PAGE 1
Prospectus for the T. Rowe Price Summit Funds, Inc., dated March
1, 1995, should be inserted here.
TO OPEN AN ACCOUNT
INVESTOR SERVICES
1-800-977-1577
FOR YIELDS & PRICES
TELE*ACCESS(REGISTERED TRADEMARK)
1-800-638-2587
24 HOURS, 7 DAYS
INVESTOR CENTERS
101 EAST LOMBARD ST.
BALTIMORE, MD
T. ROWE PRICE
FINANCIAL CENTER
10090 RED RUN BLVD.
OWINGS MILLS, MD
FARRAGUT SQUARE
900 17TH STREET, N.W.
WASHINGTON, DC
ARCO TOWER
31ST FLOOR
515 SOUTH FLOWER ST.
LOS ANGELES, CA
INVEST WITH CONFIDENCE
SIC
TO HELP YOU ACHIEVE YOUR FINANCIAL GOALS, T. ROWE PRICE OFFERS A WIDE RANGE OF
STOCK, BOND, AND MONEY MARKET INVESTMENTS, AS WELL AS CONVENIENT SERVICES AND
TIMELY, INFORMATIVE REPORTS.
Prospectus
T. Rowe Price
Summit Income Funds
T. Rowe Price
Summit Funds, Inc.
March 1, 1995
__________________________________________________________________________
A choice of corporate bond, government mortgage, and money market funds for
income-oriented investors.
Facts at a Glance
Investment Goals
Money fund: Preservation of capital, liquidity, and the highest level of
income consistent with these goals.
Bond funds: Highest level of income consistent with each fund's prescribed
investment program.
As with all mutual funds, these funds may not meet their objectives.
Strategy and Risk/Reward
Cash Reserves Fund. Invests principally in the highest-quality U.S.
dollar-denominated money market securities. Average maturity will not exceed
90 days. YOUR INVESTMENT IN THE FUND IS NEITHER INSURED NOR GUARANTEED BY THE
U.S. GOVERNMENT, AND THERE IS NO ASSURANCE THE FUND WILL BE ABLE TO MAINTAIN A
STABLE NET ASSET VALUE OF $1.00 PER SHARE.
Risk/Reward: Lowest potential risk and reward.
Limited-Term Bond Fund. Invests primarily in investment-grade corporate bonds.
Average effective maturity will range between one and five years.
Risk/Reward: Moderate income level and share-price fluctuation.
GNMA Fund. Invests primarily in mortgage-backed certificates issued by the
Government National Mortgage Association (GNMA) as well as in other U.S.
Government agency securities. Effective maturity will vary between three and
10 years.
Risk/Reward: Expected to provide higher income than the Limited-Term Bond Fund
accompanied by potentially greater share-price fluctuation.
Investor Profile Investors who seek higher yields for the fixed-income portion
of their portfolio and can meet the funds' $25,000 initial purchase
requirement. Appropriate for tax-deferred retirement plans.
Fees and Charges 100% no load. No fees or charges to buy or sell shares or to
reinvest dividends; no 12b-1 marketing fees; free telephone exchange.
Investment Manager Founded in 1937 T. Rowe Price Associates and its affiliates
managed over $57 billion in over three million individual and institutional
investor accounts as of December 31, 1994.
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.
T. ROWE PRICE
SUMMIT FUNDS, INC.
MARCH 1, 1995
PROSPECTUS
CONTENTS
__________________________________________________________________________
1 ABOUT THE FUNDS
__________________________________________________________________________
TRANSACTION AND FUND EXPENSES 2
__________________________________________________________________________
FINANCIAL HIGHLIGHTS 3
__________________________________________________________________________
FUND, MARKET, AND
RISK CHARACTERISTICS 4
__________________________________________________________________________
2 ABOUT YOUR ACCOUNT
__________________________________________________________________________
PRICING SHARES; RECEIVING
SALE PROCEEDS 11
__________________________________________________________________________
DISTRIBUTIONS AND TAXES 12
__________________________________________________________________________
TRANSACTION PROCEDURES AND
SPECIAL REQUIREMENTS 13
__________________________________________________________________________
3 MORE ABOUT THE FUNDS
ORGANIZATION AND MANAGEMENT 16
__________________________________________________________________________
UNDERSTANDING FUND PERFORMANCE 17
__________________________________________________________________________
INVESTMENT POLICIES
AND PRACTICES 18
__________________________________________________________________________
4 INVESTING WITH T. ROWE PRICE
MEETING REQUIREMENTS
FOR NEW ACCOUNTS 27
__________________________________________________________________________
OPENING A NEW ACCOUNT 27
__________________________________________________________________________
PURCHASING ADDITIONAL SHARES 28
__________________________________________________________________________
EXCHANGING AND REDEEMING 29
__________________________________________________________________________
SHAREHOLDER SERVICES 29
__________________________________________________________________________
THIS PROSPECTUS CONTAINS INFORMATION YOU SHOULD KNOW BEFORE INVESTING. PLEASE
KEEP IT FOR FUTURE REFERENCE. A STATEMENT OF ADDITIONAL INFORMATION ABOUT THE
FUNDS, DATED MARCH 1, 1995, HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE
COMMISSION AND IS INCORPORATED BY REFERENCE IN THIS PROSPECTUS. TO OBTAIN A
FREE COPY, CALL 1-800-977-1577.
1 ABOUT THE FUNDS
Transaction and Fund Expenses
Each T. Rowe Price Summit fund has a single, all-inclusive fee covering
investment management and operating expenses. This fee will not fluctuate. In
contrast, most mutual funds have a fixed management fee plus a fee for
operating expenses that varies according to a number of other factors. (See
"How are fund expenses determined?" under "The Fund's Organization and
Management.")
__________________________________________________________________________
EXPENSE RATIOS FOR THE SUMMIT FUNDS ARE SUBSTANTIALLY BELOW THEIR INDUSTRY
AVERAGES.
In Table 1 below, "Shareholder Transaction Expenses" shows that you pay no
direct sales charges. All the money you invest in a fund goes to work for you,
subject to the fees explained below. "Annual Fund Expenses" shows how much it
will cost to operate each fund for a year. These are costs you pay indirectly,
because they are deducted from the fund's total assets before the daily share
price is calculated and before dividends and other distributions are made. In
other words, you will not see these expenses on your account statement.
__________________________________________________________________________
LIKE ALL T. ROWE PRICE FUNDS, THE SUMMIT FUNDS ARE 100% NO LOAD.
Shareholder Transaction Expenses
__________________________________________________________________________
Sales charge "load" on purchases None
__________________________________________________________________________
Sales charge "load" on reinvested dividends None
__________________________________________________________________________
Redemption fees None
__________________________________________________________________________
Exchange fees None
__________________________________________________________________________
Annual Fund Expenses Percentage of Fiscal 1994 Average Net Assets
Cash Limited- GNMA
Reserves Term Bond
__________________________________________________________________________
Management fee* 0.45% 0.55% 0.60%
__________________________________________________________________________
Marketing fees (12b-1) None None None
__________________________________________________________________________
Other expenses* 0.00% 0.00% 0.00%
__________________________________________________________________________
Total fund expenses* 0.45% 0.55% 0.60%
__________________________________________________________________________
*The management fee includes operating expenses.
Note: The funds charge a $5 fee for wire redemptions under $5,000, subject to
change without notice.
__________________________________________________________________________
Table 1
o Hypothetical example: Assume you invest $1,000, the fund returns 5%
annually, expense ratios remain as listed above, and you close your
account at the end of the time periods shown. Your expenses would be:
__________________________________________________________________________
THE TABLE AT RIGHT IS JUST AN EXAMPLE; ACTUAL EXPENSES CAN BE HIGHER OR LOWER
THAN THOSE SHOWN.
1 year 3 years 5 years 10 years
__________________________________________________________________________
Cash Reserves $5 $14 $25 $57
__________________________________________________________________________
Limited-Term Bond 6 18 31 69
__________________________________________________________________________
GNMA 6 19 33 75
__________________________________________________________________________
Table 2
Financial Highlights
The following table provides information about each fund's financial history.
It is based on a single share outstanding throughout the fiscal year. The
table is part of each fund's financial statements which are included in the
funds' annual report and are incorporated by reference into the Statement of
Additional Information. This document is available to shareholders upon
request. The financial statements in the annual report have been audited by
Coopers & Lybrand L.L.P., independent accountants, whose unqualified report
covers the period shown.
<PAGE>
<TABLE>
<CAPTION>
Investment Activitities Distributions
Net Realized
Net and
Asset Value, Unrealized Total
Year Beginning Net Gain (Loss) from Net Net
Ended, of Investment on Investment Investment Realized Total
October 31 Period Income InvestmentsActivities Income Gain Distributions
_________________________________________________________________________________________________________
Cash Reserves
Fund
<S> <C> <C> <C> <C> <C> <C> <C>
1994 $1.000 $0.035 $0.035 $(0.035) $(0.035)
Limited-Term
Bond Fund
1994 $5.00 $0.33 $(0.36) $(0.03) $(0.33) $(0.33)
GNMA Fund
1994 $10.00 $0.69 $(0.85) $(0.16) $(0.69) $(0.69)
_________________________________________________________________________________________________________
<CAPTION>
End of Period
Ratio of Net
Total Return Ratio of Investment
Net Asset (Includes Net Expenses Income Portfolio
Value, Reinvested Assets to Average to Average Turnover
End of Period Dividends) ($ Thousands) Net Assets Net Assets Rate
_________________________________________________________________________________________________________
Cash Reserves
Fund
<C> <C> <C> <C> <C> <C>
$1.000 3.60% $ 186,523 0.45%a 4.03%a
Limited-Term
Bond Fund
$4.64 (0.71)% $ 21,116 0.55%a 6.98%a 296.0%a
GNMA Fund
$9.15 (1.67)% $ 17,184 0.60%a 7.31%a 61.5%a
_________________________________________________________________________________________________________
<FN>
a Annualized
</FN>
_________________________________________________________________________________________________________
Table 3
</TABLE>
<PAGE>
Fund, Market, and Risk Characteristics: What to Expect
To help you decide which of the T. Rowe Price Summit funds may be appropriate
for you, this section takes a closer look at their special benefits, the
fixed-income markets in which they invest, and the investment programs for the
Cash Reserves, Limited-Term Bond, and GNMA funds.
__________________________________________________________________________
INVESTING IN THE T. ROWE PRICE SUMMIT FUNDS OFFERS SOME SPECIAL BENEFITS.
How do I benefit from investing in the T. Rowe Price Summit funds?
You gain the advantages of funds that are tailored specifically to the needs
of self-directed individuals with substantial assets to invest in fixed-income
securities. The funds offer such investors three key benefits:
o Access to professionally managed, diversified portfolios of fixed-income
securities.
o A low-cost structure that translates into higher returns, all else being
equal.
o Services designed to help you manage your investments more effectively
and efficiently.
How do the funds achieve their low-cost advantage?
The advantage reflects their more favorable ratio of expenses to assets. The
$25,000 initial purchase requirement means that the average account balanced
in each Summit fund is high. Since shareholder recordkeeping costs a
substantial portion of fund expenses are basically the same for all sizes of
accounts, a fund with larger account balances can spread the expenses over
more investment dollars, achieving a low overall expense ratio. Expenses are
deducted from fund assets before dividends are paid, as explained on the
previous page, so lower costs result in higher dividends for Summit
shareholders.
What services can I expect to be available?
Unlike some mutual funds, low costs do not mean any reduction in service for
Summit fund investors. On the contrary, you will not only receive the wide
range of services available to all T. Rowe Price shareholders, but also have
access to specially trained fixed-income service representatives and timely
market information to help you manage your accounts.
__________________________________________________________________________
THE FUND OR FUNDS YOU SELECT SHOULD REFLECT YOUR INDIVIDUAL INVESTMENT GOALS,
BUT SHOULD NOT REPRESENT YOUR COMPLETE INVESTMENT PROGRAM. NO FUND SHOULD BE
USED FOR SHORT-TERM TRADING PURPOSES.
What are the Summit funds' objective and investment program?
Cash Reserves Fund. The fund's objectives are preservation of capital,
liquidity, and, consistent with these, the highest possible current income.
The fund invests in a diversified portfolio of U.S. dollar-denominated money
market securities issued in the U.S. and abroad, and will not invest more than
5% of its total assets in securities of any one issuer. The fund's yield will
fluctuate in response to changes in interest rates, but the share price is
managed to remain stable at $1.00. Unlike most bank accounts or certificates
of deposit, the fund is not insured or guaranteed by the U.S. Government.
The fund invests at least 95% of its total assets in securities receiving the
highest credit rating assigned by at least two established rating agencies, by
one rating agency if the security is rated by only one, or, if unrated, the
equivalent rating as established by T. Rowe Price. The fund's dollar-weighted
average maturity will not exceed 90 days. It will generally purchase
securities with maturities of 13 months or less, although U.S. Government
securities with maturities up to 25 months may also be purchased.
__________________________________________________________________________
FOR MORE DETAILED DESCRIPTIONS OF EACH FUND'S SECURITIES, SEE "INVESTMENT
POLICIES AND PRACTICES."
Limited-Term Bond Fund. The fund's objective is to provide a high level of
income consistent with moderate fluctuation in principal value. The fund will
invest at least 65% of total assets in short- and intermediate-term,
investment-grade bonds. There are no maturity limitations on individual
securities purchased, but the fund's dollar-weighted average effective
maturity will not exceed five years. Targeting effective maturity provides
additional flexibility in portfolio management but, all else being equal,
could result in higher volatility than would be true of a fund targeting a
stated maturity or maturity range.
At least 90% of the fund portfolio will be invested in securities rated in the
four highest credit categories by a nationally recognized rating agency, or,
if unrated, of equivalent quality as determined by T. Rowe Price. To enhance
yield, up to 10% of assets can be invested in below-investment-grade
securities, including those with the lowest rating. The fund's income level
should be much higher than the money fund's, but its share price will vary.
GNMA Fund. The fund's objective is to provide a high level of income and
maximum credit protection by investing at least 65% of total assets in GNMA
certificates backed by the full faith and credit of the U.S. Government. Up to
35% of assets can be invested in other types of high-quality securities (AAA
or AA), such as direct obligations of the U.S. Government, securities of other
U.S. Government-sponsored agencies, privately issued mortgage securities, and
corporate bonds. The fund's effective maturity generally will vary between
three and 10 years and will be influenced by principal prepayments of GNMA or
other mortgage-backed securities. Prices of GNMAs and other mortgage-backed
securities fluctuate like other fixed-income securities of comparable
maturity, but may have less appreciation potential when interest rates
decline, because prepayments usually increase. Prepayments of mortgage
securities that were purchased at a price over face value (par) result in a
capital loss. The fund should provide the highest income of these three funds
but is expected to experience greater share-price fluctuation.
__________________________________________________________________________
BEFORE CHOOSING A FUND, YOU MAY FIND IT HELPFUL TO REVIEW SOME FUNDAMENTALS OF
FIXED-INCOME INVESTING.
What are the major differences between money market and bond funds?
o Price Like all bond funds, bond funds have a fluctuating share price.
Money market funds are managed to maintain a stable share price.
o Maturity Limited-term bond funds have longer average maturities (from
one to 5 years) than money market funds (90 days or less). Longer-term
bond funds have the longest average maturities (10 years or more). Of
course, unlike a money market fund, the share prices of bond funds will
fluctuate and your investment may be worth more or less on redemption
than at purchase.
o Income Limited-term bond funds typically offer more income than money
market funds and less income than longer-term bond funds.
Is a fund's yield fixed or will it vary?
It will vary. The yield is calculated every day by dividing a fund's net
income per share, expressed at annual rates, by the share price. Since both
income and share price will fluctuate, a fund's yield will also vary.
(Although money fund prices are stable, income is variable.)
Is a fund's "yield" the same thing as the "total return"?
"No" for bond funds. Your total return is the result of reinvested income and
the change in share price for a given time period. Income is always a positive
contributor to total return and can enhance a rise in share price or serve as
an offset to a drop in share price. Since money funds are managed to maintain
a stable share price, however, their yield and total return should be the
same.
What is "credit quality" and how does it affect a fund's yield?
Credit quality refers to a bond issuer's expected ability to make all required
interest and principal payments in a timely manner. Because highly rated bond
issuers represent less risk, they can borrow at lower interest rates than less
creditworthy issuers. Therefore, a fund investing in high-quality securities
should have a lower yield than an otherwise comparable fund investing in lower
credit-quality securities
.
What is meant by a bond's or a fund's maturity?
Every bond has a stated maturity date when the issuer must repay the bond's
entire principal value to the investor. Some types of bonds may also have an
"effective maturity" that is shorter than the stated date. The effective
maturity of mortgage-backed bonds is determined by the rate at which
homeowners pay down the principal on the underlying mortgages. Many corporate
and municipal bonds are "callable," meaning their principal can be repaid
before their stated maturity dates on (or after) specified call dates. Bonds
are most likely to be called when interest rates are falling, because the
issuer wants to refinance at a lower rate. In such an environment, a bond's
"effective maturity" is usually its nearest call date.
A bond or money market mutual fund has no maturity in the strict sense of the
word, but does have a dollar-weighted average maturity. This number is an
average of the stated maturities of the underlying instruments, with each
maturity "weighted" by the percentage of fund assets it represents. Funds that
target effective maturities would use the effective (rather than stated)
maturities of the underlying bonds when computing the average. Targeting
effective maturity provides additional flexibility in portfolio management
but, all else being equal, could result in higher volatility than a fund
targeting a stated maturity or maturity range.
What is a bond's or bond fund's "duration"?
Duration is the time-weighted value of discounted future interest and
principal payments expressed in years. It is a better measure than maturity of
bond price sensitivity to interest rate changes because it takes into account
the time value of cash flows generated over the bond's life. Future interest
and principal payments are discounted to reflect their present value and then
are multiplied by the number of years they will be received to produce a value
that is expressed in years, i.e., the duration. A more refined measure than
average maturity, effective duration takes into account call features and
sinking fund payments which may shorten a bond's life.
Since duration can also be computed for bond funds, you can estimate the
effect of interest rates on a bond fund's share price. Simply multiply the
fund's duration (available for T. Rowe Price bond funds in our quarterly
shareholder reports) by an expected change in interest rates. For example, the
price of a bond fund with a duration of five years would be expected to fall
approximately 5% if rates rose by one percentage point.
How is a bond's price affected by changes in interest rates?
When interest rates rise, a bond's price usually falls, and vice versa.
__________________________________________________________________________
IN GENERAL, THE LONGER THE BOND'S MATURITY, THE GREATER THE PRICE INCREASE AND
DECREASE IN RESPONSE TO A GIVEN CHANGE IN INTEREST RATES, AS SHOWN IN THE
TABLE TO THE RIGHT.
How Interest Rates Affect Bond Prices
Bond MaturityCoupon Price of a $1,000 Bond If Interest Rates:
Increase Decrease
1% 2% 1% 2%
__________________________________________________________________________
1 Year 6.15% $991 $981 $1,010 $1,019
__________________________________________________________________________
5 Years 7.48 960 922 1,042 1,086
__________________________________________________________________________
10 Years 7.80 934 874 1,072 1,150
__________________________________________________________________________
30 Years 7.97 897 810 1,125 1,278
__________________________________________________________________________
Table 4 Coupons reflect yields on Treasury securities as of October 31,
1994. This is an illustration and does not represent expected
yields or share-price changes of any T. Rowe Price fund.
Since the average effective maturity of bonds held by the Limited-Term Bond
Fund is expected to be approximately five years, the fund's share price, like
the value of the underlying bonds in its portfolio, should fluctuate less than
a fund which holds bonds with longer average effective maturities. If mortgage
prepayments should accelerate in a falling interest rate environment, GNMA
securities may appreciate less than shown in the example above. The amount of
appreciation would depend on the characteristics of the mortgages, such as
their coupon or maturity.
Do money market securities react to changes in interest rates?
Yes. As interest rates change, the prices of money market securities
fluctuate, but changes are usually small because of their very short
maturities. Investments are typically held until maturity in a money fund to
help it maintain a $1.00 share price.
What are the main risks of investing in bond and money market funds?
Since they are managed to maintain a $1.00 share price, money market funds
should have little risk of principal loss. The potential for realizing a loss
of principal in a bond or money market fund could derive from:
o Interest rate or market risk the decline in the prices of fixed-income
securities and funds that may accompany a rise in the overall level of
interest rates. A sharp and unexpected rise in interest rates could
cause a money fund's price to drop below a dollar. However, the
extremely short-term securities held in money market portfolios a means
of achieving an overall fund objective of principal safety reduces much
of their potential for price fluctuation.
o Credit risk the chance that any of a fund's holdings will have its
credit rating downgraded or will default (fail to make scheduled
interest and principal payments), potentially reducing the fund's income
level and/or share price.
How does T. Rowe Price try to reduce risk?
Consistent with each fund's objective, the portfolio manager actively manages
bond and money funds in an effort to manage risk and increase total return.
Risk management tools include:
o Diversification of assets to reduce the impact of a single holding on a
fund's net asset value;
o Thorough credit research by our own analysts; and
o Adjustments in a fund's duration to try to reduce the negative impact of
rising interest rates or take advantage of the favorable effects of
falling rates.
Depending on market outlook, the investment manager may shorten or lengthen a
fund's average effective maturity within the ranges and guidelines established
in this prospectus.
What are the funds' policies on derivative investments? (Limited-Term and GNMA
Funds)
Each of these funds will invest in derivatives only if the expected rewards
and risks or their effect on the portfolio as a whole are consistent with the
fund's objectives, policies, and overall risk profile as described in this
prospectus. The funds may invest in derivatives for one or more of the
following purposes: to increase yield; to hedge against risk or adjust the
portfolio's overall risk level; to change the fund's duration; or to
capitalize on a specific market viewpoint.
A number of important points should be kept in mind regarding derivatives:
o The definition of "derivative" is very broad and can be applied to
investments representing a wide range of potential risks and rewards. A
derivative is defined as a financial instrument whose value is derived
from an underlying security (e.g., a stock or bond) or a market
benchmark (e.g., an interest rate index). Variable rate notes, stripped
mortgage securities, and bond futures and options are among the many
examples of derivatives.
o While conventional derivatives may not entail any more risk than
traditional investments, other types can involve significantly greater
risk. The amount of risk may not be indicated by the instrument's credit
rating.
o The evolution of the derivatives market has fostered new ways to
understand, measure, and manage financial risk. When used appropriately,
derivatives can be useful and efficient portfolio management tools. When
used inappropriately, however, they may increase risk. The success or
failure of a particular derivative investment should be measured against
its intended purpose. For example, a bond future may lose money but
succeed in hedging (protecting) a portfolio against an adverse change in
interest rates.
__________________________________________________________________________
THESE ARE SOME CHARACTERISTICS OF MORTGAGE-BACKED SECURITIES.
What are mortgage-backed securities and who issues them?
Mortgage lenders pool individual home mortgages with similar characteristics
to back a certificate or bond, which is sold to investors. Interest and
principal payments generated by the underlying mortgages are passed through to
the investors. The "big three" issuers of mortgage-backed securities are the
Government National Mortgage Association (Ginnie Mae), the Federal National
Mortgage Association (Fannie Mae), and the Federal Home Loan Mortgage
Corporation (Freddie Mac). Private mortgage bankers also issue these
securities.
What are the main differences between GNMAs and other mortgage-backed
securities?
GNMA is part of the Department of Housing and Urban Development (HUD), so
GNMA's guarantee of timely interest and principal payments is backed by the
full faith and credit of the U.S. Government. Fannie Mae and Freddie Mac are
privately owned, government-sponsored agencies which issue their own
guarantees for interest and principal payments on the mortgage-backed
securities they issue. Their securities do not have a direct U.S. Government
guarantee, but are of very high credit quality. Privately issued
mortgage-backed securities carry no government guarantees. For this and other
reasons, all these securities usually offer higher yields than GNMAs.
Do mortgage-backed securities usually behave like other high-quality bonds?
Generally yes, with one important exception. Mortgage securities are subject
to scheduled and unscheduled principal payments as homeowners pay down or
prepay their mortgages. As these payments are received, they must be
reinvested when interest rates may be higher or lower than on the original
mortgage security. Therefore, mortgage securities are not an effective means
of locking in long-term interest rates. In addition, when interest rates fall,
the pace of mortgage prepayments picks up. These refinanced mortgages are paid
off at face value (par), causing a loss for any investor who may have
purchased the security at a price above par. In such an environment, this risk
limits the potential price appreciation of these securities and can negatively
affect the fund's net asset value. When rates rise, however, mortgage-backed
securities have historically experienced smaller price declines than
comparable quality bonds.
__________________________________________________________________________
THE SHARE PRICE AND YIELD OF THE LIMITED- TERM BOND AND GNMA FUNDS WILL
FLUCTUATE WITH CHANGING MARKET CONDITIONS AND INTEREST RATE LEVELS. WHEN YOU
SELL YOUR SHARES, YOU MAY LOSE MONEY. THE YIELD OF THE CASH RESERVES FUND WILL
FLUCTUATE, BUT ITS SHARE PRICE IS MANAGED TO MAINTAIN A $1.00 PRICE PER SHARE.
What should I consider when selecting a fund?
Review your own financial objectives, time horizon, and risk tolerance. Use
the next table, which summarizes each funds' main characteristics, to choose a
fund (or funds) suitable for your particular needs. For example, only the
money fund is designed to provide principal stability, which makes it a good
choice for money you may need for occasional or unexpected expenses. However,
if you are investing for the highest possible income and can tolerate some
price volatility, you should consider a longer-term bond fund.
Differences Among Funds
Fund Income Risk of Share- Expected Credit
Price Average Quality
Fluctuation Maturity Categories
__________________________________________________________________________
Cash Lower Stable No more than 90 days Two Highest
Reserves
__________________________________________________________________________
Limited- Moderate Moderate 1 to 5 years Primarily Four
Term Bond Highest
__________________________________________________________________________
GNMA Higher Higher 3 to 10 years Two Highest
__________________________________________________________________________
Table 5
How does each fund's overall credit quality relate to its investment
objective?
Investing exclusively in high-quality securities helps the Cash Reserves Fund
pursue its primary goal safety of principal. To secure a higher income with
moderate principal fluctuation, the Limited-Term Bond Fund invests at least
90% of assets in investment-grade securities (rated AAA through BBB); the
balance may consist of securities rated below investment grade, including
those with the lowest rating. Like all portfolio holdings, these securities
are subject to rigorous credit research conducted by T. Rowe Price analysts.
(For further discussion, see "Investment Policies and Practices High Yield
Investing.") In keeping with its emphasis on high income consistent with
credit safety, the GNMA Fund's investments are all high quality.
Is there additional information about these funds to help me make a decision?
You should review the investment objectives and other details about each fund
set forth on the following few pages. Also, be sure to review "Investment
Policies and Practices" in Section 3, which reviews the following topics:
Types of Portfolio Securities (bonds, asset-backed securities, mortgage-backed
securities, hybrid instruments, private placements, and foreign securities);
and Types of Management Practices (cash position, borrowing money and
transferring assets, futures and options, interest rate swaps, managing
foreign currency risk, lending of portfolio securities, when issued securities
and forward commitment contracts, portfolio turnover, and high yield/high risk
investing).
2 About Your Account
Pricing Shares and Receiving Sale Proceeds
Here are some procedures you should know when investing in a fund.
__________________________________________________________________________
THE VARIOUS WAYS YOU CAN BUY, SELL, AND EXCHANGE SHARES ARE EXPLAINED AT THE
END OF THIS PROSPECTUS AND ON THE NEW ACCOUNT FORM.
How and when shares are priced
Bond and Money Funds. The share price (also called "net asset value" or NAV
per share) for a fund is calculated at 4 p.m. ET each day the New York Stock
Exchange is open for business. To calculate the NAV, the fund's assets are
valued and totaled, liabilities are subtracted, and the balance, called net
assets, is divided by the number of shares outstanding.
Money fund NAVs, which are managed to remain at $1.00, are calculated at noon
ET each day as well as 4 p.m. Amortized cost or amortized market value is used
to value money fund securities that mature in 60 days or less.
__________________________________________________________________________
WHEN FILLING OUT THE NEW ACCOUNT FORM, YOU MAY WISH TO GIVE YOURSELF THE
WIDEST RANGE OF OPTIONS FOR RECEIVING PROCEEDS FROM A SALE.
How your purchase, sale, or exchange price is determined
If we receive your request in correct form before 4 p.m. ET, your transaction
will be priced at that day's NAV. If we receive it after 4 p.m., it will be
priced at the next business day's NAV.
We cannot accept orders that request a particular day or price for your
transaction or any other special conditions.
Note: The time at which transactions are priced and until which orders are
accepted may be changed in case of an emergency or if the New York Stock
Exchange closes at a time other than 4 p.m. ET.
How you can receive the proceeds from a sale
If your request is received by 4 p.m. ET in correct form, proceeds are usually
sent the next business day. Proceeds can be sent to you by mail, or to your
bank account by ACH transfer or bank wire. Proceeds sent by ACH transfer
should be credited the second day after the sale. ACH (Automated Clearing
House) is an automated method of initiating payments from and receiving
payments in your financial institutional account. ACH is a payment system
supported by over 20,000 banks, savings banks and credit unions, which
electronically exchanges the transactions through the Federal Reserve Banks.
Proceeds sent by bank wire should be credited to your account the next
business day.
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IF FOR SOME REASON WE CANNOT ACCEPT YOUR REQUEST TO SELL SHARES, WE WILL
CONTACT YOU.
Exception:
o Under certain circumstances and when deemed to be in a fund's best
interests, your proceeds may not be sent for up to five business days
after receiving your sale or exchange request. If you were exchanging
into another bond or money fund, your new investment would not begin to
earn dividends until the sixth business day.
Useful Information on Distributions and Taxes
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THE FUND DISTRIBUTES ALL NET INVESTMENT INCOME AND REALIZED CAPITAL GAINS TO
SHAREHOLDERS.
Dividends and other distributions
Dividend and capital gain distributions are reinvested in additional fund
shares in your account unless you select another option on your New Account
Form. The advantage of reinvesting distributions arises from compounding; that
is, you receive dividend and capital gain distributions on a rising number of
shares.
Distributions not reinvested are paid by check or transmitted to your bank
account via ACH. If the Post Office cannot deliver your check, or if your
check remains uncashed for six months, the fund reserves the right to reinvest
your distribution check in your account at the then current NAV and to
reinvest all subsequent distributions in shares of the fund.
Income dividends
o Bond funds declare income dividends daily at 4 p.m. ET to shareholders
of record at that time provided payment has been received on the
previous business day.
o Money funds declare income dividends daily at noon ET to shareholders of
record at that time provided payment has been received by that time.
o Bond and money fund shares will earn dividends through the date of
redemption; shares redeemed on a Friday or prior to a holiday will
continue to earn dividends until the next business day. Generally, if
you redeem all of your shares at any time during the month, you will
also receive all dividends earned through the date of redemption in the
same check. When you redeem only a portion of your shares, all dividends
accrued on those shares will be reinvested, or paid in cash, on the next
dividend payment date.
Capital gains
o A capital gain or loss is the difference between the purchase and sale
price of a security.
o If the fund has net capital gains for the year (after subtracting any
capital losses), they are usually declared and paid in December to
shareholders of record on a specified date that month. If a second
distribution is necessary, it is usually declared and paid during the
first quarter of the following year.
Tax information
You need to be aware of the possible tax consequences when
o you sell fund shares, including an exchange from one fund to another, or
o the fund makes a distribution to your account.
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THE FUND SENDS TIMELY INFORMATION FOR YOUR TAX FILING NEEDS.
Taxes on fund redemptions. When you sell shares in any fund, you may realize a
gain or loss. An exchange from one fund to another is still a sale for tax
purposes.
In January, the fund will send you Form 1099-B, indicating the date and amount
of each sale you made in the fund during the prior year. This information will
also be reported to the IRS. For accounts opened new or by exchange in 1983 or
later, we will provide you the gain or loss of the shares you sold during the
year, based on the "average cost" method. This information is not reported to
the IRS, and you do not have to use it. You may calculate the cost basis using
other methods acceptable to the IRS, such as "specific identification."
To help you maintain accurate records, we send you a confirmation immediately
following each transaction (except for systematic purchases and redemptions)
you make and a year-end statement detailing all your transactions in each fund
account during the year.
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DISTRIBUTIONS ARE TAXABLE WHETHER REINVESTED IN ADDITIONAL SHARES OR RECEIVED
IN CASH.
Taxes on fund distributions. The following summary does not apply to
retirement accounts, such as IRAs, which are tax-deferred until you withdraw
money from them.
In January, the fund will send you Form 1099-DIV indicating the tax status of
any dividend and capital gain distribution made to you. This information will
also be reported to the IRS. All distributions made by these funds are taxable
to you for the year in which they were paid. The fund will send you any
additional information you need to determine your taxes on fund distributions,
such as the portion of your dividends, if any, that may be exempt from state
income taxes.
Short-term capital gains are taxable as ordinary income and long-term gains
are taxable at the applicable long-term gain rate. The gain is long or short
term depending on how long the fund held the securities, not how long you held
shares in the fund. If you realize a loss on the sale or exchange of fund
shares held six months or less, your short-term loss recognized is
reclassified to long-term to the extent of any capital gain distribution
received.
If distributions from the Limited-Term Bond Fund arising from transactions in
foreign currencies or securities reduce the fund's net income, a portion of
its dividends may be classified as a return of capital. Tax treatment of
distributions is explained in the year-end tax information we send.
Tax effect of buying shares before a capital gain distribution. If you buy
shares shortly before or on the "record date" the date that establishes you as
the person to receive the upcoming distribution you will receive in the form
of a taxable distribution a portion of the money you just invested. Therefore,
you may wish to find out a fund's record date(s) before investing. Of course,
a fund's share price may at any time reflect undistributed capital gains or
unrealized appreciation.
Transaction Procedures and Special Requirements
Purchase Conditions
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FOLLOWING THESE PROCEDURES HELPS ASSURE TIMELY AND ACCURATE TRANSACTIONS.
Nonpayment. If your payment is not received or you pay with a check or ACH
transfer that does not clear, your purchase will be cancelled. You will be
responsible for any losses or expenses incurred by the fund or transfer agent,
and the fund can redeem shares you own in this or another identically
registered T. Rowe Price fund as reimbursement. The fund and its agents have
the right to reject or cancel any purchase, exchange, or redemption due to
nonpayment.
U.S. dollars. All purchases must be paid for in U.S. dollars; checks must be
drawn on U.S. banks.
Sale (Redemption) Conditions
10-day hold. If you sell shares that you just purchased and paid for by check
or ACH transfer, the fund will process your redemption but will generally
delay sending you the proceeds for up to 10 calendar days to allow the check
or transfer to clear. If your redemption request was sent by mail or mailgram,
proceeds will be mailed no later than the seventh day following receipt unless
the check or ACH transfer has not cleared. If, during the clearing period, we
receive a check drawn against your bond or money market account, it will be
returned marked "uncollected." (The 10-day hold does not apply to purchases
paid for by: bank wire; cashier's, certified, or treasurer's checks; or
automatic purchases through your paycheck.)
Telephone, Tele*Access(registered trademark) and PC*Access(registered
trademark) Transactions. These exchange and redemption services are
established automatically when you sign the New Account Form unless you check
the box which states that you do not want these services. A fund uses
reasonable procedures (including shareholder identity verification) to confirm
that instructions given by telephone are genuine and is not liable for acting
on these instructions. If these procedures are not followed, it is the opinion
of certain regulatory agencies that a fund may be liable for any losses that
may result from acting on the instructions given. All conversations are
recorded, and a confirmation is sent promptly after the telephone transaction.
Redemptions over $250,000. Large sales can adversely affect a portfolio
manager's ability to implement a fund's investment strategy by causing the
premature sale of securities that would otherwise be held. If in any 90-day
period, you redeem (sell) more than $250,000, or your sale amounts to more
than 1% of the fund's net assets, the fund has the right to delay sending your
proceeds for up to five business days after receiving your request, or to pay
the difference between the redemption amount and the lesser of the two
previously mentioned figures with securities from the fund.
Excessive Trading
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T. ROWE PRICE MAY BAR EXCESSIVE TRADERS FROM PURCHASING SHARES.
Frequent trades involving either substantial fund assets, or a substantial
portion of your account or accounts controlled by you, can disrupt management
of the fund and raise its expenses. We define "excessive trading" as exceeding
one purchase and sale involving the same fund within any 120-day period.
For example, you are in fund A. You can move substantial assets from A to fund
B, and, within the next 120 days, sell your shares in fund B to return to fund
A or move to fund C.
If you exceed the number of trades described above, you may be barred
indefinitely from further purchases of T. Rowe Price funds.
Three types of transactions are exempt from excessive trading guidelines: 1)
trades solely between money market funds; 2) redemptions that are not part of
exchanges; and 3) systematic purchases or redemptions (see "Shareholder
Services").
Keeping Your Account Open
Due to the relatively high cost to the fund of maintaining small accounts, we
ask you to maintain an account balance of at least $10,000. If your balance is
below $10,000 for three months or longer, the fund has the right to close your
account after giving you 60 days in which to increase your balance. (These
conditions may vary for retirement plan accounts.)
Signature Guarantees
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A SIGNATURE GUARANTEE IS DESIGNED TO PROTECT YOU AND THE FUND FROM FRAUD BY
VERIFYING YOUR SIGNATURE.
You may need to have your signature guaranteed in certain situations, such as:
o Written requests 1) to redeem over $50,000, or 2) to wire redemption
proceeds.
o Remitting redemption proceeds to any person, address, or bank account
not on record.
o Transferring redemption proceeds to a T. Rowe Price fund account with a
different registration from yours.
o Establishing certain services after the account is opened.
You can obtain a signature guarantee from most banks, savings institutions,
broker/dealers and other guarantors acceptable to T. Rowe Price. We cannot
accept guarantees from notaries public or organizations that do not provide
reimbursement in the case of fraud.
3 More About the Funds
The Funds' Organization and Management
How are the funds organized?
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SHAREHOLDERS BENEFIT FROM T. ROWE PRICE'S 58 YEARS OF INVESTMENT MANAGEMENT
EXPERIENCE.
The funds are "diversified, open-end investment companies," or mutual funds,
and were incorporated in Maryland in 1993. Mutual funds pool money received
from shareholders and invest it to try to achieve specified objectives.
What is meant by "shares"?
As with all mutual funds, investors purchase "shares" when they invest in a
fund. These shares are part of a fund's authorized capital stock, but share
certificates are not issued.
Each share and fractional share entitles the shareholder to:
o receive a proportional interest in a fund's income and capital gain
distributions;
o cast one vote per share on certain fund matters, including the election
of fund directors/trustees, changes in fundamental policies, or approval
of changes in a fund's management contract.
Does each fund have an annual shareholder meeting?
The funds are not required to hold annual meetings and do not intend to do so
except when certain matters, such as a change in a fund's fundamental
policies, are to be decided. In addition, shareholders representing at least
10% of all eligible votes may call a special meeting if they wish for the
purpose of voting on the removal of any fund director(s)/trustee(s). If a
meeting is held and you cannot attend, you can vote by proxy. Before the
meeting, the fund will send you proxy materials that explain the issues to be
decided and include a voting card for you to mail back.
Who runs each fund?
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ALL DECISIONS REGARDING THE PURCHASE AND SALE OF FUND INVESTMENTS ARE MADE BY
T. ROWE PRICE SPECIFICALLY BY THE FUNDS' PORTFOLIO MANAGERS.
General Oversight. The funds are governed by a Board of Directors that meets
regularly to review the fund's investments, performance, expenses, and other
business affairs. The Board elects the funds' officers. The policy of the
funds is that a majority of the Board members will be independent of T. Rowe
Price.
Portfolio Management. Each fund has an Investment Advisory Committee, whose
members are listed below. Each Committee Chairman has day-to-day
responsibility for managing the fund and works with the Committee in
developing and executing the fund's investment program.
Cash Reserves Fund. Edward A. Wiese, Chairman, Patrice L. Berchtenbreiter,
Brian E. Burns, Paul W. Boltz, Robert P. Campbell, Michael J. Conelius, Donna
M. Davis-Ennis, Laura McAree, James M. McDonald, Joan R. Potee, Robert M.
Rubino, and Gwendolyn G. Wagner. Mr. Wiese joined T. Rowe Price in 1984 and
has been managing investments since 1985.
Limited-Term Bond Fund. Edward A. Wiese, Chairman, Robert P. Campbell, Christy
M. DiPietro, Thomas E. Tewksbury, and Mark J. Vaselkiv. Mr. Wiese joined T.
Rowe Price in 1984 and has been managing investments since 1985.
GNMA Fund. Peter Van Dyke, Chairman, Paul W. Boltz, Heather R. Landon, James
M. McDonald, Edmund M. Notzon, Robert M. Rubino, Gwendolyn G. Wagner, and
Charles P. Smith. Mr. Van Dyke has been managing investments since joining T.
Rowe Price in 1985.
Marketing. T. Rowe Price Investment Services, Inc., a wholly-owned subsidiary
of T. Rowe Price, distributes (sells) shares of this and all other T. Rowe
Price funds.
Shareholder Services. T. Rowe Price Services, Inc., another wholly-owned
subsidiary, acts as the funds' transfer and dividend disbursing agent and
provides shareholder and administrative services. Services for certain types
of retirement plans are provided by T. Rowe Price Retirement Plan Services,
Inc., also a wholly-owned subsidiary. The address for each is 100 East Pratt
St., Baltimore, MD 21202.
How are fund expenses determined?
Under the management agreement, all expenses of the funds will be paid by T.
Rowe Price, except interest, taxes, brokerage commissions, directors' fees and
expenses (including counsel fees and expenses) and extraordinary expenses. The
Board of Directors of the funds reserves the right to impose additional fees
against shareholder accounts to defray expenses which would otherwise be paid
by T. Rowe Price under the management agreement. The Board does not anticipate
levying such charges; such a fee, if charged, may be retained by the fund or
paid to T. Rowe Price.
The Management Fee. Each fund pays T. Rowe Price an annual all-inclusive fee
based on its average daily net assets. The funds calculate and accrue the fee
daily. (See "Transaction and Fund Expenses.")
Understanding Performance Information
This section should help you understand the terms used to describe the funds'
performance. You will come across them in shareholder reports you receive from
us four times a year, in our newsletters, "Insights" reports, in T. Rowe Price
advertisements, and in the media.
Total Return
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TOTAL RETURN IS THE MOST WIDELY USED PERFORMANCE MEASURE. DETAILED PERFORMANCE
INFORMATION IS INCLUDED IN THE FUNDS' ANNUAL REPORTS AND QUARTERLY SHAREHOLDER
REPORTS.
This tells you how much an investment in a fund has changed in value over a
given time period. It reflects any net increase or decrease in the share price
and assumes that all dividends and capital gains (if any) paid during the
period were reinvested in additional shares. Reinvesting distributions means
that total return numbers include the effect of compounding, i.e., you receive
income and capital gain distributions on a rising number of shares.
Advertisements for the fund may include cumulative or compound average annual
total return figures, which may be compared with various indices, other
performance measures, or other mutual funds.
Cumulative Total Return
This is the actual rate of return on an investment for a specified period. A
cumulative return does not indicate how much the value of the investment may
have fluctuated between the beginning and the end of the period specified.
Average Annual Total Return
This is always hypothetical. Working backward from the actual cumulative
return, it tells you what constant year-by-year return would have produced the
actual, cumulative return. By smoothing out all the variations in annual
performance, it gives you an idea of the investment's annual contribution to
your portfolio provided you held it for the entire period in question.
Yield
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YOU WILL SEE FREQUENT REFERENCES TO THE FUNDS' YIELDS IN OUR REPORTS,
ADVERTISEMENTS, IN MEDIA STORIES, AND SO ON.
The current or "dividend yield" on the fund or any investment tells you the
relationship between the investment's current level of annual income and its
price on a particular day. The dividend yield reflects the actual income paid
to shareholders for a given period, annualized, and divided by the average
price during the given period. For example, a fund providing $5 of annual
income per share and a price of $50 has a current yield of 10%. Yields can be
calculated for any time period. The Cash Reserves Fund may advertise a
"current" yield, reflecting the latest 7-day income annualized, or an
"effective" yield, which assumes the income has been reinvested in the fund.
For the bond funds, the advertised or "SEC yield" is found by determining the
net income per share (as defined by the SEC) earned by the fund during a
30-day base period and dividing this amount by the per-share price on the last
day of the base period. The "SEC yield" may differ from the dividend yield.
Investment Policies and Practices
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FUND MANAGERS HAVE CONSIDERABLE LEEWAY IN CHOOSING INVESTMENT STRATEGIES AND
SELECTING INVESTMENTS THEY BELIEVE WILL HELP THE FUNDS ACHIEVE THEIR
OBJECTIVES.
This section takes a detailed look at some of the types of securities each
fund may hold in their portfolios and the various kinds of investment
practices that may be used in day-to-day portfolio management. The funds'
investment programs are subject to further restrictions and risks described in
the "Statement of Additional Information." Each fund adheres to applicable
investment restrictions and policies at the time it makes an investment. A
later change in circumstances will not require the sale of an investment if it
was proper at the time it was made.
Shareholder approval is required to substantively change a fund's objectives
and certain investment restrictions noted in the following section as
"fundamental policies." The managers also follow certain "operating policies"
which can be changed without shareholder approval. However, significant
changes are discussed with shareholders in fund reports.
Each fund's holdings of certain kinds of investments cannot exceed maximum
percentages of total assets, which are set forth in the prospectus. For
instance, the Limited-Term Bond Fund is not permitted to invest more than 10%
of total assets in hybrid instruments. While these restrictions provide a
useful level of detail about a fund's investment program, investors should not
view them as an accurate gauge of the potential risk of such investments. For
example, in a given period, a 5% investment in hybrid securities could have
significantly more then a 5% impact on the Limited-Term Bond Fund's share
price. The net effect of a particular investment depends on its volatility and
the size of its overall return in relation to the performance of all the
fund's other investments.
Change in a fund's holdings, the fund's performance, and the contribution of
various investments are discussed in the shareholder reports we send each
quarter.
Types of Portfolio Securities
In seeking to meet its investment objectives, each fund may invest in any type
of security or instrument (including, except for the Cash Reserves Fund,
certain potentially high risk derivatives) whose yield, credit quality, and
maturity characteristics are consistent with the fund's investment program.
These and some of the other investment techniques the funds may use are
described in the following pages.
Fundamental policy: A fund will not purchase a security if, as a result, with
respect to 75% of the fund's total assets, more than 5% of its total assets
would be invested in securities of the issuer or more than 10% of the
outstanding voting securities of the issuer would be held by a fund, provided
that those limitations do not apply to a fund's purchases of securities issued
or guaranteed by the U.S. Government, its agencies or instrumentalities.
Debt Securities. A bond or money market instrument is usually an
interest-bearing security an IOU issued by companies or governmental units.
The issuer has a contractual obligation to pay interest at a stated rate on
specific dates and to repay principal (the security's face value) on a
specified date. An issuer may have the right to redeem or "call" a security
before maturity, and the investor may have to reinvest the proceeds at lower
market rates. Money market securities may also be issued in discounted form to
reflect the rate of interest paid. In such a case, no coupon interest is paid,
but the security's price is discounted so that the interest is realized when
the security matures at face value.
A bond's annual interest income, set by its coupon rate, is usually fixed for
the life of the bond. Its yield (income as a percent of current price) will
fluctuate to reflect changes in interest rate levels. Except for adjustable
rate instruments, a money market security's interest rate, as reflected in the
coupon rate or discount, is usually fixed for the life of the security. Its
current yield (coupon or discount as a percent of current price) will
fluctuate to reflect changes in interest rate levels. A debt security's price
usually rises when interest rates fall, and vice versa so its yield is
current.
Debt securities may be unsecured (backed by the issuer's general
creditworthiness) or secured (also backed by specified collateral).
Certain debt securities have interest rates that are adjusted periodically in
order to minimize fluctuations of their principal value. When calculating its
weighted average maturity, a fund may shorten the maturity of these securities
in accordance with Rule 2a-7.
Debt securities may be senior or subordinated obligations. Senior obligations
generally have the first claim on a corporation's earnings and assets and, in
the event of liquidation, are paid before subordinated debt.
Money Market Securities. The main types of money market securities in which
the funds can invest are:
o Commercial paper unsecured promissory notes that corporations typically
issue to finance current operations and other expenditures.
o Treasury bills debt obligations sold at a discount and repaid at face
value by the U.S. Treasury. Bills mature in one year or less and are
backed by the full faith and credit of the U.S. Government.
o Certificates of deposit receipts for funds deposited at large banks that
guarantee a fixed interest rate over a specified time period.
o Repurchase agreements contracts, usually involving U.S. Government
securities, that require one party to repurchase securities at a fixed
price on a designated date.
o Banker's acceptances bank-issued commitment to pay for merchandise sold
in the import/export market.
o Agency notes debt obligations of agencies sponsored by the U.S.
Government that are not backed by the full faith and credit of the
United States.
o Medium-term notes unsecured corporate debt obligations that are
continuously offered in a broad range of maturities and structures.
o Bank notes unsecured obligations of a bank that rank on an equal basis
with other kinds of deposits but do not carry FDIC insurance.
Asset-backed Securities. An underlying pool of assets, such as credit card or
automobile trade receivables or corporate loans or bonds, backs these bonds
and provides the interest and principal payments to investors. Credit quality
depends primarily on the quality of the underlying assets and the level of
credit support, if any, provided by the issuer. The underlying assets (i.e.,
loans) are subject to prepayments which can shorten the securities' weighted
average life and may lower their return. The value of these securities also
may change because of actual or perceived changes in the creditworthiness of
the originator, servicing agent, or of the financial institution providing the
credit support. There is no limit on a funds' investment in these securities.
Mortgage-backed Securities. (Limited-Term and GNMA Funds). The funds may
invest in a variety of mortgage-backed securities. For a general description
of mortgage securities, see "Fund, Market, and Risk Characteristics: What to
Expect." Mortgage-related securities in which the funds may invest include:
o GNMA Certificates. GNMA certificates evidence interests in a pool of
underlying mortgages with a maximum life of 15 or 30 years. However, due
to both scheduled and unscheduled principal payments, GNMA certificates
have a shorter average life and, therefore, less principal volatility
than a comparable 30-year bond. Since prepayment rates vary widely, it
is not possible to accurately predict the average life of a particular
GNMA pool. However, it is standard industry practice to treat new issues
of GNMA certificates as 30-year mortgage-backed securities having an
average life of no greater than 12 years. Because the expected average
life is a better indicator of the maturity characteristics of GNMA
certificates, principal volatility and yield may be more comparable to
10-year Treasury bonds.
o GNMA Project Pass-through Securities. These securities are issued by
GNMA for multi-family projects, i.e., low to moderate income housing,
nursing homes, apartment rehabitation, housing for the elderly or
handicapped and the like. Unlike GNMA "modified pass through
certificates," these bonds provide call protection for a term stated in
the issue. The project loans can be made to either private enterprise or
non-profit groups. There are penalties assessed for prepayments during
the call protected period, creating a disincentive for early prepayment.
These bonds incorporate the same standardized procedures as
single-family pass-through certificates and full and timely payment of
principal and interest is guaranteed by GNMA.
Operating policy: The GNMA Fund will invest at least 65% of its assets in GNMA
mortgage securities.
o Collateralized Mortgage Obligations (CMOs). CMOs are debt securities
that are fully collateralized by a portfolio of mortgages or
mortgage-backed securities. All interest and principal payments from the
underlying mortgages are passed through to the CMOs in such a way as to
create, in most cases, more definite maturities than is the case with
the underlying mortgages. CMOs may pay fixed or variable rates of
interest, and certain CMOs have priority over others with respect to the
receipt of prepayments.
Operating policy: The Limited-Term and GNMA Funds may invest up to 20% and 30%
of their total assets, respectively, in CMOs.
o Stripped Mortgage Securities. Stripped mortgage securities (a
potentially high risk type of derivative) are created by separating the
interest and principal payments generated by a pool of mortgage-backed
securities or a CMO to create additional classes of securities.
Generally, one class receives only interest payments (IOs) and one
principal payments (POs). Unlike other mortgage-backed securities and
POs, the value of IOs tends to move in the same direction as interest
rates. The funds could use IOs as a hedge against falling prepaying
rates (interest rates are rising) and/or a bear market environment. POs
can be used as a hedge against rising prepayment rates (interest rates
are falling) and/or a bull market environment. IOs and POs are acutely
sensitive to interest rate changes and to the rate of principal
prepayments. A rapid or unexpected increase in prepayments can severely
depress the price of IOs, while a rapid or unexpected decrease in
prepayments could have the same effect on POs. These securities are very
volatile in price and may have lower liquidity than most other
mortgage-backed securities. Certain non-stripped CMOs may also exhibit
these qualities, especially those which pay variable rates of interest
which adjust inversely with and more rapidly than short-term interest
rates. There is no guarantee the fund's investment in CMOs, IOs or POs
will be successful, and the fund's total return could be adversely
affected as a result.
Operating policy: The Limited-Term Bond and GNMA funds may each invest up to
10% of their total assets in stripped mortgage securities.
Hybrid Instruments (Limited-Term and GNMA Funds). These instruments (a
potentially high risk type of derivative) can combine the characteristics of
securities, futures and options. For example, the principal amount or interest
rate of a hybrid could be tied (positively or negatively) to the price of some
commodity, currency or securities index or another interest rate (each a
"benchmark"). Hybrids can be used as an efficient means of pursuing a variety
of investment goals, including currency hedging, duration management, and
increased total return. Hybrids may not bear interest or pay dividends. The
value of a hybrid or its interest rate may be a multiple of a benchmark and,
as a result, may be leveraged and move (up or down) more steeply and rapidly
than the benchmark. These benchmarks may be sensitive to economic and
political events, such as commodity shortages and currency devaluations, which
cannot be readily foreseen by the purchaser of a hybrid. Under certain
conditions, the redemption value of a hybrid could be zero. Hybrids can have
volatile prices and limited liquidity. Thus, an investment in a hybrid may
entail significant market risks that are not associated with a similar
investment in a traditional, U.S. dollar-denominated bond that has a fixed
principal amount and pays a fixed rate or floating rate of interest. The
purchase of hybrids also exposes the fund to the credit risk of the issuer of
the hybrid. These risks may cause significant fluctuations in the net asset
value of the fund. There is no assurance that the fund's investment in hybrids
will be successful.
Operating policy: The Limited-Term Bond and GNMA funds may each invest up to
10% of its total assets in hybrid instruments.
High Yield/High Risk Investing (Limited-Term Fund). The total return and yield
of lower quality (high yield/high risk) bonds, commonly referred to as "junk
bonds," can be expected to fluctuate more than the total return and yield of
higher quality, shorter-term bonds. Junk bonds are regarded as predominantly
speculative with respect to the issuer's continuing ability to meet principal
and interest payments. Successful investment in low and lower-medium quality
bonds involves greater investment risk and is highly dependent on T. Rowe
Price's credit analysis. A real or perceived economic downturn or higher
interest rates could cause a decline in high yield bond prices, because such
events could lessen the ability of issuers to make principal and interest
payments. These bonds are thinly traded and can be more difficult to sell and
value accurately than high-quality bonds. Because objective pricing data may
be less available, judgment may play a greater role in the valuation process.
Operating policy: The Limited-Term Fund will not purchase a non-investment
grade debt security (or junk bond) if immediately after such purchase the fund
would have more than 10% of its total assets invested in such securities.
Private Placements. These securities are sold directly to a small number of
investors, usually institutions. Unlike public offerings, such securities are
not registered with the SEC. Although certain of these securities may be
readily sold, for example under Rule 144A, others may be illiquid and their
sale may involve substantial delays and additional costs.
Operating policy: No fund will invest more than 15% of its net assets (10% for
Cash Reserves) in illiquid securities.
Foreign Securities (Cash Reserves and Limited-Term Funds). The Limited-Term
Fund may invest in foreign securities, including nondollar-denominated
securities traded outside of the U.S. The Cash Reserves and Limited-Term Funds
may invest without limitation in U.S. dollar-denominated securities that are
issued and principally traded outside the U.S. Such investments increase a
portfolio's diversification and may enhance return, but they also involve some
special risks such as exposure to potentially adverse local political and
economic developments; nationalization and exchange controls; potentially
lower liquidity and higher volatility; possible problems arising from
accounting, disclosure, settlement, and regulatory practices that differ from
U.S. standards; and the chance that fluctuations in foreign exchange rates
will decrease the investment's value (favorable changes can increase its
value).
Operating policy: The Limited-Term and Cash Reserves Funds may invest without
limitation in U.S. dollar-denominated debt securities of foreign issuers. The
Limited-Term Fund may invest up to 10% of its total assets (excluding
reserves) in non-U.S. dollar-denominated fixed-income securities principally
traded in financial markets outside the United States.
Types of Management Practices
Cash Position (Limited-Term and GNMA Funds). The funds will hold a certain
portion of their assets in U.S. (and foreign dollar-denominated) money market
securities, including repurchase agreements, in the two highest rating
categories, maturing in one year or less. For temporary, defensive purposes, a
fund may invest without limitation in such securities. This reserve position
provides flexibility in meeting redemptions, expenses, and the timing of new
investments, and serves as a short-term defense during periods of unusual
market volatility.
Borrowing Money and Transferring Assets. The funds can borrow money from banks
as a temporary measure for emergency purposes, to facilitate redemption
requests, or for other purposes consistent with the funds' investment
objectives and program. Such borrowings may be collateralized with fund
assets, subject to restrictions.
Fundamental policy: Borrowings may not exceed 33 1/3% of total fund assets.
Operating policies: The funds may not transfer as collateral any portfolio
securities except as necessary in connection with permissible borrowings or
investments, and then such transfers may not exceed 33 1/3% of the fund's
total assets. The funds may not purchase additional securities when borrowings
exceed 5% of total assets.
Futures and Options (Limited-Term and GNMA Funds). Futures (a type of
potentially high risk derivative) are often used to manage or hedge risk,
because they enable the investor to buy or sell an asset in the future at an
agreed upon price. Options (another type of potentially high risk derivative)
give the investor the right, but not the obligation, to buy or sell an asset
at a predetermined price in the future. A fund may buy and sell futures
contracts (and options on such contracts) for a number of reasons including:
to manage its exposure to changes in interest rates, bond prices, and foreign
currencies; as an efficient means of adjusting its overall exposure to certain
markets; to protect portfolio value; and to adjust the portfolio's duration. A
fund may purchase, sell, or write call and put options on securities,
financial indices, and foreign currencies.
Futures contracts and options may not always be successful hedges; their
prices can be highly volatile; using them could lower a fund's total return
and the potential loss from the use of futures can exceed a fund's initial
investment in such contracts.
Operating policies: Futures: Initial margin deposits and premiums on options
used for non-hedging purposes will not equal more than 5% of a fund's net
asset value. Options on securities: The total market value of securities
against which a fund has written call or put options may not exceed 25% of its
total assets. Each fund will not commit more than 5% of their total assets to
premiums when purchasing call or put options.
Interest Rate Swaps (Limited-Term and GNMA Funds). The funds may enter into
various interest rate transactions such as interest rate swaps and the
purchase or sale of interest rate caps and floors, to preserve a return or
spread on a particular investment or portion of its portfolio, to create
synthetic securities, or to structure transactions designed for other
non-speculative purposes.
Operating policy: The funds will not invest more than 10% of their total
assets in interest rate swaps.
Managing Foreign Currency Risk (Limited-Term Fund). Investors in foreign
securities may "hedge" their exposure to potentially unfavorable currency
changes by purchasing a contract to exchange one currency for another on some
future date at a specified exchange rate. In certain circumstances, a "proxy
currency" may be substituted for the currency in which the investment is
denominated, a strategy known as "proxy hedging." The fund might also use
these contracts to create a synthetic bond - issued by a U.S. company, for
example, but with the dollar component transformed into a foreign currency.
Although foreign currency transactions will be used primarily to protect the
fund's foreign securities from adverse currency movements relative to the
dollar, they involve the risk that anticipated currency movements will not
occur and the fund's total return could be reduced.
Operating policy: The Limited-Term Fund will not commit more than 10% of its
total assets to forward currency contracts.
Lending of Portfolio Securities. Like other mutual funds, the funds may lend
securities to broker-dealers, other institutions, or other persons to earn
additional income. The principal risk is the potential insolvency of the
broker-dealer or other borrower. In this event, the fund could experience
delays in recovering its securities and possibly capital losses.
Fundamental policy: The value of loaned securities may not exceed 33 1/3% of a
fund's total assets.
When-issued securities (All Funds) and Forward Commitment Contracts
(Limited-Term and GNMA Funds). Each fund may purchase securities on a
when-issued or delayed delivery basis or may purchase or sell securities on a
forward commitment basis. There is no limit on a fund's investment in these
securities. The price of these securities is fixed at the time of the
commitment to buy, but delivery and payment can take place a month or more
later. During the interim period, the market value of the securities can
fluctuate, and no interest accrues to the purchaser. At the time of delivery,
the value of the securities may be more or less than the purchase or sale
price. To the extent a fund remains fully or almost fully invested (in
securities with a remaining maturity of more than one year) at the time it
purchases these securities, there will be greater fluctuations in the fund's
net asset value than if the fund did not purchase them.
Portfolio Turnover (Limited-Term and GNMA Funds). Although a fund will not
generally trade for short-term profits, circumstances may warrant a sale
without regard to the length of time a security was held. A high turnover rate
may increase transaction costs and result in additional gains. The
Limited-Term and GNMA Fund's annualized portfolio turnover rates for the
fiscal year ended October 31, 1994 were 296.0% and 61.5%, respectively. In
executing transactions, each fund's Board has authorized T. Rowe Price to use
certain brokers who are indirectly related to T. Rowe Price.
Bond Ratings and High-Yield Bonds. Larger bond issues are evaluated by rating
agencies such as Moody's and Standard & Poor's on the basis of the issuer's
ability to meet all required interest and principal payments. T. Rowe Price
research analysts also evaluate all portfolio holdings of the funds, including
those rated by an outside agency. Other things being equal, lower rated bonds
have higher yields due to greater risk. "High-yield" bonds also called "junk",
are those rated below BBB (see Table 6).
Ratings of Corporate Debt Securities
Moody's Standard Fitch Investors Definition
Investors & Poor's Service, Inc.
Service, Inc. Corporation
__________________________________________________________________________
Long-Term Aaa AAA AAA Highest quality
_______________________________________________________________
Aa AA AA High quality
_______________________________________________________________
A A A Upper medium grade
_______________________________________________________________
Baa BBB BBB Medium grade
_______________________________________________________________
Ba BB BB Low grade
_______________________________________________________________
B B B Speculative
_______________________________________________________________
Caa, Ca CCC, CC CCC, CC Submarginal
_______________________________________________________________
Ca C C Income bond,
no interest
paid
_______________________________________________________________
C D DDD,DD,D Probably in
default
_______________________________________________________________
Moody's S&P Fitch
___________________________________________________________________________
Commercial P-1 Superior A-1+ Extremely F-1+ Except-
Paper quality quality ionally
strong strong
quality
_______________________________________________________________
A-1 Strong F-1 Very
quality strong
quality
___________________________________________________________________________
P-2 Strong A-2 Satisfac- F-2 Good
quality tory quality
quality
___________________________________________________________________________
P-3 Acceptable A-3 Adequate F-3 Fair
quality quality credit
quality
___________________________________________________________________________
B Specula- F-S Weak
tive credit
quality quality
___________________________________________________________________________
C Doubtful
` quality
___________________________________________________________________________
Table 6
Asset Composition. Table 7 shows the average credit quality allocation of the
Limited-Term Bond Fund's assets for the fiscal year ended October 31, 1994.
(Equities and reserves are excluded.) Percentages are computed on a
dollar-weighted basis and are an average of 12 monthly calculations.
Limited-Term Bond Fund Asset Composition
Standard & Poor's Percentage of TRPS's Assessment
Rating Total Assets Not Rated Securities
AAA 2.7 69.5
__________________________________________________________________________
AA 1.5 0.1
__________________________________________________________________________
A 4.7 0.0
__________________________________________________________________________
BBB 7.7 1.2
__________________________________________________________________________
BB 2.3 0.0
__________________________________________________________________________
B 4.4 1.1
__________________________________________________________________________
CCC 0.0 0.0
__________________________________________________________________________
CC 0.0 0.0
__________________________________________________________________________
C 0.0 0.0
__________________________________________________________________________
D 0.0 0.0
__________________________________________________________________________
Not Rated 71.9 0.0
__________________________________________________________________________
95.2% 71.9%
__________________________________________________________________________
Table 7
4 Investing with T. Rowe Price
Meeting Requirements for New Accounts
Tax Identification Number
__________________________________________________________________________
ALWAYS VERIFY YOUR TRANSACTIONS BY CAREFULLY REVIEWING THE CONFIRMATION WE
SEND YOU. PLEASE REPORT ANY DISCREPANCIES TO SHAREHOLDER SERVICES.
We must have your correct social security or corporate tax identification
number on a signed New Account Form or W-9 Form. Otherwise, federal law
requires the funds to withhold a percentage (currently 31%) of your dividends,
capital gain distributions, and redemptions, and may subject you to an IRS
fine. If this information is not received within 60 days after your account is
established, your account may be redeemed, priced at the NAV on the date of
redemption.
Unless you request otherwise, one shareholder report will be mailed to
multiple account owners with the same tax identification number and same zip
code and to shareholders who have requested that their account be combined
with someone else's for financial reporting.
Opening a New Account: $25,000 minimum initial investment
Account Registration
If you own other T. Rowe Price funds, be sure to register any new account just
like your existing accounts so you can exchange among them easily. (The name
and account type would have to be identical.)
__________________________________________________________________________
REGULAR MAIL
T. ROWE PRICE
ACCOUNT SERVICES
P.O. BOX 17300
BALTIMORE, MD
21298-9353
MAILGRAM, EXPRESS,
REGISTERED, OR CERTIFIED MAIL
T. ROWE PRICE
ACCOUNT SERVICES
10090 RED RUN BLVD.
OWINGS MILLS, MD 21117
By Mail
Please make your check payable to T. Rowe Price Funds (otherwise it will be
returned). Send your check together with the New Account Form to the address
at left. We do not accept third party checks, except for IRA Rollover checks,
to open new accounts.
By Wire
o Call Investor Services for an account number and give the following wire
address to your bank: Morgan Guaranty Trust Co. of New York, ABA#
021000238, T. Rowe Price [fund name], AC-00153938, account name(s), and
account number.
o Complete a New Account Form and mail it to one of the appropriate
addresses listed at left.
Note: No services will be established and IRS penalty withholding may occur
until a signed New Account Form is received. Also, retirement plans cannot be
opened by wire.
By Exchange
Call Shareholder Services or use Tele*Access(registered trademark) or
PC*Access(registered trademark) (see "Automated Services" under "Shareholder
Services"). The new account will have the same registration as the account
from which you are exchanging. Services for the new account may be carried
over by telephone request if preauthorized on the existing account. (See
explanation of "Excessive Trading" under "Transaction Procedures.")
In Person
Drop off your New Account Form at any of the locations listed below and obtain
a receipt.
Drop-off locations
101 East Lombard St. T. Rowe Price Farragut Square ARCO Tower
Baltimore, MD Financial Center 900 17th St., N.W. 31st Floor
10090 Red Run Blvd. Washington, DC 515 South
Owings Mills, MD Flower St.
Los Angeles, CA
Note: The fund and its agents reserve the right to waive or lower investment
minimums; to accept initial purchases by telephone or mailgram; cancel or
rescind any purchase or exchange (for example, if an account has been
restricted due to excessive trading or fraud) upon notice to the shareholder
within five business days of the trade or if the written confirmation has not
been received by the shareholder, whichever is sooner; to act on instructions
believed to be genuine; to freeze any account and temporarily suspend services
on the account when notice has been received of a dispute between the
registered or beneficial owners or there is reason to believe a fraudulent
transaction may occur; or to otherwise modify the conditions of purchase or
any services at any time.
Purchasing Additional Shares: $1,000 minimum purchase;
$100 minimum for retirement plans and Automatic Asset Builder
By ACH Transfer
Use Tele*Access(registered trademark), PC*Access(registered trademark) or call
Investor Services if you have established electronic transfers using the ACH
network.
By Wire
Call Shareholder Services or use the wire address in "Opening a New Account."
__________________________________________________________________________
REGULAR MAIL
T. ROWE PRICE FUNDS
ACCOUNT SERVICES
P.O. BOX 89000
BALTIMORE, MD
21289-1500
By Mail
o Provide your account number and the fund name on your check.
o Mail the check to us at the address shown at left either with a fund
reinvestment slip or a note indicating the fund and account number in
which you wish to purchase shares.
By Automatic Asset Builder
Fill out the Automatic Asset Builder section on the New Account or Shareholder
Services Form ($100 minimum).
Exchanging and Redeeming Shares
By Phone
Call Shareholder Services. If you find our phones busy during unusually
volatile markets, please consider placing your order by Tele*Access(registered
trademark), PC*Access(registered trademark) (if you have previously authorized
telephone services), mailgram or by express mail. For exchange policies,
please see "Transaction Procedures and Special Requirements - Excessive
Trading."
Redemption proceeds can be mailed to your account address, sent by ACH
transfer, or wired to your bank (provided your bank information is already on
file). For charges, see "Electronic Transfers - By Wire" under "Shareholder
Services."
__________________________________________________________________________
MAILGRAM, EXPRESS,
REGISTERED, OR
CERTIFIED MAIL
(SEE "OPENING A NEW ACCOUNT.")
By Mail
Provide account name(s) and numbers, fund name(s), and exchange or redemption
amount. For exchanges, mail to the appropriate address below or at left,
indicate the fund you are exchanging from and the fund(s) you are exchanging
into. T. Rowe Price requires the signatures of all owners exactly as
registered, and possibly a signature guarantee (see "Transaction Procedures
and Special Requirements Signature Guarantees").
Regular Mail
For nonretirement and IRA accounts:
T. Rowe Price Account Services
P.O. Box 89000
Baltimore, MD 21289-0220
For employer-sponsored retirement accounts:
T. Rowe Price Trust Company
P.O. Box 89000
Baltimore, MD 21289-0300
__________________________________________________________________________
T. ROWE PRICE TRUST
COMPANY
1-800-492-7670
1-410-625-6585
Note: Redemptions from retirement accounts, including IRAs, must be in
writing. Please call Shareholder Services to obtain an IRA Distribution
Request Form. For employer-sponsored retirement accounts, call T. Rowe Price
Trust Company or your plan administrator for instructions.
Shareholder Services
__________________________________________________________________________
SHAREHOLDER SERVICES
1-800-225-5132
1-410-625-6500
Many services are available to you as a T. Rowe Price shareholder; some you
receive automatically and others you must authorize on the New Account Form.
By signing up for services on the New Account Form rather than later, you
avoid having to complete a separate form and obtain a signature guarantee.
This section reviews some of the principal services currently offered. Our
Services Guide contains detailed descriptions of these and other services. If
you are a new T. Rowe Price investor, you will receive a Services Guide with
our Welcome Kit.
Note: Corporate and other institutional accounts require an original or
certified resolution to establish services and to redeem by mail. For more
information, call Investor Services.
Retirement Plans
We offer a wide range of plans for individuals and institutions, including
large and small businesses: IRAs, SEP-IRAs, Keoghs (profit sharing, money
purchase pension), 401(k), and 403(b)(7). For information on IRAs, call
Investor Services. For information on all other retirement plans, please call
our Trust Company at 1-800-492-7670.
__________________________________________________________________________
INVESTOR SERVICES
1-800-638-5660
1-410-547-2308
Exchange Service
You can move money from one account to an existing identically registered
account, or open a new identically registered account. Remember, exchanges are
purchases and sales for tax purposes. (Exchanges into a state tax-free fund
are limited to investors living in states where the funds are registered.)
Some of the T. Rowe Price funds may impose a redemption fee of .50% to 2%,
payable to such funds, on shares held for less than one year, or in some
funds, six months.
Automated Services
Tele*Access(registered trademark). 24-hour service via toll-free number
provides information on fund yields and prices, dividends, account balances,
and your latest transaction as well as the ability to request prospectuses,
account and tax forms, duplicate statements, checks and to initiate purchase,
redemption and exchange orders in your accounts (see "Electronic Transfers"
below).
PC*Access(registered trademark). 24-hour service via dial-up modem provides
the same information as Tele*Access, but on a personal computer. Please call
Investor Services for an information guide.
Telephone and Walk-In Services
Buy, sell, or exchange shares by calling one of our service representatives or
by visiting one of our four investor center locations whose addresses are
listed on the cover.
Electronic Transfers
By ACH. With no charges to pay, you can initiate a purchase or redemption for
as little as $100 or as much as $100,000 between your bank account and fund
account using the ACH network. Enter instructions via Tele*Access, PC*Access
or call Shareholder Services.
By Wire. Electronic transfers can also be conducted via bank wire. There is
currently a $5 fee for wire redemptions under $5,000, and your bank may charge
for incoming or outgoing wire transfers regardless of size.
Checkwriting (Not available for Equity Funds, High Yield and Emerging Markets
Bond Funds.)
You may write an unlimited number of free checks on any money market funds,
and most bond funds, with a minimum of $500 per check. Keep in mind, however,
that a check results in a redemption; a check written on a bond fund will
create a taxable event which you and we must report to the IRS.
Automatic Investing ($100 minimum)
You can invest automatically in several different ways, including:
o Automatic Asset Builder. You instruct us to move $100 or more once a
month or less often from your bank account, or you can instruct your
employer to send all or a portion of your paycheck to the fund or funds
you designate.
o Automatic Exchange. Enables you to set up systematic investments from
one fund account into another, such as from a money fund into a stock
fund.
Discount Brokerage
You can trade stocks, bonds, options, precious metals, and other securities at
a savings over regular commission rates. Call Investor Services for
information.
Note: If you buy or sell T. Rowe Price Funds through anyone other than T. Rowe
Price, such as broker-dealers or banks, you may be charged transaction or
service fees by those institutions. No such fees are charged by T. Rowe Price
Investment Services or the fund for transactions conducted directly with the
fund.
______________________________________________________________________________
DESCRIPTION OF SIGNIFICANT DIFFERENCES BETWEEN EDGAR FILING
AND PRINTED COPY
Information appearing in all capital letters before a paragraph in the Edgar
filing will appear, in the printed copy, as call-outs in the left margin.
PAGE 2
STATEMENT OF ADDITIONAL INFORMATION
T. ROWE PRICE SUMMIT FUNDS, INC.
T. Rowe Price Summit Cash Reserves Fund
T. Rowe Price Summit Limited-Term Bond Fund
T. Rowe Price Summit GNMA Fund
(the "Funds")
This Statement of Additional Information is not a prospectus
but should be read in conjunction with the Funds' prospectus
dated March 1, 1995, which may be obtained from T. Rowe Price
Investment Services, Inc., 100 East Pratt Street, Baltimore,
Maryland 21202.
The date of this Statement of Additional Information is
March 1, 1995.
PAGE 3
TABLE OF CONTENTS
Page Page
Adjustable Rate Securities Investment Objectives
Adjustable Rate Mortgage . and Policies . . . . . .
Securities . . . . . . . . Investment Performance .
Asset-Backed Securities . . Investment Program . . .
Capital Stock . . . . . . . Investment Restrictions .
Code of Ethics . . . . . . Legal Counsel . . . . . .
Custodian . . . . . . . . . Lending of Portfolio
Distributor for Funds . . . Securities . . . . . . .
Dividends . . . . . . . . . Management of Funds . . .
Federal and State Registration Money Market Securities .
of Shares . . . . . . . . Mortgage-Related
Foreign Currency Securities . . . . . . .
Transactions . . . . . . . Net Asset Value Per
Foreign Securities . . . . Share . . . . . . . . .
Futures Contracts . . . . . Options . . . . . . . . .
Hybrid Commodity and Security Portfolio Transactions .
Instruments . . . . . . . Pricing of Securities . .
Illiquid or Restricted . . Principal Holders of
Securities . . . . . . . . Securities . . . . . . .
Independent Accountants . . Ratings of Commercial
Industry Concentration . . Paper . . . . . . . . .
Instruments . . . . . . . Ratings of Corporate
Illiquid or Restricted . . Debt Securities . . . .
Securities . . . . . . . . Repurchase Agreements . .
Independent Accountants . . Risk Factors . . . . . .
Industry Concentration . . Tax Status . . . . . . .
Interest Rate When-Issued Securities and
Transactions . . . . . . . Forward Commitment
Investment Management Contracts . . . . . . .
Services . . . . . . . . . Yield Information . . . .
INVESTMENT OBJECTIVES AND POLICIES
The following information supplements the discussion of the
Funds' investment objectives and policies discussed in the
prospectus. The Funds will not make a material change in their
investment objectives without obtaining shareholder approval.
Unless otherwise specified, the investment programs and
restrictions of the Funds are not fundamental policies. Each
Fund's operating policies are subject to change by its Board of
Directors without shareholder approval. However, shareholders
will be notified of a material change in an operating policy.
PAGE 4
Each Fund's fundamental policies may not be changed without the
approval of at least a majority of the outstanding shares of the
Fund or, if it is less, 67% of the shares represented at a
meeting of shareholders at which the holders of 50% or more of
the shares are represented.
Throughout this Statement of Additional Information, "the
Fund" is intended to refer to each Fund listed on the cover page,
unless otherwise indicated.
RISK FACTORS
Cash Reserves Fund
There can be no assurance that the Fund will achieve its
investment objectives or be able to maintain its net asset value
per share at $1.00. The price of the Fund is not guaranteed or
insured, and its yield is not fixed. While the Fund invests in
high-grade money market instruments, investment in the Fund is
not without risk even if all portfolio instruments are paid in
full at maturity. An increase in interest rates could reduce the
value of the Fund's portfolio investments, and a decline in
interest rates could increase the value. Reference is also made
to the sections entitled "Types of Securities" and "Portfolio
Management Practices" for discussions of the risks associated
with the investments and practices described therein as they
apply to the Fund.
Limited-Term Fund
Because of its investment policy, the Fund may not be
suitable or appropriate for all investors. The Fund is not a
money market fund and is not an appropriate investment for those
whose primary objective is principal stability. There is risk in
all investment. The Fund is designed for the investor who seeks
to participate in a diversified portfolio of short- and
intermediate-term investment grade bonds and other debt
securities (up to 10% of which may be below investment grade)
which provide a higher rate of income than a money market fund
and less risk of capital fluctuation than a portfolio of long-
term debt securities. The value of the portfolio securities of
the Fund will fluctuate based upon market conditions. Although
the Fund seeks to reduce risk by investing in a diversified
portfolio, such diversification does not eliminate all risk.
There can, of course, be no assurance that the Fund will achieve
these results. Reference is also made to the sections entitled
PAGE 5
"Types of Securities" and "Portfolio Management Practices" for
discussions of the risks associated with the investments and
practices described therein as they apply to the Fund.
GNMA Fund
The Fund may or may not be suitable or appropriate for all
investors. The Fund is designed for investors seeking the
highest current income and credit protection available from
investment in securities which are backed by the full faith and
credit of the U.S. Government and other securities rated within
the highest two credit categories established by a nationally
recognized public rating agency, or, if unrated, of equivalent
quality as determined by T. Rowe Price Associates, Inc. ("T. Rowe
Price"). Consistent with a long-term investment approach,
investors in the Fund should not rely on the Fund for their
short-term financial needs. The value of the portfolio
securities of the Fund will fluctuate based upon market
conditions. Although the Fund seeks to reduce risk by investing
in a diversified portfolio, such diversification does not
eliminate all risk. There can, of course, be no assurance that
the Fund will achieve these results. Reference is also made to
the sections entitled "Types of Securities" and "Portfolio
Management Practices" for discussions of the risks associated
with the investments and practices described therein as they
apply to the Fund.
Because they consist of underlying mortgages, GNMA
Securities may not be an effective means of "locking in" long-
term interest rates due to the need for the Fund to reinvest
scheduled and unscheduled principal payments. The incidence of
unscheduled principal prepayments is also likely to increase in
mortgage pools owned by the Fund when prevailing mortgage loan
rates fall below the mortgage rates of the securities underlying
the individual pool. The effect of such prepayments in a falling
rate environment is to (1) cause the Fund to reinvest principal
payments at the then lower prevailing interest rate, and (2)
reduce the potential for capital appreciation beyond the face
amount of the security and adversely affect the return to the
Fund. Conversely, in a rising interest rate environment such
prepayments can be reinvested at higher prevailing interest rates
which will reduce the potential effect of capital depreciation to
which bonds are subject when interest rates rise. In addition,
prepayments of mortgage securities purchased at a premium (or
discount) will cause such securities to be paid off at par,
resulting in a loss (gain) to the Fund. T. Rowe Price will
PAGE 6
actively manage the Fund's portfolio in an attempt to reduce the
risk associated with investment in mortgage-backed securities.
Debt Obligations
Yields on short, intermediate, and long-term securities are
dependent on a variety of factors, including the general
conditions of the money and bond markets, the size of a
particular offering, the maturity of the obligation, and the
credit quality and rating of the issue. Debt securities with
longer maturities tend to have higher yields and are generally
subject to potentially greater capital appreciation and
depreciation than obligations with shorter maturities and lower
yields. The market prices of debt securities usually vary,
depending upon available yields. An increase in interest rates
will generally reduce the value of portfolio debt securities, and
a decline in interest rates will generally increase the value of
portfolio debt securities. The ability of the Fund to achieve
its investment objective is also dependent on the continuing
ability of the issuers of the debt securities in which the Fund
invests to meet their obligations for the payment of interest and
principal when due. Although the Fund seeks to reduce risk by
portfolio diversification, credit analysis, and attention to
trends in the economy, industries and financial markets, such
efforts will not eliminate all risk. There can, of course, be no
assurance that the Fund will achieve its investment objective.
After purchase by the Fund, a debt security may cease to be
rated or its rating may be reduced below the minimum required for
purchase by the Fund. For the Cash Reserves Fund, the procedures
set forth in Rule 2a-7, under the Investment Company Act of 1940,
may require the prompt sale of any such security. For the other
Funds, neither event will require a sale of such security by the
Fund. However, T. Rowe Price will consider such event in its
determination of whether the Fund should continue to hold the
security. To the extent that the ratings given by Moody's or S&P
may change as a result of changes in such organizations or their
rating systems, the Fund will attempt to use comparable ratings
as standards for investments in accordance with the investment
policies contained in the prospectus. When purchasing unrated
securities, T. Rowe Price, under the supervision of the Fund's
Board of Directors, determines whether the unrated security is of
a qualify comparable to that which the Fund is allowed to
purchase.
Reference is also made to the sections entitled "Types of
Securities" and "Portfolio Management Practices" for discussions
PAGE 7
of the risks associated with the investments and practices
described therein as they apply to the Fund.
All Funds (except Cash Reserves Fund)
Because of its investment policy, the Fund may or may not be
suitable or appropriate for all investors. The Fund is not a
money market fund and is not an appropriate investment for those
whose primary objective is principal stability. The value of the
portfolio securities of the Fund will fluctuate based upon market
conditions. Although the Fund seeks to reduce risk by investing
in a diversified portfolio, such diversification does not
eliminate all risk. There can, of course, be no assurance that
the Fund will achieve its investment objective.
Cash Reserves Fund
There can be no assurance that the Fund will achieve their
investment objectives or be able to maintain their net asset
value per share at $1.00. The price of the Fund is not
guaranteed or insured by the U.S. Government and its yield is not
fixed. An increase in interest rates could reduce the value of
the Fund's portfolio investments, and a decline in interest rates
could increase the value.
All Funds (except Cash Reserves Fund)
Mortgage securities differ from conventional bonds in that
principal is paid back over the life of the security rather than
at maturity. As a result, the holder of a mortgage security
(i.e., the Fund) receives monthly scheduled payments of principal
and interest, and may receive unscheduled principal payments
representing prepayments on the underlying mortgages. The
incidence of unscheduled principal prepayments is also likely to
increase in mortgage pools owned by the Fund when prevailing
mortgage loan rates fall below the mortgage rates of the
securities underlying the individual pool. The effect of such
prepayments in a falling rate environment is to (1) cause the
Fund to reinvest principal payments at the then lower prevailing
interest rate, and (2) reduce the potential for capital
appreciation beyond the face amount of the security. Conversely,
the Fund may realize a gain on prepayments of mortgage pools
trading at a discount. Such prepayments will provide an early
return of principal which may then be reinvested at the then
higher prevailing interest rate.
PAGE 8
The market value of adjustable rate mortgage securities
("ARMs"), like other U.S. government securities, will generally
vary inversely with changes in market interest rates, declining
when interest rates rise and rising when interest rates decline.
Because of their periodic adjustment feature, ARMs should be more
sensitive to short-term interest rates than long-term rates.
They should also display less volatility than long-term mortgage
securities. Thus, while having less risk of a decline during
periods of rapidly rising rates, ARMs may also have less
potential for capital appreciation than other investments of
comparable maturities. Interest rate caps on mortgages
underlying ARM securities may prevent income on the ARM from
increasing to prevailing interest rate levels and cause the
securities to decline in value. In addition, to the extent ARMs
are purchased at a premium, mortgage foreclosures and unscheduled
principal prepayments may result in some loss of the holders'
principal investment to the extent of the premium paid. On the
other hand, if ARMs are purchased at a discount, both a scheduled
payment of principal and an unscheduled prepayment of principal
will increase current and total returns and will accelerate the
recognition of income which when distributed to shareholders will
be taxable as ordinary income.
Cash Reserves and Limited-Term Bond Funds
Risk Factors of Foreign Investing
There are special risks in foreign investing. Certain of
these risks are inherent in any mutual fund investing in foreign
securities while others relate more to the countries in which the
Funds will invest. Many of the risks are more pronounced for
investments in developing or emerging countries, such as many of
the countries of Southeast Asia, Latin America, Eastern Europe
and the Middle East. Although there is no universally accepted
definition, a developing country is generally considered to be a
country which is in the initial stages of its industrialization
cycle with a per capita gross national product of less than
$8,000.
Political and Economic Factors. Individual foreign
economies of certain countries may differ favorably or
unfavorably from the United States' economy in such respects as
growth of gross national product, rate of inflation, capital
reinvestment, resource self-sufficiency and balance of payments
position. The internal politics of certain foreign countries are
not as stable as in the United States. For example, in 1991, the
existing government in Thailand was overthrown in a military
PAGE 9
coup. In 1992, there were two military coup attempts in
Venezuela and in 1992 the President of Brazil was impeached. In
addition, significant external political risks currently affect
some foreign countries. Both Taiwan and China still claim
sovereignty of one another and there is a demilitarized border
between North and South Korea.
Governments in certain foreign countries continue to
participate to a significant degree, through ownership interest
or regulation, in their respective economies. Action by these
governments could have a significant effect on market prices of
securities and payment of dividends. The economies of many
foreign countries are heavily dependent upon international trade
and are accordingly affected by protective trade barriers and
economic conditions of their trading partners. The enactment by
these trading partners of protectionist trade legislation could
have a significant adverse effect upon the securities markets of
such countries.
Currency Fluctuations. The Funds will invest in securities
denominated in various currencies. Accordingly, a change in the
value of any such currency against the U.S. dollar will result in
a corresponding change in the U.S. dollar value of the Funds'
assets denominated in that currency. Such changes will also
affect the Funds' income. Generally, when a given currency
appreciates against the dollar (the dollar weakens) the value of
the Fund's securities denominated in that currency will rise.
When a given currency depreciates against the dollar (the dollar
strengthens) the value of the Funds' securities denominated in
that currency would be expected to decline.
Investment and Repatriation of Restrictions. Foreign
investment in the securities markets of certain foreign countries
is restricted or controlled in varying degrees. These
restrictions may limit at times and preclude investment in
certain of such countries and may increase the cost and expenses
of the Funds. Investments by foreign investors are subject to a
variety of restrictions in many developing countries. These
restrictions may take the form of prior governmental approval,
limits on the amount or type of securities held by foreigners,
and limits on the types of companies in which foreigners may
invest. Additional or different restrictions may be imposed at
any time by these or other countries in which the Funds invest.
In addition, the repatriation of both investment income and
capital from several foreign countries is restricted and
PAGE 10
controlled under certain regulations, including in some cases the
need for certain government consents. For example, capital
invested in Chile normally cannot be repatriated for one year.
Market Characteristics. Foreign stock and bond markets are
generally not as developed or efficient as, and may be more
volatile than, those in the United States. While growing in
volume, they usually have substantially less volume than U.S.
markets and the Funds' portfolio securities may be less liquid
and subject to more rapid and erratic price movements than
securities of comparable U.S. companies. Equity securities may
trade at price/earnings multiples higher than comparable United
States securities and such levels may not be sustainable. Fixed
commissions on foreign stock exchanges are generally higher than
negotiated commissions on United States exchanges, although the
Funds will endeavor to achieve the most favorable net results on
their portfolio transactions. There is generally less government
supervision and regulation of foreign stock exchanges, brokers
and listed companies than in the United States. Moreover,
settlement practices for transactions in foreign markets may
differ from those in United States markets. Such differences may
include delays beyond periods customary in the United States and
practices, such as delivery of securities prior to receipt of
payment, which increase the likelihood of a "failed settlement."
Failed settlements can result in losses to a Fund.
Investment Funds. The Funds may invest in investment funds
which have been authorized by the governments of certain
countries specifically to permit foreign investment in securities
of companies listed and traded on the stock exchanges in these
respective countries. The Funds' investment in these funds is
subject to the provisions of the 1940 Act. If the Funds invest
in such investment funds, the Funds' shareholders will bear not
only their proportionate share of the expenses of the Funds
(including operating expenses and the fees of the investment
manager), but also will bear indirectly similar expenses of the
underlying investment funds. In addition, the securities of
these investment funds may trade at a premium over their net
asset value.
Information and Supervision. There is generally less
publicly available information about foreign companies comparable
to reports and ratings that are published about companies in the
United States. Foreign companies are also generally not subject
to uniform accounting, auditing and financial reporting
standards, practices and requirements comparable to those
applicable to United States companies. It also may be more
PAGE 11
difficult to keep currently informed of corporate actions which
affect the prices of portfolio securities.
Taxes. The dividends and interest payable on certain of the
Funds' foreign portfolio securities may be subject to foreign
withholding taxes, thus reducing the net amount of income
available for distribution to the Funds' shareholders.
Other. With respect to certain foreign countries,
especially developing and emerging ones, there is the possibility
of adverse changes in investment or exchange control regulations,
expropriation or confiscatory taxation, limitations on the
removal of funds or other assets of the Funds, political or
social instability, or diplomatic developments which could affect
investments by U.S. persons in those countries.
Eastern Europe and Russia. Changes occurring in Eastern
Europe and Russia today could have long-term potential
consequences. As restrictions fall, this could result in rising
standards of living, lower manufacturing costs, growing consumer
spending, and substantial economic growth. However, investment
in the countries of Eastern Europe and Russia is highly
speculative at this time. Political and economic reforms are too
recent to establish a definite trend away from centrally-planned
economies and state owned industries. In many of the countries
of Eastern Europe and Russia, there is no stock exchange or
formal market for securities. Such countries may also have
government exchange controls, currencies with no recognizable
market value relative to the established currencies of western
market economies, little or no experience in trading in
securities, no financial reporting standards, a lack of a banking
and securities infrastructure to handle such trading, and a legal
tradition which does not recognize rights in private property.
In addition, these countries may have national policies which
restrict investments in companies deemed sensitive to the
country's national interest. Further, the governments in such
countries may require governmental or quasi-governmental
authorities to act as custodian of a Fund's assets invested in
such countries and these authorities may not qualify as a foreign
custodian under the Investment Company Act of 1940 and exemptive
relief from such Act may be required. All of these
considerations are among the factors which could cause
significant risks and uncertainties to investment in Eastern
Europe and Russia. Each Fund will only invest in a company
located in, or a government of, Eastern Europe and Russia, if it
believes the potential return justifies the risk. To the extent
any securities issued by companies in Eastern Europe and Russia
PAGE 12
are considered illiquid, each Fund will be required to include
such securities within its 15% restriction on investing in
illiquid securities.
Latin America
To the extent the fund invests in Latin America, such
investments will be subject to the factors discussed below.
Inflation. Most Latin American countries have experienced,
at one time or another, severe and persistent levels of
inflation, including, in some cases, hyperinflation. This has,
in turn, led to high interest rates, extreme measures by
governments to keep inflation in check and a generally
debilitating effect on economic growth. Although inflation in
many countries has lessened, there is no guarantee it will remain
at lower levels.
Political Instability. The political history of certain
Latin American countries has been characterized by political
uncertainty, intervention by the military in civilian and
economic spheres, and political corruption. Such developments,
if they were to reoccur, could reverse favorable trends toward
market and economic reform, privatization and removal of trade
barriers and result in significant disruption in securities
markets.
Foreign Currency. Certain Latin American countries may have
managed currencies which are maintained at artificial levels to
the U.S. dollar rather than at levels determined by the market.
This type of system can lead to sudden and large adjustments in
the currency which, in turn, can have a disruptive and negative
effect on foreign investors. For example, in late 1994 the value
of the Mexican peso lost more than one-third of its value
relative to the dollar. Certain Latin American countries also
may restrict the free conversion of their currency into foreign
currencies, including the U.S. dollar. There is no significant
foreign exchange market for certain currencies and it would, as a
result, be difficult for the Fund to engage in foreign currency
transactions designed to protect the value of the Fund's
interests in securities denominated in such currencies.
Sovereign Debt. A number of Latin American countries are
among the largest debtors of developing countries. There have
been moratoria on, and reschedulings of, repayment with respect
to these debts. Such events can restrict the flexibility of
PAGE 13
these debtor nations in the international markets and result in
the imposition of onerous conditions on their economies.
Special Risks of Investing in Junk Bonds
The following special considerations are additional risk
factors associated with the Fund's investments in lower rated
debt securities.
Youth and Growth of the Lower Rated Debt Securities Market.
The market for lower rated debt securities is relatively new and
its growth has paralleled a long economic expansion. Past
experience may not, therefore, provide an accurate indication of
future performance of this market, particularly during periods of
economic recession. An economic downturn or increase in interest
rates is likely to have a greater negative effect on this market,
the value of lower rated debt securities in the Fund's portfolio,
the Fund's net asset value and the ability of the bonds' issuers
to repay principal and interest, meet projected business goals
and obtain additional financing than on higher rated securities.
These circumstances also may result in a higher incidence of
defaults than with respect to higher rated securities. An
investment in this Fund is more speculative than investment in
shares of a fund which invests only in higher rated debt
securities.
Sensitivity to Interest Rate and Economic Changes. Prices
of lower rated debt securities may be more sensitive to adverse
economic changes or corporate developments than higher rated
investments. Debt securities with longer maturities, which may
have higher yields, may increase or decrease in value more than
debt securities with shorter maturities. Market prices of lower
rated debt securities structured as zero coupon or pay-in-kind
securities are affected to a greater extent by interest rate
changes and may be more volatile than securities which pay
interest periodically and in cash. Where it deems it appropriate
and in the best interests of Fund shareholders, the Fund may
incur additional expenses to seek recovery on a debt security on
which the issuer has defaulted and to pursue litigation to
protect the interests of security holders of its portfolio
companies.
Liquidity and Valuation. Because the market for lower rated
securities may be thinner and less active than for higher rated
securities, there may be market price volatility for these
securities and limited liquidity in the resale market. Nonrated
securities are usually not as attractive to as many buyers as
PAGE 14
rated securities are, a factor which may make nonrated securities
less marketable. These factors may have the effect of limiting
the availability of the securities for purchase by the Fund and
may also limit the ability of the Fund to sell such securities at
their fair value either to meet redemption requests or in
response to changes in the economy or the financial markets.
Adverse publicity and investor perceptions, whether or not based
on fundamental analysis, may decrease the values and liquidity of
lower rated debt securities, especially in a thinly traded
market. To the extent the Fund owns or may acquire illiquid or
restricted lower rated securities, these securities may involve
special registration responsibilities, liabilities and costs, and
liquidity and valuation difficulties. Changes in values of debt
securities which the Fund owns will affect its net asset value
per share. If market quotations are not readily available for
the Fund's lower rated or nonrated securities, these securities
will be valued by a method that the Fund's Board of Directors
believes accurately reflects fair value. Judgment plays a
greater role in valuing lower rated debt securities than with
respect to securities for which more external sources of
quotations and last sale information are available.
Congressional Action. New and proposed laws may have an
impact on the market for lower rated debt securities. For
example, as a result of the Financial Institution's Reform,
Recovery, and Enforcement Act of 1989, savings and loan
associations must dispose of their high yield bonds no later than
July 1, 1994. Qualified affiliates of savings and loan
associations, however, may purchase and retain these securities,
and savings and loan associations may divest these securities by
sale to their qualified affiliates. T. Rowe Price is unable at
this time to predict what effect, if any, the legislation may
have on the market for lower rated debt securities.
Taxation. Special tax considerations are associated with
investing in lower rated debt securities structured as zero
coupon or pay-in-kind securities. The Fund accrues income on
these securities prior to the receipt of cash payments. The Fund
must distribute substantially all of its income to its
shareholders to qualify for pass-through treatment under the tax
laws and may, therefore, have to dispose of its portfolio
securities to satisfy distribution requirements.
PAGE 15
Limited-Term Bond Fund
Special Risks of Investing in Junk Bonds
The following special considerations are additional risk
factors associated with the Fund's investments in lower rated
debt securities.
Youth and Growth of the Lower Rated Debt Securities Market.
The market for lower rated debt securities is relatively new and
its growth has paralleled a long economic expansion. Past
experience may not, therefore, provide an accurate indication of
future performance of this market, particularly during periods of
economic recession. An economic downturn or increase in interest
rates is likely to have a greater negative effect on this market,
the value of lower rated debt securities in the Fund's portfolio,
the Fund's net asset value and the ability of the bonds' issuers
to repay principal and interest, meet projected business goals
and obtain additional financing than on higher rated securities.
These circumstances also may result in a higher incidence of
defaults than with respect to higher rated securities. An
investment in this Fund is more speculative than investment in
shares of a fund which invests only in higher rated debt
securities.
Sensitivity to Interest Rate and Economic Changes. Prices
of lower rated debt securities may be more sensitive to adverse
economic changes or corporate developments than higher rated
investments. Debt securities with longer maturities, which may
have higher yields, may increase or decrease in value more than
debt securities with shorter maturities. Market prices of lower
rated debt securities structured as zero coupon or pay-in-kind
securities are affected to a greater extent by interest rate
changes and may be more volatile than securities which pay
interest periodically and in cash. Where it deems it appropriate
and in the best interests of Fund shareholders, the Fund may
incur additional expenses to seek recovery on a debt security on
which the issuer has defaulted and to pursue litigation to
protect the interests of security holders of its portfolio
companies.
Liquidity and Valuation. Because the market for lower rated
securities may be thinner and less active than for higher rated
securities, there may be market price volatility for these
securities and limited liquidity in the resale market. Nonrated
securities are usually not as attractive to as many buyers as
PAGE 16
rated securities are, a factor which may make nonrated securities
less marketable. These factors may have the effect of limiting
the availability of the securities for purchase by the Fund and
may also limit the ability of the Fund to sell such securities at
their fair value either to meet redemption requests or in
response to changes in the economy or the financial markets.
Adverse publicity and investor perceptions, whether or not based
on fundamental analysis, may decrease the values and liquidity of
lower rated debt securities, especially in a thinly traded
market. To the extent the Fund owns or may acquire illiquid or
restricted lower rated securities, these securities may involve
special registration responsibilities, liabilities and costs, and
liquidity and valuation difficulties. Changes in values of debt
securities which the Fund owns will affect its net asset value
per share. If market quotations are not readily available for
the Fund's lower rated or nonrated securities, these securities
will be valued by a method that the Fund's Board of Directors
believes accurately reflects fair value. Judgment plays a
greater role in valuing lower rated debt securities than with
respect to securities for which more external sources of
quotations and last sale information are available.
Congressional Action. New and proposed laws may have an
impact on the market for lower rated debt securities. For
example, as a result of the Financial Institution's Reform,
Recovery, and Enforcement Act of 1989, savings and loan
associations were required to dispose of their high yield bonds
no later than July 1, 1994. Qualified affiliates of savings and
loan associations, however, may purchase and retain these
securities, and savings and loan associations may divest these
securities by sale to their qualified affiliates. T. Rowe Price
is unable at this time to predict what effect, if any, the
legislation may have on the market for lower rated debt
securities.
Taxation. Special tax considerations are associated with
investing in lower rated debt securities structured as zero
coupon or pay-in-kind securities. The Fund accrues income on
these securities prior to the receipt of cash payments. The Fund
must distribute substantially all of its income to its
shareholders to qualify for pass-through treatment under the tax
laws and may, therefore, have to dispose of its portfolio
securities to satisfy distribution requirements.
Reference is also made to the sections entitled "Types of
Securities" and "Portfolio Management Practices" for discussions
PAGE 17
of the risks associated with the investments and practices
described therein as they apply to the Fund.
INVESTMENT PROGRAM
Set forth below is additional information about certain of
the investments described in the Fund's prospectus.
TYPES OF SECURITIES
Adjustable Rate Securities
Generally, the maturity of a security is deemed to be the
period remaining until the date (noted on the face of the
instrument) on which the principal amount must be paid, or in the
case of an instrument called for redemption, the date on which
the redemption payment must be made. However, certain securities
may be issued with adjustable interest rates that are reset
periodically by pre-determined formulas or indexes in order to
minimize movements in the principal value of the investment.
Such securities may have long-term maturities, but may be treated
as a short-term investment under certain conditions. Generally,
as interest rates decrease or increase, the potential for capital
appreciation or depreciation on these securities is less than for
fixed-rate obligations. These securities may take the following
forms:
Variable Rate Securities. Variable rate instruments may
take the form of domestic certificates of deposit which
provide for the adjustment of their interest rate on set
dates and which, upon adjustment, can reasonably be expected
to have a market value which approximates its par value. A
variable rate instrument, the principal amount of which is
scheduled to be paid in 397 calendar days or less, is deemed
to have a maturity equal to the period remaining until the
next readjustment of the interest rate. A variable rate
instrument which is subject to a demand feature which
entitles the purchaser to receive the principal amount of
the underlying security or securities, either (i) upon
notice of no more than 30 days, or (ii) at specified
intervals not exceeding 397 calendar days and upon no more
than 30 days' notice, is deemed to have a maturity equal to
the longer of the period remaining until the next
PAGE 18
readjustment of the interest rate or the period remaining
until the principal amount can be recovered through demand.
Floating Rate Securities. Floating rate may take the form
of corporate or bank holding company notes or Eurodollar
certificates of deposit. These instruments provide for the
adjustment of their interest rates whenever a specified
interest rate changes and which, at any time, can reasonably
be expected to have a market value that approximates its par
value. Floating rate instruments with demand features are
deemed to have a maturity equal to the period remaining
until the principal amount can be recovered through demand.
An instrument that is issued or guaranteed by the U.S.
Government or any agency thereof which has a variable rate
of interest readjusted no less frequently than every 762
days may be deemed to have a maturity equal to the period
remaining until the next readjustment of the interest rate.
Put Option Bonds. Long-term obligations with maturities
longer than one year may provide purchasers an optional or
mandatory tender of the security at par value at
predetermined intervals, often ranging from one month to
several years (e.g., a 30-year bond with a five-year tender
period). These instruments are deemed to have a maturity
equal to the period remaining to the put date.
When-Issued Securities and Forward Commitment Contracts
The Funds may purchase securities on a "when-issued" or
delayed delivery basis ("When-Issueds") and the Limited-Term and
GNMA Funds may purchase securities on a forward commitment basis
("Forwards"). The price of such securities, which may be
expressed in yield terms, is fixed at the time the commitment to
purchase is made, but delivery and payment for take place at a
later date. Normally, the settlement date occurs within 90 days
of the purchase for When-Issueds, but may be substantially longer
for Forwards. During the period between purchase and settlement,
no payment is made by the Fund to the issuer and no interest
accrues to the Fund. The purchase of these securities will
result in a loss if their value declines prior to the settlement
date. This could occur, for example, if interest rates increase
prior to settlement. The longer the period between purchase and
settlement the greater these risks are. At the time the Fund
makes the commitment to purchase these securities, it will record
the transaction and reflect the value of the security in
determining its net asset value. The Fund will cover these
securities by maintaining cash and/or liquid, high-grade debt
PAGE 19
securities with its custodian bank equal in value to commitments
for them during the time between purchase and settlement.
Therefore, the longer this period, the longer the time during
which alternative investment options are not available to the
Fund (to the extent of the securities used for cover). Such
securities either will mature or, if necessary, be sold on or
before the settlement date.
To the extent the Fund remains fully or almost fully
invested (in securities with a remaining maturity of more than
one year) at the same time it purchases these securities, there
will be greater fluctuations in the Fund's net asset value than
if the Fund did not purchase them.
Money Market Securities
The money market securities that the Funds may invest in are
generally limited to those described below.
U.S. Government Obligations. Bills, notes, bonds, and other
debt securities issued by the U.S. Treasury. These are direct
obligations of the U.S. Government and differ mainly in the
length of their maturities.
U.S. Government Agency Securities. Issued or guaranteed by
U.S. Government sponsored enterprises and federal agencies.
These include securities issued by the Federal National Mortgage
Association, Government National Mortgage Association, Federal
Home Loan Bank, Federal Land Banks, Farmers Home Administration,
Banks for Cooperatives, Federal Intermediate Credit Banks,
Federal Financing Bank, Farm Credit Banks, the Small Business
Association, and the Tennessee Valley Authority. Some of these
securities are supported by the full faith and credit of the U.S.
Treasury; and the remainder are supported only by the credit of
the instrumentality, which may or may not include the right of
the issuer to borrow from the Treasury.
Bank Obligations. Certificates of deposit, bankers'
acceptances, and other short-term debt obligations. Certificates
of deposit are short-term obligations of commercial banks. A
bankers' acceptance is a time draft drawn on a commercial bank by
a borrower, usually in connection with international commercial
transactions. Certificates of deposit may have fixed or variable
rates. The Funds may invest in U.S. banks, foreign branches of
U.S. banks, U.S. branches of foreign banks and foreign branches
of foreign banks.
PAGE 20
Short-term Corporate Debt Securities. Outstanding
nonconvertible corporate debt securities (e.g., bonds and
debentures) which have one year or less remaining to maturity.
Corporate notes may have fixed, variable, or floating rates.
Commercial Paper. Short-term promissory notes issued by
corporations primarily to finance short-term credit needs.
Certain notes may have floating or variable rates.
Foreign Government Securities. Issued or guaranteed by a
foreign government, province, instrumentality, political
subdivision or similar unit thereof. However, the Cash Reserves
Fund will only purchase these securities if they are payable in
U.S. dollars.
Savings and Loan Obligations. Negotiable certificates of
deposit and other short-term debt obligations of savings and loan
associations.
Supranational Agencies. The Funds may also invest in the
securities of certain supranational entities, such as the
International Development Bank.
First Tier Money Market Securities Defined. At least 95% of
the Cash Reserves Fund's total assets will be maintained in first
tier money market securities. First tier money market securities
are those which are described as First Tier Securities under Rule
2a-7 of the Investment Company Act of 1940. These include any
security with a remaining maturity of 397 days or less that is
rated (or that has been issued by an issuer that is rated with
respect to a class of short-term debt obligations, or any
security within that class that is comparable in priority and
security with the security) by any two nationally recognized
statistical rating organizations (NRSROs) (or if only one NRSRO
has issued a rating, that NRSRO) in the highest rating category
for short-term debt obligations (within which there may be sub-
categories). First Tier Securities also include unrated
securities comparable in quality to rated securities, as
determined by T. Rowe Price pursuant to written guidelines
established in accordance with Rule 2a-7 under the Investment
Company Act of 1940 under the supervision of the Fund's Board of
Directors.
PAGE 21
Mortgage-Related Securities
Limited-Term and GNMA Funds
Mortgage-related securities in which the Fund's may invest
include, but are not limited to those described below. The GNMA
Fund will invest at least 65% of its assets in GNMA mortgage
securities.
Mortgage-Backed Securities. Mortgage-backed securities are
securities representing an interest in a pool of mortgages. The
mortgages may be of a variety of types, including adjustable
rate, conventional 30-year fixed rate, graduated payment, and 15-
year. Principal and interest payments made on the mortgages in
the underlying mortgage pool are passed through to the Fund.
This is in contrast to traditional bonds where principal is
normally paid back at maturity in a lump sum. Unscheduled
prepayments of principal shorten the securities' weighted average
life and may lower their total return. (When a mortgage in the
underlying mortgage pool is prepaid, an unscheduled principal
prepayment is passed through to the Fund. This principal is
returned to the Fund at par. As a result, if a mortgage security
were trading at a premium, its total return would be lowered by
prepayments, and if a mortgage security were trading at a
discount, its total return would be increased by prepayments.)
The value of these securities also may change because of changes
in the market's perception of the creditworthiness of the federal
agency that issued them. In addition, the mortgage securities
market in general may be adversely affected by changes in
governmental regulation or tax policies.
U.S. Government Agency Mortgage-Backed Securities. These
are obligations issued or guaranteed by the United States
Government or one of its agencies or instrumentalities, such as
the Government National Mortgage Association ("Ginnie Mae" or
"GNMA"), the Federal National Mortgage Association ("Fannie Mae"
or "FNMA") and the Federal Home Loan Mortgage Corporation
("Freddie Mac" or "FHLMC"), and the Federal Agricultural Mortgage
Corporation ("Farmer Mac" or "FAMC"). FNMA, FHLMC and FAMC
obligations are not backed by the full faith and credit of the
U.S. Government as GNMA certificates are, but FNMA and FHLMC
securities are supported by the instrumentality's right to borrow
from the United States Treasury. U.S. Government Agency
Mortgage-Backed Certificates provide for the pass-through to
investors of their pro-rata share of monthly payments (including
any prepayments) made by the individual borrowers on the pooled
mortgage loans, net of any fees paid to the guarantor of such
PAGE 22
securities and the servicer of the underlying mortgage loans.
Each of GNMA, FNMA, FHLMC and FAMC guarantees timely
distributions of interest to certificate holders. GNMA and FNMA
guarantee timely distributions of scheduled principal. FHLMC has
in the past guaranteed only the ultimate collection of principal
of the underlying mortgage loan; however, FHLMC now issues
Mortgage-Backed Securities (FHLMC Gold PCs) which also guarantee
timely payment of monthly principal reductions.
Ginnie Mae Certificates. Ginnie Mae is a wholly-owned
corporate instrumentality of the United States within the
Department of Housing and Urban Development. The National
Housing Act of 1934, as amended (the "Housing Act"), authorizes
Ginnie Mae to guarantee the timely payment of the principal of
and interest on certificates that are based on and backed by a
pool of mortgage loans insured by the Federal Housing
Administration under the Housing Act, or Title V of the Housing
Act of 1949 ("FHA Loans"), or guaranteed by the Department of
Veterans Affairs under the Servicemen's Readjustment Act of 1944,
as amended ("VA Loans"), or by pools of other eligible mortgage
loans. The Housing Act provides that the full faith and credit
of the United States government is pledged to the payment of all
amounts that may be required to be paid under any guaranty. In
order to meet its obligations under such guaranty, Ginnie Mae is
authorized to borrow from the United States Treasury with no
limitations as to amount.
Fannie Mae Certificates. Fannie Mae is a federally
chartered and privately owned corporation organized and existing
under the Federal National Mortgage Association Charter Act of
1938. FNMA Certificates represent a pro-rata interest in a group
of mortgage loans purchased by Fannie Mae. FNMA guarantees the
timely payment of principal and interest on the securities it
issues. The obligations of FNMA are not backed by the full faith
and credit of the U.S. Government.
Freddie Mac Certificates. Freddie Mac is a corporate
instrumentality of the United States created pursuant to the
Emergency Home Finance Act of 1970, as amended (the "FHLMC Act").
Freddie Mac Certificates represent a pro-rata interest in a group
of mortgage loans (a "Freddie Mac Certificate group") purchased
by Freddie Mac. Freddie Mac guarantees timely payment of
interest and principal on certain securities it issues and timely
payment of interest and eventual payment of principal on other
securities is issues. The obligations of Freddie Mac are
obligations solely of Freddie Mac and are not backed by the full
faith and credit of the U.S. Government.
PAGE 23
Farmer Mac Certificates. The Federal Agricultural Mortgage
Corporation ("Farmer Mac") is a federally chartered
instrumentality of the United States established by Title VIII of
the Farm Credit Act of 1971, as amended ("Charter Act"). Farmer
Mac was chartered primarily to attract new capital for financing
of agricultural real estate by making a secondary market in
certain qualified agricultural real estate loans. Farmer Mac
provides guarantees of timely payment of principal and interest
on securities representing interests in, or obligations backed
by, pools of mortgages secured by first liens on agricultural
real estate ("Farmer Mac Certificates"). Similar to Fannie Mae
and Freddie Mac, Farmer Mac's Certificates are not supported by
the full faith and credit of the U.S. Government; rather, Farmer
Mac may borrow up from the U.S. Treasury to meet its guaranty
obligations.
As discussed above, prepayments on the underlying mortgages
and their effect upon the rate of return of a Mortgage-Backed
Security, is the principal investment risk for a purchaser of
such securities, like the Fund. Over time, any pool of mortgages
will experience prepayments due to a variety of factors,
including (1) sales of the underlying homes (including
foreclosures), (2) refinancings of the underlying mortgages, and
(3) increased amortization by the mortgagee. These factors, in
turn, depend upon general economic factors, such as level of
interest rates and economic growth. Thus, investors normally
expect prepayment rates to increase during periods of strong
economic growth or declining interest rates, and to decrease in
recessions and rising interest rate environments. Accordingly,
the life of the Mortgage-Backed Security is likely to be
substantially shorter than the stated maturity of the mortgages
in the underlying pool. Because of such variation in prepayment
rates, it is not possible to predict the life of a particular
Mortgage-Backed Security, but FHA statistics indicate that 25- to
30-year single family dwelling mortgages have an average life of
approximately 12 years. The majority of Ginnie Mae Certificates
are backed by mortgages of this type, and, accordingly, the
generally accepted practice treats Ginnie Mae Certificates as 30-
year securities which prepay full in the 12th year. FNMA and
Freddie Mac Certificates may have differing prepayment
characteristics.
PAGE 24
Fixed Rate Mortgage-Backed Securities bear a stated "coupon
rate" which represents the effective mortgage rate at the time of
issuance, less certain fees to GNMA, FNMA and FHLMC for providing
the guarantee, and the issuer for assembling the pool and for
passing through monthly payments of interest and principal.
Payments to holders of Mortgage-Backed Securities consist of
the monthly distributions of interest and principal less the
applicable fees. The actual yield to be earned by a holder of
Mortgage-Backed Securities is calculated by dividing interest
payments by the purchase price paid for the Mortgage-Backed
Securities (which may be at a premium or a discount from the face
value of the certificate).
Monthly distributions of interest, as contrasted to semi-
annual distributions which are common for other fixed interest
investments, have the effect of compounding and thereby raising
the effective annual yield earned on Mortgage-Backed Securities.
Because of the variation in the life of the pools of mortgages
which back various Mortgage-Backed Securities, and because it is
impossible to anticipate the rate of interest at which future
principal payments may be reinvested, the actual yield earned
from a portfolio of Mortgage-Backed Securities will differ
significantly from the yield estimated by using an assumption of
a certain life for each Mortgage-Backed Security included in such
a portfolio as described above.
Fixed Rate Mortgage-Backed Securities bear a stated "coupon
rate" which represents the effective mortgage rate at the time of
issuance, less certain fees to GNMA, FNMA and FHLMC for providing
the guarantee, and the issuer for assembling the pool and for
passing through monthly payments of interest and principal.
Payments to holders of Mortgage-Backed Securities consist of
the monthly distributions of interest and principal less the
applicable fees. The actual yield to be earned by a holder of
Mortgage-Backed Securities is calculated by dividing interest
payments by the purchase price paid for the Mortgage-Backed
Securities (which may be at a premium or a discount from the face
value of the certificate).
Monthly distributions of interest, as contrasted to semi-
annual distributions which are common for other fixed interest
investments, have the effect of compounding and thereby raising
the effective annual yield earned on Mortgage-Backed Securities.
Because of the variation in the life of the pools of mortgages
which back various Mortgage-Backed Securities, and because it is
PAGE 25
impossible to anticipate the rate of interest at which future
principal payments may be reinvested, the actual yield earned
from a portfolio of Mortgage-Backed Securities will differ
significantly from the yield estimated by using an assumption of
a certain life for each Mortgage-Backed Security included in such
a portfolio as described above.
U.S. Government Agency Multiclass Pass-Through Securities.
Unlike CMOs, U.S. Government Agency Multiclass Pass-Through
Securities, which include FNMA Guaranteed REMIC Pass-Through
Certificates and FHLMC Multi-Class Mortgage Participation
Certificates, are ownership interests in a pool of Mortgage
Assets. Unless the context indicates otherwise, all references
herein to CMOs include multiclass pass-through securities.
Collateralized Mortgage Obligations (CMOs). The Limited-
Term and GNMA Funds may invest up to 30% and 20% of their total
assets, respectively, in collateralized mortgage obligations
(CMOs).
CMOs are bonds that are collateralized by whole loan
mortgages or mortgage pass-through securities. The bonds issued
in a CMO deal are divided into groups, and each group of bonds is
referred to as a "tranche." Under the traditional CMO structure,
the cash flows generated by the mortgages or mortgage pass-
through securities in the collateral pool are used to first pay
interest and then pay principal to the CMO bondholders. The
bonds issued under a CMO structure are retired sequentially as
opposed to the pro rata return of principal found in traditional
pass-through obligations. Subject to the various provisions of
individual CMO issues, the cash flow generated by the underlying
collateral (to the extent it exceeds the amount required to pay
the stated interest) is used to retire the bonds. Under the CMO
structure, the repayment of principal among the different
tranches is prioritized in accordance with the terms of the
particular CMO issuance. The "fastest-pay" tranche of bonds, as
specified in the prospectus for the issuance, would initially
receive all principal payments. When that tranche of bonds is
retired, the next tranche, or tranches, in the sequence, as
specified in the prospectus, receive all of the principal
payments until they are retired. The sequential retirement of
bond groups continues until the last tranche, or group of bonds,
is retired. Accordingly, the CMO structure allows the issuer to
use cash flows of long maturity, monthly-pay collateral to
formulate securities with short, intermediate and long final
maturities and expected average lives.
PAGE 26
CMO structures may also include floating rate CMOs, planned
amortization classes, accrual bonds and CMO residuals. These
structures affect the amount and timing of principal and interest
received by each tranche from the underlying collateral. Under
certain of these structures, given classes of CMOs have priority
over others with respect to the receipt of prepayments on the
mortgages. Therefore, depending on the type of CMOs in which the
Fund invests, the investment may be subject to a greater or
lesser risk of prepayment than other types of mortgage-related
securities.
The primary risk of any mortgage security is the uncertainty
of the timing of cash flows. For CMOs, the primary risk results
from the rate of prepayments on the underlying mortgages serving
as collateral. An increase or decrease in prepayment rates
(resulting from a decrease or increase in mortgage interest
rates) will affect the yield, average life and price of CMOs.
The prices of certain CMOs, depending on their structure and the
rate of prepayments, can be volatile. Some CMOs may also not be
as liquid as other securities.
Stripped Mortgage-Backed Securities. The Limited-Term Fund
may invest up to 10% of its total assets in stripped mortgage
securities. The GNMA Fund may invest up to 10% of its total
assets in these securities, however, it has no current intention
of investing more than 5% of its total assets in them.
Stripped Agency Mortgage-Backed securities represent
interests in a pool of mortgages, the cash flow of which has been
separated into its interest and principal components. "IOs"
(interest only securities) receive the interest portion of the
cash flow while "POs" (principal only securities) receive the
principal portion. Stripped Agency Mortgage-Backed Securities
may be issued by U.S. Government Agencies or by private issuers
similar to those described below with respect to CMOs and
privately-issued mortgage-backed certificates. As interest rates
rise and fall, the value of IOs tends to move in the same
direction as interest rates. The value of the other
mortgage-backed securities described herein, like other debt
instruments, will tend to move in the opposite direction compared
to interest rates. Under the Internal Revenue Code of 1986, as
amended (the "Code"), POs may generate taxable income from the
current accrual of original issue discount, without a
corresponding distribution of cash to the Fund.
The cash flows and yields on IO and PO classes are extremely
sensitive to the rate of principal payments (including
PAGE 27
prepayments) on the related underlying mortgage assets. In the
case of IOs, prepayments affect the amount, but not the timing,
of cash flows provided to the investor. In contrast, prepayments
on the mortgage pool affect the timing, but not the amount, of
cash flows received by investors in POs. A rapid or slow rate of
principal payments may have a material adverse effect on the
prices of IOs or POs, respectively. If the underlying mortgage
assets experience greater than anticipated prepayments of
principal, an investor may fail to recoup fully its initial
investment in an IO class of a stripped mortgage-backed security,
even if the IO class is rated AAA or Aaa or is derived from a
full faith and credit obligation. Conversely, if the underlying
mortgage assets experience slower than anticipated prepayments of
principal, the price on a PO class will be affected more severely
than would be the case with a traditional mortgage-backed
security.
The staff of the Securities and Exchange Commission has
advised the Fund that it believes the Fund should treat IOs and
POs, other than government-issued IOs or POs backed by fixed rate
mortgages, as illiquid securities and, accordingly, limit its
investments in such securities, together with all other illiquid
securities, to 15% of the Fund's net assets. Under the Staff's
position, the determination of whether a particular
government-issued IO and PO backed by fixed rate mortgages may be
made on a case by case basis under guidelines and standards
established by the Fund's Board of Directors. The Fund's Board
of Directors has delegated to T. Rowe Price the authority to
determine the liquidity of these investments based on the
following guidelines: the type of issuer; type of collateral,
including age and prepayment characteristics; rate of interest on
coupon relative to current market rates and the effect of the
rate on the potential for prepayments; complexity of the issue's
structure, including the number of tranches; size of the issue
and the number of dealers who make a market in the IO or PO. The
Fund will treat non-government-issued IOs and POs not backed by
fixed or adjustable rate mortgages as illiquid unless and until
the Securities and Exchange Commission modifies its position.
Multi-Class Residential Mortgage Securities. Such
securities represent interests in pools of mortgage loans to
residential home buyers made by commercial banks, savings and
loan associations or other financial institutions. Unlike GNMA,
FNMA and FHLMC securities, the payment of principal and interest
on Multi-Class Residential Mortgage Securities is not guaranteed
by the U.S. Government or any of its agencies. Accordingly,
yields on Multi-Class Residential Mortgage Securities have been
PAGE 28
historically higher than the yields on U.S. government mortgage
securities. However, the risk of loss due to default on such
instruments is higher since they are not guaranteed by the U.S.
Government or its agencies. Additionally, pools of such
securities may be divided into senior or subordinated segments.
Although subordinated mortgage securities may have a higher yield
than senior mortgage securities, the risk of loss of principal is
greater because losses on the underlying mortgage loans must be
borne by persons holding subordinated securities before those
holding senior mortgage securities.
Privately-Issued Mortgage-Backed Certificates. The Fund may
also invest in pass-through certificates issued by non-
governmental issuers. Pools of conventional residential mortgage
loans created by such issuers generally offer a higher rate of
interest than government and government-related pools because
there are no direct or indirect government guarantees of payment.
Timely payment of interest and principal of these pools is,
however, generally supported by various forms of insurance or
guarantees, including individual loan, title, pool and hazard
insurance. The insurance and guarantees are issued by government
entities, private insurance or the mortgage poolers. Such
insurance and guarantees and the creditworthiness of the issuers
thereof will be considered in determining whether a mortgage-
related security meets the Fund's quality standards. The Fund
may buy mortgage-related securities without insurance or
guarantees if through an examination of the loan experience and
practices of the poolers, the investment manager determines that
the securities meet the Fund's quality standards.
The Fund expects that governmental, government-related or
private entities may create mortgage loan pools offering pass-
through investments in addition to those described above. The
mortgages underlying these securities may be alternative mortgage
instruments, that is, mortgage instruments whose principal or
interest payments may vary or whose terms to maturity may differ
from customary long-term fixed rate mortgages. As new types of
mortgage-related securities are developed and offered to
investors, the investment manager will, consistent with the
Fund's objective, policies and quality standards, consider making
investments in such new types of securities.
Adjustable Rate Mortgage Securities ("ARMs"). ARMs, like
fixed rate mortgages, have a specified maturity date, and the
principal amount of the mortgage is repaid over the life of the
mortgage. Unlike fixed rate mortgages, the interest rate on ARMs
PAGE 29
is adjusted at regular intervals based on a specified, published
interest rate "index" such as a Treasury rate index. The new
rate is determined by adding a specific interest amount, the
"margin," to the interest rate of the index. Investment in ARM
securities allows the Fund to participate in changing interest
rate levels through regular adjustments in the coupons of the
underlying mortgages, resulting in more variable current income
and lower price volatility than longer term fixed rate mortgage
securities. The ARM securities in which the Fund expects to
invest will generally adjust their interest rates at regular
intervals of one year or less. ARM securities are a less
effective means of locking in long-term rates than fixed rate
mortgages since the income from adjustable rate mortgages will
increase during periods of rising interest rates and decline
during periods of falling rates.
Characteristics of Adjustable Rate Mortgage Securities. The
interest rates paid on the mortgages underlying ARM securities
are reset at regular intervals by adding an interest rate margin
to a specified interest rate index. There are three main
categories of indices: those based on U.S. Treasury securities
such as the constant maturity treasury rate (CMT); those derived
from a calculated measure such as a cost of funds index (COFI) or
a moving average of mortgage rates; and those based on certain
actively traded or prominent short-term rates such as the LIBOR.
Some indices, such as the one-year constant maturity Treasury
rate, closely mirror changes in interest rate levels. Others,
such as COFI tend to lag behind changes in market rate levels but
reset monthly thus tending to be somewhat less volatile. Such a
delay in adjusting to changes in interest rates may cause
securities owned by the Fund to increase or decrease in value,
particularly during periods between interest adjustment dates.
ARMs will frequently have caps and floors which limit the
maximum amount by which the interest rate to the residential
borrower may move up or down, respectively, each adjustment
period and over the life of the loan. Interest rate caps on ARM
securities may cause them to decrease in value in an increasing
interest rate environment. Such caps may also prevent their
income from increasing to levels commensurate with prevailing
interest rates. Conversely, interest rate floors on ARM
securities may cause their income to remain higher than
prevailing interest rate levels and result in an increase in the
value of such securities. However, this increase may be tempered
by the acceleration of prepayments.
PAGE 30
Mortgage securities generally have a maximum maturity of up
to 30 years. However, due to the adjustable rate feature of ARM
securities, their prices are considered to have volatility
characteristics which approximate the average period of time
until the next adjustment of the interest rate. As a result, the
principal volatility of ARM securities may be more comparable to
short- and intermediate-term securities than to longer term fixed
rate mortgage securities. Prepayments however, will increase
their principal volatility. See also the discussion of Mortgage-
Backed Securities on page __.
Asset-Backed Securities
Each Fund may invest a portion of its assets in debt
obligations known as asset-backed securities.
The credit quality of most asset-backed securities depends
primarily on the credit quality of the assets underlying such
securities, how well the entity issuing the security is insulated
from the credit risk of the originator or any other affiliated
entities and the amount and quality of any credit support
provided to the securities. The rate of principal payment on
asset-backed securities generally depends on the rate of
principal payments received on the underlying assets which in
turn may be affected by a variety of economic and other factors.
As a result, the yield on any asset-backed security is difficult
to predict with precision and actual yield to maturity may be
more or less than the anticipated yield to maturity. Asset-
backed securities may be classified either as pass-through
certificates or collateralized obligations.
Pass-through certificates are asset-backed securities which
represent an undivided fractional ownership interest in an
underlying pool of assets. Pass-through certificates usually
provide for payments of principal and interest received to be
passed through to their holders, usually after deduction for
certain costs and expenses incurred in administering the pool.
Because pass-through certificates represent an ownership interest
in the underlying assets, the holders thereof bear directly the
risk of any defaults by the obligors on the underlying assets not
covered by any credit support. See "Types of Credit Support".
Asset-backed securities issued in the form of debt
instruments, also known as collateralized or pay-through
obligations, are generally issued as the debt of a special
purpose entity organized solely for the purpose of owning such
assets and issuing such debt. Such assets are most often trade,
PAGE 31
credit card or automobile receivables. The assets
collateralizing such asset-backed securities are pledged to a
trustee or custodian for the benefit of the holders thereof.
Such issuers generally hold no assets other than those underlying
the asset-backed securities and any credit support provided. As
a result, although payments on such asset-backed securities are
obligations of the issuers, in the event of defaults on the
underlying assets not covered by any credit support (see "Types
of Credit Support"), the issuing entities are unlikely to have
sufficient assets to satisfy their obligations on the related
asset-backed securities.
Methods of Allocating Cash Flows. While many asset-backed
securities are issued with only one class of security, many
asset-backed securities are issued in more than one class, each
with different payment terms. Multiple class asset-backed
securities are issued for two main reasons. First, multiple
classes may be used as a method of providing credit support.
This is accomplished typically through creation of one or more
classes whose right to payments on the asset-backed security is
made subordinate to the right to such payments of the remaining
class or classes. See "Types of Credit Support". Second,
multiple classes may permit the issuance of securities with
payment terms, interest rates or other characteristics differing
both from those of each other and from those of the underlying
assets. Examples include so-called "strips" (asset-backed
securities entitling the holder to disproportionate interests
with respect to the allocation of interest and principal of the
assets backing the security), and securities with class or
classes having characteristics which mimic the characteristics of
non-asset-backed securities, such as floating interest rates
(i.e., interest rates which adjust as a specified benchmark
changes) or scheduled amortization of principal.
Asset-backed securities in which the payment streams on the
underlying assets are allocated in a manner different than those
described above may be issued in the future. The Fund may invest
in such asset-backed securities if such investment is otherwise
consistent with its investment objectives and policies and with
the investment restrictions of the Fund.
Types of Credit Support. Asset-backed securities are often
backed by a pool of assets representing the obligations of a
number of different parties. To lessen the effect of failures by
obligors on underlying assets to make payments, such securities
may contain elements of credit support. Such credit support
falls into two classes: liquidity protection and protection
PAGE 32
against ultimate default by an obligor on the underlying assets.
Liquidity protection refers to the provision of advances,
generally by the entity administering the pool of assets, to
ensure that scheduled payments on the underlying pool are made in
a timely fashion. Protection against ultimate default ensures
ultimate payment of the obligations on at least a portion of the
assets in the pool. Such protection may be provided through
guarantees, insurance policies or letters of credit obtained from
third parties, ("external credit enhancement") through various
means of structuring the transaction ("internal credit
enhancement") or through a combination of such approaches.
Examples of asset-backed securities with credit support arising
out of the structure of the transaction include "senior-
subordinated securities" (multiple class asset-backed securities
with certain classes subordinate to other classes as to the
payment of principal thereon, with the result that defaults on
the underlying assets are borne first by the holders of the
subordinated class) and asset-backed securities that have
"reserve funds" (where cash or investments, sometimes funded from
a portion of the initial payments on the underlying assets, are
held in reserve against future losses) or that have been
"overcollateralized" (where the scheduled payments on, or the
principal amount of, the underlying assets substantially exceeds
that required to make payment of the asset-backed securities and
pay any servicing or other fees). The degree of credit support
provided on each issue is based generally on historical
information respecting the level of credit risk associated with
such payments. Depending upon the type of assets securitized,
historical information on credit risk and prepayment rates may be
limited or even unavailable. Delinquency or loss in excess of
that anticipated could adversely affect the return on an
investment in an asset-backed security.
Automobile Receivable Securities. The Fund may invest in
Asset-Backed Securities which are backed by receivables from
motor vehicle installment sales contracts or installment loans
secured by motor vehicles ("Automobile Receivable Securities").
Since installment sales contracts for motor vehicles or
installment loans related thereto ("Automobile Contracts")
typically have shorter durations and lower incidences of
prepayment, Automobile Receivable Securities generally will
exhibit a shorter average life and are less susceptible to
prepayment risk.
Most entities that issue Automobile Receivable Securities
create an enforceable interest in their respective Automobile
Contracts only by filing a financing statement and by having the
PAGE 33
servicer of the Automobile Contracts, which is usually the
originator of the Automobile Contracts, take custody thereof. In
such circumstances, if the servicer of the Automobile Contracts
were to sell the same Automobile Contracts to another party, in
violation of its obligation not to do so, there is a risk that
such party could acquire an interest in the Automobile Contracts
superior to that of the holders of Automobile Receivable
Securities. Also although most Automobile Contracts grant a
security interest in the motor vehicle being financed, in most
states the security interest in a motor vehicle must be noted on
the certificate of title to create an enforceable security
interest against competing claims of other parties. Due to the
large number of vehicles involved, however, the certificate of
title to each vehicle financed, pursuant to the Automobile
Contracts underlying the Automobile Receivable Security, usually
is not amended to reflect the assignment of the seller's security
interest for the benefit of the holders of the Automobile
Receivable Securities. Therefore, there is the possibility that
recoveries on repossessed collateral may not, in some cases, be
available to support payments on the securities. In addition,
various state and federal securities laws give the motor vehicle
owner the right to assert against the holder of the owner's
Automobile Contract certain defenses such owner would have
against the seller of the motor vehicle. The assertion of such
defenses could reduce payments on the Automobile Receivable
Securities.
Credit Card Receivable Securities. The Fund may invest in
Asset Backed Securities backed by receivables from revolving
credit card agreements ("Credit Card Receivable Securities").
Credit balances on revolving credit card agreements ("Accounts")
are generally paid down more rapidly than are Automobile
Contracts. Most of the Credit Card Receivable Securities issued
publicly to date have been Pass-Through Certificates. In order
to lengthen the maturity of Credit Card Receivable Securities,
most such securities provide for a fixed period during which only
interest payments on the underlying Accounts are passed through
to the security holder and principal payments received on such
Accounts are used to fund the transfer to the pool of assets
supporting the related Credit Card Receivable Securities of
additional credit card charges made on an Account. The initial
fixed period usually may be shortened upon the occurrence of
specified events which signal a potential deterioration in the
quality of the assets backing the security, such as the
imposition of a cap on interest rates. The ability of the issuer
to extend the life of an issue of Credit Card Receivable
Securities thus depends upon the continued generation of
PAGE 34
additional principal amounts in the underlying accounts during
the initial period and the non-occurrence of specified events.
An acceleration in cardholders' payment rates or any other event
which shortens the period during which additional credit card
charges on an Account may be transferred to the pool of assets
supporting the related Credit Card Receivable Security could
shorten the weighted average life and yield of the Credit Card
Receivable Security.
Credit cardholders are entitled to the protection of a
number of state and federal consumer credit laws, many of which
give such holder the right to set off certain amounts against
balances owed on the credit card, thereby reducing amounts paid
on Accounts. In addition, unlike most other Asset Backed
Securities, Accounts are unsecured obligations of the cardholder.
Other Assets. Asset Backed Securities backed by assets
other than those described above, including, but not limited to,
small business loans and accounts receivable, equipment leases,
commercial real estate loans, boat loans and manufacturing
housing loans. The Fund may invest in such securities in the
future if such investment is otherwise consistent with its
investment objective and policies.
There are, of course, other types of securities that are, or
may become available, which are similar to the foregoing and the
Fund reserves the right to invest in these securities.
Hybrid Instruments
Limited-Term and GNMA Funds
The Funds may invest up to 10% of their total assets in
hybrid instruments.
Hybrid Instruments (a type of potentially high risk
derivative) have been developed and combine the elements of
futures contracts or options with those of debt, preferred equity
or a depository instrument (hereinafter "Hybrid Instruments").
Generally, a Hybrid Instrument will be a debt security, preferred
stock, depository share, trust certificate, certificate of
deposit or other evidence of indebtedness on which a portion of
or all interest payments, and/or the principal or stated amount
payable at maturity, redemption or retirement, is determined by
reference to prices, changes in prices, or differences between
prices, of securities, currencies, intangibles, goods, articles
or commodities (collectively "Underlying Assets") or by another
PAGE 35
objective index, economic factor or other measure, such as
interest rates, currency exchange rates, commodity indices, and
securities indices (collectively "Benchmarks"). Thus, Hybrid
Instruments may take a variety of forms, including, but not
limited to, debt instruments with interest or principal payments
or redemption terms determined by reference to the value of a
currency or commodity or securities index at a future point in
time, preferred stock with dividend rates determined by reference
to the value of a currency, or convertible securities with the
conversion terms related to a particular commodity.
Hybrid Instruments can be an efficient means of creating
exposure to a particular market, or segment of a market, with the
objective of enhancing total return. For example, a Fund may
wish to take advantage of expected declines in interest rates in
several European countries, but avoid the transactions costs
associated with buying and currency-hedging the foreign bond
positions. One solution would be to purchase a U.S. dollar-
denominated Hybrid Instrument whose redemption price is linked to
the average three year interest rate in a designated group of
countries. The redemption price formula would provide for
payoffs of greater than par if the average interest rate was
lower than a specified level, and payoffs of less than par if
rates were above the specified level. Furthermore, the Fund
could limit the downside risk of the security by establishing a
minimum redemption price so that the principal paid at maturity
could not be below a predetermined minimum level if interest
rates were to rise significantly. The purpose of this
arrangement, known as a structured security with an embedded put
option, would be to give the Fund the desired European bond
exposure while avoiding currency risk, limiting downside market
risk, and lowering transactions costs. Of course, there is no
guarantee that the strategy will be successful and the Fund could
lose money if, for example, interest rates do not move as
anticipated or credit problems develop with the issuer of the
Hybrid.
The risks of investing in Hybrid Instruments reflect a
combination of the risks of investing in securities, options,
futures and currencies. Thus, an investment in a Hybrid
Instrument may entail significant risks that are not associated
with a similar investment in a traditional debt instrument that
has a fixed principal amount, is denominated in U.S. dollars or
bears interest either at a fixed rate or a floating rate
determined by reference to a common, nationally published
Benchmark. The risks of a particular Hybrid Instrument will, of
PAGE 36
course, depend upon the terms of the instrument, but may include,
without limitation, the possibility of significant changes in the
Benchmarks or the prices of Underlying Assets to which the
instrument is linked. Such risks generally depend upon factors
which are unrelated to the operations or credit quality of the
issuer of the Hybrid Instrument and which may not be readily
foreseen by the purchaser, such as economic and political events,
the supply and demand for the Underlying Assets and interest rate
movements. In recent years, various Benchmarks and prices for
Underlying Assets have been highly volatile, and such volatility
may be expected in the future. Reference is also made to the
discussion of futures, options, and forward contracts herein for
a discussion of the risks associated with such investments.
Hybrid Instruments are potentially more volatile and carry
greater market risks than traditional debt instruments.
Depending on the structure of the particular Hybrid Instrument,
changes in a Benchmark may be magnified by the terms of the
Hybrid Instrument and have an even more dramatic and substantial
effect upon the value of the Hybrid Instrument. Also, the prices
of the Hybrid Instrument and the Benchmark or Underlying Asset
may not move in the same direction or at the same time.
Hybrid Instruments may bear interest or pay preferred
dividends at below market (or even relatively nominal) rates.
Alternatively, Hybrid Instruments may bear interest at above
market rates but bear an increased risk of principal loss (or
gain). The latter scenario may result if "leverage" is used to
structure the Hybrid Instrument. Leverage risk occurs when the
Hybrid Instrument is structured so that a given change in a
Benchmark or Underlying Asset is multiplied to produce a greater
value change in the Hybrid Instrument, thereby magnifying the
risk of loss as well as the potential for gain.
Hybrid Instruments may also carry liquidity risk since the
instruments are often "customized" to meet the portfolio needs of
a particular investor, and therefore, the number of investors
that are willing and able to buy such instruments in the
secondary market may be smaller than that for more traditional
debt securities. In addition, because the purchase and sale of
Hybrid Instruments could take place in an over-the-counter market
without the guarantee of a central clearing organization or in a
transaction between the Fund and the issuer of the Hybrid
Instrument, the creditworthiness of the counter party or issuer
of the Hybrid Instrument would be an additional risk factor which
the Fund would have to consider and monitor. Hybrid Instruments
also may not be subject to regulation of the Commodities Futures
PAGE 37
Trading Commission ("CFTC"), which generally regulates the
trading of commodity futures by U.S. persons, the SEC, which
regulates the offer and sale of securities by and to U.S.
persons, or any other governmental regulatory authority.
The various risks discussed above, particularly the market
risk of such instruments, may in turn cause significant
fluctuations in the net asset value of the Fund. Accordingly,
the Fund will limit its investments in Hybrid Instruments to 10%
of net assets. However, because of their volatility, it is
possible that the Fund's investment in Hybrid Instruments will
account for more than 10% of the Fund's return (positive or
negative).
Illiquid or Restricted Securities
Restricted securities may be sold only in privately
negotiated transactions or in a public offering with respect to
which a registration statement is in effect under the Securities
Act of 1933 (the "1933 Act"). Where registration is required,
the Fund may be obligated to pay all or part of the registration
expenses and a considerable period may elapse between the time of
the decision to sell and the time the Fund may be permitted to
sell a security under an effective registration statement. If,
during such a period, adverse market conditions were to develop,
the Fund might obtain a less favorable price than prevailed when
it decided to sell. Restricted securities will be priced at fair
value as determined in accordance with procedures prescribed by
the Fund's Board of Directors. If through the appreciation of
illiquid securities or the depreciation of liquid securities, the
Fund should be in a position where more than 15% (10% for Cash
Reserves) of the value of its net assets are invested in illiquid
assets, including restricted securities, the Fund will take
appropriate steps to protect liquidity.
Notwithstanding the above, the Fund may purchase securities
which, while privately placed, are eligible for purchase and sale
under Rule 144A under the 1933 Act. This rule permits certain
qualified institutional buyers, such as the Fund, to trade in
privately placed securities even though such securities are not
registered under the 1933 Act. T. Rowe Price under the
supervision of the Fund's Board of Directors, will consider
whether securities purchased under Rule 144A are illiquid and
thus subject to the Fund's restriction of investing no more than
15% (10% for Cash Reserves) of its assets in illiquid securities.
A determination of whether a Rule 144A security is liquid or not
is a question of fact. In making this determination, T. Rowe
PAGE 38
Price will consider the trading markets for the specific security
taking into account the unregistered nature of a Rule 144A
security. In addition, T. Rowe Price could consider the (1)
frequency of trades and quotes, (2) number of dealers and
potential purchases, (3) dealer undertakings to make a market,
and (4) the nature of the security and of marketplace trades
(e.g., the time needed to dispose of the security, the method of
soliciting offers and the mechanics of transfer). The liquidity
of Rule 144A securities would be monitored, and if as a result of
changed conditions it is determined that a Rule 144A security is
no longer liquid, a Fund's holdings of illiquid securities would
be reviewed to determine what, if any, steps are required to
assure that the Fund does not invest more than 15% (10% for Cash
Reserves) of its assets in illiquid securities. Investing in
Rule 144A securities could have the effect of increasing the
amount of a Fund's assets invested in illiquid securities if
qualified institutional buyers are unwilling to purchase such
securities.
There are, of course, other types of securities that are, or
may become available, which are similar to the foregoing and the
Funds may invest in these securities.
PORTFOLIO MANAGEMENT PRACTICES
Foreign Currency Transactions
Limited-Term Fund
A forward foreign currency contract ("forward contract")
involves an obligation to purchase or sell a specific currency at
a future date, which may be any fixed number of days from the
date of the contract agreed upon by the parties, at a price set
at the time of the contract. These contracts are principally
traded in the interbank market conducted directly between
currency traders (usually large, commercial banks) and their
customers. A forward contract generally has no deposit
requirement, and no commissions are charged at any stage for
trades.
The Limited-Term Fund may enter into forward contracts for a
variety of purposes in connection with the management of the
foreign securities portion of its portfolio. The Fund's use of
such contracts would include, but not be limited to, the
following:
PAGE 39
First, when the Fund enters into a contract for the purchase
or sale of a security denominated in a foreign currency, it may
desire to "lock in" the U.S. dollar price of the security. By
entering into a forward contract for the purchase or sale, for a
fixed amount of dollars, of the amount of foreign currency
involved in the underlying security transactions, the Fund will
be able to protect itself against a possible loss resulting from
an adverse change in the relationship between the U.S. dollar and
the subject foreign currency during the period between the date
the security is purchased or sold and the date on which payment
is made or received.
Second, when T. Rowe Price believes that one currency may
experience a substantial movement against another currency,
including the U.S. dollar, it may enter into a forward contract
to sell or buy the amount of the former foreign currency,
approximating the value of some or all of the Fund's portfolio
securities denominated in such foreign currency. Alternatively,
where appropriate, the Fund may hedge all or part of its foreign
currency exposure through the use of a basket of currencies or a
proxy currency where such currency or currencies act as an
effective proxy for other currencies. In such a case, the Fund
may enter into a forward contract where the amount of the foreign
currency to be sold exceeds the value of the securities
denominated in such currency. The use of this basket hedging
technique may be more efficient and economical than entering into
separate forward contracts for each currency held in the Fund.
The precise matching of the forward contract amounts and the
value of the securities involved will not generally be possible
since the future value of such securities in foreign currencies
will change as a consequence of market movements in the value of
those securities between the date the forward contract is entered
into and the date it matures. The projection of short-term
currency market movement is extremely difficult, and the
successful execution of a short-term hedging strategy is highly
uncertain. Under normal circumstances, consideration of the
prospect for currency parities will be incorporated into the
longer term investment decisions made with regard to overall
diversification strategies. However, T. Rowe Price believes that
it is important to have the flexibility to enter into such
forward contracts when it determines that the best interests of
the Fund will be served.
Third, the Fund may use forward contracts when the Fund
wishes to hedge out of the dollar into a foreign currency in
order to create a synthetic bond or money market instrument --
the security would be issued in U.S. dollars but the dollar
PAGE 40
component would be transformed into a foreign currency through a
forward contract.
The Fund may enter into forward contracts for any other
purpose consistent with the Fund's investment objective and
program. However, the Fund will not enter into a forward
contract, or maintain exposure to such contract(s), if the amount
of foreign currency requires to be delivered thereunder would
exceed the Fund's holdings of liquid, high-grade debt securities
and currency available for cover of the forward contract(s). In
determining the amount to be delivered under a contract, the Fund
may net offsetting positions.
At the maturity of a forward contract, the Fund may sell the
portfolio security and make delivery of the foreign currency, or
it may retain the security and either extend the maturity of the
forward contract (by "rolling" that contract forward) or may
initiate a new forward contract.
If the Fund retains the portfolio security and engages in an
offsetting transaction, the Fund will incur a gain or a loss (as
described below) to the extent that there has been movement in
forward contract prices. If the Fund engages in an offsetting
transaction, it may subsequently enter into a new forward
contract to sell the foreign currency. Should forward prices
decline during the period between the Fund's entering into a
forward contract for the sale of a foreign currency and the date
it enters into an offsetting contract for the purchase of the
foreign currency, the Fund will realize a gain to the extent the
price of the currency it has agreed to sell exceeds the price of
the currency it has agreed to purchase. Should forward prices
increase, the Fund will suffer a loss to the extent of the price
of the currency it has agreed to purchase exceeds the price of
the currency it has agreed to sell.
The Fund's dealing in forward foreign currency exchange
contracts will generally be limited to the transactions described
above. However, the Fund reserves the right to enter into
forward foreign currency contracts for different purposes and
under different circumstances. Of course, the Fund is not
required to enter into forward contracts with regard to its
foreign currency-denominated securities and will not do so unless
deemed appropriate by T. Rowe Price. It also should be realized
that this method of hedging against a decline in the value of a
currency does not eliminate fluctuations in the underlying prices
of the securities. It simply establishes a rate of exchange at a
future date. Additionally, although such contracts tend to
PAGE 41
minimize the risk of loss due to a decline in the value of the
hedged currency, at the same time, they tend to limit any
potential gain which might result from an increase in the value
of that currency.
Although the Fund values its assets daily in terms of U.S.
dollars, it does not intend to convert its holdings of foreign
currencies into U.S. dollars on a daily basis. It will do so
from time to time, and investors should be aware of the costs of
currency conversion. Although foreign exchange dealers do not
charge a fee for conversion, they do realize a profit based on
the difference (the "spread") between the prices at which they
are buying and selling various currencies. Thus, a dealer may
offer to sell a foreign currency to the Fund at one rate, while
offering a lesser rate of exchange should the Fund desire to
resell that currency to the dealer.
Lending of Portfolio Securities
Securities loans are made to broker-dealers or institutional
investors or other persons, pursuant to agreements requiring that
the loans be continuously secured by collateral at least equal at
all times to the value of the securities lent marked to market on
a daily basis. The collateral received will consist of cash,
U.S. government securities, letters of credit or such other
collateral as may be permitted under its investment program.
While the securities are being lent, each Fund will continue to
receive the equivalent of the interest or dividends paid by the
issuer on the securities, as well as interest on the investment
of the collateral or a fee from the borrower. Each Fund has a
right to call each loan and obtain the securities on five
business days' notice or, in connection with securities trading
on foreign markets, within such longer period of time which
coincides with the normal settlement period for purchases and
sales of such securities in such foreign markets. The Funds will
not have the right to vote securities while they are being lent,
but it will call a loan in anticipation of any important vote.
The risks in lending portfolio securities, as with other
extensions of secured credit, consist of possible delay in
receiving additional collateral or in the recovery of the
securities or possible loss of rights in the collateral should
the borrower fail financially. Loans will only be made to firms
deemed by T. Rowe Price to be of good standing and will not be
made unless, in the judgment of T. Rowe Price, the consideration
to be earned from such loans would justify the risk.
PAGE 42
Other Lending/Borrowing
Subject to approval by the Securities and Exchange
Commission, and certain state regulatory agencies, each Fund may
make loans to, or borrow funds from, other mutual funds sponsored
or advised by T. Rowe Price or Price-Fleming (collectively,
"Price Funds"). The Funds have no current intention of engaging
in these practices at this time.
Repurchase Agreements
Each Fund may enter into a repurchase agreement through
which an investor (such as the Fund) purchases a security (known
as the "underlying security") from a well-established securities
dealer or a bank that is a member of the Federal Reserve System.
Any such dealer or bank will be on T. Rowe Price's approved list.
At that time, the bank or securities dealer agrees to repurchase
the underlying security at the same price, plus specified
interest. Repurchase agreements are generally for a short period
of time, often less than a week. Repurchase agreements which do
not provide for payment within seven days will be treated as
illiquid securities. Each Fund will only enter into repurchase
agreements where (i) (A) Cash Reserves Fund -- the underlying
securities are either U.S. government securities or securities
that, at the time the repurchase agreement is entered into, are
rated in the highest rating category by the requisite number of
NRSROs (as required by Rule 2a-7 under the 1940 Act) and
otherwise are of the type (excluding maturity limitations) which
the Fund's investment guidelines would allow it to purchase
directly (however, the underlying securities will either be U.S.
government securities or securities which, at the time the
repurchase agreement is entered into, are rated in the highest
rating category by pubic rating agencies), (B) Limited-Term and
GNMA Funds -- the underlying securities are of the type
(excluding maturity limitations) which each Fund's investment
guidelines would allow it to purchase directly, (ii) the market
value of the underlying security, including interest accrued,
will be at all times equal to or exceed the value of the
repurchase agreement, and (iii) payment for the underlying
security is made only upon physical delivery or evidence of book-
entry transfer to the account of the custodian or a bank acting
as agent. In the event of a bankruptcy or other default of a
seller of a repurchase agreement, a Fund could experience both
delays in liquidating the underlying security and losses,
including: (a) possible decline in the value of the underlying
security during the period while the Fund seeks to enforce its
rights thereto; (b) possible subnormal levels of income and lack
PAGE 43
of access to income during this period; and (c) expenses of
enforcing its rights.
Reverse Repurchase Agreements
Although the Fund has no current intention, in the
foreseeable future, of engaging in reverse repurchase agreements,
the Fund reserves the right to do so. Reverse repurchase
agreements are ordinary repurchase agreements in which a Fund is
the seller of, rather than the investor in, securities, and
agrees to repurchase them at an agreed upon time and price. Use
of a reverse repurchase agreement may be preferable to a regular
sale and later repurchase of the securities because it avoids
certain market risks and transaction costs. A reverse repurchase
agreement may be viewed as a type of borrowing by the Fund,
subject to Investment Restriction (1). (See "Investment
Restrictions," page __.)
Options
Options are a type of potentially high risk derivative.
Limited-Term and GNMA Funds
Writing Covered Call Options
Each Fund may write (sell) American or European style
"covered" call options and purchase options to close out options
previously written by a Fund. In writing covered call options, a
Fund expects to generate additional premium income which should
serve to enhance the Fund's total return and reduce the effect of
any price decline of the security or currency involved in the
option. Covered call options will generally be written on
securities or currencies which, in T. Rowe Price's opinion, are
not expected to have any major price increases or moves in the
near future but which, over the long term, are deemed to be
attractive investments for a Fund.
A call option gives the holder (buyer) the "right to
purchase" a security or currency at a specified price (the
exercise price) at expiration of the option (European style) or
at any time until a certain date (the expiration date) (American
style). So long as the obligation of the writer of a call option
continues, he may be assigned an exercise notice by the broker-
dealer through whom such option was sold, requiring him to
deliver the underlying security or currency against payment of
the exercise price. This obligation terminates upon the
PAGE 44
expiration of the call option, or such earlier time at which the
writer effects a closing purchase transaction by repurchasing an
option identical to that previously sold. To secure his
obligation to deliver the underlying security or currency in the
case of a call option, a writer is required to deposit in escrow
the underlying security or currency or other assets in accordance
with the rules of a clearing corporation.
The Funds will write only covered call options. This means
that a Fund will own the security or currency subject to the
option or an option to purchase the same underlying security or
currency, having an exercise price equal to or less than the
exercise price of the "covered" option, or will establish and
maintain with its custodian for the term of the option, an
account consisting of cash, U.S. government securities or other
liquid high-grade debt obligations having a value equal to the
fluctuating market value of the optioned securities or
currencies.
Portfolio securities or currencies on which call options may
be written will be purchased solely on the basis of investment
considerations consistent with each Fund's investment objective.
The writing of covered call options is a conservative investment
technique believed to involve relatively little risk (in contrast
to the writing of naked or uncovered options, which the Funds
will not do), but capable of enhancing a Fund's total return.
When writing a covered call option, a Fund, in return for the
premium, gives up the opportunity for profit from a price
increase in the underlying security or currency above the
exercise price, but conversely retains the risk of loss should
the price of the security or currency decline. Unlike one who
owns securities or currencies not subject to an option, a Fund
has no control over when it may be required to sell the
underlying securities or currencies, since it may be assigned an
exercise notice at any time prior to the expiration of its
obligation as a writer. If a call option which a Fund has
written expires, the Fund will realize a gain in the amount of
the premium; however, such gain may be offset by a decline in the
market value of the underlying security or currency during the
option period. If the call option is exercised, the Fund will
realize a gain or loss from the sale of the underlying security
or currency. The Funds do not consider a security or currency
covered by a call to be "pledged" as that term is used in the
Funds' policy which limits the pledging or mortgaging of its
assets.
PAGE 45
The premium received is the market value of an option. The
premium a Fund will receive from writing a call option will
reflect, among other things, the current market price of the
underlying security or currency, the relationship of the exercise
price to such market price, the historical price volatility of
the underlying security or currency, and the length of the option
period. Once the decision to write a call option has been made,
T. Rowe Price, in determining whether a particular call option
should be written on a particular security or currency, will
consider the reasonableness of the anticipated premium and the
likelihood that a liquid secondary market will exist for those
options. The premium received by a Fund for writing covered call
options will be recorded as a liability of the Fund. This
liability will be adjusted daily to the option's current market
value, which will be the latest sale price at the time at which
the net asset value per share of a Fund is computed (close of the
New York Stock Exchange), or, in the absence of such sale, the
latest asked price. The option will be terminated upon
expiration of the option, the purchase of an identical option in
a closing transaction, or delivery of the underlying security or
currency upon the exercise of the option.
Closing transactions will be effected in order to realize a
profit on an outstanding call option, to prevent an underlying
security or currency from being called, or, to permit the sale of
the underlying security or currency. Furthermore, effecting a
closing transaction will permit a Fund to write another call
option on the underlying security or currency with either a
different exercise price or expiration date or both. If a Fund
desires to sell a particular security or currency from its
portfolio on which it has written a call option, or purchased a
put option, it will seek to effect a closing transaction prior
to, or concurrently with, the sale of the security or currency.
There is, of course, no assurance that a Fund will be able to
effect such closing transactions at favorable prices. If a Fund
cannot enter into such a transaction, it may be required to hold
a security or currency that it might otherwise have sold. When a
Fund writes a covered call option, it runs the risk of not being
able to participate in the appreciation of the underlying
securities or currencies above the exercise price, as well as the
risk of being required to hold on to securities or currencies
that are depreciating in value. This could result in higher
transaction costs. Each Fund will pay transaction costs in
connection with the writing of options to close out previously
written options. Such transaction costs are normally higher than
those applicable to purchases and sales of portfolio securities.
PAGE 46
Call options written by a Fund will normally have expiration
dates of less than nine months from the date written. The
exercise price of the options may be below, equal to, or above
the current market values of the underlying securities or
currencies at the time the options are written. From time to
time, a Fund may purchase an underlying security or currency for
delivery in accordance with an exercise notice of a call option
assigned to it, rather than delivering such security or currency
from its portfolio. In such cases, additional costs may be
incurred.
A Fund will realize a profit or loss from a closing purchase
transaction if the cost of the transaction is less or more than
the premium received from the writing of the option. Because
increases in the market price of a call option will generally
reflect increases in the market price of the underlying security
or currency, any loss resulting from the repurchase of a call
option is likely to be offset in whole or in part by appreciation
of the underlying security or currency owned by the Fund. In
order to comply with the requirements of several states, a Fund
will not write a covered call option if, as a result, the
aggregate market value of all portfolio securities or currencies
covering call or put options exceeds 25% of the market value of a
Fund's net assets. Should these state laws change or should the
Funds obtain a waiver of its application, the Fund reserves the
right to increase this percentage. In calculating the 25% limit,
the Funds will offset against the value of assets covering
written calls and puts, the value of purchased calls and puts on
identical securities with identical maturity dates.
Writing Covered Put Options
The Funds may write American or European style covered put
options and purchase options to close out options previously
written by the Fund. A put option gives the purchaser of the
option the right to sell, and the writer (seller) has the
obligation to buy, the underlying security or currency at the
exercise price during the option period (American style) or at
the expiration of the option (European style). So long as the
obligation of the writer continues, he may be assigned an
exercise notice by the broker-dealer through whom such option was
sold, requiring him to make payment of the exercise price against
delivery of the underlying security or currency. The operation
of put options in other respects, including their related risks
and rewards, is substantially identical to that of call options.
PAGE 47
Each Fund would write put options only on a covered basis,
which means that the Fund would maintain in a segregated account
cash, U.S. government securities or other liquid high-grade debt
obligations in an amount not less than the exercise price or each
Fund will own an option to sell the underlying security or
currency subject to the option having an exercise price equal to
or greater than the exercise price of the "covered" option at all
times while the put option is outstanding. (The rules of a
clearing corporation currently require that such assets be
deposited in escrow to secure payment of the exercise price.)
A Fund would generally write covered put options in
circumstances where T. Rowe Price wishes to purchase the
underlying security or currency for the Fund's portfolio at a
price lower than the current market price of the security or
currency. In such event a Fund would write a put option at an
exercise price which, reduced by the premium received on the
option, reflects the lower price it is willing to pay. Since a
Fund would also receive interest on debt securities or currencies
maintained to cover the exercise price of the option, this
technique could be used to enhance current return during periods
of market uncertainty. The risk in such a transaction would be
that the market price of the underlying security or currency
would decline below the exercise price less the premiums
received. Such a decline could be substantial and result in a
significant loss to the Fund. In addition, a Fund, because it
does not own the specific securities or currencies which it may
be required to purchase in exercise of the put, cannot benefit
from appreciation, if any, with respect to such specific
securities or currencies.
In order to comply with the requirements of several states,
the Funds will not write a covered put option if, as a result,
the aggregate market value of all portfolio securities or
currencies covering put or call options exceeds 25% of the market
value of each Fund's net assets. Should these state laws change
or should each Fund obtain a waiver of their application, each
Fund reserves the right to increase this percentage. In
calculating the 25% limit, each Fund will offset, against the
value of assets covering written puts and calls, the value of
purchased puts and calls on identical securities or currencies
with identical maturity dates.
PAGE 48
Purchasing Put Options
Each Fund may purchase American or European style put
options. As the holder of a put option, each Fund has the right
to sell the underlying security or currency at the exercise price
at any time during the option period (American style) or at the
expiration of the option (European style). Each Fund may enter
into closing sale transactions with respect to such options,
exercise them or permit them to expire. Each Fund may purchase
put options for defensive purposes in order to protect against an
anticipated decline in the value of its securities or currencies.
An example of such use of put options is provided below.
A Fund may purchase a put option on an underlying security
or currency (a "protective put") owned by the Fund as a defensive
technique in order to protect against an anticipated decline in
the value of the security or currency. Such hedge protection is
provided only during the life of the put option when a Fund, as
the holder of the put option, is able to sell the underlying
security or currency at the put exercise price regardless of any
decline in the underlying security's market price or currency's
exchange value. For example, a put option may be purchased in
order to protect unrealized appreciation of a security or
currency where T. Rowe Price deems it desirable to continue to
hold the security or currency because of tax considerations. The
premium paid for the put option and any transaction costs would
reduce any capital gain otherwise available for distribution when
the security or currency is eventually sold.
Each Fund may also purchase put options at a time when the
Fund does not own the underlying security or currency. By
purchasing put options on a security or currency it does not own,
a Fund seeks to benefit from a decline in the market price of the
underlying security or currency. If the put option is not sold
when it has remaining value, and if the market price of the
underlying security or currency remains equal to or greater than
the exercise price during the life of the put option, a Fund will
lose its entire investment in the put option. In order for the
purchase of a put option to be profitable, the market price of
the underlying security or currency must decline sufficiently
below the exercise price to cover the premium and transaction
costs, unless the put option is sold in a closing sale
transaction.
To the extent required by the laws of certain states, each
Fund may not be permitted to commit more than 5% of its assets to
premiums when purchasing put and call options. Should these
PAGE 49
state laws change or should each Fund obtain a waiver of their
application, each Fund may commit more than 5% of its assets to
premiums when purchasing call and put options. The premium paid
by a Fund when purchasing a put option will be recorded as an
asset of the Fund. This asset will be adjusted daily to the
option's current market value, which will be the latest sale
price at the time at which the net asset value per share of each
Fund is computed (close of New York Stock Exchange), or, in the
absence of such sale, the latest bid price. This asset will be
terminated upon expiration of the option, the selling (writing)
of an identical option in a closing transaction, or the delivery
of the underlying security or currency upon the exercise of the
option.
Purchasing Call Options
Each Fund may purchase American or European style call
options. As the holder of a call option, each Fund has the right
to purchase the underlying security or currency at the exercise
price at any time during the option period (American style) or at
the expiration of the option (European style). Each Fund may
enter into closing sale transactions with respect to such
options, exercise them or permit them to expire. Each Fund may
purchase call options for the purpose of increasing its current
return or avoiding tax consequences which could reduce its
current return. Each Fund may also purchase call options in
order to acquire the underlying securities or currencies.
Examples of such uses of call options are provided below.
Call options may be purchased by a Fund for the purpose of
acquiring the underlying securities or currencies for its
portfolio. Utilized in this fashion, the purchase of call
options enables a Fund to acquire the securities or currencies at
the exercise price of the call option plus the premium paid. At
times the net cost of acquiring securities or currencies in this
manner may be less than the cost of acquiring the securities or
currencies directly. This technique may also be useful to a Fund
in purchasing a large block of securities or currencies that
would be more difficult to acquire by direct market purchases.
So long as it holds such a call option rather than the underlying
security or currency itself, a Fund is partially protected from
any unexpected decline in the market price of the underlying
security or currency and in such event could allow the call
option to expire, incurring a loss only to the extent of the
premium paid for the option.
PAGE 50
To the extent required by the laws of certain states, each
Fund may not be permitted to commit more than 5% of its assets to
premiums when purchasing call and put options. Should these
state laws change or should each Fund obtain a waiver of their
application, each Fund may commit more than 5% of its assets to
premiums when purchasing call and put options. Each Fund may
also purchase call options on underlying securities or currencies
it owns in order to protect unrealized gains on call options
previously written by it. A call option would be purchased for
this purpose where tax considerations make it inadvisable to
realize such gains through a closing purchase transaction. Call
options may also be purchased at times to avoid realizing losses.
Dealer (Over-the-Counter) Options
The Funds may engage in transactions involving dealer
options. Certain risks are specific to dealer options. While a
Fund would look to a clearing corporation to exercise exchange-
traded options, if the Fund were to purchase a dealer option, it
would rely on the dealer from whom it purchased the option to
perform if the option were exercised. Failure by the dealer to
do so would result in the loss of the premium paid by a Fund as
well as loss of the expected benefit of the transaction.
Exchange-traded options generally have a continuous liquid
market while dealer options have none. Consequently, a Fund will
generally be able to realize the value of a dealer option it has
purchased only by exercising it or reselling it to the dealer who
issued it. Similarly, when a Fund writes a dealer option, it
generally will be able to close out the option prior to its
expiration only by entering into a closing purchase transaction
with the dealer to which the Fund originally wrote the option.
While each Fund will seek to enter into dealer options only with
dealers who will agree to and which are expected to be capable of
entering into closing transactions with the Fund, there can be no
assurance that the Fund will be able to liquidate a dealer option
at a favorable price at any time prior to expiration. Until a
Fund, as a covered dealer call option writer, is able to effect a
closing purchase transaction, it will not be able to liquidate
securities (or other assets) or currencies used as cover until
the option expires or is exercised. In the event of insolvency
of the contra party, a Fund may be unable to liquidate a dealer
option. With respect to options written by a Fund, the inability
to enter into a closing transaction may result in material losses
to the Fund. For example, since a Fund must maintain a secured
position with respect to any call option on a security it writes,
the Fund may not sell the assets which it has segregated to
PAGE 51
secure the position while it is obligated under the option. This
requirement may impair a Fund's ability to sell portfolio
securities or currencies at a time when such sale might be
advantageous.
The Staff of the SEC has taken the position that purchased
dealer options and the assets used to secure the written dealer
options are illiquid securities. The Funds may treat the cover
used for written OTC options as liquid if the dealer agrees that
the Fund may repurchase the OTC option it has written for a
maximum price to be calculated by a predetermined formula. In
such cases, the OTC option would be considered illiquid only to
the extent the maximum repurchase price under the formula exceeds
the intrinsic value of the option. Accordingly, each Fund will
treat dealer options as subject to the Fund's limitation on
unmarketable securities. If the SEC changes its position on the
liquidity of dealer options, each Fund will change its treatment
of such instrument accordingly.
Interest Rate Transactions
Limited-Term and GNMA Funds
The Funds may enter into various interest rate transactions
such as interest rate swaps and the purchase or sale of interest
rate caps and floors, to preserve a return or spread on a
particular investment or portion of its portfolio, to create
synthetic securities, or to structure transactions designed for
other non-speculative purposes.
Interest rate swaps involve the exchange by the Funds with
third parties of their respective commitments to pay or receive
interest, e.g., an exchange of floating rate payments for fixed
rate payments. The purchase of an interest rate cap entitles the
purchaser, to the extent that a specified index exceeds a
predetermined interest rate, to receive payments of interest on a
contractually-based principal amount from the party selling the
interest rate cap. The purchase of an interest rate floor
entitles the purchaser, to the extent that a specified index
falls below a predetermined interest rate, to receive payments of
interest on a contractually-based principal amount from the party
selling the interest rate floor. In circumstances in which T.
Rowe Price anticipates that interest rates will decline, the
Funds might, for example, enter into an interest rate swap as the
floating rate payor. In the case where the Funds purchase such
an interest rate swap, if the floating rate payments fell below
the level of the fixed rate payment set in the swap agreement,
PAGE 52
the Funds counterparties would pay the Funds' amounts equal to
interest computed at the difference between the fixed and
floating rates over the national principal amount. Such payments
would offset or partially offset the decrease in the payments the
Funds would receive in respect of floating rate assets being
hedged. In the case of purchasing an interest rate floor, if
interest rates declined below the floor rate, the Funds would
receive payments from the counterparties which would wholly or
partially offset the decrease in the payments they would receive
in respect of the financial instruments being hedged.
The Funds will usually enter into interest rate swaps on a
net basis, i.e., the two payment streams are netted out, with the
Funds receiving or paying, as the case may be, only the net
amount of the two payments. The net amount of the excess, if
any, of the Funds' obligations over its entitlements with respect
to each interest rate swap will be accrued on a daily basis and
an amount of cash or high-quality liquid securities having an
aggregate net asset value at least equal to the accrued excess
will be maintained in an account by the Funds' custodian. If the
Funds enter into an interest rate swap on other than a net basis,
the Funds would maintain an account in the full amount accrued on
a daily basis of the Funds' obligations with respect to the swap.
To the extent the Funds sell (i.e., writes) caps and floors, it
will maintain in an account cash or high-quality liquid debt
securities having an aggregate net asset value at least equal to
the full amount, accrued on a daily basis, of the Funds'
obligations with respect to any caps or floors. The Funds will
not enter into any interest rate swap, cap or floor transaction
unless the unsecured senior debt or the claims paying ability of
the counterparty thereto is rated at least A by S&P. T. Rowe
Price will monitor the creditworthiness of counterparties on an
ongoing basis. If there is a default by the other parties to
such a transaction, the Funds will have contractual remedies
pursuant to the agreements related to the transaction.
The swap market has grown substantially in recent years with
a large number of banks and investment banking firms acting both
as principals and as agents utilizing standardized swap
documentation. T. Rowe Price has determined that, as a result,
the swap market has become relative liquid. The Funds may enter
into interest rate swaps only with respect to positions held in
their portfolios. Interest rate swaps do not involve the
delivery of securities or other underlying assets or principal.
Accordingly, the risk of loss with respect to interest rate swaps
is limited to the net amount of interest payments that the Funds
are contractually obligated to make. If the other parties to
PAGE 53
interest rate swaps default, the Funds' risk of loss consists of
the net amount of interest payments that the Funds are
contractually entitled to receive. Since interest rate swaps are
individually negotiated, the Funds expect to achieve an
acceptable degree of correlation between their right to receive
interest on loan interests and their right and obligation to
receive and pay interest pursuant to interest rate swaps.
The aggregate purchase price of caps and floors held by the
Funds may not exceed 10% of the Funds' total assets. The Funds
may sell (i.e., write) caps and floors without limitation,
subject to the account coverage requirement described above.
Futures Contracts
Limited-Term and GNMA Funds
Transactions in Futures
The Fund may enter into futures contracts (a type of
potentially high risk derivative), including stock index,
interest rate and currency futures ("futures or futures
contracts").
Stock index futures contracts may be used to provide a hedge
for a portion of the Fund's portfolio, as a cash management tool,
or as an efficient way for T. Rowe Price to implement either an
increase or decrease in portfolio market exposure in response to
changing market conditions. The Fund may purchase or sell
futures contracts with respect to any stock index. Nevertheless,
to hedge the Fund's portfolio successfully, the Fund must sell
futures contacts with respect to indices or subindices whose
movements will have a significant correlation with movements in
the prices of the Fund's portfolio securities.
Interest rate or currency futures contracts may be used as a
hedge against changes in prevailing levels of interest rates or
currency exchange rates in order to establish more definitely the
effective return on securities or currencies held or intended to
be acquired by the Fund. In this regard, the Fund could sell
interest rate or currency futures as an offset against the effect
of expected increases in interest rates or currency exchange
rates and purchase such futures as an offset against the effect
of expected declines in interest rates or currency exchange
rates.
PAGE 54
The Fund will enter into futures contracts which are traded
on national or foreign futures exchanges, and are standardized as
to maturity date and underlying financial instrument. Futures
exchanges and trading in the United States are regulated under
the Commodity Exchange Act by the CFTC. Futures are traded in
London, at the London International Financial Futures Exchange,
in Paris, at the MATIF, and in Tokyo, at the Tokyo Stock
Exchange. Although techniques other than the sale and purchase
of futures contracts could be used for the above-referenced
purposes, futures contracts offer an effective and relatively low
cost means of implementing the Fund's objectives in these areas.
Regulatory Limitations
The Fund will engage in futures contracts and options
thereon only for bona fide hedging, yield enhancement, and risk
management purposes, in each case in accordance with rules and
regulations of the CFTC and applicable state law.
The Fund may not purchase or sell futures contracts or
related options if, with respect to positions which do not
qualify as bona fide hedging under applicable CFTC rules, the sum
of the amounts of initial margin deposits and premiums paid on
those positions would exceed 5% of the net asset value of the
Fund after taking into account unrealized profits and unrealized
losses on any such contracts it has entered into; provided,
however, that in the case of an option that is in-the-money at
the time of purchase, the in-the-money amount may be excluded in
calculating the 5% limitation. For purposes of this policy
options on futures contracts and foreign currency options traded
on a commodities exchange will be considered "related options".
This policy may be modified by the Board of Directors/Trustees
without a shareholder vote and does not limit the percentage of
the Fund's assets at risk to 5%.
In accordance with the rules of the State of California, the
Fund may have to apply the above 5% test without excluding the
value of initial margin and premiums paid for bona fide hedging
positions.
The Fund's use of futures contracts will not result in
leverage. Therefore, to the extent necessary, in instances
involving the purchase of futures contracts or the writing of
call or put options thereon by the Fund, an amount of cash, U.S.
government securities or other liquid, high-grade debt
obligations, equal to the market value of the futures contracts
and options thereon (less any related margin deposits), will be
PAGE 55
identified in an account with the Fund's custodian to cover the
position, or alternative cover (such as owning an offsetting
position) will be employed. Assets used as cover or held in an
identified account cannot be sold while the position in the
corresponding option or future is open, unless they are replaced
with similar assets. As a result, the commitment of a large
portion of a Fund's assets to cover or identified accounts could
impede portfolio management or the fund's ability to meet
redemption requests or other current obligations.
If the CFTC or other regulatory authorities adopt different
(including less stringent) or additional restrictions, the Fund
would comply with such new restrictions.
Trading in Futures Contracts
A futures contract provides for the future sale by one party
and purchase by another party of a specified amount of a specific
financial instrument (e.g., units of a debt security) for a
specified price, date, time and place designated at the time the
contract is made. Brokerage fees are incurred when a futures
contract is bought or sold and margin deposits must be
maintained. Entering into a contract to buy is commonly referred
to as buying or purchasing a contract or holding a long position.
Entering into a contract to sell is commonly referred to as
selling a contract or holding a short position.
Unlike when the Fund purchases or sells a security, no price
would be paid or received by the Fund upon the purchase or sale
of a futures contract. Upon entering into a futures contract,
and to maintain the Fund's open positions in futures contracts,
the Fund would be required to deposit with its custodian in a
segregated account in the name of the futures broker an amount of
cash, U.S. government securities, suitable money market
instruments, or liquid, high-grade debt securities, known as
"initial margin." The margin required for a particular futures
contract is set by the exchange on which the contract is traded,
and may be significantly modified from time to time by the
exchange during the term of the contract. Futures contracts are
customarily purchased and sold on margins that may range upward
from less than 5% of the value of the contract being traded.
If the price of an open futures contract changes (by
increase in the case of a sale or by decrease in the case of a
purchase) so that the loss on the futures contract reaches a
point at which the margin on deposit does not satisfy margin
PAGE 56
requirements, the broker will require an increase in the margin.
However, if the value of a position increases because of
favorable price changes in the futures contract so that the
margin deposit exceeds the required margin, the broker will pay
the excess to the Fund.
These subsequent payments, called "variation margin," to and
from the futures broker, are made on a daily basis as the price
of the underlying assets fluctuate making the long and short
positions in the futures contract more or less valuable, a
process known as "marking to the market." The Fund expects to
earn interest income on its margin deposits.
Although certain futures contracts, by their terms, require
actual future delivery of and payment for the underlying
instruments, in practice most futures contracts are usually
closed out before the delivery date. Closing out an open futures
contract purchase or sale is effected by entering into an
offsetting futures contract sale or purchase, respectively, for
the same aggregate amount of the identical securities and the
same delivery date. If the offsetting purchase price is less
than the original sale price, the Fund realizes a gain; if it is
more, the Fund realizes a loss. Conversely, if the offsetting
sale price is more than the original purchase price, the Fund
realizes a gain; if it is less, the Fund realizes a loss. The
transaction costs must also be included in these calculations.
There can be no assurance, however, that the Fund will be able to
enter into an offsetting transaction with respect to a particular
futures contract at a particular time. If the Fund is not able
to enter into an offsetting transaction, the Fund will continue
to be required to maintain the margin deposits on the futures
contract.
As an example of an offsetting transaction in which the
underlying instrument is not delivered, the contractual
obligations arising from the sale of one contract of September
Treasury Bills on an exchange may be fulfilled at any time before
delivery of the contract is required (i.e., on a specified date
in September, the "delivery month") by the purchase of one
contract of September Treasury Bills on the same exchange. In
such instance, the difference between the price at which the
futures contract was sold and the price paid for the offsetting
purchase, after allowance for transaction costs, represents the
profit or loss to the Fund.
A futures contract on the Standard & Poor's 500 Stock Index,
composed of 500 selected common stocks, most of which are listed
PAGE 57
on the New York Stock Exchange, provides an example of how
futures contracts operate. The S&P 500 Index assigns relative
weightings to the common stocks included in the Index, and the
Index fluctuates with changes in the market values of those
common stocks. In the case of futures contracts on the S&P 500
Index, the contracts are to buy or sell 500 units. Thus, if the
value of the S&P 500 Index were $150, one contract would be worth
$75,000 (500 units x $150). The contract specifies that no
delivery of the actual stocks making up the index will take
place. Instead, settlement in cash occurs. Over the life of the
contract, the gain or loss realized by the Fund will equal the
difference between the purchase (or sale) price of the contract
and the price at which the contract is terminated. For example,
if the Fund enters into the example contract above and the S&P
500 Index is at $154 on the termination date, the Fund will gain
$2,000 (500 units x gain of $4). If, however, the S&P 500 Index
is at $148 on that future date, the Fund will lose $1,000 (500
units x loss of $2).
Special Risks of Transactions in Futures Contracts
Volatility and Leverage. The prices of futures contracts
are volatile and are influenced, among other things, by actual
and anticipated changes in the market and interest rates, which
in turn are affected by fiscal and monetary policies and national
and international political and economic events.
Most United States futures exchanges limit the amount of
fluctuation permitted in futures contract prices during a single
trading day. The daily limit establishes the maximum amount that
the price of a futures contract may vary either up or down from
the previous day's settlement price at the end of a trading
session. Once the daily limit has been reached in a particular
type of futures contract, no trades may be made on that day at a
price beyond that limit. The daily limit governs only price
movement during a particular trading day and therefore does not
limit potential losses, because the limit may prevent the
liquidation of unfavorable positions. Futures contract prices
have occasionally moved to the daily limit for several
consecutive trading days with little or no trading, thereby
preventing prompt liquidation of futures positions and subjecting
some futures traders to substantial losses.
Because of the low margin deposits required, futures trading
involves an extremely high degree of leverage. As a result, a
relatively small price movement in a futures contract may result
in immediate and substantial loss, as well as gain, to the
PAGE 58
investor. For example, if at the time of purchase, 10% of the
value of the futures contract is deposited as margin, a
subsequent 10% decrease in the value of the futures contract
would result in a total loss of the margin deposit, before any
deduction for the transaction costs, if the account were then
closed out. A 15% decrease would result in a loss equal to 150%
of the original margin deposit, if the contract were closed out.
Thus, a purchase or sale of a futures contract may result in
losses in excess of the amount invested in the futures contract.
However, the Fund would presumably have sustained comparable
losses if, instead of the futures contract, it had invested in
the underlying financial instrument and sold it after the
decline. Furthermore, in the case of a futures contract
purchase, in order to be certain that the Fund has sufficient
assets to satisfy its obligations under a futures contract, the
Fund earmarks to the futures contract money market instruments
equal in value to the current value of the underlying instrument
less the margin deposit.
Liquidity. The Fund may elect to close some or all of its
futures positions at any time prior to their expiration. The
Fund would do so to reduce exposure represented by long futures
positions or short futures positions. The Fund may close its
positions by taking opposite positions which would operate to
terminate the Fund's position in the futures contracts. Final
determinations of variation margin would then be made, additional
cash would be required to be paid by or released to the Fund, and
the Fund would realize a loss or a gain.
Futures contracts may be closed out only on the exchange or
board of trade where the contracts were initially traded.
Although the Fund intends to purchase or sell futures contracts
only on exchanges or boards of trade where there appears to be an
active market, there is no assurance that a liquid market on an
exchange or board of trade will exist for any particular contract
at any particular time. In such event, it might not be possible
to close a futures contract, and in the event of adverse price
movements, the Fund would continue to be required to make daily
cash payments of variation margin. However, in the event futures
contracts have been used to hedge the underlying instruments, the
Fund would continue to hold the underlying instruments subject to
the hedge until the futures contracts could be terminated. In
such circumstances, an increase in the price of underlying
instruments, if any, might partially or completely offset losses
on the futures contract. However, as described below, there is
no guarantee that the price of the underlying instruments will,
in fact, correlate with the price movements in the futures
PAGE 59
contract and thus provide an offset to losses on a futures
contract.
Hedging Risk. A decision of whether, when, and how to hedge
involves skill and judgment, and even a well-conceived hedge may
be unsuccessful to some degree because of unexpected market
behavior, market or interest rate trends. There are several
risks in connection with the use by the Fund of futures contracts
as a hedging device. One risk arises because of the imperfect
correlation between movements in the prices of the futures
contracts and movements in the prices of the underlying
instruments which are the subject of the hedge. T. Rowe Price
will, however, attempt to reduce this risk by entering into
futures contracts whose movements, in its judgment, will have a
significant correlation with movements in the prices of the
Fund's underlying instruments sought to be hedged.
Successful use of futures contracts by the Fund for hedging
purposes is also subject to T. Rowe Price's ability to correctly
predict movements in the direction of the market. It is possible
that, when the Fund has sold futures to hedge its portfolio
against a decline in the market, the index, indices, or
instruments underlying futures might advance and the value of the
underlying instruments held in the Fund's portfolio might
decline. If this were to occur, the Fund would lose money on the
futures and also would experience a decline in value in its
underlying instruments. However, while this might occur to a
certain degree, T. Rowe Price believes that over time the value
of the Fund's portfolio will tend to move in the same direction
as the market indices used to hedge the portfolio. It is also
possible that if the Fund were to hedge against the possibility
of a decline in the market (adversely affecting the underlying
instruments held in its portfolio) and prices instead increased,
the Fund would lose part or all of the benefit of increased value
of those underlying instruments that it has hedged, because it
would have offsetting losses in its futures positions. In
addition, in such situations, if the Fund had insufficient cash,
it might have to sell underlying instruments to meet daily
variation margin requirements. Such sales of underlying
instruments might be, but would not necessarily be, at increased
prices (which would reflect the rising market). The Fund might
have to sell underlying instruments at a time when it would be
disadvantageous to do so.
In addition to the possibility that there might be an
imperfect correlation, or no correlation at all, between price
movements in the futures contracts and the portion of the
PAGE 60
portfolio being hedged, the price movements of futures contracts
might not correlate perfectly with price movements in the
underlying instruments due to certain market distortions. First,
all participants in the futures market are subject to margin
deposit and maintenance requirements. Rather than meeting
additional margin deposit requirements, investors might close
futures contracts through offsetting transactions, which could
distort the normal relationship between the underlying
instruments and futures markets. Second, the margin requirements
in the futures market are less onerous than margin requirements
in the securities markets, and as a result the futures market
might attract more speculators than the securities markets do.
Increased participation by speculators in the futures market
might also cause temporary price distortions. Due to the
possibility of price distortion in the futures market and also
because of the imperfect correlation between price movements in
the underlying instruments and movements in the prices of futures
contracts, even a correct forecast of general market trends by T.
Rowe Price might not result in a successful hedging transaction
over a very short time period.
Options on Futures Contracts
The Fund may purchase and sell options on the same types of
futures in which it may invest.
Options on futures are similar to options on underlying
instruments except that options on futures give the purchaser the
right, in return for the premium paid, to assume a position in a
futures contract (a long position if the option is a call and a
short position if the option is a put), rather than to purchase
or sell the futures contract, at a specified exercise price at
any time during the period of the option. Upon exercise of the
option, the delivery of the futures position by the writer of the
option to the holder of the option will be accompanied by the
delivery of the accumulated balance in the writer's futures
margin account which represents the amount by which the market
price of the futures contract, at exercise, exceeds (in the case
of a call) or is less than (in the case of a put) the exercise
price of the option on the futures contract. Purchasers of
options who fail to exercise their options prior to the exercise
date suffer a loss of the premium paid.
As an alternative to writing or purchasing call and put
options on interest rate futures, the Fund may write or purchase
call and put options on financial indices. Such options would be
used in a manner similar to the use of options on futures
PAGE 61
contracts. From time to time, a single order to purchase or sell
futures contracts (or options thereon) may be made on behalf of
the Fund and other T. Rowe Price Funds. Such aggregated orders
would be allocated among the Funds and the other T. Rowe Price
Funds in a fair and non-discriminatory manner.
Special Risks of Transactions in Options on Futures Contracts
The risks described under "Special Risks of Transactions on
Futures Contracts" are substantially the same as the risks of
using options on futures. In addition, where the Fund seeks to
close out an option position by writing or buying an offsetting
option covering the same index, underlying instrument or contract
and having the same exercise price and expiration date, its
ability to establish and close out positions on such options will
be subject to the maintenance of a liquid secondary market.
Reasons for the absence of a liquid secondary market on an
exchange include the following: (i) there may be insufficient
trading interest in certain options; (ii) restrictions may be
imposed by an exchange on opening transactions or closing
transactions or both; (iii) trading halts, suspensions or other
restrictions may be imposed with respect to particular classes or
series of options, or underlying instruments; (iv) unusual or
unforeseen circumstances may interrupt normal operations on an
exchange; (v) the facilities of an exchange or a clearing
corporation may not at all times be adequate to handle current
trading volume; or (vi) one or more exchanges could, for economic
or other reasons, decide or be compelled at some future date to
discontinue the trading of options (or a particular class or
series of options), in which event the secondary market on that
exchange (or in the class or series of options) would cease to
exist, although outstanding options on the exchange that had been
issued by a clearing corporation as a result of trades on that
exchange would continue to be exercisable in accordance with
their terms. There is no assurance that higher than anticipated
trading activity or other unforeseen events might not, at times,
render certain of the facilities of any of the clearing
corporations inadequate, and thereby result in the institution by
an exchange of special procedures which may interfere with the
timely execution of customers' orders.
Additional Futures and Options Contracts
Although the Funds have no current intention of engaging in
futures or options transactions other than those described above,
each reserves the right to do so. Such futures and options
PAGE 62
trading might involve risks which differ from those involved in
the futures and options described above.
Foreign Futures and Options--Limited-Term Fund
Participation in foreign futures and foreign options
transactions involves the execution and clearing of trades on or
subject to the rules of a foreign board of trade. Neither the
National Futures Association nor any domestic exchange regulates
activities of any foreign boards of trade, including the
execution, delivery and clearing of transactions, or has the
power to compel enforcement of the rules of a foreign board of
trade or any applicable foreign law. This is true even if the
exchange is formally linked to a domestic market so that a
position taken on the market may be liquidated by a transaction
on another market. Moreover, such laws or regulations will vary
depending on the foreign country in which the foreign futures or
foreign options transaction occurs. For these reasons, customers
who trade foreign futures or foreign options contracts may not be
afforded certain of the protective measures provided by the
Commodity Exchange Act, the CFTC's regulations and the rules of
the National Futures Association and any domestic exchange,
including the right to use reparations proceedings before the
Commission and arbitration proceedings provided by the National
Futures Association or any domestic futures exchange. In
particular, funds received from customers for foreign futures or
foreign options transactions may not be provided the same
protections as funds received in respect of transactions on
United States futures exchanges. In addition, the price of any
foreign futures or foreign options contract and, therefore, the
potential profit and loss thereon may be affected by any variance
in the foreign exchange rate between the time your order is
placed and the time it is liquidated, offset or exercised.
Federal Tax Treatment of Options, Futures Contracts and Forward
Foreign Exchange Contracts--Limited-Term and GNMA Funds
The discussion herein may refer to transactions in which the
GNMA Fund does not engage. The Fund's prospectus sets forth the
types of transactions permissible for the Fund.
The Funds may enter into certain option, futures, and
forward foreign exchange contracts, including options and futures
on currencies, which will be treated as Section 1256 contracts or
straddles.
PAGE 63
Transactions which are considered Section 1256 contracts
will be considered to have been closed at the end of a Fund's
fiscal year and any gains or losses will be recognized for tax
purposes at that time. Such gains or losses from the normal
closing or settlement of such transactions will be characterized
as 60% long-term capital gain or loss and 40% short-term capital
gain or loss regardless of the holding period of the instrument.
A Fund will be required to distribute net gains on such
transactions to shareholders even though it may not have closed
the transaction and received cash to pay such distributions.
Options, futures and forward foreign exchange contracts,
including options and futures on currencies, which offset a
foreign dollar denominated bond or currency position may be
considered straddles for tax purposes in which case a loss on any
position in a straddle will be subject to deferral to the extent
of unrealized gain in an offsetting position. The holding period
of the securities or currencies comprising the straddle will be
deemed not to begin until the straddle is terminated. For
securities offsetting a purchased put, this adjustment of the
holding period may increase the gain from sales of securities
held less than three months. The holding period of the security
offsetting an "in-the-money qualified covered call" option on an
equity security will not include the period of time the option is
outstanding.
Losses on written covered calls and purchased puts on
securities, excluding certain "qualified covered call" options on
equity securities, may be long-term capital loss, if the security
covering the option was held for more than twelve months prior to
the writing of the option.
In order for each Fund to continue to qualify for federal
income tax treatment as a regulated investment company, at least
90% of its gross income for a taxable year must be derived from
qualifying income; i.e., dividends, interest, income derived from
loans of securities, and gains from the sale of securities or
currencies. Pending tax regulations could limit the extent that
net gain realized from option, futures or foreign forward
exchange contracts on currencies is qualifying income for
purposes of the 90% requirement. In addition, gains realized on
the sale or other disposition of securities, including option,
futures or foreign forward exchange contracts on securities or
securities indexes and, in some cases, currencies, held for less
than three months, must be limited to less than 30% of a Fund's
annual gross income. In order to avoid realizing excessive gains
on securities or currencies held less than three months, a Fund
PAGE 64
may be required to defer the closing out of option, futures or
foreign forward exchange contracts beyond the time when it would
otherwise be advantageous to do so. It is anticipated that
unrealized gains on Section 1256 option, futures and foreign
forward exchange contracts, which have been open for less than
three months as of the end of a Fund's fiscal year and which are
recognized for tax purposes, will not be considered gains on
securities or currencies held less than three months for purposes
of the 30% test.
INVESTMENT RESTRICTIONS
Fundamental policies may not be changed without the approval
of the lesser of (1) 67% of a Fund's shares present at a meeting
of shareholders if the holders of more than 50% of the
outstanding shares are present in person or by proxy or (2) more
than 50% of a Fund's outstanding shares. Other restrictions in
the form of operating policies are subject to change by the
Funds' Board of Directors without shareholder approval. Any
investment restriction which involves a maximum percentage of
securities or assets shall not be considered to be violated
unless an excess over the percentage occurs immediately after,
and is caused by, an acquisition of securities or assets of, or
borrowings by, a Fund.
Fundamental Policies
As a matter of fundamental policy, the Funds may not:
(1) Borrowing. Borrow money except that the Fund may (i)
borrow for non-leveraging, temporary or emergency
purposes and (ii) engage in reverse repurchase
agreements and make other investments or engage in
other transactions, which may involve a borrowing, in
a manner consistent with the Fund's investment
objective and program, provided that the combination
of (i) and (ii) shall not exceed 33 1/3% of the value
of the Fund's total assets (including the amount
borrowed) less liabilities (other than borrowings) or
such other percentage permitted by law. Any
borrowings which come to exceed this amount will be
reduced in accordance with applicable law. The Fund
may borrow from banks, other Price Funds or other
persons to the extent permitted by applicable law.
PAGE 65
(2) Commodities. Purchase or sell commodities or
commodity contracts; except that it may enter into
futures contracts and options thereon;
(3) Industry Concentration. Purchase the securities of
any issuer if, as a result, more than 25% of the
value of the Fund's total assets would be invested in
the securities of issuers having their principal
business activities in the same industry;
(4) Loans. Make loans, although the Fund may (i) lend
portfolio securities and participate in an interfund
lending program with other Price Funds provided that
no such loan may be made if, as a result, the
aggregate of such loans would exceed 33 1/3% of the
value of the Fund's total assets; (ii) purchase money
market securities and enter into repurchase
agreements; and (iii) acquire publicly-distributed or
privately-placed debt securities and purchase debt;
(5) Percent Limit on Assets Invested in Any One Issuer.
Purchase a security if, as a result, with respect to
75% of the value of its total assets, more than 5% of
the value of the Fund's total assets would be
invested in the securities of a single issuer, except
securities issued or guaranteed by the U.S.
Government or any of its agencies or
instrumentalities;
(6) Percent Limit on Share Ownership of Any One Issuer.
Purchase a security if, as a result, with respect to
75% of the value of the Fund's total assets, more
than 10% of the outstanding voting securities of any
issuer would be held by the Fund (other than
obligations issued or guaranteed by the U.S.
Government, its agencies or instrumentalities);
(7) Real Estate. Purchase or sell real estate, including
limited partnership interests therein, unless
acquired as a result of ownership of securities or
other instruments (but this shall not prevent the
Fund from investing in securities or other
instruments backed by real estate or securities of
companies engaged in the real estate business);
PAGE 66
(8) Senior Securities. Issue senior securities except in
compliance with the Investment Company Act of 1940;
or
(9) Underwriting. Underwrite securities issued by other
persons, except to the extent that the Fund may be
deemed to be an underwriter within the meaning of the
Securities Act of 1933 in connection with the
purchase and sale of its portfolio securities in the
ordinary course of pursuing its investment program.
NOTES
The following Notes should be read in connection with
the above-described fundamental policies. The Notes
are not fundamental policies.
With respect to investment restrictions (1) and (4)
the Funds will not borrow from or lend to any other
T. Rowe Price Fund unless each Fund applies for and
receives an exemptive order from the SEC or the SEC
issues rules permitting such transactions. The Funds
have no current intention of engaging in any such
activity and there is no assurance the SEC would
grant any order requested by the Funds or promulgate
any rules allowing the transactions.
With respect to investment restriction (1), the Cash
Reserves Fund has no current intention of engaging in
any borrowing transactions.
With respect to investment restriction (2), the Funds
do not consider currency contracts or hybrid
instruments to be commodities.
For purposes of investment restriction (3), U.S.,
state or local governments, or related agencies or
instrumentalities, are not considered an industry.
Industries are determined by reference to the
classifications of industries set forth in the Funds
Semi-annual and Annual Reports.
Operating Policies
As a matter of operating policy, the Funds may not:
PAGE 67
(1) Borrowing. The Funds will not purchase additional
securities when money borrowed exceeds 5% of its
total assets.
(2) Control of Portfolio Companies. Invest in companies
for the purpose of exercising management or control;
(3) Futures Contracts. Purchase a futures contract or an
option thereon if, with respect to positions in
futures or options on futures which do not represent
bona fide hedging, the aggregate initial margin and
premiums on such positions would exceed 5% of the
Fund's net asset value.
(4) Illiquid Securities. Purchase illiquid securities
and securities of unseasoned issuers if, as a result,
more than 15% (10% Cash Reserves) of its net assets
would be invested in such securities, provided that
the Fund will not invest more than 5% of its total
assets in restricted securities and not more than 5%
in securities of unseasoned issuers. Securities
eligible for resale under Rule 144A of the Securities
Act of 1933 are not included in the 5% limitation but
are subject to the 15% (10% Cash Reserves)
limitation;
(5) Investment Companies. Purchase securities of open-
end or closed-end investment companies except in
compliance with the Investment Company Act of 1940
and applicable state law, and in the case of the Cash
Reserves Fund, only securities of other money market
fund's. Duplicate fees may result from such
purchases;
(6) Margin. Purchase securities on margin, except (i)
for use of short-term credit necessary for clearance
of purchases of portfolio securities and (ii) it may
make margin deposits in connection with futures
contracts or other permissible investments;
(7) Mortgaging. Mortgage, pledge, hypothecate or, in any
manner, transfer any security owned by the Fund as
security for indebtedness except as may be necessary
in connection with permissible borrowings or
investments and then such mortgaging, pledging or
hypothecating may not exceed 33 1/3% of the Fund's
total assets at the time of borrowing or investment;
PAGE 68
(8) Oil and Gas Programs. Purchase participations or
other direct interests or enter into leases with
respect to, oil, gas, or other mineral exploration or
development programs;
(9) Options, Etc. Invest in puts, calls, straddles,
spreads, or any combination thereof, except to the
extent permitted by the prospectus and Statement of
Additional Information;
(10) Ownership of Portfolio Securities by Officers and
Directors. Purchase or retain the securities of any
issuer if, those officers and directors of the Fund,
and of its investment manager, who each own
beneficially more than .5% of the outstanding
securities of such issuer, together own beneficially
more than 5% of such securities;
(11) Short Sales. Effect short sales of securities;
(12) Unseasoned Issuers. Purchase a security (other than
obligations issued or guaranteed by the U.S., any
foreign, state or local government, their agencies or
instrumentalities) if, as a result, more than 5% of
the value of the Fund's total assets would be
invested in the securities issuers which at the time
of purchase had been in operation for less than three
years (for this purpose, the period of operation of
any issuer shall include the period of operation of
any predecessor or unconditional guarantor of such
issuer). This restriction does not apply to
securities of pooled investment vehicles or mortgage
or asset-backed securities; or
(13) Warrants. Invest in warrants if, as a result
thereof, more than 2% of the value of the net assets
of the Fund would be invested in warrants which are
not listed on the New York Stock Exchange, the
American Stock Exchange, or a recognized foreign
exchange, or more than 5% of the value of the net
assets of the Fund would be invested in warrants
whether or not so listed. For purposes of these
percentage limitations, the warrants will be valued
at the lower of cost or market and warrants acquired
by the Funds in units or attached to securities may
be deemed to be without value.
PAGE 69
Notwithstanding anything in the above fundamental and
operating restrictions to the contrary, each Fund may invest all
of its assets in a single investment company or a series thereof
in connection with a "master-feeder" arrangement. Such an
investment would be made where the Fund (a "Feeder"), and one or
more other Funds with the same investment objective and program
as the Fund, sought to accomplish its investment objective and
program by investing all of its assets in the shares of another
investment company (the "Master"). The Master would, in turn,
have the same investment objective and program as the Fund. The
Fund would invest in this manner in an effort to achieve the
economies of scale associated with having a Master fund make
investments in portfolio companies on behalf of a number of
Feeder funds.
MANAGEMENT OF FUNDS
The officers and directors of the Funds are listed below.
Unless otherwise noted, the address of each is 100 East Pratt
Street, Baltimore, Maryland 21202. Except as indicated, each has
been an employee of T. Rowe Price for more than five years. In
the list below, the Funds' directors who are considered
"interested persons" of T. Rowe Price as defined under
Section 2(a)(19) of the Investment Company Act of 1940 are noted
with an asterisk (*). These directors are referred to as inside
directors by virtue of their officership, directorship, and/or
employment with T. Rowe Price.
ROBERT P. BLACK, Director--Retired; formerly President, Federal
Reserve Bank of Richmond; Address: 10 Dahlgren Road, Richmond,
Virginia 23233
CALVIN W. BURNETT, PH.D., Director--President, Coppin State
College; Director, Maryland Chamber of Commerce and Provident
Bank of Maryland; Former President, Baltimore Area Council Boy
Scouts of America; Vice President, Board of Directors, The
Walters Art Gallery; Address: 2000 North Warwick Avenue,
Baltimore, Maryland 21216
*GEORGE J. COLLINS, Chairman of the Board--President, Chief
Executive Officer and Managing Director, T. Rowe Price; Director,
Rowe Price-Fleming International, Inc., T. Rowe Price Retirement
Plan Services, Inc. and T. Rowe Price Trust Company; Chartered
Investment Counselor
ANTHONY W. DEERING, Director--Director, President and Chief
Executive Officer, The Rouse Company, real estate developers,
Columbia, Maryland; Advisory Director, Kleinwort, Benson (North
PAGE 70
America) Corporation, a registered broker-dealer; Address: 10275
Little Patuxent Parkway, Columbia, Maryland 21044
F. PIERCE LINAWEAVER, Director--President, F. Pierce Linaweaver &
Associates, Inc.; formerly (1987-1991) Executive Vice President,
EA Engineering, Science, and Technology, Inc., and (1987-1990)
President, EA Engineering, Inc., Baltimore, Maryland; Address:
The Legg Mason Tower, 111 South Calvert Street, Suite 2700,
Baltimore, Maryland 21202
*JAMES S. RIEPE, Vice President and Director--Managing Director,
T. Rowe Price; Chairman of the Board, T. Rowe Price Services,
Inc., T. Rowe Price Retirement Plan Services, Inc. and T. Rowe
Price Trust Company; President and Director, T. Rowe Price
Investment Services, Inc.; Director, Rhone-Poulenc Rorer, Inc.
JOHN G. SCHREIBER, Director--President, Schreiber Investments,
Inc., a real estate investment company; Director, AMLI
Residential Properties Trust; Partner, Blackstone Real Estate
Partners, L.P.; Director and formerly (12/70-12/90) Executive
Vice President, JMB Realty Corporation, a national real estate
investment manager and developer; Director, Urban Shopping
Centers, Inc.; Address: 1115 East Illinois Road, Lake Forest,
Illinois 60045
ANNE MARIE WHITTEMORE, Director--Partner, law firm of McGuire,
Woods, Battle & Boothe, L.L.P., Richmond, Virginia; formerly,
Chairman (1991-1993) and Director (1989-1993), Federal Reserve
Bank of Richmond; Director, Owens & Minor, Inc., USF&G
Corporation, James River Corporation and Wilderness Conservancy
at Mountain Lake, Inc.; Board of Visitors, Old Dominion
University; Member, Virginia State Bar and American Bar
Association; Address: One James Center, 901 East Cary Street,
Richmond, Virginia 23219-4030
WILLIAM T. REYNOLDS, President--Managing Director, T. Rowe Price
PETER VAN DYKE, Executive Vice President--Managing Director, T.
Rowe Price; Vice President, Rowe Price-Fleming International,
Inc.
EDWARD A. WIESE, Executive Vice President--Vice President, T.
Rowe Price, Rowe Price-Fleming International, Inc. and T. Rowe
Price Trust Company
ROBERT P. CAMPBELL, Vice President--Vice President, T. Rowe Price
and Rowe Price-Fleming International Inc.; formerly (4/80-5/90)
Vice President and Director, Private Finance, New York Life
Insurance Company, New York, New York
PATRICE L. BERCHTENBREITER, Vice President--Vice President, T.
Rowe Price
PAUL W. BOLTZ, Vice President--Vice President and Financial
Economist of T. Rowe Price
PAGE 71
MICHAEL J. CONELIUS, Vice President--Vice President, Rowe Price-
Fleming International, Inc. and Assistant Vice President, T. Rowe
Price
CHRISTY M. DIPIETRO, Vice President--Vice President, T. Rowe
Price and T. Rowe Price Trust Company
HENRY H. HOPKINS, Vice President--Vice President, Rowe Price-
Fleming International, Inc. and T. Rowe Price Retirement Plan
Services, Inc.; Managing Director, T. Rowe Price; Vice President
and Director, T. Rowe Price Investment Services, Inc., T. Rowe
Price Services, Inc. and T. Rowe Price Trust Company
VEENA A. KUTLER, Vice President--Vice President, T. Rowe Price
and Rowe Price-Fleming International, Inc.
HEATHER R. LANDON, Vice President--Vice President, T. Rowe Price,
T. Rowe Price Trust Company and Rowe Price-Fleming International,
Inc.
JAMES M. MCDONALD, Vice President--Vice President, T. Rowe Price
EDMUND M. NOTZON, Vice President--Vice President, T. Rowe Price
and T. Rowe Price Trust Company; formerly, (1972-1989) charter
member of the U.S. Senior Executive Services and Director,
Analysis and Evaluation Division in the Office of Water
Regulations and Standards of the U.S. Environmental Protection
Agency
JOAN R. POTEE, Vice President--Vice President, T. Rowe Price
ROBERT M. RUBINO, Vice President--Vice President, T. Rowe Price
CHARLES P. SMITH, Vice President--Managing Director, T. Rowe
Price; Vice President, Rowe Price-Fleming International, Inc.
LENORA V. HORNUNG, Secretary--Vice President, T. Rowe Price
PATRICIA S. BUTCHER, Assistant Secretary--Assistant Vice
President, T. Rowe Price and T. Rowe Price Investment Services,
Inc.
CARMEN F. DEYESU, Treasurer--Vice President, T. Rowe Price, T.
Rowe Price Services, Inc., and T. Rowe Price Trust Company
DAVID S. MIDDLETON, Controller--Vice President, T. Rowe Price, T.
Rowe Price Services, Inc., and T. Rowe Price Trust Company
ROGER L. FIERY, III, Assistant Vice President--Vice President,
Rowe Price-Fleming International Inc. and T. Rowe Price
EDWARD T. SCHNEIDER, Assistant Vice President--Vice President, T.
Rowe Price Services, Inc.
INGRID I. VORDEMBERGE, Assistant Vice President--Employee, T.
Rowe Price
PAGE 72
COMPENSATION TABLE
_________________________________________________________________
Pension or Total Compensation
Aggregate Retirement from Fund and
Name of Compensation Benefits Fund Group
Person, from Fund Accrued as Paid to
Position Expensesa Part of Fundb Directorsc
_________________________________________________________________
Summit Cash Reserves
Robert P. Black, $1,041 N/A $52,667
Director
Calvin W. Burnett, 1,041 N/A 55,583
PH.D, Director
Anthony W. Deering, 1,041 N/A 66,333
Director
F. Pierce Linaweaver, 1,041 N/A 55,583
Director
John G. Schreiber, 1,041 N/A 55,667
Director
Anne Marie Whittemore, 1,041 N/A 32,667
Director
George J. Collins, -- N/A --
Chairman of the Boardd
James S. Riepe, -- N/A --
Directord
Summit Limited-Term Bond
Robert P. Black, $1,041 N/A $52,667
Director
Calvin W. Burnett, 1,041 N/A 55,583
PH.D, Director
Anthony W. Deering, 1,041 N/A 66,333
Director
PAGE 73
F. Pierce Linaweaver, 1,041 N/A 55,583
Director
John G. Schreiber, 1,041 N/A 55,667
Director
Anne Marie Whittemore, 1,041 N/A 32,667
Director
George J. Collins, -- N/A --
Chairman of the Boardd
James S. Riepe, -- N/A --
Directord
Summit GNMA
Robert P. Black, $1,041 N/A $52,667
Director
Calvin W. Burnett, 1,041 N/A 55,583
PH.D, Director
Anthony W. Deering, 1,041 N/A 66,333
Director
F. Pierce Linaweaver, 1,041 N/A 55,583
Director
John G. Schreiber, 1,041 N/A 55,667
Director
Anne Marie Whittemore, 1,041 N/A 32,667
Director
George J. Collins, -- N/A --
Chairman of the Boardd
James S. Riepe, -- N/A --
Directord
a Amounts in this Column are for the period June 1, 1993
through May 31, 1994.
b Not applicable. The Fund does not pay pension or retirement
benefits to officers or directors/trustees of the Fund.
c Amounts in this column are for calendar year 1994, included
67 funds at December 31, 1994.
PAGE 74
d Any director/trustee of the Fund who is an officer or
employee of T. Rowe Price receives no renumeration from the
Fund.
The Funds' Executive Committee, comprised of Messrs. Collins
and Riepe, has been authorized by its Board of Directors to
exercise all powers of the Board to manage the Fund in the
intervals between meetings of the Board, except the powers
prohibited by statute from being delegated.
PRINCIPAL HOLDERS OF SECURITIES
As of the date of the prospectus, the officers and directors
of the Funds, as a group, owned less than 1% of the outstanding
shares of each Fund.
INVESTMENT MANAGEMENT SERVICES
Services Provided by T. Rowe Price
Under the Management Agreement with the Corporation relating
to each Fund, T. Rowe Price provides each Fund with discretionary
investment services. Specifically, T. Rowe Price is responsible
for supervising and directing the investments of each Fund in
accordance with its investment objectives, programs, and
restrictions as provided in the prospectus and this Statement of
Additional Information. T. Rowe Price is also responsible for
effecting all security transactions on behalf of each Fund,
including the allocation of principal business and portfolio
brokerage and the negotiation of commissions. In addition to
these services, T. Rowe Price provides each Fund with certain
corporate administrative services, including: maintaining the
Fund's corporate existence, corporate records, and registering
and qualifying the Fund's shares under federal and state laws;
monitoring the financial, accounting, and administrative
functions of each Fund; maintaining liaison with the agents
employed by each Fund such as the Fund's custodian and transfer
agent; assisting each Fund in the coordination of such agents'
activities; and permitting T. Rowe Price's employees to serve as
officers, directors, and committee members of each Fund without
cost to the Fund.
Each Fund's Management Agreement also provides that T. Rowe
Price, its directors, officers, employees, and certain other
persons performing specific functions for the Fund will only be
PAGE 75
liable to the Fund for losses resulting from willful misfeasance,
bad faith, gross negligence, or reckless disregard of duty.
Management Fee
Each Fund pays T. Rowe Price an annual all-inclusive fee
(the "Fee") of: 0.45% for the Cash Reserves Fund; 0.55% for the
Limited-Term Fund; and 0.60% for the GNMA Fund. The Fee is paid
monthly to the T. Rowe Price on the first business day of the
next succeeding calendar month and is the sum of the daily Fee
accruals for each month. The daily Fee accrual for any
particular day is calculated by multiplying the fraction of one
(1) over the number of calendar days in the year by the
appropriate Fee rate and multiplying this product by the net
assets of the Fund for that day as determined in accordance with
the Funds' prospectus as of the close of business from the
previous business day on which the Fund was open for business.
The Management Agreement between each Fund and T. Rowe Price
provides that T. Rowe Price will pay all expenses of each Fund's
operations, except interest, taxes, brokerage commissions and
other charges incident to the purchase, sale or lending of the
Fund's portfolio securities, directors' fees and expenses
(including counsel fees and expenses) and such nonrecurring or
extraordinary expenses that may arise, including the costs of
actions, suits, or proceedings to which the Fund is a party and
the expenses the Fund may incur as a result of its obligation to
provide indemnification to its officers, directors and agents.
However, the Board of Directors of the Fund reserves the right to
impose additional fees against shareholder accounts to defray
expenses which would otherwise be paid by T. Rowe Price under the
Management Agreement. The Board does not anticipate levying such
charges; such a fee, if charged, may be retained by the Fund or
paid to T. Rowe Price.
DISTRIBUTOR FOR FUNDS
T. Rowe Price Investment Services, Inc. ("Investment
Services"), a Maryland corporation formed in 1980 as a wholly-
owned subsidiary of T. Rowe Price, serves as the distributor of
the Funds. Investment Services is registered as a broker-dealer
under the Securities Exchange Act of 1934 and is a member of the
National Association of Securities Dealers, Inc. The offering of
each Fund's shares is continuous.
PAGE 76
Investment Services is located at the same address as the
Funds and T. Rowe T. Rowe Price -- 100 East Pratt Street,
Baltimore, Maryland 21202.
Investment Services serves as distributor to the Funds
pursuant to individual Underwriting Agreements ("Underwriting
Agreements"), which provide that Investment Services will pay all
fees and expenses in connection with: registering and qualifying
the Funds' shares under the various state "blue sky" laws;
preparing, setting in type, printing, and mailing its
prospectuses and reports to shareholders; issuing its shares,
including expenses of confirming purchase orders; printing and
distributing prospectuses and reports for use in offering and
selling shares for each Fund; preparing, setting in type,
printing, and mailing all sales literature and advertising;
Investment Services' federal and state registrations as a
broker-dealer; and offering and selling shares for each Fund.
The Underwriting Agreements provide that the Fund is responsible
for interest, taxes and such nonrecurring or extraordinary
expenses that may arise, including the costs of actions, suits or
proceedings to which the Fund is a party and the expenses the
Fund may incur as a result of its obligation to provide
indemnification to Investment Services. Investment Services'
expenses are paid by T. Rowe Price.
Investment Services acts as the agent of the Funds in
connection with the sale of their shares in all states in which
the shares are qualified and in which Investment Services is
qualified as a broker-dealer. Under the Underwriting Agreement,
Investment Services accepts orders for Fund shares at net asset
value. No sales charges are paid by investors or the Funds.
CUSTODIAN
State Street Bank and Trust Company is the custodian for
each Fund's securities and cash, but it does not participate in
the Funds' investment decisions. Portfolio securities purchased
in the U.S. are maintained in the custody of the Bank and may be
entered into the Federal Reserve Book Entry System, or the
security depository system of the Depository Trust Corporation.
The Bank and the Limited-Term Fund have entered into a Custodian
Agreement with The Chase Manhattan Bank, N.A., London, pursuant
to which portfolio securities which are purchased outside the
United States are maintained in the custody of various foreign
branches of The Chase Manhattan Bank and such other custodians,
including foreign banks and foreign securities depositories as
PAGE 77
are approved by the Fund's Board of Directors in accordance with
regulations under the Investment Company Act of 1940. The Bank's
main office is at 225 Franklin Street, Boston, Massachusetts
02110. The address for The Chase Manhattan Bank, N.A., London is
Woolgate House, Coleman Street, London, EC2P 2HD, England.
CODE OF ETHICS
The Funds' investment adviser (T. Rowe Price) has a written
Code of Ethics which requires all employees to obtain prior
clearance before engaging in any personal securities
transactions. In addition, all employees must report their
personal securities transactions within ten days of their
execution. Employees will not be permitted to effect
transactions in a security: If there are pending client orders in
the security; the security has been purchased or sold by a client
within seven calendar days; the security is being considered for
purchase for a client; a change has occurred in T. Rowe Price's
rating of the security within five days; or the security is
subject to internal trading restrictions. Any material violation
of the Code of Ethics is reported to the Board of the Fund. The
Board also reviews the administration of the Code of Ethics on an
annual basis.
PORTFOLIO TRANSACTIONS
Investment or Brokerage Discretion
Decisions with respect to the purchase and sale of portfolio
securities on behalf of the Funds are made by T. Rowe Price. T.
Rowe Price is also responsible for implementing these decisions,
including the negotiation of commissions and the allocation of
portfolio brokerage and principal business. Each Fund's
purchases and sales of portfolio securities are normally done on
a principal basis and do not involve the payment of a commission
although they may involve the designation of selling concessions.
That part of the discussion below relating solely to brokerage
commissions would not normally apply to a Fund. However, it is
included because T. Rowe Price does manage a significant number
of common stock portfolios which do engage in agency transactions
and pay commissions and because some research and services
resulting from the payment of such commissions may benefit the
Funds.
PAGE 78
How Brokers and Dealers are Selected
Fixed Income Securities
Fixed income securities are generally purchased from the
issuer or a primary market-maker acting as principal for the
securities on a net basis, with no brokerage commission being
paid by the client, although the price usually includes an
undisclosed compensation. Transactions placed through dealers
serving as primary market-makers reflect the spread between the
bid and asked prices. Securities may also be purchased from
underwriters at prices which include underwriting fees.
T. Rowe Price may effect principal transactions on behalf of
a Fund with a broker or dealer who furnishes brokerage and/or
research services, designate any such broker or dealer to receive
selling concessions, discounts or other allowances, or otherwise
deal with any such broker or dealer in connection with the
acquisition of securities in underwritings. T. Rowe Price may
receive brokerage and research services in connection with such
designations in fixed priced underwritings.
How Evaluations are Made of the Overall Reasonableness of
Brokerage Commissions Paid
On a continuing basis, T. Rowe Price seeks to determine what
levels of commission rates are reasonable in the marketplace for
transactions executed on behalf of the Funds. In evaluating the
reasonableness of commission rates, T. Rowe Price considers: (a)
historical commission rates, both before and since rates have
been fully negotiable; (b) rates which other institutional
investors are paying, based on available public information; (c)
rates quoted by brokers and dealers; (d) the size of a particular
transaction, in terms of the number of shares, dollar amount, and
number of clients involved; (e) the complexity of a particular
transaction in terms of both execution and settlement; (f) the
level and type of business done with a particular firm over a
period of time; and (g) the extent to which the broker or dealer
has capital at risk in the transaction.
Description of Research Services Received from Brokers and
Dealers
T. Rowe Price receives a wide range of research services
from brokers and dealers. These services include information on
the economy, industries, groups of securities, individual
companies, statistical information, accounting and tax law
PAGE 79
interpretations, political developments, legal developments
affecting portfolio securities, technical market action, pricing
and appraisal services, credit analysis, risk measurement
analysis, performance analysis and analysis of corporate
responsibility issues. These services provide both domestic and
international perspective. Research services are received
primarily in the form of written reports, computer generated
services, telephone contacts and personal meetings with security
analysts. In addition, such services may be provided in the form
of meetings arranged with corporate and industry spokespersons,
economists, academicians and government representatives. In some
cases, research services are generated by third parties but are
provided to T. Rowe Price by or through broker-dealers.
Research services received from brokers and dealers are
supplemental to T. Rowe Price's own research effort and, when
utilized, are subject to internal analysis before being
incorporated by T. Rowe Price into its investment process. As a
practical matter, it would not be possible for T. Rowe Price's
Equity Research Division to generate all of the information
presently provided by brokers and dealers. T. Rowe Price pays
cash for certain research services received from external
sources. T. Rowe Price also allocates brokerage for research
services which are available for cash. While receipt of research
services from brokerage firms has not reduced T. Rowe Price's
normal research activities, the expenses of T. Rowe Price could
be materially increased if it attempted to generate such
additional information through its own staff. To the extent that
research services of value are provided by brokers or dealers, T.
Rowe Price may be relieved of expenses which it might otherwise
bear.
T. Rowe Price has a policy of not allocating brokerage
business in return for products or services other than brokerage
or research services. In accordance with the provisions of
Section 28(e) of the Securities Exchange Act of 1934, T. Rowe
Price may from time to time receive services and products which
serve both research and non-research functions. In such event,
T. Rowe Price makes a good faith determination of the anticipated
research and non-research use of the product or service and
allocates brokerage only with respect to the research component.
Commissions to Brokers who Furnish Research Services
Certain brokers and dealers who provide quality brokerage
and execution services also furnish research services to T. Rowe
Price. With regard to the payment of brokerage commissions, T.
PAGE 80
Rowe Price has adopted a brokerage allocation policy embodying
the concepts of Section 28(e) of the Securities Exchange Act of
1934, which permits an investment adviser to cause an account to
pay commission rates in excess of those another broker or dealer
would have charged for effecting the same transaction, if the
adviser determines in good faith that the commission paid is
reasonable in relation to the value of the brokerage and research
services provided. The determination may be viewed in terms of
either the particular transaction involved or the overall
responsibilities of the adviser with respect to the accounts over
which it exercises investment discretion. Accordingly, while T.
Rowe Price cannot readily determine the extent to which
commission rates or net prices charged by broker-dealers reflect
the value of their research services, T. Rowe Price would expect
to assess the reasonableness of commissions in light of the total
brokerage and research services provided by each particular
broker. T. Rowe Price may receive research, as defined in
Section 28(e), in connection with selling concessions and
designations in fixed price offerings in which the Funds
participate.
Internal Allocation Procedures
T. Rowe Price has a policy of not precommitting a specific
amount of business to any broker or dealer over any specific time
period. Historically, the majority of brokerage placement has
been determined by the needs of a specific transaction such as
market-making, availability of a buyer or seller of a particular
security, or specialized execution skills. However, T. Rowe
Price does have an internal brokerage allocation procedure for
that portion of its discretionary client brokerage business where
special needs do not exist, or where the business may be
allocated among several brokers or dealers which are able to meet
the needs of the transaction.
Each year, T. Rowe Price assesses the contribution of the
brokerage and research services provided by brokers and dealers,
and attempts to allocate a portion of its brokerage and selling
concession business in response to these assessments. Research
analysts, counselors, various investment committees, and the
Trading Department each seek to evaluate the brokerage and
research services they receive from brokers and dealers and make
judgments as to the level of business which would recognize such
services. In addition, brokers and dealers sometimes suggest a
level of business they would like to receive in return for the
various brokerage and research services they provide. Actual
brokerage business received by any firm may be less than the
PAGE 81
suggested allocations but can, and often does, exceed the
suggestions, because the total business is allocated on the basis
of all the considerations described above. In no case is a
broker or dealer excluded from receiving business from T. Rowe
Price because it has not been identified as providing research
services.
Miscellaneous
T. Rowe Price's brokerage allocation policy is consistently
applied to all its fully discretionary accounts, which represent
a substantial majority of all assets under management. Research
services furnished by brokers through which T. Rowe Price effects
securities transactions may be used in servicing all accounts
(including non-Fund accounts) managed by T. Rowe Price.
Conversely, research services received from brokers which execute
transactions for the Fund are not necessarily used by T. Rowe
Price exclusively in connection with the management of the Fund.
From time to time, orders for clients may be placed through
a computerized transaction network.
Each Fund does not allocate business to any broker-dealer on
the basis of its sales of the Fund's shares. However, this does
not mean that broker-dealers who purchase Fund shares for their
clients will not receive business from the Fund.
Some of T. Rowe Price's other clients have investment
objectives and programs similar to those of the Funds. T. Rowe
Price may occasionally make recommendations to other clients
which result in their purchasing or selling securities
simultaneously with the Funds. As a result, the demand for
securities being purchased or the supply of securities being sold
may increase, and this could have an adverse effect on the price
of those securities. It is T. Rowe Price's policy not to favor
one client over another in making recommendations or in placing
orders. T. Rowe Price frequently follows the practice of
grouping orders of various clients for execution which generally
results in lower commission rates being attained. In certain
cases, where the aggregate order is executed in a series of
transactions at various prices on a given day, each participating
client's proportionate share of such order reflects the average
price paid or received with respect to the total order. T. Rowe
Price has established a general investment policy that it will
ordinarily not make additional purchases of a common stock of a
company for its clients (including the T. Rowe Price Funds) if,
as a result of such purchases, 10% or more of the outstanding
PAGE 82
common stock of such company would be held by its clients in the
aggregate.
To the extent possible, T. Rowe Price intends to recapture
solicitation fees paid in connection with tender offers through
T. Rowe Price Investment Services, Inc., the Fund's distributor.
At the present time, T. Rowe Price does not recapture commissions
or underwriting discounts or selling group concessions in
connection with taxable securities acquired in underwritten
offerings. T. Rowe Price does, however, attempt to negotiate
elimination of all or a portion of the selling-group concession
or underwriting discount when purchasing tax-exempt municipal
securities on behalf of its clients in underwritten offerings.
Transactions with Related Brokers and Dealers--Limited-Term Fund
As provided in the Investment Management Agreement between
the Fund and T. Rowe Price, T. Rowe Price is responsible not only
for making decisions with respect to the purchase and sale of the
Fund's portfolio securities, but also for implementing these
decisions, including the negotiation of commissions and the
allocation of portfolio brokerage and principal business. It is
expected that T. Rowe Price may place orders for the Fund's
portfolio transactions with broker-dealers through the same
trading desk T. Rowe Price uses for portfolio transactions in
domestic securities. The trading desk accesses brokers and
dealers in various markets in which the Fund's foreign securities
are located. These brokers and dealers may include of certain
affiliates of Robert Fleming Holdings Limited ("Robert Fleming
Holdings") and Jardine Fleming Group Limited ("JFG"), persons
indirectly related to T. Rowe Price. Robert Fleming Holdings,
through Copthall Overseas Limited, a wholly-owned subsidiary,
owns 25% of the common stock of Rowe Price-Fleming International,
Inc. ("RPFI"), an investment adviser registered under the
Investment Advisers Act of 1940. Fifty percent of the common
stock of RPFI is owned by TRP Finance, Inc., a wholly-owned
subsidiary of T. Rowe Price, and the remaining 25% is owned by
Jardine Fleming International Holdings Limited, a subsidiary of
JFG. JFG is 50% owned by Robert Fleming Holdings and 50% owned
by Jardine Matheson Holdings Limited. The affiliates through
whose trading desks such orders may be placed include Fleming
Investment Management Limited ("FIM"), and Robert Fleming & Co.
Limited ("RF&Co."). FIM and RF&Co. are wholly owned subsidiaries
of Robert Fleming. These trading desks will operate under strict
instructions from the Fund's portfolio manager with respect to
the terms of such transactions. Neither Robert Fleming, JFG, nor
their affiliates will receive any commission fee, or other
PAGE 83
renumeration for the use of their trading desks, although orders
for a Fund's portfolio transactions may be placed with affiliates
of Robert Fleming and JFG who may receive a commission.
The Board of Directors of the Fund has authorized T. Rowe
Price to utilize certain affiliates of Robert Fleming and JFG in
the capacity of broker in connection with the execution of the
Fund's portfolio transactions, provided that T. Rowe Price
believes that doing so will result in an economic advantage (in
the form of lower execution costs or otherwise) being obtained
for each Fund. These affiliates include, but are not limited to,
Jardine Fleming (Securities) Limited ("JFS"), a wholly-owned
subsidiary of JFG, RF&Co., Jardine Fleming Australia Securities
Limited, and Robert Fleming, Inc. (a New York brokerage firm).
The above-referenced authorization was made in accordance
with Section 17(e) of the Investment Company Act of 1940 (the
"1940 Act") and Rule 17e-1 thereunder which require the Funds'
independent directors to approve the procedures under which
brokerage allocation to affiliates is to be made and to monitor
such allocations on a continuing basis. Except with respect to
tender offers, it is not expected that any portion of the
commissions, fees, brokerage, or similar payments received by the
affiliates of Robert Fleming in such transactions will be
recaptured by the Funds. The directors have reviewed and from
time to time may continue to review whether other recapture
opportunities are legally permissible and available and, if they
appear to be, determine whether it would be advisable for a Fund
to seek to take advantage of them.
Other
For the fiscal year ended October 31, 1994, the Cash
Reserves Fund engaged in portfolio transactions involving broker-
dealers totaling $2,176,128,000. The entire amounts for the year
represented principal transactions as to which the Cash Reserves
Fund has no knowledge of the profits or losses realized by the
respective broker-dealers. For fiscal year ended October 31,
1994, approximately 81% was placed with firms which provided
research, statistical, or other services to T. Rowe Price in
connection with the management of the Cash Reserves Fund or, in
some cases, to the Cash Reserves Fund.
For the fiscal year ended October 31, 1994, the Limited-Term
Bond Fund engaged in portfolio transactions involving broker-
dealers totaling $218,628,000. The entire amounts for the year
represented principal transactions as to which the Limited-Term
PAGE 84
Bond Fund has no knowledge of the profits or losses realized by
the respective broker-dealers. For the fiscal year ending
October 31, 1994, $3,566,000 involved trades with brokers acting
as agents or underwriters, in which such brokers received total
commission, including discounts received in connection with
underwritings of $84,895. For fiscal year ended October 31,
1994, approximately 81% was placed with firms which provided
research, statistical, or other services to T. Rowe Price in
connection with the management of the Fund or, in some cases, to
the Fund.
For the fiscal year ended October 31, 1994, the GNMA Fund
engaged in portfolio transactions involving broker-dealers
totaling $34,027,000. The entire amounts for the year
represented principal transactions as to which the GNMA Fund has
no knowledge of the profits or losses realized by the respective
broker-dealers. For fiscal year ended October 31, 1994,
approximately 83% was placed with firms which provided research,
statistical, or other services to T. Rowe Price in connection
with the management of the Fund or, in some cases, to the Fund.
The portfolio turnover rates of the Limited-Term Bond and
GNMA Funds for the fiscal year ended October 31, 1994, were: 296%
and 61.5%, respectively.
PRICING OF SECURITIES
Limited-Term and GNMA Funds
Fixed income securities are generally traded in the over-
the-counter market. Investments in domestic securities with
remaining maturities of one year or more and foreign securities
are stated at fair value using a bid-side valuation as furnished
by dealers who make markets in such securities or by an
independent pricing service, which considers yield or price of
bonds of comparable quality, coupon, maturity, and type, as well
as prices quoted by dealers who make markets in such securities.
Domestic securities with remaining maturities less than one year
are stated at fair value which is determined by using a matrix
system that establishes a value for each security based on bid-
side money market yields.
There are a number of pricing services available, and the
Board of Directors, on the basis of ongoing evaluation of these
services, may use or may discontinue the use of any pricing
service in whole or in part.
PAGE 85
Cash Reserves Fund
Securities with more than 60 days remaining to maturity are
stated at fair value which is determined by using a matrix system
that establishes a value for each security based on money market
yields. Securities originally purchased with remaining
maturities of 60 days or less are valued at amortized cost. In
addition, securities purchased with maturities in excess of 60
days, but which currently have maturities of 60 days or less, are
valued at their amortized cost for the 60 days prior to maturity-
-such amortization being based on the fair value of the
securities on the 61st day prior to maturity.
For the purposes of determining the Fund's net asset value
per share, all assets and liabilities initially expressed in
foreign currencies are converted into U.S. dollars at the mean of
the bid and offer prices of such currencies against U.S. dollars
quoted by any major bank.
Assets and liabilities for which the above valuation
procedures are inappropriate or are deemed not to reflect fair
value are stated at fair value, as determined in good faith by or
under the supervision of officers of the Funds, as authorized by
the Board of Directors.
Maintenance of Net Asset Value Per Share
It is the policy of the Fund to attempt to maintain a net
asset value of $1.00 per share by rounding to the nearest one
cent. This method of valuation is commonly referred to as "penny
rounding" and is permitted by Rule 2a-7 under the Investment
Company Act of 1940. Under Rule 2a-7:
(a) the Board of Directors of the Fund must undertake
to assure, to the extent reasonably practical taking into
account current market conditions affecting the Fund's
investment objectives, that the Fund's net asset value will
not deviate from $1.00 per share;
(b) the Fund must (i) maintain a dollar-weighted
average portfolio maturity appropriate to its objective of
maintaining a stable price per share, (ii) not purchase any
instrument with a remaining maturity greater than 397 days
(or in the case of U.S. government securities greater than
762 days), and (iii) maintain a dollar-weighted average
portfolio maturity of 90 days or less;
PAGE 86
(c) the Fund must limit its purchase of portfolio
instruments, including repurchase agreements, to those U.S.
dollar-denominated instruments which the Fund's Board of
Directors determines present minimal credit risks, and
which are eligible securities as defined by Rule 2a-7; and
(d) the Board of Directors must determine that (i) it
is in the best interest of the Fund and its shareholders to
maintain a stable price per share under the penny rounding
method; and (ii) the Fund will continue to use the penny
rounding method only so long as the Board of Directors
believes that it fairly reflects the market based net asset
value per share.
Although the Fund believes that it will be able to maintain
its net asset value at $1.00 per share under most conditions,
there can be no absolute assurance that it will be able to do so
on a continuous basis. If the Fund's net asset value per share
declined, or was expected to decline, below $1.00 (rounded to the
nearest one cent), the Board of Directors of the Fund might
temporarily reduce or suspend dividend payments in an effort to
maintain the net asset value at $1.00 per share. As a result of
such reduction or suspension of dividends, an investor would
receive less income during a given period than if such a
reduction or suspension had not taken place. Such action could
result in an investor receiving no dividend for the period during
which he holds his shares and in his receiving, upon redemption,
a price per share lower than that which he paid. On the other
hand, if the Fund's net asset value per share were to increase,
or were anticipated to increase above $1.00 (rounded to the
nearest one cent), the Board of Directors of the Fund might
supplement dividends in an effort to maintain the net asset value
at $1.00 per share.
Prime Money Market Securities Defined. Prime money market
securities are those which are described as First Tier Securities
under Rule 2a-7 of the Investment Company Act of 1940. These
include any security with a remaining maturity of 397 days or
less that is rated (or that has been issued by an issuer that is
rated with respect to a class of short-term debt obligations, or
any security within that class that is comparable in priority and
security with the security) by any two nationally recognized
statistical rating organizations (NRSROs) (or if only one NRSRO
has issued a rating, that NRSRO) in the highest rating category
for short-term debt obligations (within which there may be sub-
categories). First Tier Securities also include unrated
PAGE 87
securities comparable in quality to rated securities, as
determined by T. Rowe Price under the supervision of the Fund's
Board of Directors.
Limited-Term and GNMA Funds
Fixed income securities are generally traded in the over-
the-counter market. Investments in domestic securities with
remaining maturities of one year or more and foreign securities
are stated at fair value using bid-side valuation as furnished by
dealers who make markets in such securities or by an independent
pricing service, which considers yield or price of bonds of
comparable quality, coupon, maturity, and type, as well as prices
quoted by dealers who make markets in such securities. Domestic
securities with remaining maturities less than one year are
stated at fair value which is determined by using a matrix system
that establishes a value for each security based on bid-side
money market yields.
There are a number of pricing services available, and the
Board of Directors, on the basis of an ongoing evaluation of
these services, may use or may discontinue the use of any pricing
service in whole or in part.
For the purposes of determining a Fund's net asset value
per share, all assets and liabilities initially expressed in
foreign currencies are converted into U.S. dollars at the mean of
the bid and offer prices of such currencies against U.S. dollars
quoted by any major bank.
Assets and liabilities for which the above valuation
procedures are inappropriate or are deemed not to reflect fair
value are stated at fair value, as determined in good faith by or
under the supervision of officers of the Fund as authorized by
its Board of Directors.
NET ASSET VALUE PER SHARE
The purchase and redemption price of the Funds' shares is
equal to the Funds' net asset value per share or share price.
Each Fund determines its net asset value per share by subtracting
the Funds' liabilities (including accrued expenses and dividends
payable) from its total assets (the market value of the
securities the Fund holds plus cash and other assets, including
income accrued but not yet received) and dividing the result by
the total number of shares outstanding. The net asset value per
PAGE 88
share of each Fund is calculated as of the close of trading on
the New York Stock Exchange ("NYSE") every day the NYSE is open
for trading. The net asset value of the Money Fund is also
calculated as of 12:00 noon (Eastern time) every day the NYSE is
open for trading. The NYSE is closed on the following days: New
Year's Day, Washington's Birthday, Good Friday, Memorial Day,
Independence Day, Labor Day, Thanksgiving Day, and Christmas Day.
Determination of net asset value (and the offering, sale,
redemption and repurchase of shares) for a Fund may be suspended
at times (a) during which the NYSE is closed, other than
customary weekend and holiday closings, (b) during which trading
on the NYSE is restricted, (c) during which an emergency exists
as a result of which disposal by a Fund of securities owned by it
is not reasonably practicable or it is not reasonably practicable
for the Fund fairly to determine the value of its net assets, or
(d) during which a governmental body having jurisdiction over the
Fund may by order permit such a suspension for the protection of
the Fund's shareholders; provided that applicable rules and
regulations of the Securities and Exchange Commission (or any
succeeding governmental authority) shall govern as to whether the
conditions prescribed in (b), (c), or (d) exist.
DIVIDENDS
Unless you elect otherwise, the Fund's annual capital gain
distributions, if any, will be reinvested on the reinvestment
date using the NAV per share of that date. The reinvestment date
normally precedes the payment date by about 10 days although the
exact timing is subject to change.
TAX STATUS
Each Fund intends to qualify as a "regulated investment
company" under Subchapter M of the Internal Revenue Code of 1986,
as amended ("Code").
A portion of the dividends paid by each Fund may be
eligible for the dividends-received deduction for corporate
shareholders. For tax purposes, it does not make any difference
whether dividends and capital gain distributions are paid in cash
or in additional shares. Each Fund must declare dividends by
December 31 of each year equal to at least 98% of ordinary income
(as of December 31) and capital gains (as of October 31) in order
to avoid a federal excise tax and distribute within 12 months
PAGE 89
100% of ordinary income and capital gains as of its tax year-end
to avoid federal income tax.
At the time of your purchase, a Fund's net asset value may
reflect undistributed capital gains or net unrealized
appreciation of securities held by the Fund. A subsequent
distribution to you of such amounts, although constituting a
return of your investment, would be taxable as a capital gain
distribution. For federal income tax purposes, a Fund is
permitted to carry forward its net realized capital losses, if
any, for eight years and realize net capital gains up to the
amount of such losses without being required to pay taxes on, or
distribute such gains. On October 31, 1994, the books of each
Fund indicated that each Fund's aggregate net assets included
undistributed net income, net realized capital gains, and
unrealized appreciation which are listed below.
Net Realized Unrealized
Undistributed Capital Appreciation/
Fund Net Income Gains/(Losses) (Depreciation)
Cash Reserves $3,647,000 $ 1,000 $ (83,000)
Limited-Term Bond 1,057,000 (1,132,000) (305,000)
GNMA 1,001,000 (223,000) (1,266,000)
If, in any taxable year, the Funds should not qualify as
regulated investment companies under the Code: (i) each Fund
would be taxed at normal corporate rates on the entire amount of
its taxable income, if any, without deduction for dividends or
other distributions to shareholders; and (ii) each Fund's
distributions to the extent made out of the Fund's current or
accumulated earnings and profits would be taxable to shareholders
as ordinary dividends (regardless of whether they would otherwise
have been considered capital gain dividends).
Taxation of Foreign Shareholders
The Code provides that dividends from net income will be
subject to U.S. tax. For shareholders who are not engaged in a
business in the U.S., this tax would be imposed at the rate of
30% upon the gross amount of the dividends in the absence of a
Tax Treaty providing for a reduced rate or exemption from U.S.
taxation. Distributions of net long-term capital gains realized
by the Fund are not subject to tax unless the foreign shareholder
is a nonresident alien individual who was physically present in
the U.S. during the tax year for more than 182 days.
PAGE 90
Foreign Currency Gains and Losses--Limited-Term Fund
Foreign currency gains and losses, including the portion of
gain or loss on the sale of debt securities attributable to
foreign exchange rate fluctuations, are taxable as ordinary
income. If the net effect of these transactions is a gain, the
ordinary income dividend paid by the Fund will be increased; if
the result is a loss, a portion of its ordinary income divided
may be classified as a return of capital. Adjustments to reflect
these gains and losses will be made at the end of the Fund's
taxable year.
To the extent a Fund invests in foreign securities, the
following would apply:
Passive Foreign Investment Companies
Each Fund may purchase the securities of certain foreign
investment funds or trusts called passive foreign investment
companies. Capital gains on the sale of such holdings will be
deemed to be ordinary income regardless of how long the Fund
holds its investment. In addition to bearing their proportionate
share of the funds expenses (management fees and operating
expenses) shareholders will also indirectly bear similar expenses
of such funds. In addition, the Funds may be subject to
corporate income tax and an interest charge on certain dividends
and capital gains earned from these investments, regardless of
whether such income and gains were distributed to shareholders.
In accordance with tax regulations, the Funds intend to
treat these securities as sold on the last day of a Fund's fiscal
year and recognize any gains for tax purposes at that time;
losses will not be recognized. Such gains will be considered
ordinary income which a Fund will be required to distribute even
though it has not sold the security and received cash to pay such
distributions.
YIELD INFORMATION
Cash Reserves Fund
The Cash Reserves Fund's current and historical yield for a
period is calculated by dividing the net change in value of an
account (including all dividends accrued and dividends reinvested
in additional shares) by the account value at the beginning of
PAGE 91
the period to obtain the base period return. This base period
return is divided by the number of days in the period then
multiplied by 365 to arrive at the annualized yield for that
period. The Fund's annualized compound yield for such period is
compounded by dividing the base period return by the number of
days in the period, and compounding that figure over 365 days.
The seven day yield ending October 31, 1994 for the Fund
was 4.69%.
Limited-Term Fund
An income factor is calculated for each security in the
portfolio based upon the security's market value at the beginning
of the period and yield as determined in conformity with
regulation of the Securities and Exchange Commission. The income
factors are then totalled for all securities in the portfolio.
Next, expenses of the Fund for the period net of expected
reimbursement are deducted from the income to arrive at net
income, which is then converted to a per-share amount by dividing
net income by the average number of shares outstanding during the
period. The net income per share is divided by the net asset
value on the last day of the period to produce a monthly yield
which is then annualized. Quoted yield factors are for
comparison purposes only, and are not intended to indicate future
performance or forecast the dividend per share of the Fund.
The yield of the Fund calculated under the above-described
method for the month ended October 31, 1994 was 7.08%.
GNMA Fund
In conformity with regulations of the Securities and
Exchange Commission, an income factor is calculated for each
security in the portfolio based upon the security's coupon rate.
The income factors are then adjusted for any gains or losses
which have resulted from prepayments of principal during the
period. The income factors are then totalled for all securities
in the portfolio. Next, expenses of the Fund for the period, net
of expected reimbursements, are deducted from the income to
arrive at net income, which is then converted to a per-share
amount by dividing net income by the average number of shares
outstanding during the period. The net income per share is
divided by the net asset value on the last day of the period to
produce a monthly yield which is then annualized. Quoted yield
PAGE 92
factors are for comparison purposes only, and are not intended to
indicate future performance or forecast the dividend per share of
the Fund.
The yield of the Fund calculated under the above-described
method for the month ended October 31, 1994 was 7.09%.
INVESTMENT PERFORMANCE
Total Return Performance--Limited-Term and GNMA Funds
Each Fund's calculation of total return performance
includes the reinvestment of all capital gain distributions and
income dividends for the period or periods indicated, without
regard to tax consequences to a shareholder in the Fund. Total
return is calculated as the percentage change between the
beginning value of a static account in each Fund and the ending
value of that account measured by the then current net asset
value, including all shares acquired through reinvestment of
income and capital gains dividends. The results shown are
historical and should not be considered indicative of the future
performance of a Fund. Each average annual compound rate of
return is derived from the cumulative performance of each Fund
over the time period specified. The annual compound rate of
return for each Fund over any other period of time will vary from
the average.
Cumulative Performance Percentage Change
1 Yr. Since
Ended Inception
10/31/94 10/29/94
Cash Reserves Fund
T. Rowe Price Summit
Cash Reserves Fund 3.60% 3.60%
Lipper Money Market Investment
Funds Average 3.28 3.28
PAGE 93
Limited-Term Bond Fund
T. Rowe Price Summit
Limited-Term Bond Fund -0.71% -0.71%
Lehman Bros. 1-3 year
Gov't./Corp. Bond Index 1.23% 1.23%
Lipper Short Investment
Grade Debt Funds Average 0.10% 0.10%
GNMA Fund
T. Rowe Price Summit
GNMA Fund -1.67% -1.67%
Salomon Brothers 30-year
GNMA Index -1.42% -1.42%
Lehman Brothers GNMA
Bond Index -1.54% -1.54%
Average Annual Compound Rates of Return
1 Yr. Since
Ended Inception
10/31/94 10/29/94
Cash Reserves Fund
T. Rowe Price Summit
Cash Reserves Fund 3.60% 3.60%
Lipper Money Market Investment
Funds Average 3.28% 3.28%
Limited-Term Bond Fund
T. Rowe Price Summit
Limited-Term Bond Fund -0.71% -0.71%
Lehman Bros. 1-3 year
Gov't./Corp. Bond Index 1.23% 1.23%
Lipper Short Investment
Grade Debt Funds Average 0.10% 0.10%
PAGE 94
GNMA Fund
T. Rowe Price Summit
GNMA Fund -1.67% -1.67%
Salomon Brothers 30-year
GNMA Index -1.42% -1.42%
Lehman Brothers GNMA
Bond Index -1.54% -1.54%
Outside Sources of Information
From time to time, in reports and promotional literature,
one or more of the T. Rowe Price funds, including this Fund, may
compare its performance to Overnight Government Repurchase
Agreements, Treasury bills, notes, and bonds, certificates of
deposit, and money market deposit accounts. Performance may also
be compared to (1) indices of broad groups of managed and
unmanaged securities considered to be representative of or
similar to Fund portfolio holdings; (2) other mutual funds; or
(3) other measures of performance set forth in publications such
as:
Advertising News Service, Inc., "Bank Rate Monitor+ - The
Weekly Financial Rate Reporter" is a weekly publication
which lists the yields on various money market instruments
offered to the public by 100 leading banks and thrift
institutions in the U.S., including loan rates offered by
these banks. Bank certificates of deposit differ from
mutual funds in several ways: the interest rate
established by the sponsoring bank is fixed for the term of
a CD; there are penalties for early withdrawal from CDs;
and the principal on a CD is insured.
Bloomberg Financial Markets (Cash Reserves Fund only), a
comprehensive financial data distribution network which
tracks a broad range of financial markets.
Donoghue Organization, Inc., "Donoghue's Money Fund Report"
is a weekly publication which tracks net assets, yield,
maturity and portfolio holdings on approximately 380 money
market mutual funds offered in the U.S. These funds are
broken down into various categories such as U.S. Treasury,
Domestic Prime and Euros, Domestic Prime and Euros and
Yankees, and Aggressive.
PAGE 95
Donoghue's "Money Fund Insights" (Cash Reserves Fund only)
a monthly publication which tracks net assets, monthly
yields and 12-month yields on approximately 735 money
market mutual funds offered in the U.S. These funds are
broken down into various categories such as U.S. Treasury,
Domestic Prime and Euros, and Domestic Prime and Euros and
Yankees.
Knight Ridder Financial Services Market Data (Cash Reserves
Fund only), a financial data delivery network which tracks
current and historical data on the fixed-income markets.
First Boston High Yield Index (Limited-Term and GNMA Funds
only). It shows statistics on the Composite Index and
analytical data on new issues in the marketplace and low-
grade issuers.
Lipper Analytical Services, Inc., "Lipper-Fixed Income Fund
Performance Analysis" is a monthly publication which tracks
net assets, total return, principal return and yield on
over 1900 fixed income mutual funds offered in the United
States.
Merrill Lynch, Pierce, Fenner & Smith, Inc., "Taxable Bond
Indices" is a monthly publication which lists principal,
coupon and total return on over 100 different taxable bond
indices tracked by Merrill Lynch, together with the par
weighted characteristics of each Index.
Morningstar, Inc. - is a widely used independent research
firm which rates mutual funds by overall performance,
investment objectives, and assets.
Salomon Brothers Inc., "Analytical Record of Yields and
Yield Spreads" is a publication which tracks historical
yields and yield spreads on short-term market rates, public
obligations of the U.S. Treasury and agencies of the U.S.
Government, public corporate debt obligations, municipal
debt obligations and preferred stocks.
Salomon Brothers Inc., "Bond Market Round-up" is a weekly
publication which tracks the yields and yield spreads on a
large, but select, group of money market instruments,
public corporate debt obligations, and public obligations
of the U.S. Treasury and agencies of the U.S. Government.
PAGE 96
Salomon Brothers Inc., "Market Performance" - a monthly
publication which tracks principal return, total return and
yield on the Salomon Brothers Broad investment - Grade Bond
Index and the components of the Index as well as some money
market instruments not included in the index.
Shearson Lehman Brothers, Inc., "The Bond Market Report" -
a monthly publication which tracks principal, coupon and
total return on the Shearson Lehman Govt./Corp. Index and
Shearson Lehman Aggregate Bond Index, as well as all the
components of these Indices.
Telerate Systems, Inc., a market data distribution network
computer system which tracks a broad range of financial
markets including, the daily rates on money market
instruments, public corporate debt obligations and public
obligations of the U.S. Treasury and agencies of the U.S.
Government.
Wall Street Journal, is a national daily financial news
publication which lists the yields and current market
values on money market instruments, public corporate debt
obligations, public obligations of the U.S. Treasury and
agencies of the U.S. Government as well as common stocks,
preferred stocks, convertible preferred stocks, options and
commodities; in addition to indices prepared by the
research departments of such financial organizations as
Shearson Lehman/American Express Inc., and Merrill Lynch,
Pierce, Fenner and Smith, Inc., including information
provided by the Federal Reserve Board.
Performance rankings and ratings reported periodically in
national financial publications such as MONEY, FORBES, BUSINESS
WEEK, BARRON'S, etc. will also be used.
Benefits of Investing in High-Quality Bond Funds--Limited-Term
and GNMA Funds
o Higher Income
Bonds have generally provided a higher income than money
market securities because yield usually increased with
longer maturities. For instance, the yield on the 30-year
Treasury bond usually exceeds the yield on the 1-year
Treasury bill or 5-year Treasury note. However, securities
with longer maturities fluctuate more in price than those
with shorter maturities. Therefore, the investor must
PAGE 97
weigh the advantages of higher yields against the
possibility of greater fluctuation in the principal value
of your investment.
o Income Compounding
Investing in bond mutual funds allows investors to benefit
from easy and convenient compounding because you can
automatically reinvest monthly dividends in additional fund
shares. Each month investors earn interest on a larger
number of shares. Also, reinvesting dividends removes the
temptation to spend the income.
o Broad Diversification
Each share of a mutual fund represents an interest in a
large pool of securities, so even a small investment is
broadly diversified by maturity. Since most bonds trade
efficiently only in very large blocks, mutual funds provide
a degree of diversification that may be difficult for
individual investors to achieve on their own.
o Lower Portfolio Volatility
Investing a portion of one's assets in longer term, high-
quality bonds can help smooth out the fluctuations in your
overall investment results, because bond prices do not
necessarily move with stock prices. Also, bonds usually
have higher income yields than stocks, thus increasing the
total income component of your portfolio. This strategy
should also add stability to overall results, as income is
always a positive component of total return.
o Liquidity
A bond fund can supplement a money market fund or bank
account as a source of capital for unexpected
contingencies. T. Rowe Price fixed-income funds offer you
easy access to money through free checkwriting and
convenient redemption and exchange features. Of course,
the value of a bond fund's shares redeemed through
checkwriting may be worth more or less than their value at
the time of their original purchase.
PAGE 98
Suitability
High-quality bond funds are most suitable for the following
objectives: obtaining a higher current income with minimal
credit risk; compounding of income over time; or
diversifying overall investments to reduce volatility.
IRAs--All Funds
An IRA is a long-term investment whose objective is to
accumulate personal savings for retirement. Due to the long-term
nature of the investment, even slight differences in performance
will result in significantly different assets at retirement.
Mutual funds, with their diversity of choice, can be used for IRA
investments. Generally, individuals may need to adjust their
underlying IRA investments as their time to retirement and
tolerance for risk changes.
Other Features and Benefits--All Funds
Each Fund is a member of the T. Rowe Price Family of Funds
and may help investors achieve various long-term investment
goals, such as investing money for retirement, saving for a down
payment on a home, or paying college costs. To explain how the
Fund could be used to assist investors in planning for these
goals and to illustrate basic principles of investing, various
worksheets and guides prepared by T. Rowe Price Associates, Inc.
and/or T. Rowe Price Investment Services, Inc. may be made
available. These currently include: the Asset Mix Worksheet
which is designed to show shareholders how to reduce their
investment risk by developing a diversified investment plan: the
College Planning Guide which discusses various aspects of
financial planning to meet college expenses and assists parents
in projecting the costs of a college education for their
children; the Retirement Planning Kit (also available in a PC
version) which includes a detailed workbook to determine how much
money you may need for retirement and suggests how you might
invest to reach your goal; and the Retirees Financial Guide which
includes a detailed workbook to determine how much money you can
afford to spend and still preserve your purchasing power and
suggest how you might invest to reach your goal. From time to
time, other worksheets and guides may be made available as well.
Of course, an investment in the Fund cannot guarantee that such
goals will be met.
To assist investors in understanding the different returns
and risk characteristics of various investments, the
PAGE 99
aforementioned guides will include presentation of historical
returns of various investments using published indices. An
example of this is shown below.
Historical Returns for Different Investments
Annualized returns for periods ended 12/31/94
50 years 20 years 10 years 5 years
Small-Company Stocks 14.4% 20.3% 11.1% 11.8%
Large-Company Stocks 11.9 14.6 14.4 8.7
Foreign Stocks N/A 16.3 17.9 1.8
Long-Term Corporate Bonds 5.3 10.0 11.6 8.4
Intermediate-Term U.S.
Gov't. Bonds 5.6 9.3 9.4 7.5
Treasury Bills 4.7 7.3 5.8 4.7
U.S. Inflation 4.5 5.5 3.6 3.5
Sources: Ibbotson Associates, Morgan Stanley. Foreign stocks
reflect performance of The Morgan Stanley Capital International
EAFE Index, which includes some 1,000 companies representing the
stock markets of Europe, Australia, New Zealand, and the Far
East. This chart is for illustrative purposes only and should
not be considered as performance for, or the annualized return
of, any T. Rowe Price Fund. Past performance does not guarantee
future results.
Also included will be various portfolios demonstrating how these
historical indices would have performed in various combinations
over a specified time period in terms of return. An example of
this is shown on the next page.
PAGE 100
Performance of Retirement Portfolios*
Asset Mix Average Annualized Value
Returns 20 Years of
Ended 12/31/94 $10,000
Investment
After Period
________________ __________________ ____________
Nominal Real Best Worst
Portfolio Growth Income Safety Return Return** Year Year
I. Low
Risk 40% 40% 20% 12.4% 6.9% 24.9% 0.1%$ 92,515
II. Moderate
Risk 60% 30% 10% 13.5% 8.1% 29.1% -1.8%$118,217
III. High
Risk 80% 20% 0% 14.5% 9.1% 33.4% -5.2%$149,200
Source: T. Rowe Price Associates; data supplied by Lehman
Brothers, Wilshire Associates, and Ibbotson Associates.
* Based on actual performance for the 20 years ended 1993 of
stocks (85% Wilshire 5000 and 15% Europe, Australia, Far
East [EAFE] Index), bonds (Lehman Brothers Aggregate Bond
Index from 1976-94 and Lehman Brothers Government/Corporate
Bond Index from 1975), and 30-day Treasury bills from
January 1975 through December 1994. Past performance does
not guarantee future results. Figures include changes in
principal value and reinvested dividends and assume the same
asset mix is maintained each year. This exhibit is for
illustrative purposes only and is not representative of the
performance of any T. Rowe Price fund.
** Based on inflation rate of 5.5% for the 20-year period ended
12/31/94.
Insights
From time to time, Insights, a T. Rowe Price publication of
reports on specific investment topics and strategies, may be
included in the Fund's fulfillment kit. Such reports may include
information concerning: calculating taxable gains and losses on
mutual fund transactions, coping with stock market volatility,
benefiting from dollar cost averaging, understanding
PAGE 101
international markets, investing in high-yield "junk" bonds,
growth stock investing, conservative stock investing, value
investing, investing in small companies, tax-free investing,
fixed income investing, investing in mortgage-backed securities,
as well as other topics and strategies.
Other Publications
From time to time, in newsletters and other publications
issued by T. Rowe Price Investment Services, Inc., reference may
be made to economic, financial and political developments in the
U.S. and abroad and their effect on securities prices. Such
discussions may take the form of commentary on these developments
by T. Rowe Price mutual fund portfolio managers and their views
and analysis on how such developments could affect investments in
mutual funds.
Redemptions in Kind
In the unlikely event a shareholder of the Fund were to
receive an in kind redemption of portfolio securities of the
Fund, brokerage fees could be incurred by the shareholder in
subsequent sale of such securities.
Issuance of Fund Shares for Securities
Transactions involving issuance of Fund shares for
securities or assets other than cash will be limited to (1) bona
fide reorganizations; (2) statutory mergers; or (3) other
acquisitions of portfolio securities that: (a) meet the
investment objective and policies of the Fund; (b) are acquired
for investment and not for resale except in accordance with
applicable law; (c) have a value that is readily ascertainable
via listing on or trading in a recognized United States or
international exchange or market; and (d) are not illiquid.
CAPITAL STOCK
The Charter of the T. Rowe Price Summit Funds, Inc. (the
"Corporation") authorizes its Board of Directors to classify and
reclassify any and all shares which are then unissued, including
unissued shares of capital stock into any number of classes or
series, each class or series consisting of such number of shares
and having such designations, such powers, preferences, rights,
qualifications, limitations, and restrictions, as shall be
PAGE 102
determined by the Board subject to the Investment Company Act and
other applicable law. The shares of any such additional classes
or series might therefore differ from the shares of the present
class and series of capital stock and from each other as to
preferences, conversions or other rights, voting powers,
restrictions, limitations as to dividends, qualifications or
terms or conditions of redemption, subject to applicable law, and
might thus be superior or inferior to the capital stock or to
other classes or series in various characteristics. The
Corporation's Board of Directors may increase or decrease the
aggregate number of shares of stock or the number of shares of
stock of any class or series that the Funds have authorized to
issue without shareholder approval.
Except to the extent that the Corporation's Board of
Directors might provide by resolution that holders of shares of a
particular class are entitled to vote as a class on specified
matters presented for a vote of the holders of all shares
entitled to vote on such matters, there would be no right of
class vote unless and to the extent that such a right might be
construed to exist under Maryland law. The Charter contains no
provision entitling the holders of the present class of capital
stock to a vote as a class on any matter. Accordingly, the
preferences, rights, and other characteristics attaching to any
class of shares, including the present class of capital stock,
might be altered or eliminated, or the class might be combined
with another class or classes, by action approved by the vote of
the holders of a majority of all the shares of all classes
entitled to be voted on the proposal, without any additional
right to vote as a class by the holders of the capital stock or
of another affected class or classes.
Shareholders are entitled to one vote for each full share
held (and fractional votes for fractional shares held) and will
vote in the election of or removal of directors (to the extent
hereinafter provided) and on other matters submitted to the vote
of shareholders. There will normally be no meetings of
shareholders for the purpose of electing directors unless and
until such time as less than a majority of the directors holding
office have been elected by shareholders, at which time the
directors then in office will call a shareholders' meeting for
the election of directors. Except as set forth above, the
directors shall continue to hold office and may appoint successor
directors. Voting rights are not cumulative, so that the holders
of more than 50% of the shares voting in the election of
directors can, if they choose to do so, elect all the directors
of the Fund, in which event the holders of the remaining shares
PAGE 103
will be unable to elect any person as a director. As set forth
in the By-Laws of the Corporation, a special meeting of
shareholders of the Corporation shall be called by the Secretary
of the Corporation on the written request of shareholders
entitled to cast at least 10% of all the votes of the Corporation
entitled to be cast at such meeting. Shareholders requesting
such a meeting must pay to the Corporation the reasonably
estimated costs of preparing and mailing the notice of the
meeting. The Corporation, however, will otherwise assist the
shareholders seeking to hold the special meeting in communicating
to the other shareholders of the Corporation to the extent
required by Section 16(c) of the Investment Company Act of 1940.
FEDERAL AND STATE REGISTRATION OF SHARES
Each Fund's shares are registered for sale under the
Securities Act of 1933, and the Fund or its shares are registered
under the laws of all states which require registration, as well
as the District of Columbia and Puerto Rico.
LEGAL COUNSEL
Shereff, Friedman, Hoffman, & Goodman LLP, whose address is
919 Third Avenue, New York, New York 10022, is legal counsel to
the Funds.
INDEPENDENT ACCOUNTANTS
Coopers & Lybrand L.L.P., 217 East Redwood Street,
Baltimore, Maryland 21202, are independent accountants to the
Fund. The financial statements of the Fund for the year ended
October 31, 1994, and the report of independent accountants are
included in the Fund's Annual Report for the year ended October
31, 1994. A copy of the Annual Report accompanies this Statement
of Additional Information. The following financial statements
and the report of independent accountants appearing in the Annual
Report for the year ended October 31, 1994, are incorporated into
this Statement of Additional Information by reference:
PAGE 104
CASH
RESERVES LIMITED-TERM
FUND GNMA FUND BOND FUND
________ ___________ ___________
Report of Independent
Accountants 19 19 19
Statement of Net Assets,
October 31, 1994 7-9 13-14 10-12
Statement of Operations,
October 29, 1993 (Commencement
of Operations) to
October 31, 1994 15 15 15
Statement of Changes in Net
Assets, October 29, 1993
(Commencement of Operations)
to October 31, 1994 16 16 16
Notes to Financial Statements,
October 31, 1994 17-18 17-18 17-18
Financial Highlights,
October 29, 1993 (Commencement
of Operations) to
October 31, 1994 18 18 18
RATINGS OF COMMERCIAL PAPER
Moody's Investors Service, Inc. The rating of Prime-1 is the
highest commercial paper rating assigned by Moody's. Among the
factors considered by Moody's in assigning ratings are the
following: valuation of the management of the issuer; economic
evaluation of the issuer's industry or industries and an
appraisal of speculative-type risks which may be inherent in
certain areas; evaluation of the issuer's products in relation to
competition and customer acceptance; liquidity; amount and
quality of long-term debt; trend of earnings over a period of 10
years; financial strength of the parent company and the
relationships which exist with the issuer; and recognition by the
management of obligations which may be present or may arise as a
result of public interest questions and preparations to meet such
obligations. These factors are all considered in determining
whether the commercial paper is rated P1, P2, or P3.
Standard & Poor's Corporation. Commercial paper rated A (highest
quality) by S&P has the following characteristics: liquidity
ratios are adequate to meet cash requirements; long-term senior
PAGE 105
debt is rated "A" or better, although in some cases "BBB" credits
may be allowed. The issuer has access to at least two additional
channels of borrowing. Basic earnings and cash flow have an
upward trend with allowance made for unusual circumstances.
Typically, the issuer's industry is well established and the
issuer has a strong position within the industry. The
reliability and quality of management are unquestioned. The
relative strength or weakness of the above factors determines
whether the issuer's commercial paper is rated A1, A2, or A3.
Fitch Investors Service, Inc.: Fitch 1 - Highest grade.
Commercial paper assigned this rating is regarded as having the
strongest degree of assurance for timely payment. Fitch 2 - Very
good grade. Issues assigned this rating reflect an assurance of
timely payment only slightly less in degree than the strongest
issues.
RATINGS OF CORPORATE DEBT SECURITIES
Moody's Investors Service, Inc.
Aaa - Bonds rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk.
Aa - Bonds 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.
A - Bonds rated A possess many favorable investment attributes
and are to be considered as upper medium grade obligations.
Baa - Bonds rated Baa are considered as medium grade obligations,
i.e., they are neither highly protected nor poorly secured.
Interest payments and principal security appear adequate for the
present but certain protective elements may be lacking or may be
characteristically unreliable over any great length of time.
Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba - Bonds 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 characterize
bonds in this class.
PAGE 106
B - Bonds rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments of or
maintenance of other terms of the contract over any long period
of time may be small.
Caa - Bonds 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 rated Ca represent obligations which are speculative
in a high degree. Such issues are often in default or have other
marked short-comings.
C - Lowest-rated; extremely poor prospects of ever attaining
investment standing.
Standard & Poor's Corporation
AAA - This is the highest rating assigned by Standard & Poor's to
a debt obligation and indicates an extremely strong capacity to
pay principal and interest.
AA - Bonds rated AA also qualify as high-quality debt
obligations. Capacity to pay principal and interest is very
strong.
A - Bonds rated A have a strong capacity to pay principal and
interest, although they are somewhat more susceptible to the
adverse effects of changes in circumstances and economic
conditions.
BBB - Bonds rated BBB are regarded as having an adequate capacity
to pay principal and interest. Whereas they normally exhibit
adequate protection parameters, adverse economic conditions or
changing circumstances are more likely to lead to a weakened
capacity to pay principal and interest for bonds in this category
than for bonds in the A category.
BB, B, CCC, CC - Bonds rated BB, B, CCC, and CC are regarded on
balance, as predominantly speculative with respect to the
issuer's capacity to pay interest and repay principal in
accordance with the terms of the obligation. BB indicates the
lowest degree of speculation and CC the highest degree of
speculation. While such bonds will likely have some quality and
protective characteristics, these are outweighed by large
uncertainties or major risk exposures to adverse conditions.
PAGE 107
D - In default.
Fitch Investors Service, Inc.
AAA - High grade, broadly marketable, suitable for investment by
trustees and fiduciary institutions, and liable to but slight
market fluctuation other than through changes in the money rate.
The prime feature of a "AAA" bond is the showing of earnings
several times or many times interest requirements for such
stability of applicable interest that safety is beyond reasonable
question whenever changes occur in conditions. Other features
may enter, such as a wide margin of protection through
collateral, security or direct lien on specific property.
Sinking funds or voluntary reduction of debt by call or purchase
are often factors, while guarantee or assumption by parties other
than the original debtor may influence their rating.
AA - Of safety virtually beyond question and readily salable.
Their merits are not greatly unlike those of "AAA" class but a
bond so rated may be junior though of strong lien, or the margin
of safety is less strikingly broad. The issue may be the
obligation of a small company, strongly secured, but influenced
as to rating by the lesser financial power of the enterprise and
more local type of market.
