<PAGE> 1
PROSPECTUS
OCTOBER 29, 1996
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, 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 ("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. For more information on the Fund's
investment objective and policies, please see "Investment Objective and
Policies" on page 10.
-------------------------
Pursuant to the Merrill Lynch Select Pricing(SM) System, the Fund offers
four classes of shares, each with a different combination of sales charges,
ongoing fees and other features. The Merrill Lynch Select 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 9081, Princeton, New Jersey 08543-9081 [(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 29, 1996 (the "Statement of Additional Information"), has
been filed with the Securities and Exchange Commission (the "Commission") and is
available, without charge, by calling or by writing Merrill Lynch 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> 2
FEE TABLE
A general comparison of the sales arrangements and other nonrecurring and
recurring expenses applicable to shares of the Fund follows:
<TABLE>
<CAPTION>
CLASS A(a) CLASS B(b) CLASS C CLASS D
---------- ------------------------------- -------- -------
<S> <C> <C> <C> <C>
SHAREHOLDER TRANSACTION EXPENSES:
Maximum Sales Charge Imposed on Purchases (as a
percentage of offering price)..................... 4.00%(c) None None 4.00%(c)
Sales Charge Imposed on Dividend Reinvestments...... None None None None
Deferred Sales Charge (as a percentage of original
purchase price or redemption proceeds, whichever
is lower)......................................... None(d) 4.0% during the first year, 1.0% for None(d)
decreasing 1.0% annually one
thereafter to 0.0% after the year(f)
fourth year(e)
Exchange Fee........................................ None None None None
ANNUAL FUND OPERATING EXPENSES (AS A PERCENTAGE OF
AVERAGE NET ASSETS):
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.................................... 0.01% 0.01% 0.01% 0.01%
Shareholder Servicing Costs(i).................... 0.04% 0.05% 0.05% 0.04%
Other............................................. 0.52% 0.51% 0.51% 0.51%
------ --- --- ----
Total Other Expenses.......................... 0.57% 0.57% 0.57% 0.56%
------ --- --- ----
Total Fund Operating Expenses+........................ 1.12% 1.62% 1.72% 1.21%
====== ===== ===== =====
</TABLE>
- ---------------
(a) Class A shares are sold to a limited group of investors including existing
Class A shareholders and certain participants in fee-based programs. See
"Purchase of Shares--Initial Sales Charge Alternatives--Class A and Class D
Shares"--page 24 and "Shareholder Services--Fee-Based Programs"--page 34.
(b) Class B shares convert to Class D shares automatically approximately ten
years after initial purchase. See "Purchase of Shares Deferred Sales Charge
Alternatives--Class B and Class C Shares"--page 26.
(c) Reduced for purchases of $25,000 and over and waived for purchases of Class
A shares in connection with certain fee-based programs. Class A or Class D
purchases of $1,000,000 or more may not be subject to an initial sales
charge. See "Purchase of Shares--Initial Sales Charge Alternatives--Class A
and Class D Shares"--page 24.
(d) Class A and Class D shares are not subject to a contingent deferred sales
charge ("CDSC"), except that certain purchases of $1,000,000 or more which
are not subject to an initial sales charge may instead be subject to a CDSC
of 1.0% of amounts redeemed within the first year after purchase. Such CDSC
may be waived in connection with redemptions to fund participation in
certain fee-based programs. See "Shareholder Services--Fee-Based
Programs"--page 34.
(e) The CDSC may be modified in connection with redemptions to fund
participation in certain fee-based programs. See "Shareholder
Services--Fee-Based Programs"--page 34.
(f) The CDSC may be waived in connection with redemptions to fund participation
in certain fee-based programs. See "Shareholder Services--Fee-Based
Programs"--page 34.
(footnotes continued on next page)
2
<PAGE> 3
(g) See "Management of the Trust--Management and Advisory Arrangements"--page
20.
(h) See "Purchase of Shares--Distribution Plans"--page 28.
(i) See "Management of the Trust--Transfer Agency Services"--page 21.
+ For the fiscal year ended July 31, 1996, Fund Asset Management, L.P. (the
"Manager") voluntarily waived $161,021 of the management fees due from the
Fund and voluntarily reimbursed the Fund for a portion of other expenses
(excluding Rule 12b-1 fees). Total Fund Operating Expenses in the fee table
have been restated to assume the absence of any such waiver or reimbursement
because the Manager may discontinue or reduce such waiver of fees and/or
assumption of expenses at any time without notice. For the fiscal year ended
July 31, 1996, the Manager waived management fees and reimbursed expenses
totaling 0.65% for Class A shares, 0.64% for Class B shares, 0.63% for Class
C shares and 0.63% for Class D shares after which the Fund's total expense
ratio was 0.47% for Class A shares, 0.98% for Class B shares, 1.09% for
Class C shares and 0.58% for Class D shares.
EXAMPLE:
<TABLE>
<CAPTION>
CUMULATIVE EXPENSES PAID
FOR THE PERIOD OF:
----------------------------------------
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
An investor would pay the following expenses on a $1,000
investment including the maximum $40 initial sales charge
(Class A and Class D shares only) and assuming (1) the
Total Fund Operating Expenses for each class set forth on
page 2, (2) a 5% annual return throughout the periods and
(3) redemption at the end of the period:
Class A................................................. $ 51 $74 $ 99 $171
Class B................................................. $ 56 $71 $ 88 $192
Class C................................................. $ 27 $54 $ 93 $203
Class D................................................. $ 52 $77 $ 104 $181
An investor would pay the following expenses on the same
$1,000 investment assuming no redemption at the end of the
period:
Class A................................................. $ 51 $74 $ 99 $171
Class B................................................. $ 16 $51 $ 88 $192
Class C................................................. $ 17 $54 $ 93 $203
Class D................................................. $ 52 $77 $ 104 $181
</TABLE>
The foregoing Fee Table is intended to assist investors in understanding
the costs and expenses that a shareholder in the Fund will bear directly or
indirectly. The example set forth above assumes reinvestment of all dividends
and distributions and utilizes a 5% annual rate of return as mandated by
Commission regulations. THE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF
PAST OR FUTURE EXPENSES OR ANNUAL RATES OF RETURN, AND ACTUAL EXPENSES OR ANNUAL
RATES OF RETURN MAY BE MORE OR LESS THAN THOSE ASSUMED FOR PURPOSES OF THE
EXAMPLE. Class B and Class C shareholders who hold their shares for an extended
period of time may pay more in Rule 12b-1 distribution fees than the economic
equivalent of the maximum front-end sales charges permitted under the Conduct
Rules of the National Association of Securities Dealers, Inc. (the "NASD").
Merrill Lynch may charge its customers a processing fee (presently $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".
The Manager of the Fund, Fund Asset Management, L.P. (the "Manager" or
"FAM"), has voluntarily agreed to assume a portion of the operating expenses of
the Fund. The Manager may discontinue or reduce such assumption of expenses at
any time without notice.
3
<PAGE> 4
MERRILL LYNCH SELECT PRICING(SM) SYSTEM
The Fund offers four classes of shares under the Merrill Lynch Select
Pricing(SM) System. The shares of each class may be purchased at a price equal
to the next determined net asset value per share subject to the sales charges
and ongoing fee arrangements described below. Shares of Class A and Class D are
sold to investors choosing the initial sales charge alternatives, and shares of
Class B and Class C are sold to investors choosing the deferred sales charge
alternatives. The Merrill Lynch Select Pricing(SM) System is used by more than
50 registered investment companies advised by Merrill Lynch Asset Management,
L.P. ("MLAM") or FAM, an affiliate of MLAM. Funds advised by MLAM or FAM which
utilize the Merrill Lynch Select Pricing(SM) System are referred to herein as
"MLAM-advised mutual funds".
Each Class A, Class B, Class C or Class D share of the Fund represents an
identical interest in the investment portfolio of the Fund and has the same
rights, except that Class B, Class C and Class D shares bear the expenses of the
ongoing account maintenance fees and Class B and Class C shares bear the
expenses of the ongoing distribution fees and the additional incremental
transfer agency costs resulting from the deferred sales charge arrangements. The
deferred sales charges, distribution and account maintenance fees that are
imposed on Class B and Class C shares, as well as the account maintenance fees
that are imposed on the Class D shares, are imposed directly against those
classes and not against all assets of the Fund and, accordingly, such charges
will not affect the net asset value of any other class or have any impact on
investors choosing another sales charge option. Dividends paid by the Fund for
each class of shares will be calculated in the same manner at the same time and
will differ only to the extent that account maintenance and distribution fees
and any incremental transfer agency costs relating to a particular class are
borne exclusively by that class. Each class has different exchange privileges.
See "Shareholder Services--Exchange Privilege".
Investors should understand that the purpose and function of the initial
sales charges with respect to the Class A and Class D shares are the same as
those of the 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.
4
<PAGE> 5
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".
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------
<C> <S> <C> <C> <C>
- -------------------------------------------------------------------------------------------------------
<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 0.25% 0.25% B shares convert to D
rate of 4.0% during the first shares
year, decreasing 1.0% annually to automatically after
0.0%(4) approximately ten
years(5)
- -------------------------------------------------------------------------------------------------------
C 1.0% CDSC for one year(6) 0.25% 0.35% No
- -------------------------------------------------------------------------------------------------------
D Maximum 4.00% initial sales 0.10% No No
charge(3)
- -------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------
</TABLE>
- ---------------
(1) Initial sales charges are imposed at the time of purchase as a percentage of
the offering price. CDSCs are imposed if the redemption occurs within the
applicable CDSC time period. The charge will be assessed on an amount equal
to the lesser of the proceeds of redemption or the cost of the shares being
redeemed.
(2) Offered only to eligible investors. See "Purchase of Shares--Initial Sales
Charge Alternatives--Class A and Class D Shares-- Eligible Class A
Investors".
(3) Reduced for purchases of $25,000 or more and waived for purchases of Class A
shares in connection with certain fee-based programs. Class A and Class D
share purchases of $1,000,000 or more may not be subject to an initial sales
charge but instead may be subject to a 1.0% CDSC if redeemed within one
year. Such CDSC may be waived in connection with redemptions to fund
participation in certain fee-based programs. See "Class A" and "Class D"
below.
(4) The CDSC may be modified in connection with redemptions to fund
participation in certain fee-based programs.
(5) The conversion period for dividend reinvestment shares and certain fee-based
programs may be modified. Also, Class B shares of certain other MLAM-advised
mutual funds into which exchanges may be made have an eight-year conversion
period. If Class B shares of the Fund are exchanged for Class B shares of
another MLAM-advised mutual fund, the conversion period applicable to the
Class B shares acquired in the exchange will apply, and the holding period
for the shares exchanged will be tacked onto the holding period for the
shares acquired.
(6) The CDSC may be waived in connection with redemptions to fund participation
in certain fee-based programs.
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 of the Fund in a
shareholder account are entitled to purchase additional Class A shares
of the Fund in that account. Other eligible investors include
participants in certain fee-based programs. In addition, Class A shares
will be offered at net asset value to Merrill Lynch & Co., Inc. ("ML &
Co.") 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 and waived for
purchases of Class A shares in connection with certain fee-based
programs. Purchases of $1,000,000 or more may not be subject to an
initial sales charge but if the initial sales charge is waived, such
purchases may be subject to a 1.0% CDSC if the shares are redeemed
within one year after purchase. Such CDSC may be waived in connection
5
<PAGE> 6
with redemptions to fund participation in certain fee-based programs.
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".
Class B: Class B shares do not incur a sales charge when they are purchased, but
they are subject to an ongoing account maintenance fee of 0.25%, and an
ongoing distribution fee of 0.25% of the Fund's average net assets
attributable to the Class B shares, as well as a CDSC if they are
redeemed within four years of purchase. Such CDSC may be modified in
connection with redemptions to fund participation in certain fee-based
programs. Approximately ten years after issuance, Class B shares will
convert automatically into Class D shares of the Fund, which are
subject to a lower account maintenance fee of 0.10% and no distribution
fee; Class B shares of certain other MLAM-advised mutual funds into
which exchanges may be made convert into Class D shares automatically
after approximately eight years. If Class B shares of the Fund are
exchanged for Class B shares of another MLAM-advised mutual fund, the
conversion period applicable to the Class B shares acquired in the
exchange will apply, as will the Class D account maintenance fee of the
acquired fund upon the conversion, and the holding period for the
shares exchanged will be tacked onto the holding period for the shares
acquired. Automatic conversion of Class B shares into Class D shares
will occur at least once a month on the basis of the relative net asset
values of the shares of the two classes on the conversion date, without
the imposition of any sales load, fee or other charge. Conversion of
Class B shares to Class D shares will not be deemed a purchase or sale
of the shares for Federal income tax purposes. Shares purchased through
reinvestment of dividends on Class B shares also will convert
automatically to Class D shares. The conversion period for dividend
reinvestment shares is modified as described under "Purchase of
Shares--Deferred Sales Charge Alternatives--Class B and Class C
Shares--Conversion of Class B Shares to Class D Shares".
Class C: Class C shares do not incur a sales charge when they are purchased, but
they are subject to an ongoing account maintenance fee of 0.25% and an
ongoing distribution fee of 0.35% of the Fund's average net assets
attributable to Class C shares. Class C shares are also subject to a
CDSC of 1.0% if they are redeemed within one year of purchase. Such
CDSC may be waived in connection with redemptions to fund participation
in certain fee-based programs. Although Class C shares are subject to a
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 account maintenance fees
and higher 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 may be subject to a CDSC of 1.0% if the shares are redeemed
within one year after purchase. Such CDSC may be waived in connection
with redemptions to fund participation in certain fee-based programs.
The schedule of initial sales charges and reductions for the Class D
shares is the same as the schedule for Class A shares, except that
there is no waiver for purchases of Class D shares in connection with
certain fee-based programs. Class D shares also will
6
<PAGE> 7
be issued upon conversion of Class B shares as described above under
"Class B". See "Purchase of Shares--Initial Sales Charge
Alternatives--Class A and Class D Shares".
The following is a discussion of the factors that investors should consider
in determining the method of purchasing shares under the Merrill Lynch Select
Pricing(SM) System that the investor believes is most beneficial under his
particular circumstances.
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 there is an account maintenance fee
imposed on Class D shares. Investors qualifying for significantly reduced
initial sales charges may find the initial sales charge alternative particularly
attractive because similar sales charge reductions are not available with
respect to the CDSCs imposed in connection with purchases of Class B or Class C
shares. Investors not qualifying for reduced initial sales charges who expect to
maintain their investment for an extended period of time also may elect to
purchase Class A or Class D shares, because over time the accumulated ongoing
account maintenance and distribution fees on Class B or Class C shares may
exceed the initial sales charge and, in the case of Class D shares, the account
maintenance fee. Although some investors that previously purchased Class A
shares may no longer be eligible to purchase Class A shares of other
MLAM-advised mutual funds, those previously purchased Class A shares, together
with Class B, Class C and Class D share holdings, will count toward a right of
accumulation 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> 8
FINANCIAL HIGHLIGHTS
The financial information in the table below has been audited in
conjunction with the annual audits of the financial statements of the Fund by
Deloitte & Touche LLP, independent auditors. Financial statements for the fiscal
year ended July 31, 1996 and the independent auditors' report thereon are
included in the Statement of Additional Information. The following per share
data and ratios have been derived from information provided in the Fund's
audited financial statements. Further information about the performance of the
Fund is contained in the Fund's most recent annual report to shareholders which
may be obtained, without charge, by calling or by writing the Trust at the
telephone number or address on the front cover of this Prospectus.
<TABLE>
<CAPTION>
CLASS A CLASS B
-------------------------------- ----------------------------------
<S> <C> <C> <C> <C> <C> <C>
FOR THE FOR THE
PERIOD PERIOD
FOR THE YEAR NOVEMBER 26, FOR THE YEAR NOVEMBER 26,
ENDED JULY 31, 1993+ TO ENDED JULY 31, 1993+ TO
----------------- JULY 31, ------------------- JULY 31,
1996 1995 1994 1996 1995 1994
------ ------ ------------ ------- ------- ------------
Increase (Decrease) in Net Asset Value:
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period.............. $ 9.41 $ 9.38 $ 10.00 $ 9.41 $ 9.38 $ 10.00
------ ------ ------- ------- ------- -------
Investment income--net............................ .50 .52 .34 .45 .48 .31
Realized and unrealized gain (loss) on
investments--net................................ .04 .03 (.62) .04 .03 (.62)
------ ------ ------- ------- ------- -------
Total from investment operations.................. .54 .55 (.28) .49 .51 (.31)
------ ------ ------- ------- ------- -------
Less dividends from investment income--net........ (.50) (.52) (.34) (.45) (.48) (.31)
------ ------ ------- ------- ------- -------
Net asset value, end of period.................... $ 9.45 $ 9.41 $ 9.38 $ 9.45 $ 9.41 $ 9.38
====== ====== ======= ======= ======= =======
TOTAL INVESTMENT RETURN**:
Based on net asset value per share................ 5.83% 6.20% (2.83)%# 5.29% 5.66% (3.16)%#
====== ====== ======= ======= ======= =======
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of reimbursement.................... .47% .24% .03%* .98% .76% .54%*
====== ====== ======= ======= ======= =======
Expenses.......................................... 1.12% 1.40% 1.52%* 1.62% 1.93% 2.03%*
====== ====== ======= ======= ======= =======
Investment income--net............................ 5.24% 5.71% 5.36%* 4.73% 5.20% 4.73%*
====== ====== ======= ======= ======= =======
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands).......... $8,777 $9,755 $ 10,634 $18,407 $17,116 $ 14,522
====== ====== ======= ======= ======= =======
Portfolio Turnover................................ 49.13% 73.86% 82.71% 49.13% 73.86% 82.71%
====== ====== ======= ======= ======= =======
</TABLE>
- ---------------
<TABLE>
<C> <S>
+ Commencement of operations.
* Annualized.
** Total investment returns exclude the effects of sales loads.
# Aggregate total investment return.
</TABLE>
8
<PAGE> 9
<TABLE>
<CAPTION>
CLASS C CLASS D
---------------------------------- ----------------------------------
FOR THE PERIOD FOR THE PERIOD
FOR THE YEAR OCTOBER 21, 1994+ FOR THE YEAR OCTOBER 21, 1994+
ENDED JULY 31, TO JULY 31, ENDED JULY 31, TO JULY 31,
1996 1995 1996 1995
-------------- ----------------- -------------- -----------------
<S> <C> <C> <C> <C>
Increase (Decrease) in Net Asset Value:
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period.................... $ 9.41 $ 9.03 $ 9.40 $ 9.03
------ ------ ------ ------
Investment income--net.................................. .44 .35 .49 .40
Realized and unrealized gain on investments--net........ .05 .38 .05 .37
------ ------ ------ ------
Total from investment operations........................ .49 .73 .54 .77
------ ------ ------ ------
Less dividends from investment income--net.............. (.44) (.35) (.49) (.40)
------ ------ ------ ------
Net asset value, end of period.......................... $ 9.46 $ 9.41 $ 9.45 $ 9.40
====== ====== ====== ======
TOTAL INVESTMENT RETURN**:
Based on net asset value per share...................... 5.29% 8.27%# 5.84% 8.74%#
====== ====== ====== ======
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of reimbursement.......................... 1.09% .95%* .58% .38%*
====== ====== ====== ======
Expenses................................................ 1.72% 2.04%* 1.21% 1.49%*
====== ====== ====== ======
Investment income--net.................................. 4.62% 5.01%* 5.13% 5.66%*
====== ====== ====== ======
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands)................ $ 449 $ 162 $2,173 $ 1,265
====== ====== ====== ======
Portfolio Turnover...................................... 49.13% 73.86% 49.13% 73.86%
====== ====== ====== ======
</TABLE>
- ---------------
<TABLE>
<C> <S>
+ Commencement of operations.
* Annualized.
** Total investment returns exclude the effects of sales loads.
# Aggregate total investment return.
</TABLE>
9
<PAGE> 10
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 Fund may also
invest in variable rate demand obligations ("VRDOs"). 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 Ratings Group ("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 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
10
<PAGE> 11
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 VRDOs and VRDOs in the form of
participation interests ("Participating VRDOs") in variable rate tax-exempt
obligations held by a financial institution. The VRDOs in which the Fund will
invest are tax-exempt obligations which contain a floating or variable interest
rate adjustment formula and an unconditional right of demand on the part of the
holder thereof to receive payment of the unpaid principal balance plus accrued
interest on a short notice period not to exceed seven days. Participating VRDOs
provide the Fund with a specified undivided interest (up to 100%) of the
underlying obligation and the right to demand payment of the unpaid principal
balance plus accrued interest on the Participating VRDOs from the financial
institution on a specified number of days' notice, not to exceed seven days.
There is, however, the possibility that because of a default or insolvency, the
demand feature of VRDOs or Participating VRDOs may not be honored. The Fund has
been advised by its counsel that the Fund should be entitled to treat the income
received on Participating VRDOs as interest from tax-exempt obligations.
VRDOs that contain an unconditional right of demand to receive payment of
the unpaid principal balance plus accrued interest on a notice period exceeding
seven days may be deemed illiquid securities. A VRDO with a demand notice period
exceeding seven days will therefore be subject to the Fund's restriction on
illiquid investments unless, in the judgment of the Trustees, such VRDO is
liquid. The Trustees may adopt guidelines and delegate to the Manager the daily
function of determining and monitoring liquidity of such VRDOs. The Trustees,
however, will retain sufficient oversight and be ultimately responsible for such
determinations.
The Fund ordinarily does not intend to realize investment income not exempt
from Federal and 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 such
investments are permitted by the Investment Company Act of 1940, as amended (the
"1940 Act"). Other Non-Municipal Tax-Exempt Securities could include trust
certificates or other derivative instruments evidencing interests in one or more
Municipal Bonds.
11
<PAGE> 12
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 through SP-2 for notes and A1 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 MUNICIPAL BONDS
The risks and special considerations involved in investments in Municipal
Bonds vary with the types of instruments being acquired. Investments in
Non-Municipal Tax-Exempt Securities may present similar risks, depending on the
particular product. Certain instruments in which the Fund may invest may be
characterized as derivative instruments. See "Description of Municipal Bonds"
and "Financial Futures Transactions and Options".
Moreover, the Fund ordinarily will invest at least 65% of its total assets
in 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.
12
<PAGE> 13
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 1995 and are expected to increase in 1996 as well,
although generally at rates lower than those for 1995. 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 restricts 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. In addition, the Amendment
requires prior voter approval for the creation of any multiple fiscal year debt
or other financial obligations, except refundings at a lower rate or obligations
of an enterprise. The provisions of the Amendment are unclear and have required
judicial interpretation.
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.
For additional information on the Amendment and the current economic conditions
in Colorado, see Appendix I--"Economic and Financial Conditions in Colorado" in
the Statement of Additional Information.
DESCRIPTION OF MUNICIPAL BONDS
Municipal Bonds include debt obligations issued to obtain funds for various
public purposes, including construction and equipping of a wide range of public
facilities (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 local facilities for water supply, gas,
electricity or sewage or solid waste disposal. For purposes of this Prospectus,
such obligations are referred to as Municipal Bonds if the interest paid thereon
is excluded from gross income for purposes of Federal income taxation 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 its state constitution 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
13
<PAGE> 14
payment of interest and the repayment of principal when due is affected by the
issuer's maintenance of its tax base.
Revenue bonds are payable only from the revenues derived from a particular
facility or class of facilities or, in some cases, from the proceeds of a
special excise tax or other specific revenue source such as payments from the
user of the facility being financed; accordingly, the timely payment of interest
and the repayment of principal in accordance with the terms of the revenue or
special obligation bond is a function of the economic viability of such facility
or such revenue source. The Fund will not invest in 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 continuing business
operation if such investments, together with investments in other various
unseasoned issuers, would exceed 5% of the Fund's total assets. 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, in most cases, tax-exempt securities issued by states,
municipalities or public authorities to provide funds, usually through a loan or
lease arrangement, to a private entity for the purpose of financing construction
or improvement of a facility to be used by the entity. Such bonds are secured
primarily by revenues derived from loan repayments or lease payments due from
the entity which may or may not be guaranteed by a parent company or otherwise
secured. IDBs and private activity bonds are generally not 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 generally depends on the revenues of a
private entity and be aware of the risks that such an investment may entail.
Continued ability of an entity to generate sufficient revenues for the payment
of principal and interest on such bonds will be affected by many factors
including the size of the entity, capital structure, demand for its products or
services, competition, general economic conditions, governmental regulation and
the entity's dependence on revenues for the operation of the particular facility
being financed. The Fund may also invest in so-called "moral obligation" bonds.
If an issuer of moral obligation bonds is unable to meet its obligations,
repayment of such bonds becomes a moral commitment, but not a legal obligation,
of the state or municipality in question.
The Fund may invest in Municipal Bonds (and Non-Municipal Tax-Exempt
Securities) the return on which is based on a particular index of value or
interest rates. For example, the Fund may invest in Municipal Bonds that pay
interest based on an index of Municipal Bond interest rates or based on the
value of gold or some other commodity. The principal amount payable upon
maturity of certain Municipal Bonds also may be based on the value of an index.
To the extent the Fund invests in these types of Municipal Bonds, the Fund's
return on such Municipal Bonds will be subject to risk with respect to the value
of the particular index. Interest and principal payable on the Municipal Bonds
may also be based on relative changes among production indices. Also, the Fund
may invest in so-called "inverse floating obligations" or "residual interest
bonds" on which the interest rates typically decline as market rates increase
and increase as market rates decline. The Fund's return on such types of
Municipal Bonds (and Non-Municipal Tax-Exempt Securities) will be subject to
risk with respect to the value of the particular index, which may include
reduced or eliminated interest payments and losses of invested principal. Such
securities have the effect of providing a degree of investment leverage, since
they may increase or decrease in value in response to changes, as an
illustration, in market interest rates at a rate which is a multiple (typically
two) of the rate at which fixed-rate
14
<PAGE> 15
long-term tax-exempt securities increase or decrease in response to such
changes. As a result, the market values of such securities will generally be
more volatile than the market values of fixed-rate tax-exempt securities. To
seek to limit the volatility of these securities, the Fund may purchase inverse
floating obligations with shorter-term maturities or which contain limitations
on the extent to which the interest rate may vary. Certain investments in such
obligations may be illiquid. The Fund may not invest in such illiquid
obligations if such investments, together with other illiquid investments, would
exceed 15% of the Fund's total assets. The Manager believes, however, that
indexed and inverse floating obligations represent flexible portfolio management
instruments for the Fund which allow the Fund to seek potential investment
rewards, hedge other portfolio positions or vary the degree of investment
leverage relatively efficiently under different market conditions.
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 total assets. The Fund may, however, invest without
regard to such limitation in lease obligations which the Manager, pursuant to
guidelines which have been adopted by the 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 obligations rated below investment grade, 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.
The value of bonds and other fixed-income obligations may fall when
interest rates rise and rise when interest rates fall. In general, bonds and
other fixed-income obligations with longer maturities will be subject to greater
volatility resulting from interest rate fluctuations than will similar
obligations with shorter maturities. Under normal conditions, it is generally
anticipated that the Fund's average weighted maturity would be in excess of ten
years.
15
<PAGE> 16
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.
CALL RIGHTS
The Fund may purchase a Municipal Bond issuer's right to call all or a
portion of such Municipal Bond for mandatory tender for purchase (a "Call
Right"). A holder of a Call Right may exercise such right to require a mandatory
tender for the purchase of related Municipal Bonds, subject to certain
conditions. A Call Right that is not exercised prior to the maturity of the
related Municipal Bond will expire without value. The economic effect of holding
both the Call Right and the related Municipal Bond is identical to that of
holding a Municipal Bond as a non-callable security. Certain investments in such
obligations may be illiquid. The Fund may not invest in such illiquid
obligations if such investments, together with other illiquid investments, would
exceed 15% of the Fund's total assets.
WHEN-ISSUED SECURITIES AND DELAYED DELIVERY TRANSACTIONS
The Fund may purchase or sell Municipal Bonds on a delayed delivery basis
or a when-issued basis at fixed purchase terms. These transactions arise when
securities are purchased or sold by the Fund with payment and delivery taking
place in the future. The purchase will be recorded on the date the Fund enters
into the commitment and the value of the obligation will thereafter be reflected
in the calculation of the Fund's net asset value. The value of the obligation on
the delivery date may be more or less than its purchase price. A separate
account of the Fund will be established with its custodian consisting of cash,
cash equivalents or liquid securities having a market value at all times at
least equal to the amount of the forward commitment.
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-
16
<PAGE> 17
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.
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
17
<PAGE> 18
adjustable notes) or liquid securities in a segregated account with the Fund's
custodian, so that the amount so segregated plus the amount of initial and
variation margin held in the account of its broker equals the market value of
the futures contracts, thereby ensuring that the use of such 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.
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 total
assets. In the event of default by the seller under a repurchase agreement, the
Fund may suffer time delays and incur costs or possible losses in connection
with the disposition of the underlying securities.
18
<PAGE> 19
INVESTMENT RESTRICTIONS
The Fund's investment activities are subject to further restrictions that
are described in the Statement of Additional Information. Investment
restrictions and policies which are fundamental policies may not be changed
without the approval of the holders of a majority of the Fund's outstanding
voting securities, as defined in the 1940 Act which means the lesser of (i) 67%
of the shares represented at a meeting at which more than 50% of the outstanding
shares are represented or (ii) more than 50% of the outstanding shares. Among
its fundamental policies, the Fund may not invest more than 25% of its assets,
taken at market value at the time of each investment, in the securities of
issuers in any particular industry (excluding the U.S. Government and its
agencies and instrumentalities) [For purposes of this restriction, states,
municipalities and their political subdivisions are not considered to be part of
any industry]. Investment restrictions and policies that are non-fundamental
policies may be changed by the Board of Trustees without shareholder approval.
As a non-fundamental policy, the Fund may not borrow amounts in excess of 20% of
its total assets taken at market value (including the amount borrowed), and then
only from banks as a temporary measure for extraordinary or emergency purposes.
In addition, the Fund will not purchase securities while borrowings are
outstanding.
As a non-fundamental policy, the Fund will not invest in securities which
cannot be readily resold because of legal or contractual restrictions or which
cannot otherwise be marketed, redeemed or put to the issuer or a third party, if
at the time of acquisition more than 15% of its total assets would be invested
in such securities. [This restriction shall not apply to securities which mature
within seven days or securities which the Board of Trustees of the Trust has
otherwise determined to be liquid pursuant to applicable law.]
The Fund is classified as non-diversified within the meaning of the 1940
Act, which means that the Fund is not limited by the 1940 Act in the proportion
of its assets that it may invest in obligations of a single issuer. However, the
Fund's investments will be limited so as to qualify as a "regulated investment
company" for purposes of the Internal Revenue Code. See "Distributions and
Taxes--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.
19
<PAGE> 20
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 of the Manager and its affiliate, MLAM; President
and Director of Princeton Services, Inc. ("Princeton Services"); Executive Vice
President of ML & Co; and Director of the Distributor.
JAMES H. BODURTHA--Director and Executive Vice President, The China
Business Group, Inc.
HERBERT I. LONDON--John M. Olin Professor of Humanities, New York
University.
ROBERT R. MARTIN--Former Chairman, Kinnard Investments, Inc.
JOSEPH L. MAY--Attorney in private practice.
ANDRE F. PEROLD--Professor, Harvard Business School.
- ---------------
* Interested person, as defined in the 1940 Act, of the Trust.
MANAGEMENT AND ADVISORY ARRANGEMENTS
The Manager, which is an affiliate of MLAM and is owned and controlled by
ML & Co., a financial services holding company, acts as the manager for the Fund
and provides the Fund with management services. The Manager or MLAM acts as the
investment adviser for more than 130 registered investment companies. MLAM also
provides investment advisory services to individual and institutional accounts.
As of September 30, 1996, the Manager and MLAM had a total of approximately
$214.1 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.
Hugh T. Hurley, III is the Portfolio Manager of the Fund and is responsible
for the day-to-day management of the Fund's investment portfolio. He has been
Assistant Vice President of MLAM since 1993 and a Municipal Bond Broker with
Titus and Donnelly Municipal Bond Brokers from 1990 to 1993.
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
20
<PAGE> 21
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 fiscal year ended
July 31, 1996, the total fee payable by the Fund to the Manager was $163,546
(based on average net assets of approximately $29.7 million), of which $161,021
was voluntarily waived.
The Management Agreement obligates the Trust on behalf of the Fund to pay
certain expenses incurred in the Fund's operations, including, among other
things, the management fee, legal and audit fees, unaffiliated Trustees' fees
and expenses, registration fees, custodian and transfer agency fees, accounting
and pricing costs, and certain of the costs of printing proxies, shareholder
reports, prospectuses and statements of additional information. Accounting
services are provided to the Fund by the Manager, and the Fund reimburses the
Manager for its costs in connection with such services. The Manager may waive
all or a portion of its management fee and may voluntarily assume all or a
portion of the Fund's expenses. For the fiscal year ended July 31, 1996, the
Fund paid the Manager $38,579 for accounting services. For the fiscal year ended
July 31, 1996, the ratio of total expenses to average net assets was 1.12% for
Class A shares, 1.62% for Class B shares, 1.72% for Class C shares and 1.21% for
Class D shares.
CODE OF ETHICS
The Board of Trustees of the Trust has adopted a Code of Ethics under Rule
17j-1 of the 1940 Act which incorporates the Code of Ethics of the Manager
(together, the "Codes"). The Codes significantly restrict the personal investing
activities of all employees of the Manager and, as described below, impose
additional, more onerous, restrictions on fund investment personnel.
The Codes require that all employees of the Manager preclear any personal
securities investment (with limited exceptions, such as government securities).
The preclearance requirement and associated procedures are designed to identify
any substantive prohibition or limitation applicable to the proposed investment.
The substantive restrictions applicable to all employees of the Manager include
a ban on acquiring any securities in a "hot" initial public offering and a
prohibition from profiting on short-term trading in securities. In addition, no
employee may purchase or sell any security which at the time is being purchased
or sold (as the case may be), or to the knowledge of the employee is being
considered for purchase or sale, by any fund advised by the Manager.
Furthermore, the Codes provide for trading "blackout periods" which prohibit
trading by investment personnel of the Fund within periods of trading by the
Fund in the same (or equivalent) security (15 or 30 days depending upon the
transaction).
TRANSFER AGENCY SERVICES
Merrill Lynch 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 fiscal year
ended July 31, 1996, the Fund paid the Transfer Agent a total fee of $14,241
pursuant to the
21
<PAGE> 22
Transfer Agency Agreement for providing transfer agency services. At August 31,
1996, the Fund had 139 Class A shareholder accounts, 655 Class B shareholder
accounts, 20 Class C shareholder accounts and 38 Class D shareholder accounts.
At this level of accounts, the annual fee payable to the Transfer Agent would
aggregate approximately $11,397, plus miscellaneous and out-of-pocket expenses.
PURCHASE OF SHARES
The Distributor, an affiliate of the Manager, MLAM and Merrill Lynch, acts
as the distributor of the shares of the Fund. Shares of the Fund are offered
continuously for sale by the Distributor and other eligible securities dealers
(including Merrill Lynch). Shares of the Fund may be purchased from securities
dealers or by mailing a purchase order directly to the Transfer Agent. The
minimum initial purchase is $1,000 and the minimum subsequent purchase is $50.
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(SM) System, as described below. The applicable offering price for
purchase orders is based upon the net asset value of the Fund next determined
after receipt of the purchase orders by the Distributor. As to purchase orders
received by securities dealers prior to the close of business on the New York
Stock Exchange (the "NYSE") (generally, 4:00 P.M. New York time), which includes
orders received after the close of business on the previous day, the applicable
offering price will be based on the net asset value determined as of 15 minutes
after the close of business on the NYSE on that day, provided the Distributor
receives the orders from the securities dealer prior to 30 minutes after the
close of business on the NYSE, on that day. If the purchase orders are not
received prior to 30 minutes after the close of business on the NYSE, 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.
The Fund issues four classes of shares under the Merrill Lynch Select
Pricing(SM) System, which permits each investor to choose the method of
purchasing shares that the investor believes is most beneficial given the amount
of the purchase, the length of time the investor expects to hold the shares and
other relevant circumstances. Shares of Class A and Class D are sold to
investors choosing the initial sales charge alternatives and shares of Class B
and Class C are sold to investors choosing the deferred sales charge
alternatives. Investors should determine whether under their particular
circumstances it is more advantageous to incur an initial sales charge or to
have the entire initial purchase price invested in the Fund with the investment
thereafter being subject to a CDSC and ongoing distribution fees and higher
account maintenance fees. A discussion of the factors that investors should
consider in determining the method of purchasing shares under the Merrill Lynch
Select Pricing(SM) System is set forth under "Merrill Lynch Select Pricing(SM)
System" on page 4.
22
<PAGE> 23
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, distribution and account maintenance fees that are
imposed on Class B and Class C shares, as well as the account maintenance fees
that are imposed on Class D shares, will be imposed directly against those
classes and not against all assets of the Fund and, accordingly, such charges
will not affect 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".
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>
- -------------------------------------------------------------------------------------------------------
<C> <S> <C> <C> <C>
- -------------------------------------------------------------------------------------------------------
<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 0.25% 0.25% B shares convert to D
rate of 4.0% during the first shares
year, decreasing 1.0% annually to automatically after
0.0%(4) approximately ten
years(5)
- -------------------------------------------------------------------------------------------------------
C 1.0% CDSC for one year(6) 0.25% 0.35% No
- -------------------------------------------------------------------------------------------------------
D Maximum 4.00% initial sales 0.10% No No
charge(3)
- -------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------
</TABLE>
- ---------------
(1) Initial sales charges are imposed at the time of purchase as a percentage of
the offering price. CDSCs are imposed if the redemption occurs within the
applicable CDSC time period. The charge will be assessed on an amount equal
to the lesser of the proceeds of redemption or the cost of the shares being
redeemed.
(2) Offered only to eligible investors. See "Initial Sales Charge
Alternatives--Class A and Class D Shares--Eligible Class A Investors".
(3) Reduced for purchases of $25,000 or more and waived for purchases of Class A
shares in connection with certain fee-based programs. Class A and Class D
share purchases of $1,000,000 or more may not be subject to an initial sales
charge but instead may be subject
(footnotes continued on next page)
23
<PAGE> 24
to a 1.0% CDSC if redeemed within one year. Such CDSC may be waived in
connection with redemptions to fund participation in certain fee-based
programs.
(4) The CDSC may be modified in connection with redemptions to fund
participation in certain fee-based programs.
(5) The conversion period for dividend reinvestment shares and certain fee-based
programs may be modified. Also, Class B shares of certain other MLAM-advised
mutual funds into which exchanges may be made have an eight-year conversion
period. If Class B shares of the Fund are exchanged for Class B shares of
another MLAM-advised mutual fund, the conversion period applicable to the
Class B shares acquired in the exchange will apply, and the holding period
for the shares exchanged will be tacked onto the holding period for the
shares acquired.
(6) The CDSC may be waived in connection with redemptions to fund participation
in certain fee-based programs.
INITIAL SALES CHARGE ALTERNATIVES--CLASS A AND CLASS D SHARES
Investors choosing the initial sales charge alternatives who are eligible
to purchase Class A shares should purchase Class A shares rather than Class D
shares because there is an account maintenance fee imposed on Class D shares.
The public offering price of Class A 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
AS PERCENTAGE PERCENTAGE* SELECTED DEALERS
OF OFFERING OF THE NET AS PERCENTAGE OF
AMOUNT OF PURCHASE PRICE AMOUNT INVESTED THE OFFERING PRICE
- --------------------------------------------------- -------------- --------------- ------------------
<S> <C> <C> <C>
Less than $25,000.................................. 4.00% 4.17% 3.75%
$25,000 but less than $50,000...................... 3.75 3.90 3.50
$50,000 but less than $100,000..................... 3.25 3.36 3.00
$100,000 but less than $250,000.................... 2.50 2.56 2.25
$250,000 but less than $1,000,000.................. 1.50 1.52 1.25
$1,000,000 and over**.............................. 0.00 0.00 0.00
</TABLE>
- ---------------
* Rounded to the nearest one-hundredth percent.
** The initial sales charge may be waived on Class A and Class D purchases of
$1,000,000 or more and on Class A purchases in connection with certain
fee-based programs. If the sales charge is waived in connection with a
purchase of $1,000,000 or more, such purchase may be subject to a CDSC of
1.0% if the shares are redeemed within one year after purchase. Such CDSC may
be waived in connection with redemptions to fund participation in certain
fee-based programs. The charge will be assessed on an amount equal to the
lesser of the proceeds of redemption or the cost of the shares being
redeemed.
The Distributor may reallow discounts to selected dealers and retain the
balance over such discounts. At times the Distributor may reallow the entire
sales charge to such dealers. Since securities dealers selling Class A and Class
D shares of the Fund will receive a concession equal to most of the sales
charge, they may be deemed to be underwriters under the Securities Act. For the
fiscal year ended July 31, 1996, the Fund sold 146,883 Class A shares for
aggregate net proceeds of $1,403,098. The gross sales charges for the sale of
Class A shares of the Fund for the period were $1,497, of which $260 and $1,237
were received by the Distributor and Merrill Lynch, respectively. For the fiscal
year ended July 31, 1996, the Distributor received no CDSCs with respect to
redemption within one year after purchase of Class A shares purchased subject to
a front-end sales charge waiver. For the fiscal year ended July 31, 1996, the
Fund sold 146,932 Class D shares for aggregate net proceeds of $1,396,111. The
gross sales charges for the sale of Class D shares of the Fund for the period
were $5,872 of which $1,010 and $4,862 were received by the Distributor and
Merrill Lynch, respectively. For the fiscal year ended July 31, 1996, the
Distributor received no CDSCs with respect to
24
<PAGE> 25
redemption within one year after purchase of Class D shares purchased subject to
a front-end sales charge waiver.
Eligible Class A Investors. Class A shares are offered to a limited group
of investors and also will be issued upon reinvestment of dividends on
outstanding Class A shares. Investors that currently own Class A shares of the
Fund in a shareholder account are entitled to purchase additional Class A shares
of the Fund in that account. Class A shares are available at net asset value to
corporate warranty insurance reserve fund programs 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, collective
investment trusts for which Merrill Lynch Trust Company serves as trustee and
purchases made in connection with certain fee-based programs. In addition, Class
A shares are offered at net asset value to ML & Co. and its subsidiaries and
their directors and employees and to members of the Boards of MLAM-advised
investment companies, including the Trust. Certain persons who acquired shares
of certain MLAM-advised closed-end funds in their initial offering who wish to
reinvest the net proceeds from a sale of their closed-end fund shares of common
stock in shares of the Fund also may purchase Class A shares of the Fund if
certain conditions set forth in the Statement of Additional Information are met.
In addition, Class A shares of the Fund and certain other MLAM-advised mutual
funds are offered at net asset value to shareholders of Merrill Lynch Senior
Floating Rate Fund, Inc. and, if certain conditions set forth in the Statement
of Additional Information are met, to shareholders of Merrill Lynch Municipal
Strategy Fund, Inc. and Merrill Lynch High Income Municipal Bond Fund, Inc. who
wish to reinvest the net proceeds from a sale of certain of their shares of
common stock pursuant to a tender offer conducted by such funds in shares of the
Fund and certain other MLAM-advised mutual funds.
Reduced Initial Sales Charges. No initial sales charges are imposed upon
Class A and Class D shares issued as a result of the automatic reinvestment of
dividends or capital gains distributions. Class A and Class D sales charges also
may be reduced under a Right of Accumulation and a Letter of Intention. Class A
shares are offered at net asset value to certain eligible Class A investors as
set forth above under "Eligible Class A Investors". See "Shareholder
Services--Fee-Based Programs". Class A and Class D shares are offered at net
asset value to Employee Access Accounts(SM) available through qualified
employers which provide employer-sponsored retirement and savings plans that are
eligible to purchase such shares at net asset value. Class A and Class D shares
are offered at net asset value to shareholders of Merrill Lynch Municipal
Strategy Fund, Inc. and Merrill Lynch High Income Municipal Bond Fund, Inc. who
wish to reinvest in shares of the Fund the net proceeds from a sale of certain
of their shares of common stock, pursuant to tender offers conducted by those
funds.
Class D shares are offered at net asset value, without sales charge, to an
investor who has a business relationship with a Merrill Lynch financial
consultant if certain conditions set forth in the Statement of Additional
Information are met. Class D shares may be offered at net asset value in
connection with the acquisition of assets of other investment companies.
Additional information concerning these reduced initial sales charges is
set forth in the Statement of Additional Information.
25
<PAGE> 26
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". The proceeds from the account
maintenance fees are used to compensate Merrill Lynch for providing continuing
account maintenance activities.
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.
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. 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. 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.
26
<PAGE> 27
The following table sets forth the rates of the Class B CDSC:
<TABLE>
<CAPTION>
CLASS B
CDSC AS
PERCENTAGE OF
YEAR SINCE PURCHASE DOLLAR AMOUNT
PAYMENT MADE SUBJECT TO 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 year ended July 31, 1996, the Distributor received CDSCs of
$35,113 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.
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 a CDSC because of dividend reinvestment. With
respect to the remaining 40 shares, the CDSC is applied only to the original
cost of $10 per share and not to the increase in net asset value of $2 per
share. Therefore, $400 of the $600 redemption proceeds will be charged at a rate
of 2.0% (the applicable 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 Code) of a shareholder. Additional information
concerning the waiver of the Class B CDSC is set forth in the Statement of
Additional Information. The terms of the CDSC may be modified in connection with
redemptions to fund participation in certain fee-based programs. See
"Shareholder Services--Fee-Based Programs".
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. For the fiscal year ended July 31,
1996, the Distributor received CDSCs of $1,229 with respect to redemptions of
Class C shares, all of which were paid to Merrill Lynch. No Class C CDSC will be
assessed in connection with redemptions to fund participation in certain fee-
based programs. See "Shareholder Services--Fee-Based Programs".
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In determining whether a Class C CDSC is applicable to a redemption, the
calculation will be determined in the manner that results in the lowest possible
rate being charged. Therefore, it will be assumed that the redemption is first
of shares held for over one year or shares acquired pursuant to reinvestment of
dividends or distributions and then of shares held longest during the one-year
period. The charge will not be applied to dollar amounts representing an
increase in the net asset value since the time of purchase. A transfer of shares
from a shareholder's account to another account will be assumed to be made in
the same order as a redemption.
Conversion of Class B Shares to Class D Shares. After approximately ten
years (the "Conversion Period"), Class B shares will be converted automatically
into Class D shares of the Fund. Class D shares are subject to an ongoing
account maintenance fee of 0.10% of net assets but are not subject to the
distribution fee that is borne by Class B shares. Automatic conversion of Class
B shares into Class D shares will occur at least once each month (on the
"Conversion Date") on the basis of the relative net asset values of the shares
of the two classes on the Conversion Date, without the imposition of any sales
load, fee or other charge. Conversion of Class B shares to Class D shares will
not be deemed a purchase or sale of the shares for Federal income tax purposes.
In addition, shares purchased through reinvestment of dividends on Class B
shares also will convert automatically to Class D shares. The Conversion Date
for dividend reinvestment shares will be calculated taking into account the
length of time the shares underlying such dividend reinvestment shares were
outstanding. If at a Conversion Date the conversion of Class B shares to Class D
shares of the Fund in a single account will result in less than $50 worth of
Class B shares being left in the account, all of the Class B shares of the Fund
held in the account on the Conversion Date will be converted to Class D shares
of the Fund.
Share certificates for Class B shares of the Fund to be converted must be
delivered to the Transfer Agent at least one week prior to the Conversion Date
applicable to those shares. In the event such certificates are not received by
the Transfer Agent at least one week prior to the Conversion Date, the related
Class B shares will convert to Class D shares on the next scheduled Conversion
Date after such certificates are delivered.
In general, Class B shares of equity MLAM-advised mutual funds will convert
approximately eight years after initial purchase, and Class B shares of taxable
and tax-exempt fixed income MLAM-advised mutual funds will convert approximately
ten years after initial purchase. If, during the Conversion Period, a
shareholder exchanges Class B shares with an eight-year Conversion Period for
Class B shares with a ten-year Conversion Period, or vice versa, the Conversion
Period applicable to the Class B shares acquired in the exchange will apply, and
the holding period for the shares exchanged will be tacked onto the holding
period for the shares acquired.
The Conversion Period may be modified for certain fee-based programs. See
"Shareholder Services-- Fee-Based Programs".
DISTRIBUTION PLANS
The Fund has adopted separate distribution plans for Class B, Class C and
Class D shares pursuant to Rule 12b-1 under the 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.
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<PAGE> 29
The Distribution Plans for Class B, Class C and Class D shares each provide
that the Fund pays the Distributor an account maintenance fee relating to the
shares of the relevant class, accrued daily and paid monthly, at the annual
rates of 0.25%, 0.25% and 0.10%, respectively, of the average daily net assets
of the Fund attributable to shares of the relevant class in order to compensate
the Distributor and Merrill Lynch (pursuant to a sub-agreement) in connection
with account maintenance activities.
The Distribution Plans for Class B and Class C shares each provide that the
Fund also pays the Distributor a distribution fee relating to the shares of the
relevant class, accrued daily and paid monthly, at the annual rates of 0.25% and
0.35%, respectively, of the average daily net assets of the Fund attributable to
the shares of the relevant class in order to compensate the Distributor and
Merrill Lynch (pursuant to a sub-agreement) for providing shareholder and
distribution services, and bearing certain distribution-related expenses of the
Fund, including payments to financial consultants for selling Class B and Class
C shares of the Fund. The Distribution Plans relating to Class B and Class C
shares are designed to permit an investor to purchase Class B and Class C shares
through dealers without the assessment of an initial sales charge and at the
same time permit the dealer to compensate its financial consultants in
connection with the sale of the Class B and Class C shares. In this regard, the
purpose and function of the ongoing distribution fees and the CDSC are the same
as those of the initial sales charge with respect to the Class A and Class D
shares of the Fund in that the deferred sales charges provide for the financing
of the distribution of the Fund's Class B and Class C shares.
For the fiscal year ended July 31, 1996, the Fund paid the Distributor
$91,012 pursuant to the Class B Distribution Plan (based on average net assets
subject to such Class B Distribution Plan of approximately $18.2 million), all
of which was paid to Merrill Lynch for providing account maintenance and
distribution-related activities and services in connection with Class B shares.
For the fiscal year ended July 31, 1996 the Fund paid the Distributor $2,722
pursuant to the Class C Distribution Plan (based on average net assets subject
to such Class C Distribution Plan of approximately $453,640), all of which was
paid to Merrill Lynch for providing account maintenance and distribution-related
activities and services in connection with Class C shares. For the fiscal year
ended July 31, 1996, the Fund paid the Distributor $1,686 pursuant to the Class
D Distribution Plan (based on average net assets subject to such Class D
Distribution Plan of approximately $1.7 million), all of which was paid to
Merrill Lynch for providing account maintenance activities in connection with
Class D shares. At August 31, 1996, the net assets of the Fund subject to the
Class B Distribution Plan aggregated approximately $18.4 million. At this asset
level, the annual fee payable pursuant to such Class B Distribution Plan would
aggregate approximately $91,766. At August 31, 1996, the net assets of the Fund
subject to the Class C Distribution Plan aggregated approximately $448,232. At
this asset level, the annual fee payable pursuant to such Class C Distribution
Plan would aggregate approximately $2,689. At August 31, 1996, the net assets of
the Fund subject to the Class D Distribution Plan aggregated approximately $2.2
million. At this asset level, the annual fee payable pursuant to such Class D
Distribution Plan would aggregate approximately $2,175.
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
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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, 1995,
the fully allocated accrual expenses incurred by the Distributor and Merrill
Lynch for the period since the commencement of operations of Class B shares
exceeded fully allocated accrual revenues by approximately $459,000 (2.44% of
Class B net assets at that date). As of July 31, 1996, direct cash expenses for
the period since the commencement of operations of Class B shares exceeded
direct cash revenues by $36,205 (0.20% of Class B net assets at that date).
Similar fully allocated accrual data for Class C shares is not presented because
such revenues and expenses for the period from the commencement of operations of
Class C shares to December 31, 1995 are de minimis. As of July 31, 1996, direct
cash revenues for the period since the commencement of operations of Class C
shares exceeded direct cash expenses by approximately $2,805 (0.63% of Class C
net assets at that date).
LIMITATIONS ON THE PAYMENT OF DEFERRED SALES CHARGES
The maximum sales charge rule in the Conduct Rules of the NASD imposes a
limitation on certain asset-based sales charges such as the distribution fee and
the CDSC borne by the Class B and Class C shares but not the account maintenance
fee. The maximum sales charge rule is applied separately to each class. As
applicable to the Fund, the maximum sales charge rule limits the aggregate of
distribution fee payments and CDSCs payable by the Fund to (1) 6.25% of eligible
gross sales of Class B shares and Class C shares, computed separately (defined
to exclude shares issued pursuant to dividend reinvestments and exchanges) plus
(2) interest on the unpaid balance for the respective class, computed separately
at the prime rate plus 1% (the unpaid balance being the maximum amount payable
minus amounts received from the payment of the distribution fee and the CDSC).
In connection with the Class B shares, the Distributor has voluntarily agreed to
waive interest charges on the unpaid balance in excess of 0.50% of eligible
gross sales. Consequently, the maximum amount payable to the Distributor
(referred to as the "voluntary maximum") in connection with the Class B shares
is 6.75% of eligible gross sales. The Distributor retains the right to stop
waiving the interest charges at any time. To the extent payments would exceed
the voluntary maximum, the Fund will not make further payments of the
distribution fee with respect to Class B shares, and any CDSCs will be paid to
the Fund rather than to the Distributor; however, the Fund will continue to make
payments of the account maintenance fee. In certain circumstances the amount
payable pursuant to the voluntary maximum may exceed the amount payable under
the NASD formula. In such circumstances 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".
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<PAGE> 31
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, Merrill Lynch Financial
Data Services, Inc., P.O. Box 45289, Jacksonville, Florida 32232-5289.
Redemption requests delivered other than by mail should be delivered to Merrill
Lynch Financial Data Services, Inc., 4800 Deer Lake Drive East, Jacksonville,
Florida 32246-6484. Proper notice of redemption in the case of shares deposited
with the Transfer Agent may be accomplished by a written letter requesting
redemption. Proper notice of redemption in the case of shares for which
certificates have been issued may be accomplished by a written letter as noted
above accompanied by certificates for the shares to be redeemed. Redemption
requests should not be sent to the Trust. The 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.
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 NYSE (generally, 4:00 P.M. New York time on the day received and such
request is received by the Trust from such dealer not later than 30 minutes
after the close of business on the NYSE on the same day. Dealers have the
responsibility of submitting such repurchase requests to the Trust not later
than 30 minutes after the close of business on the NYSE, in order to obtain that
day's closing price.
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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. Repurchases directly through the Transfer Agent are not subject to
the processing fee. The Trust reserves the right to reject any order for
repurchase, which right of rejection might adversely affect shareholders seeking
redemption through the repurchase procedure. However, a shareholder whose order
for repurchase is rejected by the Trust may redeem Fund shares as set forth
above.
Redemption payments will be made within seven days of the proper tender of
the certificates, if any, and stock power or letter requesting redemption, in
each instance with signatures guaranteed as noted above.
REINSTATEMENT PRIVILEGE--CLASS A AND CLASS D SHARES
Shareholders who have redeemed their Class A or Class D shares have a
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.
Alternatively, the reinstatement privilege may be exercised through the
investor's Merrill Lynch Financial Consultant within 30 days after the date the
request for redemption was accepted by the Transfer Agent or the Distributor.
The reinstatement will be made at the net asset value per share next determined
after the notice of reinstatement is received and cannot exceed the amount of
the redemption proceeds.
SHAREHOLDER SERVICES
The Trust offers a number of shareholder services and investment plans
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 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 gains 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 or her Investment Account at any time by mailing a check
directly to the Transfer Agent. Shareholders may also maintain their accounts
through Merrill Lynch. Upon the transfer of shares out of a Merrill Lynch
brokerage account, an Investment Account in the transferring shareholder's name
will be opened automatically, at the Transfer Agent. Shareholders considering
transferring their Class A or Class D shares from Merrill Lynch to another
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<PAGE> 33
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
U.S. shareholders of each class of shares of the Fund each have an exchange
privilege with certain other MLAM-advised mutual funds. There is currently no
limitation on the number of times a shareholder may exercise the exchange
privilege. The exchange privilege may be modified or terminated at any time in
accordance with the rules of the Commission.
Under the Merrill Lynch Select Pricing(SM) System, Class A shareholders may
exchange Class A shares of the Fund for Class A shares of a second MLAM-advised
mutual fund if the shareholder holds any Class A shares of the second fund in
his or her account in which the exchange is made at the time of the exchange or
is otherwise eligible to purchase Class A shares of the second fund. If the
Class A shareholder wants to exchange Class A shares for shares of a second
MLAM-advised mutual fund, and the shareholder does not hold Class A shares of
the second fund in his or her account at the time of the exchange and is not
otherwise eligible to acquire Class A shares of the second fund, the shareholder
will receive Class D shares of the second fund as a result of the exchange.
Class D shares also may be exchanged for Class A shares of a second MLAM-advised
mutual fund at any time as long as, at the time of the exchange, the shareholder
holds Class A shares of the second fund in the account in which the exchange is
made or is otherwise eligible to purchase Class A shares of the second fund.
Exchanges of Class A and Class D shares are made on the basis of the
relative net asset values per Class A or Class D share, respectively, plus an
amount equal to the difference, if any, between the sales charge previously paid
on the Class A or Class D shares being exchanged and the sales charge payable at
the time of the exchange on the shares being acquired.
Class B, Class C and Class D shares are exchangeable with shares of the
same class of other MLAM-advised mutual funds.
Shares of the Fund which are subject to a CDSC are exchangeable on the
basis of relative net asset value per share without the payment of any CDSC that
might otherwise be due upon redemption of the shares of the Fund. For purposes
of computing the CDSC that may be payable upon a disposition of the shares
acquired in the exchange, the holding period for the previously owned shares of
the Fund is "tacked" to the holding period for the newly acquired shares of the
other Fund.
Class A, Class B, Class C and Class D shares also are exchangeable for
shares of certain MLAM-advised money market funds specifically designated as
available for exchange by holders of Class A, Class B, Class C or 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
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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.
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 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 or her Investment Account in the form of payments by check or
through automatic payment by direct deposit to his or her bank account on either
a monthly or quarterly basis. Alternatively, 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 CMA(R) or CBA(R) 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 or her regular bank account. Alternatively, investors who maintain CMA(R)
or CBA(R) accounts may arrange to have periodic investments made in the Fund in
their CMA(R) or CBA(R) account or in certain related accounts in amounts of $100
or more through the CMA(R) or CBA(R) Automated Investment Program.
FEE-BASED PROGRAMS
Certain Merrill Lynch fee-based programs, including pricing alternatives
for securities transactions, (each referred to in this paragraph as a "Program")
may permit the purchase of Class A shares at net asset value. Under specified
circumstances, participants in certain Programs may deposit other classes of
shares which will be exchanged for Class A shares. Initial or deferred sales
charges otherwise due in connection with such exchanges may be waived or
modified, as may the Conversion Period applicable to the deposited shares.
Termination of participation in a Program may result in the redemption of shares
held therein or the automatic exchange thereof to another class at net asset
value, which may be shares of a money market fund.
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<PAGE> 35
In addition, upon termination of participation in a Program, shares that have
been held for less than specified periods within such Program may be subject to
a fee based upon the current value of such shares. These Programs also generally
prohibit such shares from being transferred to another account at Merrill Lynch,
to another broker-dealer or to the Transfer Agent. Except in limited
circumstances (which may also involve an exchange as described above), such
shares must be redeemed and another class of shares purchased (which may involve
the imposition of initial or deferred sales charges and distribution and account
maintenance fees) in order for the investment not to be subject to Program fees.
Additional information regarding a specific Program (including charges and
limitations on transferability applicable to shares that may be held in such
Program) is available in such Program's client agreement and from Merrill Lynch
Investor Services at (800) MER-FUND (637-3863).
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. The Trust has applied for on exemptive
order permitting it to, among other things, (i) purchase high quality tax-exempt
securities from Merrill Lynch when Merrill Lynch is a member of an underwriting
syndicate and (ii) purchase tax-exempt securities from and sell tax-exempt
securities to Merrill Lynch in secondary market transactions. 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, prior
to the determination of the net asset value which is calculated 15 minutes after
the close of business on the NYSE (generally, 4:00 P.M., New York time) on that
day. The net investment income of the Fund for dividend purposes consists of
interest earned on portfolio securities, less expenses, in each case computed
since the most recent determination of the net asset value. Expenses of the
Fund, including the management fees and the account maintenance and distribution
fees, are accrued daily. Dividends of net investment income are declared daily
and reinvested monthly in the form of additional full and fractional shares of
the Fund at net asset value as of the close of business on the "payment date"
unless the shareholder elects to receive such dividends in cash. Shares will
accrue dividends as long as they are issued and outstanding. Shares are issued
and outstanding from the settlement date of a purchase order to the day prior to
the settlement date of a redemption order.
All net realized 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 Code. If it
so qualifies, the Fund (but not its shareholders) will not be subject to Federal
income tax to the extent that it distributes its net investment income and net
realized capital gains. The Trust intends to cause the Fund to distribute
substantially all of such income.
To the extent that the dividends distributed to the Fund's Class A, Class
B, Class C and Class D shareholders (together, the "shareholders") are derived
from interest income exempt from Federal income tax under Code Section 103(a)
and are properly designated as "exempt-interest dividends" by the Trust, they
will 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 incurred or continued to purchase or carry Fund shares is not
deductible for Federal or Colorado income tax purposes to the extent
36
<PAGE> 37
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.
Distributions, if any, from an excess of net long-term capital gains over net
short-term capital losses derived from the sale of securities or from certain
transactions in futures or options ("capital gain dividends") are taxable as
long-term capital gains for Federal income tax purposes, regardless of the
length of time the shareholder has owned Fund shares and, for Colorado income
tax purposes, are treated as capital gains which are taxed at ordinary income
rates. Distributions by the Fund, whether from exempt-interest income, ordinary
income or capital gains, will not be eligible for the dividends received
deduction allowed to corporations under the Code.
All or a portion of the Fund's gain from the sale or redemption of
tax-exempt obligations purchased at a market discount will be treated as
ordinary income rather than capital gain. This rule may increase the amount of
ordinary income dividends received by shareholders. Distributions in excess of
the fund's earnings and profits will first reduce the adjusted tax basis of a
holder's shares and, after such adjusted tax basis is reduced to zero, will
constitute capital gains to such holder (assuming the shares are held as a
capital asset). Any loss upon the sale or exchange of shares held for six months
or less will be disallowed to the extent of any exempt-interest dividends
received by the shareholder. In addition, any such loss that is not disallowed
under the rule stated above will be treated as long-term capital loss to the
extent of any capital gain dividends received by the shareholder. If the Fund
pays a dividend in January which was declared in the previous October, November
or 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 certain "private activity bonds" issued after August 7,
1986. Private activity bonds are bonds which, although tax-exempt, are used for
purposes other than those generally performed by governmental units and which
benefit non-governmental entities (e.g., bonds used for industrial development
or housing purposes). Income received on such bonds is classified as an item of
"tax preference", which could subject certain investors in such bonds, including
shareholders of the Fund, to an alternative minimum tax. The Fund will purchase
such "private activity bonds" and the Trust will report to shareholders within
60 days after the Fund's taxable year-end the portion of the Fund's dividends
declared during the year which constitutes an item of tax preference for
alternative minimum tax purposes. The Code further provides that corporations
are subject to an alternative minimum tax based, in part, on certain differences
between taxable income as adjusted for other tax preferences and the
corporation's "adjusted
37
<PAGE> 38
current earnings", which more closely reflect a corporation's economic income.
Because an exempt-interest dividend paid by the Fund will be included in
adjusted current earnings, a corporate shareholder may be required to pay
alternative minimum tax on exempt-interest dividends paid by the Fund.
No gain or loss will be recognized by Class B shareholders on the
conversion of their Class B shares into Class D shares. A shareholder's basis in
the Class D shares acquired will be the same as such shareholder's basis in the
Class B shares converted, and the holding period of the acquired Class D shares
will include the holding period for the converted Class B shares.
If a shareholder exercises an exchange privilege within 90 days of
acquiring the shares, then the loss the shareholder can recognize on the
exchange will be reduced (or the gain increased) to the extent any sales charge
paid to the Fund on the exchanged shares reduces any sales charge 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 advisors 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.
PERFORMANCE DATA
From time to time the Fund may include its average annual total return,
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.
38
<PAGE> 39
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 and Class C 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,
1996 was 4.91% for Class A shares, 4.61% for Class B shares, 4.50% for Class C
shares and 4.81% for Class D shares and the tax-equivalent yield for the same
period (based on a Federal income tax rate of 28%) was 6.82% for Class A shares,
6.40% for Class B shares, 6.25% for Class C shares and 6.68% for Class D shares.
The yield without voluntary reimbursement or waiver of Fund expenses for the
30-day period would have been 4.48% for Class A shares, 4.16% for Class B
shares, 4.06% for Class C shares and 4.39% for Class D shares with a
tax-equivalent yield of 6.22% for Class A shares, 5.78% for Class B shares,
5.64% for Class C shares and 6.10% for Class D shares.
39
<PAGE> 40
Total return, yield and tax-equivalent yield figures are based on the
Fund's historical performance and are not intended to indicate future
performance. The Fund's total return, yield and tax-equivalent yield will vary
depending on market conditions, the securities comprising the Fund's portfolio,
the Fund's operating expenses and the amount of realized and unrealized net
capital gains or losses during the period. The value of an investment in the
Fund will fluctuate and an investor's shares, when redeemed, may be worth more
or less than their original cost.
On occasion, the Fund may compare its performance to performance data
published by Lipper Analytical Services, Inc., 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 indicative of the Fund's relative
performance for any future period.
ADDITIONAL INFORMATION
DETERMINATION OF NET ASSET VALUE
The net asset value of the shares of all classes of the Fund is determined
once daily 15 minutes after the close of business on the NYSE (generally, 4:00
P.M., New York time), on each day during which the NYSE is open for trading. The
net asset value per share is computed by dividing the sum of the value of the
securities held by the Fund plus any cash or other assets 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
fees, higher account maintenance fees and higher transfer agency fees applicable
with respect to Class B and Class C shares. It is expected, however, that the
per share net asset value of the classes will tend to converge (although not
necessarily meet) immediately after the 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
40
<PAGE> 41
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, and
in certain cases, state and local income taxes as is consistent with prudent
investment management. 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 Trustees of the Trust may classify and reclassify the shares of any
Series into additional classes at a future date.
Shareholders are entitled to one vote for each full share and to fractional
votes for fractional shares held in the election of Trustees (to the extent
hereinafter provided) and on other matters submitted to the vote of
shareholders. There normally will be no meeting of shareholders for the purpose
of electing Trustees unless and until such time as less than a majority of the
Trustees holding office have been elected by shareholders, at which time the
Trustees then in office will call a shareholders' meeting for the election of
Trustees. Shareholders may, in accordance with the terms of the Declaration of
Trust, cause a meeting of shareholders to be held for the purpose of voting on
the removal of Trustees. Also, the Trust will be required to call a special
meeting of shareholders of a Series in accordance with the requirements of the
1940 Act to seek approval of new management and advisory arrangements, of a
material increase in distribution fees or of a change in the fundamental
policies, objectives or restrictions of a Series. Except as set forth above, the
Trustees shall continue to hold office and appoint successor Trustees. 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:
Merrill Lynch Financial Data Services, Inc.
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
41
<PAGE> 42
questions regarding this matter please call your Merrill Lynch Financial
Consultant or Merrill Lynch Financial Data Services, Inc. at 800-637-3863.
SHAREHOLDER INQUIRIES
Shareholder inquiries may be addressed to the Trust at the address or
telephone number set forth on the cover page of this Prospectus.
------------------
The Declaration of Trust establishing the Trust, dated 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.
42
<PAGE> 43
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 Merrill Lynch Financial
Data Services, Inc., as an initial investment (minimum $1,000). I understand
that this purchase will be executed at the applicable offering price next to
be determined after this Application is received by you.
B. I already own shares of the following Merrill Lynch mutual funds that
would qualify for the right of accumulation as outlined in the Statement of
Additional Information: (Please list all funds. Use a separate sheet of
paper if necessary.)
<TABLE>
<S> <C>
1. ................................................... 4....................................................
2. ................................................... 5....................................................
3. ................................................... 6....................................................
</TABLE>
Name............................................................................
First Name Initial Last Name
Name of Co-Owner (if any).......................................................
First Name Initial Last Name
Address.........................................................................
................................................................................
(Zip Code)
<TABLE>
<S> <C>
Occupation .................................. Name and Address of Employer.......................................
...................................................................
...................................................................
............................................. ...................................................................
Signature of Owner Signature of Co-Owner (if any)
</TABLE>
(In the case of co-owners, a joint tenancy with right of survivorship will be
presumed unless otherwise specified.)
- --------------------------------------------------------------------------------
2. DIVIDEND AND CAPITAL GAIN DISTRIBUTION OPTIONS
Ordinary Income Dividends Long-Term Capital Gains
------------------------------- -------------------------------
SELECT / / Reinvest SELECT / / Reinvest
ONE: / / Cash ONE: / / Cash
------------------------------- -------------------------------
If no election is made, dividends and capital gains will be automatically
reinvested at net asset value without a sales charge.
IF CASH, SPECIFY HOW YOU WOULD LIKE YOUR DISTRIBUTIONS PAID TO YOU: / / Check
or / / Direct Deposit to bank account
IF DIRECT DEPOSIT TO BANK ACCOUNT IS SELECTED, PLEASE COMPLETE BELOW:
I hereby authorize payment of dividend and capital gain distributions by direct
deposit to my bank account and, if necessary, debit entries and adjustments for
any credit entries made to my account in accordance with the terms I have
selected on the Merrill Lynch 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 MERRILL LYNCH FINANCIAL DATA SERVICES, INC. AMENDING OR
TERMINATING THIS SERVICE.
Signature of Depositor..........................................................
Signature of Depositor ................................................ Date....
(if joint account, both must sign)
NOTE: IF DIRECT DEPOSIT TO BANK ACCOUNT IS SELECTED, YOUR BLANK, UNSIGNED CHECK
MARKED "VOID" OR A DEPOSIT SLIP FROM YOUR SAVINGS ACCOUNT SHOULD ACCOMPANY THIS
APPLICATION.
43
<PAGE> 44
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
"Distribution and Taxes--Taxes") either because I have not been notified that I
am subject thereto as a result of a failure to report all interest or dividends,
or the Internal Revenue Service ("IRS") has notified me that I am no longer
subject thereto.
INSTRUCTION: YOU MUST STRIKE OUT THE LANGUAGE IN (2) ABOVE IF YOU HAVE BEEN
NOTIFIED THAT YOU ARE SUBJECT TO BACKUP WITHHOLDING DUE TO UNDER-REPORTING 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 D SHARES ONLY (See terms and conditions in
the Statement of Additional Information)
...................,19....
Dear Sir/Madam: Date of Initial Purchase
Although I am not obligated to do so, I intend to purchase shares of Merrill
Lynch 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 this Letter of Intention. I hereby
irrevocably constitute and appoint Merrill Lynch Funds Distributor, Inc., my
attorney, with full power of substitution, to surrender for redemption any or
all shares of Merrill Lynch 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
Branch Office, Address, Stamp
--- ---
| |
| |
--- ---
This form when completed should be mailed to:
Merrill Lynch Colorado Municipal Bond Fund
c/o Merrill Lynch Financial Data Services, Inc.
P.O. Box 45289
Jacksonville, FL 32232-5289
We hereby authorize Merrill Lynch Funds Distributor, Inc. to act as our agent in
connection with transactions under this authorization form and agree to notify
the Distributor of any purchases or sales made under a Letter of Intention,
Automatic Investment Plan or Systematic Withdrawal Plan. We guarantee the
shareholder's signature.
................................................................................
Dealer Name and Address
By .............................................................................
Authorized Signature of Dealer
<TABLE>
<S> <C> <C>
- ------- ---------
/ / / / / / / / / ..........................
- ------- ---------
Branch Code F/C No. F/C Last Name
- ------- ---------
/ / / / / / / / /
- ------- ---------
Dealer's Customer A/C No.
</TABLE>
44
<PAGE> 45
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............................................................ / /
------------------------------------
Social Security No.
or Taxpayer Identification Number
Name of Co-Owner (if any)................................................
Address..................................................................
......................................................................... 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 ________________ or as soon as possible thereafter.
(month)
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 MERRILL LYNCH 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.
45
<PAGE> 46
MERRILL LYNCH COLORADO MUNICIPAL BOND FUND--AUTHORIZATION FORM (PART
2)--(CONTINUED)
- --------------------------------------------------------------------------------
3. APPLICATION FOR AUTOMATIC INVESTMENT PLAN
I hereby request that Merrill Lynch Financial Data Services, Inc. draw an
automated clearing house ("ACH") debit on my checking account as described below
each month to purchase: (choose one)
/ / Class A shares / / Class B shares / / Class C
shares / / Class D shares
of Merrill Lynch 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.
MERRILL LYNCH 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 No..................................................................
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, Merrill Lynch 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 MERRILL LYNCH 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 Merrill Lynch
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 Signature of Depositor
Number (If joint account, both must sign)
NOTE: IF AUTOMATIC INVESTMENT PLAN IS ELECTED, YOUR BLANK, UNSIGNED CHECK MARKED
"VOID" SHOULD ACCOMPANY THIS APPLICATION.
46
<PAGE> 47
MANAGER
Fund Asset Management
Administrative Offices:
800 Scudders Mill Road
Plainsboro, New Jersey
Mailing Address:
P.O. Box 9011
Princeton, New Jersey 08543-9011
DISTRIBUTOR
Merrill Lynch Funds Distributor, Inc.
Administrative Offices:
800 Scudders Mill Road
Plainsboro, New Jersey
Mailing Address:
P.O. Box 9081
Princeton, New Jersey 08543-9081
CUSTODIAN
State Street Bank and Trust Company
P.O. Box 351
Boston, Massachusetts 02101
TRANSFER AGENT
Merrill Lynch Financial Data Services, Inc.
Administrative Offices:
4800 Deer Lake Drive East
Jacksonville, Florida 32246-6484
Mailing Address:
P.O. Box 45289
Jacksonville, Florida 32232-5289
INDEPENDENT AUDITORS
Deloitte & Touche LLP
117 Campus Drive
Princeton, New Jersey 08540-6400
COUNSEL
Brown & Wood LLP
One World Trade Center
New York, New York 10048-0557
<PAGE> 48
- ------
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.............. 10
Potential Benefits........................... 12
Special and Risk Considerations Relating to
Municipal Bonds............................ 12
Description of Municipal Bonds............... 13
Call Rights.................................. 16
When-Issued Securities and Delayed Delivery
Transactions............................... 16
Financial Futures Transactions and Options... 16
Repurchase Agreements........................ 18
Investment Restrictions...................... 19
Management of the Trust........................ 20
Trustees..................................... 20
Management and Advisory Arrangements......... 20
Code of Ethics............................... 21
Transfer Agency Services..................... 21
Purchase of Shares............................. 22
Initial Sales Charge Alternatives--
Class A and Class D Shares................. 24
Deferred Sales Charge Alternatives--
Class B and Class C Shares................. 26
Distribution Plans........................... 28
Limitations on the Payment of Deferred Sales
Charges.................................... 30
Redemption of Shares........................... 31
Redemption................................... 31
Repurchase................................... 31
Reinstatement Privilege--Class A and
Class D Shares............................. 32
Shareholder Services........................... 32
Investment Account........................... 32
Exchange Privilege........................... 33
Automatic Reinvestment of Dividends and
Capital
Gains Distributions........................ 34
Systematic Withdrawal Plans.................. 34
Automatic Investment Plans................... 34
Fee-Based Programs........................... 34
Portfolio Transactions......................... 35
Distributions and Taxes........................ 36
Distributions................................ 36
Taxes........................................ 36
Performance Data............................... 38
Additional Information......................... 40
Determination of Net Asset Value............. 40
Organization of the Trust.................... 40
Shareholder Reports.......................... 41
Shareholder Inquiries........................ 42
Authorization Form............................. 43
Code # 16914-1096
</TABLE>
Merrill Lynch
Colorado Municipal
Bond Fund
Merrill Lynch Multi-State
Municipal Series Trust
PROSPECTUS LOGO
October 29, 1996
Distributor:
Merrill Lynch
Funds Distributor, Inc.
This prospectus should be
retained for future reference.
<PAGE> 49
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 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 ("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 29,
1996 (the "Prospectus"), which has been filed with the Securities and Exchange
Commission (the "Commission") and can be obtained, without charge, by calling or
by writing the Fund at the above telephone number or address. This Statement of
Additional Information has been incorporated by reference into the Prospectus.
Capitalized terms used but not defined herein have the same meanings as in the
Prospectus.
-------------------------
FUND ASSET MANAGEMENT--MANAGER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC.--DISTRIBUTOR
-------------------------
The date of this Statement of Additional Information is October 29, 1996.
<PAGE> 50
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
2
<PAGE> 51
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.
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. For example, to the
extent the Fund invests in these types of Municipal Bonds, the Fund's return on
such Municipal Bonds will be subject to risk with respect to the value of the
particular index, which may include reduced or eliminated interest payments and
losses of invested principal. Such securities have the effect of providing a
degree of investment leverage, since they may increase or decrease in value in
response to changes, as an illustration, in market interest rates at a rate
which is a multiple (typically two) of the rate at which fixed-rate long-term
tax exempt securities increase or decrease in response to such changes. As a
result, the market values of such securities will generally be more volatile
than the market values of fixed-rate tax exempt securities. To seek to limit the
volatility of these securities, the Fund may purchase inverse floating
obligations with shorter term maturities or which contain limitations on the
extent to which the interest rate may vary. Certain investments in such
obligations may be illiquid. The Fund may not invest in such illiquid
obligations if such investments, together with other illiquid investments, would
exceed 15% of the Fund's total assets. The Manager believes, however, that
indexed and inverse floating obligations represent flexible portfolio management
instruments for the Fund which allow the Fund to seek potential investment
rewards, hedge other portfolio positions or vary the degree of investment
leverage relatively efficiently under different market conditions.
3
<PAGE> 52
The Fund may purchase a Municipal Bond issuer's right to call all or a
portion of such Municipal Bond for mandatory tender for purchase (a "Call
Right"). A holder of a Call Right may exercise such right to require a mandatory
tender for the purchase of related Municipal Bonds, subject to certain
conditions. A Call Right that is not exercised prior to the maturity of the
related Municipal Bond will expire without value. The economic effect of holding
both the Call Right and the related Municipal Bond is identical to holding a
Municipal Bond as a non-callable security. Certain investments in such
obligations may be illiquid. The Fund may not invest in such illiquid
obligations if such investments, together with other illiquid investments, would
exceed 15% of the Fund's total assets.
The Fund may invest up to 20% of its total assets in 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 Bond" 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 or obligors 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. In addition, the market for
high yield municipal securities is relatively new and has not weathered a major
economic recession, and it is unknown what effects such a recession might have
on such securities. 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
4
<PAGE> 53
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 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 industrial development bonds or private activity bonds are
issued by or on behalf of public authorities to finance various privately owned
or operated facilities. Such obligations are included within the term Municipal
Bonds if the interest paid thereon is, in the opinion of bond counsel, 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.
5
<PAGE> 54
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
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 limited tax or other specific revenue source such as payments from
the user of the facility being financed. IDBs or 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. If an issuer of moral obligation bonds is unable to meet its
obligations, repayment of such bonds 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 total assets. The Fund may, however, invest without regard to such
limitation in lease obligations which the Manager, pursuant to the guidelines
which have been adopted by the 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
6
<PAGE> 55
to applicable bankruptcy, insolvency and similar laws and court decisions
affecting the rights of creditors generally.
DESCRIPTION OF TEMPORARY INVESTMENTS
The Fund may invest in short-term tax-free and taxable securities subject
to the limitations set forth under "Investment Objective and Policies". The
tax-exempt money market securities may include municipal notes, municipal
commercial paper, municipal bonds with remaining maturity of less than one year,
variable rate demand notes and participations therein. Municipal notes include
tax anticipation notes, bond anticipation notes and grant anticipation notes.
Anticipation notes are sold as interim financing in anticipation of tax
collection, bond sales, government grants or revenue receipts. Municipal
commercial paper refers to short-term unsecured promissory notes generally
issued to finance short-term credit needs. The taxable money market securities
in which the Fund may invest as Temporary Investments consist of U.S. Government
securities, U.S. Government agency securities, domestic bank or savings
institution certificates of deposit and bankers' acceptances, short-term
corporate debt securities such as commercial paper, and repurchase agreements.
These Temporary Investments must have a stated maturity not in excess of one
year from the date of purchase.
Variable rate demand obligations ("VRDOs") are tax-exempt obligations which
contain a floating or variable interest rate adjustment formula and an
unconditional right of demand on the part of the holder thereof to receive
payment of the unpaid principal balance plus accrued interest upon a short
notice period not to exceed seven days. There is, however, the possibility that
because of default or insolvency the demand feature of VRDOs and Participating
VRDOs, described below, may not be honored. The interest rates are adjustable at
intervals (ranging from daily to up to one year) to some prevailing market rate
for similar investments, such adjustment formula being calculated to maintain
the market value of the 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 Public Securities Association Index or some
other appropriate interest rate adjustment index. The Fund may invest in all
types of tax-exempt instruments currently outstanding or to be issued in the
future which satisfy the short-term maturity and quality standards of the Fund.
The Fund also may invest in VRDOs in the form of participation interests
("Participating VRDOs") in variable rate tax-exempt obligations held by a
financial institution, typically a commercial bank. Participating VRDOs provide
the Fund with a specified undivided interest (up to 100%) of the underlying
obligation and the right to demand payment of the unpaid principal balance plus
accrued interest on the Participating VRDOs from the financial institution upon
a specified number of days' notice, not to exceed seven days. In addition, a
Participating VRDO is backed by an irrevocable letter of credit or guaranty of
the financial institution. The Fund would have an undivided interest in the
underlying obligation and thus participate on the same basis as the financial
institution in such obligation except that the financial institution typically
retains fees out of the interest paid on the obligation for servicing the
obligation, providing the letter of credit and issuing the repurchase
commitment. The Fund has been advised by its counsel that the Fund should be
entitled to treat the income received on Participating VRDOs as interest from
tax-exempt obligations.
VRDOs that contain an unconditional right of demand to receive payment of
the unpaid principal balance plus accrued interest on a notice period exceeding
seven days may be deemed to be illiquid securities. A VRDO with a demand notice
period exceeding seven days therefore will be subject to the Fund's restriction
7
<PAGE> 56
on illiquid investments unless, in the judgment of the Trustees, such VRDO is
liquid. The Trustees may adopt guidelines and delegate to the Manager the daily
function of determining and monitoring liquidity of such VRDOs. The Trustees,
however, will retain sufficient oversight and will be ultimately responsible for
such determination.
The Trust has established the following standards with respect to money
market securities and VRDOs in which the Fund invests. Commercial paper
investments at the time of purchase must be rated "A-1" through "A-3" by
Standard & Poor's, "Prime-1" through "Prime-3" by Moody's or "F-1" through "F-3"
by Fitch or, if not rated, issued by companies having an outstanding debt issue
rated at least "A" by Standard & Poor's, Fitch or Moody's. Investments in
corporate bonds and debentures (which must have maturities at the date of
purchase of one year or less) must be rated at the time of purchase at least "A"
by Standard & Poor's, Moody's or Fitch. Notes and VRDOs at the time of purchase
must be rated SP-1/A-1 through SP-2/A-3 by Standard & Poor's, MIG-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 a 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 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 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, instead of the contractual fixed rate
of return, the rate of return to the Fund will depend on intervening
fluctuations of the market value of such security and the accrued interest on
the security. In such event, the Fund would have rights against the seller for
breach of contract with respect to any losses arising from market fluctuations
following the failure of the seller to perform. The Fund may not invest in
repurchase agreements maturing in more than seven days if such investments,
together with all other illiquid investments, would exceed 15% of the Fund's
total assets.
8
<PAGE> 57
In general, for Federal income tax purposes, repurchase agreements are
treated as collateralized loans secured by the securities "sold". Therefore,
amounts earned under such agreements will not be considered tax-exempt interest.
FINANCIAL FUTURES TRANSACTIONS AND OPTIONS
Reference is made to the discussion concerning futures transactions under
"Investment Objective and Policies" in the Prospectus. Set forth below is
additional information concerning these transactions.
As described in the Prospectus, the Fund may purchase and sell exchange
traded financial futures contracts ("financial futures contracts") to hedge its
portfolio of Municipal Bonds against declines in the value of such securities
and to hedge against increases in the cost of securities the Fund intends to
purchase. However, any transactions involving financial futures or options (or
puts and calls associated therewith) will be in accordance with the Fund's
investment policies and limitations. See "Investment Objective and
Policies--Investment Restrictions" in the Prospectus. To hedge its portfolio,
the Fund may take an investment position in a 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
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<PAGE> 58
requirements are added to, and an equal number of old issues are deleted from,
the Municipal Bond Index. The value of the Municipal Bond Index is computed
daily according to a formula based on the price of each bond in the Municipal
Bond Index, as evaluated by six dealer-to-dealer brokers.
The Municipal Bond Index 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
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<PAGE> 59
futures contracts will be closed out. Due to changing market conditions and
interest rate forecasts, however, a futures position may be terminated without a
corresponding purchase of portfolio securities.
Call Options on 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 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
11
<PAGE> 60
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 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 liquid securities will be deposited in a segregated account with
the Fund's custodian so that the amount so segregated, plus the amount of
initial and variation margin held in the account of its broker, equals the
market value of the futures contract, thereby ensuring that the use of such
futures is unleveraged.
Risk Factors in Futures Transactions and Options. Investment in futures
contracts involves the risk of imperfect correlation between movements in the
price of the futures contract and the price of the security being hedged. The
hedge will not be fully effective when there is imperfect correlation between
the movements in the prices of two financial instruments. For example, if the
price of the futures contract moves more than the price of the hedged security,
the Fund will experience either a loss or gain on the futures contract which is
not offset completely by movements in the price of the hedged securities. To
compensate for imperfect correlations, the Fund may purchase or sell futures
contracts in a greater dollar amount than the hedged securities if the
volatility of the hedged securities is historically greater than the volatility
of the futures contracts. Conversely, the Fund may purchase or sell fewer
futures contracts if the volatility of the price of the hedged securities is
historically less than that of the futures contracts.
The particular municipal bonds comprising the index underlying the
Municipal Bond Index financial futures contract may vary from the 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.
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<PAGE> 61
The successful use of transactions in futures and related options also
depends on the ability of the Manager to forecast correctly the direction and
extent of interest rate movements within a given time frame. To the extent
interest rates remain stable during the period in which a futures contract or
option is held by the Fund or such rates move in a direction opposite to that
anticipated, the Fund may realize a loss on the hedging transaction which is not
fully or partially offset by an increase in the value of portfolio securities.
As a result, the Fund's total return for such period may be less than if it had
not engaged in the hedging transaction.
Because of low initial margin deposits made on the opening of a futures
position, futures transactions involve substantial leverage. As a result,
relatively small movements in the price of the futures contracts can result in
substantial unrealized gains or losses. Because the Fund will engage in the
purchase and sale of futures contracts solely for hedging purposes, however, any
losses incurred in connection therewith should, if the hedging strategy is
successful, be offset in whole or in part by increases in the value of
securities held by the Fund or decreases in the price of securities the Fund
intends to acquire.
The amount of risk the Fund assumes when it purchases an option on a
futures contract is the premium paid for the option plus related transaction
costs. In addition to the correlation risks discussed above, the purchase of an
option on a futures contract also entails the risk that changes in the value of
the underlying futures contract will not be reflected fully in the value of the
option purchased.
Municipal Bond Index futures contracts were approved for trading in 1986.
Trading in such futures contracts may tend to be less liquid than that in other
futures contracts. The trading of futures contracts also is subject to certain
market risks, such as inadequate trading activity, which could at times make it
difficult or impossible to liquidate existing positions.
INVESTMENT RESTRICTIONS
The Fund has adopted a number of fundamental and non-fundamental
restrictions and policies relating to the investment of its assets and its
activities. The fundamental policies set forth below may not be changed without
the approval of the holders of a majority of the Fund's outstanding voting
securities (which for this purpose and under the 1940 Act means the lesser of
(i) 67% of the Fund's shares present at a meeting at which more than 50% of the
outstanding shares of the Fund are represented or (ii) more than 50% of the
Fund's outstanding shares). The Fund may not:
1. Invest more than 25% of its assets, taken at market value at the
time of each investment, in the securities of issuers in any particular
industry (excluding the U.S. Government and its agencies and
instrumentalities). For purposes of this restriction, states,
municipalities and their political subdivisions are not considered part of
any industry.
2. Make investments for the purpose of exercising control or
management.
3. Purchase or sell real estate, except that, to the extent permitted
by applicable law, the Fund may invest in securities directly or indirectly
secured by real estate or interests therein or issued by companies which
invest in real estate or interests therein.
4. Make loans to other persons, except that the acquisition of bonds,
debentures or other corporate debt securities and investment in government
obligations, commercial paper, pass-through instruments, certificates of
deposit, bankers' acceptances, repurchase agreements or any similar
instruments shall not
13
<PAGE> 62
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, to the extent permitted
by applicable law, 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.
8. Purchase or sell commodities or contracts on commodities, except to
the extent that the Fund may do so in accordance with applicable law and
the Fund's Prospectus and Statement of Additional Information, as they may
be amended from time to time, and without registering as a commodity pool
operator under the Commodity Exchange Act.
Under the non-fundamental investment restrictions, the Fund may not:
a. Purchase securities of other investment companies, except to the
extent such purchases are permitted by applicable law.
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.
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
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<PAGE> 63
to exceed 2% of the Fund's net assets, are warrants which are not listed on
the New York Stock Exchange (the "NYSE") 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 Trustees of the Trust, the officers and general
partner of the Manager, 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.
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.
In addition, to comply with Federal income tax requirements for
qualification as a "regulated investment company", the Fund's investments will
be limited in a manner such that, at the close of each quarter of each fiscal
year, (a) no more than 25% of the Fund's total assets are invested in the
securities of a single issuer, and (b) with regard to at least 50% of the Fund's
total assets, no more than 5% of its total assets are invested in the securities
of a single issuer. For purposes of this restriction, the Fund will regard each
state and each political subdivision, agency or instrumentality of such state
and each multi-state agency of which such state is a member and each public
authority which issues securities on behalf of a private entity as a separate
issuer, except that if the security is backed only by the assets and revenues of
a non-governmental entity then the entity with the ultimate responsibility for
the payment of interest and principal may be regarded as the sole issuer. These
tax-related limitations may be changed by the Trustees of the Trust to the
extent necessary to comply with changes to the Federal income tax requirements.
Because of the affiliation of Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("Merrill Lynch") with the Trust, the Fund is prohibited from
engaging in certain transactions involving such firm or its affiliates except
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.
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<PAGE> 64
MANAGEMENT OF THE TRUST
TRUSTEES AND OFFICERS
Information about the Trustees, executive officers and the portfolio
manager of the Trust, including their ages and their principal occupations for
at least the last five years, is set forth below. Unless otherwise noted, the
address of each Trustee and executive officer is P.O. Box 9011, Princeton, New
Jersey 08543-9011.
ARTHUR ZEIKEL (64)--President and Trustee(1)(2)--President of the Manager
(which term, as used herein, includes the Manager's corporate predecessors)
since 1977; President of Merrill Lynch Asset Management, L.P. ("MLAM") (which
term, as used herein, includes its corporate predecessors) since 1977; President
and Director of Princeton Services, Inc. ("Princeton Services") since 1993;
Executive Vice President of Merrill Lynch & Co., Inc. ("ML&Co.") since 1990;
Director of Merrill Lynch Funds Distributor, Inc. ("MLFD" or the "Distributor")
since 1977.
JAMES H. BODURTHA (52)--Trustee(2)--36 Popponesset Road, Cotuit,
Massachusetts 02635. Director and Executive Vice President, The China Business
Group, Inc. since 1996; Chairman and Chief Executive Officer, China Enterprise
Management Corporation from 1993 to 1996; Chairman, Berkshire Corporation since
1980; Partner, Squire, Sanders & Dempsey from 1980 to 1993.
HERBERT I. LONDON (57)--Trustee(2)--113-115 University Place, New York, New
York 10003. John M. Olin Professor of Humanities, New York University since 1993
and Professor thereof since 1980; Dean, Gallatin Division of New York University
from 1978 to 1993; 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 from 1983 to 1993;
Limited Partner, Hypertech L.P. since 1996.
ROBERT R. MARTIN (69)--Trustee(2)--513 Grand Hill, St. Paul, Minnesota
55102. Chairman and Chief Executive Officer, Kinnard Investments, Inc. from 1990
to 1993; Executive Vice President, Dain Bosworth from 1974 to 1989; Director,
Carnegie Capital Management from 1977 to 1985 and Chairman thereof in 1979;
Director, Securities Industry Association from 1981 to 1982 and Public
Securities Association from 1979 to 1980; Chairman of the Board, WTC Industries,
Inc. in 1994; Trustee, Northland College since 1992.
JOSEPH L. MAY (67)--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 (44)--Trustee(2)--Morgan Hall, Soldiers Field, Boston,
Massachusetts 02163. Professor, Harvard Business School since 1989 and Associate
Professor from 1983 to 1989; Trustee, The Common Fund, since 1989; Director,
Quantec Limited since 1991.
TERRY K. GLENN (56)--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; President of Princeton Administrators, L.P. since
1988.
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<PAGE> 65
VINCENT R. GIORDANO (52)--Vice President(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 (45)--Vice President(1)(2)--Vice President of the Manager
and MLAM since 1984.
HUGH T. HURLEY, III (32)--Portfolio Manager(1)(2)--Assistant Vice President
of MLAM since 1993; Municipal Bond Broker with Titus & Donnelley Municipal Bond
Brokers from 1990 to 1993.
DONALD C. BURKE (36)--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 (47)--Treasurer(1)(2)--Senior Vice President and
Treasurer of the Manager and MLAM since 1984; Senior Vice President and
Treasurer of Princeton Services since 1993; Treasurer of MLFD since 1984 and
Vice President thereof since 1981.
JERRY WEISS (38)--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, 1996, the Trustees and officers of the Trust as a group
(12 persons) owned an aggregate of less than 1% of the outstanding shares of
Common Stock of ML&Co. and owned an aggregate of less than 1% of the outstanding
shares of the Fund.
COMPENSATION OF TRUSTEES
The Trust pays each Trustee not affiliated with the Manager (each a
"non-affiliated Trustee") a fee of $10,000 per year plus $1,000 per meeting
attended. The Trust also compensates members of its Audit and Nominating
Committee (the "Committee"), which consists of all the non-affiliated Trustees,
an annual fee of $2,000 plus $500 per meeting attended. The Trust reimburses
each non-affiliated Trustee for his out-of-pocket expenses relating to
attendance at Board and Committee meetings. The fees and expenses of the
Trustees are allocated to the respective series of the Trust on the basis of
asset size. For the fiscal year ended July 31, 1996, fees and expenses paid to
non-affiliated Trustees which were allocated to the Fund aggregated $1,445.
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The following table sets forth for the fiscal year ended July 31, 1996,
compensation paid by the Fund to the non-affiliated Trustees and, for the
calendar year ended December 31, 1995, the aggregate compensation paid by all
registered investment companies (including the Trust) advised by the Manager and
its affiliate, MLAM ("FAM/MLAM Advised Funds") to the non-affiliated Trustees:
<TABLE>
<CAPTION>
AGGREGATE COMPENSATION
PENSION OR FROM FUND AND
RETIREMENT BENEFITS FAM/MLAM ADVISED
NAME OF COMPENSATION ACCRUED AS PART FUNDS PAID TO
TRUSTEE FROM FUND OF FUND EXPENSE TRUSTEES(1)
- ----------------------------------------- ------------ ------------------- ----------------------
<S> <C> <C> <C>
James H. Bodurtha........................ $270 None $157,500*
Herbert I. London........................ $270 None $157,500
Robert R. Martin......................... $270 None $157,500
Joseph L. May............................ $270 None $157,500
Andre F. Perold.......................... $270 None $157,500
</TABLE>
- ---------------
(1) The Trustees serve on the boards of FAM/MLAM Advised Funds as follows: Mr.
Bodurtha (22 registered investment companies consisting of 46 portfolios);
Mr. London (22 registered investment companies consisting of 46 portfolios);
Mr. Martin (22 registered investment companies consisting of 46 portfolios);
Mr. May (22 registered investment companies consisting of 46 portfolios);
and Mr. Perold (22 registered investment companies consisting of 46
portfolios).
* $157,500 represents the amount Mr. Bodurtha would have received if he had
been a Trustee for the entire calendar year ended December 31, 1995. Mr.
Bodurtha was elected to the Trust's Board of Trustees effective June 23,
1995.
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) to July 31, 1994, the total management fee payable
by the Fund to the Manager was $78,643 (based on average net assets of
approximately $21 million), all of which was voluntarily waived by the Manager.
For that period, the Manager also voluntarily reimbursed the Fund for other
expenses in the amount of $134,420. For the fiscal year ended July 31, 1995, the
total management fee payable by the Fund to the Manager was $138,993 (based on
average net assets of approximately $25.5 million), all of which was voluntarily
waived by the Manager. For the fiscal year ended July 31, 1996, the total
management fee payable by the Fund to the Manager was $163,546 (based on average
net assets of
18
<PAGE> 67
approximately $29.7 million), of which $161,021 was voluntarily waived by the
Manager. For that year, the Manager also voluntarily reimbursed the Fund for
other expenses in the amount of $30,788.
The Management Agreement obligates the Manager to provide investment
advisory services and to pay all compensation of and furnish office space for
officers and employees of the Trust connected with investment and economic
research, trading and investment management of the Trust, as well as the fees of
all Trustees of the Trust who are affiliated persons of ML&Co. or any of its
affiliates. The Fund pays all other expenses incurred in its operation and, if
other Series shall be added ("Series"), a portion of the Trust's general
administrative expenses will be allocated on the basis of the asset size of the
respective Series. Expenses that will be borne directly by the Series include,
among other things, redemption expenses, expenses of portfolio transactions,
expenses of registering the shares under Federal and state securities laws,
pricing costs (including the daily calculation of net asset value), expenses of
printing shareholder reports, prospectuses and statements of additional
information (except to the extent paid by 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) to July 31, 1994, the
Fund paid the Manager $18,821 for accounting services. For the fiscal years
ended July 31, 1995 and 1996, the Fund paid the Manager $46,434 and $38,579,
respectively, for accounting services. 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 Class B and Class
C 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 Plans".
The Manager is a limited partnership, the partners of which are ML&Co. and
Princeton Services. ML&Co. and Princeton Services are "controlling persons" of
the Manager as defined under the 1940 Act because of their ownership of its
voting securities or their power to exercise a controlling influence over its
management or policies.
Duration and Termination. Unless earlier terminated as described 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.
19
<PAGE> 68
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".
The Merrill Lynch Select Pricing(SM) System is used by more than 50
registered investment companies advised by MLAM or its affiliate, the Manager.
Funds advised by MLAM or the Manager which utilize the Merrill Lynch Select
Pricing(SM) System 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 gross sales charges for the sale of Class A shares for the period
November 29, 1993 (commencement of operations) to July 31, 1994 were $120,789,
of which the Distributor received $2,080 and Merrill Lynch received $118,709.
The gross sales charges for the sale of Class A shares for the fiscal year ended
July 31, 1995 were $3,908, of which the Distributor received $343 and Merrill
Lynch received $3,565. The gross sales charges for the sale of Class A shares
for the fiscal year ended July 31, 1996 were $1,497, of which the Distributor
received $260 and Merrill Lynch received $1,237. The gross sales charges for the
sale of Class D shares for the period October 21, 1994 (commencement of
operations) to July 31, 1995 were $4,103, of which the Distributor received $540
and Merrill Lynch received $3,563. The gross sales charges for the sale of Class
D shares for the fiscal year ended July 31, 1996 were $5,872, of which the
Distributor received $1,010 and Merrill Lynch received $4,862. For the period
November 29, 1993 (commencement of operations) to July 31, 1994 and for the
fiscal years ended July 31, 1995 and 1996, the Distributor received no CDSCs
with respect to redemption within one year after purchase of Class A shares
purchased subject to a front-end sales charge waiver. For the period October 21,
1994 (commencement of operations) to July 31, 1995 and for the
20
<PAGE> 69
fiscal year ended July 31, 1996, the Distributor received no CDSCs with respect
to redemption within one year after purchase of Class D shares purchased subject
to a front-end sales charge waiver.
The term "purchase", as used in the Prospectus and this Statement of
Additional Information in connection with an investment in Class A and Class D
shares of the Fund, refers to a single purchase by an individual, or to
concurrent purchases, which in the aggregate are at least equal to the
prescribed amounts, by an individual, his 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, the date
the Merrill Lynch Select Pricing(SM) System commenced operations, 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 continuously maintained in a Merrill Lynch securities
account. Fourth, there must be a minimum purchase of $250 to be eligible for the
investment option.
Shareholders of certain MLAM-advised continuously offered closed-end funds
may reinvest at net asset value the net proceeds from a sale of certain shares
of common stock of such funds in shares of the Fund. Upon exercise of this
investment option, shareholders of Merrill Lynch Senior Floating Rate Fund, Inc.
will receive Class A shares of the Fund and shareholders of Merrill Lynch
Municipal Strategy Fund, Inc. and Merrill Lynch High Income Municipal Bond Fund,
Inc. will receive Class D shares of the Fund, except that shareholders already
owning Class A shares of the Fund will be eligible to purchase additional Class
A shares pursuant to this option, if such additional Class A shares will be held
in the same account as the existing Class A shares and the other requirements
pertaining to the reinvestment privilege are met. In order to exercise this
investment option, a shareholder of one of the above-referenced continuously
offered closed-end funds (an "eligible fund") must sell his or her shares of
common stock of the eligible fund (the "eligible shares") back to the eligible
fund in connection with a tender offer conducted by the eligible fund and
reinvest the proceeds immediately in the designated class of shares of the Fund.
This investment option is available only with respect to eligible shares as to
which no Early Withdrawal Charge or CDSC (each as defined in the
21
<PAGE> 70
eligible fund's prospectus) is applicable. Purchase orders from eligible fund
shareholders wishing to exercise this investment option will be accepted only on
the day that the related tender offer terminates and will be effected at the net
asset value of the designated class of the Fund on such day.
REDUCED INITIAL SALES CHARGES
Right of Accumulation. Reduced sales charges are applicable through a
right of accumulation under which eligible investors are permitted to purchase
shares of the Fund subject to an initial sales charge at the offering price
applicable to the total of (a) the public offering price of the shares then
being purchased plus (b) an amount equal to the then current net asset value or
cost, whichever is higher, of the purchaser's combined holdings of all classes
of shares of the Fund and of other MLAM-advised mutual funds. For any such right
of accumulation to be made available, the Distributor must be provided at the
time of purchase, by the purchaser or the purchaser's securities dealer, 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 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
22
<PAGE> 71
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.
Employee Access Accounts(SM). Class A or Class D shares are offered at net
asset value to Employee Access Accounts available through qualified employers
that provide employer-sponsored retirement or savings plans that are eligible to
purchase such shares at net asset value. The initial minimum for such accounts
is $500, except that the initial minimum for shares purchased for such accounts
pursuant to the Automatic Investment Program is $50.
TMA(SM) Managed Trusts. Class A 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 are 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; and 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 the shares of
such other fund were subject to a sales charge either at the time of purchase or
on a deferred basis; and second, such purchase of Class D shares must be made
within 90 days after such notice.
Class D shares of the Fund 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 served as a selected dealer if the following conditions
are satisfied: First, the investor must advise Merrill Lynch that it will
purchase Class D shares of the Fund with proceeds from the redemption of such
other mutual fund and that such shares have been outstanding for a period of no
less than six months; and second, such purchase of Class D shares must be made
within 60 days after the redemption and the proceeds from the redemption must be
maintained in the interim in cash or a money market fund.
23
<PAGE> 72
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
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.
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<PAGE> 73
LIMITATIONS ON THE PAYMENT OF DEFERRED SALES CHARGES
The maximum sales charge rule in the Conduct Rules of the National
Association of Securities Dealers, Inc. ("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.
25
<PAGE> 74
The following table sets forth comparative information as of July 31, 1996
with respect to the Class B and Class C shares of the Fund indicating the
maximum allowable payments that can be made under the NASD maximum sales charge
rule and, with respect to Class B shares, the Distributor's voluntary maximum.
<TABLE>
<CAPTION>
DATA CALCULATED AS OF JULY 31, 1996
--------------------------------------------------------------------------------------------
(IN THOUSANDS)
ANNUAL
DISTRIBUTION
ALLOWABLE ALLOWABLE AMOUNTS FEE AT
ELIGIBLE AGGREGATE INTEREST MAXIMUM PREVIOUSLY AGGREGATE CURRENT
GROSS SALES ON UNPAID AMOUNT PAID TO UNPAID NET ASSET
SALES(1) CHARGES BALANCE(2) PAYABLE DISTRIBUTOR(3) BALANCE LEVEL(4)
------- --------- ---------- ------- -------------- --------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
CLASS B SHARES, FOR THE
PERIOD NOVEMBER 26, 1993
(COMMENCEMENT OF
OPERATIONS) TO JULY 31,
1996:
Under NASD Rule as
Adopted................... $20,934 $ 1,308 $257 $1,565 $200 $ 1,365 $ 46
Under Distributor's
Voluntary Waiver.......... $20,934 $ 1,308 $105 $1,413 $200 $ 1,213 $ 46
CLASS C SHARES, FOR THE
PERIOD OCTOBER 21, 1994
(COMMENCEMENT OF
OPERATIONS) TO JULY 31,
1996:
Under NASD Rule as
Adopted................... $ 471 $ 30 $ 2 $ 32 $ 3 $ 29 $ 2
</TABLE>
- ---------------
(1) Purchase price of all eligible Class B or Class C shares sold during the
periods indicated other than shares acquired through dividend reinvestment
and the exchange privilege.
(2) Interest is computed on a monthly basis based upon the prime rate, as
reported in The Wall Street Journal, plus 1.0% as permitted under the NASD
Rule.
(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.
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 NYSE
is restricted as determined by the Commission or the NYSE is closed (other than
customary weekend and holiday closings), for any period during which an
emergency exists, as defined by the Commission, as a result of which disposal of
portfolio securities or determination of the net asset value of the Fund is not
reasonably practicable, and for such other periods as the Commission may by
order permit for the protection of shareholders of the Fund.
26
<PAGE> 75
DEFERRED SALES CHARGES--CLASS B AND CLASS C SHARES
As discussed in the Prospectus under "Purchase of Shares--Deferred Sales
Charge Alternatives-- Class B and Class C Shares", while Class B shares redeemed
within four years of purchase are subject to a CDSC under most circumstances,
the charge is waived on redemptions of Class B shares following the death or
disability of a Class B shareholder. Redemptions for which the waiver applies
are any partial or complete redemption following the death or disability (as
defined in the Internal Revenue Code of 1986, as amended (the "Code")) of a
Class B shareholder (including one who owns the Class B shares as joint tenant
with his or her spouse), provided the redemption is requested within one year of
the death or initial determination of disability. For the period November 26,
1993 (commencement of operations) to July 31, 1994 and the fiscal years ended
July 31, 1995 and 1996, the Distributor received CDSCs of $16,384, $42,885 and
$35,113, respectively, with respect to redemptions of Class B shares, all of
which were paid to Merrill Lynch. For the period October 21, 1994 (commencement
of operations) to July 31, 1995, the Distributor received no CDSCs with respect
to redemptions of Class C shares. For the fiscal year ended July 31, 1996, the
Distributor received CDSCs of $1,229 with respect to redemptions of Class C
shares, all of which were paid to Merrill Lynch.
PORTFOLIO TRANSACTIONS
Reference is made to "Investment Objective and Policies" and "Portfolio
Transactions" in the Prospectus.
Under the 1940 Act, persons affiliated with the Trust are prohibited from
dealing with the Fund as 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 (commencement of
operations) to July 31, 1994 and for the fiscal years ended July 31, 1995 and
1996, the Fund engaged in no transactions pursuant to such exemptive order. The
Trust has applied for an exemptive order permitting it to, among other things,
(i) purchase high quality tax-exempt securities from Merrill Lynch when Merrill
Lynch is a member of an underwriting syndicate and (ii) purchase tax-exempt
securities from and sell tax-exempt securities to Merrill Lynch in secondary
market transactions. 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 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 and
Trustees of the Trust, the officers and general partner of the Manager, the
directors of such general partner or the officers and directors of any
subsidiary thereof each 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
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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 rates for the fiscal years ended July 31, 1995 and 1996
were 73.86% and 49.13%, respectively.
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 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.
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DETERMINATION OF NET ASSET VALUE
The net asset value of shares of all classes of the Fund is determined once
daily, Monday through Friday, as of 15 minutes after the close of business on
the NYSE (generally, 4:00 P.M., New York time), on each day during which the
NYSE is open for trading. The NYSE is not open on New Year's Day, 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 Class A shares, reflecting the daily expense
accruals of the account maintenance, distribution and higher transfer agency
fees applicable with respect to Class B and Class C shares and the daily expense
accruals of the account maintenance fees applicable with respect to Class D
shares; moreover, the per share net asset value of Class B and Class C shares
generally will be lower than the per share net asset value of Class D shares,
reflecting the daily expense accruals of the distribution fees, higher account
maintenance fees and higher transfer agency fees applicable with respect to
Class B and Class C shares of the Fund. It is expected, however, that the per
share net asset value of the four classes will tend to converge (although not
necessarily meet) immediately after the payment of dividends, which will differ
by approximately the amount of the expense accrual differentials between the
classes.
The Municipal Bonds, and other portfolio securities in which the Fund
invests are traded primarily in 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
and
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long-term capital gains distributions. These statements will also show any other
activity in the account since the previous statement. Shareholders also will
receive separate confirmations for each purchase or sale transaction other than
automatic investment purchases and the reinvestment of ordinary income dividends
and long-term capital gains distributions. A shareholder may make additions to
his Investment Account at any time by mailing a check directly to the Transfer
Agent.
Share certificates are issued only for full shares and only upon the
specific request of the shareholder who has an Investment Account. Issuance of
certificates representing all or only part of the full shares in an Investment
Account may be requested by a shareholder directly from the Transfer Agent.
Shareholders considering transferring their Class A or Class D shares from
Merrill Lynch to another brokerage firm or financial institution should be aware
that, if the firm to which the Class A or Class D shares are to be transferred
will not take delivery of shares of the Fund, a shareholder either must redeem
the Class A or Class D shares (paying any applicable CDSC) so that the cash
proceeds can be transferred to the account at the new firm or such shareholder
must continue to maintain an Investment Account at the Transfer Agent for those
Class A or Class D shares. Shareholders interested in transferring their Class B
or Class C shares from Merrill Lynch and who do not wish to have an Investment
Account maintained for such shares at the Transfer Agent may request their new
brokerage firm to maintain such shares in an account registered in the name of
the brokerage firm for the benefit of the shareholder at the Transfer Agent. If
the new brokerage firm is willing to accommodate the shareholder in this manner,
the shareholder must request that he or she be issued certificates for his or
her shares, and then must turn the certificates over to the new firm for re-
registration as described in the preceding sentence.
AUTOMATIC INVESTMENT PLANS
A shareholder may make additions to an Investment Account at any time by
purchasing Class A shares (if an eligible Class A investor as described in the
Prospectus) or Class B, Class C or Class D shares at the applicable public
offering price either through the shareholder's securities dealer, or by mail
directly to the Transfer Agent, acting as agent for such securities dealers.
Voluntary accumulation also can be made through a service known as the Automatic
Investment Plan whereby the Fund is authorized through pre-authorized checks 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. Alternatively, investors who
maintain CMA(R) or CBA(R) accounts may arrange to have periodic investments made
in the Fund in their CMA(R) or CBA(R) account or in certain related accounts in
amounts of $100 or more through the CMA(R) or CBA(R) Automated Investment
Program.
AUTOMATIC REINVESTMENT OF DIVIDENDS AND CAPITAL GAINS DISTRIBUTIONS
Unless specific instructions are given as to the method of payment of
dividends and capital gains distributions, dividends and distributions will be
automatically reinvested in additional shares of the Fund. Such reinvestment
will be at the net asset value of shares of the Fund as of the close of business
on the monthly payment date for such dividends and distributions. Shareholders
may elect in writing to receive either their income dividends or capital gains
distributions, or both, in cash, in which event payment will be mailed on or
about the payment date.
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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.
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 15
minutes after the close of business on the NYSE (generally, 4:00 P.M., New York
time) on the 24th day of each month or the 24th day of the last month of each
quarter, whichever is applicable. If the NYSE is not open for business on such
date, the 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.
Alternatively, 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 CMA(R) or
CBA(R) Systematic Redemption Program. The minimum fixed dollar amount redeemable
is $25. The proceeds of systematic redemptions will be posted to the
shareholder's account three 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 Fund shares
are being purchased within the account pursuant to the Automatic
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Investment Program. For more information on the CMA(R) or CBA(R) Systematic
Redemption Program, eligible shareholders should contact their Financial
Consultant.
EXCHANGE PRIVILEGE
Shareholders of each class of shares of the Fund have an exchange privilege
with certain other MLAM-advised mutual funds. Under the Merrill Lynch Select
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 are exchangeable
with shares of the same class of other MLAM-advised mutual funds. For purposes
of computing the CDSC that may be payable upon a disposition of the shares
acquired in the exchange, the holding period for the previously owned shares of
the Fund is "tacked" to the holding period for the newly acquired shares of the
other Fund as more fully described below. Class A, Class B, Class C and Class D
shares also are exchangeable for shares of certain MLAM-advised money market
funds as follows: Class A shares may be exchanged for shares of Merrill Lynch
Ready Assets Trust, Merrill Lynch Retirement Reserves Money Fund (available only
for exchanges within certain retirement plans), Merrill Lynch U.S.A. Government
Reserves and Merrill Lynch U.S. Treasury Money Fund; Class B, Class C and Class
D shares may be exchanged for shares of Merrill Lynch Government Fund, Merrill
Lynch Institutional Fund, Merrill Lynch Institutional Tax-Exempt Fund and
Merrill Lynch Treasury Fund. Shares with a net asset value of at least $100 are
required to qualify for the exchange privilege, and any shares utilized in an
exchange must have been held by the shareholder for 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 certain money market funds with a reduced or without a sales charge.
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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 subject to the Fund's CDSC
schedule if such schedule is higher than the CDSC schedule relating to the new
Class B shares acquired through use of the exchange privilege. In addition,
Class B shares of the Fund acquired through use of the exchange privilege will
be subject to the Fund's CDSC schedule if such schedule is higher than the CDSC
schedule relating to the Class B shares of the fund from which the exchange has
been made. For purposes of computing the sales load that may be payable on a
disposition of the new Class B or Class C shares, the holding period for the
outstanding Class B or Class C shares is "tacked" to the holding period of the
new Class B or Class C shares. For example, an investor may exchange Class B
shares of the Fund for those of Merrill Lynch Special Value Fund, Inc. ("Special
Value Fund") after having held the Fund's Class B shares for two and a half
years. The 2% CDSC that generally would apply to a redemption would not apply to
the exchange. Three years later the investor may decide to redeem the Class B
shares of Special Value Fund and receive cash. There will be no CDSC due on this
redemption, since by "tacking" the two and a half year holding period of the
Fund's Class B shares to the three-year holding period for the Special Value
Fund Class B shares, the investor will be deemed to have held the new Class B
shares for more than five years.
Shareholders also may exchange shares of the Fund into shares of certain
money market funds advised by the Manager or its affiliates, but the period of
time that Class B or Class C shares are held in a money market 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 the Fund may, in turn,
be exchanged back into Class B or Class C shares, respectively, of any fund
offering such shares, in which event the holding period for Class B or Class C
shares of the newly-acquired fund will be aggregated with previous holding
periods for purposes of reducing the CDSC. Thus, for example, an investor may
exchange Class B shares of the Fund for shares of Merrill Lynch Institutional
Fund after having held the Fund Class B shares for two and a half years and
three years later decide to redeem the shares of Merrill Lynch Institutional
Fund for cash. At the time of this redemption, the 2% CDSC that would have been
due had the Class B shares of the Fund been redeemed for cash rather than
exchanged for shares of Merrill Lynch Institutional Fund will be payable. If,
instead of such redemption the shareholder exchanged such shares for Class B
shares of a fund which the shareholder continues to hold for an additional two
and a half years, any subsequent redemption would not incur a CDSC.
Before effecting an exchange, shareholders should obtain a currently
effective prospectus of the fund into which the exchange is to be made.
To exercise the exchange privilege, a shareholder should contact his or her
Merrill Lynch Financial Consultant, who will advise the Fund of the exchange.
Shareholders of the Fund, and shareholders of the other 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
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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, 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
are 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
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 rule permitting the issuance and sale
of multiple classes of shares) that is based on the gross income allocable to
Class A, Class B, Class C and Class D shareholders during the taxable year, or
such other method as the Internal Revenue Service may prescribe. To the extent
that the dividends distributed to the Fund's shareholders are derived from
interest income exempt from Federal income tax under Code Section 103(a) and are
properly designated as exempt-interest dividends, they will be excludable from a
shareholder's gross income for Federal income tax purposes. Exempt-interest
dividends are included, however, in determining the portion, if any, of a
person's social security and railroad retirement benefits subject to Federal
income taxes. Interest on indebtedness incurred or continued to purchase or
carry shares of a RIC
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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 portion of the Fund's exempt-interest dividends paid from interest
received by the Fund 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.
Distributions, if any, from an excess of net long-term capital gains over net
short-term capital losses derived from the sale of securities or from certain
transactions in futures or options ("capital gain dividends") are taxable as
long-term capital gains for Federal income tax purposes, regardless of the
length of time the shareholder has owned Fund shares, and for Colorado income
tax purposes, will be treated as capital gains which are taxed at ordinary
income rates. Distributions by the Fund, whether from exempt-interest income,
ordinary income or capital gains, will not be eligible for the dividends
received deduction allowed to corporations under the Code.
All or a portion of the Fund's gain from the sale or redemption of
tax-exempt obligations purchased at a market discount will be treated as
ordinary income rather than capital gain. This rule may increase the amount of
ordinary income dividends received by shareholders. Distributions in excess of
the Fund's earnings and profits will first reduce the adjusted tax basis of a
holder's shares and, after such adjusted tax basis is reduced to zero, will
constitute capital gains to such holder (assuming the shares are held as a
capital asset). Any loss upon the sale or exchange of Fund shares held for six
months or less will be disallowed to the extent of any exempt-interest dividends
received by the shareholder. In addition, any such loss that is not disallowed
under the rule stated above will be treated as long-term capital loss to the
extent of any capital gain dividends received by the shareholder. If the Fund
pays a dividend in January which was declared in the previous October, November
or December to shareholders of record on a specific date in one of such months,
then such
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dividend will be treated for tax purposes as being paid by the Fund and received
by its shareholders on December 31 of the year in which such dividend was
declared.
The Code subjects interest received on certain otherwise tax-exempt
securities to an alternative minimum tax. The alternative minimum tax applies to
interest received on certain "private activity bonds" issued after August 7,
1986. Private activity bonds are bonds which, although tax-exempt, are used for
purposes other than those generally performed by governmental units and which
benefit non-governmental entities (e.g., bonds used for industrial development
or housing purposes). Income received on such bonds is classified as an item of
"tax preference", which could subject certain investors in such bonds, including
shareholders of the Fund, to an alternative minimum tax. The Fund will purchase
such "private activity bonds" and the Trust will report to shareholders within
60 days after the Fund's taxable year-end the portion of the Fund's dividends
declared during the year which constitutes an item of tax preference for
alternative minimum tax purposes. The Code further provides that corporations
are subject to an alternative minimum tax based, in part, on certain differences
between taxable income as adjusted for other tax preferences and the
corporation's "adjusted current earnings", which more closely reflect a
corporation's economic income. Because an exempt-interest dividend paid by the
Fund will be included in adjusted current earnings, a corporate shareholder may
be required to pay alternative minimum tax on exempt-interest dividends paid by
the Fund.
The Fund may invest in high yield securities, as described in the
Prospectus. Furthermore, the Fund may also invest in instruments the return on
which includes nontraditional features such as indexed principal or interest
payments ("nontraditional instruments"). These instruments may be subject to
special tax rules under which the Fund may be required to accrue and distribute
income before amounts due under the obligations are paid. In addition, it is
possible that all or a portion of the interest payments on such high yield
securities and/or nontraditional instruments could be recharacterized as taxable
ordinary income.
No gain or loss will be recognized by Class B shareholders on the
conversion of their Class B shares into Class D shares. A shareholder's basis in
the Class D shares acquired will be same as such shareholder's basis in the
Class B shares converted, and the holding period of the acquired Class D shares
will include the holding period for the converted Class B shares.
If a shareholder exercises an exchange privilege within 90 days of
acquiring the shares, then the loss the shareholder can recognize on the
exchange will be reduced (or the gain increased) to the extent any sales charge
paid to the Fund on the exchanged shares reduces any sales charge 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.
Ordinary income dividends paid to shareholders who are nonresident aliens
or foreign entities will be subject to a 30% United States withholding tax under
existing provisions of the Code applicable to foreign individuals and entities
unless a reduced rate of withholding or a withholding exemption is provided
under applicable treaty law. Nonresident shareholders are urged to consult their
own tax advisors concerning the applicability of the United States withholding
tax.
36
<PAGE> 85
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 previously imposed 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 has
expired for tax years beginning after December 31, 1995, but may be reinstated
in the future. The Environmental Tax was imposed even if the corporation was not
required to pay an alternative minimum tax because the corporation's regular
income tax liability exceeded its minimum tax liability. The Code provides,
however, that a RIC, such as the Fund, would not be subject to the Environmental
Tax. However, exempt-interest dividends paid by the Fund that create alternative
minimum taxable income for corporate shareholders (as described above) could
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. The
mark-to-market rules outlined above, however, will not apply to certain
transactions entered into by the Fund solely to reduce the risk of changes in
price or interest rates with respect to its investments.
Code Section 1092, which applies to certain "straddles", may affect the
taxation of the Fund's sales of securities and transactions in financial futures
contracts and related options. Under Section 1092, the Fund may be required to
postpone recognition for tax purposes of losses incurred in certain sales of
securities and certain closing transactions in financial futures contracts or
the related options.
37
<PAGE> 86
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, judicial 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, foreign state or
local taxes.
PERFORMANCE DATA
From time to time the Fund may include its average annual total return and
other total return data, as well as yield and tax-equivalent yield, in
advertisements or information furnished to present or prospective shareholders.
From time to time, the Fund may include the Fund's Morningstar risk-adjusted
performance ratings in advertisements or supplemental sales literature. Total
return, 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, yield and tax-equivalent yield are determined
separately for Class A, Class B, Class C and Class D shares in accordance with
formulas specified by the Commission.
Average annual total return quotations for the specified periods are
computed by finding the average annual compounded rates of return (based on net
investment income and any realized and unrealized capital gains or losses on
portfolio investments over such periods) that would equate the initial amount
invested to the redeemable value of such investment at the end of each period.
Average annual total return is computed assuming all dividends and distributions
are reinvested and taking into account all applicable recurring and nonrecurring
expenses, including the maximum sales charge in the case of Class A and Class D
shares and the CDSC that would be applicable to a complete redemption of the
investment at the end of the specified period in the case of the Class B and
Class C shares.
The Fund also may quote annual, average annual and annualized total return
and aggregate total return performance data, both as a percentage and as a
dollar amount based on a hypothetical $1,000 investment, for various periods
other than those noted below. Such data will be computed as described above,
except that (1) as required by the periods of the quotations, actual annual,
annualized or aggregate data, rather than average annual data, may be quoted and
(2) the maximum applicable sales charges will not be included with respect to
annual or annualized rates of return calculations. Aside from the impact on the
performance data calculations of including or excluding the maximum applicable
sales charges, actual annual or annualized total return data generally will be
lower than average annual total return data since the average rates of return
reflect compounding of return; aggregate total return data generally will be
higher than average annual total return data since the aggregate rates of return
reflect compounding over a longer period of time.
38
<PAGE> 87
Set forth below is the total return, yield and tax-equivalent yield
information for Class A, Class B, Class C and Class D shares of the Fund for the
periods indicated.
<TABLE>
<CAPTION>
CLASS A SHARES CLASS B SHARES
-------------------------------------- --------------------------------------
REDEEMABLE REDEEMABLE
EXPRESSED VALUE OF A EXPRESSED VALUE OF A
AS A PERCENTAGE HYPOTHETICAL AS A PERCENTAGE HYPOTHETICAL
BASED ON A $1,000 INVESTMENT BASED ON A $1,000 INVESTMENT
HYPOTHETICAL AT THE END HYPOTHETICAL AT THE END
$1,000 INVESTMENT OF THE PERIOD $1,000 INVESTMENT OF THE PERIOD
------------------ ----------------- ------------------ -----------------
<S> <C> <C> <C> <C>
AVERAGE ANNUAL TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGE)
<CAPTION>
<S> <C> <C> <C> <C>
One year ended July 31, 1996................. 1.60% $1,016.00 1.29% $1,012.90
Inception (November 26, 1993) to July 31,
1996....................................... 1.78% $1,048.50 2.14% $1,058.40
ANNUAL TOTAL RETURN
(EXCLUDING MAXIMUM APPLICABLE SALES CHARGE)
Year ended July 31, 1996..................... 5.83% $1,058.30 5.29% $1,052.90
Year ended July 31, 1995..................... 6.20% $1,062.00 5.66% $1,056.60
Inception (November 26, 1993) to July 31,
1994....................................... (2.83)% $ 971.70 (3.16)% $ 968.40
AGGREGATE TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGE)
Inception (November 26, 1993) to July 31,
1996....................................... 4.85% $1,048.50 5.84% $1,058.40
YIELD
30 days ended July 31, 1996.................. 4.91% 4.61%
TAX-EQUIVALENT YIELD*
30 days ended July 31, 1996.................. 6.82% 6.40%
</TABLE>
- ---------------
* Based on a Federal income tax rate of 28%.
<TABLE>
<CAPTION>
CLASS C SHARES CLASS D SHARES
-------------------------------------- --------------------------------------
REDEEMABLE REDEEMABLE
EXPRESSED VALUE OF A EXPRESSED VALUE OF A
AS A PERCENTAGE HYPOTHETICAL AS A PERCENTAGE HYPOTHETICAL
BASED ON A $1,000 INVESTMENT BASED ON A $1,000 INVESTMENT
HYPOTHETICAL AT THE END HYPOTHETICAL AT THE END
$1,000 INVESTMENT OF THE PERIOD $1,000 INVESTMENT OF THE PERIOD
------------------ ----------------- ------------------ -----------------
<S> <C> <C> <C> <C>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGE)
<S> <C> <C> <C> <C>
One year ended July 31, 1996................. 4.29% $1,042.90 1.60% $1,016.00
Inception (October 21, 1994) to July 31,
1996....................................... 7.64% $1,139.90 5.76% $1,104.80
ANNUAL TOTAL RETURN
(EXCLUDING MAXIMUM APPLICABLE SALES CHARGE)
Year ended July 31, 1996..................... 5.29% $1,052.90 5.84% $1,058.40
Inception (October 21, 1994) to July 31,
1995....................................... 8.27% $1,082.70 8.74% $1,087.40
AGGREGATE TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGE)
Inception (October 21, 1994) to July 31,
1996....................................... 13.99% $1,139.90 10.48% $1,104.80
YIELD
30 days ended July 31, 1996.................. 4.50% 4.81%
TAX-EQUIVALENT YIELD*
30 days ended July 31, 1996.................. 6.25% 6.68%
</TABLE>
- ---------------
* Based on a Federal income tax rate of 28%.
In order to reflect the reduced sales charges in the case of Class A or
Class D shares or the waiver of the CDSC in the case of Class B or Class C
shares applicable to certain investors, as described under "Purchase of Shares"
and "Redemption of Shares", respectively, the total return data quoted by the
Fund in advertisements directed to such investors may take into account the
reduced, and not the maximum, sales charge or may take into account the CDSC and
therefore may reflect greater total return since, due to the reduced sales
charge or the waiver of sales charges, a lower amount of expenses is deducted.
39
<PAGE> 88
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 Arkansas 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 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
expenditures. The Board of Trustees may classify and reclassify the shares of
any Series into additional classes at a future date.
All shares of the Trust have equal voting rights, except that only shares
of the respective Series are entitled to vote on matters concerning only that
Series and, as noted above, Class B, Class C and Class D shares 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 are 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
40
<PAGE> 89
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
were paid by the Fund and are being amortized over a period not exceeding five
years. The proceeds realized by the Manager (or any subsequent 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, Class
B, Class C and Class D shares of the Fund based on the value of the Fund's net
assets and number of shares outstanding on July 31, 1996 is calculated as set
forth below.
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C CLASS D
---------- ----------- -------- ----------
<S> <C> <C> <C> <C>
Net Assets...................................... $8,777,297 $18,407,044 $448,695 $2,173,415
========= ========== ======== =========
Number of Shares Outstanding.................... 928,601 1,947,239 47,455 230,065
========= ========== ======== =========
Net Asset Value Per Share (net assets divided by
number of shares outstanding)................. $ 9.45 $ 9.45 $ 9.46 $ 9.45
Sales Charge (for Class A and Class D shares:
4.00% of offering price; 4.17% of net asset
value per share)*............................. .39 ** ** .39
---------- ----------- -------- ----------
Offering Price.................................. $ 9.84 $ 9.45 $ 9.46 $ 9.84
========= ========== ======== =========
</TABLE>
- ---------------
* Rounded to the nearest one-hundredth percent; assumes maximum sales charge is
applicable.
** Class B and Class C shares are not subject to an initial sales charge but may
be subject to a CDSC on redemption of shares. See "Purchase of
Shares--Deferred Sales Charge Alternatives--Class B and Class C Shares" in
the Prospectus and "Redemption of Shares--Deferred Sales Charges--Class B and
Class C Shares" herein.
INDEPENDENT AUDITORS
Deloitte & Touche LLP, 117 Campus Drive, Princeton, New Jersey 08540, has
been selected as the independent auditors of the Fund. The independent auditors
are responsible for auditing the annual financial statements of the Fund.
CUSTODIAN
State Street Bank and Trust Company, 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.
41
<PAGE> 90
TRANSFER AGENT
Merrill Lynch Financial Data Services, Inc., 4800 Deer Lake Drive East,
Jacksonville, Florida 32246-6484, acts as the Trust's transfer agent. The
Transfer Agent is responsible for the issuance, transfer and redemption of
shares and the opening, maintenance and servicing of shareholder accounts. See
"Management of the Trust--Transfer Agency Services" in the Prospectus.
LEGAL COUNSEL
Brown & Wood LLP, One World Trade Center, New York, New York 10048-0557, is
counsel for the Trust.
REPORTS TO SHAREHOLDERS
The fiscal year of the Fund ends on 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 Commission, Washington,
D.C., under the Securities Act and the 1940 Act, to which reference is hereby
made.
The Declaration of Trust establishing the Trust dated 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, no persons or entities owned beneficially 5%
or more of the Fund's outstanding shares on October 1, 1996.
42
<PAGE> 91
APPENDIX I
ECONOMIC AND FINANCIAL CONDITIONS IN COLORADO
The following information is a brief summary of factors affecting the
economy of the State and does not purport to be a complete description of such
factors. Other factors will affect issuers. The summary is based primarily upon
one or more official publications of the State of Colorado and other sources
that are generally available to investors; however, it has not been updated nor
will it be updated during the year. The Trust has not independently verified the
information.
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 1996, June 20, 1996 (the "Economic Report"), over 50% of non-agricultural
employment in Colorado in 1995 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 next largest employment
sectors in the State, representing approximately 16.5% and 10.4%, respectively,
of non-agricultural employment in the State in 1995. The Office of Planning and
Budgeting projects similar concentrations for 1996 and 1997.
According to the Economic Report, the unemployment rate in Colorado
remained unchanged from an average of 4.2% from calendar years 1994 to 1995.
Colorado continued to surpass the job growth rate of the U.S. in 1995, with a
4.7% growth rate for Colorado in calendar year 1995, as compared to 2.3% for the
nation as a whole. However, the rate of job growth in Colorado is projected to
be lower in 1996 than the 1995 rate as a result of layoffs at various companies.
Personal income rose in Colorado during 1994 and 1995. Retail sales
increased by 5.1% in 1995.
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 was set
at 1% for 1993 and 2% for 1994, and is set at 3% for 1995 and later years.
General Fund appropriations also are 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 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
43
<PAGE> 92
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 the
Economic Report estimates, the 1996 fiscal year ending 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
restricts 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 have required judicial
interpretation. Among other provisions, the Amendment requires voter approval
prior to tax increases, the imposition of a new tax, 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 1995 and later years is 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.
Litigation concerning several issues relating to the Amendment has been
brought in the Colorado courts. The litigation deals with three principal
issues: (i) whether Districts can increase mill levies to pay debt service on
general obligation bonds without obtaining voter approval; (ii) whether a
multi-year lease-purchase agreement subject to annual appropriation 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 general obligation
bonds issued after the effective date of the Amendment; in June, 1995, the
Colorado Supreme Court validated mill levy increases to pay general obligation
bonds issued prior to the Amendment. In late 1994, the Colorado Court of Appeals
held that multi-year lease-purchase agreements subject to annual appropriation
do not require voter approval and that decision was not appealed. Finally, in
May, 1995, the Colorado Supreme Court ruled that entities with the power to levy
taxes may not themselves be "enterprises" for purposes of the Amendment;
however, the Court did not address the issue of how valid enterprises may be
created. Many Colorado local governments interpret this decision to mean that a
government with taxing power cannot be an enterprise but that a business
activity (such as a utility) owned by such a government can be. Additional
litigation in the "enterprise" arena may be filed to clarify these issues.
44
<PAGE> 93
Litigation is currently pending before the Colorado Supreme Court as to whether
voters can authorize a government to keep and spend all revenues received in
excess of the spending limits. Other aspects of the spending limits are being
litigated in district court actions.
According to the Economic Report, for fiscal year 1994, general fund
revenues (adjusted for cash funds that are exempt from the Amendment) were
$3,681.4 million and program revenues (cash funds) were $1,703.7 million, for
revenues totaling $5,385.1 million. During calendar year 1993, population and
inflation grew at rates of 4.2% and 2.9%, respectively, for a combined total
limit of 7.1%. Accordingly, under the Amendment, increases in State revenues
during the 1995 fiscal year could not exceed $5,767.5 million and the actual
1995 general fund and program revenues of $5,757.3 million were under the limit.
The limitation for fiscal year 1996 is 7.0% over revenues during the 1995 fiscal
year; accordingly, 1996 fiscal year revenues cannot exceed $6,160.3 million.
Fiscal year 1996 revenues are estimated to be $6,087.2 million which is $73.2
million under the limitation. The limitation for the 1997 fiscal year is
currently projected to be 6.6% over 1996 which translates to a revenue limit of
approximately $6,488.9 million for fiscal year 1997.
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
general obligation debt.
STATE FINANCES
On a generally accepted accounting principles (GAAP) basis, the State has
had unrestricted General Fund balances at June 30 of between $16 million and
$400 million for the years 1991 through 1995. The Economic Report projects the
fiscal year 1996 unrestricted General Fund ending balance to be approximately
$315.2 million.
For fiscal year 1995, individual income taxes generated the largest portion
of the State's General Fund gross receipts, representing approximately 52.7% of
such receipts. Sales, use and other excise taxes represented the second largest
source at approximately 32.9% of fiscal year 1995 gross receipts, while
corporate income taxes represented about 4.8% of fiscal year 1995 gross
receipts. For fiscal year 1996, General Fund revenues of approximately $4,239.9
million and appropriations of approximately $4,413.2 million are projected
resulting in a projected General Fund balance of approximately $315.2 million.
The percentages of General Fund revenue generated by type of tax for fiscal year
1996 are not expected to be significantly different from fiscal year 1995
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.
45
<PAGE> 94
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.
46
<PAGE> 95
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 RATING GROUP ("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.
47
<PAGE> 96
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 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, Debt rated "BB", "B", "CCC", "CC" and "C" is regarded, on balance, as
B, predominately speculative with respect to capacity to pay interest and
CCC, repay principal in accordance with the terms of the obligations. "BB"
CC indicates the lowest degree of speculation and "CC" the highest degree of
and C 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.
48
<PAGE> 97
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 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.
49
<PAGE> 98
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).
-- 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 issuer 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 Standard & Poor'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.
50
<PAGE> 99
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.
Fitch ratings are based on information obtained from issuers, other
obligors, underwriters, their experts, and other sources Fitch believes to be
reliable. Fitch does not audit or verify the truth or accuracy of such
information. Ratings may be changed, suspended, or withdrawn as a result of
changes in, or the unavailability of, information or for any other reasons.
AAA Bonds considered to be investment grade and of the highest credit
quality. The obligor has an exceptionally strong ability to pay interest
and repay principal, which is unlikely to be affected by reasonably
foreseeable events.
AA Bonds considered to be investment grade and of very high credit quality.
The obligor's ability to pay interest and repay principal is very strong,
although not quite as strong as bonds rated "AAA". Because bonds rated in
the "AAA" and "AA" categories are not significantly vulnerable to
foreseeable future developments, short-term debt of these issuers is
generally rated "F-1+".
A Bonds considered to be investment grade and of high credit quality. The
obligor's ability to pay interest and repay principal is considered to be
strong, but may be more vulnerable to adverse changes in economic
conditions and circumstances than bonds with higher ratings.
BBB Bonds considered to be investment grade and of satisfactory credit
quality. The obligor's ability to pay interest and repay principal is
considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have adverse impact on these
bonds, and therefore, impair timely payment. The likelihood that the
ratings of these bonds will fall below investment grade is higher than
for bonds with higher ratings.
Plus (+) or Minus (-): Plus and minus signs are used with a rating symbol
to indicate the relative position of a credit within the rating category. Plus
and minus signs, however, are not used in the "AAA" category.
Credit Trend Indicator: Credit trend indicators show whether credit
fundamentals are improving, stable, declining, or uncertain, as follows:
Improving up arrow
Stable left and right arrow
Declining down arrow
Uncertain up and down arrow
51
<PAGE> 100
Credit trend indicators are not predictions that any rating change will
occur, and have a longer-term time frame than issues placed on FitchAlert.
NR Indicates that Fitch does not rate the specific issue.
Conditional A conditional rating is premised on the successful completion of a
project or the occurrence of a specific event.
Suspended A rating is suspended when Fitch deems the amount of information
available from the issuer to be inadequate for rating purposes.
Withdrawn A rating will be withdrawn when an issue matures or is called or
refinanced and, at Fitch's discretion, when an issuer fails to
furnish proper and timely information.
FitchAlert Ratings are placed on FitchAlert to notify investors of an
occurrence that is likely to result in a rating change and the
likely direction of such change. These are designated as
"Positive," indicating a potential upgrade, "Negative," for
potential downgrade, or "Evolving," where ratings may be raised or
lowered. FitchAlert is relatively short-term, and should be
resolved within 12 months.
DESCRIPTION OF FITCH SPECULATIVE GRADE BOND RATINGS
Fitch speculative grade bond ratings provide a guide to investors in
determining the credit risk associated with a particular security. The ratings
("BB" to "C") represent Fitch's assessment of the likelihood of timely payment
of principal and interest in accordance with the terms of obligation for bond
issues not in default. For defaulted bonds, the rating ("DDD" to "D") is an
assessment of the ultimate recovery value through reorganization or liquidation.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the current and prospective
financial condition and operating performance of the issuer and any guarantor,
as well as the economic and political environment that might affect the issuer's
future financial strength.
Bonds that have the same rating are of similar but not necessarily
identical credit quality since rating categories cannot fully reflect the
differences in degrees of credit risk.
BB Bonds are considered speculative. The obligor's ability to pay
interest and repay principal may be affected over time by
adverse economic changes. However, business and financial
alternatives can be identified which could assist the obligor
in satisfying its debt service requirements.
B Bonds are considered highly speculative. While bonds in this
class are currently meeting debt service requirements, the
probability of continued timely payment of principal and
interest reflects the obligor's limited margin of safety and
the need for reasonable business and economic activity
throughout the life of the issue.
CCC Bonds have certain identifiable characteristics which, if not
remedied, may lead to default. The ability to meet obligations
requires an advantageous business and economic environment.
52
<PAGE> 101
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.
Plus (+) or Minus (-): Plus and minus signs are used with a rating symbol
to indicate the relative position of a credit within the rating category. Plus
and minus signs, however, are not used in the "DDD", "DD", or "D" categories.
DESCRIPTION OF FITCH INVESTMENT GRADE SHORT-TERM RATINGS
Fitch's short-term ratings apply to debt obligations that are payable on
demand or have original maturities of generally up to three years, including
commercial paper, certificates of deposit, medium-term notes, and municipal and
investment notes.
The short-term rating places greater emphasis than a long-term rating on
the existence of liquidity necessary to meet the issuer's obligations in a
timely manner.
Fitch short-term ratings are as follows:
F-1+ Exceptionally Strong Credit Quality. Issues assigned this rating are
regarded as having the strongest degree of assurance for timely payment.
F-1 Very Strong Credit Quality. Issues assigned this rating reflect an
assurance of timely payment only slightly less in degree than issues
rated "F-1+".
F-2 Good Credit Quality. Issues assigned this rating have a satisfactory
degree of assurance for timely payment, but the margin of safety is not
as great as for issues assigned "F-1+" and "F-1" ratings.
F-3 Fair Credit Quality. Issues assigned this rating have characteristics
suggesting that the degree of assurance for timely payment is adequate,
however, near-term adverse changes could cause these securities to be
rated below investment grade.
F-S Weak Credit Quality. Issues assigned this rating have characteristics
suggesting a minimal degree of assurance for timely payment and are
vulnerable to near-term adverse changes in financial and economic
conditions.
D Default. Issues assigned this rating are in actual or imminent payment
default.
LOC The symbol "LOC" indicates that the rating is based on a letter of credit
issued by a commercial bank.
INS The symbol "INS" indicates that the rating is based on an insurance
policy or financial guaranty issued by an insurance company.
53
<PAGE> 102
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, 1996, the
related statements of operations for the year then ended and changes in net
assets for each of the years in the two-year period then ended, and the
financial highlights for each of the years in the
two-year period then ended and 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 audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and the financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned at July 31,
1996 by correspondence with the custodian and broker. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of Merrill Lynch
Colorado Municipal Bond Fund of Merrill Lynch Multi-State Municipal Series Trust
as of July 31, 1996, the results of its operations, the changes in its net
assets, and the financial highlights for the respective stated periods in
conformity with generally accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
September 6, 1996
54
<PAGE> 103
<TABLE>
SCHEDULE OF INVESTMENTS (in Thousands)
<CAPTION>
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note 1a)
Colorado--97.8%
<S> <S> <C> <S> <C>
AAA Aaa $1,000 Adams and Arapahoe Counties, Colorado, Joint School District Number 28J
(Aurora), UT, Series C, 5.75% due 12/01/2006 (b) $ 1,048
AAA Aaa 1,000 Alamosa and Conejos Counties, Colorado, School District Number 11J, UT, 5%
due 12/01/2015 (b)(f) 923
AAA Aaa 1,000 Arapahoe County, Colorado, Capital Improvement Trust Fund, Highway Revenue
Bonds (Vehicle Registration), Series A, 6.15% due 8/31/2026 (b) 1,035
AA Aa 1,400 Arapahoe County, Colorado, School District Number 5 (Cherry Creek), UT,
Series B, 5.15% due 12/15/2015 1,315
AAA Aaa 1,175 Arvada, Colorado, Sales and Use Tax Revenue Refunding and Improvement Bonds,
6.25% due 12/01/2017 (d) 1,213
AAA Aaa 250 Auraria, Colorado, Higher Education Center Revenue Refunding Bonds (Student
Fee), 5.30% due 5/01/2021 (c) 231
AAA Aaa 500 Bayfield County, Colorado, Joint School District Number 10, Building Revenue
Bonds, UT, Series R, 6.65% due 6/01/2015 (b)(f) 542
Colorado Health Facilities Authority Revenue Bonds:
A1+ VMIG1++ 100 (Boulder Community Hospital Project), VRDN, Series C, 3.55% due
10/01/2014 (a)(b) 100
AAA Aaa 1,000 Refunding (Boulder Community Hospital), Series B, 5.875%
due 10/01/2023 (b)(h) 999
NR* Aaa 500 (Swedish Medical Center Project), Series A, 6.80% due 1/01/2003 (g) 561
NR* Aa 870 Colorado Housing Financing Authority, Refunding Bonds, Series D-II, 8.125%
due 6/01/2025 986
NR* Aa 770 Colorado Housing Financing Authority, S/F Program, AMT, Senior Series F,
8.625% due 6/01/2025 (e) 880
A+ A1 800 Colorado Springs, Colorado, Revenue Bonds (Colorado College Project), 5.125%
due 6/01/2016 742
Colorado Springs, Colorado, Utilities Revenue Bonds, Series A:
AA Aa 1,125 6.10% due 11/15/2024 1,146
AA Aa 500 Refunding, 6.50% due 11/15/2015 531
</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)
S/F Single-Family
UT Unlimited Tax
VRDN Variable Rate Demand Notes
55
<PAGE> 104
<TABLE>
SCHEDULE OF INVESTMENTS (concluded) (in Thousands)
<CAPTION>
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note 1a)
Colorado (concluded)
<S> <S> <C> <S> <C>
AA Aa $1,000 Colorado Water Resource Power Development Authority, Clean Water Revenue
Bonds, Series A, 6.30% due 9/01/2014 $ 1,042
BBB Baa 500 Denver, Colorado, City and County Airport Revenue Bonds, AMT, Series D,
7.75% due 11/15/2013 588
Denver, Colorado, City and County School District Number 1, Refunding Bonds,
A+ A 1,000 Series A: 6.50% due 6/01/2010 1,107
A+ A 2,000 6.50% due 12/01/2010 2,219
AAA Aaa 3,250 Douglas County, Colorado, School District Number 1 Revenue Bonds (Douglas
and Elbert Counties Improvement Project), Series A, 6.50% due 12/15/2016 (b) 3,488
NR* Aa1 1,000 El Paso County, Colorado, School District Number 12 Revenue Bonds
(Cheyenne Mountain), UT, 6.65% due 9/15/2014 (f) 1,087
AAA Aaa 1,000 El Paso County, Colorado, School District Number 49 Revenue Bonds (Falcon),
UT, 6.50% due 12/01/2015 (b) 1,088
AAA Aaa 1,000 Garfield, Pitkin and Eagle Counties, Colorado, School District Number 1
Revenue Bonds (Roaring Fork), UT, 6.60% due 6/15/2004 (b)(g) 1,120
AAA Aaa 1,500 La Plata County, Colorado, School District Number 9 Revenue Bonds
(R Durango), UT, 6.60% due 11/01/2017 (d) 1,612
AAA Aaa 500 Left Hand Water District, Colorado, Water Revenue Bonds, 5.70%
due 11/15/2015 (b)(f) 501
NR* A 750 Pitkin County, Colorado, Refunding and Improvement Bonds, UT, 6.875%
due 12/01/2024 (f) 809
AAA Aaa 1,000 Poudre Valley, Colorado, District Hospital Revenue Bonds, 6.625%
due 12/01/2001 (c)(g) 1,099
AAA Aaa 1,000 Summit County, Colorado, School District Number 1 Revenue Bonds (Summit),
UT, 6.70% due 12/01/2004 (d)(g) 1,124
Total Investments (Cost--$28,032)--97.8% 29,136
Variation Margin on Financial Futures Contracts**--(0.1%) (21)
Other Assets Less Liabilities--2.3% 691
-------
Net Assets--100.0% $29,806
=======
<FN>
(a)The interest rate is subject to change periodically based
upon prevailing market rates. The interest rate
shown is the rate in effect at July 31, 1996.
(b)MBIA Insured.
(c)AMBAC Insured.
(d)FGIC Insured.
(e)FHA Insured.
(f)Bank Qualified.
(g)Prerefunded.
(h)All or portion of security held as collateral in connection with
open financial futures contracts.
++Highest short-term rating by Moody's Investors Service, Inc.
*Not Rated.
**Financial futures contracts sold as of July 31, 1996 (in
thousands) were as follows:
Number of Expiration Value
Contracts Issue Date (Notes 1a & 1b)
30 US Treasury Bonds September 1996 $(3,274)
Total Financial Futures Contracts Sold
(Total Contract Price--$3,213) $(3,274)
========
</TABLE>
Ratings of issues shown have not been audited by Deloitte & Touche LLP.
See Notes to Financial Statements.
56
<PAGE> 105
FINANCIAL INFORMATION
<TABLE>
Statement of Assets and Liabilities as of July 31, 1996
<S> <S> <C> <C>
Assets: Investments, at value (identified cost--$28,031,771) (Note 1a) $ 29,136,352
Cash 95,738
Receivables:
Securities sold $ 505,711
Interest 349,396
Beneficial interest sold 7,995 863,102
------------
Deferred organization expenses (Note 1e) 14,815
Prepaid registration fees and other assets (Note 1e) 26,250
------------
Total assets 30,136,257
------------
Liabilities: Payables:
Beneficial interest redeemed 186,242
Dividends to shareholders (Note 1f) 36,338
Variation margin (Note 1b) 20,625
Distributor (Note 2) 8,228
Investment adviser (Note 2) 2,524 253,957
------------
Accrued expenses 75,849
------------
Total liabilities 329,806
------------
Net Assets: Net assets $ 29,806,451
------------
Net Assets Class A Shares of beneficial interest, $.10 par value, unlimited
Consist of: number of shares authorized $ 92,860
Class B Shares of beneficial interest, $.10 par value, unlimited
number of shares authorized 194,724
Class C Shares of beneficial interest, $.10 par value, unlimited
number of shares authorized 4,746
Class D Shares of beneficial interest, $.10 par value, unlimited
number of shares authorized 23,006
Paid-in capital in excess of par 30,582,291
Accumulated realized capital losses on investments--net (Note 5) (2,134,820)
Unrealized appreciation on investments--net 1,043,644
------------
Net assets $ 29,806,451
============
Net Asset Value: Class A--Based on net assets of $8,777,297 and 928,601 shares
of beneficial interest outstanding $ 9.45
============
Class B--Based on net assets of $18,407,044 and 1,947,239 shares
of beneficial interest outstanding $ 9.45
============
Class C--Based on net assets of $448,695 and 47,455 shares
of beneficial interest outstanding $ 9.46
============
Class D--Based on net assets of $2,173,415 and 230,065 shares
of beneficial interest outstanding $ 9.45
============
See Notes to Financial Statements.
</TABLE>
57
<PAGE> 106
FINANCIAL INFORMATION (continued)
<TABLE>
Statement of Operations
<CAPTION>
For the Year Ended
July 31, 1996
<S> <S> <C> <C>
Investment Income Interest and amortization of premium and discount earned $ 1,703,868
(Note 1d):
Expenses: Investment advisory fees (Note 2) $ 163,546
Account maintenance and distribution fees--Class B (Note 2) 91,012
Professional fees 53,568
Accounting services (Note 2) 38,579
Printing and shareholder reports 32,247
Registration fees (Note 1e) 15,430
Transfer agent fees--Class B (Note 2) 9,451
Amortization of organization expenses (Note 1e) 6,402
Pricing fees 4,744
Transfer agent fees--Class A (Note 2) 3,859
Custodian fees 2,793
Account maintenance and distribution fees--Class C (Note 2) 2,722
Account maintenance fees--Class D (Note 2) 1,686
Trustees' fees and expenses 1,445
Transfer agent fees--Class D (Note 2) 681
Transfer agent fees--Class C (Note 2) 250
Other 1,739
------------
Total expenses before reimbursement 430,154
Reimbursement of expenses (Note 2) (191,809)
------------
Total expenses after reimbursement 238,345
------------
Investment income--net 1,465,523
------------
Realized & Realized loss on investments--net (170,906)
Unrealized Change in unrealized appreciation on investments--net 281,822
Gain (Loss) on ------------
Investments--Net Net Increase in Net Assets Resulting from Operations $ 1,576,439
(Notes 1b, 1d & 3): ============
See Notes to Financial Statements.
</TABLE>
58
<PAGE> 107
FINANCIAL INFORMATION (continued)
<TABLE>
Statements of Changes in Net Assets
<CAPTION>
For the Year Ended July 31,
Increase (Decrease) in Net Assets: 1996 1995
<S> <S> <C> <C>
Operations: Investment income--net $ 1,465,523 $ 1,363,938
Realized loss on investments--net (170,906) (1,161,781)
Change in unrealized appreciation on investments--net 281,822 1,501,199
------------ ------------
Net increase in net assets resulting from operations 1,576,439 1,703,356
------------ ------------
Dividends to Investment income--net:
Shareholders Class A (494,015) (524,727)
(Note 1f): Class B (863,714) (795,258)
Class C (21,014) (1,891)
Class D (86,780) (42,062)
------------ ------------
Net decrease in net assets resulting from dividends to
shareholders (1,465,523) (1,363,938)
------------ ------------
Beneficial Net increase in net assets derived from beneficial interest
Interest transactions 1,398,401 2,801,169
Transactions ------------ ------------
(Note 4):
Net Assets: Total increase in net assets 1,509,317 3,140,587
Beginning of year 28,297,134 25,156,547
------------ ------------
End of year $ 29,806,451 $ 28,297,134
============ ============
See Notes to Financial Statements.
</TABLE>
59
<PAGE> 108
FINANCIAL INFORMATION (concluded)
<TABLE>
Financial Highlights
<CAPTION>
Class A Class B
For the For the
Period Period
The following per share data and ratios have been derived Nov. 26, Nov. 26,
from information provided in the financial statements. For the Year Ended 1993++ to For the Year Ended 1993++ to
July 31, July 31, July 31, July 31,
Increase (Decrease) in Net Asset Value: 1996 1995 1994 1996 1995 1994
<S> <S> <C> <C> <C> <C> <C> <C>
Per Share Net asset value, beginning of
Operating period $ 9.41 $ 9.38 $ 10.00 $ 9.41 $ 9.38 $ 10.00
Performance: --------- --------- --------- --------- --------- ---------
Investment income--net .50 .52 .34 .45 .48 .31
Realized and unrealized gain
(loss) on investments--net .04 .03 (.62) .04 .03 (.62)
--------- --------- --------- --------- --------- ---------
Total from investment operations .54 .55 (.28) .49 .51 (.31)
--------- --------- --------- --------- --------- ---------
Less dividends from investment
income--net (.50) (.52) (.34) (.45) (.48) (.31)
--------- --------- --------- --------- --------- ---------
Net asset value, end of period $ 9.45 $ 9.41 $ 9.38 $ 9.45 $ 9.41 $ 9.38
========= ========= ========= ========= ========= =========
Total Investment Based on net asset value per share 5.83% 6.20% (2.83%)+++ 5.29% 5.66% (3.16%)+++
Return:** ========= ========= ========= ========= ========= =========
Ratios to Expenses, net of reimbursement .47% .24% .03%* .98% .76% .54%*
Average ========= ========= ========= ========= ========= =========
Net Assets: Expenses 1.12% 1.40% 1.52%* 1.62% 1.93% 2.03%*
========= ========= ========= ========= ========= =========
Investment income--net 5.24% 5.71% 5.36%* 4.73% 5.20% 4.73%*
========= ========= ========= ========= ========= =========
Supplemental Net assets, end of period
Data: (in thousands) $ 8,777 $ 9,755 $ 10,634 $ 18,407 $ 17,116 $ 14,522
========= ========= ========= ========= ========= =========
Portfolio turnover 49.13% 73.86% 82.71% 49.13% 73.86% 82.71%
========= ========= ========= ========= ========= =========
<CAPTION>
Class C Class D
For the For the
For the Period For the Period
The following per share data and ratios have been derived Year Oct. 21, Year Oct. 21,
from information provided in the financial statements. Ended 1994++ to Ended 1994++ to
July 31, July 31, July 31, July 31,
Increase (Decrease) in Net Asset Value: 1996 1995 1996 1995
<S> <S> <C> <C> <C> <C>
Per Share Net asset value, beginning of period $ 9.41 $ 9.03 $ 9.40 $ 9.03
Operating -------- -------- -------- --------
Performance: Investment income--net .44 .35 .49 .40
Realized and unrealized gain on investments--net .05 .38 .05 .37
-------- -------- -------- --------
Total from investment operations .49 .73 .54 .77
-------- -------- -------- --------
Less dividends from investment income--net (.44) (.35) (.49) (.40)
-------- -------- -------- --------
Net asset value, end of period $ 9.46 $ 9.41 $ 9.45 $ 9.40
======== ======== ======== ========
Total Investment Based on net asset value per share 5.29% 8.27%+++ 5.84% 8.74%+++
Return:** ======== ======== ======== ========
Ratios to Expenses, net of reimbursement 1.09% .95%* .58% .38%*
Average ======== ======== ======== ========
Net Assets: Expenses 1.72% 2.04%* 1.21% 1.49%*
======== ======== ======== ========
Investment income--net 4.62% 5.01%* 5.13% 5.66%*
======== ======== ======== ========
Supplemental Net assets, end of period (in thousands) $ 449 $ 162 $ 2,173 $ 1,265
Data: ======== ======== ======== ========
Portfolio turnover 49.13% 73.86% 49.13% 73.86%
======== ======== ======== ========
<FN>
*Annualized.
**Total investment returns exclude the effects
of sales loads.
++Commencement of Operations.
+++Aggregate total investment return.
See Notes to Financial Statements.
</TABLE>
60
<PAGE> 109
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. The Fund offers
four classes of shares under the Merrill Lynch Select Pricing SM
System. Shares of Class A and Class D are sold with a front-end
sales charge. Shares of Class B and Class C may be subject to a
contingent deferred sales charge. All classes of shares have
identical voting, dividend, liquidation and other rights and the
same terms and conditions, except that Class B, Class C and Class D
Shares bear certain expenses related to the account maintenance of
such shares, and Class B and Class C Shares also bear certain
expenses related to the distribution of such shares. Each class has
exclusive voting rights with respect to matters relating to its
account maintenance and distribution expenditures. The following is
a summary of significant accounting policies followed by the Fund.
(a) Valuation of investments--Municipal bonds and other portfolio
securities in which the Fund invests are traded primarily in the
over-the-counter municipal bond and money markets and are valued at
the last available bid price in the over-the-counter market or on
the basis of yield equivalents as obtained from one or more dealers
that make markets in the securities. Financial futures contracts and
options thereon, which are traded on exchanges, are valued at their
settlement prices as of the close of such exchanges. Short-term
investments with remaining maturities of sixty days or less are
valued at amortized cost, which approximates market value.
Securities and assets for which market quotations are not readily
available are valued at fair value as determined in good faith by or
under the direction of the Board of Trustees of the Trust, including
valuations furnished by a pricing service retained by the Trust,
which may utilize a matrix system for valuations. The procedures of
the pricing service and its valuations are reviewed by the officers
of the Trust under the general supervision of the Trustees.
(b) Derivative financial instruments--The Fund may engage in various
portfolio strategies to seek to increase its return by hedging its
portfolio against adverse movements in the debt markets. Losses may
arise due to changes in the value of the contract or if the
counterparty does not perform under the contract.
* Financial futures contracts--The Fund may purchase or sell interest
rate futures contracts and options on such futures contracts for the
purpose of hedging the market risk on existing securities or the
intended purchase of securities. Futures contracts are contracts for
delayed delivery of securities at a specific future date and at a
specific price or yield. Upon entering into a contract, the Fund
deposits and maintains as collateral such initial margin as required
by the exchange on which the transaction is effected. Pursuant to
the contract, the Fund agrees to receive from or pay to the broker
an amount of cash equal to the daily fluctuation in value of the
contract. Such receipts or payments are known as variation margin
and are recorded by the Fund as unrealized gains or losses. When the
contract is closed, the Fund records a realized gain or loss equal
to the difference between the value of the contract at the time it
was opened and the value at the time it was closed.
(c) Income taxes--It is the Fund's policy to comply with the
requirements of the Internal Revenue Code applicable to regulated
investment companies and to distribute substantially all of its
taxable income to its shareholders. Therefore, no Federal income tax
provision is required.
(d) Security transactions and investment income--Security
transactions are recorded on the dates the transactions are entered
into (the trade dates). Interest income is recognized on the accrual
basis. Discounts and market premiums are amortized into interest
income. Realized gains and losses on security transactions are
determined on the identified cost basis.
(e) Deferred organization expenses and prepaid registration fees--
Deferred organization expenses are charged to expense on a straight-
line basis over a five-year period. Prepaid registration fees are
charged to expense as the related shares are issued.
(f) Dividends and distributions--Dividends from net investment
income are declared daily and paid monthly. Distributions of capital
gains are recorded on the ex-dividend dates.
2. Investment Advisory Agreement and Transactions
with Affiliates:
The Fund has entered into an Investment Advisory Agreement with Fund
Asset Management, L.P. ("FAM"). The general partner of FAM is
Princeton Services, Inc. ("PSI"), an indirect wholly-owned
subsidiary of Merrill
61
<PAGE> 110
Lynch & Co., Inc. ("ML & Co."), which is the limited partner.
The Fund has also entered into a Distribution Agreement and
Distribution Plans with Merill Lynch Funds Distributor, Inc.
("MLFD" or "Distributor"), a wholly-owned subsidiary of Merrill
Lynch Group, Inc.
FAM is responsible for the management of the Fund's portfolio and
provides the necessary personnel, facilities, equipment and certain
other services necessary to the operations of the Fund. For such
services, the Fund pays a monthly fee based upon the average daily
value of the Fund's net assets at the following annual rates: 0.55%
of the Fund's average daily net assets not exceeding $500 million;
0.525% of average daily net assets in excess of $500 million but not
exceeding $1 billion; and 0.50% of average daily net assets in
excess of $1 billion. 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 to FAM during any fiscal year which will cause such expenses
to exceed expense limitations at the time of payment. For the year
ended July 31, 1996, FAM earned fees of $163,546, of which $161,021
was voluntarily waived. FAM also reimbursed the Fund additional
expenses of $30,788.
Pursuant to the distribution plans (the "Distribution Plans")
adopted by the Fund in accordance with Rule 12b-1 under the
Investment Company Act of 1940, the Fund pays the Distributor
ongoing account maintenance and distribution fees. The fees are
accrued daily and paid monthly at annual rates based upon the
average daily net assets of the shares as follows:
Account
Maintenance Distribution
Fee Fee
Class B 0.25% 0.25%
Class C 0.25% 0.35%
Class D 0.10% --
Pursuant to a sub-agreement with the Distributor, Merrill Lynch,
Pierce, Fenner & Smith Inc. ("MLPF&S"), a subsidiary of ML & Co.,
also provides account maintenance and distribution services to the
Fund. The ongoing account maintenance fee compensates the
Distributor and MLPF&S for providing account maintenance services to
Class B, Class C and Class D shareholders. The ongoing distribution
fee compensates the Distributor and MLPF&S for providing shareholder
and distribution-related services to Class B and Class C
shareholders.
For the year ended July 31, 1996, MLFD earned underwriting discounts
and MLPF&S earned dealer concessions on sales of the Fund's Class A
and Class D Shares as follows:
MLFD MLPF&S
Class A $ 260 $1,237
Class D $1,010 $4,862
For the year ended July 31, 1996, MLPF&S received contingent
deferred sales charges of $35,113 and $1,229 relating to
transactions in Class B and Class C Shares, respectively.
Merrill Lynch Financial Data Services, Inc. ("MLFDS"), a wholly-
owned subsidiary of ML & Co., is the Fund's transfer agent.
Accounting services are provided to the Fund by FAM at cost.
Certain officers and/or trustees of the Fund are officers and/or
directors of FAM, PSI, MLPF&S, MLFDS, MLFD, and/or ML & Co.
3. Investments:
Purchases and sales of investments, excluding short-term securities,
for the year ended July 31, 1996 were $17,038,699 and $13,979,803,
respectively.
Net realized and unrealized gains (losses) as of July 31, 1996 were
as follows:
Realized Unrealized
Gains (Losses) Gains (Losses)
Long-term investments $ 46,018 $ 1,104,581
Financial futures contracts (216,924) (60,937)
----------- -----------
Total $ (170,906) $ 1,043,644
=========== ===========
As of July 31, 1996, net unrealized appreciation for Federal income
tax purposes aggregated $1,104,581, of which $1,239,097 related to
appreciated securities and $134,516 related to depreciated
securities. The aggregate cost of investments at July 31, 1996 for
Federal income tax purposes was $28,031,771.
62
<PAGE> 111
NOTES TO FINANCIAL STATEMENTS (concluded)
4. Beneficial Interest Transactions:
Net increase in net assets derived from beneficial interest
transactions was $1,398,401 and $2,801,169 for the years ended July
31, 1996 and July 31, 1995, respectively.
Transactions in shares of beneficial interest for each class were as
follows:
Class A Shares for the Year Dollar
Ended July 31, 1996 Shares Amount
Shares sold 146,883 $ 1,403,098
Shares issued to share-
holders in reinvestment
of dividends 15,973 152,184
----------- -----------
Total issued 162,856 1,555,282
Shares redeemed (271,026) (2,585,723)
----------- -----------
Net decrease (108,170) $(1,030,441)
=========== ===========
Class A Shares for the Year Dollar
Ended July 31, 1995 Shares Amount
Shares sold 845,320 $ 7,350,840
Shares issued to share-
holders in reinvestment
of dividends 17,353 159,391
----------- -----------
Total issued 862,673 7,510,231
Shares redeemed (958,997) (8,589,491)
----------- -----------
Net decrease (96,324) $(1,079,260)
=========== ===========
Class B Shares for the Year Dollar
Ended July 31, 1996 Shares Amount
Shares sold 429,323 $ 4,107,558
Shares issued to share-
holders in reinvestment
of dividends 35,409 337,321
----------- -----------
Total issued 464,732 4,444,879
Shares redeemed (332,089) (3,170,672)
Automatic conversion
of shares (4,546) (42,736)
----------- -----------
Net increase 128,097 $ 1,231,471
=========== ===========
Class B Shares for the Year Dollar
Ended July 31, 1995 Shares Amount
Shares sold 590,823 $ 5,418,198
Shares issued to share-
holders in reinvestment
of dividends 30,471 279,150
----------- -----------
Total issued 621,294 5,697,348
Shares redeemed (349,817) (3,164,237)
----------- -----------
Net increase 271,477 $ 2,533,111
=========== ===========
Class C Shares for the Year Dollar
Ended July 31, 1996 Shares Amount
Shares sold 44,615 $ 421,180
Shares issued to share-
holders in reinvestment
of dividends 1,423 13,580
----------- -----------
Total issued 46,038 434,760
Shares redeemed (15,840) (150,183)
----------- -----------
Net increase 30,198 $ 284,577
=========== ===========
Class C Shares for the Period Dollar
October 21, 1994++ to July 31, 1995 Shares Amount
Shares sold 17,718 $ 165,714
Shares issued to share-
holders in reinvestment
of dividends 121 1,130
----------- -----------
Total issued 17,839 166,844
Shares redeemed (581) (5,534)
----------- -----------
Net increase 17,258 $ 161,310
=========== ===========
[FN]
++Commencement of operations.
Class D Shares for the Year Dollar
Ended July 31, 1996 Shares Amount
Shares sold 146,932 $ 1,396,111
Automatic conversion
of shares 4,548 42,736
Shares issued to share-
holders in reinvestment
of dividends 3,609 34,400
----------- -----------
Total issued 155,089 1,473,247
Shares redeemed (59,500) (560,453)
----------- -----------
Net increase 95,589 $ 912,794
=========== ===========
63
<PAGE> 112
Class D Shares for the Period Dollar
October 21, 1994++ to July 31, 1995 Shares Amount
Shares sold 160,346 $ 1,421,717
Shares issued to share-
holders in reinvestment
of dividends 1,729 16,078
----------- -----------
Total issued 162,075 1,437,795
Shares redeemed (27,599) (251,787)
----------- -----------
Net increase 134,476 $ 1,186,008
=========== ===========
[FN]
++Commencement of operations.
5. Capital Loss Carryforward:
At July 31, 1996, the Fund had a net capital loss
carryforward of approximately $1,833,000, of which $1,707,000
expires in 2003 and $126,000 expires in 2004. This amount will be
available to offset like amounts of any future taxable gains.
64
<PAGE> 113
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<PAGE> 114
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<PAGE> 115
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............................ 16
Trustees and Officers............................. 16
Compensation of Trustees.......................... 17
Management and Advisory Arrangements.............. 18
Purchase of Shares................................. 20
Initial Sales Charge Alternatives--
Class A and Class D Shares...................... 20
Reduced Initial Sales Charges..................... 22
Distribution Plans................................ 24
Limitations on the Payment of Deferred Sales
Charges......................................... 25
Redemption of Shares............................... 26
Deferred Sales Charges--
Class B and Class C Shares...................... 27
Portfolio Transactions............................. 27
Determination of Net Asset Value................... 29
Shareholder Services............................... 29
Investment Account................................ 29
Automatic Investment Plans........................ 30
Automatic Reinvestment of Dividends and Capital
Gains Distributions............................. 30
Systematic Withdrawal Plans--
Class A and Class D Shares...................... 31
Exchange Privilege................................ 32
Distributions and Taxes............................ 34
Environmental Tax................................. 37
Tax Treatment of Option and Futures
Transactions.................................... 37
Performance Data................................... 38
General Information................................ 40
Description of Shares............................. 40
Computation of Offering Price Per Share........... 41
Independent Auditors.............................. 41
Custodian......................................... 41
Transfer Agent.................................... 42
Legal Counsel..................................... 42
Reports to Shareholders........................... 42
Additional Information............................ 42
Appendix I--Economic and Financial Conditions in
Colorado.......................................... 43
Appendix II--Ratings of Municipal Bonds............ 46
Independent Auditors' Report....................... 54
Financial Statements............................... 55
Code # 16916-1096
</TABLE>
Merrill Lynch
Colorado Municipal
Bond Fund
Merrill Lynch Multi-State
Municipal Series Trust
STATEMENT OF
ADDITIONAL
INFORMATION
October 29, 1996
Distributor:
Merrill Lynch
Funds Distributor, Inc.
<PAGE> 116
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 Back cover of Prospectus and
graph paper and Merrill Lynch back cover of Statement of
logo including stylized market Additional Information
bull.
</TABLE>
