange
privilege. The exchange privilege may be modified or terminated at any time in
accordance with the rules of the Commission.
Under the Merrill Lynch Select Pricing-SM- System, Class A shareholders may
exchange Class A shares of the Fund for Class A shares of a second MLAM-advised
mutual fund if the shareholder holds any Class A shares of the second fund in
his account in which the exchange is made at the time of the exchange or is
otherwise eligible to purchase Class A shares of the second fund. If the Class A
shareholder wants to exchange Class A shares for shares of a second MLAM-advised
mutual fund, and the shareholder does not hold Class A shares of the second fund
in his account at the time of the exchange and is not otherwise eligible to
acquire Class A shares of the second fund, the shareholder will receive Class D
shares of the second fund as a result of the exchange. Class D shares also may
be exchanged for Class A shares of a second MLAM-
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advised mutual fund at any time as long as, at the time of the exchange, the
shareholder holds Class A shares of the second fund in the account in which the
exchange is made or is otherwise eligible to purchase Class A shares of the
second fund.
Exchanges of Class A and Class D shares are made on the basis of the
relative net asset values per Class A or Class D share, respectively, plus an
amount equal to the difference, if any, between the sales charge previously paid
on the Class A or Class D shares being exchanged and the sales charge payable at
the time of the exchange on the shares being acquired.
Class B, Class C and Class D shares will be exchangeable with shares of the
same class of other MLAM-advised mutual funds.
Shares of the Fund which are subject to a CDSC will be exchangeable on the
basis of relative net asset value per share without the payment of any CDSC that
might otherwise be due upon redemption of the shares of the Fund. For purposes
of computing the CDSC that may be payable upon a disposition of the shares
acquired in the exchange, the holding period for the previously owned shares of
the Fund is "tacked" to the holding period of the newly acquired shares of the
other Fund.
Class A, Class B, Class C and Class D shares also will be exchangeable for
shares of certain MLAM-advised money market funds specifically designated as
available for exchange by holders of Class A, Class B, Class C or Class D
shares. The period of time that Class A, Class B, Class C or Class D shares are
held in a money market fund, however, will not count toward satisfaction of the
holding period requirement for reduction of any CDSC imposed on such shares, if
any, and, with respect to Class B shares, toward satisfaction of the Conversion
Period.
Class B shareholders of the Fund exercising the exchange privilege will
continue to be subject to the Fund's CDSC schedule if such schedule is higher
than the CDSC schedule relating to the new Class B shares. In addition, Class B
shares of the Fund acquired through use of the exchange privilege will be
subject to the Fund's CDSC schedule if such schedule is higher than the CDSC
schedule relating to the Class B shares of the MLAM-advised mutual fund from
which the exchange has been made.
Exercise of the exchange privilege is treated as a sale for Federal income
tax purposes. For further information, see "Shareholder Services -- Exchange
Privilege" in the Statement of Additional Information.
The Fund's exchange privilege is modified with respect to purchases of Class
A and Class D shares under the Merrill Lynch Mutual Fund Adviser ("MFA")
program. First, the initial allocation of assets is made under the MFA program.
Then, any subsequent exchange under the MFA program of Class A or Class D shares
of a MLAM-advised mutual fund for Class A or Class D shares of the Fund will be
made solely on the basis of the relative net asset values of the shares being
exchanged. Therefore, there will not be a charge for any difference between the
sales charge previously paid on the shares of the other MLAM-advised mutual fund
and the sales charge payable on the shares of the Fund being acquired in the
exchange under the MFA program.
AUTOMATIC REINVESTMENT OF DIVIDENDS AND CAPITAL GAINS DISTRIBUTIONS
All dividends and capital gains distributions are reinvested automatically
in full and fractional shares of the Fund, without a sales charge, at the net
asset value per share at the close of business on the monthly payment date for
such dividends and distributions. A shareholder may at any time, by written
notification or
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by telephone (1-800-MER-FUND) to the Transfer Agent, elect to have subsequent
dividends or both dividends and capital gains distributions paid in cash, rather
than reinvested, in which event payment will be mailed on or about the payment
date. Cash payments can also be directly deposited to the shareholder's bank
account. No CDSC will be imposed upon redemption of shares issued as a result of
the automatic reinvestment of dividends or capital gains distributions.
SYSTEMATIC WITHDRAWAL PLANS
A Class A or Class D shareholder may elect to receive systematic withdrawal
payments from his Investment Account in the form of payments by check or through
automatic payment by direct deposit to his bank account on either a monthly or
quarterly basis. A Class A or Class D shareholder whose shares are held within a
CMA-R- or CBA-R- Account may elect to have shares redeemed on a monthly,
bimonthly, quarterly, semiannual or annual basis through the Systematic
Redemption Program, subject to certain conditions.
AUTOMATIC INVESTMENT PLANS
Regular additions of Class A, Class B, Class C and Class D shares may be
made to an investor's Investment Account by prearranged charges of $50 or more
to his regular bank account. Alternatively, investors who maintain CMA-R-
accounts may arrange to have periodic investments made in the Fund in their
CMA-R- account or in certain related accounts in amounts of $100 or more through
the CMA-R- Automated Investment Program.
PORTFOLIO TRANSACTIONS
The Trust has no obligation to deal with any dealer or group of dealers in
the execution of transactions in portfolio securities of the Fund. Municipal
Bonds and other securities in which the Fund invests are traded primarily in the
over-the-counter market. Where possible, the Trust deals directly with the
dealers who make a market in the securities involved except in those
circumstances where better prices and execution are available elsewhere. It is
the policy of the Trust to obtain the best net results in conducting portfolio
transactions for the Fund, taking into account such factors as price (including
the applicable dealer spread), the size, type and difficulty of the transactions
involved, the firm's general execution and operations facilities, and the firm's
risk in positioning the securities involved and the provision of supplemental
investment research by the firm. While reasonably competitive spreads or
commissions are sought, the Fund will not necessarily be paying the lowest
spread or commission available. The sale of shares of the Fund may be taken into
consideration as a factor in the selection of brokers or dealers to execute
portfolio transactions for the Fund. The portfolio securities of the Fund
generally are traded on a net basis and normally do not involve either brokerage
commissions or transfer taxes. The cost of portfolio securities transactions of
the Fund primarily consists of dealer or underwriter spreads. Under the 1940
Act, persons affiliated with the Trust, including Merrill Lynch, are prohibited
from dealing with the Trust as a principal in the purchase and sale of
securities unless such trading is permitted by an exemptive order issued by the
Commission. The Trust has obtained an exemptive order permitting it to engage in
certain principal transactions with Merrill Lynch involving high quality
short-term municipal bonds subject to certain conditions. In addition, the Trust
may not purchase securities, including Municipal Bonds, for the Fund during the
existence of any underwriting syndicate of which Merrill Lynch is a member
except pursuant to procedures approved by the Trustees of the Trust which comply
with rules adopted by the Commission. Affiliated persons of the Trust may serve
as its broker in over-the-counter transactions conducted for the Fund on an
agency basis only.
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DISTRIBUTIONS AND TAXES
DISTRIBUTIONS
The net investment income of the Fund is declared as dividends daily
following the normal close of trading on the New York Stock Exchange (currently
4:00 P.M.) prior to the determination of the net asset value on that day. The
net investment income of the Fund for dividend purposes consists of interest
earned on portfolio securities, less expenses, in each case computed since the
most recent determination of the net asset value. Expenses of the Fund,
including the management fees and the account maintenance and distribution fees,
are accrued daily. Dividends of net investment income are declared daily and
reinvested monthly in the form of additional full and fractional shares of the
Fund at net asset value as of the close of business on the "payment date" unless
the shareholder elects to receive such dividends in cash. Shares will accrue
dividends as long as they are issued and outstanding. Shares are issued and
outstanding from the settlement date of a purchase order to the day prior to
settlement date of a redemption order.
All net realized long-or short-term capital gains, if any, are declared and
distributed to the Fund's shareholders at least annually. Capital gains
distributions will be reinvested automatically in shares unless the shareholder
elects to receive such distributions in cash.
The per share dividends and distributions on each class of shares will be
reduced as a result of any account maintenance, distribution and transfer agency
fees applicable to that class. See "Additional Information -- Determination of
Net Asset Value".
See "Shareholder Services" for information as to how to elect either
dividend reinvestment or cash payments. Portions of dividends and distributions
which are taxable to shareholders as described below are subject to income tax
whether they are reinvested in shares of the Fund or received in cash.
TAXES
The Trust intends to continue to qualify the Fund for the special tax
treatment afforded regulated investment companies ("RICs") under the Internal
Revenue Code of 1986, as amended (the "Code"). If it so qualifies, in any
taxable year in which it distributes at least 90% of its taxable net income and
90% of its tax-exempt net income (see below), the Fund (but not its
shareholders) will not be subject to Federal income tax to the extent that it
distributes its net investment income and net realized capital gains. The Trust
intends to cause the Fund to distribute substantially all of such income.
To the extent that the dividends distributed to the Fund's Class A, Class B,
Class C and Class D shareholders (together, the "shareholders") are derived from
interest income exempt from Federal income tax under Code Section 103(a) and are
properly designated as "exempt-interest dividends" by the Trust, they will be
excludable from a shareholder's gross income for Federal income tax purposes.
Exempt-interest dividends are included, however, in determining the portion, if
any, of a person's social security and railroad retirement benefits subject to
Federal income taxes. The portion of exempt-interest dividends paid from
interest received by the Fund from Colorado Municipal Bonds will not be subject
to Colorado personal and corporate income taxes. Shareholders subject to income
taxation by states other than Colorado will realize a lower after-tax rate of
return than Colorado shareholders since the dividends distributed by the Fund
generally will not be exempt, to any significant degree, from income taxation by
such other states. The Trust will inform shareholders annually as to the portion
of the Fund's distributions which constitutes exempt-interest dividends and the
portion which is exempt from Colorado income taxes. Interest on indebtedness
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incurred or continued to purchase or carry Fund shares is not deductible for
Federal or Colorado income tax purposes to the extent attributable to
exempt-interest dividends. Persons who may be "substantial users" (or "related
persons" of substantial users) of facilities financed by industrial development
bonds or private activity bonds held by the Fund should consult their tax
advisers before purchasing Fund shares.
Colorado presently includes in Colorado alternative minimum taxable income
of individuals, estates and trusts a portion of certain items of tax preference
as defined in the Code. Interest paid on private activity bonds issued after
August 7, 1986 constitutes such a tax preference. Accordingly, any distributions
of the Fund's portfolio attributable to such private activity bonds will not be
exempt from Colorado alternative minimum tax.
Shares of the Fund will not be subject to the Colorado personal property
tax.
To the extent that the Fund's distributions are derived from interest on its
taxable investments or from an excess of net short-term capital gains over net
long-term capital losses ("ordinary income dividends"), such distributions are
considered ordinary income for Federal and Colorado income tax purposes. Such
distributions are not eligible for the dividends received deduction for
corporations. Distributions, if any, of net long-term capital gains from the
sale of securities or from certain transactions in futures and options ("capital
gain dividends") are taxable as long-term capital gains for Federal income tax
purposes, regardless of the length of time the shareholder has owned Fund shares
and, for Colorado income tax purposes, are treated as capital gains which are
taxed at ordinary income rates. Under the Revenue Reconciliation Act of 1993,
all or a portion of the Fund's gain from the sale or redemption of tax-exempt
obligations purchased at a market discount will be treated as ordinary income
rather than capital gain. This rule may increase the amount of ordinary income
dividends received by shareholders. Distributions in excess of the fund's
earnings and profits will first reduce the adjusted tax basis of a holder's
shares and, after such adjusted tax basis is reduced to zero, will constitute
capital gains to such holder (assuming the shares are held as a capital asset).
Any loss upon the sale or exchange of Fund shares held for six months or less
will be treated as long-term capital loss to the extent of any capital gain
dividends received by the shareholder. In addition, such loss will be disallowed
to the extent of any exempt-interest dividends received by the shareholder. If
the Fund pays a dividend in January which was declared in the previous October,
November or December to shareholders of record on a specified date in one of
such months, then such dividend will be treated for tax purposes as being paid
by the Fund and received by its shareholders on December 31 of the year in which
such dividend was declared.
The Code subjects interest received on certain otherwise tax-exempt
securities to an alternative minimum tax. This alternative minimum tax applies
to interest received on "private activity bonds" issued after August 7, 1986.
Private activity bonds are bonds which, although tax-exempt, are used for
purposes other than those generally performed by governmental units and which
benefit non-governmental entities (e.g., bonds used for industrial development
or housing purposes). Income received on such bonds is classified as an item of
"tax preference", which could subject investors in such bonds, including
shareholders of the Fund, to an alternative minimum tax. The Fund will purchase
such "private activity bonds", and the Trust will report to shareholders within
60 days after the Fund's taxable year-end the portion of the Fund's dividends
declared during the year which constitutes an item of tax preference for
alternative minimum tax purposes. The Code further provides that corporations
are subject to an alternative minimum tax based, in part, on certain differences
between taxable income as adjusted for other tax preferences and the
corporation's
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"adjusted current earnings" (which more closely reflect a corporation's economic
income). Because an exempt-interest dividend paid by the Fund will be included
in adjusted current earnings, a corporate shareholder may be required to pay
alternative minimum tax on exempt-interest dividends paid by the Fund.
The Revenue Reconciliation Act of 1993 has added new marginal tax brackets
of 36% and 39.6% for individuals and has created a graduated structure of 26%
and 28% for the alternative minimum tax applicable to individual taxpayers.
These rate increases may affect an individual investor's after-tax return from
an investment in the Fund as compared with such investor's return from taxable
investments.
No gain or loss will be recognized by Class B shareholders on the conversion
of their Class B shares into Class D shares. A shareholder's basis in the Class
D shares acquired will be the same as such shareholder's basis in the Class B
shares converted, and the holding period of the acquired Class D shares will
include the holding period for the converted Class B shares.
If a shareholder exercises an exchange privilege within 90 days of acquiring
the shares, then the loss the shareholder can recognize on the exchange will be
reduced (or the gain increased) to the extent the sales charge paid to the Fund
reduces any sales charge such shareholder would have owed upon purchase of the
new shares in the absence of the exchange privilege. Instead, such sales charge
will be treated as an amount paid for the new shares.
A loss realized on a sale or exchange of shares of the Fund will be
disallowed if other Fund shares are acquired (whether through the automatic
reinvestment of dividends or otherwise) within a 61-day period beginning 30 days
before and ending 30 days after the date that the shares are disposed of. In
such a case, the basis of the shares acquired will be adjusted to reflect the
disallowed loss.
Under certain provisions of the Code, some shareholders may be subject to a
31% withholding tax on certain ordinary income dividends and on capital gain
dividends and redemption payments ("backup withholding"). Generally,
shareholders subject to backup withholding will be those for whom no certified
taxpayer identification number is on file with the Trust or who, to the Trust's
knowledge, have furnished an incorrect number. When establishing an account, an
investor must certify under penalty of perjury that such number is correct and
that such investor is not otherwise subject to backup withholding.
The Code provides that every person required to file a tax return must
include for information purposes on such return the amount of exempt-interest
dividends received from all sources (including the Fund) during the taxable
year.
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code, Treasury regulations and Colorado tax laws presently in
effect. For the complete provisions, reference should be made to the pertinent
Code sections, the Treasury regulations promulgated thereunder and the
applicable Colorado income tax laws. The Code and the Treasury regulations, as
well as the Colorado tax laws, are subject to change by legislative, judicial or
administrative action either prospectively or retroactively.
Shareholders are urged to consult their tax advisers regarding the
availability of any exemptions from state and local taxes (other than those
imposed by Colorado) and with specific questions as to Federal, foreign, state
or local taxes.
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PERFORMANCE DATA
From time to time the Fund may include its average annual total return and
yield and tax equivalent yield for various specified time periods in
advertisements or information furnished to present or prospective shareholders.
Average annual total return, yield and tax equivalent yield are computed
separately for Class A, Class B, Class C and Class D shares in accordance with
formulas specified by the Commission.
Average annual total return quotations for the specified periods will be
computed by finding the average annual compounded rates of return (based on net
investment income and any realized and unrealized capital gains or losses on
portfolio investments over such periods) that would equate the initial amount
invested to the redeemable value of such investment at the end of each period.
Average annual total return will be computed assuming all dividends and
distributions are reinvested and taking into account all applicable recurring
and nonrecurring expenses, including any CDSC that would be applicable to a
complete redemption of the investment at the end of the specified period such as
in the case of Class B shares and Class C shares and the maximum sales charge in
the case of Class A and Class D shares. Dividends paid by the Fund with respect
to all shares, to the extent any dividends are paid, will be calculated in the
same manner at the same time on the same day and will be in the same amount,
except that account maintenance fees and distribution charges and any
incremental transfer agency costs relating to each class of shares will be borne
exclusively by that class. The Fund will include performance data for all
classes of shares of the Fund in any advertisement or information including
performance data of the Fund.
The Fund also may quote total return and aggregate total return performance
data for various specified time periods. Such data will be calculated
substantially as described above, except that (1) the rates of return calculated
will not be average annual rates, but rather, actual annual, annualized or
aggregate rates of return and (2) the maximum applicable sales charges will not
be included with respect to annual or annualized rates of return calculations.
Aside from the impact on the performance data calculations of including or
excluding the maximum applicable sales charges, actual annual or annualized
total return data generally will be lower than average annual total return data
since the average annual rates of return reflect compounding; aggregate total
return data generally will be higher than average annual total return data since
the aggregate rates of return reflect compounding over a longer period of time.
In advertisements distributed to investors whose purchases are subject to waiver
of the CDSC in the case of Class B shares or to reduced sales charges in the
case of Class A or Class D shares, the performance data may take into account
the reduced, and not the maximum, sales charge or may not take into account the
CDSC and therefore may reflect greater total return since, due to the reduced
sales charges or waiver of the CDSC, a lower amount of expenses is deducted. See
"Purchase of Shares". The Fund's total return may be expressed either as a
percentage or as a dollar amount in order to illustrate such total return on a
hypothetical $1,000 investment in the Fund at the beginning of each specified
period.
Yield quotations will be computed based on a 30-day period by dividing (a)
the net income based on the yield of each security earned during the period by
(b) the average daily number of shares outstanding during the period that were
entitled to receive dividends multiplied by the maximum offering price per share
on the last day of the period. Tax equivalent yield quotations will be computed
by dividing (a) the part of the Fund's yield that is tax-exempt by (b) one minus
a stated tax rate and (c) adding the result to that part, if any, of the Fund's
yield that is not tax-exempt. The yield for the 30-day period ended July 31,
1994 was 5.36% for Class A shares and 5.08% for Class B shares and the
tax-equivalent yield for the same period (based on a Federal income tax rate of
28%) was 7.44% for Class A shares and 7.06% for Class B shares. The yield
37
<PAGE>
without voluntary reimbursement for the 30-day period would have been 4.13% for
Class A shares and 3.80% for Class B shares with a tax-equivalent yield of 5.74%
for Class A shares and 5.28% for Class B shares.
Total return and yield figures are based on the Fund's historical
performance and are not intended to indicate future performance. The Fund's
total return and yield will vary depending on market conditions, the securities
comprising the Fund's portfolio, the Fund's operating expenses and the amount of
realized and unrealized net capital gain or losses during the period. The value
of an investment in the Fund will fluctuate and an investor's shares, when
redeemed, may be worth more or less than their original cost.
On occasion, the Fund may compare its performance to performance data
published by Lipper Analytical Services, Inc., Morningstar Publications, Inc.
("MORNINGSTAR") and CDA Investment Technology, Inc., or to data contained in
publications such as MONEY MAGAZINE, U.S. NEWS & WORLD REPORT, BUSINESS WEEK,
FORBES MAGAZINE and FORTUNE MAGAZINE. From time to time, the Fund may include
the Fund's Morningstar risk-adjusted performance ratings in advertisements or
supplemental sales literature. As with other performance data, performance
comparisons should not be considered representative of the Fund's relative
performance for any future period.
ADDITIONAL INFORMATION
DETERMINATION OF NET ASSET VALUE
The net asset value of the shares of all classes of the Fund is determined
once daily as of 4:15 P.M., New York time, on each day during which the New York
Stock Exchange is open for trading. The net asset value per share is computed by
dividing the sum of the value of the securities held by the Fund plus any cash
or other assets minus all liabilities by the total number of shares outstanding
at such time, rounded to the nearest cent. Expenses, including the fees payable
to the Manager and the Distributor, are accrued daily.
The per share net asset value of the Class A shares will generally be higher
than the per share net asset value of shares of the other classes, reflecting
the daily expense accruals of the account maintenance, distribution and higher
transfer agency fees applicable with respect to Class B and Class C shares and
the daily expense accruals of the account maintenance fees with respect to the
Class D shares; moreover, the per share net asset value of Class D shares
generally will be higher than the per share net asset value of Class B and Class
C shares, reflecting the daily expense accruals of the distribution and higher
transfer agency fees applicable with respect to Class B and Class C shares. It
is expected, however, that the per share net asset value of the classes will
tend to converge immediately after the payment of dividends or distributions
which will differ by approximately the amount of the expense accrual
differentials between the classes.
ORGANIZATION OF THE TRUST
The Trust is an unincorporated business trust organized on August 2, 1985
under the laws of Massachusetts. On October 1, 1987, the Trust changed its name
from "Merrill Lynch Multi-State Tax-Exempt Series Trust" to "Merrill Lynch
Multi-State Municipal Bond Series Trust" and on December 22, 1987 the Trust
changed its name to "Merrill Lynch Multi-State Municipal Series Trust". The
Trust is an open-end management investment company comprised of separate series
("Series"), each of which is a separate portfolio offering shares to selected
groups of purchasers. Each of the Series is to be managed independently in order
to provide to shareholders who are residents of the state to which such Series
relates as high a level of income exempt from Federal, state and local income
taxes as is consistent with prudent investment management.
38
<PAGE>
The Trustees are authorized to create an unlimited number of Series and, with
respect to each Series, to issue an unlimited number of full and fractional
shares of beneficial interest of $.10 par value of different classes.
Shareholder approval is not required for the authorization of additional Series
or classes of a Series of the Trust. At the date of this Prospectus, the shares
of the Fund are divided into Class A, Class B, Class C and Class D shares. Class
A, Class B, Class C and Class D shares represent interests in the same assets of
the Fund and are identical in all respects except that Class B, Class C and
Class D shares bear certain expenses related to the account maintenance
associated with such shares, and Class B and Class C shares bear certain
expenses related to the distribution of such shares. Each class has exclusive
voting rights with respect to matters relating to account maintenance and
distribution expenditures as applicable. See "Purchase of Shares". The Trust has
received an order (the "Order") from the Commission permitting the issuance and
sale of multiple classes of shares. The Order permits the Trust to issue
additional classes of shares of any Series of the Board of Trustees deems such
issuance to be in the best interest of the Trust.
Shareholders are entitled to one vote for each full share and to fractional
votes for fractional shares held in the election of Trustees (to the extent
hereinafter provided) and on other matters submitted to the vote of
shareholders. There normally will be no meeting of shareholders for the purpose
of electing Trustees unless and until such time as less than a majority of the
Trustees holding office have been elected by shareholders, at which time the
Trustees then in office will call a shareholders' meeting for the election of
Trustees. Shareholders may, in accordance with the terms of the Declaration of
Trust, cause a meeting of shareholders to be held for the purpose of voting on
the removal of Trustees. Also, the Trust will be required to call a special
meeting of shareholders of a Series in accordance with the requirements of the
1940 Act to seek approval of new management and advisory arrangements, of a
material increase in distribution fees or of a change in the fundamental
policies, objectives or restrictions of a Series. Except as set forth above, the
Trustees shall continue to hold office and appoint successor Trustees. Each
issued and outstanding share is entitled to participate equally in dividends and
distributions declared by the respective Series and in net assets of such Series
upon liquidation or dissolution remaining after satisfaction of outstanding
liabilities except that, as noted above, the Class B, Class C and Class D shares
bear certain additional expenses. The obligations and liabilities of a
particular Series are restricted to the assets of that Series and do not extend
to the assets of the Trust generally. The shares of each Series, when issued,
will be fully-paid and non-assessable by the Trust.
SHAREHOLDER REPORTS
Only one copy of each shareholder report and certain shareholder
communications will be mailed to each identified shareholder regardless of the
number of accounts such shareholder has. If a shareholder wishes to receive
separate copies of each report and communication for each of the shareholder's
related accounts, the shareholder should notify in writing:
Financial Data Services, Inc.
Attn: TAMFO
P.O. Box 45289
Jacksonville, FL 32232-5289
The written notification should include the shareholder's name, address, tax
identification number and Merrill Lynch, Pierce, Fenner & Smith Incorporated
and/or mutual fund account numbers. If you have any questions regarding this
matter please call your Merrill Lynch financial consultant or Financial Data
Services, Inc. at 800-637-3863.
39
<PAGE>
SHAREHOLDER INQUIRIES
Shareholder inquiries may be addressed to the Trust at the address or
telephone number set forth on the cover page of this Prospectus.
The Declaration of Trust establishing the Trust, dated August 2, 1985, a
copy of which together with all amendments thereto (the "Declaration"), is on
file in the office of the Secretary of the Commonwealth of Massachusetts,
provides that the name "Merrill Lynch Multi-State Municipal Series Trust" refers
to the Trustees under the Declaration collectively as Trustees, but not as
individuals or personally; and no Trustee, shareholder, officer, employee or
agent of the Trust shall be held to any personal liability, nor shall resort be
had to such person's private property for the satisfaction of any obligation or
claim of the Trust, but the "Trust Property" only shall be liable.
40
<PAGE>
MERRILL LYNCH COLORADO MUNICIPAL BOND FUND - AUTHORIZATION FORM (PART 1)
- --------------------------------------------------------------------------------
1. SHARE PURCHASE APPLICATION
I, being of legal age, wish to purchase: (choose one)
/ / Class A shares / / Class B shares / / Class C shares / / Class D shares
of Merrill Lynch Colorado Municipal Bond Fund and establish an Investment
Account as described in the Prospectus. In the event that I am not eligible to
purchase Class A shares, I understand that Class D shares will be purchased.
Basis for establishing an Investment Account:
A. I enclose a check for $ . payable to Financial Data Services, Inc.,
as an initial investment (minimum $1,000). I understand that this purchase
will be executed at the applicable offering price next to be determined
after this Application is received by you.
B. I already own shares of the following Merrill Lynch mutual funds
that would qualify for the right of accumulation as outlined in the
Statement of Additional Information: (Please list all funds. Use a separate
sheet of paper if necessary.)
<TABLE>
<S> <C>
1. ......................................................... 4. .........................................................
2. ......................................................... 5. .........................................................
3. ......................................................... 6. .........................................................
</TABLE>
<TABLE>
<S> <C>
Name ...................................................................................................................
First Name Initial Last Name
Name of Co-Owner (if any) ..............................................................................................
First Name Initial Last Name
</TABLE>
<TABLE>
<S> <C>
Address ....................................................
........................................................... Name and Address of Employer ...............................
(Zip Code)
Occupation ................................................. ............................................................
........................................................... ............................................................
Signature of Owner Signature of Co-Owner (if any)
(in the case of co-owner, a joint tenancy with right of survivorship will be presumed unless otherwise specified.)
</TABLE>
- --------------------------------------------------------------------------------
2. DIVIDEND AND CAPITAL GAIN DISTRIBUTION OPTIONS
<TABLE>
<S> <C> <C> <C> <C> <C>
ORDINARY INCOME DIVIDENDS LONG-TERM CAPITAL GAINS
Select / / Reinvest Select / / Reinvest
One: / / Cash One: / / Cash
</TABLE>
If no election is made, dividends and capital gains will be automatically
reinvested at net asset value without a sales charge.
IF CASH, SPECIFY HOW YOU WOULD LIKE YOUR DISTRIBUTIONS PAID TO YOU: / / Check
or / / Direct Deposit to bank account
IF DIRECT DEPOSIT TO BANK ACCOUNT IS SELECTED, PLEASE COMPLETE BELOW:
I hereby authorize payment of dividend and capital gain distributions by direct
deposit to my bank account and, if necessary, debit entries and adjustments for
any credit entries made to my account in accordance with the terms I have
selected on the Merrill Lynch Colorado Municipal Bond Fund Authorization Form.
SPECIFY TYPE OF ACCOUNT (CHECK ONE) / / checking / / savings
Name on your account ...........................................................
Bank Name ......................................................................
Bank Number ........................ Account Number ........................
Bank address ...................................................................
I AGREE THAT THIS AUTHORIZATION WILL REMAIN IN EFFECT UNTIL I PROVIDE WRITTEN
NOTIFICATION TO FINANCIAL DATA SERVICES, INC. AMENDING OR TERMINATING THIS
SERVICE.
Signature of Depositor .........................................................
Signature of Depositor ........................ Date .......................
(if joint account, both must sign)
NOTE: IF DIRECT DEPOSIT TO BANK ACCOUNT IS SELECTED, YOUR BLANK, UNSIGNED CHECK
MARKED "VOID" OR A DEPOSIT SLIP FROM YOUR SAVINGS ACCOUNT SHOULD ACCOMPANY THIS
APPLICATION.
41
<PAGE>
MERRILL LYNCH COLORADO MUNICIPAL BOND FUND - AUTHORIZATION FORM (PART 1) -
(CONTINUED)
- --------------------------------------------------------------------------------
3. SOCIAL SECURITY NUMBER OR TAXPAYER IDENTIFICATION NUMBER
------------------------------------------------------------
Social Security Number or Taxpayer Identification Number
Under penalty of perjury, I certify (1) that the number set forth above is
my correct Social Security Number or Taxpayer Identification Number and (2) that
I am not subject to backup withholding (as discussed in the Prospectus under
"Distributions and Taxes -- Taxes") either because I have not been notified that
I am subject thereto as a result of a failure to report all interest or
dividends, or the Internal Revenue Service ("IRS") has notified me that I am no
longer subject thereto.
INSTRUCTION: YOU MUST STRIKE OUT THE LANGUAGE IN (2) ABOVE IF YOU HAVE BEEN
NOTIFIED THAT YOU ARE SUBJECT TO BACKUP WITHHOLDING DUE TO UNDERREPORTING AND IF
YOU HAVE NOT RECEIVED A NOTICE FROM THE IRS THAT BACKUP WITHHOLDING HAS BEEN
TERMINATED. THE UNDERSIGNED AUTHORIZES THE FURNISHING OF THIS CERTIFICATION TO
OTHER MERRILL LYNCH SPONSORED MUTUAL FUNDS.
<TABLE>
<S> <C>
........................................................... ............................................................
Signature of Owner Signature of Co-Owner (if any)
</TABLE>
- --------------------------------------------------------------------------------
4. LETTER OF INTENTION -- CLASS A AND CLASS D SHARES ONLY (See terms and
conditions in the Statement of Additional Information)
Dear Sir/Madam:
..................................... , 19 ....................................
Date of initial purchase
Although I am not obligated to do so, I intend to purchase shares of Merrill
Lynch Colorado Municipal Bond Fund or any other investment company with an
initial sales charge or deferred sales charge for which Merrill Lynch Funds
Distributor, Inc. acts as distributor over the next 13-month period which will
equal or exceed:
/ / $25,000 / / $50,000 / / $100,000 / / $250,000 / / $1,000,000
Each purchase will be made at the then reduced offering price applicable to
the amount checked above, as described in the Merrill Lynch Colorado Municipal
Bond Fund Prospectus.
I agree to the terms and conditions of the Letter of Intention. I hereby
irrevocably constitute and appoint Merrill Lynch Funds Distributor, Inc., my
attorney, with full power of substitution, to surrender for redemption any or
all shares of Merrill Lynch Colorado Municipal Bond Fund held as security.
<TABLE>
<S> <C>
By.......................................................... ............................................................
Signature of Owner Signature of Co-Owner
(if registered in joint names, both must sign)
</TABLE>
In making purchases under this letter, the following are the related
accounts on which reduced offering prices are to apply:
<TABLE>
<S> <C>
(1) Name.................................................... (2) Name....................................................
Account Number.............................................. Account Number..............................................
</TABLE>
- --------------------------------------------------------------------------------
5. FOR DEALER ONLY
<TABLE>
<S> <C>
Branch Office, Address, Stamp We hereby authorize Merrill Lynch Funds Distributor, Inc. to
act as our agent in connection with transactions under this
authorization form and agree to notify the Distributor of
any purchases made under a Letter of Intention or Systematic
Withdrawal Plan. We guarantee the shareholder's signature.
This form, when completed, should be mailed to: ............................................................
Merrill Lynch Colorado Municipal Bond Fund Dealer Name and Address
c/o Financial Data Services, Inc. By: .......................................................
Transfer Agency Mutual Fund Operations Authorized Signature of Dealer
P.O. Box 45289 ------------ ----------------
Jacksonville, Florida 32232-5289 ------------ ----------------
............................................................
Branch Code F/C No. F/C Last Name
------------ --------------------
------------ --------------------
Dealer's Customer A/C No.
</TABLE>
42
<PAGE>
MERRILL LYNCH COLORADO MUNICIPAL BOND FUND - AUTHORIZATION FORM (PART 2)
- --------------------------------------------------------------------------------
NOTE: THIS FORM IS REQUIRED TO APPLY FOR THE SYSTEMATIC WITHDRAWAL OR AUTOMATIC
INVESTMENT PLANS ONLY.
- --------------------------------------------------------------------------------
1. ACCOUNT REGISTRATION
<TABLE>
<S> <C>
Name of Owner .............................................. ----------------------------------------
Name of Co-Owner (if any) .................................. Social Security Number
Address .................................................... or Taxpayer Identification Number
........................................................... Account Number .............................................
(if existing account)
</TABLE>
- --------------------------------------------------------------------------------
2. SYSTEMATIC WITHDRAWAL PLAN--CLASS A AND D SHARES ONLY (SEE TERMS AND
CONDITIONS IN THE STATEMENT OF ADDITIONAL INFORMATION)
Minimum Requirements: $10,000 for monthly disbursements, $5,000 for
quarterly, of / / Class A or / / Class D shares in Merrill Lynch Colorado
Municipal Bond Fund at cost or current offering price. Withdrawals to be made
either (check one) / / Monthly on the 24th day of each month,
or / / Quarterly on the 24th day of March, June, September and December. If the
24th falls on a weekend or holiday, the next succeeding business day will be
utilized. Begin systematic withdrawal on ________________(month)________________
or as soon as possible thereafter.
SPECIFY HOW YOU WOULD LIKE YOUR WITHDRAWAL PAID TO YOU (CHECK
ONE): / / $ ........ or / / ....... % of the current value of / / Class A or
/ / Class D shares in the account.
SPECIFY WITHDRAWAL METHOD: / / check or / / direct deposit to bank account
(check one and complete part (a) or (b) below):
DRAW CHECKS PAYABLE (CHECK ONE)
(a) I hereby authorize payment by check
/ / as indicated in Item 1.
/ / to the order of .........................................................
Mail to (check one)
/ / the address indicated in Item 1.
/ / Name (please print) .....................................................
Address .......................................................................
.......................................................................
Signature of Owner .......................... Date .........................
Signature of Co-Owner (if any) .................................................
(B) I HEREBY AUTHORIZE PAYMENT BY DIRECT DEPOSIT TO MY BANK ACCOUNT AND, IF
NECESSARY, DEBIT ENTRIES AND ADJUSTMENTS FOR ANY CREDIT ENTRIES MADE TO MY
ACCOUNT. I AGREE THAT THIS AUTHORIZATION WILL REMAIN IN EFFECT UNTIL I PROVIDE
WRITTEN NOTIFICATION TO FINANCIAL DATA SERVICES, INC. AMENDING OR TERMINATING
THIS SERVICE.
Specify type of account (check one) / / checking / / savings
Name on your account ...........................................................
Bank Name ......................................................................
Bank Number ......................... Account Number .........................
Bank Address ..................................................................
..................................................................
Signature of Depositor ......................... Date ........................
Signature of Depositor .........................................................
(if joint account, both must sign)
NOTE: IF DIRECT DEPOSIT IS ELECTED, YOUR BLANK, UNSIGNED CHECK MARKED "VOID" OR
A DEPOSIT SLIP FROM YOUR SAVINGS ACCOUNT SHOULD ACCOMPANY THIS APPLICATION.
43
<PAGE>
MERRILL LYNCH COLORADO MUNICIPAL BOND FUND - AUTHORIZATION FORM (PART 2) -
(CONTINUED)
- --------------------------------------------------------------------------------
3. APPLICATION FOR AUTOMATIC INVESTMENT PLAN
I hereby request that Financial Data Services, Inc. draw an automated
clearing house ("ACH") debit on my checking account as described below each
month to purchase: (choose one)
/ / Class A shares / / Class B shares / / Class C shares / / Class D shares
of Merrill Lynch Colorado Municipal Bond Fund subject to the terms set forth
below. In the event that I am not eligible to purchase Class A shares, I
understand that Class D shares will be purchased.
FINANCIAL DATA SERVICES, INC.
You are hereby authorized to draw an ACH debit each month on my bank account for
investment in Merrill Lynch Colorado Municipal Bond Fund as indicated below:
Amount of each ACH debit $ .................................................
Account number ............................................................
Please date and invest ACH debits on the 20th of each month
beginning .................................. or as soon thereafter as possible.
(Month)
I agree that you are drawing these ACH debits voluntarily at my request and
that you shall not be liable for any loss arising from any delay in preparing or
failure to prepare any such debit. If I change banks or desire to terminate or
suspend this program, I agree to notify you promptly in writing. I hereby
authorize you to take any action to correct erroneous ACH debits of my bank
account or purchases of fund shares including liquidating shares of the Fund and
crediting my bank account. I further agree that if a check or debit is not
honored upon presentation, Financial Data Services, Inc. is authorized to
discontinue immediately the Automatic Investment Plan and to liquidate
sufficient shares held in my account to offset the purchase made with the
dishonored debit.
................................... ..................................
Date Signature of Depositor
........................................
Signature of Depositor
(If joint account, both must sign)
AUTHORIZATION TO HONOR ACH DEBITS
DRAWN BY FINANCIAL DATA SERVICES, INC.
To ........................................................................ Bank
(Investor's Bank)
Bank Address ...................................................................
City ................... State ................... Zip Code ..................
As a convenience to me, I hereby request and authorize you to pay and charge to
my account ACH debits drawn on my account by and payable to Financial Data
Services, Inc. I agree that your rights in respect to each such debit shall be
the same as if it were a check drawn on you and signed personally by me. This
authority is to remain in effect until revoked personally by me in writing.
Until you receive such notice, you shall be fully protected in honoring any such
debit. I further agree that if any such debit be dishonored, whether with or
without cause and whether intentionally or inadvertently, you shall be under no
liability.
................................... ..................................
Date Signature of Depositor
................................... ..................................
Bank Account Number Signature of Depositor
(If joint account, both must sign)
NOTE: IF AUTOMATIC INVESTMENT PLAN IS ELECTED, YOUR BLANK, UNSIGNED CHECK MARKED
"VOID" SHOULD ACCOMPANY THIS APPLICATION.
44
<PAGE>
MANAGER
Fund Asset Management
Administrative Offices:
800 Scudders Mill Road
Plainsboro, New Jersey
Mailing Address:
P.O. Box 9011
Princeton, New Jersey 08543-9011
DISTRIBUTOR
Merrill Lynch Funds Distributor, Inc.
Administrative Offices:
800 Scudders Mill Road
Plainsboro, New Jersey
Mailing Address:
P.O. Box 9011
Princeton, New Jersey 08543-9011
CUSTODIAN
State Street Bank and
Trust Company
P.O. Box 351
Boston, Massachusetts 02101
TRANSFER AGENT
Financial Data Services, Inc.
Administrative Offices:
Transfer Agency Mutual Fund Operations
4800 Deer Lake Drive East
Jacksonville, Florida 32246-6484
Mailing Address:
P.O. Box 45289
Jacksonville, Florida 32232-5289
INDEPENDENT AUDITORS
Deloitte & Touche LLP
117 Campus Drive
Princeton, New Jersey 08540
COUNSEL
Brown & Wood
One World Trade Center
New York, New York 10048-0557
<PAGE>
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, IN CONNECTION
WITH THE OFFER CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER
INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE TRUST, THE MANAGER OR THE DISTRIBUTOR. THIS PROSPECTUS DOES NOT
CONSTITUTE AN OFFERING IN ANY STATE IN WHICH SUCH OFFERING MAY NOT LAWFULLY BE
MADE.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Fee Table...................................... 2
Merrill Lynch Select Pricing-SM- System........ 4
Financial Highlights........................... 8
Investment Objective and Policies.............. 9
Potential Benefits........................... 11
Special and Risk Considerations Relating to
Colorado Municipal Bonds................... 11
Description of Municipal Bonds............... 12
When-Issued Securities and Delayed Delivery
Transactions............................... 14
Call Rights.................................. 14
Financial Futures Transactions and Options... 15
Repurchase Agreements........................ 17
Investment Restrictions...................... 17
Management of the Trust........................ 19
Trustees..................................... 19
Management and Advisory Arrangements......... 19
Transfer Agency Services..................... 20
Purchase of Shares............................. 20
Initial Sales Charge Alternatives -- Class A
and Class D Shares......................... 22
Deferred Sales Charge Alternatives -- Class B
and Class C Shares......................... 24
Distribution Plans........................... 27
Limitations on the Payment of Deferred Sales
Charges.................................... 28
Redemption of Shares........................... 29
Redemption................................... 29
Repurchase................................... 30
Reinstatement Privilege -- Class A and Class
D Shares................................... 30
Shareholder Services........................... 31
Investment Account........................... 31
Exchange Privilege........................... 31
Automatic Reinvestment of Dividends and
Capital Gains Distributions................ 32
Systematic Withdrawal Plans.................. 33
Automatic Investment Plans................... 33
Portfolio Transactions......................... 33
Distributions and Taxes........................ 34
Distributions................................ 34
Taxes........................................ 34
Performance Data............................... 37
Additional Information......................... 38
Determination of Net Asset Value............. 38
Organization of the Trust.................... 38
Shareholder Reports.......................... 39
Shareholder Inquiries........................ 40
Authorization Form............................. 41
Code # 16914-1094
</TABLE>
[LOGO]
Merrill Lynch
Colorado Municipal
Bond Fund
Merrill Lynch Multi-State
Municipal Series Trust
PROSPECTUS
October 21, 1994
Distributor:
Merrill Lynch
Funds Distributor, Inc.
This prospectus should be
retained for future reference
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
MERRILL LYNCH COLORADO MUNICIPAL BOND FUND
MERRILL LYNCH MULTI-STATE MUNICIPAL SERIES TRUST
P.O. BOX 9011, PRINCETON, NEW JERSEY 08543-9011 - PHONE NO. (609) 282-2800
-------------------
Merrill Lynch Colorado Municipal Bond Fund (the "Fund") is a series of
Merrill Lynch Multi-State Municipal Series Trust (the "Trust"), an open-end
management investment company organized as a Massachusetts business trust. The
investment objective of the Fund is to provide shareholders with as high a level
of income exempt from Federal and Colorado income taxes as is consistent with
prudent investment management. The Fund invests primarily in a portfolio of
long-term investment grade obligations the interest on which is exempt from
Federal and Colorado income taxes in the opinion of bond counsel to the issuer
("Colorado Municipal Bonds"). There can be no assurance that the investment
objective of the Fund will be realized.
Pursuant to the Merrill Lynch Select Pricing-SM- System, the Fund offers
four classes of shares, each with a different combination of sales charges,
ongoing fees and other features. The Merrill Lynch Select Pricing-SM- System
permits an investor to choose the method of purchasing shares that the investor
believes is most beneficial given the amount of the purchase, the length of time
the investor expects to hold the shares and other relevant circumstances.
-------------------
The Statement of Additional Information of the Fund is not a prospectus and
should be read in conjunction with the Prospectus of the Fund, dated October 21,
1994 (the "Prospectus"), which has been filed with the Securities and Exchange
Commission and can be obtained, without charge, by calling or by writing the
Fund at the above telephone number or address. This Statement of Additional
Information has been incorporated by reference into the Prospectus. Capitalized
terms used but not defined herein have the same meanings as in the Prospectus.
-------------------
FUND ASSET MANAGEMENT--MANAGER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC.--DISTRIBUTOR
The date of this Statement of Additional Information is October 21, 1994.
<PAGE>
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to provide shareholders with as high
a level of income exempt from Federal and Colorado personal income taxes as is
consistent with prudent investment management. The Fund seeks to achieve its
objective by investing primarily in a portfolio of long-term obligations issued
by or on behalf of the State of Colorado, its political subdivisions, agencies
and instrumentalities and obligations of other qualifying issuers, such as
issuers located in Puerto Rico, the Virgin Islands and Guam, which pay interest
exempt, in the opinion of bond counsel to the issuer, from Federal and Colorado
income taxes. Obligations exempt from Federal income taxes are referred to
herein as "Municipal Bonds" and obligations exempt from both Federal and
Colorado income taxes are referred to as "Colorado Municipal Bonds". Unless
otherwise indicated, references to Municipal Bonds shall be deemed to include
Colorado Municipal Bonds. The Fund anticipates that at all times, except during
temporary defensive periods, it will maintain at least 65% of its total assets
invested in Colorado Municipal Bonds. At times, the Fund will seek to hedge its
portfolio through the use of futures transactions to reduce volatility in the
net asset value of Fund shares. Reference is made to "Investment Objective and
Policies" in the Prospectus for a discussion of the investment objective and
policies of the Fund.
Municipal Bonds may include general obligation bonds of the State and its
political subdivisions, revenue bonds to finance utility systems, highways,
bridges, port and airport facilities, colleges, hospitals, housing facilities,
etc., and industrial development bonds or private activity bonds. The interest
on such obligations may bear a fixed rate or be payable at a variable or
floating rate. The Municipal Bonds purchased by the Fund will be primarily what
are commonly referred to as "investment grade" securities, which are obligations
rated at the time of purchase within the four highest quality ratings as
determined by either Moody's Investors Service, Inc. ("Moody's") (currently Aaa,
Aa, A and Baa), Standard & Poor's Corporation ("Standard & Poor's") (currently
AAA, AA, A and BBB) or Fitch Investors Service, Inc. ("Fitch") (currently AAA,
AA, A and BBB). If unrated, such securities will possess creditworthiness
comparable, in the opinion of the manager of the Fund, Fund Asset Management,
L.P. (the "Manager"), to other obligations in which the Fund may invest.
The Fund ordinarily does not intend to realize investment income not exempt
from Federal and Colorado income taxes. However, to the extent that suitable
Colorado Municipal Bonds are not available for investment by the Fund, the Fund
may purchase Municipal Bonds issued by other states, their agencies and
instrumentalities, the interest income on which is exempt, in the opinion of
bond counsel, from Federal but not Colorado taxation. The Fund also may invest
in securities not issued by or on behalf of a state or territory or by an agency
or instrumentality thereof, if the Fund nevertheless believes such securities to
be exempt from Federal income taxation ("Non-Municipal Tax-Exempt Securities").
Non-Municipal Tax-Exempt Securities may include securities issued by other
investment companies that invest in municipal bonds, to the extent permitted by
applicable law. Other Non-Municipal Tax-Exempt Securities also could include
trust certificates or other derivative instruments evidencing interests in one
or more Municipal Bonds.
Except when acceptable securities are unavailable as determined by the
Manager, the Fund, under normal circumstances, will invest at least 65% of its
total assets in Colorado Municipal Bonds. For temporary periods or to provide
liquidity, the Fund has the authority to invest as much as 35% of its total
assets in tax-exempt or taxable money market obligations with a maturity of one
year or less (such short-term obligations being referred to herein as "Temporary
Investments"), except that taxable Temporary Investments shall not exceed 20% of
the Fund's net assets. The Fund at all times will have at least 80% of its net
assets invested in
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securities exempt from Federal income taxation. However, interest received on
certain otherwise tax-exempt securities which are classified as "private
activity bonds" (in general bonds that benefit non-governmental entities) may be
subject to an alternative minimum tax. The Fund may purchase such private
activity bonds. See "Distributions and Taxes". In addition, the Fund reserves
the right to invest temporarily a greater portion of its assets in Temporary
Investments for defensive purposes, when, in the judgment of the Manager, market
conditions warrant. The investment objective of the Fund set forth in this
paragraph is a fundamental policy of the Fund which may not be changed without a
vote of a majority of the outstanding shares of the Fund. The Fund's hedging
strategies are not fundamental policies and may be modified by the Trustees of
the Trust without the approval of the Fund's shareholders.
Municipal Bonds may at times be purchased or sold on a delayed delivery
basis or a when-issued basis. These transactions arise when securities are
purchased or sold by the Fund with payment and delivery taking place in the
future, often a month or more after the purchase. The payment obligation and the
interest rate are each fixed at the time the buyer enters into the commitment.
The Fund will make only commitments to purchase such securities with the
intention of actually acquiring the securities, but the Fund may sell these
securities prior to the settlement date if it is deemed advisable. Purchasing
Municipal Bonds on a when-issued basis involves the risk that the yields
available in the market when the delivery takes place actually may be higher
than those obtained in the transaction itself; if yields so increase, the value
of the when-issued obligations generally will decrease. The Fund will maintain a
separate account at its custodian bank consisting of cash, cash equivalents or
high-grade, liquid Municipal Bonds or Temporary Investments (valued on a daily
basis) equal at all times to the amount of the when-issued commitment.
The Fund may invest in Municipal Bonds (and Non-Municipal Tax-Exempt
Securities) the return on which is based on a particular index of value or
interest rates. For example, the Fund may invest in Municipal Bonds that pay
interest based on an index of Municipal Bond interest rates or based on the
value of gold or some other commodity. The principal amount payable upon
maturity of certain Municipal Bonds also may be based on the value of an index.
To the extent the Fund invests in these types of Municipal Bonds, the Fund's
return on such Municipal Bonds will be subject to risk with respect to the value
of the particular index. Also, the Fund may invest in so-called "inverse
floating obligations" or "residual interest bonds" on which the interest rates
typically decline as market rates increase and increase as market rates decline.
Such securities have the effect of providing a degree of investment leverage,
since they may increase or decrease in value in response to changes, as an
illustration, in market interest rates at a rate which is a multiple (typically
two) of the rate at which fixed-rate long-term tax exempt securities increase or
decrease in response to such changes. As a result, the market values of such
securities will generally be more volatile than the market values of fixed-rate
tax exempt securities. To seek to limit the volatility of these securities, the
Fund may purchase inverse floating obligations with shorter term maturities or
which contain limitations on the extent to which the interest rate may vary. The
Manager believes that indexed and inverse floating obligations represent a
flexible portfolio management instrument for the Fund which allows the Manager
to vary the degree of investment leverage relatively efficiently under different
market conditions. Certain investments in such obligations may be illiquid. The
Fund may not invest in such illiquid obligations if such investments, together
with other illiquid investments, would exceed 15% of the Fund's net assets.
The Fund may purchase a Municipal Bond issuer's right to call all or a
portion of such Municipal Bond for mandatory tender for purchase (a "Call
Right"). A holder of a Call Right may exercise such right to require a mandatory
tender for the purchase of related Municipal Bonds, subject to certain
conditions. A
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Call Right that is not exercised prior to the maturity of the related Municipal
Bond will expire without value. The economic effect of holding both the Call
Right and the related Municipal Bond is identical to holding a Municipal Bond as
a non-callable security. Certain investments in such obligations may be
illiquid. The Fund may not invest in such illiquid obligations if such
investments, together with other illiquid investments, would exceed 15% of the
Fund's net assets.
The Fund may invest up to 20% of its total assets in Municipal Bonds which
are rated below Baa by Moody's or below BBB by Standard & Poor's or Fitch or
which, in the Manager's judgment, possess similar credit characteristics ("high
yield securities"). See Appendix II -- "Ratings of Municipal Bonds" -- for
additional information regarding ratings of debt securities. The Manager
considers the ratings assigned by Standard & Poor's, Moody's or Fitch as one of
several factors in its independent credit analysis of issuers.
High yield securities are considered by Standard & Poor's, Moody's and Fitch
to have varying degrees of speculative characteristics. Consequently, although
high yield securities can be expected to provide higher yields, such securities
may be subject to greater market price fluctuations and risk of loss of
principal than lower yielding, higher rated debt securities. Investments in high
yield securities will be made only when, in the judgment of the Manager, such
securities provide attractive total return potential relative to the risk of
such securities, as compared to higher quality debt securities. The Fund
generally will not invest in debt securities in the lowest rating categories
(those rated CC or lower by Standard & Poor's or Fitch or Ca or lower by
Moody's) unless the Manager believes that the financial condition of the issuer
or the protection afforded the particular securities is stronger than would
otherwise be indicated by such low ratings. The Fund does not intend to purchase
debt securities that are in default or which the Manager believes will be in
default.
Issuers of high yield securities may be highly leveraged and may not have
available to them more traditional methods of financing. Therefore, the risks
associated with acquiring the securities of such issuers generally are greater
than is the case with higher rated securities. For example, during an economic
downturn or a sustained period of rising interest rates, issuers of high yield
securities may be more likely to experience financial stress, especially if such
issuers are highly leveraged. During periods of economic recession, such issuers
may not have sufficient revenues to meet their interest payment obligations. The
issuer's ability to service its debt obligations also may be adversely affected
by specific issuer developments, or the issuer's inability to meet specific
projected business forecasts, or the unavailability of additional financing. The
risk of loss due to default by the issuer is significantly greater for the
holders of high yield securities because such securities may be unsecured and
may be subordinated to other creditors of the issuer.
High yield securities frequently have call or redemption features that would
permit an issuer to repurchase the security from the Fund. If a call were
exercised by the issuer during a period of declining interest rates, the Fund
likely would have to replace such called security with a lower yielding
security, thus decreasing the net investment income to the Fund and dividends to
shareholders.
The Fund may have difficulty disposing of certain high yield securities
because there may be a thin trading market for such securities. Because not all
dealers maintain markets in all high yield securities, there is no established
secondary market for many of these securities, and the Fund anticipates that
such securities could be sold only to a limited number of dealers or
institutional investors. To the extent that a secondary trading market for high
yield securities does exist, it generally is not as liquid as the secondary
market for higher rated securities. Reduced secondary market liquidity may have
an adverse impact on market price
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and the Fund's ability to dispose of particular issues when necessary to meet
the Fund's liquidity needs or in response to a specific economic event such as a
deterioration in the creditworthiness of the issuer. Reduced secondary market
liquidity for certain securities also may make it more difficult for the Fund to
obtain accurate market quotations for purposes of valuing the Fund's portfolio.
Market quotations generally are available on many high yield securities only
from a limited number of dealers and may not necessarily represent firm bids of
such dealers or prices for actual sales.
It is expected that a significant portion of the high yield securities
acquired by the Fund will be purchased upon issuance, which may involve special
risks because the securities so acquired are new issues. In such instances the
Fund may be a substantial purchaser of the issue and therefore have the
opportunity to participate in structuring the terms of the offering. Although
this may enable the Fund to seek to protect itself against certain of such
risks, the considerations discussed herein would nevertheless remain applicable.
Adverse publicity and investor perceptions, which may not be based on
fundamental analysis, also may decrease the value and liquidity of high yield
securities, particularly in a thinly traded market. Factors adversely affecting
the market value of high yield securities are likely to affect adversely the
Fund's net asset value. In addition, the Fund may incur additional expenses to
the extent that it is required to seek recovery upon a default on a portfolio
holding or participate in the restructuring of the obligation.
DESCRIPTION OF MUNICIPAL BONDS AND TEMPORARY INVESTMENTS
Set forth below is a description of the Municipal Bonds and Temporary
Investments in which the Fund may invest. A more complete discussion concerning
futures and options transactions is set forth under "Investment Objective and
Policies" in the Prospectus. Information with respect to ratings assigned to
tax-exempt obligations which the Fund may purchase is set forth in Appendix II
to this Statement of Additional Information.
DESCRIPTION OF MUNICIPAL BONDS
Municipal Bonds include debt obligations issued to obtain funds for various
public purposes, including construction of a wide range of public facilities,
refunding of outstanding obligations and obtaining funds for general operating
expenses and loans to other public institutions and facilities. In addition,
certain types of bonds are issued by or on behalf of public authorities to
finance various privately owned or operated facilities, including certain
facilities for the local furnishing of electric energy or gas, sewage
facilities, solid waste disposal facilities and other specialized facilities.
Such obligations are included within the term Municipal Bonds if the interest
paid thereon is, in the opinion of bond counsel, excluded from gross income for
Federal income tax purposes and, in the case of Colorado Municipal Bonds, exempt
from Colorado income taxes. Other types of industrial development bonds or
private activity bonds, the proceeds of which are used for the construction,
equipment or improvement of privately operated industrial or commercial
facilities, may constitute Municipal Bonds, although the current Federal tax
laws place substantial limitations on the size of such issues.
The two principal classifications of Municipal Bonds are "general
obligation" bonds and "revenue" bonds which latter category includes industrial
development bonds and, for bonds issued after August 15, 1986, private activity
bonds. General obligation bonds are secured by the issuer's pledge of faith,
credit and taxing power for the payment of principal and interest. Revenue bonds
are payable only from the revenues derived from a particular facility or class
of facilities or, in some cases, from the proceeds of a special or
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limited tax or other specific revenue source such as payments from the user of
the facility being financed. Industrial development bonds ("IDBs") and private
activity bonds are in most cases revenue bonds and generally do not constitute
the pledge of the credit or taxing power of the issuer of such bonds. Generally,
the payment of the principal of and interest on such IDBs and private activity
bonds depends solely on the ability of the user of the facility financed by the
bonds to meet its financial obligations and the pledge, if any, of real and
personal property so financed as security for such payment, unless a line of
credit, bond insurance or other security is furnished. The Fund also may invest
in "moral obligation" bonds, which are normally issued by special purpose public
authorities. Under a moral obligation bond, if the issuer thereof is unable to
meet its obligations, the repayment of the bond becomes a moral commitment, but
not a legal obligation, of the state or municipality in question.
Also included within the general category of Municipal Bonds are
participation certificates issued by government authorities or entities to
finance the acquisition or construction of equipment, land and/or facilities.
The certificates represent participations in a lease, an installment purchase
contract or a conditional sales contract (hereinafter collectively called "lease
obligations") relating to such equipment, land or facilities. Although lease
obligations do not constitute general obligations of the issuer for which the
issuer's unlimited taxing power is pledged, a lease obligation is frequently
backed by the issuer's covenant to budget for, appropriate and make the payments
due under the lease obligation. Certain investments in lease obligations may be
illiquid. The Fund may not invest in illiquid lease obligations if such
investments, together with all other illiquid investments, would exceed 15% of
the Fund's net assets. The Fund may, however, invest without regard to such
limitation in lease obligations which the Manager, pursuant to the guidelines
which have been adopted by the Board of Trustees and subject to the supervision
of the Board of Trustees, determines to be liquid. The Manager will deem lease
obligations liquid if they are publicly offered and have received an investment
grade rating of Baa or better by Moody's, or BBB or better by Standard & Poor's
or Fitch. Unrated lease obligations, or those rated below investment grade, will
be considered liquid if the obligations come to the market through an
underwritten public offering and at least two dealers are willing to give
competitive bids. In reference to the latter, the Manager must, among other
things, also review the creditworthiness of the municipality obligated to make
payment under the lease obligation and make certain specified determinations
based on such factors as the existence of a rating or credit enhancement such as
insurance, the frequency of trades or quotes for the obligation and the
willingness of dealers to make a market in the obligation.
Yields on Municipal Bonds are dependent on a variety of factors, including
the general condition of the money market and of the municipal bond market, the
size of a particular offering, the financial condition of the issuer, the
general conditions of the Municipal Bond market, the maturity of the obligation,
and the rating of the issue. The ability of the Fund to achieve its investment
objective also is dependent on the continuing ability of the issuers of the
bonds in which the Fund invests to meet their obligations for the payment of
interest and principal when due. There are variations in the risks involved in
holding Municipal Bonds, both within a particular classification and between
classifications, depending on numerous factors. Furthermore, the rights of
owners of Municipal Bonds and the obligations of the issuer of such Municipal
Bonds may be subject to applicable bankruptcy, insolvency and similar laws and
court decisions affecting the rights of creditors generally.
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DESCRIPTION OF TEMPORARY INVESTMENTS
The Fund may invest in short-term tax-free and taxable securities subject to
the limitations set forth under "Investment Objective and Policies". The
tax-exempt money market securities may include municipal notes, municipal
commercial paper, municipal bonds with remaining maturity of less than one year,
variable rate demand notes and participations therein. Municipal notes include
tax anticipation notes, bond anticipation notes and grant anticipation notes.
Anticipation notes are sold as interim financing in anticipation of tax
collection, bond sales, government grants or revenue receipts. Municipal
commercial paper refers to short-term unsecured promissory notes generally
issued to finance short-term credit needs. The taxable money market securities
in which the Fund may invest as Temporary Investments consist of U.S. Government
securities, U.S. Government agency securities, domestic bank or savings
institution certificates of deposit and bankers' acceptances, short-term
corporate debt securities such as commercial paper, and repurchase agreements.
These Temporary Investments must have a stated maturity not in excess of one
year from the date of purchase.
Variable rate demand obligations ("VRDOs") are tax-exempt obligations which
contain a floating or variable interest rate adjustment formula and an
unconditional right of demand on the part of the holder thereof to receive
payment of the unpaid principal balance plus accrued interest upon a short
notice period not to exceed seven days. There is, however, the possibility that
because of default or insolvency the demand feature of VRDOs and Participating
VRDOs, described below, may not be honored. The interest rates are adjustable at
intervals (ranging from daily to up to one year) to some prevailing market rate
for similar investments, such adjustment formula being calculated to maintain
the market value of the VRDO at approximately the par value of the VRDOs on the
adjustment date. The adjustments typically are set at a rate determined by the
remarketing agent or based upon the prime rate of a bank or some other
appropriate interest rate adjustment index. The Fund may invest in all types of
tax-exempt instruments currently outstanding or to be issued in the future which
satisfy the short-term maturity and quality standards of the Fund.
The Fund also may invest in VRDOs in the form of participation interests
("Participating VRDOs") in variable rate tax-exempt obligations held by a
financial institution, typically a commercial bank. Participating VRDOs provide
the Fund with a specified undivided interest (up to 100%) of the underlying
obligation and the right to demand payment of the unpaid principal balance plus
accrued interest on the Participating VRDOs from the financial institution upon
a specified number of days' notice, not to exceed seven days. In addition, a
Participating VRDO is backed by an irrevocable letter of credit or guaranty of
the financial institution. The Fund would have an undivided interest in the
underlying obligation and thus participate on the same basis as the financial
institution in such obligation except that the financial institution typically
retains fees out of the interest paid on the obligation for servicing the
obligation, providing the letter of credit and issuing the repurchase
commitment. The Fund has been advised by its counsel that the Fund should be
entitled to treat the income received on Participating VRDOs as interest from
tax-exempt obligations.
VRDOs that contain an unconditional right of demand to receive payment of
the unpaid principal balance plus accrued interest on a notice period exceeding
seven days may be deemed to be illiquid securities. A VRDO with a demand notice
period exceeding seven days therefore will be subject to the Fund's restriction
on illiquid investments unless, in the judgment of the Trustees, such VRDO is
liquid. The
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Trustees may adopt guidelines and delegate to the Manager the daily function of
determining and monitoring liquidity of such VRDOs. The Trustees, however, will
retain sufficient oversight and will be ultimately responsible for such
determination.
The Trust has established the following standards with respect to money
market securities and VRDOs in which the Fund invests. Commercial paper
investments at the time of purchase must be rated "A-1" through "A-3" by
Standard & Poor's, "Prime-1" through "Prime-3" by Moody's or "F-1" through "F-3"
by Fitch or, if not rated, issued by companies having an outstanding debt issue
rated at least "A" by Standard & Poor's, Fitch or Moody's. Investments in
corporate bonds and debentures (which must have maturities at the date of
purchase of one year or less) must be rated at the time of purchase at least "A"
by Standard & Poor's, Moody's or Fitch. Notes and VRDOs at the time of purchase
must be rated SP-1/A-1 through SP-2/A-3 by Standard & Poor's, MIG-l/VMIG-1
through MIG-4/VMIG-4 by Moody's or F-1 through F-3 by Fitch. Temporary
Investments, if not rated, must be of comparable quality to securities rated in
the above rating categories in the opinion of the Manager. The Fund may not
invest in any security issued by a commercial bank or a savings institution
unless the bank or institution is organized and operating in the United States,
has total assets of at least one billion dollars and is a member of the Federal
Deposit Insurance Corporation ("FDIC"), except that up to 10% of total assets
may be invested in certificates of deposit of small institutions if such
certificates are insured fully by the FDIC.
REPURCHASE AGREEMENTS
The Fund may invest in securities pursuant to repurchase agreements.
Repurchase agreements may be entered into only with a member bank of the Federal
Reserve System or primary dealer or an affiliate thereof in U.S. Government
securities. Under such agreements, the bank or primary dealer or an affiliate
thereof agrees, upon entering into the contract, to repurchase the security at a
mutually agreed upon time and price, thereby determining the yield during the
term of the agreement. This results in a fixed rate of return insulated from
market fluctuations during such period. In the case of repurchase agreements,
the prices at which the trades are conducted do not reflect accrued interest on
the underlying obligations. Such agreements usually cover short periods, such as
under one week. Repurchase agreements may be construed to be collateralized
loans by the purchaser to the seller secured by the securities transferred to
the purchaser. In the case of a repurchase agreement, the Fund will require the
seller to provide additional collateral if the market value of the securities
falls below the repurchase price at any time during the term of the repurchase
agreement. In the event of default by the seller under a repurchase agreement
construed to be a collateralized loan, the underlying securities are not owned
by the Fund but only constitute collateral for the seller's obligation to pay
the repurchase price. Therefore, the Fund may suffer time delays and incur costs
or possible losses in connection with the disposition of the collateral. In the
event of a default under such a repurchase agreement or under a purchase and
sale contract, instead of the contractual fixed rate of return, the rate of
return to the Fund will depend on intervening fluctuations of the market value
of such security and the accrued interest on the security. In such event, the
Fund would have rights against the seller for breach of contract with respect to
any losses arising from market fluctuations following the failure of the seller
to perform. The Fund may not invest in repurchase agreements maturing in more
than seven days if such investments, together with all other illiquid
investments, would exceed 15% of the Fund's net assets.
In general, for Federal income tax purposes, repurchase agreements are
treated as collateralized loans secured by the securities "sold". Therefore,
amounts earned under such agreements will not be considered tax-exempt interest.
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FINANCIAL FUTURES TRANSACTIONS AND OPTIONS
Reference is made to the discussion concerning futures transactions under
"Investment Objective and Policies" in the Prospectus. Set forth below is
additional information concerning these transactions.
As described in the Prospectus, the Fund may purchase and sell exchange
traded financial futures contracts ("financial futures contracts") to hedge its
portfolio of Municipal Bonds against declines in the value of such securities
and to hedge against increases in the cost of securities the Fund intends to
purchase. However, any transactions involving financial futures or options (or
puts and calls associated therewith) will be in accordance with the Fund's
investment policies and limitations. See "Investment Objective and Policies --
Investment Restrictions" in the Prospectus. To hedge its portfolio, the Fund may
take an investment position in a futures contract which will move in the
opposite direction from the portfolio position being hedged. While the Fund's
use of hedging strategies is intended to moderate capital changes in portfolio
holdings and thereby reduce the volatility of the net asset value of Fund
shares, the Fund anticipates that its net asset value will fluctuate. Set forth
below is information concerning futures transactions.
DESCRIPTION OF FUTURES CONTRACTS. A futures contract is an agreement between
two parties to buy and sell a security, or in the case of an index-based futures
contract, to make and accept a cash settlement for a set price on a future date.
A majority of transactions in futures contracts, however, do not result in the
actual delivery of the underlying instrument or cash settlement, but are settled
through liquidation, i.e., by entering into an offsetting transaction. Futures
contracts have been designed by boards of trade which have been designated
"contracts markets" by the Commodity Futures Trading Commission ("CFTC").
The purchase or sale of a futures contract differs from the purchase or sale
of a security in that no price or premium is paid or received. Instead, an
amount of cash or securities acceptable to the broker and the relevant contract
market, which varies, but is generally about 5% of the contract amount, must be
deposited with the broker. This amount is known as "initial margin" and
represents a "good faith" deposit assuring the performance of both the purchaser
and seller under the futures contract. Subsequent payments to and from the
broker, called "variation margin", are required to be made on a daily basis as
the price of the futures contract fluctuates making the long and short positions
in the futures contract more or less valuable, a process known as "mark to the
market". At any time prior to the settlement date of the futures contract, the
position may be closed out by taking an opposite position which will operate to
terminate the position in the futures contract. A final determination of
variation margin is then made, additional cash is required to be paid to or
released by the broker, and the purchaser realizes a loss or gain. In addition,
a nominal commission is paid on each completed sale transaction.
The Fund may deal in financial futures contracts based on a long-term
municipal bond index developed by the Chicago Board of Trade ("CBT") and The
Bond Buyer (the "Municipal Bond Index"). The Municipal Bond Index is comprised
of 40 tax-exempt municipal revenue and general obligations bonds. Each bond
included in the Municipal Bond Index must be rated A or higher by Moody's or
Standard & Poor's and must have a remaining maturity of 19 years or more. Twice
a month new issues satisfying the eligibility requirements are added to, and an
equal number of old issues are deleted from, the Municipal Bond Index. The value
of the Municipal Bond Index is computed daily according to a formula based on
the price of each bond in the Municipal Bond Index, as evaluated by six
dealer-to-dealer brokers.
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The Municipal Bond Index futures contract is traded only on the CBT. Like
other contract markets, the CBT assures performance under futures contracts
through a clearing corporation, a nonprofit organization managed by the exchange
membership which also is responsible for handling daily accounting of deposits
or withdrawals of margin.
As described in the Prospectus, the Fund may purchase and sell financial
futures contracts on U.S. Government securities as a hedge against adverse
changes in interest rates as described below. With respect to U.S. Government
securities, currently there are financial futures contracts based on long-term
U.S. Treasury bonds, Treasury notes, Government National Mortgage Association
("GNMA") Certificates and three-month U.S. Treasury bills. The Fund may purchase
and write call and put options on futures contracts on U.S. Government
securities in connection with its hedging strategies.
Subject to policies adopted by the Trustees, the Fund also may engage in
other futures contracts transactions such as futures contracts on other
municipal bond indices which may become available if the Manager and the
Trustees should determine that there is normally a sufficient correlation
between the prices of such futures contracts and the Municipal Bonds in which
the Fund invests to make such hedging appropriate.
FUTURES STRATEGIES. The Fund may sell a financial futures contract (i.e.,
assume a short position) in anticipation of a decline in the value of its
investments in Municipal Bonds resulting from an increase in interest rates or
otherwise. The risk of decline could be reduced without employing futures as a
hedge by selling such Municipal Bonds and either reinvesting the proceeds in
securities with shorter maturities or by holding assets in cash. This strategy,
however, entails increased transaction costs in the form of dealer spreads and
typically would reduce the average yield of the Fund's portfolio securities as a
result of the shortening of maturities. The sale of futures contracts provides
an alternative means of hedging against declines in the value of its investments
in Municipal Bonds. As such values decline, the value of the Fund's positions in
the futures contracts will tend to increase, thus offsetting all or a portion of
the depreciation in the market value of the Fund's Municipal Bond investments
which are being hedged. While the Fund will incur commission expenses in selling
and closing out futures positions, commissions on futures transactions are lower
than transaction costs incurred in the purchase and sale of Municipal Bonds. In
addition, the ability of the Fund to trade in the standardized contracts
available in the futures markets may offer a more effective defensive position
than a program to reduce the average maturity of the portfolio securities due to
the unique and varied credit and technical characteristics of the municipal debt
instruments available to the Fund. Employing futures as a hedge also may permit
the Fund to assume a defensive posture without reducing the yield on its
investments beyond any amounts required to engage in futures trading.
When the Fund intends to purchase Municipal Bonds, the Fund may purchase
futures contracts as a hedge against any increase in the cost of such Municipal
Bonds, resulting from an increase in interest rates or otherwise, that may occur
before such purchases can be effected. Subject to the degree of correlation
between the Municipal Bonds and the futures contracts, subsequent increases in
the cost of Municipal Bonds should be reflected in the value of the futures held
by the Fund. As such purchases are made, an equivalent amount of futures
contracts will be closed out. Due to changing market conditions and interest
rate forecasts, however, a futures position may be terminated without a
corresponding purchase of portfolio securities.
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CALL OPTIONS ON FUTURES CONTRACTS. The Fund also may purchase and sell
exchange traded call and put options on financial futures contracts on U.S.
Government securities. The purchase of a call option on a futures contract is
analogous to the purchase of a call option on an individual security. Depending
on the pricing of the option compared to either the futures contract on which it
is based, or on the price of the underlying debt securities, it may or may not
be less risky than ownership of the futures contract or underlying debt
securities. Like the purchase of a futures contract, the Fund will purchase a
call option on a futures contract to hedge against a market advance when the
Fund is not fully invested.
The writing of a call option on a futures contract constitutes a partial
hedge against declining prices of the securities which are deliverable upon
exercise of the futures contract. If the futures price at expiration is below
the exercise price, the Fund will retain the full amount of the option premium
which provides a partial hedge against any decline that may have occurred in the
Fund's portfolio holdings.
PUT OPTIONS ON FUTURES CONTRACTS. The purchase of options on a futures
contract is analogous to the purchase of protective put options on portfolio
securities. The Fund will purchase put options on futures contracts to hedge the
Fund's portfolio against the risk of rising interest rates.
The writing of a put option on a futures contract constitutes a partial
hedge against increasing prices of the securities which are deliverable upon
exercise of the futures contract. If the futures price at expiration is higher
than the exercise price, the Fund will retain the full amount of the option
premium which provides a partial hedge against any increase in the price of
Municipal Bonds which the Fund intends to purchase.
The writer of an option on a futures contract is required to deposit initial
and variation margin pursuant to requirements similar to those applicable to
futures contracts. Premiums received from the writing of an option will be
included in initial margin. The writing of an option on a futures contract
involves risks similar to those relating to futures contracts.
-------------------
The Trust has received an order from the Securities and Exchange Commission
(the "Commission") exempting it from the provisions of Section 17(f) and Section
18(f) of the Investment Company Act of 1940, as amended (the "1940 Act"), in
connection with its strategy of investing in futures contracts. Section 17(f)
relates to the custody of securities and other assets of an investment company
and may be deemed to prohibit certain arrangements between the Trust and
commodities brokers with respect to initial and variation margin. Section 18(f)
of the 1940 Act prohibits an open-end investment company such as the Trust from
issuing a "senior security" other than a borrowing from a bank. The staff of the
Commission has in the past indicated that a futures contract may be a "senior
security" under the 1940 Act.
RESTRICTIONS ON USE OF FUTURES TRANSACTIONS. Regulations of the CFTC
applicable to the Fund require that all of the Fund's futures transactions
constitute bona fide hedging transactions and that the Fund purchase and sell
futures contracts and options thereon (i) for bona fide hedging purposes, and
(ii) for non-hedging purposes, if the aggregate initial margin and premiums
required to establish positions in such contracts and options does not exceed 5%
of the liquidation value of the Fund's portfolio assets after taking into
account unrealized profits and unrealized losses on any such contracts and
options. (However, the Fund intends to engage in options and futures
transactions only for hedging purposes.) Margin deposits may consist of cash or
securities acceptable to the broker and the relevant contract market.
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When the Fund purchases futures contracts or a call option with respect
thereto or writes a put option on a futures contract, an amount of cash, cash
equivalents or short-term, high-grade, fixed income securities will be deposited
in a segregated account with the Fund's custodian so that the amount so
segregated, plus the amount of initial and variation margin held in the account
of its broker, equals the market value of the futures contract, thereby ensuring
that the use of such futures is unleveraged.
RISK FACTORS IN FUTURES TRANSACTIONS AND OPTIONS. Investment in futures
contracts involves the risk of imperfect correlation between movements in the
price of the futures contract and the price of the security being hedged. The
hedge will not be fully effective when there is imperfect correlation between
the movements in the prices of two financial instruments. For example, if the
price of the futures contract moves more than the price of the hedged security,
the Fund will experience either a loss or gain on the futures contract which is
not offset completely by movements in the price of the hedged securities. To
compensate for imperfect correlations, the Fund may purchase or sell futures
contracts in a greater dollar amount than the hedged securities if the
volatility of the hedged securities is historically greater than the volatility
of the futures contracts. Conversely, the Fund may purchase or sell fewer
futures contracts if the volatility of the price of the hedged securities is
historically less than that of the futures contracts.
The particular municipal bonds comprising the index underlying the Municipal
Bond Index financial futures contract may vary from the Municipal Bonds held by
the Fund. As a result, the Fund's ability to hedge effectively all or a portion
of the value of its Municipal Bonds through the use of such financial futures
contracts will depend in part on the degree to which price movements in the
index underlying the financial futures contract correlate with the price
movements of the Municipal Bonds held by the Fund. The correlation may be
affected by disparities in the average maturity, ratings, geographical mix or
structure of the Fund's investments as compared to those comprising the
Municipal Bond Index, and general economic or political factors. In addition,
the correlation between movements in the value of the Municipal Bond Index may
be subject to change over time as additions to and deletions from the Municipal
Bond Index alter its structure. The correlation between futures contracts on
U.S. Government securities and the Municipal Bonds held by the Fund may be
adversely affected by similar factors and the risk of imperfect correlation
between movements in the prices of such futures contracts and the prices of the
Municipal Bonds held by the Fund may be greater.
The Fund expects to liquidate a majority of the futures contracts it enters
into through offsetting transactions on the applicable contract market. There
can be no assurance, however, that a liquid secondary market will exist for any
particular futures contract at any specific time. Thus, it may not be possible
to close out a futures position. In the event of adverse price movements, the
Fund would continue to be required to make daily cash payments of variation
margin. In such situations, if the Fund has insufficient cash, it may be
required to sell portfolio securities to meet daily variation margin
requirements at a time when it may be disadvantageous to do so. The inability to
close out futures positions also could have an adverse impact on the Fund's
ability to hedge effectively its investments in Municipal Bonds. The Fund will
enter into a futures position only if, in the judgment of the Manager, there
appears to be an actively traded secondary market for such futures contracts.
The successful use of transactions in futures and related options also
depends on the ability of the Manager to forecast correctly the direction and
extent of interest rate movements within a given time frame. To the extent
interest rates remain stable during the period in which a futures contract or
option is held by the Fund or such rates move in a direction opposite to that
anticipated, the Fund may realize a loss on the
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hedging transaction which is not fully or partially offset by an increase in the
value of portfolio securities. As a result, the Fund's total return for such
period may be less than if it had not engaged in the hedging transaction.
Because of low initial margin deposits made on the opening of a futures
position, futures transactions involve substantial leverage. As a result,
relatively small movements in the price of the futures contracts can result in
substantial unrealized gains or losses. Because the Fund will engage in the
purchase and sale of futures contracts solely for hedging purposes, however, any
losses incurred in connection therewith should, if the hedging strategy is
successful, be offset in whole or in part by increases in the value of
securities held by the Fund or decreases in the price of securities the Fund
intends to acquire.
The amount of risk the Fund assumes when it purchases an option on a futures
contract is the premium paid for the option plus related transaction costs. In
addition to the correlation risks discussed above, the purchase of an option on
a futures contract also entails the risk that changes in the value of the
underlying futures contract will not be reflected fully in the value of the
option purchased.
Municipal Bond Index futures contracts have only recently been approved for
trading and therefore have little trading history. It is possible that trading
in such futures contracts will be less liquid than that in other futures
contracts. The trading of futures contracts also is subject to certain market
risks, such as inadequate trading activity, which could at times make it
difficult or impossible to liquidate existing positions.
INVESTMENT RESTRICTIONS
CURRENT INVESTMENT RESTRICTIONS. In addition to the investment restrictions
set forth in the Prospectus, the Trust has adopted the following restrictions
and policies relating to the investment of its assets and its activities, which
are fundamental policies and may not be changed without the approval of the
holders of a majority of the Fund's outstanding voting securities (which for
this purpose and under the 1940 Act means the lesser of (i) 67% of the Fund's
shares present at a meeting at which more than 50% of the outstanding shares of
the Fund are represented or (ii) more than 50% of the Fund's outstanding
shares). The Fund may not (1) purchase any securities other than securities
referred to under "Investment Objective and Policies" herein and in the
Prospectus; (2) invest more than 25% of its total assets (taken at market value
at the time of each investment) in securities of issuers in any particular
industry (other than U.S. Government securities or Government agency securities,
Municipal Bonds and Non-Municipal Tax-Exempt Securities); (3) invest more than
10% of its total assets (taken at market value at the time of each investment)
in industrial revenue bonds where the entity supplying the revenues from which
the issuer is to be paid, and the guarantor of the obligation, including
predecessors, each have a record of less than three years of continuous business
operation; (4) make investments for the purpose of exercising control or
management; (5) purchase securities of other investment companies, except in
connection with a merger, consolidation, acquisition or reorganization, and
provided further that the Fund may purchase securities of closed-end investment
companies if immediately thereafter not more than (i) 3% of the total
outstanding voting stock of such company is owned by the Fund, (ii) 5% of the
Fund's total assets, taken at market value, would be invested in any one such
company, or (iii) 10% of the Fund's total assets, taken at market value, would
be invested in such securities; (6) purchase or sell real estate (including
limited partnership interests, but provided that such restriction shall not
apply to readily marketable securities secured by real estate or interests
therein or
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issued by companies which invest in real estate or interests therein),
commodities or commodity contracts (except that the Fund may purchase and sell
financial futures contracts), interests in oil, gas or other mineral exploration
or development programs or leases; (7) purchase any securities on margin, except
for use of short-term credit necessary for clearance of purchases and sales of
portfolio securities (the deposit or payment by the Fund of initial or variation
margin in connection with financial futures contracts is not considered the
purchase of a security on margin); (8) make short sales of securities or
maintain a short position or invest in put, call, straddle or spread options
(this restriction does not apply to options on financial futures contracts); (9)
make loans to other persons, provided that the Fund may purchase a portion of an
issue of tax-exempt securities (the acquisition of a portion of an issue of
tax-exempt securities or bonds, debentures or other debt securities which are
not publicly distributed is considered to be the making of a loan under the 1940
Act) and provided further that investments in repurchase agreements and purchase
and sale contracts shall not be deemed to be the making of a loan; (10) borrow
amounts in excess of 20% of its total assets taken at market value (including
the amount borrowed), and then only from banks as a temporary measure for
extraordinary or emergency purposes [Usually only "leveraged" investment
companies may borrow in excess of 5% of their assets; however, the Fund will not
borrow to increase income but only to meet redemption requests which might
otherwise require untimely disposition of portfolio securities. The Fund will
not purchase securities while borrowings are outstanding. Interest paid on such
borrowings will reduce net income]; (11) mortgage, pledge, hypothecate or in any
manner transfer as security for indebtedness any securities owned or held by the
Fund except as may be necessary in connection with borrowings mentioned in (10)
above, and then such mortgaging, pledging or hypothecating may not exceed 10% of
its total assets, taken at market value, or except as may be necessary in
connection with transactions in financial futures contracts; (12) invest in
securities which cannot be readily resold because of legal or contractual
restrictions or which are not readily marketable, including individually
negotiated loans that constitute illiquid investments and illiquid lease
obligations, or in repurchase agreements or purchase and sale contracts maturing
in more than seven days, if, regarding all such securities, more than 15% of its
net assets (taken at market value), would be invested in such securities; and
(13) act as an underwriter of securities, except to the extent that the Fund may
technically be deemed an underwriter when engaged in the activities described in
(12) above or insofar as the Fund may be deemed an underwriter under the
Securities Act of 1933, as amended, in selling portfolio securities.
In addition, to comply with Federal income tax requirements for
qualification as a "regulated investment company", the Fund's investments will
be limited in a manner such that, at the close of each quarter of each fiscal
year, (a) no more than 25% of the Fund's total assets are invested in the
securities of a single issuer, and (b) with regard to at least 50% of the Fund's
total assets, no more than 5% of its total assets are invested in the securities
of a single issuer. [For purposes of this restriction, the Fund will regard each
state and each political subdivision, agency or instrumentality of such state
and each multi-state agency of which such state is a member and each public
authority which issues securities on behalf of a private entity as a separate
issuer, except that if the security is backed only by the assets and revenues of
a non-governmental entity then the entity with the ultimate responsibility for
the payment of interest and principal may be regarded as the sole issuer. These
tax-related limitations may be changed by the Trustees of the Trust to the
extent necessary to comply with changes to the Federal income tax requirements.
PROPOSED UNIFORM INVESTMENT RESTRICTIONS. As discussed in the Prospectus
under "Investment Objectives and Policies -- Investment Restrictions", the Board
of Trustees of the Fund has approved the replacement of
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the Fund's existing investment restrictions with the fundamental and
non-fundamental investment restrictions set forth below. These uniform
investment restrictions have been proposed for adoption by all of the non-money
market mutual funds advised by the Manager or its affiliate, Merrill Lynch Asset
Management, L.P. ("MLAM"). The investment objective and policies of the Fund
will be unaffected by the adoption of the proposed investment restrictions.
Shareholders of the Fund are currently considering whether to approve the
proposed revised investment restrictions. If such shareholder approval is
obtained, the Fund's current investment restrictions will be replaced by the
proposed restrictions, and the Fund's Prospectus and Statement of Additional
Information will be supplemented to reflect such change.
Under the proposed fundamental investment restrictions, the Funds may not:
1. Invest more than 25% of its assets, taken at market value, in the
securities of issuers in any particular industry (excluding the U.S.
Government and its agencies and instrumentalities).
2. Make investments for the purpose of exercising control or
management.
3. Purchase or sell real estate, except that, to the extent permitted
by applicable law, the Fund may invest in securities directly or indirectly
secured by real estate or interests therein or issued by companies which
invest in real estate or interests therein.
4. Make loans to other persons, except that the acquisition of bonds,
debentures or other corporate debt securities and investment in government
obligations, commercial paper, pass-through instruments, certificates of
deposit, bankers acceptances, repurchase agreements or any similar
instruments shall not be deemed to be the making of a loan, and except
further that the Fund may lend its portfolio securities, provided that the
lending of portfolio securities may be made only in accordance with
applicable law and the guidelines set forth in the Fund's Prospectus and
Statement of Additional Information, as they may be amended from time to
time.
5. Issue senior securities to the extent such issuance would violate
applicable law.
6. Borrow money, except that (i) the Fund may borrow from banks (as
defined in the 1940 Act) in amounts up to 33 1/3% of its total assets
(including the amount borrowed), (ii) the Fund may borrow up to an
additional 5% of its total assets for temporary purposes, (iii) the Fund may
obtain such short-term credit as may be necessary for the clearance of
purchases and sales of portfolio securities and (iv) the Fund may purchase
securities on margin to the extent permitted by applicable law. The Fund may
not pledge its assets other than to secure such borrowings or, to the extent
permitted by the Fund's investment policies as set forth in its Prospectus
and Statement of Additional Information, as they may be amended from time to
time, in connection with hedging transactions, short sales, when-issued and
forward commitment transactions and similar investment strategies.
7. Underwrite securities of other issuers except insofar as the Fund
technically may be deemed an underwriter under the Securities Act of 1933,
as amended (the "Securities Act") in selling portfolio securities.
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<PAGE>
8. Purchase or sell commodities or contracts on commodities, except to
the extent that the Fund may do so in accordance with applicable law and the
Fund's Prospectus and Statement of Additional Information, as they may be
amended from time to time, and without registering as a commodity pool
operator under the Commodity Exchange Act.
Under the proposed non-fundamental investment restrictions, the Fund may
not:
a. Purchase securities of other investment companies, except to the
extent such purchases are permitted by applicable law.
b. Make short sales of securities or maintain a short position, except
to the extent permitted by applicable law. The Fund currently does not
intend to engage in short sales, except short sales "against the box".
c. Invest in securities which cannot be readily resold because of legal
or contractual restrictions or which cannot otherwise be marketed, redeemed
or put to the issuer or a third party, if at the time of acquisition more
than 15% of its total assets would be invested in such securities. This
restriction shall not apply to securities which mature within seven days or
securities which the Board of Trustees of the Fund has otherwise determined
to be liquid pursuant to applicable law. Notwithstanding the 15% limitation
herein, to the extent the laws of any state in which the Fund's shares are
registered or qualified for sale require a lower limitation, the Fund will
observe such limitation. As of the date hereof, therefore, the Fund will not
invest more than 10% of its total assets in securities which are subject to
this investment restriction (c).
d. Invest in warrants if, at the time of acquisition, its investments
in warrants, valued at the lower of cost or market value, would exceed 5% of
that Fund's net assets; included within such limitation, but not to exceed
2% of the Fund's net assets, are warrants which are not listed on the New
York Stock Exchange or American Stock Exchange or a major foreign exchange.
For purposes of this restriction, warrants acquired by the Fund in units or
attached to securities may be deemed to be without value.
e. Invest in securities of companies having a record, together with
predecessors, of less than three years of continuous operation, if more than
5% of the Fund's total assets would be invested in such securities. This
restriction shall not apply to mortgage-backed securities, asset-backed
securities or obligations issued or guaranteed by the U.S. Government, its
agencies or instrumentalities.
f. Purchase or retain the securities of any issuer, if those individual
officers and directors of the Fund, the officers and general partner of the
Investment Advisor, the directors of such general partner or the officers
and directors of any subsidiary thereof each owning beneficially more than
one-half of one percent of the securities of such issuer own in the
aggregate more than 5% of the securities of such issuer.
g. Invest in real estate limited partnership interests or interests in
oil, gas or other mineral leases, or exploration or development programs,
except that the Fund may invest in securities issued by companies that
engage in oil, gas or other mineral exploration or development activities.
h. Write, purchase or sell puts, calls, straddles, spreads or
combinations thereof, except to the extent permitted in the Fund's
Prospectus and Statement of Additional Information, as they may be amended
from time to time.
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i. Notwithstanding fundamental investment restriction (6) above, borrow
amounts in excess of 20% of its total assets taken at market value, and then
only from banks as a temporary measure for extraordinary or emergency
purposes.
Because of the affiliation of Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("Merrill Lynch") with the Trust, the Fund is prohibited from
engaging in certain transactions involving such firm or its affiliates except
for brokerage transactions permitted under the 1940 Act involving only usual and
customary commissions or transactions pursuant to an exemptive order under the
1940 Act. Included among such restricted transactions will be purchases from or
sales to Merrill Lynch of securities in transactions in which it acts as
principal. See "Portfolio Transactions". An exemptive order has been obtained
which permits the Trust to effect principal transactions with Merrill Lynch in
high quality, short-term, tax-exempt securities subject to conditions set forth
in such order.
MANAGEMENT OF THE TRUST
TRUSTEES AND OFFICERS
The Trustees and executive officers of the Trust and their principal
occupations for at least the last five years are set forth below. Unless
otherwise noted, the address of each Trustee and executive officer is P.O. Box
9011, Princeton, New Jersey 08543-9011.
ARTHUR ZEIKEL -- PRESIDENT AND TRUSTEE(1)(2) -- President and Chief
Investment Officer of the Manager (which term, as used herein, includes the
Manager's corporate predecessors) since 1977; President of Merrill Lynch Asset
Management, L.P. (which term, as used herein, includes its corporate
predecessors) ("MLAM") since 1977 and Chief Investment Officer thereof since
1976; President and Director of Princeton Services, Inc. ("Princeton Services")
since 1993; Executive Vice President of Merrill Lynch & Co., Inc. ("ML&Co.")
since 1991; Executive Vice President of Merrill Lynch since 1990 and a Senior
Vice President thereof from 1985 to 1990; Director of Merrill Lynch Funds
Distributor, Inc. ("MLFD" or the "Distributor").
KENNETH S. AXELSON -- TRUSTEE(2) -- 75 Jameson Point Road, Rockland, Maine
04841. Executive Vice President and Director, J.C. Penney Company, Inc. until
1982; Director, UNUM Corporation, Protection Mutual Insurance Company, Zurn
Industries, Inc. and, formerly, of Central Maine Power Company (until 1992), and
Key Trust Company of Maine (until 1992) and Grumman Corporation (until 1994);
Trustee, The Chicago Dock and Canal Trust.
HERBERT I. LONDON -- TRUSTEE(2) -- New York University -- Gallatin Division,
113-115 University Place, New York, New York 10003. John M. Olin Professor of
Humanities, New York University since 1993 and Professor thereof since 1973;
Dean, Gallatin Division of New York University from 1978 to 1993 and Director
from 1975 to 1976; Distinguished Fellow, Herman Kahn Chair, Hudson Institute
from 1984 to 1985; Trustee, Hudson Institute since 1980; Director, Damon
Corporation since 1991; Overseer, Center for Naval Analyses.
ROBERT R. MARTIN -- TRUSTEE(2) -- 513 Grand Hill, St. Paul, Minnesota 55102.
Chairman, WTC Industries, Inc. since 1994; Chairman and Chief Executive Officer,
Kinnard Investments, Inc. from 1990 to
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<PAGE>
1993; Executive Vice President, Dain Bosworth from 1974 to 1989; Director,
Carnegie Capital Management from 1977 to 1985 and Chairman thereof in 1979;
Director, Securities Industry Association from 1981 to 1982 and Public
Securities Association from 1979 to 1980; Trustee, Northland College since 1992.
JOSEPH L. MAY -- TRUSTEE(2) -- 424 Church Street, Suite 2000, Nashville,
Tennessee 37219. Attorney in private practice since 1984; President, May and
Athens Hosiery Mills Division, Wayne-Gossard Corporation from 1954 to 1983; Vice
President, Wayne-Gossard Corporation from 1972 to 1983; Chairman, The May
Corporation (personal holding company) from 1972 to 1983; Director, Signal
Apparel Co. from 1972 to 1989.
ANDRE F. PEROLD -- TRUSTEE(2) -- Morgan Hall, Soldiers Field, Boston,
Massachusetts 02163. Professor, Harvard Business School and Associate Professor
from 1983 to 1989; Trustee, The Common Fund, since 1989; Director, Quantec
Limited since 1991 and Teknekron Software Systems since 1994.
TERRY K. GLENN -- EXECUTIVE VICE PRESIDENT(1)(2) -- Executive Vice President
of the Manager and MLAM since 1983; Executive Vice President and Director of
Princeton Services since 1993; President of MLFD since 1986 and Director thereof
since 1991.
VINCENT R. GIORDANO -- VICE PRESIDENT AND PORTFOLIO MANAGER(1)(2) --
Portfolio Manager of the Manager and MLAM since 1977 and Senior Vice President
of the Manager and MLAM since 1984; Vice President of MLAM from 1980 to 1984;
Senior Vice President of Princeton Services since 1993.
KENNETH A. JACOB -- VICE PRESIDENT AND PORTFOLIO MANAGER(1)(2) -- Vice
President of the Manager and MLAM since 1984.
DONALD C. BURKE -- VICE PRESIDENT(1)(2) -- Vice President and Director of
Taxation of MLAM since 1990; Employee of Deloitte & Touche LLP from 1982 to
1990.
GERALD M. RICHARD -- TREASURER(1)(2) -- Senior Vice President and Treasurer
of the Manager and MLAM since 1984; Senior Vice President and Treasurer of
Princeton Services since 1993; Treasurer of MLFD since 1984 and Vice President
since 1981.
JERRY WEISS -- SECRETARY(1)(2) -- Vice President of MLAM since 1990;
Attorney in private practice from 1982 to 1990.
- ---------
(1) Interested person, as defined in the 1940 Act, of the Trust.
(2) Such Trustee or officer is a director or officer of certain other investment
companies for which the Manager or MLAM acts as investment adviser or
manager.
At September 30, 1994, the Trustees and officers of the Trust as a group (12
persons) owned an aggregate of less than 1/4 of 1% of the outstanding shares of
Common Stock of ML&Co. and owned an aggregate of less than 1% of the outstanding
shares of the Fund.
The Trust pays each Trustee not affiliated with the Manager a fee of $10,000
per year plus $1,000 per meeting attended, together with such Trustee's actual
out-of-pocket expenses relating to attendance at meetings. The Trust also
compensates members of its Audit Committee, which consists of all the non-
affiliated Trustees a fee of $2,000 per year plus $500 per meeting attended.
Fees and expenses paid to the unaffiliated Trustees aggregated $257 for the
period November 26, 1993 (commencement of operations) to July 31, 1994.
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MANAGEMENT AND ADVISORY ARRANGEMENTS
Reference is made to "Management of the Trust -- Management and Advisory
Arrangements" in the Prospectus for certain information concerning the
management and advisory arrangements of the Fund.
Securities may be held by, or be appropriate investments for, the Fund as
well as other funds or investment advisory clients of the Manager or its
affiliates. Because of different objectives or other factors, a particular
security may be bought for one or more clients when one or more clients are
selling the same security. If the Manager or its affiliates purchase or sell
securities for the Fund or other funds for which they act as manager or for
their advisory clients and such sales or purchases arise for consideration at or
about the same time, transactions in such securities will be made, insofar as
feasible, for the respective funds and clients in a manner deemed equitable to
all. To the extent that transactions on behalf of more than one client of the
Manager or its affiliates during the same period may increase the demand for
securities being purchased or the supply of securities being sold, there may be
an adverse effect on price.
Pursuant to a management agreement between the Trust on behalf of the Fund
and the Manager (the "Management Agreement"), the Manager receives for its
services to the Fund monthly compensation based upon the average daily net
assets of the Fund at the following annual rates: 0.55% of the average daily net
assets not exceeding $500 million; 0.525% of the average daily net assets
exceeding $500 million but not exceeding $1.0 billion; and 0.50% of the average
daily net assets exceeding $1.0 billion. For the period November 26, 1993
(commencement of operations) through July 31, 1994, the total fee paid by the
Fund to the Manager was $78,643 (based on average net assets of approximately
$21 million) all of which was voluntarily reimbursed by the Manager. For that
period, the Manager also voluntarily reimbursed the Fund for other operating
expenses in the amount of $134,420.
California imposes limitations on the expenses of the Fund. These annual
expense limitations require that the Manager reimburse the Fund in an amount
necessary to prevent the aggregate ordinary operating expenses (excluding taxes,
brokerage fees and commissions, distribution fees and extraordinary charges such
as litigation costs) from exceeding in any fiscal year 2.5% of the Fund's first
$30,000,000 of average net assets, 2.0% of the next $70,000,000 of average net
assets and 1.5% of the remaining average net assets. The Manager's obligation to
reimburse the Fund is limited to the amount of the management fee. Expenses not
covered by this limitation are interest, taxes, brokerage commissions and other
items such as extraordinary legal expenses. No fee payment will be made to the
Manager during any fiscal year which will cause such expenses to exceed
limitations at the time of such payment. No fee reimbursements were made during
the period November 29, 1993, the Fund's commencement of operations, to July 31,
1994 pursuant to these operating expense limitations.
The Management Agreement obligates the Manager to provide investment
advisory services and to pay all compensation of and furnish office space for
officers and employees of the Trust connected with investment and economic
research, trading and investment management of the Trust, as well as the fees of
all Trustees of the Trust who are affiliated persons of the Manager or any of
its subsidiaries. The Fund pays all other expenses incurred in its operation
and, if other Series shall be added ("Series"), a portion of the Trust's general
administrative expenses will be allocated on the basis of the asset size of the
respective Series. Expenses that will be borne directly by the Series include,
among other things, redemption expenses, expenses of portfolio transactions,
expenses of registering the shares under Federal and state securities laws,
pricing costs (including the daily calculation of net asset value), expenses of
printing shareholder reports,
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<PAGE>
prospectuses and statements of additional information (except to the extent paid
by the Distributor as described below), fees for legal and auditing services,
Commission fees, interest, certain taxes, and other expenses attributable to a
particular Series. Expenses which will be allocated on the basis of asset size
of the respective Series include fees and expenses of unaffiliated Trustees,
state franchise taxes, costs of printing proxies and other expenses related to
shareholder meetings, and other expenses properly payable by the Trust. The
organizational expenses of the Trust were paid by the Trust, and if additional
Series are added to the Trust, the organizational expenses are allocated among
the Series (including the Fund) in a manner deemed equitable by the Trustees.
Depending upon the nature of a lawsuit, litigation costs may be assessed to the
specific Series to which the lawsuit relates or allocated on the basis of the
asset size of the respective Series. The Trustees have determined that this is
an appropriate method of allocation of expenses. Accounting services are
provided to the Fund by the Manager and the Fund reimburses the Manager for its
costs in connection with such services. For the period November 26, 1993
(commencement of operations) through July 31, 1994, the Fund paid the Manager
$18,821 for accounting services, all of which was voluntarily reimbursed by the
Manager. As required by the Fund's Distribution Agreements, the Distributor will
pay the promotional expenses of the Fund incurred in connection with the
offering of shares of the Fund. Certain expenses in connection with account
maintenance and the distribution of shares will be financed by the Fund pursuant
to the Distribution Plans in compliance with Rule 12b-1 under the 1940 Act. See
"Purchase of Shares -- Distribution Plan".
The Manager is a limited partnership, the partners of which are ML & Co.,
Fund Asset Management, Inc. and Princeton Services.
DURATION AND TERMINATION. Unless earlier terminated as described herein, the
Management Agreement will remain in effect from year to year if approved
annually (a) by the Trustees of the Trust or by a majority of the outstanding
shares of the Fund and (b) by a majority of the Trustees who are not parties to
such contract or interested persons (as defined in the 1940 Act) of any such
party. Such contracts are not assignable and may be terminated without penalty
on 60 days' written notice at the option of either party thereto or by vote of
the shareholders of the Fund.
PURCHASE OF SHARES
Reference is made to "Purchase of Shares" in the Prospectus for certain
information as to the purchase of Fund shares.
The Fund issues four classes of shares under the Merrill Lynch Select
Pricing-SM- System: shares of Class A and Class D are sold to investors choosing
the initial sales charge alternatives, and shares of Class B and Class C are
sold to investors choosing the deferred sales charge alternatives. Each Class A,
Class B, Class C and Class D share of the Fund represents identical interests in
the investment portfolio of the Fund and has the same rights, except that Class
B, Class C and Class D shares bear the expenses of the ongoing account
maintenance fees, and Class B and Class C shares bear the expenses of the
ongoing distribution fees and the additional incremental transfer agency costs
resulting from the deferred sales charge arrangements. Class B, Class C and
Class D shares each have exclusive voting rights with respect to the Rule 12b-1
distribution plan adopted with respect to such class pursuant to which account
maintenance and/or distribution fees are paid. Each class has different exchange
privileges. See "Shareholder Services -- Exchange Privilege".
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The Merrill Lynch Select Pricing-SM- System is used by more than 50 mutual
funds advised by MLAM or its affiliate, the Manager. Funds advised by MLAM or
the Manager are referred to herein as "MLAM-advised mutual funds".
The Fund has entered into four separate distribution agreements with the
Distributor in connection with the subscription and continuous offering of each
class of shares of the Fund (the "Distribution Agreements"). The Distribution
Agreements obligate the Distributor to pay certain expenses in connection with
the offering of each class of shares of the Fund. After the prospectuses,
statements of additional information and periodic reports have been prepared,
set in type and mailed to shareholders, the Distributor pays for the printing
and distribution of copies thereof used in connection with the offering to
dealers and prospective investors. The Distributor also pays for other
supplementary sales literature and advertising costs. The Distribution
Agreements are subject to the same renewal requirements and termination
provisions as the Management Agreement described above.
INITIAL SALES CHARGE ALTERNATIVES--CLASS A AND CLASS D SHARES
The Fund commenced the public offering of its Class A shares on November 29,
1993. The gross sales charges for the sale of Class A shares for the period
November 29, 1993 (commencement of operations) through July 31, 1994 were
$120,789 of which the Distributor received $2,080 and Merrill Lynch received
$118,709.
The term "purchase", as used in the Prospectus and this Statement of
Additional Information in connection with an investment in Class A and Class D
shares of the Fund, refers to a single purchase by an individual, or to
concurrent purchases, which in the aggregate are at least equal to the
prescribed amounts, by an individual, his spouse and their children under the
age of 21 years purchasing shares for his or their own account and to single
purchases by a trustee or other fiduciary purchasing shares for a single trust
estate or single fiduciary account although more than one beneficiary is
involved. The term "purchase" also includes purchases by any "company", as that
term is defined in the 1940 Act, but does not include purchases by any such
company which has not been in existence for at least six months or which has no
purpose other than the purchase of shares of the Fund or shares of other
registered investment companies at a discount; provided, however, that it shall
not include purchases by any group of individuals whose sole organizational
nexus is that the participants therein are credit cardholders of a company,
policyholders of an insurance company, customers of either a bank or
broker-dealer or clients of an investment adviser.
CLOSED-END INVESTMENT OPTION. Class A shares of the Fund and other
MLAM-advised mutual funds ("Eligible Class A Shares") are offered at net asset
value to shareholders of certain closed-end funds advised by the Manager or MLAM
who purchased such closed-end fund shares prior to October 21, 1994 and wish to
reinvest the net proceeds of a sale of their closed-end fund shares of common
stock in Eligible Class A shares, if the conditions set forth below are
satisfied. Alternatively, closed-end fund shareholders who purchased such shares
on or after October 21, 1994 and wish to reinvest the net proceeds from a sale
of their closed-end fund shares are offered Class A Shares (if eligible to buy
Class A Shares) or Class D shares of the Fund and other MLAM-advised mutual
funds ("Eligible Class D Shares"), if the following conditions are met. First,
the sale of closed-end fund shares must be made through Merrill Lynch, and the
net proceeds therefrom must be immediately reinvested in Eligible Class A or
Class D shares. Second, the closed-end fund shares must either have been
acquired in the initial public offering or be shares representing dividends from
shares of common stock acquired in such offering. Third, the closed-end fund
shares must have been
21
<PAGE>
continuously maintained in a Merrill Lynch securities account. Fourth, there
must be a minimum purchase of $250 to be eligible for the investment option.
Class A shares of the Fund are offered at net asset value to shareholders of
Merrill Lynch Senior Floating Rate Fund, Inc. ("Senior Floating Rate Fund") who
wish to reinvest the net proceeds from a sale of certain of their shares of
common stock of Senior Floating Rate Fund in shares of the Fund. In order to
exercise this investment option, Senior Floating Rate Fund shareholders must
sell their Senior Floating Rate Fund shares to the Senior Floating Rate Fund in
connection with a tender offer conducted by the Senior Floating Rate Fund and
reinvest the proceeds immediately in the Fund. This investment option is
available only with respect to the proceeds of Senior Floating Rate Fund shares
as to which no Early Withdrawal Charge (as defined in the Senior Floating Rate
Fund prospectus) is applicable. Purchase orders from Senior Floating Rate Fund
shareholders wishing to exercise this investment option will be accepted only on
the day that the related Senior Floating Fund tender offer terminates and will
be effected at the net asset value of the Fund at such day.
REDUCED INITIAL SALES CHARGES
RIGHT OF ACCUMULATION. Reduced sales charges are applicable through a right
of accumulation under which eligible investors are permitted to purchase shares
of the Fund subject to an initial sales charge at the offering price applicable
to the total of (a) the public offering price of the shares then being purchased
plus (b) an amount equal to the then current net asset value or cost, whichever
is higher, of the purchaser's combined holdings of all classes of shares of the
Fund and of other MLAM-advised mutual funds. For any such right of accumulation
to be made available, the Distributor must be provided at the time of purchase,
by the purchaser or the purchaser's securities dealer, with sufficient
information to permit confirmation of qualification. Acceptance of the purchase
order is subject to such confirmation. The right of accumulation may be amended
or terminated at any time. Shares held in the name of a nominee or custodian
under pensions, profit-sharing, or other employee benefit plans may not be
combined with other shares to qualify for the right of accumulation.
LETTER OF INTENTION. Reduced sales charges are applicable to purchases
aggregating $25,000 or more of the Class A or Class D shares of the Fund or any
other MLAM-advised mutual funds made within a thirteen-month period starting
with the first purchase pursuant to a Letter of Intention in the form provided
in the Prospectus. The Letter of Intention is available only to investors whose
accounts are maintained at the Fund's Transfer Agent. The Letter of Intention is
not available to employee benefit plans for which Merrill Lynch provides plan
participant record-keeping services. The Letter of Intention is not a binding
obligation to purchase any amount of Class A or Class D shares; however, its
execution will result in the purchaser paying a lower sales charge at the
appropriate quantity purchase level. A purchase not originally made pursuant to
a Letter of Intention may be included under a subsequent Letter of Intention
executed within 90 days of such purchase if the Distributor is informed in
writing of this intent within such 90-day period. The value of Class A and Class
D shares of the Fund and of other MLAM-advised mutual funds presently held, at
cost or maximum offering price (whichever is higher), on the date of the first
purchase under the Letter of Intention, may be included as a credit toward the
completion of such Letter, but the reduced sales charge applicable to the amount
covered by such Letter will be applied only to new purchases. If the total
amount of shares does not equal the amount stated in the Letter of Intention
(minimum of $25,000), the investor will be notified and must pay, within 20 days
of the expiration of such Letter, the difference between the sales charge on the
Class A or Class D shares purchased at the reduced rate and the sales charge
applicable to the shares actually purchased through the Letter. Class A or Class
D shares equal to at least five percent of the intended
22
<PAGE>
amount will be held in escrow during the thirteen-month period (while remaining
registered in the name of the purchaser) for this purpose. The first purchase
under the Letter of Intention must be at least five percent of the dollar amount
of such Letter. If during the term of such Letter, a purchase brings the total
amount invested to an amount equal to or in excess of the amount indicated in
the Letter, the purchaser will be entitled on that purchase and subsequent
purchases to that further reduced percentage sales charge, but there will be no
retroactive reduction of the sales charges on any previous purchase. The value
of any shares redeemed or otherwise disposed of by the purchaser prior to
termination or completion of the Letter of Intention will be deducted from the
total purchases made under such Letter. An exchange from Merrill Lynch
Government Fund, Merrill Lynch Institutional Fund, Merrill Lynch Treasury Fund,
Merrill Lynch Ready Assets Trust, Merrill Lynch Retirement Reserves Money Fund,
Merrill Lynch Institutional Tax Exempt Fund, Merrill Lynch U.S. Treasury Money
Fund or Merrill Lynch U.S.A. Government Reserves into the Fund that creates a
sales charge will count toward completing a new or existing Letter of Intention
from the Fund.
TMA-SM- MANAGED TRUSTS. Class A and Class D shares are offered to TMA-SM-
Managed Trusts to which Merrill Lynch Trust Company provides discretionary
trustee services at net asset value.
PURCHASE PRIVILEGE OF CERTAIN PERSONS. Trustees of the Trust, members of the
Boards of other MLAM-advised investment companies, ML & Co. and its subsidiaries
(the term "subsidiaries", when used herein with respect to Merrill Lynch & Co.,
Inc., includes MLAM, FAM and certain other entities directly or indirectly
wholly-owned and controlled by Merrill Lynch & Co., Inc.) and their directors
and employees, and any trust, pension, profit-sharing or other benefit plan for
such persons, may purchase Class A shares of the Fund at net asset value.
Class D shares of the Fund will be offered at net asset value, without sales
charge, to an investor who has a business relationship with a financial
consultant who joined Merrill Lynch from another investment firm within six
months prior to the date of purchase by such investor, if the following
conditions are satisfied. First, the investor must advise Merrill Lynch that it
will purchase Class D shares of the Fund with proceeds from a redemption of a
mutual fund that was sponsored by the financial consultant's previous firm and
was subject to a sales charge either at the time of purchase or on a deferred
basis. Second, the investor also must establish that such redemption had been
made within 60 days prior to the investment in the Fund, and the proceeds from
the redemption had been maintained in the interim in cash or a money market
fund.
Class D shares of the Fund are also offered at net asset value, without
sales charge, to an investor who has a business relationship with a Merrill
Lynch financial consultant and who has invested in a mutual fund sponsored by a
non-Merrill Lynch company for which Merrill Lynch has served as a selected
dealer and where Merrill Lynch has either received or given notice that such
arrangement will be terminated ("notice"), if the following conditions are
satisfied: First, the investor must purchase Class D shares of the Fund with
proceeds from a redemption of shares of such other mutual fund and such fund was
subject to a sales charge either at the time of purchase or on a deferred basis.
Second, such purchase of Class D shares must be made within 90 days after such
notice.
Class D shares of the Fund will be offered at net asset value, without a
sales charge, to an investor who has a business relationship with a Merrill
Lynch financial consultant and who has invested in a mutual fund for which
Merrill Lynch has not serviced as a selected dealer if the following conditions
are satisfied: First, the investor must advise Merrill Lynch that it will
purchase Class D shares of the Fund with proceeds from
23
<PAGE>
the redemption of such shares of other mutual funds and that such shares have
been outstanding for a period of no less than six months; and second, such
purchase of Class D shares must be made within 60 days after the redemption and
the proceeds from the redemption must be maintained in the interim in cash or a
money market fund.
ACQUISITION OF CERTAIN INVESTMENT COMPANIES. The public offering price of
Class D shares may be reduced to the net asset value per Class D share in
connection with the acquisition of the assets of or merger or consolidation with
a personal holding company or a public or private investment company. The value
of the assets or company acquired in a tax-free transaction may be adjusted in
appropriate cases to reduce possible adverse tax consequences to the Fund which
might result from an acquisition of assets having net unrealized appreciation
which is disproportionately higher at the time of acquisition than the realized
or unrealized appreciation of the Fund. The issuance of Class D shares for
consideration other than cash is limited to bona fide reorganizations, statutory
mergers or other acquisitions of portfolio securities which (i) meet the
investment objectives and policies of the Fund; (ii) are acquired for investment
and not for resale (subject to the understanding that the disposition of the
Fund's portfolio securities shall at all times remain within its control); and
(iii) are liquid securities, the value of which is readily ascertainable, which
are not restricted as to transfer either by law or liquidity of market (except
that the Fund may acquire through such transactions restricted or illiquid
securities to the extent the Fund does not exceed the applicable limits on
acquisition of such securities set forth under "Investment Objective and
Policies" herein).
Reductions in or exemptions from the imposition of a sales load are due to
the nature of the investors and/or the reduced sales efforts that will be needed
in obtaining such investments.
DISTRIBUTION PLANS
Reference is made to "Purchase of Shares -- Distribution Plans" in the
Prospectus for certain information with respect to the separate distribution
plans for Class B, Class C and Class D shares pursuant to Rule 12b-1 under the
1940 Act (each a "Distribution Plan") with respect to the account maintenance
and/or distribution fees paid by the Fund to the Distributor with respect to
such classes.
Payments of the account maintenance fees and/or distribution fees are
subject to the provisions of Rule 12b-1 under the 1940 Act. Among other things,
each Distribution Plan provides that the Distributor shall provide and the
Trustees shall review quarterly reports of the disbursement of the account
maintenance fees and/or distribution fees paid to the Distributor. In their
consideration of each Distribution Plan, the Trustees must consider all factors
they deem relevant, including information as to the benefits of the Distribution
Plan to the Fund and its related class of shareholders. Each Distribution Plan
further provides that, so long as the Distribution Plan remains in effect, the
selection and nomination of Trustees who are not "interested persons" of the
Trust, as defined in the 1940 Act (the "Independent Trustees"), shall be
committed to the discretion of the Independent Trustees then in office. In
approving each Distribution Plan in accordance with Rule 12b-1, the Independent
Trustees concluded that there is reasonable likelihood that such Distribution
Plan will benefit the Fund and its related class of shareholders. Each
Distribution Plan can be terminated at any time, without penalty, by the vote of
a majority of the Independent Trustees or by the vote of the holders of a
majority of the outstanding related class of voting securities of the Fund. A
Distribution Plan cannot be amended to increase materially the amount to be
spent by the Fund without the approval of the related class of shareholders, and
all material amendments are required to be approved by the vote of Trustees,
including a majority of the Independent Trustees who have no direct or indirect
24
<PAGE>
financial interest in such Distribution Plan, cast in person at a meeting called
for that purpose. Rule 12b-1 further requires that the Trust preserve copies of
each Distribution Plan and any report made pursuant to such plan for a period of
not less than six years from the date of such Distribution Plan or such report,
the first two years in an easily accessible place.
LIMITATIONS ON THE PAYMENT OF DEFERRED SALES CHARGES
The maximum sales charge rule in the Rules of Fair Practice of the National
Association of Securities Dealers, Inc. ("NASD") imposes a limitation on certain
asset-based sales charges such as the distribution fee and the contingent
deferred sales charge ("CDSC") borne by the Class B and Class C shares but not
the account maintenance fee. The maximum sales charge rule is applied separately
to each class. As applicable to the Fund, the maximum sales charge rule limits
the aggregate of distribution fee payments and CDSCs payable by the Fund to (1)
6.25% of eligible gross sales of Class B shares and Class C shares, computed
separately (defined to exclude shares issued pursuant to dividend reinvestments
and exchanges), plus (2) interest on the unpaid balance for the respective
class, computed separately, at the prime rate plus 1% (the unpaid balance being
the maximum amount payable minus amounts received from the payment of the
distribution fee and the CDSC). In connection with the Class B shares, the
Distributor has voluntarily agreed to waive interest charges on the unpaid
balance in excess of 0.50% of eligible gross sales. Consequently, the maximum
amount payable to the Distributor (referred to as the "voluntary maximum") in
connection with the Class B shares is 6.75% of eligible gross sales. The
Distributor retains the right to stop waiving the interest charges at any time.
To the extent payments would exceed the voluntary maximum, the Fund will not
make further payments of the distribution fee with respect to Class B shares,
and any CDSCs will be paid to the Fund rather than to the Distributor; however,
the Fund will continue to make payments of the account maintenance fee. In
certain circumstances the amount payable pursuant to the voluntary maximum may
exceed the amount payable under the NASD formula. In such circumstances payment
in excess of the amount payable under the NASD formula will not be made.
REDEMPTION OF SHARES
Reference is made to "Redemption of Shares" in the Prospectus for certain
information as to the redemption and repurchase of Fund shares.
The right to redeem shares or to receive payment with respect to any such
redemption may be suspended only for any period during which trading on the New
York Stock Exchange is restricted as determined by the Commission or such
Exchange is closed (other than customary weekend and holiday closings), for any
period during which an emergency exists, as defined by the Commission, as a
result of which disposal of portfolio securities or determination of the net
asset value of the Fund is not reasonably practicable, and for such other
periods as the Commission may by order permit for the protection of shareholders
of the Fund.
DEFERRED SALES CHARGE--CLASS B SHARES
As discussed in the Prospectus under "Purchase of Shares -- Deferred Sales
Charge Alternatives -- Class B and Class C Shares", while Class B shares
redeemed within four years of purchase are subject to a CDSC under most
circumstances, the charge is waived on redemptions of Class B shares following
the death or disability of a Class B shareholder. Redemptions for which the
waiver applies are any partial or complete redemption following the death or
disability (as defined in the Internal Revenue Code of 1986, as amended
25
<PAGE>
(the "Code")) of a Class B shareholder (including one who owns the Class B
shares as joint tenant with his or her spouse), provided the redemption is
requested within one year of the death or initial determination of disability.
The minimum initial and subsequent purchase requirements are waived in
connection with the above-referenced Retirement Plans. For the period November
26, 1993 (commencement of operations) through July 31, 1994, the Distributor
received CDSCs of $16,384, all of which were paid to Merrill Lynch.
The following table sets forth comparative information as of July 31, 1994,
with respect to the Class B shares of the Fund indicating the maximum allowable
payments that can be made under the NASD maximum sales charge rule and the
Distributor's voluntary maximum for the period November 26, 1993 (commencement
of the public offering of Class B shares) to July 31, 1994. Since Class C shares
of the Fund had not been publicly issued prior to the date of this Statement of
Additional Information, information concerning Class C shares is not yet
provided below.
<TABLE>
<CAPTION>
DATA CALCULATED AS OF JULY 31, 1994
-------------------------------------------------------------------------------------------------
(IN THOUSANDS)
ANNUAL
ALLOWABLE ALLOWABLE AMOUNTS DISTRIBUTION
ELIGIBLE AGGREGATE INTEREST ON MAXIMUM PREVIOUSLY PAID AGGREGATE FEE AT CURRENT
GROSS SALES UNPAID AMOUNT TO UNPAID NET ASSET
SALES(1) CHARGES BALANCE(2) PAYABLE DISTRIBUTORS(3) BALANCE LEVEL(4)
--------- ----------- ------------- ----------- --------------- ----------- ---------------
<S> <C> <C> <C> <C> <C> <C> <C>
Under NASD Rule as Adopted.... $ 14,518 $ 907 $ 40 $ 947 $ 38 $ 909 $ 36
Under Distributor's Voluntary
Waiver....................... $ 14,518 $ 907 $ 73 $ 980 $ 38 $ 942 $ 36
<FN>
- ---------
(1) Purchase price of all eligible Class B shares sold since November 26, 1993
(commencement of the public offering of shares) other than shares acquired
through dividend reinvestment and the exchange privilege.
(2) Interest is computed on a monthly basis based upon the prime rate, as
reported in THE WALL STREET JOURNAL, plus 1.0%, as permitted under the NASD
Rule.
(3) Consists of CDSC payments, distribution fee payments and accruals.
(4) Provided to illustrate the extent to which the current level of
distribution fee payments (not including any CDSC payments) is amortizing
the unpaid balance. No assurance can be given that payments of the
distribution fee will reach either the voluntary maximum or the NASD
maximum.
</TABLE>
PORTFOLIO TRANSACTIONS
Reference is made to "Investment Objective and Policies" and "Portfolio
Transactions" in the Prospectus.
Under the 1940 Act, persons affiliated with the Trust are prohibited from
dealing with the Fund as a principal in the purchase and sale of securities
unless such trading is permitted by an exemptive order issued by the Commission.
Since over-the-counter transactions are usually principal transactions,
affiliated persons of the Trust, including Merrill Lynch, may not serve as
dealer in connection with transactions with the Fund. The Trust has obtained an
exemptive order permitting it to engage in certain principal transactions with
Merrill Lynch involving high quality short-term municipal bonds subject to
certain conditions. For the period November 26, 1993 through July 31, 1994, the
Fund engaged in no transactions pursuant to such exemptive order. Affiliated
persons of the Trust may serve as broker for the Fund in over-the-counter
transactions conducted on an agency basis. Certain court decisions have raised
questions as to the extent to which
26
<PAGE>
investment companies should seek exemptions under the 1940 Act in order to seek
to recapture underwriting and dealer spreads from affiliated entities. The
Trustees have considered all factors deemed relevant, and have made a
determination not to seek such recapture at this time. The Trustees will
reconsider this matter from time to time.
As a non-fundamental restriction, the Trust will prohibit the purchase or
retention by the Fund of the securities of any issuer if the officers, directors
or trustees of the Trust or the Manager owning beneficially more than one-half
of one per cent of the securities of an issuer together own beneficially more
than five per cent of the securities of that issuer. In addition, under the 1940
Act, the Fund may not purchase securities during the existence of any
underwriting syndicate of which Merrill Lynch is a member except pursuant to an
exemptive order or rules adopted by the Commission. Rule 10f-3 under the 1940
Act sets forth conditions under which the Fund may purchase municipal bonds in
such transactions. The rule sets forth requirements relating to, among other
things, the terms of an issue of municipal bonds purchased by the Fund, the
amount of municipal bonds which may be purchased in any one issue and the assets
of the Fund which may be invested in a particular issue.
The Fund does not expect to use any particular dealer in the execution of
transactions but, subject to obtaining the best net results, dealers who provide
supplemental investment research (such as information concerning tax-exempt
securities, economic data and market forecasts) to the Manager may receive
orders for transactions by the Fund. Information so received will be in addition
to and not in lieu of the services required to be performed by the Manager under
its Management Agreement and the expenses of the Manager will not necessarily be
reduced as a result of the receipt of such supplemental information.
The Trust has no obligation to deal with any broker in the execution of
transactions for the Fund's portfolio securities. In addition, consistent with
the Rules of Fair Practice of the National Association of Securities Dealers,
Inc. and policies established by the Trustees of the Trust, the Manager may
consider sales of shares of the Fund as a factor in the selection of brokers or
dealers to execute portfolio transactions for the Fund.
Generally, the Fund does not purchase securities for short-term trading
profits. However, the Fund may dispose of securities without regard to the time
they have been held when such action, for defensive or other reasons, appears
advisable to its Manager. While it is not possible to predict turnover rates
with any certainty, at present it is anticipated that the Fund's annual
portfolio turnover rate, under normal circumstances after the Fund's portfolio
is invested in accordance with its investment objective, will be less than 100%.
(The portfolio turnover rate is calculated by dividing the lesser of purchases
or sales of portfolio securities for the particular fiscal year by the monthly
average of the value of the portfolio securities owned by the Fund during the
particular fiscal year. For purposes of determining this rate, all securities
whose maturities at the time of acquisition are one year or less are excluded.)
The portfolio turnover for the period November 29, 1993 (commencement of
operations) through July 31, 1994, was 82.71%.
Section 11(a) of the Securities Exchange Act of 1934, as amended, generally
prohibits members of the U.S. national securities exchanges from executing
exchange transactions for their affiliates and institutional accounts which they
manage unless the member (i) has obtained prior express authorization from the
account to effect such transactions, (ii) at least annually furnishes the
account with a statement setting forth the aggregate compensation received by
the member in effecting such transactions, and (iii) complies with any rules the
Securities and Exchange Commission has prescribed with respect to the
requirements of
27
<PAGE>
clauses (i) and (ii). To the extent Section 11(a) would apply to Merrill Lynch
acting as a broker for the Fund in any of its portfolio transactions executed on
any such securities exchange of which it is a member, appropriate consents have
been obtained from the Fund and annual statements as to aggregate compensation
will be provided to the Fund.
DETERMINATION OF NET ASSET VALUE
The net asset value of all shares of the Fund is determined once daily,
Monday through Friday, as of 4:15 P.M., New York City time, on each day during
which the New York Stock Exchange is open for trading. The New York Stock
Exchange is not open on New Year's Day, Presidents' Day, Good Friday, Memorial
Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day. Net asset
value per share is computed by dividing the sum of the value of the securities
held by the Fund plus any cash or other assets minus all liabilities by the
total number of shares outstanding at such time, rounded to the nearest cent.
Expenses, including the fees payable to the Manager and any account maintenance
and/or distribution fees, are accrued daily. The per share net asset value of
the Class B, Class C and Class D shares may be lower than the per share net
asset value of the Class A shares reflecting the daily expense accruals of the
account maintenance, distribution and higher transfer agency fees applicable
with respect to the Class B and Class C shares and the daily expense accruals of
the account maintenance fees applicable with respect to the Class D shares. Even
under those circumstances, the per share net asset value of the four classes
will tend to converge immediately after the payment of dividends, which will
differ by approximately the amount of the expense accrual differential between
the classes.
The Municipal Bonds, and other portfolio securities in which the Fund
invests are traded primarily in over-the-counter municipal bond and money
markets and are valued at the last available bid price in the over-the-counter
market or on the basis of yield equivalents as obtained from one or more dealers
that make markets in the securities. One bond is the "yield equivalent" of
another bond when, taking into account market price, maturity, coupon rate,
credit rating and ultimate return of principal, both bonds will theoretically
produce an equivalent return to the bondholder. Financial futures contracts and
options thereon, which are traded on exchanges, are valued at their settlement
prices as of the close of such exchanges. Short-term investments with a
remaining maturity of 60 days or less are valued on an amortized cost basis,
which approximates market value. Securities and assets for which market
quotations are not readily available are valued at fair value as determined in
good faith by or under the direction of the Trustees of the Trust, including
valuations furnished by a pricing service retained by the Trust, which may
utilize a matrix system for valuations. The procedures of the pricing service
and its valuations are reviewed by the officers of the Trust under the general
supervision of the Trustees.
SHAREHOLDER SERVICES
The Trust offers a number of shareholder services described below which are
designed to facilitate investment in shares of the Fund. Full details as to each
of such services and copies of the various plans described below can be obtained
from the Trust, the Distributor or Merrill Lynch.
INVESTMENT ACCOUNT
Each shareholder whose account is maintained at the Transfer Agent has an
Investment Account and will receive statements, at least quarterly, from the
Transfer Agent. These statements will serve as transaction confirmations for
automatic investment purchases and the reinvestment of ordinary income dividends
28
<PAGE>
and long-term capital gain distributions. The statements will also show any
other activity in the account since the preceding statement. Shareholders will
receive separate transaction confirmations for each purchase or sale transaction
other than automatic investment purchases and the reinvestment of ordinary
income dividends and long-term capital gain distributions. Shareholders
considering transferring their Class A or Class D (paying any applicable CDSC)
shares from Merrill Lynch to another brokerage firm or financial institution
should be aware that, if the firm to which the Class A or Class D shares are to
be transferred will not take delivery of shares of the Fund, a shareholder
either must redeem the Class A or Class D shares so that the cash proceeds can
be transferred to the account at the new firm or such shareholder must continue
to maintain an Investment Account at the Transfer Agent for those Class A or
Class D shares. Shareholders interested in transferring their Class B or Class C
shares from Merrill Lynch and who do not wish to have an Investment Account
maintained for such shares at the Transfer Agent may request their new brokerage
firm to maintain such shares in an account registered in the name of the
brokerage firm for the benefit of the shareholder.
Share certificates are issued only for full shares and only upon the
specific request of the shareholder who has an Investment Account. Issuance of
certificates representing all or only part of the full shares in an Investment
Account may be requested by a shareholder directly from the Transfer Agent.
AUTOMATIC INVESTMENT PLANS
A shareholder may make additions to an Investment Account at any time by
purchasing Class A shares (if an eligible Class A investor as described in the
Prospectus) or Class B, Class C or Class D shares at the applicable public
offering price either through the shareholder's securities dealer, or by mail
directly to the Transfer Agent, acting as agent for such securities dealers.
Voluntary accumulation also can be made through a service known as the Automatic
Investment Plan whereby the Fund is authorized through pre-authorized checks or
automated clearing house debits of $50 or more to charge the regular bank
account of the shareholder on a regular basis to provide systematic additions to
the Investment Account of such shareholder. The Fund's Automatic Investment
Program is not available to shareholders whose shares are held in a brokerage
account with Merrill Lynch. Alternatively, investors who maintain CMA-R-
accounts may arrange to have periodic investments made in the Fund in their
CMA-R- account or in certain related accounts in amounts of $100 or more through
the CMA-R- Automated Investment Program.
AUTOMATIC REINVESTMENT OF DIVIDENDS AND CAPITAL GAINS DISTRIBUTIONS
Unless specific instructions are given as to the method of payment of
dividends and capital gains distributions, dividends and distributions will be
reinvested automatically in additional shares of the Fund. Such reinvestment
will be at the net asset value of shares of the Fund as of the close of business
on the monthly payment date for such dividends and distributions. Shareholders
may elect in writing to receive either their income dividends or capital gains
distributions, or both, in cash, in which event payment will be mailed or direct
deposited on or about the payment date.
Shareholders may, at any time, notify the Transfer Agent in writing or by
telephone (1-800-MER-FUND) that they no longer wish to have their dividends
and/or capital gains distributions reinvested in shares of the Fund or vice
versa and, commencing ten days after the receipt by the Transfer Agent of such
notice, such instructions will be effected.
29
<PAGE>
SYSTEMATIC WITHDRAWAL PLANS--CLASS A AND CLASS D SHARES
A Class A or Class D shareholder may elect to make systematic withdrawals
from an Investment Account on either a monthly or quarterly basis as provided
below. Quarterly withdrawals are available for shareholders who have acquired
Class A or Class D shares of the Fund having a value, based on cost or the
current offering price, of $5,000 or more, and monthly withdrawals are available
for shareholders with Class A or Class D shares with such a value of $10,000 or
more.
At the time of each withdrawal payment, sufficient Class A or Class D shares
are redeemed from those on deposit in the shareholder's account to provide the
withdrawal payment specified by the shareholder. The shareholder may specify
either a dollar amount or a percentage of the value of his Class A or Class D
shares. Redemptions will be made at net asset value as determined at the normal
close of business on the New York Stock Exchange (currently 4:00 P.M., New York
City time) on the 24th day of each month or the 24th day of the last month of
each quarter, whichever is applicable. If the Exchange is not open for business
on such date, the Class A or Class D shares will be redeemed at the close of
business on the following business day. The check for the withdrawal payment
will be mailed, or the direct deposit for the withdrawal payment will be made,
on the next business day following redemption. When a shareholder is making
systematic withdrawals, dividends and distributions on all Class A or Class D
shares in the Investment Account are reinvested automatically in the Fund's
Class A or Class D shares, respectively. A shareholder's Systematic Withdrawal
Plan may be terminated at any time, without charge or penalty, by the
shareholder, the Trust, the Transfer Agent or the Distributor. Withdrawal
payments should not be considered as dividends, yield or income. Each withdrawal
is a taxable event. If periodic withdrawals continuously exceed reinvested
dividends, the shareholder's original investment may be reduced correspondingly.
Purchases of additional Class A or Class D shares concurrent with withdrawals
are ordinarily disadvantageous to the shareholder because of sales charges and
tax liabilities. The Trust will not knowingly accept purchase orders for Class A
or Class D shares of the Fund from investors who maintain a Systematic
Withdrawal Plan unless such purchase is equal to at least one year's scheduled
withdrawals or $1,200, whichever is greater. Periodic investments may not be
made into an Investment Account in which the shareholder has elected to make
systematic withdrawals.
A Class A or Class D shareholder whose shares are held within a CMA-R- or
CBA-R- Account may elect to have shares redeemed on a monthly, bimonthly,
quarterly, semiannual or annual basis through the Systematic Redemption Program.
The minimum fixed dollar amount redeemable is $25. The proceeds of systematic
redemptions will be posted to the shareholder's account five business days after
the date the shares are redeemed. Monthly systematic redemptions will be made at
net asset value on the first Monday of each month, bimonthly systematic
redemption will be made at net asset value on the first Monday of every other
month, and quarterly, semiannual or annual redemptions are made at net asset
value on the first Monday of months selected at the shareholder's option. If the
first Monday of the month is a holiday, the redemption will be processed at net
asset value on the next business day. The Systematic Redemption Program is not
available if Company shares are being purchased within the account pursuant to
the Automatic Investment Program. For more information on the Systematic
Redemption Program, eligible shareholders should contact their Financial
Consultant.
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EXCHANGE PRIVILEGE
Shareholders of each class of shares of the Fund have an exchange privilege
with certain other MLAM-advised mutual funds listed below. Under the Merrill
Lynch Select Pricing-SM- System, Class A shareholders may exchange Class A
shares of the Fund for Class A shares of a second MLAM-advised mutual fund if
the shareholder holds any Class A shares of the second fund in his account in
which the exchange is made at the time of the exchange or is otherwise eligible
to purchase Class A shares of the second fund. If the Class A shareholder wants
to exchange Class A shares for shares of a second MLAM-advised mutual fund, and
the shareholder does not hold Class A shares of the second fund in his account
at the time of the exchange and is not otherwise eligible to acquire Class A
shares of the second fund, the shareholder will receive Class D shares of the
second fund as a result of the exchange. Class D shares also may be exchanged
for Class A shares of a second MLAM-advised mutual fund at any time as long as,
at the time of the exchange, the shareholder holds Class A shares of the second
fund in the account in which the exchange is made or is otherwise eligible to
purchase Class A shares of the second fund. Class B, Class C and Class D shares
will be exchangeable with shares of the same class of other MLAM-advised mutual
funds. For purposes of computing the CDSC that may be payable upon a disposition
of the shares acquired in the exchange, the holding period for the previously
owned shares of the Fund is "tacked" to the holding period of the newly acquired
shares of the other Fund as more fully described below. Class A, Class B, Class
C and Class D shares also will be exchangeable for shares of certain
MLAM-advised money market funds specifically designated below as available for
exchange by holders of Class A, Class B, Class C and Class D shares. Shares with
a net asset value of at least $100 are required to qualify for the exchange
privilege, and any shares utilized in an exchange must have been held by the
shareholder for 15 days. It is contemplated that the exchange privilege may be
applicable to other new mutual funds whose shares may be distributed by the
Distributor.
Exchanges of Class A or Class D shares outstanding ("outstanding Class A or
Class D shares") for Class A or Class D shares of another MLAM-advised mutual
fund ("new Class A or Class D shares") are transacted on the basis of relative
net asset value per Class A or Class D share, respectively, plus an amount equal
to the difference, if any, between the sales charge previously paid on the
outstanding Class A or Class D shares and the sales charge payable at the time
of the exchange on the new Class A or Class D shares. With respect to
outstanding Class A or Class D shares as to which previous exchanges have taken
place, the "sales charge previously paid" shall include the aggregate of the
sales charges paid with respect to such Class A or Class D shares in the initial
purchase and any subsequent exchange. Class A or Class D shares issued pursuant
to dividend reinvestment are sold on a no-load basis in each of the funds
offering Class A or Class D shares. For purposes of the exchange privilege,
Class A and Class D shares acquired through dividend reinvestment shall be
deemed to have been sold with a sales charge equal to the sales charge
previously paid on the Class A or Class D shares on which the dividend was paid.
Based on this formula, Class A and Class D shares of the Fund generally will be
exchanged into the Class A or Class D shares of the other funds or into shares
of the Class A and Class D money market funds with a reduced or without a sales
charge.
In addition, each of the funds with Class B and Class C shares outstanding
offers to exchange its Class B or Class C shares ("outstanding Class B or Class
C shares") for Class B or Class C shares, respectively ("new Class B or Class C
shares") of any of the other funds on the basis of relative net asset value per
Class B or Class C share, without the payment of any CDSC that might otherwise
be due on redemption of the outstanding shares. Class B shareholders of the Fund
exercising the exchange privilege will continue to be
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subject to the Fund's CDSC schedule if such schedule is higher than the CDSC
schedule relating to the new Class B shares acquired through use of the exchange
privilege. In addition, Class B shares of the Fund acquired through use of the
exchange privilege will be subject to the Fund's CDSC schedule if such schedule
is higher than the CDSC schedule relating to the Class B shares of the fund from
which the exchange has been made. For purposes of computing the sales load that
may be payable on a disposition of the new Class B or Class C shares, the
holding period for the outstanding Class B or Class C shares is "tacked" to the
holding period of the new Class B or Class C shares. For example, an investor
may exchange Class B shares of the Fund for those of Merrill Lynch Special Value
Fund, Inc. ("Special Value Fund") after having held the Fund's Class B shares
for two and a half years. The 2% sales load that generally would apply to a
redemption would not apply to the exchange. Three years later the investor may
decide to redeem the Class B shares of Special Value Fund and receive cash.
There will be no CDSC due on this redemption, since by "tacking" the two and a
half year holding period of the Fund's Class B shares to the three-year holding
period for the Special Value Fund Class B shares, the investor will be deemed to
have held the new Class B shares for more than five years.
Shareholders also may exchange shares of the Fund into shares of a money
market fund advised by the Manager or its affiliates, but the period of time
that Class B or Class C shares are held in a money market fund will not count
towards satisfaction of the holding period requirement for purposes of reducing
the CDSC or with respect to Class B shares, towards satisfaction of the
conversion period. However, shares of a money market fund which were acquired as
a result of an exchange for Class B or Class C shares of a fund may, in turn, be
exchanged back into Class B or Class C shares, respectively, of any fund
offering such shares, in which event the holding period for Class B or Class C
shares of the fund will be aggregated with previous holding periods for purposes
of reducing the CDSC. Thus, for example, an investor may exchange Class B shares
of the Fund for shares of Merrill Lynch Institutional Fund after having held the
Fund Class B shares for two and a half years and three years later decide to
redeem the shares of Merrill Lynch Institutional Fund for cash. At the time of
this redemption, the 2% CDSC that would have been due had the Class B shares of
the Fund been redeemed for cash rather than exchanged for shares of Merrill
Lynch Institutional Fund will be payable. If, instead of such redemption the
shareholder exchanged such shares for Class B shares of a fund which the
shareholder continues to hold for an additional two and a half years, any
subsequent redemption will not incur a CDSC.
Set forth below is a description of the investment objectives of the other
funds into which exchanges can be made:
FUNDS ISSUING CLASS A, CLASS B, CLASS C AND CLASS D SHARES:
<TABLE>
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MERRILL LYNCH ADJUSTABLE RATE SECURITIES
FUND, INC.................................. High current income consistent with a policy
of limiting the degree of fluctuation in net
asset value of fund shares resulting from
movements in interest rates through
investment primarily in a portfolio of
adjustable rate securities.
</TABLE>
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<TABLE>
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MERRILL LYNCH AMERICAS INCOME FUND, INC...... A high level of current income, consistent
with prudent investment risk, by investing
primarily in debt securities denominated in
a currency of a country located in the
Western Hemisphere (I.E., North and South
America and the surrounding waters).
MERRILL LYNCH ARIZONA LIMITED MATURITY
MUNICIPAL BOND FUND........................ A portfolio of Merrill Lynch Multi-State
Limited Maturity Municipal Series Trust, a
series fund, whose objective is to provide
as high a level of income exempt from
Federal and Arizona income taxes as is
consistent with prudent investment
management through investment in a
portfolio primarily of intermediate-term
investment grade Arizona Municipal Bonds.
MERRILL LYNCH ARIZONA MUNICIPAL BOND FUND.... A portfolio of Merrill Lynch Multi-State
Municipal Series Trust, a series fund, whose
objective is to provide as high a level of
income exempt from Federal and Arizona
income taxes as is consistent with prudent
investment management.
MERRILL LYNCH ARKANSAS MUNICIPAL BOND FUND... A portfolio of Merrill Lynch Multi-State
Municipal Series Trust, a series Fund, whose
objective is to provide a high a level of
income exempt from Federal and Arkansas
income taxes as is consistent with prudent
investment management.
MERRILL LYNCH ASSET GROWTH FUND, INC......... High total investment return, consistent with
prudent risk, from investment in United
States and foreign equity, debt and money
market securities the combination of which
will be varied both with respect to types
of securities and markets in response to
changing market and economic trends.
MERRILL LYNCH ASSET INCOME FUND, INC......... A high level of current income through
investment primarily in United States fixed
income securities.
MERRILL LYNCH BALANCED FUND FOR INVESTMENT
AND RETIREMENT............................. As high a level of total investment return as
is consistent with a relatively low level of
risk through investment in common stock and
other types of securities, including fixed
income securities and convertible
securities.
</TABLE>
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<TABLE>
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MERRILL LYNCH BASIC VALUE FUND, INC.......... Capital appreciation and, secondarily, income
through investment in securities, primarily
equities, that are undervalued and
therefore represent basic investment value.
MERRILL LYNCH CALIFORNIA INSURED MUNICIPAL
BOND FUND.................................. A portfolio of Merrill Lynch California
Municipal Series Trust, a series fund whose
objective is to provide as high a level of
income exempt from Federal and California
income taxes as is consistent with prudent
investment management through investment in
a portfolio primarily of insured California
Municipal Bonds.
MERRILL LYNCH CALIFORNIA LIMITED MATURITY
MUNICIPAL BOND FUND........................ A portfolio of Merrill Lynch Multi-State
Limited Maturity Municipal Series Trust, a
series fund, whose objective is to provide
as high a level of income exempt from
Federal and California income taxes as is
consistent with prudent investment
management through investment in a port-
folio primarily of intermediate-term
investment grade California Municipal
Bonds.
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND
FUND....................................... A portfolio of Merrill Lynch California
Municipal Series Trust, a series fund, whose
objective is to provide as high a level of
income exempt from Federal and California
income taxes as is consistent with prudent
investment management.
MERRILL LYNCH CAPITAL FUND, INC.............. The highest total investment return
consistent with prudent risk through a fully
managed investment policy utilizing equity,
debt and convertible securities.
MERRILL LYNCH CONNECTICUT MUNICIPAL BOND
FUND....................................... A portfolio of Merrill Lynch Multi-State
Municipal Series Trust, a series fund, whose
objective is to provide as high a level of
income exempt from Federal and Connecticut
income taxes as is consistent with prudent
investment management.
MERRILL LYNCH CORPORATE BOND FUND, INC....... Current income from three separate
diversified portfolios of fixed income
securities.
</TABLE>
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<TABLE>
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MERRILL LYNCH DEVELOPING CAPITAL MARKETS
FUND, INC.................................. Long-term appreciation through investment in
securities, principally equities, of issuers
in countries having smaller capital
markets.
MERRILL LYNCH DRAGON FUND, INC............... Capital appreciation primarily through
investment in equity and debt securities of
issuers domiciled in developing countries
located in Asia and the Pacific Basin.
MERRILL LYNCH EUROFUND....................... Capital appreciation primarily through
investment in equity securities of
corporations domiciled in Europe.
MERRILL LYNCH FEDERAL SECURITIES TRUST....... High current return through investments in
U.S. Government and Government agency
securities, including GNMA mortgage-backed
certificates and other mortgage-backed
Government securities.
MERRILL LYNCH FLORIDA LIMITED MATURITY
MUNICIPAL BOND FUND........................ A portfolio of Merrill Lynch Multi-State
Limited Maturity Municipal Series Trust, a
series fund, whose objective is to provide
as high a level of income exempt from
Federal income taxes as is consistent with
prudent investment management while seeking
to offer shareholders the opportunity to
own securities exempt from Florida intangi-
ble personal property taxes through
investment in a portfolio primarily of
intermediate-term investment grade Florida
Municipal Bonds.
MERRILL LYNCH FLORIDA MUNICIPAL BOND FUND.... A portfolio of Merrill Lynch Multi-State
Municipal Series Trust, a series fund, whose
objective is to provide as high a level of
income exempt from Federal income taxes as
is consistent with prudent investment
management while seeking to offer
shareholders the opportunity to own
securities exempt from Florida intangible
personal property taxes.
MERRILL LYNCH FUND FOR TOMORROW, INC......... Long-term growth through investment in a
portfolio of good quality securities,
primarily common stock, potentially
positioned to benefit from demographic and
cultural changes as they affect consumer
markets.
</TABLE>
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<TABLE>
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MERRILL LYNCH FUNDAMENTAL GROWTH FUND,
INC........................................ Long-term growth through investment in a
diversified portfolio of equity securities
placing particular emphasis on companies
that have exhibited above-average growth
rates in earnings.
MERRILL LYNCH GLOBAL ALLOCATION FUND, INC.... High total investment return, consistent with
prudent risk, through a fully managed
investment policy utilizing United States
and foreign equity, debt and money market
securities, the combination of which will
be varied from time to time both with
respect to the types of securities and
markets in response to changing market and
economic trends.
MERRILL LYNCH GLOBAL BOND FUND FOR INVESTMENT
AND RETIREMENT............................. High total investment return from investment
in a global portfolio of debt instruments
denominated in various currencies and
multi-national currency units.
MERRILL LYNCH GLOBAL CONVERTIBLE FUND,
INC........................................ High total return from investment primarily
in an internationally diversified portfolio
of convertible debt securities, convertible
preferred stock and "synthetic" convertible
securities consisting of a combination of
debt securities or preferred stock and
warrants or options.
MERRILL LYNCH GLOBAL HOLDINGS, INC.
(residents of Arizona must meet investor
suitability standards)..................... The highest total investment return
consistent with prudent risk through
worldwide investment in an internationally
diversified portfolio of securities.
MERRILL LYNCH GLOBAL RESOURCES TRUST......... Long-term growth and protection of capital
from investment in securities of domestic and
foreign companies that possess substantial
natural resource assets.
MERRILL LYNCH GLOBAL SMALLCAP FUND, INC...... Long-term growth of capital by investing
primarily in equity securities of companies
with relatively small market
capitalizations located in various foreign
countries and in the United States.
</TABLE>
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MERRILL LYNCH GLOBAL UTILITY FUND, INC....... Capital appreciation and current income
through investment of at least 65% of its
total assets in equity and debt securities
issued by domestic and foreign companies
which are primarily engaged in the
ownership or operation of facilities used
to generate, transmit or distribute
electricity, telecommunications, gas or
water.
MERRILL LYNCH GROWTH FUND FOR INVESTMENT AND
RETIREMENT................................. Growth of capital and, secondarily, income
from investment in a diversified portfolio of
equity securities placing principal
emphasis on those securities which
management of the fund believes to be un-
dervalued.
MERRILL LYNCH HEALTHCARE FUND, INC.
(residents of Wisconsin must meet investor
suitability standards)..................... Capital appreciation through worldwide
investment in equity securities of companies
that derive or are expected to derive a
substantial portion of their sales from
products and services in healthcare.
MERRILL LYNCH INTERNATIONAL EQUITY FUND...... Capital appreciation and, secondarily, income
by investing in a diversified portfolio of
equity securities of issuers located in
countries other than the United States.
MERRILL LYNCH LATIN AMERICA FUND, INC........ Capital appreciation by investing primarily
in Latin American equity and debt securities.
MERRILL LYNCH MARYLAND MUNICIPAL BOND FUND... A portfolio of Merrill Lynch Multi-State
Municipal Series Trust, a series fund, whose
objective is to provide as high a level of
income exempt from Federal and Maryland
income taxes as is consistent with prudent
investment management.
MERRILL LYNCH MASSACHUSETTS LIMITED MATURITY
MUNICIPAL BOND FUND........................ A portfolio of Merrill Lynch Multi-State
Limited Maturity Municipal Series Trust, a
series fund, whose objective is to provide
as high a level of income exempt from
Federal and Massachusetts income taxes as
is consistent with prudent investment
management through investment in a port-
folio primarily of intermediate-term
investment grade Massachusetts Municipal
Bonds.
</TABLE>
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<TABLE>
<S> <C>
MERRILL LYNCH MASSACHUSETTS MUNICIPAL BOND
FUND....................................... A portfolio of Merrill Lynch Multi-State
Municipal Series Trust, a series fund, whose
objective is to provide as high a level of
income exempt from Federal and
Massachusetts income taxes as is con-
sistent with prudent investment management.
MERRILL LYNCH MICHIGAN LIMITED MATURITY
MUNICIPAL BOND FUND........................ A portfolio of Merrill Lynch Multi-State
Limited Maturity Municipal Series Trust, a
series fund, whose objective is to provide
as high a level of income exempt from
Federal and Michigan income taxes as is
consistent with prudent investment
management through investment in a port-
folio primarily of intermediate-term
investment grade Michigan Municipal Bonds.
MERRILL LYNCH MICHIGAN MUNICIPAL BOND FUND... A portfolio of Merrill Lynch Multi-State
Municipal Series Trust, a series fund, whose
objective is to provide as high a level of
income exempt from Federal and Michigan
income taxes as is consistent with prudent
investment management.
MERRILL LYNCH MINNESOTA MUNICIPAL BOND
FUND....................................... A portfolio of Merrill Lynch Multi-State
Municipal Series Trust, a series fund, whose
objective is to provide as high a level of
income exempt from Federal and Minnesota
personal income taxes as is consistent with
prudent investment management.
MERRILL LYNCH MUNICIPAL BOND FUND, INC....... Tax-exempt income from three separate
diversified portfolios of municipal bonds.
MERRILL LYNCH MUNICIPAL INTERMEDIATE TERM
FUND....................................... Currently the only portfolio of Merrill Lynch
Municipal Series Trust, a series fund, whose
objective is to provide as high a level as
possible of income exempt from Federal
income taxes by investing in investment
grade obligations with a dollar weighted
average maturity of five to twelve years.
</TABLE>
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<TABLE>
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MERRILL LYNCH NEW JERSEY LIMITED MATURITY
MUNICIPAL BOND FUND........................ A portfolio of Merrill Lynch Multi-State
Limited Maturity Municipal Series Trust, a
series fund, whose objective is to provide
as high a level of income exempt from
Federal and New Jersey income taxes as is
consistent with prudent investment
management through a portfolio primarily of
intermediate-term investment grade New
Jersey Municipal Bonds.
MERRILL LYNCH NEW JERSEY MUNICIPAL BOND
FUND....................................... A portfolio of Merrill Lynch Multi-State
Municipal Series Trust, a series fund, whose
objective is to provide as high a level of
income exempt from Federal and New Jersey
income taxes as is consistent with prudent
investment management.
MERRILL LYNCH NEW MEXICO MUNICIPAL BOND
FUND....................................... A portfolio of Merrill Lynch Multi-State
Municipal Series Trust, a series fund, whose
objective is to provide as high a level of
income exempt from Federal and New Mexico
income taxes as is consistent with prudent
management.
MERRILL LYNCH NEW YORK LIMITED MATURITY
MUNICIPAL BOND FUND........................ A portfolio of Merrill Lynch Multi-State
Limited Maturity Municipal Series Trust, a
series fund, whose objective is to provide
as high a level of income exempt from
Federal, New York State and New York City
income taxes as is consistent with prudent
investment management through investment in
a portfolio primarily of intermediate-term
investment grade New York Municipal Bonds.
MERRILL LYNCH NEW YORK MUNICIPAL BOND FUND... A portfolio of Merrill Lynch Multi-State
Municipal Series Trust, a series fund, whose
objective is to provide as high a level of
income exempt from Federal, New York State
and New York City income taxes as is
consistent with prudent investment
management.
MERRILL LYNCH NORTH CAROLINA MUNICIPAL BOND
FUND....................................... A portfolio of Merrill Lynch Multi-State
Municipal Series Trust, a series fund, whose
objective is to provide as high a level of
income exempt from Federal and North
Carolina income taxes as is consistent with
prudent investment management.
</TABLE>
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<TABLE>
<S> <C>
MERRILL LYNCH OHIO MUNICIPAL BOND FUND....... A portfolio of Merrill Lynch Multi-State
Municipal Series Trust, a series fund, whose
objective is to provide as high a level of
income exempt from Federal and Ohio income
taxes as is consistent with prudent
investment management.
MERRILL LYNCH OREGON MUNICIPAL BOND FUND..... A portfolio of Merrill Lynch Multi-State
Municipal Series Trust, a series fund, whose
objective is to provide as high a level of
income exempt from Federal and Oregon
income taxes as is consistent with prudent
investment management.
MERRILL LYNCH PACIFIC FUND, INC.............. Capital appreciation by investing in equity
securities of corporations domiciled in Far
Eastern and Western Pacific countries,
including Japan, Australia, Hong Kong and
Singapore.
MERRILL LYNCH PENNSYLVANIA LIMITED MATURITY
MUNICIPAL BOND FUND........................ A portfolio of Merrill Lynch Multi-State
Limited Maturity Municipal Series Trust, a
series fund, whose objective is to provide
as high a level of income exempt from
Federal and Pennsylvania income taxes as is
consistent with prudent investment
management through investment in a port-
folio of intermediate-term investment grade
Pennsylvania Municipal Bonds.
MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND
FUND....................................... A portfolio of Merrill Lynch Multi-State
Municipal Series Trust, a series fund, whose
objective is to provide as high a level of
income exempt from Federal and Pennsylvania
personal income taxes as is consistent with
prudent investment management.
MERRILL LYNCH PHOENIX FUND, INC.............. Long-term growth of capital by investing in
equity and fixed income securities, including
tax-exempt securities, of issuers in weak
financial condition or experiencing poor
operating results believed to be
undervalued relative to the current or
prospective condition of such issuer.
</TABLE>
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<TABLE>
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MERRILL LYNCH SHORT-TERM GLOBAL INCOME FUND,
INC........................................ As high a level of current income as is
consistent with prudent investment management
from a global portfolio of high quality
debt securities denominated in various
currencies and multinational currency units
and having remaining maturities not
exceeding three years.
MERRILL LYNCH SPECIAL VALUE FUND, INC........ Long-term growth of capital from investments
in securities, primarily equities, of
relatively small companies believed to have
special investment value and emerging
growth companies regardless of size.
MERRILL LYNCH STRATEGIC DIVIDEND FUND........ Long-term total return from investment in
dividend paying common stocks which yield
more than Standard & Poor's 500 Composite
Stock Price Index.
MERRILL LYNCH TECHNOLOGY FUND, INC........... Capital appreciation through worldwide
investment in equity securities of companies
that derive or are expected to derive a
substantial portion of their sales from
products and services in technology.
MERRILL LYNCH TEXAS MUNICIPAL BOND FUND...... A portfolio of Merrill Lynch Multi-State
Municipal Series Trust, a series fund, whose
objective is to provide as high a level of
income exempt from Federal income taxes as
is consistent with prudent investment
management by investing primarily in a
portfolio of long-term, investment grade
municipal obligations issued by the State
of Texas, its political subdivisions,
agencies and instrumentalities.
MERRILL LYNCH UTILITY INCOME FUND, INC....... High current income through investment in
equity and debt securities issued by
companies which are primarily engaged in
the ownership or operation of facilities
used to generate, transmit or distribute
electricity, telecommunications, gas or
water.
MERRILL LYNCH WORLD INCOME FUND, INC......... High current income by investing in a global
portfolio of fixed income securities
denominated in various currencies,
including multinational currencies.
</TABLE>
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<TABLE>
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CLASS A SHARE MONEY MARKET FUNDS:
MERRILL LYNCH READY ASSETS TRUST............. Preservation of capital, liquidity and the
highest possible current income consistent
with the foregoing objectives from the
short-term money market securities in which
the Trust invests.
MERRILL LYNCH RETIREMENT RESERVES
MONEY FUND (available only if the exchange
occurs within certain retirement plans).... Currently the only portfolio of Merrill Lynch
Retirement Series Trust, a series fund, whose
objectives are current income, preservation
of capital and liquidity available from
investing in a diversified portfolio of
short-term money market securities.
MERRILL LYNCH U.S.A. GOVERNMENT
RESERVES................................... Preservation of capital, current income and
liquidity available from investing in direct
obligations of the U.S. Government and
repurchase agreements relating to such
securities.
MERRILL LYNCH U.S. TREASURY MONEY FUND....... Preservation of capital, liquidity and
current income through investment exclusively
in a diversified portfolio of short-term
marketable securities which are direct
obligations of the U.S. Treasury.
CLASS B, CLASS C AND CLASS D SHARE MONEY MARKET FUNDS:
MERRILL LYNCH GOVERNMENT FUND................ A portfolio of Merrill Lynch Funds For
Institutions Series, a series fund, whose
objective is to provide current income
consistent with liquidity and security of
principal from investment in securities is-
sued or guaranteed by the U.S. Government,
its agencies and instrumentalities and in
repurchase agreements secured by such
obligations.
MERRILL LYNCH INSTITUTIONAL FUND............. A portfolio of Merrill Lynch Funds For
Institutions Series, a series fund, whose
objective is to provide maximum current
income consistent with liquidity and the
maintenance of a high quality portfolio of
money market securities.
MERRILL LYNCH INSTITUTIONAL TAX-EXEMPT
FUND....................................... A portfolio of Merrill Lynch Funds For
Institutions Series, a series fund, whose
objective is to provide current income
exempt from Federal income taxes,
preservation of capital and liquidity
available from investing in a diversified
portfolio of short-term, high quality
municipal bonds.
</TABLE>
42
<PAGE>
<TABLE>
<S> <C>
MERRILL LYNCH TREASURY FUND.................. A portfolio of Merrill Lynch Funds For
Institutions Series, a series fund, whose
objective is to provide current income
consistent with liquidity and security of
principal from investment in direct obliga-
tions of the U.S. Treasury and up to 10% of
its total assets in repurchase agreements
secured by such obligations.
</TABLE>
Before effecting an exchange, shareholders should obtain a currently
effective prospectus of the fund into which the exchange is to be made.
To exercise the exchange privilege, shareholders should contact their
Merrill Lynch financial consultant, who will advise the Fund of the exchange.
Shareholders of the Fund, and shareholders of the other funds described above
with shares for which certificates have not been issued, may exercise the
exchange privilege by wire through their securities dealers. The Fund reserves
the right to require a properly completed Exchange Application. This exchange
privilege may be modified or terminated at any time in accordance with the rules
of the Commission. The Fund reserves the right to limit the number of times an
investor may exercise the exchange privilege. Certain funds may suspend the
continuous offering of their shares to the general public at any time and may
thereafter resume such offering from time to time. The exchange privilege is
available only to U.S. shareholders in states where the exchange legally may be
made.
DISTRIBUTIONS AND TAXES
The Trust intends to continue to qualify the Fund for the special tax
treatment afforded regulated investment companies ("RICs") under the Internal
Revenue Code of 1986, as amended (the "Code"). If it so qualifies, in any
taxable year in which it distributes at least 90% of its taxable net income and
90% of its tax-exempt net income (see below), the Fund (but not its
shareholders) will not be subject to Federal income tax to the extent that it
distributes its net investment income and net realized capital gains. The Trust
intends to cause the Fund to distribute substantially all of its income.
As discussed in the Fund's Prospectus, the Trust has established other
series in addition to the Fund (together with the Fund, the "Series"). Each
Series of the Trust is treated as a separate corporation for Federal income tax
purposes. Each Series, therefore, is considered to be a separate entity in
determining its treatment under the rules for RICs described in the Prospectus.
Losses in one Series do not offset gains in another Series, and the requirements
(other than certain organizational requirements) for qualifying for RIC status
will be determined at the Series level rather than at the Trust level.
The Code requires a RIC to pay a nondeductible 4% excise tax to the extent
the RIC does not distribute, during each calendar year, 98% of its ordinary
income, determined on a calendar year basis, and 98% of its capital gains,
determined, in general, on an October 31 year end, plus certain undistributed
amounts from previous years. The required distributions, however, are based only
on the taxable income of a RIC. The excise tax, therefore, generally will not
apply to the tax-exempt income of a RIC, such as the Fund, that pays
exempt-interest dividends.
The Trust intends to qualify the Fund to pay "exempt-interest dividends" as
defined in Section 852(b)(5) of the Code. Under such section if, at the close of
each quarter of the Fund's taxable year, at least 50% of the value of the Fund's
total assets consists of obligations exempt from Federal income tax ("tax-exempt
43
<PAGE>
obligations") under Section 103(a) of the Code (relating generally to
obligations of a state or local governmental unit), the Fund shall be qualified
to pay exempt-interest dividends to its Class A, Class B, Class C and Class D
shareholders (together, the "shareholders"). Exempt-interest dividends are
dividends or any part thereof paid by the Fund which are attributable to
interest on tax-exempt obligations and designated by the Trust as
exempt-interest dividends in a written notice mailed to the Fund's shareholders
within 60 days after the close of the Fund's taxable year. For this purpose, the
Fund will allocate interest from tax-exempt obligations (as well as ordinary
income, capital gains and tax preference items discussed below) among the Class
A, Class B, Class C and Class D shareholders according to a method (which it
believes is consistent with the Commission's exemptive order permitting the
issuance and sale of multiple classes of shares) that is based on the gross
income allocable to Class A, Class B, Class C and Class D shareholders during
the taxable year, or such other method as the Internal Revenue Service may
prescribe. To the extent that the dividends distributed to the Fund's
shareholders are derived from interest income exempt from Federal income tax
under Code Section 103(a) and are properly designated as exempt-interest
dividends, they will be excludable from a shareholder's gross income for Federal
income tax purposes. Exempt-interest dividends are included, however, in
determining the portion, if any, of a person's social security and railroad
retirement benefits subject to Federal income taxes. Interest on indebtedness
incurred or continued to purchase or carry shares of a RIC paying
exempt-interest dividends, such as the Fund, will not be deductible by the
investor for Federal or Colorado income tax purposes to the extent attributable
to exempt-interest dividends. Shareholders are advised to consult their tax
advisers with respect to whether exempt-interest dividends retain the exclusion
under Code Section 103(a) if a shareholder would be treated as a "substantial
user" or "related person" under Code Section 147(a) with respect to property
financed with the proceeds of an issue of "industrial development bonds" or
"private activity bonds," if any, held by the Fund.
The Fund's exempt-interest dividends, to the extent they are attributable to
interest from Colorado Municipal Bonds, will be exempt from Colorado personal
and corporate income taxes. Shareholders subject to income taxation in states
other than Colorado will realize a lower after-tax rate of return than Colorado
shareholders since the dividends distributed by the Fund generally will not be
exempt, to any significant degree, from income taxation by such other states.
The Trust will inform shareholders annually regarding the portion of the Fund's
distributions which constitutes exempt-interest dividends and the portion which
is exempt from Colorado income taxes. The Fund will allocate exempt-interest
dividends among Class A, Class B, Class C and Class D shareholders for Colorado
income tax purposes based on a method similar to that described above for
Federal income tax purposes.
Colorado presently includes in Colorado alternative minimum taxable income
of individuals, estates, and trusts a portion of certain items of tax preference
as defined in the Code. Interest paid on private activity bonds issued after
August 7, 1986 constitutes such a tax preference. Accordingly, any distributions
of the Fund's portfolio attributable to such private activity bonds will not be
exempt from Colorado alternative minimum tax.
Shares of the Fund will not be subject to the Colorado personal property
tax.
To the extent that the Fund's distributions are derived from interest on its
taxable investments or from an excess of net short-term capital gains over net
long-term capital losses ("ordinary income dividends"), such distributions are
considered ordinary income for Federal and Colorado income tax purposes. Such
distributions are not eligible for the dividends received deduction for
corporations. Distributions, if any, of net long-term capital gains from the
sale of securities or from certain transactions in futures or options
44
<PAGE>
("capital gain dividends") are taxable as long-term capital gains for Federal
income tax purposes, regardless of the length of time the shareholder has owned
Fund shares, and for Colorado income tax purposes, will be treated as capital
gains which are taxed at ordinary income rates. Under the Revenue Reconciliation
Act of 1993, all or a portion of the Fund's gain from the sale or redemption of
tax-exempt obligations purchased at a market discount will be treated as
ordinary income rather than capital gain. This rule may increase the amount of
ordinary income dividends received by shareholders. Distributions in excess of
the Fund's earnings and profits will first reduce the adjusted tax basis of a
holder's shares and, after such adjusted tax basis is reduced to zero, will
constitute capital gains to such holder (assuming the shares are held as a
capital asset). Any loss upon the sale or exchange of Fund shares held for six
months or less will be treated as long-term capital loss to the extent of
capital gain dividends received by the shareholder. In addition, such loss will
be disallowed to the extent of any exempt-interest dividends received by the
shareholder. If the Fund pays a dividend in January which was declared in the
previous October, November or December to shareholders of record on a specific
date in one of such months, then such dividend will be treated for tax purposes
as being paid by the Fund and received by its shareholders on December 31 of the
year in which such dividend was declared.
The Code subjects interest received on certain otherwise tax-exempt
securities to an alternative minimum tax. The alternative minimum tax applies to
interest received on "private activity bonds" issued after August 7, 1986.
Private activity bonds are bonds which, although tax-exempt, are used for
purposes other than those generally performed by governmental units and which
benefit non-governmental entities (e.g., bonds used for industrial development
or housing purposes). Income received on such bonds is classified as an item of
"tax preference," which could subject investors in such bonds, including
shareholders of the Fund, to an alternative minimum tax. The Fund will purchase
such "private activity bonds," and the Trust will report to shareholders within
60 days after the Fund's taxable year-end the portion of the Fund's dividends
declared during the year which constitutes an item of tax preference for
alternative minimum tax purposes. The Code further provides that corporations
are subject to an alternative minimum tax based, in part, on certain differences
between taxable income as adjusted for other tax preferences and the
corporation's "adjusted current earnings" (which more closely reflect a
corporation's economic income). Because an exempt-interest dividend paid by the
Fund will be included in adjusted current earnings, a corporate shareholder may
be required to pay alternative minimum tax on exempt-interest dividends paid by
the Fund.
The Revenue Reconciliation Act of 1993 has added new marginal tax brackets
of 36% and 39.6% for individuals and has created a graduated structure of 26%
and 28% for the alternative minimum tax applicable to individual taxpayers.
These rate increases may affect an individual investor's after-tax return from
an investment in the Fund as compared with such investor's return from taxable
investments.
No gain or loss will be recognized by Class B shareholders on the conversion
of their Class B shares into Class D shares. A shareholder's basis in the Class
D shares acquired will be same as such shareholder's basis in the Class B shares
converted, and the holding period of the acquired Class D shares will include
the holding period for the converted Class B shares.
If a shareholder exercises an exchange privilege within 90 days of acquiring
the shares, then the loss the shareholder can recognize on the exchange will be
reduced (or the gain increased) to the extent the sales charge paid to the Fund
reduces any sales charge such shareholder would have owed upon purchase of the
new shares in the absence of the exchange privilege. Instead, such sales charge
will be treated as an amount paid for the new shares.
45
<PAGE>
A loss realized on a sale or exchange of shares of the Fund will be
disallowed if other Fund shares are acquired (whether through the automatic
reinvestment of dividends or otherwise) within a 61-day period beginning 30 days
before and ending 30 days after the date that the shares are disposed of. In
such a case, the basis of the shares acquired will be adjusted to reflect the
disallowed loss.
Ordinary income dividends paid by the Fund to shareholders who are
nonresident aliens or foreign entities will be subject to a 30% United States
withholding tax under existing provisions of the Code applicable to foreign
individuals and entities unless a reduced rate of withholding or a withholding
exemption is provided under applicable treaty law. Nonresident shareholders are
urged to consult their own tax advisers concerning the applicability of the
United States withholding tax.
Under certain provisions of the Code, some shareholders may be subject to a
31% withholding tax on certain ordinary income dividends and on capital gain
dividends and redemption payments ("backup withholding"). Generally,
shareholders subject to backup withholding will be those for whom no certified
taxpayer identification number is on file with the Trust or who, to the Trust's
knowledge, have furnished an incorrect number. When establishing an account, an
investor must certify under penalty of perjury that such number is correct and
that such investor is not otherwise subject to backup withholding.
The Code provides that every person required to file a tax return must
include for information purposes on such return the amount of exempt-interest
dividends received from all sources (including the Fund) during the taxable
year.
ENVIRONMENTAL TAX
The Code imposes a deductible tax (the "Environmental Tax") on a
corporation's modified alternative minimum taxable income (computed without
regard to the alternative tax net operating loss deduction and the deduction for
the Environmental Tax) at a rate of $12 per $10,000 (0.12%) of alternative
minimum taxable income in excess of $2,000,000. The Environmental Tax is imposed
for taxable years beginning after December 31, 1986, and before January 1, 1996.
The Environmental Tax is imposed even if the corporation is not required to pay
an alternative minimum tax because the corporation's regular income tax
liability exceeds its minimum tax liability. The Code provides, however, that a
RIC, such as the Fund, is not subject to the Environmental Tax. However,
exempt-interest dividends paid by the Fund that create alternative minimum
taxable income for corporate shareholders under the Code (as described above)
may subject corporate shareholders of the Fund to the Environmental Tax.
TAX TREATMENT OF OPTION AND FUTURES TRANSACTIONS
The Fund may purchase or sell municipal bond index futures contracts and
interest rate futures contracts on U.S. Government securities ("financial
futures contracts"). The Fund may also purchase and write call and put options
on such financial futures contracts. In general, unless an election is available
to the Fund or an exception applies, such options and financial futures
contracts that are "Section 1256 contracts" will be "marked to market" for
Federal income tax purposes at the end of each taxable year, I.E., each such
option or financial futures contract will be treated as sold for its fair market
value on the last day of the taxable year and any gain or loss attributable to
Section 1256 contracts will be 60% long-term and 40% short-term capital gain or
loss. Application of these rules to Section 1256 contracts held by the Fund may
alter the timing and character of distributions to shareholders.
46
<PAGE>
Code Section 1092, which applies to certain "straddles," may affect the
taxation of the Fund's transactions in financial futures contracts and related
options. Under Section 1092, the Fund may be required to postpone recognition
for tax purposes of losses incurred in certain closing transactions in financial
futures contracts or the related options.
One of the requirements for qualification as a RIC is that less than 30% of
the Fund's gross income be derived from gains from the sale or other disposition
of securities held for less than three months. Accordingly, the Fund may be
restricted in effecting closing transactions within three months after entering
into an option or financial futures contract.
-------------------
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code, Treasury regulations and Colorado tax laws presently in
effect. For the complete provisions, reference should be made to the pertinent
Code sections, the Treasury regulations promulgated thereunder and the
applicable Colorado tax laws. The Code and the Treasury regulations, as well as
the Colorado tax laws, are subject to change by legislative or administrative
action either prospectively or retroactively.
Shareholders are urged to consult their own tax advisers regarding the
availability of any exemptions from state or local taxes (other than those
imposed by Colorado) and with specific questions as to Federal, state, local or
foreign taxes.
PERFORMANCE DATA
From time to time the Fund may include its average annual total return and
other total return data, as well as yield and tax-equivalent yield, in
advertisements or information furnished to present or prospective shareholders.
Total return and yield and tax-equivalent yield figures are based on the Fund's
historical performance and are not intended to indicate future performance.
Average annual total return and yield are determined separately for Class A,
Class B, Class C and Class D shares in accordance with formulas specified by the
Commission.
Average annual total return quotations for the specified periods are
computed by finding the average annual compounded rates of return (based on net
investment income and any realized and unrealized capital gains or losses on
portfolio investments over such periods) that would equate the initial amount
invested to the redeemable value of such investment at the end of each period.
Average annual total return is computed assuming all dividends and distributions
are reinvested and taking into account all applicable recurring and nonrecurring
expenses, including the maximum sales charge in the case of Class A and Class D
shares and the CDSC that would be applicable to a complete redemption of the
investment at the end of the specified period in the case of the Class B and
Class C shares.
The Fund also may quote annual, average annual and annualized total return
and aggregate total return performance data, both as a percentage and as a
dollar amount based on a hypothetical $1,000 investment, for various periods
other than those noted below. Such data will be computed as described above,
except that (1) as required by the periods of the quotations, actual annual,
annualized or aggregate data, rather than average annual data, may be quoted and
(2) the maximum applicable sales charges will not be included with respect to
annual or annualized rates of return calculations. Aside from the impact on the
performance data calculations of including or excluding the maximum applicable
sales charges, actual annual or annualized
47
<PAGE>
total return data generally will be lower than average annual total return data
since the average rates of return reflect compounding of return; aggregate total
return data generally will be higher than average annual total return data since
the aggregate rates of return reflect compounding over a longer period of time.
Set forth below is the total return, yield and tax-equivalent yield
information for Class A and Class B shares of the Fund for the period indicated.
Since Class C and Class D shares have not been issued prior to the date of this
Statement of Additional Information, performance information concerning Class C
and Class D shares is not yet provided.
<TABLE>
<CAPTION>
CLASS A SHARES CLASS B SHARES
------------------------------------ ------------------------------------
REDEEMABLE VALUE REDEEMABLE VALUE
OF A OF A
EXPRESSED AS HYPOTHETICAL EXPRESSED AS HYPOTHETICAL
A PERCENTAGE $1,000 A PERCENTAGE $1,000
BASED ON A INVESTMENT BASED ON A INVESTMENT
HYPOTHETICAL AT THE END OF HYPOTHETICAL AT THE END OF
$1,000 INVESTMENT THE PERIOD $1,000 INVESTMENT THE PERIOD
----------------- ---------------- ----------------- ----------------
AVERAGE ANNUAL TOTAL RETURN (INCLUDING MAXIMUM APPLICABLE SALES CHARGE)
<S> <C> <C> <C> <C>
November 26, 1993
(Inception) to July 31,
1994.................... -9.76% $ 932.80 -10.04% $ 930.90
ANNUAL TOTAL RETURN (EXCLUDING MAXIMUM APPLICABLE SALES CHARGE)
November 26, 1993
(Inception) to July 31,
1994.................... -2.83% $ 971.70 -3.16% $ 968.40
AGGREGATE TOTAL RETURN (INCLUDING MAXIMUM APPLICABLE SALES CHARGE)
November 26, 1993
(Inception) to July 31,
1994.................... -6.72% $ 932.80 -6.91% $ 930.90
YIELD
30 days ended on July 31,
1994.................... 5.36% 5.08%
TAX-EQUIVALENT YIELD*
30 days ended on July 31,
1994.................... 7.44% 7.06%
<FN>
- ---------
* Based on a Federal income tax rate of 28%
</TABLE>
In order to reflect the reduced sales charges in the case of Class A or
Class D shares or the waiver of the CDSC in the case of Class B shares
applicable to certain investors, as described under "Purchase of Shares" and
"Redemption of Shares", respectively, the total return data quoted by the Fund
in advertisements directed to such investors may take into account the reduced,
and not the maximum, sales charge or may take into account the CDSC and
therefore may reflect greater total return since, due to the reduced sales
charge or the waiver of sales charges, a lower amount of expenses is deducted.
GENERAL INFORMATION
DESCRIPTION OF SHARES
The Declaration of Trust provides that the Trust shall be comprised of
separate Series each of which will consist of a separate portfolio which will
issue separate shares. The Trust is presently comprised of the Fund, Merrill
Lynch Arizona Municipal Bond Fund, Merrill Lynch Connecticut Municipal Bond
Fund, Merrill Lynch Florida Municipal Bond Fund, Merrill Lynch Maryland
Municipal Bond Fund, Merrill Lynch Massachusetts Municipal Bond Fund, Merrill
Lynch Michigan Municipal Bond Fund, Merrill Lynch Minnesota Municipal Bond Fund,
Merrill Lynch New Jersey Municipal Bond Fund, Merrill Lynch New Mexico Municipal
Bond Fund, Merrill Lynch New York Municipal Bond Fund, Merrill Lynch North
Carolina
48
<PAGE>
Municipal Bond Fund, Merrill Lynch Ohio Municipal Bond Fund, Merrill Lynch
Oregon Municipal Bond Fund, Merrill Lynch Pennsylvania Municipal Bond Fund and
Merrill Lynch Texas Municipal Bond Fund. The Trustees are authorized to create
an unlimited number of Series and, with respect to each Series, to issue an
unlimited number of full and fractional shares of beneficial interest, par value
$.10 per share, of different classes and to divide or combine the shares into a
greater or lesser number of shares without thereby changing the proportionate
beneficial interests in the Series. Shareholder approval is not necessary for
the authorization of additional Series or classes of a Series of the Trust. At
the date of this Statement of Additional Information, the shares of the Fund are
divided into Class A, Class B, Class C and Class D shares. Class A, Class B,
Class C and Class D shares represent an interest in the same assets of the Fund
and are identical in all respects except that the Class B, Class C and Class D
shares bear certain expenses related to the account maintenance and/or
distribution of such shares and have exclusive voting rights with respect to
matters relating to such account maintenance and/or distribution expenditures.
The Trust has received an order ("the Order") from the Commission permitting the
issuance and sale of multiple classes of shares. The Order permits the Trust to
issue additional classes of shares of any Series if the Board of Trustees deems
such issuance to be in the best interest of the Trust.
All shares of the Trust have equal voting rights, except that only shares of
the respective Series are entitled to vote on matters concerning only that
Series and, as noted above, Class B, Class C and Class D shares will have
exclusive voting rights with respect to matters relating to the account
maintenance and/or distribution expenses being borne solely by such class. Each
issued and outstanding share is entitled to one vote and to participate equally
in dividends and distributions declared by the Fund and in the net assets of
such Series upon liquidation or dissolution remaining after satisfaction of
outstanding liabilities, except that, as noted above, expenses related to the
account maintenance and/or distribution of the Class B, Class C and Class D
shares will be borne solely by such class. There normally will be no meeting of
shareholders for the purposes of electing Trustees unless and until such time as
less than a majority of the Trustees holding office have been elected by
shareholders, at which time the Trustees then in office will call a
shareholders' meeting for the election of Trustees. Shareholders may, in
accordance with the terms of the Declaration of Trust, cause a meeting of
shareholders to be held for the purpose of voting on the removal of Trustees.
Also, the Trust will be required to call a special meeting of shareholders in
accordance with the requirements of the 1940 Act to seek approval of new
management and advisory arrangements, of a material increase in distribution
fees or of a change in the fundamental policies, objectives or restrictions of a
Series.
The obligations and liabilities of a particular Series are restricted to the
assets of that Series and do not extend to the assets of the Trust generally.
The shares of each Series, when issued, will be fully paid and nonassessable,
have no preference, preemptive, conversion, exchange or similar rights, and are
freely transferable. Holders of shares of any Series are entitled to redeem
their shares as set forth elsewhere herein and in the Prospectus. Shares do not
have cumulative voting rights and the holders of more than 50% of the shares of
the Trust voting for the election of Trustees can elect all of the Trustees if
they choose to do so and in such event the holders of the remaining shares would
not be able to elect any Trustees. No amendments may be made to the Declaration
of Trust without the affirmative vote of a majority of the outstanding shares of
the Trust.
The Manager provided the initial capital for the Fund by purchasing 10,000
shares of the Fund for $100,000. Such shares were acquired for investment and
can only be disposed of by redemption. The organizational expenses of the Fund
(estimated at approximately $37,600) were paid by the Fund and are amortized
over a period not exceeding five years. The proceeds realized by the Manager (or
any subsequent
49
<PAGE>
holder) upon the redemption of any of the shares initially purchased by it will
be reduced by the proportionate amount of unamortized organizational expenses
which the number of shares redeemed bears to the number of shares initially
purchased. Such organizational expenses include certain of the initial
organizational expenses of the Trust which have been allocated to the Fund by
the Trustees. If additional Series are added to the Trust, the organizational
expenses will be allocated among the Series in a manner deemed equitable by the
Trustees.
COMPUTATION OF OFFERING PRICE PER SHARE
An illustration of the computation of the offering price for Class A and
Class B shares of the Fund based on the value of the Fund's net assets and
number of shares outstanding on July 31, 1994 is calculated as set forth below.
Information is not provided for Class C and Class D shares since no Class C or
Class D shares were publicly offered prior to the date of this Statement of
Additional Information. The offering price for Class B and Class C shares of the
Fund is the net asset value of Class B and Class C shares, respectively.
TABLE*
<TABLE>
<CAPTION>
CLASS A CLASS B
------------- -------------
<S> <C> <C>
Net Assets............................................................... $ 10,634,060 $ 14,522,487
------------- -------------
------------- -------------
Number of Shares Outstanding............................................. 1,133,095 1,547,664
------------- -------------
------------- -------------
Net Asset Value Per Share (net assets divided by number of shares
outstanding)............................................................ $ 9.38 $ 9.38
Sales Charge (for Class A and Class D shares: 4.00% of offering price
(4.17% of net asset value per share))*.................................. .39 **
------------- -------------
Offering Price........................................................... $ 9.77 $ 9.38
------------- -------------
------------- -------------
<FN>
- ---------
* Rounded to the nearest one-hundredth percent; assumes maximum sales charge
is applicable.
** Class B and Class C shares are not subject to an initial sales charge but
may be subject to a CDSC on redemption of shares. See "Purchase of Shares
-- Deferred Sales Charge Alternatives -- Class B and Class C Shares" in the
Prospectus.
</TABLE>
INDEPENDENT AUDITORS
Deloitte & Touche LLP, 117 Campus Drive, Princeton, New Jersey 08540, has
been selected as the independent auditors of the Fund. The selection of
independent auditors is subject to ratification by the shareholders of the Fund.
The independent auditors are responsible for auditing the annual financial
statements of the Fund.
CUSTODIAN
State Street Bank and Trust Company, P.O. Box 351, Boston, Massachusetts
02101, acts as the custodian of the Fund's assets. The custodian is responsible
for safeguarding and controlling the Fund's cash and securities, handling the
delivery of securities and collecting interest on the Fund's investments.
TRANSFER AGENT
Financial Data Services, Inc., 4800 Deer Lake Drive East, Jacksonville,
Florida 32246-6484, acts as the Trust's transfer agent. The Transfer Agent is
responsible for the issuance, transfer and redemption of shares and the opening,
maintenance and servicing of shareholder accounts. See "Management of the Trust
- -- Transfer Agency Services" in the Prospectus.
50
<PAGE>
LEGAL COUNSEL
Brown & Wood, One World Trade Center, New York, New York 10048-0557, is
counsel for the Trust.
REPORTS TO SHAREHOLDERS
The fiscal year of the Fund ends on July 31 of each year. The Trust sends to
shareholders of the Fund at least semi-annually reports showing the Fund's
portfolio and other information. An annual report, containing financial
statements audited by independent auditors, is sent to shareholders each year.
After the end of each year shareholders will receive Federal income tax
information regarding dividends and capital gains distributions.
ADDITIONAL INFORMATION
The Prospectus and this Statement of Additional Information do not contain
all the information set forth in the Registration Statement and the exhibits
relating thereto, which the Trust has filed with the Securities and Exchange
Commission, Washington, D.C., under the Securities Act of 1933 and the
Investment Company Act of 1940, to which reference is hereby made.
The Declaration of Trust establishing the Trust dated August 2, 1985, a copy
of which, together with all amendments thereto (the "Declaration") is on file in
the office of the Secretary of The Commonwealth of Massachusetts, provides that
the name "Merrill Lynch Multi-State Municipal Series Trust" refers to the
Trustees under the Declaration collectively as Trustees, but not as individuals
or personally; and no Trustee, shareholder, officer, employee or agent of the
Trust shall be held to any personal liability; nor shall resort be had to any
such person's private property for the satisfaction of any obligation or claim
of the Trust but the "Trust Property" only shall be liable.
To the knowledge of the Trust, the following persons or entities owned
beneficially 5% or more of the Fund's outstanding shares on September 30, 1994.
<TABLE>
<CAPTION>
PERCENT OF
NAME ADDRESS FUND
- -------------------- ------------------------------ -------------
<S> <C> <C>
Jay P.K. Kenney c/o Barrett/Gurovich PC 6.09%
1512 Larimer Street, #550
Denver, CO 80202
Suzanna G. Russo c/o Barrett/Gurovich PC 6.09%
1512 Larimer Street, #550
Denver, CO 80202
Olivia L. Edwards 574 Linden Park Ct 5.04%
Boulder, CO 80304
</TABLE>
51
<PAGE>
APPENDIX I
ECONOMIC AND FINANCIAL CONDITIONS IN COLORADO
THE INFORMATION SET FORTH BELOW IS DERIVED FROM OFFICIAL PUBLICATIONS OF THE
STATE OF COLORADO (THE "STATE") AND OTHER SOURCES THAT ARE GENERALLY AVAILABLE
TO INVESTORS. THE INFORMATION IS PROVIDED AS GENERAL INFORMATION INTENDED TO
GIVE A RECENT HISTORICAL DESCRIPTION AND IS NOT INTENDED TO INDICATE FUTURE OR
CONTINUING TRENDS IN THE FINANCIAL OR OTHER POSITIONS OF THE STATE. THE FUND HAS
NOT INDEPENDENTLY VERIFIED THIS INFORMATION.
The information set forth in this Appendix I is not intended to, and does
not, describe factors or trends affecting specific issuers of Municipal Bonds
within the State, or credit or other risks associated with any particular issuer
or issue of Municipal Bonds held in the Fund's portfolio at any time. The
presentation of financial and other information concerning the State in this
Appendix I is not intended to imply that the State has or will have any
obligation with respect to payment of principal or interest on any such
Municipal Bonds.
STATE ECONOMY
Based on data published by the State of Colorado, Office of State Planning
and Budgeting as presented in the COLORADO ECONOMIC PERSPECTIVE, FOURTH QUARTER,
FY 1993-94, JUNE 20, 1994 (the "Economic Report"), over 50% of non-agricultural
employment in Colorado in 1993 was concentrated in the retail and wholesale
trade and service sectors, reflecting the importance of tourism to the State's
economy and of Denver as a regional economic and transportation hub. The
government and manufacturing sectors followed as the fourth and fifth largest
employment sectors in the State in 1993. The Office of Planning and Budgeting
projects similar concentrations for 1994 and 1995.
According to the Economic Report, the unemployment rate improved slightly
during 1993. Colorado continued to surpass the job growth rate of the U.S. in
1993, with continued growth projected for Colorado during 1994. However, the
rate of job growth in Colorado is expected to decline in 1995, primarily due to
the completion of large public works projects, such as Denver International
Airport, Coors Baseball Field, and the Denver Public Library renovation project.
Personal income rose in Colorado during 1991, 1992 and 1993. Retail sales
increased by nearly 10% in 1993.
RESTRICTIONS OF APPROPRIATIONS AND REVENUES
The State Constitution requires that expenditures for any fiscal year not
exceed revenues for such fiscal year. By statute, the amount of General Fund
revenues available for appropriation is based upon revenue estimates which,
together with other available resources, must exceed annual appropriations by
the amount of the unappropriated reserve (the "Unappropriated Reserve"). The
Unappropriated Reserve requirement for fiscal years 1991, 1992 and 1993 was set
at 3% of total appropriations from the General Fund. For fiscal years 1994 and
thereafter, the Unappropriated Reserve requirement is set at 4%. In addition to
the Unappropriated Reserve, a constitutional amendment approved by Colorado
voters in 1992 requires the State and each local government to reserve a certain
percentage of its fiscal year spending (excluding bonded debt service) for
emergency use (the "Emergency Reserve"). The minimum Emergency Reserve is set at
2% for 1994 and 3% for 1995 and later years. General Fund appropriations are
also limited by statute to an amount equal to the cost of performing certain
required reappraisals of taxable property plus an amount equal to the lesser of
(i) 5% of Colorado personal income or (ii) 106% of the total General Fund
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appropriations for the previous fiscal year. This restriction does not apply to
any General Fund appropriations which are required as a result of a new federal
law, a final state or federal court order or moneys derived from the increase in
the rate or amount of any tax or fee approved by a majority of the registered
electors of the State voting at any general election. In addition, the statutory
limit on the level of General Fund appropriations may be exceeded for a given
fiscal year upon the declaration of a State fiscal emergency by the State
General Assembly.
During each of the past several years, Colorado has met the Unappropriated
Reserve and Emergency Reserve requirements described above. Based on June 20,
1994 estimates, the 1994 fiscal year end General Fund balance is expected to
exceed the required Unappropriated Reserve and Emergency Reserve.
On November 3, 1992, voters in Colorado approved a constitutional amendment
(the "Amendment") which, in general, became effective December 31, 1992, and
which could restrict the ability of the State and local governments to increase
revenues and impose taxes. The Amendment applies to the State and all local
governments, including home rule entities ("Districts"). Enterprises, defined as
government-owned businesses authorized to issue revenue bonds and receiving
under 10% of annual revenue in grants from all Colorado state and local
governments combined, are excluded from the provisions of the Amendment.
The provisions of the Amendment are unclear and will probably require
judicial interpretation. Among other provisions, the Amendment requires voter
approval prior to tax increases, creation of debt, or mill levy or valuation for
assessment ratio increases. The Amendment also limits increases in government
spending and property tax revenues to specified percentages. The Amendment
requires that District property tax revenues yield no more than the prior year's
revenues adjusted for inflation, voter approved changes and (except with regard
to school districts) local growth in property values according to a formula set
forth in the Amendment. School districts are allowed to adjust tax levies for
changes in student enrollment. Pursuant to the Amendment, local government
spending is to be limited by the same formula as the limitation for property tax
revenues. The Amendment limits increases in expenditures from the State General
Fund and program revenues (cash funds) to the growth in inflation plus the
percentage change in State population in the prior calendar year. The bases for
initial spending and revenue limits are fiscal year 1992 spending and 1991
property taxes collected in 1992. The bases for spending and revenue limits for
fiscal year 1994 and later years will be the prior fiscal year's spending and
property taxes collected in the prior calendar year. Debt service changes,
reductions and voter-approved revenue changes are excluded from the calculation
bases. The Amendment also prohibits new or increased real property transfer tax
rates, new State real property taxes and local District income taxes.
According to the Economic Report, inflation for 1992 was 3.8% and population
grew at the rate of 2.8% in Colorado. Accordingly, under the Amendment,
increases in State expenditures during the 1994 fiscal year will be limited to
6.6% over expenditures during the 1993 fiscal year which is the base year for
calculating the limitation for the 1994 fiscal year. The 1994 fiscal year
General Fund and program revenues (cash funds) are projected to be approximately
$150 million less than expenditures allowed under the spending limitation. The
limitation for the 1995 fiscal year is projected to be 7.1% based on projected
inflation of 4.2% for 1993 and projected population growth of 2.9% during 1993.
Litigation concerning several issues relating to the Amendment is pending in
the Colorado courts. The litigation deals with three principal issues: (i)
whether Districts can increase mill levies to pay debt service on
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general obligation bonds without obtaining voter approval; (ii) whether a
multi-year lease-purchase agreement subject to annual appropriations is an
obligation which requires voter approval prior to execution of the agreement;
and (iii) what constitutes an "enterprise" which is excluded from the provisions
of the Amendment. In September, 1994, the Colorado Supreme Court held that
Districts can increase mill levies to pay debt service on outstanding general
obligation bonds issued after the effective date of the Amendment; litigation
regarding mill levy increases to pay general obligation bonds issued prior to
the Amendment is still pending. Various cases addressing the remaining issues
are at different stages in the trial and appellate process. The outcome of such
litigation cannot be predicted at this time.
There is also a statutory restriction on the amount of annual increases in
taxes that the various taxing jurisdictions in Colorado can levy without
electoral approval. This restriction does not apply to taxes levied to pay
existing general obligation debt.
STATE FINANCES
On a GAAP basis, the State has had unrestricted General Fund balances at
June 30 of between $16 million and $330 million for the years 1989 through 1993.
The fiscal year 1994 unrestricted General Fund ending balance currently is
projected to be approximately $338 million.
For fiscal year 1993, individual income taxes generated the largest portion
of the State's General Fund gross receipts, representing approximately 51% of
such receipts. Sales, use and other excise taxes represented the second largest
source at approximately 31% of fiscal year 1993 gross receipts, while corporate
income taxes represented about 4% of fiscal year 1993 gross receipts. The final
budget for fiscal year 1994 projects General Fund revenues of approximately
$3,570 million and appropriations of approximately $3,556 million. The
percentages of General Fund revenue generated by type of tax for fiscal year
1994 are not expected to be significantly different from fiscal year 1993
percentages.
STATE DEBT
Under its constitution, the State of Colorado is not permitted to issue
general obligation bonds secured by the full faith and credit of the State.
However, certain agencies and instrumentalities of the State are authorized to
issue bonds secured by revenues from specific projects and activities. The State
enters into certain lease transactions which are subject to annual renewal at
the option of the State. In addition, the State is authorized to issue
short-term revenue anticipation notes. Local governmental units in the State are
also authorized to incur indebtedness. The major source of financing for such
local government indebtedness is an ad valorem property tax. In addition, in
order to finance public projects, local governments in the State can issue
revenue bonds payable from the revenues of a utility or enterprise or from the
proceeds of an excise tax, or assessment bonds payable from special assessments.
Colorado local governments can also finance public projects through leases which
are subject to annual appropriation at the option of the local government. Local
governments in Colorado also issue tax anticipation notes. The Amendment
requires prior voter approval for the creation of any multiple fiscal year debt
or other financial obligation whatsoever, except for refundings at a lower rate
or obligations of an enterprise.
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APPENDIX II
RATINGS OF MUNICIPAL BONDS
DESCRIPTION OF MOODY'S INVESTORS SERVICE, INC.'S ("MOODY'S") MUNICIPAL BOND
RATINGS
Aaa Bonds which are rated Aaa are judged to be of the best quality. They carry
the smallest degree of investment risk and are generally referred to as
"gilt edge". Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be
visualized are most unlikely to impair the fundamentally strong position
of such issues.
Aa Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally
known as high grade bonds. They are rated lower than the best bonds
because margins of protection may not be as large as in Aaa securities or
fluctuation of protective elements may be of greater amplitude or there
may be other elements present which make the long-term risks appear
somewhat larger than in Aaa securities.
A Bonds which are rated A possess many favorable investment attributes and
are to be considered as upper medium grade obligations. Factors giving
security to principal and interest are considered adequate, but elements
may be present which suggest a susceptibility to impairment sometime in
the future.
Baa Bonds which are rated Baa are considered as medium grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest
payment and principal security appear adequate for the present but certain
protective elements may be lacking or may be characteristically unreliable
over any great length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well.
Ba Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well assured. Often the protection of
interest and principal payments may be very moderate and thereby not well
safeguarded during both good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
B Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance
of other terms of the contract over any long period of time may be small.
Caa Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to
principal or interest.
Ca Bonds which are rated Ca represent obligations which are speculative in a
high degree. Such issues are often in default or have other marked
shortcomings.
C Bonds which are rated C are the lowest rated class of bonds, and issues so
rated can be regarded as having extremely poor prospects of ever attaining
any real investment standing.
NOTE: Those bonds in the Aa, A, Baa, Ba and B groups which Moody's believes
possess the strongest investment attributes are designated by the symbols Aa1,
A1, Baa1, Ba1 and B1.
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SHORT-TERM NOTES: The four ratings of Moody's for short-term notes are MIG
1/VMIG1, MIG 2/VMIG2, MIG 3/VMIG3 and MIG 4/VMIG4; MIG 1/VMIG1 denotes "best
quality . . . strong protection by established cash flows"; MIG 2/VMIG2 denotes
"high quality" with ample margins of protection; MIG 3/VMIG3 notes are of
"favorable quality . . . but . . . lacking the undeniable strength of the
preceding grades"; MIG 4/VMIG4 notes are of "adequate quality . . . [p]rotection
commonly regarded as required of an investment security is present . . . there
is specific risk."
DESCRIPTION OF MOODY'S CORPORATE BOND RATINGS
Excerpts from Moody's description of its corporate bond ratings: Aaa-judged
to be the best quality, carry the smallest degree of investment risk; Aa-judged
to be of high quality by all standards; A-possess many favorable investment
attributes and are to be considered as upper medium grade obligations.
DESCRIPTION OF MOODY'S COMMERCIAL PAPER RATINGS
Moody's Commercial Paper ratings are opinions of the ability of issuers to
repay punctually promissory obligations not having an original maturity in
excess of nine months. Moody's employs the following three designations, all
judged to be investment grade, to indicate the relative repayment capacity of
rated issuers:
Issuers rated Prime-1 (or related supporting institutions) have a superior
capacity for repayment of short-term promissory obligations. Prime-1 repayment
capacity will normally be evidenced by the following characteristics: leading
market positions in well established industries; high rates of return on funds
employed; conservative capitalization structures with moderate reliance on debt
and ample asset protection; broad margins in earning coverage of fixed financial
charges and high internal cash generation; and well established access to a
range of financial markets and assured sources of alternate liquidity.
Issuers rated Prime-2 (or related supporting institutions) have a strong
capacity for repayment of short-term promissory obligations. This will normally
be evidenced by many of the characteristics cited above but to a lesser degree.
Earnings trends and coverage ratios, while sound, will be more subject to
variation. Capitalization characteristics, while still appropriate, may be more
affected by external conditions. Ample alternate liquidity is maintained.
Issuers rated Prime-3 (or related supporting institutions) have an
acceptable capacity for repayment of short-term promissory obligations. The
effects of industry characteristics and market composition may be more
pronounced. Variability in earnings and profitability may result in changes in
the level of debt protection measurements and the requirement for relatively
high financial leverage. Adequate alternate liquidity is maintained.
Issuers rated Not Prime do not fall within any of the Prime rating
categories.
DESCRIPTION OF STANDARD & POOR'S CORPORATION'S ("STANDARD & POOR'S") MUNICIPAL
DEBT RATINGS
A Standard & Poor's municipal debt rating is a current assessment of the
creditworthiness of an obligor with respect to a specific obligation. This
assessment may take into consideration obligors such as guarantors, insurers, or
lessees.
The debt rating is not a recommendation to purchase, sell or hold a
security, inasmuch as it does not comment as to market price or suitability for
a particular investor.
The ratings are based on current information furnished by the issuer or
obtained by Standard & Poor's from other sources Standard & Poor's considers
reliable. Standard & Poor's does not perform an audit in
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connection with any rating and may, on occasion, rely on unaudited financial
information. The ratings may be changed, suspended or withdrawn as a result of
changes in, or unavailability of, such information, or for other circumstances.
The ratings are based, in varying degrees, on the following considerations:
I. Likelihood of default-capacity and willingness of the obligor as to the
timely payment of interest and repayment of principal in accordance with
the terms of the obligation;
II. Nature of and provisions of the obligations;
III. Protection afforded by, and relative position of, the obligation in the
event of bankruptcy, reorganization or other arrangement under the laws
of bankruptcy and other laws affecting creditors' rights.
AAA Debt rated "AAA" has the highest rating assigned by Standard &
Poor's. Capacity to pay interest and repay principal is
extremely strong.
AA Debt rated "AA" has a very strong capacity to pay interest and
repay principal and differs from the higher-rated issues only
in small degree.
A Debt rated "A" has a strong capacity to pay interest and repay
principal although it is somewhat more susceptible to the
adverse effects of changes in circumstances and economic
conditions than debt in higher-rated categories.
BBB Debt rated "BBB" is regarded as having an adequate capacity to
pay interest and repay principal. Whereas it normally exhibits
adequate protection parameters, adverse economic conditions or
changing circumstances are more likely to lead to a weakened
capacity to pay interest and repay principal for debt in this
category than for debt in higher rated categories.
BB, B, CCC, CC Debt rated "BB", "B", "CCC", "CC" and "C" is regarded, on
and C balance, as predominately speculative with respect to capacity
to pay interest and repay principal in accordance with the
terms of the obligations. "BB" indicates the lowest degree of
speculation and "CC" the highest degree of speculation. While
such debt will likely have some quality and protective
characteristics, these are outweighed by large uncertainties or
major exposures to adverse conditions.
CI The rating "CI" is reserved for income bonds on which no
interest is being paid.
D Debt rated "D" is in payment default. The "D" rating category
is used when interest payments or principal payments are not
made on the date due even if the applicable grace period has
not expired, unless Standard & Poor's believes that such
payments will be made during such grace period. The "D" rating
also will be used upon the filing of a bankruptcy petition if
debt service payments are jeopardized.
Plus (+) or Minus (-): The ratings from "AA" to "CCC" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
DESCRIPTION OF STANDARD & POOR'S CORPORATE BOND RATINGS
A Standard & Poor's corporate debt rating is a current assessment of the
creditworthiness of an obligor with respect to a specific obligation. Debt rated
"AAA" has the highest rating assigned by Standard & Poor's. Capacity to pay
interest and repay principal is extremely strong. Debt rated "AA" has a very
strong capacity
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to pay interest and to repay principal and differs from the highest rated issues
only in small degree. Debt rated "A" has a strong capacity to pay interest and
repay principal although it is somewhat more susceptible to the adverse effects
of changes in circumstances and economic conditions than debt of a higher rated
category. Debt rated "BBB" is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher rated categories.
The ratings from "AA" to "BBB" may be modified by the addition of a plus or
minus sign to show relative standing within the major rating categories.
DESCRIPTION OF STANDARD & POOR'S COMMERCIAL PAPER RATINGS
A Standard & Poor's Commercial Paper Rating is a current assessment of the
likelihood of timely payment of debt having an original maturity of no more than
365 days. Ratings are graded into four categories, ranging from "A" for the
highest quality obligations to "D" for the lowest. Ratings are applicable to
both taxable and tax-exempt commercial paper. Issues assigned the highest rating
are regarded as having the greatest capacity for timely payment. Issues in this
category are further refined with the designation 1, 2 and 3 to indicate the
relative degree of safety. The three designations in the "A" category are as
follows:
A-1 This designation indicates that the degree of safety regarding timely
payment is either overwhelming or very strong. Those issues determined to
possess extremely strong safety characteristics are denoted with a plus
sign (+) designation.
A-2 Capacity for timely payment on issues with this designation is strong.
However, the relative degree of safety is not as overwhelming as for
issues designated "A-1".
A-3 Issues carrying this designation have a satisfactory capacity for timely
payment. They are, however, somewhat more vulnerable to the adverse
effects of changes in circumstances than obligations carrying the higher
designations.
B Issues rated "B" are regarded as having only speculative capacity for
timely payment.
C This rating is assigned to short-term debt obligations with a doubtful
capacity for payment.
D Debt rated "D" is in payment default. The "D" rating category is used when
interest payments or principal payments are not made on the date due, even
if the applicable grace period has not expired, unless S&P believes that
such payments will be made during such grace period.
A Commercial Paper Rating is not a recommendation to purchase or sell a
security. The ratings are based on current information furnished to Standard &
Poor's by the issuer and obtained by Standard & Poor's from other sources it
considers reliable. The ratings may be changed, suspended, or withdrawn as a
result of changes in, or unavailability of, such information.
A Standard & Poor's note rating reflects the liquidity concerns and market
access risks unique to notes. Notes due in 3 years or less will likely receive a
note rating. Notes maturing beyond 3 years will most likely receive a long-term
debt rating. The following criteria will be used in making that assessment.
--Amortization schedule (the larger the final maturity relative to other
maturities, the more likely it will be treated as a note).
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--Source of payment (the more dependent the issue is on the market for its
refinancing, the more likely it will be treated as a note).
Note rating symbols are as follows:
SP-1 A very strong or strong capacity to pay principal and interest. Those
issues determined to possess overwhelming safety characteristics will be
given a "+" designation.
SP-2 A satisfactory capacity to pay principal and interest.
SP-3 A speculative capacity to pay principal and interest.
Standard & Poor's may continue to rate note issues with a maturity greater
than three years in accordance with the same rating scale currently employed for
municipal bond ratings.
UNRATED: Where no rating has been assigned or where a rating has been
suspended or withdrawn, it may be for reasons unrelated to the quality of the
issue.
Should no rating be assigned, the reason may be one of the following:
1. An application for rating was not received or accepted.
2. The issue or issuers belongs to a group of securities that are not
rated as a matter of policy.
3. There is a lack of essential data pertaining to the issue or issuer.
4. The issue was privately placed, in which case the rating is not
published in Moody's publications.
Suspension or withdrawal may occur if new and material circumstances arise,
the effects of which preclude satisfactory analysis; if there is no longer
available reasonable up-to-date information to permit a judgment to be formed;
if a bond is called for redemption; or for other reasons.
DESCRIPTION OF FITCH INVESTORS SERVICE, INC.'S ("FITCH") INVESTMENT GRADE BOND
RATINGS
Fitch investment grade bond ratings provide a guide to investors in
determining the credit risk associated with a particular security. The ratings
represent Fitch's assessment of the issuer's ability to meet the obligations of
a specific debt issue or class of debt in a timely manner.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the current and prospective
financial condition and operating performance of the issuer and of any
guarantor, as well as the economic and political environment that might affect
the issuer's future financial strength and credit quality.
Fitch ratings do not reflect any credit enhancement that may be provided by
insurance policies or financial guaranties unless otherwise indicated.
Bonds that have the same rating are of similar but not necessarily identical
credit quality since the rating categories do not fully reflect small
differences in the degrees of credit risk.
Fitch ratings are not recommendations to buy, sell, or hold any security.
Ratings do not comment on the adequacy of market price, the suitability of any
security for a particular investor, or the tax-exempt nature or taxability of
payments made in respect of any security.
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Fitch ratings are based on information obtained from issuers, other
obligors, underwriters, their experts, and other sources Fitch believes to be
reliable. Fitch does not audit or verify the truth or accuracy of such
information. Ratings may be changed, suspended, or withdrawn as a result of
changes in, or the unavailability of, information or for any other reasons.
<TABLE>
<S> <C>
AAA Bonds considered to be investment grade and of the highest credit quality. The
obligor has an exceptionally strong ability to pay interest and repay principal,
which is unlikely to be affected by reasonably foreseeable events.
AA Bonds considered to be investment grade and of very high credit quality. The
obligor's ability to pay interest and repay principal is very strong, although not
quite as strong as bonds rated "AAA". Because bonds rated in the "AAA" and "AA"
categories are not significantly vulnerable to foreseeable future developments,
short-term debt of these issuers is generally rated "F-1+".
A Bonds considered to be investment grade and of high credit quality. The obligor's
ability to pay interest and repay principal is considered to be strong, but may be
more vulnerable to adverse changes in economic conditions and circumstances than
bonds with higher ratings.
BBB Bonds considered to be investment grade and of satisfactory credit quality. The
obligor's ability to pay interest and repay principal is considered to be adequate.
Adverse changes in economic conditions and circumstances, however, are more likely
to have adverse impact on these bonds, and therefore, impair timely payment. The
likelihood that the ratings of these bonds will fall below investment grade is
higher than for bonds with higher ratings.
</TABLE>
Plus (+) or Minus (-): Plus and minus signs are used with a rating symbol to
indicate the relative position of a credit within the rating category. Plus and
minus signs, however, are not used in the "AAA" category.
Credit Trend Indicator: Credit trend indicators show whether credit
fundamentals are improving, stable, declining, or uncertain, as follows:
Improving UP ARROW
Stable LEFT ARROW, RIGHT ARROW
Declining DOWN ARROW
Uncertain UP ARROW, DOWN ARROW
Credit trend indicators are not predictions that any rating change will occur,
and have a longer-term time frame than issues placed on FitchAlert.
<TABLE>
<S> <C>
NR Indicates that Fitch does not rate the specific issue.
Conditional A conditional rating is premised on the successful completion of a project
or the occurrence of a specific event.
Suspended A rating is suspended when Fitch deems the amount of information available
from the issuer to be inadequate for rating purposes.
</TABLE>
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<TABLE>
<S> <C>
Withdrawn A rating will be withdrawn when an issue matures or is called or
refinanced and, at Fitch's discretion, when an issuer fails to furnish
proper and timely information.
FitchAlert Ratings are placed on FitchAlert to notify investors of an occurrence that
is likely to result in a rating change and the likely direction of such
change. These are designated as "Positive," indicating a potential
upgrade, "Negative," for potential downgrade, or "Evolving," where ratings
may be raised or lowered. FitchAlert is relatively short-term, and should
be resolved within 12 months.
</TABLE>
DESCRIPTION OF FITCH SPECULATIVE GRADE BOND RATINGS
Fitch speculative grade bond ratings provide a guide to investors in
determining the credit risk associated with a particular security. The ratings
("BB" to "C") represent Fitch's assessment of the likelihood of timely payment
of principal and interest in accordance with the terms of obligation for bond
issues not in default. For defaulted bonds, the rating ("DDD" to "D") is an
assessment of the ultimate recovery value through reorganization or liquidation.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the current and prospective
financial condition and operating performance of the issuer and any guarantor,
as well as the economic and political environment that might affect the issuer's
future financial strength.
Bonds that have the same rating are of similar but not necessarily identical
credit quality since rating categories cannot fully reflect the differences in
degrees of credit risk.
<TABLE>
<C> <S>
BB Bonds are considered speculative. The obligor's ability to pay interest
and repay principal may be affected over time by adverse economic changes.
However, business and financial alternatives can be identified which could
assist the obligor in satisfying its debt service requirements.
B Bonds are considered highly speculative. While bonds in this class are
currently meeting debt service requirements, the probability of continued
timely payment of principal and interest reflects the obligor's limited
margin of safety and the need for reasonable business and economic
activity throughout the life of the issue.
CCC Bonds have certain identifiable characteristics which, if not remedied,
may lead to default. The ability to meet obligations requires an
advantageous business and economic environment.
CC Bonds are minimally protected. Default in payment of interest and/or
principal seems probable over time.
C Bonds are in imminent default in payment of interest or principal.
DDD, DD and D Bonds are in default on interest and/or principal payments. Such bonds are
extremely speculative and should be valued on the basis of their ultimate
recovery value in liquidation or reorganization of the obligor. "DDD"
represents the highest potential for recovery on these bonds, and "D"
represents the lowest potential for recovery.
</TABLE>
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Plus (+) or Minus (-): Plus and minus signs are used with a rating symbol to
indicate the relative position of a credit within the rating category. Plus and
minus signs, however, are not used in the "DDD", "DD", or "D" categories.
DESCRIPTION OF FITCH INVESTMENT GRADE SHORT-TERM RATINGS
Fitch's short-term ratings apply to debt obligations that are payable on
demand or have original maturities of generally up to three years, including
commercial paper, certificates of deposit, medium-term notes, and municipal and
investment notes.
The short-term rating places greater emphasis than a long-term rating on the
existence of liquidity necessary to meet the issuer's obligations in a timely
manner.
Fitch short-term ratings are as follows:
<TABLE>
<C> <S>
F-1+ Exceptionally Strong Credit Quality. Issues assigned this rating are regarded
as having the strongest degree of assurance for timely payment.
F-1 Very Strong Credit Quality. Issues assigned this rating reflect an assurance
of timely payment only slightly less in degree than issues rated "F-1+".
F-2 Good Credit Quality. Issues assigned this rating have a satisfactory degree of
assurance for timely payment, but the margin of safety is not as great as for
issues assigned "F-1+" and "F-1" ratings.
F-3 Fair Credit Quality. Issues assigned this rating have characteristics
suggesting that the degree of assurance for timely payment is adequate,
however, near-term adverse changes could cause these securities to be rated
below investment grade.
F-S Weak Credit Quality. Issues assigned this rating have characteristics
suggesting a minimal degree of assurance for timely payment and are vulnerable
to near-term adverse changes in financial and economic conditions.
D Default. Issues assigned this rating are in actual or imminent payment
default.
LOC The symbol "LOC" indicates that the rating is based on a letter of credit
issued by a commercial bank.
INS The symbol "INS" indicates that the rating is based on an insurance policy or
financial guaranty issued by an insurance company.
</TABLE>
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INDEPENDENT AUDITORS' REPORT
The Board of Trustees and Shareholders,
MERRILL LYNCH COLORADO MUNICIPAL BOND FUND OF
MERRILL LYNCH MULTI-STATE MUNICIPAL SERIES TRUST:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of Merrill Lynch Colorado Municipal Bond Fund of
Merrill Lynch Multi-State Municipal Series Trust as of July 31, 1994, the
related statements of operations and changes in net assets and financial
highlights for the period November 26, 1993 (commencement of operations) to July
31, 1994. These financial statements and the financial highlights are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements and the financial highlights based on our
audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements and the financial highlights
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. Our
procedures included confirmation of securities owned at July 31, 1994, by
correspondence with the custodian and brokers. An audit also includes assessing
the accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe that
our audit provides a reasonable basis for our opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of Merrill Lynch
Colorado Municipal Bond Fund of Merrill Lynch Multi-State Municipal Series Trust
as of July 31, 1994, the results of its operations, the changes in its net
assets, and the financial highlights for the period November 26, 1993 to July
31, 1994 in conformity with generally accepted accounting principles.
DELOITTE & TOUCHE LLP
Princeton, New Jersey
August 29, 1994
63
<PAGE>
<TABLE>
<CAPTION>
SCHEDULE OF INVESTMENTS (in Thousands)
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note 1a)
<C> <C> <C> <S> <C>
Colorado--89.8%
AAA Aaa $ 1,000 Adams County, Colorado, PCR, Refunding (Public Service Company, Colorado
Project), Series A, 5.875% due 4/01/2014 (b) $ 990
AAA Aaa 500 Arvada, Colorado, Sales and Use Tax Revenue Refunding and Improvement Bonds,
6.25% due 12/01/2017 (d) 511
AAA Aaa 1,000 Auraria, Colorado, Higher Education Center Revenue Bonds (Student Fee),
Series B, 6.50% due 11/01/2016 (c) 1,041
BBB+ Baa1 1,500 Boulder County, Colorado, Hospital Revenue Refunding Bonds (Longmont United
Hospital Project), 5.875% due 12/01/2020 1,334
Colorado Health Facilities Authority Revenue Bonds:
NR A 500 (Craig Hospital Project), 5.50% due 12/01/2021 429
AAA Aaa 1,750 Refunding (Boulder Community Hospital), Series B, 5.875% due 10/01/2023 (b) 1,701
BBB+ Baa1 500 (Swedish Medical Center Project), Series A, 6.80% due l/01/2023 495
NR VMIG1 800 Colorado Housing Financing Authority, M/F Revenue Bonds (Hamden & Estes), VRDN,
2.75% due 12/01/2005 (a) 800
AAA Aaa 1,000 Colorado Regional Transportation District, Sales Tax Revenue Refunding and
Improvement Bonds, 6.25% due 11/01/2012 (d) 1,030
AA Aa 2,000 Colorado Springs, Colorado, Utilities Revenue Refunding Bonds, Series A, 6.125%
due 11/15/2020 1,996
AAA Aaa 1,000 Colorado State Colleges Board of Trustees, Auxiliary Facilities System Revenue
Bonds, Refunding (Enterprise-Mesa State College), Series B, 5.70% due 5/15/2014 (b) 975
NR A 1,000 Colorado State Student Obligation Board Authority, Student Loan Notes, Senior
Sub-Series 1-B, 5.70% due 12/01/2006 1,002
AA Aa 1,000 Colorado Water Resource Power Development Authority, Clean Water Revenue Bonds,
Series A, 6.30% due 9/01/2014 1,019
Denver, Colorado, City and County, Airport Revenue Bonds, Series D, AMT:
BB Baa 500 7.75% due 11/15/2013 514
BB Baa 620 7% due 11/15/2025 578
</TABLE>
PORTFOLIO ABBREVIATIONS
To simplify the listings of Merrill Lynch Colorado Municipal Bond
Fund's portfolio holdings in the Schedule of Investments, we have
abbreviated the names of many of the securities according to the
list at right.
AMT Alternative Minimum Tax (subject to)
IDR Industrial Development Revenue Bonds
M/F Multi-Family
PCR Pollution Control Revenue Bonds
UT Unlimited Tax
VRDN Variable Rate Demand Notes
64
<PAGE>
<TABLE>
<CAPTION>
SCHEDULE OF INVESTMENTS (concluded) (in Thousands)
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note 1a)
<C> <C> <C> <S> <C>
Colorado (concluded)
Denver, Colorado, City and County, School District Number 1, Refunding
Bonds, Series A:
A+ A $ 1,000 6.50% due 6/01/2010 $ 1,056
A+ A 2,000 6.50% due 12/01/2010 2,118
A Baa1 1,000 El Paso County, Colorado, School District Number 020, Refunding Bonds, UT,
Series A, 6.15% due 12/15/2008 1,009
AAA Aaa 1,500 La Plata County, Colorado, School District Number 9, Refunding Bonds (R Durango),
6.60% due 11/01/2017 (d) 1,578
AAA MIG1++ 400 Northglenn, Colorado, IDR, Refunding (Castle Gardens Retirement), VRDN, 2.45% due
l/01/2009 (a) 400
A+ Aa 500 Platte River Power Authority, Colorado, Power Revenue Refunding Bonds, Series BB,
6.125% due 6/01/2009 514
BBB NR 500 Prowers County, Colorado, Sales and Use Tax Revenue Refunding Bonds, 5.50% due
7/15/2011 458
AAA Aaa 1,000 Thorton, Colorado, Sales and Use Tax Revenue Bonds, Series A, 6.25% due
9/01/2012 (d) 1,031
Puerto Rico--5.8%
A Baa1 1,000 Puerto Rico Commonwealth, Highway and Transportation Authority, Highway Revenue
Refunding Bonds, Series V, 5.75% due 7/01/2018 934
BBB- NR 600 Puerto Rico, Industrial, Tourist, Educational, Medical and Environmental Control
Facilities Financing Authority, Higher Education Revenue Bonds (PolyTechnic
University of Puerto Rico Project), Series A, 5.50% due 8/01/2024 526
Total Investments (Cost--$24,778)--95.6% 24,039
Other Assets Less Liabilities--4.4% 1,118
-------
Net Assets--100.0% $25,157
=======
<FN>
(a)The interest rate is subject to change periodically based upon the prevailing market rate.
The interest rates shown are those in effect at July 31, 1994.
(b)MBIA Insured.
(c)AMBAC Insured.
(d)FGIC Insured.
++Highest short-term rating by Moody's Investors Service, Inc.
NR--Not Rated.
Ratings shown have not been audited by Deloitte & Touche LLP.
</TABLE>
See Notes to Financial Statements.
65
<PAGE>
<TABLE>
<CAPTION>
FINANCIAL INFORMATION
Statement of Assets and Liabilities as of July 31, 1994
<C> <S> <C> <C>
Assets: Investments, at value (identified cost--$24,777,884) (Note 1a) $24,038,507
Cash 696,703
Receivables:
Securities sold $ 1,101,995
Interest 292,250
Investment adviser (Note 2) 134,420
Beneficial interest sold 31,002 1,559,667
------------
Deferred organization expenses (Note 1e) 32,493
Prepaid expenses and other assets (Note 1e) 41,210
------------
Total assets 26,368,580
============
Liabilities: Payables:
Securities purchased 1,000,000
Beneficial interest redeemed 116,905
Dividends to shareholders (Note 1f) 21,218
Distributor (Note 2) 6,153 1,144,276
------------
Accrued expenses and other liabilities 67,757
------------
Total liabilities 1,212,033
------------
Net Assets: Net assets $ 25,156,547
============
Net Assets Class A Shares of beneficial interest, $.10 par value,
Consist of: unlimited number of shares authorized $ 113,310
Class B Shares of beneficial interest, $.10 par value, unlimited
number of shares authorized 154,766
Paid-in capital in excess of par 26,429,981
Accumulated realized capital losses--net (802,133)
Unrealized depreciation on investments--net (739,377)
------------
Net assets $ 25,156,547
============
Net Asset Class A--Based on net assets of $10,634,060 and 1,133,095 shares of
Value: beneficial interest outstanding $ 9.38
============
Class B--Based on net assets of $14,522,487 and 1,547,664 shares of
beneficial interest outstanding $ 9.38
============
</TABLE>
See Notes to Financial Statements.
66
<PAGE>
<TABLE>
<CAPTION>
FINANCIAL INFORMATION (continued)
Statement of Operations
For the Period
November 26, 1993++
to July 31, 1994
<C> <S> <C>
Investment Interest and amortization of premium and discount earned $ 759,864
Income
(Note 1d):
Expenses: Investment advisory fees (Note 2) 78,643
Printing and shareholder reports 59,225
Distribution fees--Class B (Note 2) 43,694
Accounting services (Note 2) 18,821
Registration fees (Note 1e) 18,380
Professional fees 11,864
Listing fees 9,618
Custodian fees 5,440
Amortization of organization expenses (Note 1e) 5,106
Transfer agent fees--Class B (Note 2) 4,889
Transfer agent fees--Class A (Note 2) 2,479
Pricing fees 2,415
Trustees' fees and expenses 257
Other 722
------------
Total expenses before reimbursement 261,553
Reimbursement of expenses (Note 2) (213,063)
------------
Total expenses after reimbursement 48,490
------------
Investment income--net 711,374
------------
Realized & Realized loss on investments--net (802,133)
Unrealized Unrealized depreciation on investments--net (739,377)
Losses on ------------
Investments Net Decrease in Net Assets Resulting from Operations $ (830,136)
- --Net (Notes ============
1d & 3):
<FN>
++Commencement of Operations.
</TABLE>
See Notes to Financial Statements.
67
<PAGE>
<TABLE>
<CAPTION>
FINANCIAL INFORMATION (continued)
Statement of Changes in Net Assets
For the Period
November 26, 1993++
Increase (Decrease) in Net Assets: to July 31, 1994
<C> <S> <C>
Operations: Investment income--net $ 711,374
Realized loss on investments--net (802,133)
Unrealized depreciation on investments--net (739,377)
------------
Net decrease in net assets resulting from operations (830,136)
============
Dividends to Investment income--net:
Shareholders Class A (297,744)
(Note 1f): Class B (413,630)
------------
Net decrease in net assets resulting from dividends to shareholders (711,374)
------------
Beneficial Net increase in net assets derived from capital share transactions 26,598,057
Interest ------------
Transactions
(Note 4):
Net Assets: Total increase in net assets 25,056,547
Beginning of period 100,000
------------
End of period $ 25,156,547
============
<FN>
++Commencement of Operations.
</TABLE>
See Notes to Financial Statements
68
<PAGE>
<TABLE>
<CAPTION>
FINANCIAL INFORMATION (concluded)
Financial Highlights
Class A Class B
For the For the
Period Period
November 26, November 26,
The following per share data and ratios have been derived 1993++ 1993++
from information provided in the financial statements. to July 31, to July 31,
Increase (Decrease) in Net Asset Value: 1994 1994
<C> <S> <C> <C>
Per Share Net asset value, beginning of period $ 10.00 $ 10.00
Operating ------------ ------------
Performance: Investment income--net .34 .31
Realized and unrealized loss on investments--net (.62) (.62)
------------ ------------
Total from investment operations (.28) (.31)
------------ ------------
Less dividends from investment income--net (.34) (.31)
------------ ------------
Net asset value, end of period $ 9.38 $ 9.38
============ ============
Total Investment Based on net asset value per share (2.83%)+++ (3.16%)+++
Return:** ============ ============
Ratios to Expenses, excluding distribution fees and net of reimbursement .03%* .04%*
Average ============ ============
Net Assets: Expenses, net of reimbursement .03%* .54%*
============ ============
Expenses 1.52%* 2.03%*
============ ============
Investment income--net 5.36%* 4.73%*
============ ============
Supplemental Net assets, end of period (in thousands) $ 10,634 $ 14,522
Data: ============ ============
Portfolio turnover 82.71% 82.71%
============ ============
<FN>
++Commencement of Operations.
+++Aggregate total investment return.
*Annualized.
**Total investment returns exclude the effects of sales loads.
</TABLE>
See Notes to Financial Statements.
69
<PAGE>
NOTES TO FINANCIAL STATEMENTS
1. Significant Accounting Policies:
Merrill Lynch Colorado Municipal Bond Fund (the "Fund") is part of Merrill Lynch
Multi-State Municipal Series Trust (the "Trust"). The Fund is registered under
the Investment Company Act of 1940 as a non-diversified, open-end management
investment company. Prior to commencement of operations on November 26, 1993,
the Fund had no operations other than those relating to organizational matters
and the issuance of 5,000 Class A Shares of beneficial interest and 5,000 Class
B Shares of beneficial interest of the Fund to Fund Asset Management, L.P.
("FAM") for $100,000. The Fund offers both Class A and Class B Shares. Class A
Shares are sold with a front-end sales charge. Class B Shares may be subject to
a contingent deferred sales charge. Both classes of shares have identical
voting, dividend, liquidation and other rights and the same terms and
conditions, except that Class B Shares bear certain expenses related to the
distribution of such shares and have exclusive voting rights with respect to
matters relating to such distribution expenditures. The following is a summary
of significant accounting policies followed by the Fund.
(a) Valuation of investments--Municipal bonds and other portfolio securities in
which the Fund invests are traded primarily in the over-the-counter municipal
bond and money markets and are valued at the last available bid price in the
over-the-counter market or on the basis of yield equivalents as obtained from
one or more dealers that make markets in the securities. Financial futures
contracts and options thereon, which are traded on exchanges, are valued at
their settlement prices as of the close of such exchanges. Options, which are
traded on exchanges, are valued at their last sale price as of the close of such
exchanges or, lacking any sales, at the last available bid price. Short-term
investments with a remaining maturity of sixty days or less are valued on an
amortized cost basis, which approximates market value. Securities and assets for
which market quotations are not readily available are valued at fair value as
determined in good faith by or under the direction of the Board of Trustees of
the Trust, including valuations furnished by a pricing service retained by the
Trust, which may utilize a matrix system for valuations. The procedures of the
pricing service and its valuations are reviewed by the officers of the Trust
under the general supervision of the Trustees.
(b) Financial futures contracts--The Fund may purchase or sell interest rate
futures contracts and options on such futures contracts for the purpose of
hedging the market risk on existing or the intended purchase of securities.
Futures contracts are contracts for delayed delivery of securities at a specific
future date and at a specific price or yield. Upon entering into a contract, the
Fund agrees to receive from or pay to the broker an amount of cash equal to the
daily fluctuation in value of the contract. Such receipts or payments are known
as variation margin and are recorded by the Fund as unrealized gains or losses.
When the contract is closed, the Fund records a realized gain or loss equal to
the difference between the value of the contract at the time it was opened and
the value at the time it was closed.
(c) Income taxes--It is the Fund's policy to comply with the requirements of the
Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required.
(d) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Interest income is recognized on the accrual basis. Discounts and market
premiums are amortized into interest income. Realized gains and losses on
security transactions are determined on the identified cost basis.
70
<PAGE>
NOTES TO FINANCIAL STATEMENTS (concluded)
(e) Deferred organization expenses and prepaid registration fees--Deferred
organization expenses are charged to expense on a straight-line basis over a
five-year period. Prepaid registration fees are charged to expense as the
related shares are issued.
(f) Dividends and distributions--Dividends from net investment income are
declared daily and paid monthly. Distributions of capital gains are recorded on
the ex-dividend dates.
2. Investment Advisory Agreement and
Transactions with Affiliates:
The Fund has entered into an Investment Advisory Agreement with FAM. Effective
January 1, 1994, the investment advisory business of FAM was reorganized from a
corporation to a limited partnership. Both prior to and after the
reorganization, ultimate control of FAM was vested with Merrill Lynch & Co.,
Inc. ("ML & Co."). The general partner of FAM is Princeton Services, Inc.
("PSI"), an indirect wholly-owned subsidiary of ML&Co. The limited partners are
ML & Co. and Fund Asset Management, Inc. ("FAMI"), which is also an indirect
wholly-owned subsidiary of ML & Co. The Fund has also entered into Distribution
Agreements and a Distribution Plan with Merrill Lynch Funds Distributor, Inc.
("MLFD" or "Distributor"), a wholly-owned subsidiary of Merrill Lynch Investment
Management, Inc. ("MLIM"), which is also an indirect wholly-owned subsidiary of
ML&Co.
FAM is responsible for the management of the Fund's portfolio and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the Fund. For such services, the Fund pays a monthly fee
based upon the average daily value of the Fund's net assets at the following
annual rates: 0.55% of the Fund's average daily net assets not exceeding $500
million; 0.525% of average daily net assets in excess of $500 million but not
exceeding $1 billion; and 0.50% of average daily net assets in excess of $1
billion. The Investment Advisory Agreement obligates FAM to reimburse the Fund
to the extent the Fund's expenses (excluding interest, taxes, distribution fees,
brokerage fees and commissions, and extraordinary items) exceed 2.5% of the
Fund's first $30 million of average daily net assets, 2.0% of the next $70
million of average daily net assets, and 1.5% of the average daily net assets in
excess thereof. FAM's obligation to reimburse the Fund is limited to the amount
of the management fee. No fee payment will be made during any fiscal year which
will cause such expenses to exceed expense limitations at the time of such
payment. For the period November 26, 1993 to July 31, 1994, FAM earned fees of
$78,643, all of which was voluntarily waived. FAM also voluntarily reimbursed
the Fund additional expenses of $134,420.
The Fund has adopted a Plan of Distribution (the "Plan") in accordance with Rule
12b-1 under the Investment Company Act of 1940, pursuant to which the Fund pays
the Distributor an ongoing account maintenance fee and distribution fee from the
Fund for the sale of Class B Shares, which are accrued daily and paid monthly at
the annual rates of 0.25% and 0.25%, respectively, of the average daily net
assets of the Class B Shares of the Fund. Pursuant to a sub-agreement with the
Distributor, Merrill Lynch, Pierce, Fenner & Smith, Inc. ("MLPF&S"), an
affiliate of ML & Co., also provides account maintenance and distribution
services to the Fund. The ongoing distribution and account maintenance fees
compensate the Distributor and MLPF&S for providing distribution and account
maintenance services to Class B shareholders. As authorized by the Plan,
71
<PAGE>
the Distributor has entered into an agreement with MLPF&S, an affiliate of ML &
Co., which provides for the compensation of MLPF&S for providing
distribution-related services to the Fund. For the period November 26, 1993 to
July 31, 1994, MLFD earned underwriting discounts of $2,080, and MLPF&S earned
dealer concessions of $118,709 on sales of the Fund's Class A Shares.
MLPF&S also received contingent deferred sales charges of $16,384
relating to Class B Share transactions during the period.
Financial Data Services, Inc. ("FDS), a wholly-owned subsidiary of ML & Co., is
the Fund's transfer agent.
Accounting services are provided to the Fund by FAM at cost.
Certain officers and/or trustees of the Fund are officers and/or directors of
FAM, FAMI, PSI, MLIM, MLFD, FDS, MLPF&S, and/or ML & Co.
3. Investments:
Purchases and sales of investments, excluding short-term securities, for the
period ended July 31, 1994 were $38,260,569 and $13,764,236, respectively.
Net realized and unrealized gains (losses) as of July 31, 1994 were as follows:
<TABLE>
<CAPTION>
Realized
Gains Unrealized
(Losses) Losses
<S> <C> <C>
Long-term investments $ (900,983) $ (739,377)
Short-term investments 1,589 --
Financial futures contracts 97,261 --
----------- -----------
Total $ (802,133) $ (739,377)
=========== ===========
</TABLE>
As of July 31, 1994, net unrealized depreciation for Federal income tax purposes
aggregated $739,377, of which $91,802 related to appreciated securities and
$831,179 related to depreciated securities. The aggregate cost of investments at
July 31, 1994 for Federal income tax purposes was $24,777,884.
4. Beneficial Interest Transactions:
Net increase in net assets derived from beneficial interest transactions was
$26,598,057 for the period ended July 31, 1994.
Transactions in shares of beneficial interest for Class A and Class B shares
were as follows:
<TABLE>
<CAPTION>
Class A Shares for the Period
November 26, 1993++ to Dollar
July 31, 1994 Shares Amount
<S> <C> <C>
Shares sold 1,233,303 $12,258,088
Shares issued to shareholders
in reinvestment of dividends
and distributions 11,404 108,470
----------- -----------
Total issued 1,244,707 12,366,558
Shares redeemed (116,612) (1,140,447)
----------- -----------
Net increase 1,128,095 $11,226,111
=========== ===========
<FN>
++Prior to November 26, 1993 (commencement of operations), the Fund
issued 5,000 shares to FAM for $50,000.
</TABLE>
<TABLE>
<CAPTION>
Class B Shares for the Period
November 26, 1993++ to Dollar
July 31, 1994 Shares Amount
<S> <C> <C>
Shares sold 1,665,981 $16,563,289
Shares issued to shareholders
in reinvestment of dividends
and distributions 14,570 139,229
----------- -----------
Total issued 1,680,551 16,702,518
Shares redeemed (137,887) (1,330,572)
----------- -----------
Net increase 1,542,664 $15,371,946
=========== ===========
<FN>
++Prior to November 26, 1993 (commencement of operations), the Fund
issued 5,000 shares to FAM for $50,000.
</TABLE>
72
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Investment Objective and Policies.............. 2
Description of Municipal Bonds and Temporary
Investments.................................. 5
Description of Municipal Bonds............. 5
Description of Temporary Investments....... 7
Repurchase Agreements...................... 8
Financial Futures Transactions and
Options................................... 9
Investment Restrictions........................ 13
Management of the Trust........................ 17
Trustees and Officers...................... 17
Management and Advisory Arrangements....... 19
Purchase of Shares............................. 20
Initial Sales Charge Alternatives--Class A
and Class D Shares........................ 21
Reduced Initial Sales Charges.............. 22
Distribution Plans......................... 24
Limitations on the Payment of Deferred
Sales Charges............................. 25
Redemption of Shares........................... 25
Deferred Sales Charges--Class B Shares..... 25
Portfolio Transactions......................... 26
Determination of Net Asset Value............... 28
Shareholder Services........................... 28
Investment Account......................... 28
Automatic Investment Plans................. 29
Automatic Reinvestment of Dividends and
Capital Gains Distributions............... 29
Systematic Withdrawal Plans--Class A and
Class D Shares............................ 30
Exchange Privilege......................... 31
Distributions and Taxes........................ 43
Environmental Tax.......................... 46
Tax Treatment of Option and Futures
Transactions.............................. 46
Performance Data............................... 47
General Information............................ 48
Description of Shares...................... 48
Computation of Offering Price Per Share.... 50
Independent Auditors....................... 50
Custodian.................................. 50
Transfer Agent............................. 50
Legal Counsel.............................. 51
Reports to Shareholders.................... 51
Additional Information..................... 51
Appendix I -- Economic and Financial Conditions
in Colorado.................................. 52
Appendix II -- Ratings of Municipal Bonds...... 55
Independent Auditors' Report................... 63
Financial Statements........................... 64
Code #16916-1094
</TABLE>
[LOGO]
Merrill Lynch
Colorado Municipal
Bond Fund
Merrill Lynch Multi-State
Municipal Series Trust
STATEMENT OF
ADDITIONAL INFORMATION
October 21, 1994
Distributor:
Merrill Lynch
Funds Distributor, Inc.
<PAGE>
APPENDIX FOR GRAPHIC AND IMAGE MATERIAL
Pursuant to Rule 304 of Regulation S-T, the following table presents fair
and accurate narrative descriptions of graphic and image material omitted from
this EDGAR Submission File due to ASCII-incompatibility and cross-references
this material to the location of each occurrence in the text.
<TABLE>
<CAPTION>
DESCRIPTION OF OMITTED LOCATION OF GRAPHIC
GRAPHIC OR IMAGE OR IMAGE IN TEXT
- ---------------------------------------------- ----------------------------------------------
<S> <C>
Compass plate, circular graph paper and Back cover of Prospectus and back cover of
Merrill Lynch logo including stylized market Statement of Additional Information
bull
</TABLE>
