<PAGE> 1
PROSPECTUS
$10,000,000
PUTNAM INVESTMENT GRADE MUNICIPAL TRUST III
MUNICIPAL INCOME PREFERRED SHARES
200 SHARES
LIQUIDATION PREFERENCE $50,000 PER SHARE
------------------------
Putnam Investment Grade Municipal Trust III (the "Fund") is offering hereby
200 Municipal Income Preferred Shares ("Preferred Shares"), with a liquidation
preference of $50,000 per share plus accumulated and unpaid dividends. Dividends
on each Preferred Share will be cumulative from the Date of Original Issue and
will be payable, when, as and if declared, subject to certain exceptions, on
each Dividend Payment Date for each such share. The Initial Dividend Period for
Preferred Shares will end on February 9, 1995. The First Initial Dividend
Payment Date for Preferred Shares will be March 1, 1994, and dividends will be
payable thereafter during the Initial Dividend Period, subject to certain
exceptions, on the first day of each calendar month and through the first day of
the last calendar month in the Initial Dividend Period and on the last Initial
Dividend Payment Date of February 10, 1995. The Applicable Dividend Rate on
Preferred Shares for the Initial Dividend Period will be 3.09% per annum. After
the Initial Dividend Period for Preferred Shares, each subsequent Dividend
Period (other than a Special Dividend Period) will generally be a 28-day
Dividend Period and, except as otherwise described herein, dividends on
Preferred Shares will accumulate at the Applicable Dividend Rate in effect from
time to time as determined by the Remarketing Agent in advance of such Dividend
Period, as more fully described herein.
This Prospectus explains concisely what investors should know before
investing in the Fund. Investors are advised to read this Prospectus carefully
and to retain it for future reference.
(continued on following page)
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 COM-
MISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS.
ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
===============================================================================================
<CAPTION>
PRICE TO SALES PROCEEDS TO
PUBLIC(1) LOAD(2) FUND(1)(3)
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Per Share................................ $50,000 $750 $49,250
- -----------------------------------------------------------------------------------------------
Total.................................... $10,000,000 $150,000 $9,850,000
===============================================================================================
<FN>
(1) Plus accumulated dividends, if any, from the Date of Original Issue.
(2) The Fund and Putnam have agreed to indemnify the Underwriter against certain
liabilities, including liabilities under the Securities Act of 1933. See
"Underwriting."
(3) Before deducting expenses, estimated at $170,000, payable by the Fund.
</TABLE>
------------------------
The Preferred Shares are offered by the Underwriter, subject to prior sale,
when, as and if issued by the Fund and accepted by the Underwriter, subject to
approval of certain legal matters by counsel for the Underwriter and certain
other conditions. The Underwriter reserves the right to withdraw, cancel or
modify such offer and to reject orders in whole or in part. It is expected that
one certificate for the Preferred Shares will be delivered to the nominee of The
Depository Trust Company on or about February 10, 1994.
SMITH BARNEY SHEARSON INC.
February 7, 1994
<PAGE> 2
(CONTINUED FROM COVER PAGE)
The Fund is a closed-end, diversified management investment company. The
Fund's investment objective is to seek as high a level of current income exempt
from federal income tax as the Fund's investment manager believes is consistent
with preservation of capital. The Fund will invest in tax exempt securities
rated investment grade at the time of investment, or, with respect to 20% of its
total assets, if not rated, determined by the Fund's investment manager to be of
comparable quality. Investment grade securities are rated BBB or higher by
Standard & Poor's Corporation or Fitch Investors Service, Inc. or Baa or higher
by Moody's Investors Service, Inc. (or equivalently rated by another nationally
recognized rating service). The Fund may invest a portion of its assets in tax
exempt securities that pay interest that is subject to the federal alternative
minimum tax. See "Investment Objective and Policies" and "Taxation."
Putnam Investment Management, Inc. ("Putnam") serves as investment manager
and administrator to the Fund. The Fund's address is One Post Office Square,
Boston, Massachusetts 02109, and its telephone number is (617) 292-1000.
Dividends on the Preferred Shares, to the extent payable from tax-exempt
interest earned on the Fund's investments, will be exempt from Federal income
tax in the hands of holders of such shares, subject to the possible application
of the Federal alternative minimum tax. If, on the basis of an estimate made by
the Fund, the Fund anticipates that any portion of a dividend on Preferred
Shares at the Applicable Dividend Rate will not be exempt from Federal income
tax solely because the Fund, in its judgment, believes it is required, in order
to comply with a published position of the Internal Revenue Service described in
this Prospectus, to allocate to Preferred Shares capital gains or other income
not exempt from Federal income tax, then the Fund will either (i) give notice of
the amount of any taxable income to be included in the dividend prior to the
Remarketing in which the Applicable Dividend Rate for such dividend will be
determined, or (ii) include such taxable income in that dividend without giving
notice of such inclusion prior to the setting of the Applicable Dividend Rate
and increase the dividend by an amount to offset (on the basis of certain
assumptions set forth in the Prospectus) the Federal tax effect thereof, all as
more fully described herein. See "Taxation" and "Remarketing -- Remarketing
Schedule; Advance Notice of Allocation of Taxable Income; Inclusion of Taxable
Income in Dividend."
Each Preferred Share subject to Tender and Dividend Reset may be tendered
in a Remarketing by submitting to the Remarketing Agent no later than 12:00
noon, New York City time, on the Remarketing Date an order to sell such share on
such date. There can be no assurance that all shares so tendered will be sold in
a Remarketing. Prospective purchasers should carefully review the remarketing
procedures described herein. Under certain conditions, Preferred Shares will be
redeemable at the option of the Fund, and will under certain other circumstances
be subject to mandatory redemption, at $50,000 per share plus accumulated but
unpaid dividends (plus, in the case of an optional redemption, any applicable
premium). Preferred Shares will not be redeemable at the option of the Fund
during the Initial Dividend Period. See "Description of Preferred Shares --
Redemption."
Subject to certain exceptions, ownership of Preferred Shares will be in
book entry form by or through the Securities Depository. The Paying Agent will
maintain a record of certain beneficial owners of Preferred Shares for purposes
of determining such owners entitled to participate in Remarketings and for
certain other purposes. The Paying Agent will only record transfers of such
beneficial ownership, in a Remarketing or otherwise, of which it is notified in
accordance with its procedures in effect from time to time. See "Remarketing --
Restrictions on Transfer." Prior to this offering, no Preferred Shares have been
outstanding, and accordingly there has not been a market for such shares.
2
<PAGE> 3
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information appearing elsewhere in this Prospectus and the Appendices hereto.
Capitalized terms not defined in this Summary are defined in the Glossary
appearing on page 65 of this Prospectus or, in certain cases, are defined
elsewhere herein.
THE FUND
Putnam Investment Grade Municipal Trust III (the "Fund") is a closed-end,
diversified management investment company. As a recently organized entity, the
Fund has a limited operating history. See "The Fund." The Fund is managed by
Putnam Investment Management, Inc. ("Putnam").
THE OFFERING
The Fund is offering 200 Preferred Shares at a purchase price of $50,000
per Share. The Preferred Shares are being offered by Smith Barney Shearson Inc.
(the "Underwriter"). The Preferred Shares will entitle their holders to receive
cash dividends at a rate per annum that may vary for the successive Dividend
Periods for the Preferred Shares. Each Dividend Period subsequent to the Initial
Dividend Period will generally be 28 days in length or such other period as the
Fund may determine, as described below. The Applicable Dividend Rate for a
particular Dividend Period will generally be determined by a Remarketing
conducted on the Business Day next preceding the start of such Dividend Period.
For a discussion of special considerations relating to Preferred Shares, see
"Description of Preferred Shares."
INVESTMENT OBJECTIVE AND POLICIES
The Fund's investment objective is to seek as high a level of current
income exempt from federal income tax as the Fund's investment manager believes
is consistent with preservation of capital.
The Fund intends to pursue its objective by investing in a diversified
portfolio of investment grade tax exempt securities which Putnam believes does
not involve undue risk to income or principal. Investment grade tax exempt
securities are rated BBB or higher by Standard & Poor's Corporation ("S&P") or
Fitch Investors Service, Inc. ("Fitch") or Baa or higher by Moody's Investors
Service, Inc. ("Moody's") (or equivalently rated by another nationally
recognized rating service). The Fund may also invest up to 20% of its total
assets in non-rated tax exempt securities determined by Putnam at the time of
investment to be of comparable quality to rated securities in which the Fund may
invest. Tax exempt securities rated BBB by S&P or Fitch or Baa by Moody's (and
non-rated securities of comparable quality) are considered medium grade
securities and have speculative characteristics. See "Investment Objective and
Policies" and "Appendix C -- Description of Bond Ratings."
The Fund may invest up to 20% of its total assets in tax exempt securities
the interest on which is subject to the federal alternative minimum tax, and as
a result, a portion of the Fund's distributions may be taxable to certain
shareholders. All or a portion of the Fund's distributions may be subject to
state and local taxation.
The Fund may also invest in inverse floating obligations or residual
interest bonds whose stated rates of interest generally vary inversely with
changes in market rates of tax exempt interest. The values of inverse floating
obligations are generally more volatile, and the market for inverse floating
obligations is generally more illiquid, than those of many other tax exempt
securities. In addition, because coupon rates of interest on inverse floating
obligations vary inversely with changes in market rates of interest, interest
income earned by the Fund may be more volatile than if the Fund invested solely
in fixed-rate tax exempt securities. Because inverse floating obligations
represent a relatively recent innovation in the municipal securities market,
there is a lack of historical data concerning the attributes of such securities
under all market conditions. Such securities also have the effect of providing a
degree of investment leverage, since they will generally increase or decrease in
value in response to changes in market interest rates at a rate which is a
multiple of the rate at which fixed-rate tax exempt securities of comparable
maturity and credit quality increase or decrease in value in response to such
changes. Putnam believes that inverse floating obligations represent a flexible
portfolio management instrument for the Fund which will allow Putnam to vary the
degree of investment leverage
3
<PAGE> 4
relatively efficiently under different market conditions. Often, inverse
floating obligations are created by selling two complementary interests in a
single, previously issued fixed-rate tax exempt security: a floating rate
obligation and the inverse floating obligation. In other cases, the issuer will
itself issue directly the two complementary obligations. In seeking to limit the
risks associated with the less liquid secondary market for inverse floating
obligations, the Fund will only purchase such securities if, pursuant to their
terms or the terms of the complementary instruments, such securities may be
recombined with the complementary floating rate obligation. Also, to seek to
limit credit risk, the Fund will only purchase inverse floating obligations
which are themselves rated, or which represent components of fixed-rate tax
exempt securities that are rated, AAA (or an equivalent rating) by S&P, Fitch,
Moody's or another nationally recognized rating service. To seek to limit the
interest rate risk of these securities, the Fund may purchase inverse floating
obligations with shorter-term maturities or which contain limitations on the
extent to which the interest rate may vary. The Fund will not invest more than
25% of its total assets in inverse floating obligations. In addition, at any
time when Preferred Shares are outstanding, the Fund will not invest more than
15% of its total assets in such obligations. See "Investment Objective and
Policies."
In an effort to preserve capital, the Fund may engage in interest rate and
other hedging transactions by purchasing and selling financial futures contracts
and options on fixed-income securities indices and on U.S. Government
securities. The Fund may also enter into forward commitments and repurchase
agreements. These investment practices entail risks and may give rise to taxable
income. The Fund may also invest in certain tax exempt securities, the terms of
which include elements of instruments that may be used by the Fund in its
hedging activities.
The Fund may implement various temporary "defensive" strategies at times
when Putnam determines that conditions in the markets for tax exempt securities
make pursuing the Fund's basic investment strategy inconsistent with the best
interests of its shareholders. These strategies may include an increase in the
portion of the Fund's assets invested in high-quality tax exempt securities and
investments in taxable obligations.
The market values of fixed-income securities generally rise during periods
of falling interest rates and fall during periods of rising interest rates. Such
changes in the values of fixed-income securities will not affect interest income
derived from them but will affect the net asset value of the Fund.
Putnam believes that, in general, the secondary market for tax exempt
securities is less liquid than that for taxable fixed-income securities.
Consequently, the ability of the Fund to buy and sell tax exempt securities may,
at any particular time and with respect to any particular securities, be
limited. The publicly available information about the financial condition of an
issuer of tax exempt securities may not be as extensive as comparable
information about corporations whose securities are publicly traded. Obligations
of issuers of tax exempt securities may be subject to the provisions of
bankruptcy, insolvency and other laws affecting the rights and remedies of
creditors, such as the United States Bankruptcy Code and applicable state laws,
which could limit the ability of the Fund to recover payments of principal or
interest on such securities.
The Fund may at times purchase securities at prices greater than the
principal amounts payable on maturity. Such securities provide the Fund a higher
level of investment income distributable to Common Shareholders on a current
basis than if the Fund purchased securities bearing current market rates of
interest. However, because the value of premium securities tends to approach the
principal amount as they approach maturity (or call price in the case of
securities approaching their first call date), the purchase of such securities
increases the Fund's risk of capital loss. See "Investment Objective and
Policies -- Tax exempt securities."
Certain tax exempt securities which may be held by the Fund may permit the
issuer at its option to "call," or redeem, its securities. If an issuer were to
redeem tax exempt securities held by the Fund during a time of declining
interest rates, any gain that the Fund might otherwise realize on another
disposition of its investment may be reduced, and the Fund may not be able to
reinvest the proceeds in tax exempt securities providing as high a level of
investment return as the securities redeemed. See "Investment Objective and
Policies."
4
<PAGE> 5
With respect to the 20% of the Fund's total assets which may be invested in
non-rated tax exempt securities determined by Putnam at the time of investment
to be of comparable quality to rated securities in which the Fund may invest,
the Fund will be more dependent upon Putnam's investment analysis of such non-
rated tax exempt securities than in the case of rated securities. See
"Investment Objective and Policies."
The Fund is not intended to be a complete investment program, and there is
no assurance that the Fund will achieve its objective.
See "Investment Objective and Policies," "Other Investment Practices,"
"Taxation" and "Appendix C -- Description of Bond Ratings."
INVESTMENT MANAGER AND ADMINISTRATOR
Putnam Investment Management, Inc. ("Putnam") serves as the investment
manager and administrator to the Fund. Putnam has been a manager of mutual funds
since 1937. Putnam serves as the investment manager for the funds in the Putnam
family, with approximately $64 billion in assets in over three million
shareholder accounts as of December 31, 1993, including approximately $17
billion invested in tax exempt securities. Putnam currently employs seven
portfolio managers dedicated to the tax exempt securities market, supported by
ten investment analysts and other research personnel. In addition to the Fund,
Putnam manages sixteen closed-end funds, nine of which, Putnam Investment Grade
Municipal Trust, Putnam Investment Grade Municipal Trust II, Putnam California
Investment Grade Municipal Trust, Putnam New York Investment Grade Municipal
Trust, Putnam Tax-Free Health Care Fund, Putnam Managed Municipal Trust, Putnam
Investment Grade Intermediate Municipal Trust, Putnam Municipal Opportunities
Trust and Putnam High Yield Municipal Trust, invest primarily in tax exempt
securities. An affiliate, The Putnam Advisory Company, Inc., manages domestic
and foreign institutional accounts and foreign mutual funds. Another affiliate,
Putnam Fiduciary Trust Company, provides investment advice to institutional
clients under its banking and fiduciary powers. Putnam and its affiliates
managed over $90 billion in assets as of December 31, 1993. See "Investment
Manager and Administrator."
MANAGEMENT FEES
The Fund pays Putnam a quarterly investment management fee based on the
average weekly net asset value of the Fund, at the annual rate of 0.50% of the
first $500 million of the average net asset value of the Fund, 0.43% of the next
$500 million, 0.39% of the next $500 million and 0.35% of any excess over $1.5
billion of such average net asset value, pursuant to a Management Contract
between the Fund and Putnam. The net asset value upon which the investment
management fee is calculated includes net assets attributable to any outstanding
Preferred Shares (not treating the liquidation preference of the Preferred
Shares as a liability). If dividends payable on any Preferred Shares during any
dividend period plus expenses attributable to the Preferred Shares for that
period exceed the gross income of the Fund during that period attributable to
the investment of the proceeds of the Preferred Shares, then the management fee
payable to Putnam for that period will be reduced by an amount equal to the
product of such excess and a fraction, the numerator of which shall be the fee
otherwise payable to Putnam pursuant to the Management Contract and the
denominator of which shall be the sum of the fee otherwise payable to Putnam
pursuant to the Management Contract and the administrative service fee otherwise
payable to Putnam under the Administrative Services Contract, described below,
between the Fund and Putnam; provided, however, that the amount of such
reduction for any such dividend period shall not exceed the amount determined by
multiplying (i) the aggregate liquidation preference of the average number of
Preferred Shares outstanding during the dividend period, by (ii) the percentage
of the aggregate net asset value of the Fund which the fee payable to Putnam
during such dividend period pursuant to the Management Contract would constitute
without giving effect to such reduction. Putnam has agreed to waive its
investment management fee for the three-month period commencing November 26,
1993. See "Investment Management Contract."
5
<PAGE> 6
ADMINISTRATIVE SERVICE FEES
The Fund pays Putnam a quarterly administrative service fee at the annual
rate of 0.20% of the first $500 million of the average net asset value of the
Fund, 0.17% of the next $500 million, 0.16% of the next $500 million and 0.15%
of any excess over $1.5 billion of such average net asset value pursuant to an
Administrative Services Contract between the Fund and Putnam. The net asset
value upon which the administrative service fee is calculated includes net
assets attributable to any outstanding Preferred Shares (not treating the
liquidation preference of the Preferred Shares as a liability). If dividends
payable on the Preferred Shares during any dividend period plus expenses
attributable to the Preferred Shares for that period exceed the gross income of
the Fund during that period attributable to the investment of the proceeds of
the Preferred Shares, then the administrative service fee payable to Putnam for
that period will be reduced by an amount equal to the product of such excess and
a fraction, the numerator of which shall be the fee otherwise payable to Putnam
pursuant to the Administrative Services Contract and the denominator of which
shall be the sum of the fee otherwise payable to Putnam pursuant to the
Administrative Services Contract and the management fee otherwise payable to
Putnam under the Management Contract between the Fund and Putnam; provided,
however, that the amount of such reduction for any such period shall not exceed
the amount determined by multiplying (i) the aggregate liquidation preference of
the average number of Preferred Shares outstanding during that period, by (ii)
the percentage of the aggregate net asset value of the Fund which the fee
payable to Putnam during such period pursuant to the Administrative Services
Contract would constitute without giving effect to such reduction. Putnam has
agreed to waive its administrative service fee for the three-month period
commencing November 26, 1993. See "Administrative Services Contract."
DIVIDENDS AND DIVIDEND PERIODS
The Applicable Dividend Rate on Preferred Shares for the Initial Dividend
Period ending February 9, 1995, will be 3.09% per annum. For each Dividend
Period thereafter, except as otherwise described herein, the Applicable Dividend
Rate on the Preferred Shares will be the dividend rate per annum determined by
the Remarketing Agent in its sole discretion (which discretion will be
conclusive and binding on all holders) in accordance with the remarketing
procedures described below. See "Remarketing -- Remarketing Procedures --
Applicable Dividend Rates." After the Initial Dividend Period for Preferred
Shares, each subsequent Dividend Period will generally consist of 28 days (a
"28-day Dividend Period"), unless the Fund elects, prior to any Remarketing, a
Special Dividend Period. A "Special Dividend Period" is a Dividend Period
consisting of a specified number of days (other than 28), evenly divisible by
seven and not fewer than seven nor more than 364 (a "Short Term Dividend
Period"), or a Dividend Period consisting of a specified period of one whole
year or more but not greater than five years (a "Long Term Dividend Period").
Dividends on Preferred Shares will be cumulative from their Date of Original
Issue and will be payable, when, as and if declared by the Trustees, commencing
on March 1, 1994, and generally on each Dividend Payment Date thereafter. See
"Description of Preferred Shares -- Dividends -- Dividend Payment Dates." The
holder of a Preferred Share may elect to tender such share or hold such share
for the next Dividend Period by providing notice to the Remarketing Agent in
connection with the Remarketing for that Dividend Period. See "Remarketing --
Remarketing Procedures."
If the holder of a Preferred Share fails to make such an election, he shall
continue to hold such share for the subsequent Dividend Period at the Applicable
Dividend Rate determined in the Remarketing for such Dividend Period; provided
that, (i) if there is no Remarketing Agent, or the Remarketing Agent is not
required to conduct a Remarketing, or the Remarketing Agent is unable to
remarket in the Remarketing on the Remarketing Date all Preferred Shares
tendered (or deemed tendered) to it at a price of $50,000 per share, then the
next Dividend Period for all Preferred Shares shall be a 28-day Dividend Period
and the Applicable Dividend Rate therefor shall be the applicable Maximum
Dividend Rate for a 28-day Dividend Period, and (ii) if such current Dividend
Period is a Special Dividend Period of more than 90 days or the succeeding
Dividend Period has been designated by the Trustees as a Special Dividend Period
of more than 90 days, then such holder will be deemed to have elected to tender
the shares.
If the Fund has elected a Special Dividend Period, but the Remarketing
Agent is unable to remarket in the Remarketing for that Special Dividend Period
all Preferred Shares tendered (or deemed tendered) to it
6
<PAGE> 7
for that Special Dividend Period at a price of $50,000 per share, then the next
Dividend Period will instead be a 28-day Dividend Period and the Applicable
Dividend Rate therefor shall be the applicable Maximum Dividend Rate.
<TABLE>
Except during a Non-Payment Period, the Applicable Dividend Rate for any
Dividend Period will not exceed the applicable Maximum Dividend Rate. The
Maximum Dividend Rate for Preferred Shares will depend on the credit rating or
ratings assigned to such shares. The Maximum Dividend Rate for any Dividend
Period will be the Applicable Percentage (specified below) of the Reference Rate
on the applicable Remarketing Date. "Reference Rate" means (i) with respect to a
28-day Dividend Period or a Short Term Dividend Period having 28 or fewer days,
the higher of the applicable "AA" Composite Commercial Paper Rate and the
Taxable Equivalent of the Short-Term Municipal Bond Rate, (ii) with respect to
any Short Term Dividend Period having more than 28 but fewer than 183 days, the
applicable "AA" Composite Commercial Paper Rate, (iii) with respect to any Short
Term Dividend Period having 183 or more but fewer than 365 days, the U.S.
Treasury Bill Rate and (iv) with respect to any Long Term Dividend Period, the
applicable U.S. Treasury Note Rate. The "Applicable Percentage" on any
Remarketing Date will be determined based on the lower of the credit rating or
ratings assigned on such date to Preferred Shares by Moody's and S&P (or if
Moody's or S&P or both shall not make such rating available, the equivalent of
either or both of such ratings by a Substitute Rating Agency or two Substitute
Rating Agencies or in the event that only one such rating shall be available,
such rating) as follows:
<CAPTION>
APPLICABLE
PERCENTAGE
OF REFERENCE
MOODY'S S&P RATE
------- --- ------------
<S> <C> <C>
"aa3" or higher AA- or higher 110%
"a3" to "a1" A- to A+ 125%
"baa3" to "baa1" BBB- to BBB+ 150%
"ba3" to "ba1" BB- to BB+ 200%
Below "ba3" Below BB- 250%
</TABLE>
provided, however, that in the event the Fund has notified the Paying Agent and
the Remarketing Agent of its intent to allocate income taxable for federal
income tax purposes to the Preferred Shares prior to the Remarketing Agent
establishing the Applicable Dividend Rate for such shares, the applicable
percentage in the foregoing table shall be divided by the quantity 1 minus the
Gross-Up Tax Rate (as hereinafter defined). If the ratings for the Preferred
Shares are split between two of the foregoing credit rating categories, the
lower rating will determine the prevailing rating.
There is no minimum Applicable Dividend Rate in respect of any Dividend
Period.
The Applicable Dividend Rate for any Dividend Period commencing during any
Non-Payment Period, and the rate used to calculate any applicable late charge,
will generally be 250% of the Reference Rate (or 300% of such rate if the Fund
has provided a Tax Notification to the Remarketing Agent with respect to that
Dividend Period).
So long as a certificate representing Preferred Shares is held by the
Securities Depository, dividends with respect to such shares will be paid to the
Securities Depository or its nominee as the record holder of such shares. The
Securities Depository is responsible for crediting such dividends to the
accounts of the Agent Members of the beneficial owners of such shares, and the
Agent Members will be responsible for holding or disbursing such payments on the
applicable Dividend Payment Date to such owners in accordance with the
instructions of such owners. If a certificate representing Preferred Shares is
not held by the Securities Depository, dividends on such shares will be paid
directly to the record holder in same-day funds. The Fund shall have no
obligation, including any obligation to provide notice or to make any payment
(in respect of any dividend or otherwise), to any person (including without
limitation any holder of any beneficial interest in Preferred Shares, whether or
not such interest is reflected on the share transfer books of the Paying Agent)
other than the holders of record of the Preferred Shares shown on the share
records of the Paying Agent from time to time.
7
<PAGE> 8
ADVANCE NOTICE OF ALLOCATION OF TAXABLE INCOME; INCLUSION OF TAXABLE INCOME IN
DIVIDEND
Dividends paid by the Fund, to the extent paid from tax exempt interest
earned on tax-exempt securities and properly designated as exempt-interest
dividends, will be exempt from Federal income tax, subject to the possible
application of the Federal alternative minimum tax. The Internal Revenue Service
(the "IRS") has taken the position in a published ruling that the Fund is
required for each taxable year to allocate net capital gain and other income
subject to regular Federal income tax, if any, proportionately between the
Common Shares and the Preferred Shares in accordance with the percentage of
total Fund distributions received by each such class of shares with respect to
such year. Whenever the Fund intends to include any net capital gain or other
income subject to regular Federal income tax in a dividend on Preferred Shares
solely because the Fund, in its judgment, believes it is required, in order to
comply with the IRS's published position, to allocate taxable income to
Preferred Shares, the Fund may notify the Remarketing Agent of the amount to be
so included prior to the Remarketing establishing the Applicable Dividend Rate
for such dividend. Alternatively, if the Fund has not provided the notice
referred to in the preceding sentence, and nevertheless intends to include such
income in a dividend on Preferred Shares, it will increase the dividend by an
amount such that the return (determined on the basis of the assumptions set
forth in this Prospectus) to a holder of Preferred Shares with respect to such
dividend (as so increased and after giving effect to Federal income tax at the
Gross-Up Tax Rate) equals the Applicable Dividend Rate (or, in the case where
the notice referred to above has been given but the Fund intends to include an
additional amount of such taxable income, the after-tax return the Applicable
Dividend Rate would have produced without the inclusion of additional taxable
income). Neither the underlying dividend nor the additional amount referred to
in the preceding sentence will be increased to compensate for the fact that they
may be subject to state and local taxes. The "Gross-Up Tax Rate" shall be equal
to the sum of (i) the percentage of the taxable income included in the dividend
that is taxable for Federal income tax purposes as ordinary income, multiplied
by the greater of (A) the highest marginal Federal corporate income tax rate
(without regard to the phase-out of graduated rates) applicable to ordinary
income and (B) the highest marginal Federal individual income tax rate
applicable to ordinary income (including any surtax but without regard to any
phase-out of personal exemptions or any limitation on itemized deductions), and
(ii) the percentage of the taxable income included in the dividend that is
taxable for Federal income tax purposes as long-term capital gain, multiplied by
the greater of (A) the highest marginal Federal corporate income tax rate
(without regard to the phase-out of graduated rates) applicable to long-term
capital gain and (B) the highest marginal Federal individual income tax rate
applicable to long-term capital gain (including any surtax but without regard to
any phase-out of personal exemptions or any limitation on itemized deductions).
If for any reason it is determined after the payment of any dividend that a
portion of that dividend was subject to Federal income tax, the Fund will not be
required to pay any additional amount to compensate for any tax payable on the
dividend (other than Additional Dividends payable under the circumstances
described in this Prospectus). See "Taxation" and "Remarketing -- Remarketing
Schedule; Advance Notice of Allocation of Taxable Income; Inclusion of Taxable
Income in Dividend."
If the Fund characterizes retroactively all or a portion of a dividend
already paid on Preferred Shares as consisting of net capital gain or other
income subject to regular Federal income tax solely because (i) the Fund has
redeemed all or a portion of the outstanding Preferred Shares or has liquidated
and (ii) the Fund, in its judgment, believes it is required, in order to comply
with the published position of the IRS described above, to allocate such taxable
income to the Preferred Shares, the Fund will pay Additional Dividends
(calculated assuming a rate of tax equal to the Gross-up Tax Rate) to holders of
Preferred Shares whose dividends were so recharacterized. Such Additional
Dividends will not include an amount to compensate for the fact that the
Additional Dividends or the amount so recharacterized may be subject to state
and local taxes. Additional Dividends will be payable only in the foregoing
circumstances. See "Description of Preferred Shares -- Dividends -- Additional
Dividends."
The Fund will not be required to provide any notice of the prospective
inclusion of, or increase any dividend on Preferred Shares (including through
the payment of an Additional Dividend) as a result of the inclusion of, any
taxable income in any dividend other than in the circumstances described above.
No provision will be made to compensate holders of Preferred Shares for any
alternative minimum tax liability in
8
<PAGE> 9
respect of distributions on Preferred Shares. See "Description of Preferred
Shares -- Dividends" and "Taxation."
REMARKETING
Prospective purchasers should carefully review the remarketing procedures
described below and more fully detailed in this Prospectus, including the
Appendices hereto, and should note that (i) an election to tender Preferred
Shares cannot be revoked except as provided in the Bylaws and as more fully
described in this Prospectus, (ii) each Remarketing will be conducted through
telephonic communications, (iii) settlement for purchases and sales in a
Remarketing will be made on the Settlement Date, and (iv) each prospective
purchaser and each holder of Preferred Shares will be bound by the remarketing
procedures, including the Remarketing Agent's determination of the Applicable
Dividend Rate pursuant to the remarketing procedures.
Remarketing Schedule. Each Remarketing for Preferred Shares will take
place over a two-Business Day period consisting of the Remarketing Date
(normally a Thursday) and the Settlement Date (normally a Friday). An example of
the time sequence of the events in a normal remarketing schedule is provided in
Appendix A hereto. The first Remarketing Date for the Preferred Shares will be
February 9, 1995.
Remarketing Date. By 9:00 a.m., New York City time, on each Remarketing
Date for Preferred Shares, the Remarketing Agent will, after canvassing the
market and considering prevailing market conditions, provide to holders of
Preferred Shares subject to Tender and Dividend Reset non-binding indications of
the Applicable Dividend Rate for the next succeeding 28-day Dividend Period or
Special Dividend Period, as the case may be. THE ACTUAL APPLICABLE DIVIDEND RATE
FOR SUCH DIVIDEND PERIOD MAY BE GREATER THAN OR LESS THAN THE RATE INDICATED IN
SUCH NON-BINDING INDICATIONS (BUT NOT GREATER THAN THE APPLICABLE MAXIMUM
DIVIDEND RATE) AND WILL NOT BE DETERMINED UNTIL AFTER A HOLDER IS REQUIRED TO
ELECT TO HOLD OR TENDER ITS PREFERRED SHARES OR A NEW PURCHASER IS REQUIRED TO
AGREE TO PURCHASE PREFERRED SHARES. By 12:00 noon, New York City time, on such
Remarketing Date, each holder of Preferred Shares subject to Tender and Dividend
Reset must notify the Remarketing Agent of its desire on a share-by-share basis,
either to tender such share at a price of $50,000 per share or to continue to
hold such share for the next Dividend Period (whether a 28-Day Dividend Period
or a Special Dividend Period). Any holder or prospective purchaser may
informally indicate to the Remarketing Agent its Applicable Dividend Rate
preferences. However, any such notice given to the Remarketing Agent to tender
or hold shares for a particular Dividend Period is irrevocable and may not be
conditioned upon the level at which the Applicable Dividend Rate is set.
Accordingly, the Applicable Dividend Rate with respect to a Dividend Period may
be greater or less than such rate preferences. Any such notice may not be
revoked by the holder; provided that, the Remarketing Agent may, in its sole
discretion, (i) at the request of a holder that has tendered one or more
Preferred Shares to the Remarketing Agent, waive such holder's tender and
thereby enable such holder to continue to hold such share or shares for the next
Dividend Period, as agreed to by the holder and the Remarketing Agent at such
time, so long as such tendering holder has indicated that it would accept the
new Applicable Dividend Rate for such Dividend Period, and (ii) at the request
of a holder that has elected to hold one or more of its Preferred Shares, waive
such holder's election with respect thereto, either such waiver to be contingent
upon the Remarketing Agent's being able to remarket all shares tendered to it in
such Remarketing. Subject to the last sentence of this paragraph, holders of
Preferred Shares that fail on a Remarketing Date for such shares to elect to
tender or hold such shares will be deemed to have elected to continue to hold
such shares for the next Dividend Period if each of the current Dividend Period
and the next Dividend Period is a 28-day Dividend Period or a Special Dividend
Period of 90 days or less. If, on a Remarketing Date for Preferred Shares, the
current Dividend Period is a Special Dividend Period of more than 90 days, or
the succeeding Dividend Period has been designated by the Trustees as a Special
Dividend Period of more than 90 days, then holders of such shares that fail to
elect to tender or hold such shares will be deemed to have elected to tender
such shares.
There can be no assurance that the Remarketing Agent will be able to
remarket all Preferred Shares tendered in a Remarketing. If any Preferred Shares
tendered in a Remarketing are not remarketed, a holder thereof may be required
to hold some or all of its shares at least until the end of the next Dividend
Period
9
<PAGE> 10
therefor or to sell its shares outside a Remarketing. In such case, the
remarketing procedures may require an allocation of Preferred Shares on a pro
rata basis, to the extent practicable, or by lot, as determined by the
Remarketing Agent in its sole discretion, which may result in a holder's selling
a number of Preferred Shares that is less than the number of Preferred Shares
specified in such holder's tender order. See "Remarketing -- Remarketing
Procedures Allocation of Shares; Failure to Remarket at $50,000 Per Share,"
"Remarketing -- Restrictions on Transfer" and "Remarketing -- The Remarketing
Agent".
Settlement Date. On a Settlement Date for Preferred Shares, which will be
the first Business Day following the related Remarketing Date and which will be
the first day of the new Dividend Period, each person purchasing Preferred
Shares as a result of a Remarketing must pay, or cause its Agent Member to pay
on its behalf, the purchase price against delivery of such shares by the holder
thereof or its Agent Member.
After the initial sale of Preferred Shares through this offering,
settlement for purchases and sales of Preferred Shares in a Remarketing will
generally be made with respect to each Preferred Share through the Securities
Depository on the related Settlement Date therefor in accordance with its normal
procedures, which provide for payment in same-day funds.
Preferred Shares tendered in a Remarketing will be purchased solely out of
the proceeds received from purchasers of Preferred Shares in such Remarketing.
Neither the Fund, nor the Paying Agent or the Remarketing Agent will be
obligated to provide funds to make payment upon any holder's tender in a
Remarketing unless, in the case of the Paying Agent or the Remarketing Agent,
the shares are purchased for its own account. Tendered Preferred Shares will
also be subject to purchase in a Remarketing by the Remarketing Agent for its
own account or as nominee for others, although the Remarketing Agent is not
obligated to purchase any shares.
Remarketing Agent. The Remarketing Agent for Preferred Shares initially
will be Smith Barney Shearson Inc. Performance by the Remarketing Agent will be
subject to certain conditions. The Remarketing Agent may not terminate the
Remarketing Agreement except in accordance with the procedures set forth in such
agreement. See "Remarketing -- The Remarketing Agent".
RESTRICTIONS ON TRANSFER
Unless, during a Non-Payment Period, the Fund has chosen to waive this
requirement, Preferred Shares will be held only by book entry through the
Securities Depository. The Securities Depository maintains an account for each
Agent Member, which, in turn, will maintain records of its clients' beneficial
ownership. The Paying Agent will maintain a record of certain beneficial owners
of Preferred Shares, for purposes of determining such owners entitled to
participate in Remarketings and for certain other purposes. The Paying Agent
will only record transfers of such beneficial ownership, in a Remarketing or
otherwise, of which it is notified in accordance with its procedures in effect
from time to time. The Fund intends that any certificate for Preferred Shares
will bear a legend to the effect that such certificate is issued subject to
certain provisions restricting transfers of such shares. See "Remarketing --
Restrictions on Transfer".
SECONDARY MARKET
The Remarketing Agent has advised the Fund that it currently intends to
make a secondary trading market in the Preferred Shares outside of Remarketings.
The Remarketing Agent would earn customary brokerage commissions for trades in
the secondary market, which would be in addition to the annual remarketing fee
paid by the Fund. The Remarketing Agent, however, has no obligation to make a
secondary market in the Preferred Shares outside of Remarketings, and there can
be no assurance that a secondary market for Preferred Shares will exist at any
particular time or, if it does exist, that it will provide holders with
liquidity of investment. The Preferred Shares will not be registered on any
stock exchange or on the National Association of Securities Dealers Automated
Quotation System. If the Remarketing Agent purchases Preferred Shares in the
secondary market or in a Remarketing, it may be in a position of holding for its
own account or as nominee for others Preferred Shares at the time it determines
the Applicable Dividend Rate in a Remarketing therefor, and may tender such
shares in such Remarketing. See "Remarketing -- Restrictions on Transfer --
Secondary Market".
10
<PAGE> 11
ASSET MAINTENANCE; RATING AGENCY REQUIREMENTS
Under the Bylaws of the Fund (the "Bylaws"), the Fund must maintain 1940
Act Preferred Shares Asset Coverage of at least 200%. See "Investment Objective
and Policies -- Asset Maintenance".
In connection with their respective ratings of the Preferred Shares,
Moody's and S&P have each established asset coverage guidelines which are
incorporated into the Bylaws to ensure the payment of the liquidation preference
and the Fund's other obligations in respect of its outstanding Preferred Shares.
These guidelines require the Fund among other things to maintain
investment-grade assets with a value (discounted in accordance with each rating
agency's guidelines) equal to the Preferred Shares Basic Maintenance Amount.
They also impose restrictions on the securities in which the Fund may invest,
limit the Fund's use of futures, options and forward commitments, and prohibit
the use of borrowing for leverage and the Fund's entering into short sales,
securities lending and reverse repurchase agreements. These requirements are
explained in greater detail in Appendix B. If the Fund fails to meet such asset
maintenance requirements and such failure is not cured, the Fund will be
required under certain circumstances to redeem some or all of the Preferred
Shares. See "Description of Preferred Shares -- Redemption," below.
In connection with its rating of the Preferred Shares, S&P has established
dividend coverage guidelines, which are incorporated into the Bylaws, requiring
the Fund to maintain a sufficient level of highly liquid assets to ensure
certain dividend payments and expense payments with respect to the Preferred
Shares. Like the Preferred Shares Basic Maintenance Amount requirements, these
Minimum Liquidity Level guidelines impose limitations on the Fund's investment
activities. The Minimum Liquidity Level requirements are explained in greater
detail in Appendix B.
MANDATORY REDEMPTION
If the Preferred Shares Basic Maintenance Amount or the 1940 Act Preferred
Shares Asset Coverage is not maintained or restored as specified herein, the
Preferred Shares will be subject to mandatory redemption on a date specified by
the Trustees, out of funds legally available therefor, at the redemption price
of $50,000 per share plus an amount equal to dividends thereon (whether or not
earned or declared) accumulated but unpaid to the date fixed for redemption. Any
such redemption will be limited to the number of Preferred Shares necessary to
restore the Preferred Shares Basic Maintenance Amount or the 1940 Act Preferred
Shares Asset Coverage, as the case may be. See "Description of Preferred Shares
- -- Redemption".
OPTIONAL REDEMPTION
Except as described under "Description of Preferred Shares -- Redemption",
Preferred Shares are redeemable, in whole or in part, at the option of the Fund,
on the next succeeding scheduled Dividend Payment Date (except during the
Initial Dividend Period or a Non-Call Period) applicable to Preferred Shares
called for redemption, out of funds legally available therefor, at the
redemption price of $50,000 per share plus an amount equal to dividends thereon
accumulated but unpaid to the date fixed for redemption plus any premium
accruing during a Premium Call Period.
LIQUIDATION PREFERENCE
The liquidation preference of the Preferred Shares will be $50,000 per
share plus accumulated but unpaid dividends, if any. See "Description of
Preferred Shares -- Dividends -- Dividend Payments" and "Description of
Preferred Shares -- Liquidation/Bankruptcy".
VOTING RIGHTS
The Bylaws require that the holders of Preferred Shares, voting as a
separate class, have the right to elect at least two Trustees at all times and
to elect a majority of the Trustees at any time two years' dividends on the
Preferred Shares are unpaid. The holders of Preferred Shares will vote as a
separate class on certain other matters as required under the Bylaws, the 1940
Act and Massachusetts law. See "Description of Preferred
11
<PAGE> 12
Shares -- Voting Rights" and "Description of Preferred Shares -- Certain
Provisions in the Declaration of Trust".
RATINGS
It is a condition to their issuance that the Preferred Shares be issued
with a rating of "aaa" from Moody's and AAA from S&P.
12
<PAGE> 13
THE FUND
Putnam Investment Grade Municipal Trust III (the "Fund") is a closed-end,
diversified management investment company registered under the Investment
Company Act of 1940, as amended (the "1940 Act"). The Fund was organized as a
Massachusetts business trust on September 23, 1993. A copy of the Agreement and
Declaration of Trust (the "Agreement and Declaration of Trust"), which is
governed by Massachusetts law, is on file with the Secretary of State of The
Commonwealth of Massachusetts. As a recently organized entity, the Fund has a
limited operating history. The Fund's principal office is located at One Post
Office Square, Boston, Massachusetts 02109, and its telephone number is (617)
292-1000.
The Fund commenced operations on November 26, 1993 upon the closing of an
initial public offering of 4,000,000 of its common shares of beneficial interest
(together with all other common shares, the "Common Shares"). The net proceeds
of such offering were approximately $56,092,223, after payment of organizational
and offering expenses and the underwriting discount.
INVESTMENT MANAGER AND ADMINISTRATOR
The Fund's investment manager and administrator is Putnam Investment
Management, Inc. ("Putnam"), a Delaware corporation with offices at One Post
Office Square, Boston, Massachusetts 02109. Putnam is a wholly owned subsidiary
of Putnam Investments, Inc., a holding company which is in turn wholly owned by
Marsh & McLennan Companies, Inc., a publicly owned holding company whose
principal businesses are international insurance and reinsurance brokerage,
employee benefit consulting and investment management.
Putnam has been managing mutual funds since 1937. The firm serves as the
investment manager for the funds in the Putnam family, with approximately $64
billion in assets in over three million shareholder accounts as of December 31,
1993, including approximately $17 billion invested in tax exempt securities. In
addition to the Fund, Putnam manages sixteen closed-end funds, nine of which,
Putnam Investment Grade Municipal Trust, Putnam Investment Grade Municipal Trust
II, Putnam California Investment Grade Municipal Trust, Putnam New York
Investment Grade Municipal Trust, Putnam Tax-Free Health Care Fund, Putnam
Managed Municipal Trust, Putnam Investment Grade Intermediate Municipal Trust,
Putnam Municipal Opportunities Trust and Putnam High Yield Municipal Trust,
invest primarily in tax exempt securities. The Putnam Advisory Company, Inc., an
affiliate, manages domestic and foreign institutional accounts and foreign
mutual funds. Another affiliate, Putnam Fiduciary Trust Company, provides
investment advice to institutional clients under its banking and fiduciary
powers. Putnam and its affiliates managed over $90 billion in assets as of
December 31, 1993.
Putnam performs a detailed credit analysis on all of the tax exempt
securities in which a fund invests. Putnam currently employs seven portfolio
managers dedicated to the tax exempt securities market, supported by ten
investment analysts and other research personnel. Their investment analysis is
supported by Putnam's computer modeling techniques and issuer data base. The two
portfolio managers who will be primarily responsible for the day-to-day
management of the Fund's portfolio are identified under "Trustees and Officers"
below. Putnam considers a tax exempt security's rating by a nationally
recognized rating service as only one factor in its analysis of the security.
USE OF PROCEEDS
The net proceeds of this offering are estimated to be $9,680,000, after
payment of the sales load ($150,000) and offering expenses ($170,000).
The net proceeds will be invested in accordance with the Fund's investment
objective and policies during a period estimated not to exceed three months from
the completion of the offering, depending on market conditions and the
availability of appropriate securities. Pending such investment, the proceeds
will be invested in high quality, short-term money market instruments.
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<PAGE> 14
<TABLE>
CAPITALIZATION
The following table sets forth the capitalization of the Fund as of
December 31, 1993, and as adjusted to give effect to the issuance of the
Preferred Shares offered hereby.
<CAPTION>
AS
ACTUAL ADJUSTED
------ --------
<S> <C> <C>
Shareholders' Equity:
Preferred Shares, without par value; no shares authorized,
issued and outstanding (6,000 Preferred Shares authorized,
200 shares issued and outstanding, as adjusted, at $50,000
per share liquidation preference)........................... $ -- $10,000,000
----------- -----------
Common Shares, without par value; unlimited shares
authorized; 4,007,092 shares issued and outstanding......... $56,256,537 $55,936,537
----------- -----------
Undistributed net investment income.............................. $ 281,822 $ 281,822
----------- -----------
Net unrealized appreciation of investments....................... $ 1,022,837 $ 1,022,837
----------- -----------
Accumulated net realized loss on investments..................... $ (2,040) $ (2,040)
----------- -----------
Net assets....................................................... $57,559,156 $67,239,156
=========== ===========
</TABLE>
<TABLE>
PORTFOLIO COMPOSITION
As of December 31, 1993, 100% of the Fund's portfolio was invested in
investment grade tax exempt securities. The following table sets forth certain
information with respect to the composition of the Fund's investment portfolio
as of December 31, 1993.
<CAPTION>
NUMBER MARKET
S&P* MOODY'S* OF ISSUES VALUE PERCENT
---- -------- --------- ------ -------
<S> <C> <C> <C> <C>
AAA Aaa 4 $12,204,375 21.6%
AA, AA+, AA- Aa, Aa1 1 $ 3,333,750 5.9
A, A- A 7 $24,280,844 43.0
BBB, BBB+, BBB- Baa, Baa1 4 $ 8,662,000 15.4
SP-1 VMIG-1 1 $ 3,000,000 5.3
BB, BB+, BB- Ba, Ba1 --
B, B- B --
CCC, CCC+, CCC Caa, Caa1 --
Not rated 1 $ 4,981,250 8.8
-- ----------- ---
Total 18 $56,462,219 100%
== =========== ===
<FN>
- ---------------
* In the event that Moody's and S&P have not assigned comparable ratings to a
security, the information presented assumes that both rating agencies assigned
the higher of the two ratings actually assigned.
</TABLE>
INVESTMENT OBJECTIVE AND POLICIES
The Fund's investment objective is to seek as high a level of current
income exempt from federal income tax as the Fund's investment manager believes
is consistent with preservation of capital.
The Fund intends to pursue its objective by investing in a diversified
portfolio of investment grade tax exempt securities which Putnam believes does
not involve undue risk to income or principal. Investment grade tax exempt
securities are rated BBB or higher by Standard & Poor's Corporation ("S&P") or
Fitch Investors Service, Inc. ("Fitch") or Baa or higher by Moody's Investors
Service, Inc. ("Moody's") (or equivalently rated by another nationally
recognized rating service) in the case of long-term obligations, and have
equivalent ratings in the case of short-term obligations. The Fund may also
invest up to 20% of its total assets in non-rated tax exempt securities
determined by Putnam, at the time of investment, to be of comparable quality to
rated securities in which the Fund may invest. Tax exempt securities rated BBB
by S&P or Fitch or Baa by Moody's (and non-rated securities of comparable
quality) are considered medium grade securities and have
14
<PAGE> 15
speculative characteristics. For a description of the four highest ratings of
each of the rating agencies, see Appendix C to this Prospectus.
The Fund may invest up to 20% of its total assets in tax exempt securities
the interest on which is subject to the federal alternative minimum tax, and as
a result, a portion of the Fund's distributions may be taxable to certain
shareholders. All or a portion of the Fund's distributions may be subject to
state and local taxation.
An investment in the Fund may not be appropriate for all investors, and
there is no assurance that the Fund will achieve its investment objective. The
Fund is designed primarily as a long-term investment and not as a trading
vehicle.
TAX EXEMPT SECURITIES
"Tax exempt securities" are obligations issued by or on behalf of states,
territories and possessions of the United States and the District of Columbia
and their political subdivisions, agencies and instrumentalities, the interest
on which, in the opinion of bond counsel or other counsel to the issuer of such
securities, is at the time of issuance not includable in gross income for
federal income tax purposes. Under normal market conditions, at least 80% of the
Fund's assets will be invested in tax exempt securities. The foregoing is a
fundamental policy and cannot be changed without shareholder approval. However,
the Fund may invest a portion of its assets in tax exempt securities that pay
interest that is subject to the federal alternative minimum tax for individuals.
Such investments will not be treated as tax exempt securities for the purpose of
the 80% test. Investors should thus consider the possible effect of the federal
alternative minimum tax on an investment in the Fund. The suitability of the
Fund for investors who may be (or may become as a result of investment in the
Fund) subject to the federal alternative minimum tax will depend upon a
comparison of the yield likely to be provided from the Fund with the yield from
comparable tax exempt investments not subject to the federal alternative minimum
tax and with the yield from comparable fully taxable investments, in light of
each such investor's tax position. See "Taxation." Subject to the limitations
set forth in this Prospectus, the Fund may engage in certain hedging
transactions involving the use of futures contracts, options on futures
contracts, and options on indices of fixed-income securities and on U.S.
Government securities. Such hedging transactions may give rise to taxable gains.
Tax exempt securities include long-term obligations, often called bonds, as
well as short-term notes, participation certificates, municipal leases and tax
exempt commercial paper. The terms of certain of these tax exempt securities may
from time to time include elements of instruments (such as futures and options)
that may be used by the Fund in its hedging activities. See "Other Investment
Practices -- Futures and Options." The Fund may also invest in securities
representing interests in tax exempt securities, known as inverse floating
obligations or residual interest bonds. Often, inverse floating obligations are
created by selling two complementary interests in previously issued fixed-rate
tax exempt securities: a floating rate obligation and the inverse floating
obligation. In other cases, the issuer will itself issue directly the two
complementary obligations. Inverse floating obligations or residual interest
bonds generally pay interest rates that vary inversely to changes in the
interest rates of specified short-term tax exempt securities or an index of
short-term tax exempt securities. The interest rates on inverse floating
obligations or residual interest bonds will typically decline as short-term
market interest rates increase and increase as short-term market rates decline.
Such securities have the effect of providing a degree of investment leverage,
since they will generally increase or decrease in value in response to changes
in market interest rates at a rate which is a multiple of the rate at which
fixed-rate tax exempt securities of comparable maturity and credit quality
increase or decrease in response to such changes. As a result, the market values
of inverse floating obligations and residual interest bonds will generally be
more volatile than the market values of fixed-rate tax exempt securities of
comparable maturity and credit quality. Because inverse floating obligations
represent a relatively recent innovation in the municipal securities market,
there is a lack of historical data concerning the attributes of such securities
under all market conditions. In seeking to limit the risks associated with the
less liquid secondary market for inverse floating obligations, the Fund will
only purchase such securities if, pursuant to their terms or the terms of the
complementary instruments, such securities may be recombined with the
complementary floating rate obligation. Also, to seek to limit credit risk, the
Fund will only purchase inverse floating obligations which are themselves rated,
or which represent components of fixed-rate tax exempt securities that are rated
AAA (or
15
<PAGE> 16
an equivalent rating) by S&P, Fitch, Moody's, or another nationally recognized
rating service. To seek to limit the interest rate risk of these securities, the
Fund may purchase inverse floating obligations with shorter-term maturities or
which contain limitations on the extent to which the interest rate may vary. The
Fund will not invest more than 25% of its total assets in inverse floating
obligations. In addition, at any time when Preferred Shares are outstanding, the
Fund will not invest more than 15% of its total assets in such obligations.
Long-term tax exempt securities generally provide a higher yield than
short-term tax exempt securities of comparable quality, and therefore, the Fund
generally expects to be invested primarily in long-term tax exempt securities.
The Fund may, however, be primarily invested in short-term tax exempt securities
when yields on such securities are greater than yields available on long-term
tax exempt securities, to stabilize net asset value, for temporary defensive
purposes, and during a period of up to three months from the closing of this
offering as Putnam selects long-term tax exempt securities to purchase for its
portfolio.
The two principal classifications of tax exempt bonds are "general
obligation" bonds and "revenue" or "special obligation" bonds, which include
"industrial revenue bonds" and "private activity bonds." General obligation
bonds are secured by the issuer's pledge of its faith, credit and taxing power
for the payment of interest and the repayment of principal, and, accordingly,
the capacity of the issuer of a general obligation bond as to the timely payment
of interest and the repayment of principal when due is affected by the issuer's
maintenance of its tax base. Revenue or special obligation bonds are payable
only from the revenues derived from a particular facility or class of facilities
or, in some cases, from the proceeds of a special tax or other specific revenue
source such as from the users of the facility being financed; accordingly, the
timely payment of interest and the repayment of principal in accordance with the
terms of the revenue or special obligation bond is a function of the economic
viability of such facility or such revenue source. Although the ratings of S&P,
Fitch or Moody's of the tax exempt securities in the Fund's portfolio are
relative and subjective, and are not absolute standards of quality, such ratings
reflect the assessment of S&P, Fitch or Moody's, as the case may be, at the time
of issuance of the rating, of the issuer's ability or the economic viability of
the special revenue source with respect to the timely payment of interest and
the repayment of principal in accordance with the terms of the obligation, but
do not reflect an assessment of the market value of the obligation. The Fund
will not necessarily dispose of a security when its rating is reduced below its
rating at the time of purchase, although Putnam will monitor the investment to
determine whether continued investment in the security is consistent with the
Fund's investment objective. The rating services undertake no obligation to
update their ratings of securities. See Appendix C.
Also included within the general category of tax exempt securities are
participations in lease obligations or installment purchase contract obligations
(hereinafter collectively called "lease obligations") of municipal authorities
or entities. Although lease obligations do not constitute general obligations of
the municipality for which the municipality's taxing power is pledged, a lease
obligation is ordinarily backed by the municipality's covenant to budget for,
appropriate and make the payments due under the lease obligation. However,
certain lease obligations contain "non-appropriation" clauses which provide that
the municipality has no obligation to make lease or installment purchase
payments in future years unless money is appropriated for such purpose on a
yearly basis. In addition to the "non-appropriation" risk, these securities
represent a relatively new type of financing that has not yet developed the
depth of marketability associated with more conventional securities. Although
"non-appropriation" lease obligations are secured by the leased property,
disposition of the property in the event of foreclosure might prove difficult.
In addition, the tax treatment of such obligations in the event of
non-appropriation is unclear.
Participation certificates are obligations issued by state and local
governments or authorities to finance the acquisition of equipment and
facilities. They may represent participations in a lease, an installment
purchase contract, or a conditional sales contract. Some municipal leases and
participation certificates may not be readily marketable.
Tax exempt securities may have fixed or variable interest rates. The Fund
may purchase floating and variable rate demand notes, which are securities
normally having a stated maturity in excess of one year, but which permit the
holder to tender the notes for purchase at the principal amount thereof. The
interest rate on
16
<PAGE> 17
a floating rate demand note is based on a known interest index and adjusts
automatically as that index rate changes. The interest rate on a variable rate
demand note is adjusted at specified intervals according to an agreed upon
formula. There generally is no secondary market for these notes, although they
generally may be tendered for redemption at face value.
From time to time, proposals have been introduced before Congress for the
purpose of restricting or eliminating the federal income tax exemption for
interest on various types of tax exempt securities, and such proposals may well
be introduced in the future. If adopted, such proposals could have the effect of
limiting the availability of suitable investments for the Fund. If it appeared
that the availability of tax exempt securities for investment by the Fund and
the value of the Fund's portfolio could be materially affected by such changes
in law, the Trustees of the Fund would reevaluate its investment objective and
policies and consider changes in the structure of the Fund or its dissolution.
The market value of the Fund's investments will change in response to
changes in interest rates and other factors. During periods of falling interest
rates, the values of long-term fixed-income securities generally increase.
Conversely, during periods of rising interest rates, the values of such
securities generally decline. The magnitude of these fluctuations will generally
be greater at times when the Fund's average maturity is longer. Changes in
interest rates will over time affect the Fund's yield. During periods of rising
interest rates, the Fund's yield will likely rise as amounts received by the
Fund from repayments of principal are reinvested by the Fund in investments
paying higher interest rates. Conversely, during times of falling interest
rates, the Fund's yield will likely decline, as it reinvests such amounts in
investments paying lower interest rates. Changes by nationally recognized rating
services in the credit ratings of tax exempt securities, and in the ability of
an issuer to make payments of interest and principal, will also affect the value
of the Fund's investments. Changes in the value of portfolio securities will not
affect interest income derived from those securities but will affect the Fund's
net asset value.
Putnam believes that, in general, the secondary market for tax exempt
securities is less liquid than that for taxable fixed-income securities.
Consequently, the ability of the Fund to buy and sell tax exempt securities may,
at any particular time and with respect to any particular securities, be
limited. The publicly available information about the financial condition of an
issuer of tax exempt securities may not be as extensive as comparable
information about corporations whose securities are publicly traded. Obligations
of issuers of tax exempt securities may be subject to provisions of bankruptcy,
insolvency and other laws affecting the rights and remedies of creditors, such
as the United States Bankruptcy Code and applicable state laws, which could
limit the ability of the Fund to recover payments of principal or interest on
such obligations.
From time to time, the Fund's investments in tax exempt securities may
include securities as to which the Fund, by itself or together with other funds
or accounts managed by Putnam and its affiliates, holds a major portion or all
of an issue of tax exempt securities. Because there may be relatively few
potential purchasers for such investments (including the Fund's investments in
inverse floating obligations), especially under adverse market or economic
conditions or in the event of adverse changes in the condition of the issuer,
and, in some cases, there may be contractual restrictions on resales, the Fund
may find it more difficult to sell such securities at a time when Putnam
believes it is advisable to do so or may be able to sell such securities only at
prices lower than if such securities were more widely held. At times, it may
also be more difficult to determine the fair value of such securities for
purposes of computing the Fund's net asset value. In addition, in order to
enforce its rights in the event of a default in the payment of interest or
repayment of principal or both, the Fund may be required to take possession of
and manage the assets securing the issuer's obligations on such securities,
which may increase the Fund's operating expenses and adversely affect the net
asset value of the Fund. Any income derived from the Fund's ownership or
operation of such assets will not be tax exempt. In addition, the Fund's
intention to qualify as a "regulated investment company" under the Code may
limit the extent to which the Fund may exercise its rights by taking possession
of such assets, because as a regulated investment company, the Fund is subject
to certain limitations on its investments and on the nature of its income.
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<PAGE> 18
Certain tax exempt securities held by the Fund may permit the issuer at its
option to "call," or redeem, its securities. If an issuer were to redeem tax
exempt securities held by the Fund during a time of declining interest rates,
any gain that the Fund might otherwise realize on another disposition of its
investment may be reduced and the Fund may not be able to reinvest the proceeds
in tax exempt securities providing as high a level of investment return as the
securities redeemed.
The Fund may invest up to 20% of its total assets in non-rated tax exempt
securities determined by Putnam at the time of investment to be of comparable
quality to rated securities in which the Fund may invest. The Fund will be more
dependent upon Putnam's investment analysis of such non-rated tax exempt
securities than in the case of rated securities. See "Investment Objective and
Policies."
SELECTION OF INVESTMENTS
Putnam will buy and sell securities for the Fund's portfolio with a view to
seeking a high level of current income exempt from federal income tax, and will
select securities constituting a portfolio which Putnam believes does not
involve undue risk to income or principal considered in relation to the
particular investment policies of the Fund. As a result, the Fund will not
necessarily invest in the highest yielding tax exempt securities permitted by
its investment policies if Putnam determines that market risks or credit risks
associated with such investments would subject the Fund's portfolio to excessive
risk. The potential for realization of capital gains resulting from possible
changes in interest rates will not be a major consideration. Although under
current market conditions Putnam expects to invest in a portfolio of longer-term
tax exempt securities, Putnam will be free to take full advantage of the entire
range of maturities offered by tax exempt securities and may adjust the average
maturity of the Fund's portfolio from time to time, depending on its assessment
of the relative yields available on securities of different maturities and its
expectations of future changes in interest rates.
The Fund will not generally invest more than 25% of its total assets in any
one industry. Governmental issuers of municipal securities are not considered
part of any "industry." However, municipal securities backed only by the assets
and revenues of nongovernmental users may, for this purpose, be deemed to be
related to the industry in which such nongovernmental users engage, and the 25%
limitation would apply to such obligations. It is nonetheless possible that the
Fund may invest more than 25% of its assets in a broader segment of the
municipal securities market, such as revenue obligations of hospitals and other
health care facilities, housing agency revenue obligations, or airport revenue
obligations. This would be the case only if Putnam determines that the yields
available from obligations in a particular segment of the market justified the
additional risks associated with a large investment in such segment. Although
such obligations could be supported by the credit of governmental users or by
the credit of nongovernmental users engaged in a number of industries, economic,
business, political and other developments generally affecting the revenues of
such users (for example, proposed legislation or pending court decisions
affecting the financing of such projects and market factors affecting the demand
for their services or products) may have a general adverse effect on all
municipal securities in such a market segment. The Fund reserves the right to
invest more than 25% of its assets in industrial development bonds or private
activity bonds (subject to the limitation that under normal market conditions
not more than 20% of the Fund's assets will be invested in private activity
bonds the interest on which may be subject to federal alternative minimum tax
for individuals) or in securities of issuers located in the same state, although
it has no present intention to invest more than 25% of its assets in issuers
located in the same state and current rating agency requirements applicable to
the Fund in seeking a rating of the Preferred Shares may limit such investment.
If the Fund were to invest more than 25% of its assets in issuers located in the
same state, it would be more susceptible to adverse economic, business or
regulatory conditions in that state.
The Fund will not invest more than 5% of its total assets in the tax exempt
securities of any single issuer, except that up to 25% of the Fund's total
assets may be invested without regard to this limitation. As a result, up to 25%
of the Fund's total assets could be invested in tax exempt securities of a
single issuer, with the result that the Fund's portfolio could be subject to
greater risks than that of a fund investing in a more broadly diversified
portfolio.
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<PAGE> 19
DEFENSIVE STRATEGIES
At times, Putnam may judge that conditions in the markets for tax exempt
securities make pursuing the Fund's basic investment strategy inconsistent with
the best interests of its Shareholders. At such times Putnam may use alternative
strategies, primarily designed to reduce fluctuations in the value of the Fund's
assets. In implementing these "defensive" strategies, the Fund may invest
substantially all of its assets in high-quality tax exempt obligations. If these
high-quality tax exempt obligations are not available or, in Putnam's judgment,
do not afford sufficient protection against adverse market conditions, the Fund
may invest in taxable obligations. Such taxable obligations may include:
obligations of the U.S. Government, its agencies or instrumentalities; other
debt securities rated within the four highest grades by either S&P or Moody's;
commercial paper rated in the highest grade by either rating service;
certificates of deposit and bankers' acceptances; repurchase agreements with
respect to any of the foregoing investments; or any other investment-grade
quality fixed-income securities that Putnam considers consistent with such
strategy. To the extent that the use of certain of these strategies produces
taxable income, this taxable income will be distributed to Common and Preferred
Shareholders based on each class's proportionate share of such income as
determined according to the percentage of total dividends paid by the Fund
during a particular year that are paid to such class. Such strategies may, under
certain circumstances, require the Fund to pay additional amounts to holders of
Preferred Shares to reduce the effect of allocations of taxable income on such
holders' return (see "Remarketing -- Remarketing Schedule; Advance Notice of
Allocation of Taxable Income; Inclusion of Taxable Income in Dividend"), or to
pay Additional Dividends (hereinafter defined) on Preferred Shares, thus
reducing the amount of income available for distributions on Common Shares. It
is impossible to predict when, or for how long, the Fund will use these
alternative strategies. See "Taxation."
PORTFOLIO TURNOVER
Putnam will buy and sell securities for the Fund to further its investment
objective. The investment policies of the Fund may lead to frequent changes in
investments, particularly in periods of rapidly fluctuating interest rates. The
Fund's investments may also be traded to take advantage of perceived short-term
disparities in market values or yields among securities of comparable quality
and maturity. From time to time, consistent with its investment objective, the
Fund may sell securities in anticipation of a market decline or buy securities
in anticipation of a market rise.
The Fund's portfolio turnover rate may be higher at times than that of
other investment companies. Although it is impossible to predict portfolio
turnover rate, based on its experience in managing similar investments, Putnam
expects that the annual portfolio turnover rate of the Fund will not exceed 100%
after the initial investment of the proceeds of this offering in accordance with
its investment objective and policies. Portfolio turnover generally involves
some expense to the Fund, including brokerage commissions or dealer mark-ups and
other transaction costs on the sale of securities and reinvestment in other
securities. Such transactions may result in the realization of taxable capital
gains.
RATING AGENCY GUIDELINES
The composition of the Fund's portfolio will reflect guidelines established
by Moody's and S&P in connection with the Fund's receipt of a rating for such
shares on their date of original issue of at least "aaa" by Moody's and AAA by
S&P. Moody's and S&P, nationally recognized statistical rating organizations,
issue ratings for various securities reflecting the perceived creditworthiness
of such securities. The guidelines described under "Investment Objective and
Policies -- Asset Maintenance" and in Appendix B have been developed by Moody's
and S&P in connection with issuances of asset-backed and similar securities,
including debt obligations and variable rate preferred stocks, generally on a
case-by-case basis through discussions with the issuers of these securities. The
guidelines are generally designed to ensure that assets underlying outstanding
debt or preferred stock will be sufficiently varied and will be of sufficient
quality and amount to justify investment-grade ratings. The guidelines do not
have the force of law but have been adopted by the Fund in order to satisfy
current requirements necessary for Moody's and S&P to issue the above-described
ratings for Preferred Shares, which ratings are generally relied upon by
institutional investors in purchasing
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<PAGE> 20
such securities. The guidelines include a set of tests for portfolio composition
and asset coverage that supplement (and in some cases are more restrictive than)
the applicable requirements under the 1940 Act.
ASSET MAINTENANCE
The Fund will be required to satisfy a number of asset maintenance
requirements under the terms of the Bylaws. These requirements are summarized
below.
1940 Act Preferred Shares Asst Coverage. The Fund will be required under
the Bylaws to maintain, as of the last Business Day of each month in which any
Preferred Shares are outstanding, asset coverage of at least 200% with respect
to outstanding senior securities which are stock, including the Preferred Shares
(or such other asset coverage as may in the future be specified in or under the
1940 Act as the minimum asset coverage for senior securities which are shares of
a closed-end investment company as a condition of paying dividends on its common
shares) ("1940 Act Preferred Shares Asset Coverage"). If the Fund fails to
maintain 1940 Act Preferred Shares Asset Coverage and such failure is not cured
as of the last Business Day of the month following the date of such failure (the
"1940 Act Cure Date"), the Fund will be required under certain circumstances to
redeem certain of the Preferred Shares. See "Description of Preferred Shares --
Redemption" below.
<TABLE>
Based on the composition of the Fund's portfolio at December 31, 1993, 1940
Act Preferred Shares Asset Coverage with respect to the Preferred Shares,
following the issuance of all Preferred Shares offered hereby and after giving
effect to the deduction of the sales load and offering costs for the Preferred
Shares estimated at $320,000, would be computed as follows:
<S> <C> <C>
Value of Fund assets less
liabilities not constituting
senior securities $67,239,156
- ------------------------------- = ----------- = 672%
Senior securities $10,000,000
representing indebtedness
plus liquidation value
of the Preferred Shares
</TABLE>
Preferred Shares Basic Maintenance Amount. In connection with their
respective ratings of the Preferred Shares, Moody's and S&P have each
established asset coverage guidelines which are incorporated into the Bylaws to
ensure the payment of the liquidation preference and the Fund's other
obligations in respect of its outstanding Preferred Shares. These guidelines
require the Fund among other things to maintain investment-grade assets with a
value (discounted in accordance with each rating agency's guidelines) equal to
the Preferred Shares Basic Maintenance Amount. These guidelines impose
restrictions on the securities in which the Fund may invest, limit the Fund's
use of futures, options and forward commitments, and prohibit the use of
borrowing for leverage and the Fund's entering into short sales, securities
lending and reverse repurchase agreements. These requirements are explained in
greater detail in Appendix B. If the Fund fails to meet such requirements and
such failure is not cured, the Fund will be required under certain circumstances
to redeem some or all of the Preferred Shares. See "Description of Preferred
Shares -- Redemption," below.
Minimum Liquidity Level. In connection with its rating of the Preferred
Shares, S&P has established dividend coverage guidelines which are incorporated
into the Bylaws requiring the Fund to maintain a sufficient level of highly
liquid assets to ensure certain dividend payments and certain expense payments
with respect to the Preferred Shares. Like the Preferred Shares Basic
Maintenance Amount requirements, these Minimum Liquidity Level guidelines impose
limitations on the Fund's investment activities. The Minimum Liquidity Level
requirements are explained in greater detail in Appendix B.
General. The Fund may, but is not required to, adopt any modifications to
these guidelines that may hereafter be established by Moody's or S&P. Failure to
adopt any such modifications, however, may result in a change in the ratings
described above or a withdrawal of ratings altogether. In addition, any rating
agency providing a rating for the Preferred Shares may, at any time, change or
withdraw any such rating. As set forth in the Bylaws, the Trustees may, without
shareholder approval, modify certain definitions or restrictions which
20
<PAGE> 21
have been adopted by the Fund pursuant to the rating agency guidelines, provided
in certain cases the Trustees have obtained written confirmation from Moody's
and S&P that any such change would not impair the ratings then assigned by
Moody's and S&P to the Preferred Shares.
As recently described by Moody's and S&P, a preferred stock rating is an
assessment of the capacity and willingness of an issuer to pay preferred stock
obligations. The ratings on the Preferred Shares are not recommendations to
purchase, hold or sell Preferred Shares, inasmuch as the ratings do not comment
as to market price or suitability for a particular investor. Nor do the rating
agency guidelines address the likelihood that a holder of Preferred Shares will
be able to sell such shares in a Remarketing. The ratings are based on current
information furnished to Moody's and S&P by the Fund and Putnam and information
obtained from other sources. The ratings may be changed, suspended or withdrawn
as a result of changes in, or the unavailability of, such information. The
Common Shares have not been rated by a nationally recognized statistical rating
organization.
OTHER INVESTMENT PRACTICES
The Fund may engage in the following incidental investment practices, some
of which may result in taxable income, and each of which may involve certain
special risks. The investment guidelines imposed by Moody's and S&P limit, and
in some cases prohibit, the Fund's use of certain of these investment practices
without the express authorization of the applicable rating agency.
Futures and Options. The Fund may purchase and sell financial futures
contracts and options in an effort to hedge against changes in the values of
tax-exempt securities the Fund owns or expects to purchase. There can be no
assurance that the Fund's hedging transactions will be effective. For so long as
Preferred Shares are rated by Moody's, the Fund will not purchase or sell
futures contracts or write, purchase or sell options on futures contracts or
write put or call options (except covered call or put options) on portfolio
securities unless it receives written confirmation from Moody's that engaging in
such transactions would not impair the rating then assigned to the Preferred
Shares by Moody's, except that the Fund may purchase or sell exchange-traded
futures contracts based on the Municipal Index or Treasury Bonds and purchase or
sell exchange-traded put options on such futures contracts and purchase, write
or sell exchange-traded call options on such futures contracts (collectively
"Moody's Hedging Transactions"), subject to the limitations described in
Appendix B. For so long as the Preferred Shares are rated by S&P, the Fund will
not purchase or sell futures contracts or write, purchase or sell options on
futures contracts or write put options (except covered put options) or call
options (except covered call options) on portfolio securities unless it receives
written confirmation from S&P that engaging in such transactions will not impair
the rating then assigned to the Preferred Shares by S&P, except that the Fund
may purchase or sell futures contracts based on the Municipal Index or Treasury
Bonds with remaining maturities of ten years or more and write, purchase or sell
put and call options on such contracts (collectively "S&P Hedging Transactions")
subject to the limitations described in Appendix B.
Futures contracts on the Long-Term Municipal Bond Index are traded on the
Chicago Board of Trade and may, as described below, be used for hedging purposes
by the Fund. However, because the market for such contracts currently lacks
liquidity, for the purposes of hedging, the Fund, subject to any limitations
imposed from time to time by Moody's and S&P, may purchase and sell futures
contracts and related options with respect to U.S. Government securities,
including U.S. Treasury bills, notes and bonds and may purchase and sell options
directly on U.S. Government securities. Putnam believes that, under certain
market conditions, price movements in U.S. Government securities futures and
related options and in options on U.S. Government securities may correlate
closely with price movements in tax exempt securities and may, as a result,
provide hedging opportunities for the Fund. Such futures and options would be
used in a way similar to the Fund's use of index futures and options described
below.
The Long-Term Municipal Bond Index, made up of high-quality tax exempt
municipal securities with a remaining term to maturity of 19 years or longer, is
intended to represent a numerical measure of market performance for long-term
tax exempt bonds. The Fund, subject to any limitations imposed from time to time
by Moody's and S&P, may purchase and sell futures contracts on this index (or
any other tax exempt bond
21
<PAGE> 22
index approved for trading by the Commodity Futures Trading Commission) to hedge
against general changes in market values of tax exempt securities which the Fund
owns or expects to purchase. For example, if Putnam expected interest rates to
increase, the Fund might sell futures contracts on an index. If rates did
increase, the value of tax exempt securities held by the Fund would decline, but
this decline would be generally offset in whole or in part by an increase in the
value of the Fund's position in the index futures contracts. If, on the other
hand, the Fund held cash reserves and short-term investments pending anticipated
investment in tax exempt securities, and Putnam expected interest rates to
decline, the Fund might purchase index futures contracts. The Fund could thus
take advantage of the anticipated rise in the values of tax exempt securities
without actually buying them until the market had stabilized. The Fund may also
purchase and sell put and call options on index futures for hedging purposes. If
and when trading commences in put and call options on tax exempt bond indices
directly, the Fund may also purchase or sell these options for similar hedging
purposes. The Fund will only purchase or sell futures or options when, in the
opinion of Putnam, price movements in such futures and options are likely to
correlate closely with price movements in the tax exempt securities which are
the subject of a hedge.
The Fund will not purchase or sell financial futures contracts or options
on futures contracts if, as a result, the sum of initial margin deposits on the
Fund's existing futures contracts and related options plus premiums paid for
outstanding options on futures contracts purchased by the Fund would exceed 5%
of the Fund's net assets. (For options that are "in-the-money" at the time of
purchase, the amount by which the option is "in-the-money" is excluded from this
calculation.)
The successful use of futures and options will usually depend on Putnam's
ability to forecast interest rate movements correctly. The Fund's ability to
hedge its portfolio positions through transactions in futures and options also
depends on the degree of correlation between movements in the prices of such
financial futures and options and movements in the prices of the underlying
municipal bond index or U.S. Government securities or of the tax exempt
securities which are the subject of a hedge. The successful use of futures and
options also depends on the availability of a liquid secondary market to enable
the Fund to close out its positions on a timely basis. There can be no assurance
that such a market will exist at a particular time. In the case of options
purchased by the Fund, the risk of loss is limited to the premium paid, whereas
in the case of options written by the Fund and in the case of futures
transactions, the risk of loss is limited only to the extent that increases in
the value of the Fund's investments during the period of the futures contract or
option may offset losses on the futures contracts or options over the same
period. Certain provisions of the Code limit the Fund's ability to engage in
futures and options transactions. See Appendix D for more detailed information
about these practices, including limitations designed to reduce risks.
Forward Commitments. The Fund may make contracts to purchase securities
for a fixed price at a future date beyond customary settlement time ("forward
commitments") if it holds, and maintains until the settlement date in a
segregated account, cash or high-grade debt obligations in an amount sufficient
to meet the purchase price, or if it enters into offsetting contracts for the
forward sale of other securities it owns. Forward commitments may be considered
securities in themselves, and involve a risk of loss if the value of the
security to be purchased declines prior to the settlement date, which risk is in
addition to the risk of decline in value of the Fund's other assets. Where such
purchases are made through dealers, the Fund relies on the dealer to consummate
the sale. The dealer's failure to do so may result in the loss to the Fund of an
advantageous yield or price. Although the Fund will generally enter into forward
commitments with the intention of acquiring portfolio securities or for delivery
pursuant to option contracts it has entered into, the Fund may dispose of a
commitment prior to settlement if Putnam deems it appropriate to do so. The Fund
may realize capital gains or losses upon the sale of forward commitments.
Repurchase Agreements. The Fund may enter into repurchase agreements with
respect to up to 25% of its total assets (taken at current value). A repurchase
agreement is a contract under which the Fund acquires a security for a
relatively short period (usually not more than one week) subject to the
obligation of the seller to repurchase and the Fund to resell such security at a
fixed time and price (representing the Fund's cost plus interest). It is the
Fund's present intention to enter into repurchase agreements only with
commercial banks and registered broker-dealers and only with respect to
obligations of the U.S. Government or its agencies or instrumentalities.
Repurchase agreements may also be viewed as loans made by the Fund which are
22
<PAGE> 23
collateralized by the securities subject to repurchase. Putnam will monitor such
transactions to ensure that the value of the underlying securities will be at
least equal at all times to the total amount of the repurchase obligation,
including the interest factor. If the seller defaults, the Fund could realize a
loss on the sale of the underlying security to the extent that the proceeds of
the sale, including accrued interest, are less than the resale price provided in
the agreement including interest. In addition, if the seller should be involved
in bankruptcy or insolvency proceedings, the Fund may incur delay and costs in
selling the underlying security or may suffer a loss of principal and interest
if the Fund is treated as an unsecured creditor and required to return the
underlying collateral to the seller's estate. The Fund's investments in
repurchase agreements generally will give rise to taxable income.
Certain Restrictions. For so long as Preferred Shares are rated by S&P or
Moody's, the Fund will not, unless it has received any required written
confirmation from S&P or Moody's, as the case may be, that such action would not
impair the ratings then assigned to the Preferred Shares by S&P or Moody's, as
the case may be, (i) borrow money except for the purpose of clearing
transactions in portfolio securities, (ii) engage in short sales of securities,
(iii) lend any portfolio securities, (iv) issue any class or series of shares of
beneficial interest ranking prior to or on a parity with the Preferred Shares
with respect to the payment of dividends or the distribution of assets upon
liquidation of the Fund, (v) merge or consolidate into or with any other
corporation or entity, (vi) engage in reverse repurchase agreements, or (vii)
designate a new Pricing Service.
INVESTMENT RESTRICTIONS
The Fund has adopted the following investment restrictions which may not be
changed without the affirmative vote of a "majority of the outstanding voting
securities" of the Fund, which is defined in the 1940 Act to mean the
affirmative vote of the lesser of (1) more than 50% of the outstanding Common
Shares and of the outstanding Preferred Shares of the Fund, each voting as a
separate class, or (2) 67% or more of the Common Shares and of the outstanding
Preferred Shares, each voting as a separate class, present at a meeting if more
than 50% of the outstanding Shares of each class are represented at the meeting
in person or by proxy. The Fund may not:
1. Issue senior securities, as defined in the 1940 Act, other than
shares of beneficial interest with preference rights, except to the extent
such issuance might be involved with respect to borrowings described under
restriction 2 below or with respect to transactions involving financial
futures, options, and other financial instruments.
2. Borrow money in excess of 10% of the value (taken at the lower of
cost or current value) of its total assets (not including the amount
borrowed) at the time the borrowing is made, and then only from banks as a
temporary measure (not for leverage) in situations which might otherwise
require the untimely disposition of portfolio investments or for
extraordinary or emergency purposes. Such borrowings will be repaid before
any additional investments are purchased.
3. Pledge, hypothecate, mortgage, or otherwise encumber its assets in
excess of 15% of its total assets (taken at the lower of cost and current
value) in connection with borrowings permitted by restriction 2 above.
4. Purchase securities on margin, except such short-term credits as
may be necessary for the clearance of purchases and sales of securities,
and except that it may make margin payments in connection with transactions
in futures contracts, options, and other financial instruments.
5. Make short sales of securities or maintain a short position for
the account of the Fund unless at all times when a short position is open
it owns an equal amount of such securities or owns securities which,
without payment of any further consideration, are convertible into or
exchangeable for securities of the same issue as, and in equal amount to,
the securities sold short.
6. Underwrite securities issued by other persons except to the extent
that, in connection with the disposition of its portfolio investments, it
may be deemed to be an underwriter under the federal securities laws.
23
<PAGE> 24
7. Purchase or sell real estate, although it may purchase securities
of issuers which deal in real estate, securities which are secured by
interests in real estate, and securities representing interests in real
estate, and it may acquire and dispose of real estate or interests in real
estate acquired through the exercise of its rights as a holder of debt
obligations secured by real estate or interests therein.
8. Purchase or sell commodities or commodity contracts, except that
it may purchase or sell financial futures contracts or options.
9. Make loans, except by purchase of debt obligations in which the
Fund may invest consistent with its investment policies and by entering
into repurchase agreements with respect to not more than 25% of its total
assets (taken at current value).
10. Invest in securities of any issuer, if, to the knowledge of the
Fund, officers and Trustees of the Fund and officers and directors of
Putnam who beneficially own more than 0.5% of the securities of that issuer
together own more than 5% of such securities.
11. With respect to 75% of its total assets, invest in securities of
any issuer if, immediately after such investment, more than 5% of the total
assets of the Fund (taken at current value) would be invested in the
securities of such issuer; provided that this limitation does not apply to
securities of the U.S. Government or its agencies or instrumentalities.
12. Acquire more than 10% of the voting securities of any issuer.
13. Invest more than 25% of the value of its total assets in
securities of issuers in any one industry. (Securities of the U.S.
Government, its agencies, or instrumentalities, and securities backed by
the credit of a governmental entity are not considered to represent
industries.)
14. Invest in the securities of registered open-end investment
companies, except as they may be acquired as part of a merger or
consolidation or acquisition of assets.
15. Buy or sell oil, gas, or other mineral leases, rights, or royalty
contracts, although it may purchase securities of issuers which deal in,
represent interests in, or are secured by interests in such leases, rights,
or contracts, and it may acquire or dispose of such leases, rights, or
contracts acquired through the exercise of its rights as a holder of debt
obligations secured thereby.
16. Make investments for the purpose of gaining control of a
company's management.
All percentage limitations on investments will apply at the time of
investment and shall not be considered violated unless an excess or deficiency
occurs or exists immediately after and as a result of such investment. Except
for the investment restrictions listed above and the Fund's policy under normal
market conditions to invest at least 80% of its total assets in tax exempt
securities, the other investment policies described in this Prospectus are not
fundamental and may be changed by approval of the Trustees. As a matter of
policy, the Trustees would not materially change the Fund's investment objective
without Shareholder approval.
TRUSTEES AND OFFICERS
The Trustees of the Fund are responsible for the general oversight of the
Fund's business. The initial Trustees and executive officers of the Fund and
their principal occupations during the last five years are set forth below. The
mailing address of each of the officers and Trustees is One Post Office Square,
Boston, Massachusetts 02109.
TRUSTEES
George Putnam, Chairman and President. Chairman and Director of Putnam
Investment Management, Inc., and Putnam Mutual Funds Corp. Director of American
Public Broadcasting, Inc., The Boston Company, Inc., Boston Safe Deposit and
Trust Company, Freeport McMoRan, Inc., General Mills, Inc., Houghton Mifflin
Company, Marsh & McLennan Companies, Inc., and Rockefeller Group, Inc.(a)
- ---------------
(a) Trustee who is an "interested person" (as defined in the 1940 Act) of the
Fund, Putnam, and/or Putnam Mutual Funds Corp.
24
<PAGE> 25
William F. Pounds, Vice Chairman. Professor of Management, Alfred P. Sloan
School of Management, Massachusetts Institute of Technology. Director of Fisher
Price, Inc., IDEXX, M/A-COM, Inc., EG&G, Inc., and Sun Company, Inc.
Jameson Adkins Baxter, Trustee. President, Baxter Associates, Inc.
(consultants to management). Director of Banta Corporation, Avondale Federal
Savings Bank and ASHTA Chemicals, Inc. Chairman of the Board of Trustees, Mount
Holyoke College.
Hans H. Estin, Trustee. Vice Chairman, North American Management Corp. (a
registered investment adviser). Director of The Boston Company, Inc. and Boston
Safe Deposit and Trust Co.
John A. Hill, Trustee. Chairman and Managing Director, First Reserve
Corporation (a registered investment adviser). Director of Lantana Corporation,
Maverick Tube Corporation, Snyder Oil Corporation, and various First Reserve
Funds.
Robert E. Patterson, Trustee. Executive Vice President, Cabot Partners
Limited Partnership (a registered investment adviser).
George Putnam, III, Trustee. President, New Generation Research, Inc.(a)
Elizabeth T. Kennan, Trustee. President, Mount Holyoke College. Director
of NYNEX Corporation, Northeast Utilities and the Kentucky Home Life Insurance
Companies. Trustee, the University of Notre Dame.
Lawrence J. Lasser, Trustee and Vice President. President, Chief Executive
Officer and Director of Putnam Investments, Inc. and Putnam Investment
Management, Inc. Director of Marsh & McLennan Companies, Inc. and
INROADS/Central New England, Inc.(a)
Donald S. Perkins, Trustee. Director of various corporations, including
American Telephone & Telegraph Company, AON Corp., Cummins Engine Company, Inc.,
Illinois Power Company, Inland Steel Industries, Inc., K Mart Corporation,
LaSalle Street Fund, Inc., Springs Industries, Inc., TBG, Inc. and Time Warner
Inc.
A.J.C. Smith, Trustee. Chairman, Chief Executive Officer and Director,
Marsh & McLennan Companies, Inc.(a)
W. Nicholas Thorndike, Trustee. Director of various corporations and
charitable organizations, including Providence Journal Co. Also, Trustee and
President, Massachusetts General Hospital and Trustee of Eastern Utilities
Associates.(b)
OFFICERS
Charles E. Porter, Executive Vice President. Managing Director of Putnam
Investments, Inc. and Putnam Investment Management, Inc. Executive Vice
President of the Putnam funds.
Patricia C. Flaherty, Senior Vice President. Senior Vice President of the
Putnam funds.
Gordon H. Silver, Vice President. Director and Senior Managing Director of
Putnam Investment Management, Inc. and Putnam Investments, Inc. Vice President
of the Putnam funds.
William N. Shiebler, Vice President. Director and Senior Managing Director
of Putnam Investments, Inc. President and Director of Putnam Mutual Funds Corp.
Vice President of the Putnam funds.
John R. Verani, Vice President. Senior Vice President of Putnam Investment
Management, Inc. and Putnam Investments, Inc. Vice President of the Putnam
funds.
- ---------------
(a) Trustee who is an "interested person" (as defined in the 1940 Act) of
the Fund, Putnam, and/or Putnam Mutual Funds Corp.
(b) Trustee who, during the offering of the Preferred Shares, may be deemed
to be an "interested person" of the Fund and of the Underwriter by
reason of owning, beneficially or in a fiduciary capacity, publicly
traded securities issued by the Underwriter or by a company controlling
the Underwriter.
25
<PAGE> 26
Robert F. Lucey, Vice President. President and Director of Putnam
Fiduciary Trust Company. Senior Managing Director of Putnam Investments, Inc.
Vice President of the Putnam funds.
Gary N. Coburn, Vice President. Senior Managing Director of Putnam
Investment Management, Inc. and Putnam Investments, Inc. Vice President of
certain of the Putnam funds.
James E. Erickson, Vice President. Managing Director of Putnam Investment
Management, Inc. Vice President of certain of the Putnam funds.
Thomas C. Goggins, Vice President. Vice President of Putnam Investment
Management, Inc.
Paul M. O'Neil, Vice President. Vice President of Putnam Investments, Inc.
and Putnam Investment Management, Inc. Vice President of the Putnam funds.
John D. Hughes, Treasurer. Treasurer of the Putnam funds.
Paul G. Bucuvalas, Assistant Treasurer. Assistant Treasurer of the Putnam
funds.
Beverly Marcus, Clerk. Clerk of the Putnam funds.
Except as stated below, the principal occupations of the officers and
Trustees for the last five years have been with the employers as shown above,
although in some cases they have held different positions with such employers.
Prior to November 1990, Mr. Shiebler was President and Chief Operating Officer
of the InterCapital Division of Dean Witter Reynolds.
Mr. Erickson and Mr. Goggins are primarily responsible for the day-to-day
management of the Fund's portfolio. Mr. Erickson has been employed by Putnam
Investment Management, Inc. for in excess of the past five years in the
management of tax exempt funds in the Putnam family of funds. Mr. Goggins has
been employed by Putnam Investment Management, Inc. since June 1, 1993. From
1989 to 1993, Mr. Goggins was a Portfolio Manager, and from 1987 to 1989, an
Analyst at Transamerica Investment Services, Inc.
Each of the Trustees is a Trustee of all the other Putnam funds, and each
receives fees for his or her services from each of such funds. Each Trustee of
the Fund receives an annual fee, initially expected not to exceed $2,000, and an
additional fee for each Trustees' meeting attended. Trustees who are not
interested persons of Putnam and who serve on committees of the Trustees receive
additional fees for attendance at certain committee meetings. Such fees are
determined from time to time based primarily on the relative net assets of the
Fund and of the other Putnam funds.
The Agreement and Declaration of Trust of the Fund provides that the Fund
will indemnify its Trustees and officers against liabilities and expenses
incurred in connection with litigation in which they may be involved because of
their offices with the Fund, except if it is determined in the manner specified
in the Agreement and Declaration of Trust that they have not acted in good faith
in the reasonable belief that their actions were in the best interests of the
Fund or that such indemnification would relieve any officer or Trustee of any
liability to the Fund or its Shareholders by reason of willful misfeasance, bad
faith, gross negligence, or reckless disregard of his or her duties. The Fund,
at its expense, provides liability insurance for the benefit of its Trustees and
officers.
<TABLE>
PRINCIPAL HOLDERS OF SECURITIES
Except as set forth in the following tables, no person or "group" (as
defined by regulation of the Securities and Exchange Commission) was known to
the Fund to be the beneficial or record owner of 5% or more of the Common Shares
of the Fund as of December 31, 1993.
<CAPTION>
AMOUNT OF
NAME AND ADDRESS RECORD OWNERSHIP PERCENT
---------------- ---------------- -------
<S> <C> <C>
Smith Barney Shearson Inc.................................. 1,644,931 41.0%
PaineWebber Incorporated................................... 779,000 19.4%
</TABLE>
As of December 31, 1993, the officers and Trustees of the Fund owned less
than 1% of the outstanding Common Shares.
26
<PAGE> 27
INVESTMENT MANAGEMENT CONTRACT
Under a Management Contract between the Fund and Putnam, subject to such
policies as the Trustees may determine, Putnam, at its own expense, furnishes
continuously an investment program for the Fund and makes investment decisions
on behalf of the Fund. Subject to the control of the Trustees, Putnam also
places all orders for the purchase and sale of the Fund's portfolio securities.
As compensation for the services rendered, facilities furnished and
expenses borne by Putnam, the Fund pays Putnam a quarterly fee based on the
Fund's average net asset value (determined as described below), at the annual
rate of 0.50% of the first $500 million of the average net asset value of the
Fund, 0.43% of the next $500 million, 0.39% of the next $500 million and 0.35%
of any excess over $1.5 billion of such average net asset value. If dividends
payable on the Preferred Shares during any dividend period plus expenses
attributable to the Preferred Shares for that period exceed the gross income of
the Fund during that period attributable to the investment of the proceeds of
the Preferred Shares, then the fee payable to Putnam for that period will be
reduced by an amount equal to the product of such excess and a fraction, the
numerator of which shall be the fee otherwise payable to Putnam pursuant to the
Management Contract and the denominator of which shall be the sum of the fee
otherwise payable to Putnam pursuant to the Management Contract and the
administrative service fee otherwise payable to Putnam under the Administrative
Services Contract, described below, between the Fund and Putnam; provided,
however, that the amount of such reduction for any such dividend period shall
not exceed the amount determined by multiplying (i) the aggregate liquidation
preference of the average number of Preferred Shares outstanding during the
dividend period, by (ii) the percentage of the aggregate net asset value of the
Fund which the fee payable to Putnam during such period pursuant to the
Management Contract would constitute without giving effect to such reduction.
The net asset value upon which the investment management fee is calculated
includes net assets attributable to any outstanding Preferred Shares (not
treating the liquidation preference of the Preferred Shares as a liability).
Average net asset value is to be determined by taking the average of the weekly
determinations of the net asset value, determined at the close of the last
business day of each week, for each week which ends during the quarter. Putnam
has advanced or will advance certain of the Fund's organizational and offering
expenses, which will be repaid by the Fund. Putnam will waive its management fee
under the Management Contract for the three-month period commencing November 26,
1993.
The Management Contract provides that Putnam shall not be subject to any
liability to the Fund or to any Shareholder of the Fund for any act or omission
in the course of or connected with rendering services to the Fund in the absence
of willful misfeasance, bad faith, gross negligence, or reckless disregard of
its duties on the part of Putnam.
The Management Contract may be terminated without penalty by vote of the
Trustees or the Shareholders of the Fund, or by Putnam, on 30 days' written
notice. It may be amended only by a vote of the Shareholders of the Fund. The
Management Contract also terminates without payment of any penalty in the event
of its assignment. The Management Contract provides that it will continue in
effect only so long as such continuance is approved at least annually by vote of
either the Trustees or the Shareholders, and, in either case, by a majority of
the Trustees who are not "interested persons" of Putnam or the Fund. In each of
the foregoing cases, the vote of the Shareholders is the affirmative vote of a
"majority of the outstanding voting securities" as defined in the 1940 Act. See
"Investment Restrictions."
Putnam has entered into an agreement with Smith Barney Shearson Inc. for
various services, including services with respect to the Fund's market
performance and general economic and interest rate conditions. Putnam from its
own assets (and not from the assets of the Fund) will pay Smith Barney Shearson
Inc. a fee for such services in an amount up to 0.15% of the net assets of the
Fund. Smith Barney Shearson Inc. will have no responsibility with respect to the
Fund's investments or administration.
27
<PAGE> 28
ADMINISTRATIVE SERVICES CONTRACT
The Fund pays Putnam a quarterly administrative service fee at the annual
rate of 0.20% of the first $500 million of the average net asset value of the
Fund, 0.17% of the next $500 million, 0.16% of the next $500 million and 0.15%
of any excess over $1.5 billion of such average net asset value pursuant to an
Administrative Services Contract between the Fund and Putnam. If dividends
payable on the Preferred Shares during any dividend period plus expenses
attributable to the Preferred Shares for that period exceed the gross income of
the Fund during that period attributable to the investment of the proceeds of
the Preferred Shares, then the administrative service fee payable to Putnam for
that period will be reduced by an amount equal to the product of such excess and
a fraction, the numerator of which shall be the fee otherwise payable to Putnam
pursuant to the Administrative Services Contract and the denominator of which
shall be the sum of the fee otherwise payable to Putnam pursuant to the
Administrative Services Contract and the management fee otherwise payable to
Putnam under the Management Contract between the Fund and Putnam; provided,
however, that the amount of such reduction for any such period shall not exceed
the amount determined by multiplying (i) the aggregate liquidation preference of
the average number of Preferred Shares outstanding during that period, by (ii)
the percentage of the aggregate net asset value of the Fund which the fee
payable to Putnam during such period pursuant to the Administrative Services
Contract would constitute without giving effect to such reduction. The net asset
value upon which the administrative service fee is calculated includes net
assets attributable to any outstanding Preferred Shares (not treating the
liquidation preference of the Preferred Shares as a liability). Average net
asset value is to be determined by taking the average of the weekly
determination of net asset value, determined at the close of the last business
day of each week, for each week which ends during the quarter. Putnam will waive
its administrative service fee for the three-month period commencing November
26, 1993.
Under the terms and conditions of the Administrative Services Contract, in
addition to the fee paid to Putnam, the Fund reimburses Putnam for a portion of
the compensation and related expenses of certain officers of the Fund and their
assistants who provide certain administrative services for the Fund and the
other funds in the Putnam family, each of which bears an allocated share of the
foregoing costs. The aggregate amount of all such payments and reimbursements
will be determined annually by the Trustees. Putnam pays all other salaries of
officers of the Fund. The Fund pays all expenses not otherwise borne by Putnam
including, without limitation, legal, custody and shareholder servicing
expenses.
The Administrative Services Contract provides that Putnam shall not be
subject to any liability to the Fund or to any Shareholder of the Fund for any
act or omission in the course of or connected with rendering services to the
Fund in the absence of willful misfeasance, bad faith, gross negligence, or
reckless disregard of its duties on the part of Putnam.
PORTFOLIO TRANSACTIONS
INVESTMENT DECISIONS
Investment decisions for the Fund and for the other investment advisory
clients of Putnam and its affiliates, The Putnam Advisory Company, Inc. and
Putnam Fiduciary Trust Company, are made with a view to achieving their
respective investment objectives. Investment decisions are the product of many
factors in addition to basic suitability for the particular client involved.
Thus, a particular security may be bought or sold for certain clients even
though it could have been bought or sold for other clients at the same time.
Likewise, a particular security may be bought for one or more clients when one
or more clients are selling the security. In some instances, one client may sell
a particular security to another client. Sometimes, two or more clients
simultaneously purchase or sell the same security, in which event each day's
transactions in such security are, insofar as possible, averaged as to price and
allocated between such clients in a manner which in Putnam's opinion is
equitable to each and in accordance with the amount being purchased or sold by
each. There may be circumstances when purchases or sales of portfolio securities
for one or more clients will have an adverse effect on other clients.
28
<PAGE> 29
BROKERAGE AND RESEARCH SERVICES
Most purchases and sales of portfolio investments by the Fund will be with
underwriters of or dealers in tax exempt securities, acting as principal. In
such cases, the price paid by the Fund usually will include an undisclosed
dealer commission or markup. Accordingly, the Fund will not ordinarily pay
significant brokerage commissions, but may pay underwriting commissions on
underwritten offerings. In such offerings, the price paid by the Fund will
include a disclosed, fixed commission or discount retained by the underwriter or
dealer. Transactions on U.S. stock exchanges and other agency transactions
involve the payment by the Fund of negotiated brokerage commissions. Such
commissions vary among different brokers. Also, a particular broker may charge
different commissions according to such factors as the difficulty and size of
the transaction.
Putnam will place orders for the purchase and sale of portfolio securities
for the Fund and will buy and sell securities for the Fund through a substantial
number of broker-dealers. In so doing, Putnam will use its best efforts to
obtain for the Fund the most favorable price and execution available, except to
the extent it may be permitted to pay higher brokerage commissions as described
below. In seeking the most favorable price and execution, Putnam, having in mind
the Fund's best interests, considers all factors it deems relevant, including
price, the size of the transaction, the nature of the market for the security,
the amount of the commission, the timing of the transaction taking into account
market prices and trends, the reputation, experience and financial stability of
the broker-dealer involved, and the quality of service rendered by the
broker-dealer in other transactions.
It has for many years been a common practice in the investment advisory
business for advisers of investment companies and other institutional investors
to receive "brokerage and research services" (as defined in the Securities
Exchange Act of 1934, as amended) from broker-dealers which execute portfolio
transactions for the clients of such advisers and from third parties with which
such broker-dealers have arrangements. Consistent with this practice, Putnam
receives brokerage and research services from many broker-dealers with which
Putnam places the Fund's portfolio transactions and from third parties with
which these broker-dealers have arrangements. These services include such
matters as general economic and security market reviews, industry and company
reviews, evaluations of securities, recommendations as to the purchase and sale
of securities, newspapers, magazines, pricing services, quotation services, news
services and personal computers utilized by Putnam's managers and analysts.
Where the services referred to above are not used exclusively by Putnam for
research purposes, Putnam, based upon its own allocations of expected use, bears
that portion of the cost of these services which directly relates to their
non-research use. Some of these services are of value to Putnam and its
affiliates, The Putnam Advisory Company, Inc. and Putnam Fiduciary Trust
Company, in advising various of their clients (including the Fund), although not
all of these services are necessarily useful and of value in managing the Fund.
The management fee paid by the Fund is not reduced because Putnam and its
affiliate receive these services even though Putnam might otherwise be required
to purchase some of these services for cash.
As permitted by Section 28(e) of the Securities Exchange Act of 1934, as
amended, and by the Management Contract, Putnam may cause the Fund to pay a
broker-dealer which provides brokerage and research services to Putnam an amount
of disclosed commission for effecting a securities transaction for the Fund in
excess of the commission which another broker-dealer would have charged for
effecting that transaction. Putnam's authority to cause the Fund to pay any such
greater commissions is also subject to such policies as the Trustees may adopt
from time to time.
The Management Contract provides that the fee payable to Putnam by the Fund
will be reduced by an amount equal to any commissions, fees, brokerage, or
similar payments received by Putnam or an affiliate in connection with the
purchase and sale of portfolio securities of the Fund, less any direct expenses
approved by the Trustees. Putnam seeks to reduce for the Fund soliciting dealer
fees on the tender of the Fund's portfolio securities in tender or exchange
offers. Any such reductions are likely to be minor in amount.
Consistent with the Rules of Fair Practice of the National Association of
Securities Dealers, Inc. and subject to seeking the most favorable price and
execution available and such other policies as the Trustees may determine,
Putnam may consider sales of Common Shares of the Fund by underwriters and
dealers in
29
<PAGE> 30
this offering (and, if permitted by law, sales of the other Putnam funds) as a
factor in the selection of broker-dealers to execute portfolio transactions for
the Fund.
DETERMINATION OF NET ASSET VALUE
The Fund will determine the net asset value of its Common Shares at least
once each week as of the close of business on the last day on which the New York
Stock Exchange is open. Net asset value will be determined by dividing the value
of all assets of the Fund (including accrued interest and dividends), less all
liabilities (including accrued expenses) and the liquidation value of any
outstanding Preferred Shares, by the total number of Common Shares outstanding.
Tax exempt securities will be stated on the basis of valuations provided by a
pricing service approved by the Trustees, which uses information with respect to
transactions in bonds, quotations from bond dealers, market transactions in
comparable securities and various relationships between securities in
determining value. The Fund believes that reliable market quotations are
generally not readily available for purposes of valuing its portfolio
securities. As a result, it is likely that most of the valuations provided by
such pricing service will be based upon fair market value determined on the
basis of the factors listed above. Non-tax exempt securities for which market
quotations are readily available will be stated at market value. Short-term
investments having remaining maturities of 60 days or less are stated at
amortized cost, which approximates market value. All other securities and assets
will be valued at their fair value following procedures approved by the
Trustees.
If any securities held by the Fund are restricted as to resale, Putnam will
determine their fair value following procedures approved by the Trustees. The
Trustees periodically review such valuations and procedures. The fair value of
such securities generally will be determined as the amount which the Fund could
reasonably expect to realize from an orderly disposition of such securities over
a reasonable period of time. The valuation procedures applied in any specific
instance are likely to vary from case to case. However, consideration is
generally given to the financial position of the issuer and other fundamental
analytical data relating to the investment and to the nature of the restrictions
on disposition of the securities (including any registration expenses that might
be borne by the Fund in connection with such disposition). In addition, specific
factors are also generally considered such as the cost of the investment, the
market value of any unrestricted securities of the same class (both at the time
of purchase and at the time of valuation), the size of the holding, the prices
of any recent transactions or offers with respect to such securities, and any
available analysts' reports regarding the issuer.
REMARKETING
GENERAL
The Bylaws provide that the Applicable Dividend Rate for each Preferred
Share for each Dividend Period therefor (except the Initial Dividend Period)
will be (i) unless such Dividend Period commences during a Non-Payment Period
(described below under "Description of Preferred Shares -- Dividends --
Non-Payment Period; Late Charge"), equal to the lower of (a) the rate per annum
that the Remarketing Agent determines on the Remarketing Date preceding the
first day of such Dividend Period pursuant to the procedures set forth in the
Bylaws and (b) the applicable Maximum Dividend Rate or (ii) if such Dividend
Period commences during a Non-Payment Period, equal to the Non-Payment Period
Rate which is a multiple (generally 200%) of the Reference Rate described below
under "Remarketing -- Remarketing Procedures -- Reference Rate." Each Dividend
Period commencing during a Non-Payment Period will be a 28-day Dividend Period,
the Preferred Shares will not be subject to Tender and Dividend Reset and the
holders of Preferred Shares will not be able to tender their shares in a
Remarketing. See "Description of Preferred Shares -- Dividends -- Non-Payment
Period; Late Charge".
The Fund will enter into a Paying Agent Agreement with IBJ Schroeder Bank &
Trust Company. The Paying Agent Agreement will provide, among other things, that
the Paying Agent will (i) act as transfer agent, registrar, dividend and
redemption price disbursing agent, settlement agent and agent for certain
30
<PAGE> 31
notifications (including notices of redemption) with respect to the Preferred
Shares and (ii) carry out certain other procedures. See "Description of
Preferred Shares -- Redemption".
REMARKETING SCHEDULE; ADVANCE NOTICE OF ALLOCATION OF TAXABLE INCOME; INCLUSION
OF TAXABLE INCOME
IN DIVIDEND
Each Remarketing for the Preferred Shares will take place over a
two-Business Day period consisting of the Remarketing Date (normally a Thursday)
and the Settlement Date (normally a Friday).
If, for example, Thursday or Friday of a particular week is not a Business
Day, the normal remarketing schedule will be adjusted as follows: (i) if
Thursday is not a Business Day, Wednesday shall be the Remarketing Date and
Friday shall be the Settlement Date; and (ii) if Friday is not a Business Day,
Thursday shall be the Remarketing Date and Monday shall be the Settlement Date.
If, for any reason, neither of the foregoing clauses can be given effect, the
Remarketing Agent shall, in its sole discretion, adjust the remarketing schedule
as appropriate to complete such Remarketing.
A description of the time sequence of the events in a normal remarketing
schedule is provided in Appendix A to this Prospectus.
The Internal Revenue Service has taken the position in a published ruling
that the Fund is required for each taxable year to allocate net capital gain and
other income subject to regular Federal income tax, if any, proportionately
between the Common Shares and the Preferred Shares in accordance with the
percentage of total Fund distributions received by each such class of shares
with respect to such year. Whenever the Fund intends to include any net capital
gain or other income subject to regular Federal income tax in a dividend on
Preferred Shares solely because the Fund, in its judgment, believes it is
required, in order to comply with the published position of the Internal Revenue
Service, to allocate taxable income to such shares, the Fund may notify the
Remarketing Agent of the amount to be so included at least five Business Days
prior to the Remarketing Date on which the Applicable Dividend Rate for such
dividend is to be established. Alternatively, if the Fund has not provided the
notice referred to in the preceding sentence, and nevertheless intends to
include such income in a dividend on Preferred Shares solely because the Fund,
in its judgment, believes it is required, in order to comply with the published
position of the Internal Revenue Service, to allocate such income to Preferred
Shares, it will (i) increase the dividend by an amount such that the return to a
holder of Preferred Shares with respect to such dividend (as so increased and
after giving effect to Federal income tax at the Gross-Up Tax Rate) equals the
Applicable Dividend Rate and (ii) notify the Paying Agent of the additional
amount to be included in the dividend at least five Business Days prior to the
applicable Dividend Payment Date. In the event the Fund has provided notice of
an inclusion of taxable income in an upcoming dividend on Preferred Shares as
referred to above, yet, after giving such notice the Fund intends to include
additional taxable income in such dividend solely because, in the judgment of
the Fund, it is required to do so in order to comply with the IRS's published
ruling, the Fund will (i) increase the dividend by an amount such that the
return to a holder of Preferred Shares with respect to such dividend (as so
increased and after giving effect to Federal income tax at the Gross-Up Tax
Rate) shall equal the return such holder of Preferred Shares would have
received, after application of Federal income tax (at the greater of the maximum
Federal individual or corporate income tax rate applicable to the character of
income reflected in such notice), if such additional amount of taxable income
had not been included in such dividend (and such dividend had not been increased
to take account of any additional taxable income) and (ii) notify the Paying
Agent of the additional amount to be included in the dividend at least five
Business Days prior to the applicable Dividend Payment Date. Neither the
underlying dividend nor the additional amounts referred to in the two preceding
sentences will be increased to compensate for the fact that they may be subject
to state and local taxes. The Gross-Up Tax Rate shall be equal to the sum of (i)
the percentage of the taxable income included in the dividend that is taxable
for Federal income tax purposes as ordinary income, multiplied by the greater of
(A) the highest marginal Federal corporate income tax rate (without regard to
the phase-out of graduated rates) applicable to ordinary income and (B) the
highest marginal Federal individual income tax rate applicable to ordinary
income (including any surtax but without regard to any phase-out of personal
exemptions or any limitation on itemized deductions), and (ii) the percentage of
the taxable income included in the dividend that is taxable for Federal income
tax purposes as long-term capital gain, multiplied by the greater of (A) the
highest
31
<PAGE> 32
marginal Federal corporate income tax rate (without regard to the phase-out of
graduated rates) applicable to long-term capital gain and (B) the highest
marginal Federal individual income tax rate applicable to long-term capital gain
(including any surtax but without regard to any phase-out of personal exemptions
or any limitation on itemized deductions). If for any reason it is determined
after the payment of any dividend that a portion of that dividend was subject to
Federal income tax, the Fund will not be required to pay any additional amount
to compensate for any tax payable on the dividend (other than Additional
Dividends payable under the circumstances described in this Prospectus). The
Fund will not be required to provide any notice of the prospective inclusion of,
or increase any dividend on Preferred Shares as a result of the inclusion of,
any taxable income in any dividend (other than in the circumstances described
above and in the circumstances under which the Fund is required to pay
Additional Dividends). No provision will be made to compensate holders of
Preferred Shares for any alternative minimum tax liability in respect of
distributions on Preferred Shares. See "Description of Preferred Shares --
Dividends -- Additional Dividends."
THE REMARKETING AGENT
The Remarketing Agent for the Preferred Shares initially will be Smith
Barney Shearson Inc.
The Fund will enter into a Remarketing Agreement with the Remarketing Agent
which will provide, among other things, that the Remarketing Agent will follow
certain procedures for remarketing Preferred Shares on behalf of holders thereof
as provided in the Bylaws for the purpose of determining the Applicable Dividend
Rate that will enable the Remarketing Agent to remarket Preferred Shares
tendered to it at a price of $50,000 per share for a 28-day Dividend Period or a
Special Dividend Period, as the case may be. See "Remarketing -- Remarketing
Procedures -- Applicable Dividend Rates" below. Each periodic operation of such
procedures with respect to Preferred Shares is referred to as a "Remarketing".
Under certain circumstances, Preferred Shares tendered in a Remarketing may be
tendered or purchased by the Remarketing Agent for its own account. See
"Remarketing -- Remarketing Procedures -- Tender by Holders" below.
For its services in determining the Applicable Dividend Rate and
remarketing Preferred Shares for a 28-day Dividend Period, the Remarketing Agent
will receive from the Fund a fee for such period calculated at a rate equal to
approximately .25% per annum of the average amount of Preferred Shares
outstanding during the Dividend Period. If the Dividend Period is a Special
Dividend Period, the Fund will instead pay to the Remarketing Agent a fee, to be
determined by mutual consent of the Fund and the Remarketing Agent, based on the
selling concession that would be applicable to an underwriting of a fixed or
variable rate preferred stock issue with a similar dividend period. The
Remarketing Agent will pay to selected broker-dealers a portion of the fees
described above, reflecting shares sold through such broker-dealers to
purchasers in Remarketings.
The Fund and Putnam have agreed to indemnify the Remarketing Agent against
certain liabilities arising out of or in connection with its duties under the
Remarketing Agreement.
Any Remarketing Agent may resign and be discharged from its duties with
respect to the Preferred Shares under a Remarketing Agreement by giving at least
60 days' prior notice in writing to the Fund, the Securities Depository, the
Paying Agent and each other Remarketing Agent, if any, and the Fund may remove a
Remarketing Agent under a Remarketing Agreement by giving at least 60 days'
prior notice in writing to such Remarketing Agent, the Securities Depository,
the Paying Agent and any other Remarketing Agent of such removal; provided that
if (i) the resigning or removed Remarketing Agent is at the time the sole
Remarketing Agent, or (ii) each other Remarketing Agent elects to resign or is
removed within one week of delivery of such notice, then neither any such
resignation nor any such removal will be effective until a successor remarketing
agent which is a nationally recognized broker-dealer shall have entered into a
remarketing agreement with the Fund in which such successor remarketing agent
shall have agreed to conduct Remarketings with respect to the Preferred Shares
in accordance with the terms and conditions of the Bylaws.
A Remarketing Agent may also terminate a Remarketing Agreement or may
resign by giving notice in writing to the Fund, the Securities Depository, the
Paying Agent and each other Remarketing Agent, if any, if any of the following
events has occurred and has not been cured prior to the proposed date of such
termination or resignation (in each case for a period of 30 days after notice
thereof has been given to the Fund specifying the condition or event): (i) the
rating of the Preferred Shares shall have been downgraded or withdrawn by a
32
<PAGE> 33
national rating service, the effect of which, in the opinion of the Remarketing
Agents or Remarketing Agent, as the case may be, is to affect materially and
adversely the market price of such Preferred Shares or the ability of the
Remarketing Agents or Remarketing Agent, as the case may be, to remarket such
shares; (ii) all of the Preferred Shares shall have been called for redemption;
or (iii) without the prior written consent of the Remarketing Agent or
Remarketing Agents, as the case may be, the Agreement and Declaration of Trust,
the Bylaws or the Paying Agent Agreement shall have been amended in any manner
that, in the opinion of the Remarketing Agent or Remarketing Agents, as the case
may be, materially changes the nature of the Preferred Shares or the remarketing
procedures with respect thereto.
The Remarketing Agent is not obligated to set the Applicable Dividend Rate
or Rates on Preferred Shares or to remarket such shares during a Non-Payment
Period as provided in the Bylaws or at any time that certain conditions
specified in the Remarketing Agreement have not been met or any of the events
set forth in clauses (i), (ii) or (iii) of the immediately preceding paragraph
has occurred.
RESTRICTIONS ON TRANSFER
General. The Paying Agent will maintain a record of certain beneficial
owners of Preferred Shares, for purposes of determining such owners entitled to
participate in Remarketings and for certain other purposes. The Paying Agent
will only record transfers of such beneficial ownership, in a Remarketing or
otherwise, of which it is notified in accordance with its procedures in effect
from time to time.
Book Entry Only. DTC initially will act as Securities Depository for the
Agent Members with respect to Preferred Shares. Except as discussed below, as
long as DTC is the Securities Depository, one certificate for the outstanding
Preferred Shares will be registered in the name of Cede & Co. ("Cede") as
nominee of the Securities Depository, and Cede will be the holder of record of
all Preferred Shares. Such certificate will bear a legend to the effect that
such certificate is issued subject to the provisions contained in the Bylaws.
Unless the Fund shall have waived this requirement during a Non-Payment Period,
Preferred Shares may be held only in book entry form through the Securities
Depository (which, either directly or through a nominee, will be the registered
owner of Preferred Shares as described above), and the Fund will issue
stop-transfer instructions to the Paying Agent for the Preferred Shares to this
effect. If the Fund shall have waived the foregoing requirement during a
Non-Payment Period, a holder of Preferred Shares may obtain a certificate or
certificates for such shares. The Fund is advised that DTC is a New
York-chartered limited purpose trust company, which performs services for its
participants (including the Agent Members), some of which (and/or their
representatives) own DTC. The Fund is advised further that DTC maintains lists
of its participants and will maintain as record holder the positions (beneficial
ownership interests) held by each Agent Member in the Preferred Shares, whether
such Agent Member is a holder for its own account or as a nominee for another
holder. The Fund shall have no obligation, including without limitation any
obligation to provide notice or to make any payment (in respect of any dividend
or otherwise), to any person (including without limitation any holder of any
beneficial interest in Preferred Shares, whether or not such interest is
reflected on the share transfer books of the Paying Agent) other than the
holders of record of the Preferred Shares shown on the share transfer books of
the Paying Agent from time to time. The share transfer books of the Fund as kept
by the Paying Agent shall be conclusive as to who is the holder of record of any
Preferred Shares at any time and as to the number of Preferred Shares held from
time to time by any such holder. No Remarketing Agent, Paying Agent, Securities
Depository, or Agent Member will have any obligation to any person having any
interest in any Preferred Share other than the holder of record and the
beneficial owner thereof as shown from time to time on the share transfer books
kept by the Paying Agent. The Paying Agent shall have no obligation to record
any transfer of record or beneficial ownership in any share unless and until it
shall have received proper notice and evidence of such transfer and the right of
the transferee in accordance with the Paying Agent's procedures in effect from
time to time.
Secondary Market. The Remarketing Agent has advised the Fund that it
currently intends to make a secondary trading market in the Preferred Shares
outside of Remarketings. However, the Remarketing Agent has no obligation to
make a secondary market in the Preferred Shares outside of Remarketings, and
there can be no assurance that a secondary market for Preferred Shares will
develop or, if it does develop, that it will provide holders with liquidity of
investment. The Preferred Shares will not be registered on any stock exchange
33
<PAGE> 34
or on the National Association of Securities Dealers Automated Quotation System.
If a Remarketing Agent purchases Preferred Shares in the secondary market or in
a Remarketing, it may be in a position of holding for its own account or as
nominee for others Preferred Shares subject to a Remarketing at the time it
determines the Applicable Dividend Rate in such Remarketing and may tender such
shares in such Remarketing.
REMARKETING PROCEDURES
Tender by Holders. Each share of Preferred Shares is subject to Tender and
Dividend Reset only on the relevant Remarketing Date at the end of each Dividend
Period applicable to such share.
Except during a Non-Payment Period, by 12:00 noon, New York City time, on
the Remarketing Date in the Remarketing at the end of each Dividend Period, the
holder of a Preferred Share may elect to tender such share or hold such share
for the next Dividend Period. If the holder of such Preferred Share elects to
hold such share, such holder shall hold such Preferred Share at the Applicable
Dividend Rate for a 28-day Dividend Period or a Special Dividend Period if the
succeeding Dividend Period with respect to such share has been designated by the
Trustees as a Special Dividend Period, provided that, except during a
Non-Payment Period, if (i) there is no Remarketing Agent, (ii) the Remarketing
Agent is not required to conduct a Remarketing or (iii) the Remarketing Agent is
unable to remarket in the Remarketing on such Remarketing Date all such
Preferred Shares tendered (or deemed tendered) to it at a price of $50,000 per
share, then the next Dividend Period for all Preferred Shares shall be a 28-day
Dividend Period and the Applicable Dividend Rate therefor shall be the
applicable Maximum Dividend Rate.
Preferred Shares may be tendered only in a Remarketing which commences on
the Remarketing Date immediately prior to the end of the current Dividend Period
with respect thereto. By 9:00 a.m., New York City time, on such Remarketing
Date, the Remarketing Agent will, after canvassing the market and considering
prevailing market conditions at the time for such shares and similar securities,
provide to holders of such shares non-binding indications of the Applicable
Dividend Rate for the next succeeding 28-day Dividend Period or Special Dividend
Period, as the case may be. THE ACTUAL APPLICABLE DIVIDEND RATE FOR SUCH
DIVIDEND PERIOD MAY BE GREATER OR LESS THAN THE RATE INDICATED IN SUCH
NON-BINDING INDICATIONS (BUT NOT GREATER THAN THE APPLICABLE MAXIMUM DIVIDEND
RATE) AND WILL NOT BE DETERMINED UNTIL AFTER A HOLDER IS REQUIRED TO ELECT TO
HOLD OR SELL ITS PREFERRED SHARES AND A NEW PURCHASER IS REQUIRED TO AGREE TO
PURCHASE PREFERRED SHARES. See Appendix A.
By 12:00 noon, New York City time, on any Remarketing Date with respect to
the Preferred Shares, each holder of Preferred Shares must notify the
Remarketing Agent of its desire (on a share-by-share basis) either to tender
such share at a price of $50,000 per share or to continue to hold such share for
the next 28-day Dividend Period or, if applicable, the designated Special
Dividend Period. Holders of such Preferred Shares who do not provide such notice
shall be deemed to have elected (i) to hold all their Preferred Shares if the
current Dividend Period and succeeding Dividend Period is a 28-day Dividend
Period or a Special Dividend Period of 90 days or less, and (ii) to tender all
their Preferred Shares if the current Dividend Period or succeeding Dividend
Period is a Special Dividend Period of more than 90 days. Any holder or
prospective purchaser may informally indicate to the Remarketing Agent its
Applicable Dividend Rate preferences. However, any notice given to the
Remarketing Agent to tender or hold shares for a particular Dividend Period is
irrevocable and may not be conditioned upon the level at which Applicable
Dividend Rates are set. Accordingly, the Applicable Dividend Rate with respect
to a Dividend Period may be greater or less than such rate preferences. Any
notice of tender may not be revoked, except that the Remarketing Agent may, in
its sole discretion, (i) at the request of a tendering holder that has tendered
one or more Preferred Shares to the Remarketing Agent, waive such holder's
tender, and thereby enable such holder to continue to hold such share or shares
for a 28-day Dividend Period or a designated Special Dividend Period, as agreed
to by the holder and the Remarketing Agent at such time, so long as such
tendering holder has indicated to the Remarketing Agent that it would accept the
new Applicable Dividend Rate for such Dividend Period, such waiver to be
contingent upon the Remarketing Agent's being able to remarket all shares
tendered to it in such Remarketing, and (ii) at the request of a holder that has
elected to hold one or more of its Preferred Shares, waive such holder's
34
<PAGE> 35
election with respect thereto, such waiver to be contingent upon the Remarketing
Agent's being able to remarket all shares tendered to it in such Remarketing.
When Preferred Shares are tendered in a Remarketing therefor, the
Remarketing Agent is required to use its best efforts to remarket such tendered
shares on behalf of the holders thereof, but there can be no assurance that the
Remarketing Agent will be able to remarket all Preferred Shares tendered. See
"Remarketing -- Remarketing Procedures -- Allocation of Shares; Failure to
Remarket at $50,000 Per Share" below. Each holder's right to tender Preferred
Shares in a Remarketing therefor is limited to the extent that (i) the
Remarketing Agent conducts a Remarketing pursuant to the terms of the
Remarketing Agreement, (ii) shares tendered have not been called for redemption,
and (iii) the Remarketing Agent is able to find purchasers for tendered
Preferred Shares at an Applicable Dividend Rate for a 28-day Dividend Period or
a designated Special Dividend Period, as the case may be, not in excess of any
applicable Maximum Dividend Rate. If the Remarketing Agent is unable to find a
purchaser or purchasers for all Preferred Shares tendered in a Remarketing
therefor, the shares to be sold in such Remarketing will be selected either pro
rata or by lot from among all the tendered shares. See "Remarketing --
Remarketing Procedures -- Allocation of Shares; Failure to Remarket at $50,000
Per Share" below. Each purchase or sale in a Remarketing will be made for
settlement on the related Settlement Date. See "Remarketing -- Remarketing
Procedures -- Notification of Results; Settlement" below and Appendix A.
There can be no assurance that the Remarketing Agent will be able to
remarket all Preferred Shares tendered in a Remarketing therefor. If any
Preferred Shares so tendered are not remarketed, a holder thereof may be
required to continue to hold some or all of its shares until at least the end of
the next Dividend Period therefor or to sell such shares outside a Remarketing.
See "Remarketing -- Remarketing Procedures -- Allocation of Shares; Failure to
Remarket at $50,000 Per Share" below, and "Remarketing -- Restrictions on
Transfer" and "Remarketing -- The Remarketing Agent" above.
Tendered Preferred Shares will also be subject to purchase in a Remarketing
therefor by the Remarketing Agent. If the Remarketing Agent holds Preferred
Shares for its own account after a Remarketing, it is required to establish an
Applicable Dividend Rate in such Remarketing that is no higher than the
Applicable Dividend Rate that would have been set if the Remarketing Agent did
not hold or had not purchased such shares. The Remarketing Agent may purchase
Preferred Shares for its own account in a Remarketing only if the Remarketing
Agent purchases for its own account or the account of others all tendered (or
deemed tendered) Preferred Shares subject to Tender and Dividend Reset but not
sold to other purchasers in such Remarketing. The Remarketing Agent is not
obligated to purchase any Preferred Shares that would otherwise remain unsold in
a Remarketing. If the Remarketing Agent holds any Preferred Shares immediately
prior to a Remarketing and if all other Preferred Shares subject to Tender and
Dividend Reset and tendered for sale by other owners have been sold in such
Remarketing, then the Remarketing Agent may sell in such Remarketing such number
of its shares which are subject to Tender and Dividend Reset as there are
outstanding orders to purchase that have not been filled by shares tendered for
sale on behalf of accounts other than that of the Remarketing Agent. See
"Remarketing -- Restrictions on Transfer -- Secondary Market" above. Neither the
Fund, nor the Paying Agent or the Remarketing Agent will be obligated in any
case to provide funds to make payment to any holder upon such holder's tender of
its Preferred Shares in any Remarketing. If the Remarketing Agent purchases
Preferred Shares in the secondary market or in a Remarketing, it may be in the
position of holding for its own account or as nominee for others Preferred
Shares subject to Tender and Dividend Reset in a Remarketing at the time it
determines the Applicable Dividend Rate in such Remarketing and may tender such
shares in such Remarketing.
Applicable Dividend Rates. By 3:00 p.m., New York City time, on each
Remarketing Date, the Remarketing Agent will determine the Applicable Dividend
Rate to the nearest one-thousandth (0.001) of one percent per annum for the next
28-day Dividend Period (or, if designated, a Special Dividend Period, provided
that, if the Remarketing Agent is unable to remarket on such Remarketing Date
all such tendered shares in a Remarketing at a price of $50,000 per share, then
the Remarketing Agent will assign no shares to any Special Dividend Period).
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<PAGE> 36
The Applicable Dividend Rate for each such Dividend Period, except as
otherwise described herein, will be the dividend rate per annum that the
Remarketing Agent determines to be the lowest rate that will enable it to
remarket on behalf of the holders thereof the Preferred Shares subject to Tender
and Dividend Reset in such Remarketing and tendered to it on such Remarketing
Date at a price of $50,000 per share. The Applicable Dividend Rate for Preferred
Shares will be determined as aforesaid by the Remarketing Agent in its sole
discretion and will be conclusive and binding on the Fund and all holders of
Preferred Shares. In determining such Applicable Dividend Rate, the Remarketing
Agent will, after taking into account market conditions as reflected in the
prevailing dividend yields on fixed and variable rate taxable and tax exempt
debt securities and the prevailing dividend yields of fixed and variable rate
preferred stocks determined for the purpose of providing non-binding indications
of the Applicable Dividend Rates to holders and potential purchasers of
Preferred Shares, (i) consider the number of Preferred Shares tendered in the
applicable Remarketing and the number of Preferred Shares prospective purchasers
are willing to purchase and (ii) contact by telephone or otherwise current and
prospective holders of the Preferred Shares subject to Tender and Dividend Reset
to ascertain the dividend rates at which they would be willing to hold such
shares. If no Applicable Dividend Rate shall have been established on a
Remarketing Date for the next 28-day Dividend Period, or Special Dividend
Period, if any, for any reason (other than because there is no Remarketing
Agent, the Remarketing Agent is not required to conduct a Remarketing pursuant
to the terms of the Remarketing Agreement or the Remarketing Agent is unable to
remarket on the Remarketing Date all Preferred Shares tendered (or deemed
tendered) to it at a price of $50,000 per share), then the Remarketing Agent, in
its sole discretion, shall, except during a Non-Payment Period, after taking
into account market conditions as reflected in the prevailing yields on fixed
and variable rate taxable and tax exempt debt securities and the prevailing
dividend yields of fixed and variable rate preferred stock, determine the
Applicable Dividend Rate that would be the rate per annum that would be the
initial dividend rate fixed in an offering on such Remarketing Date, assuming in
each case a comparable dividend period, issuer and security. If a Remarketing
for Preferred Shares does not take place because there is no Remarketing Agent,
the Remarketing Agent is not required to conduct a Remarketing or the
Remarketing Agent is unable to remarket in the Remarketing all such Preferred
Shares tendered (or deemed tendered) to it at a price of $50,000 per share,
then, except during a Non-Payment Period, the Applicable Dividend Rate for the
subsequent Dividend Period for such shares will be the applicable Maximum
Dividend Rate for a 28-day Dividend Period and such subsequent Dividend Period
shall be a 28-day Dividend Period.
Except during a Non-Payment Period, the Applicable Dividend Rate for any
Dividend Period for Preferred Shares will not be more than the Maximum Dividend
Rate applicable to such shares.
The Maximum Dividend Rate for Preferred Shares will be the "Applicable
Percentage" (as described below) of the Reference Rate. The Remarketing Agent
will round each Maximum Dividend Rate to the nearest one-thousandth (0.001) of
one percent per annum, with any such number ending in five ten-thousandths
(0.0005) of one percent being rounded upwards to the nearest one-thousandth
(0.001) of one percent. The Remarketing Agent will not round the applicable
Reference Rate as part of its calculation of any Maximum Dividend Rate.
"Reference Rate" means (i) with respect to a Dividend Period having 28 or
fewer days, the higher of the applicable "AA" Composite Commercial Paper Rate
and the Taxable Equivalent of the Short-Term Municipal Bond Rate, (ii) with
respect to any Short Term Dividend Period having more than 28 but fewer than 183
days, the applicable "AA" Composite Commercial Paper Rate, (iii) with respect to
any Short Term Dividend Period having 183 or more but fewer than 365 days, the
U.S. Treasury Bill Rate, and (iv) with respect to any Long Term Dividend Period,
the applicable U.S. Treasury Note Rate.
" 'AA' Composite Commercial Paper Rate," on any date of determination,
means (i) the Interest Equivalent of the rate on commercial paper placed on
behalf of issuers whose corporate bonds are rated "AA" by S&P or "Aa" by Moody's
or the equivalent of such rating by another nationally-recognized rating agency,
as such rate is made available on a discount basis or otherwise by the Federal
Reserve Bank of New York for the Business Day immediately preceding such date,
or (ii) in the event that the Federal Reserve Bank of New York does not make
available such a rate, then the arithmetic average of the Interest Equivalent of
the rate on commercial paper placed on behalf of such issuers, as quoted on a
discount basis or otherwise by the
36
<PAGE> 37
Commercial Paper Dealers to the Remarketing Agent for the close of business on
the Business Day immediately preceding such date. If one of the Commercial Paper
Dealers does not quote a rate required to determine the "AA" Composite
Commercial Paper Rate, the "AA" Composite Commercial Paper Rate will be
determined on the basis of the quotation or quotations furnished by any
Substitute Commercial Paper Dealer or Substitute Commercial Paper Dealers
selected by the Fund to provide such rate or rates not being supplied by the
Commercial Paper Dealer. If the number of Dividend Period days (in each case
determined without regard to any adjustment in the length of a Dividend Period
or the remarketing schedule in respect of non-Business Days) shall be (i) 7 or
more days but fewer than 49 days, such rate shall be the Interest Equivalent of
the 30-day rate on such commercial paper; (ii) 49 or more days but fewer than 70
days, such rate shall be the Interest Equivalent of the 60-day rate on such
commercial paper; (iii) 70 or more days but fewer than 85 days, such rate shall
be the arithmetic average of the Interest Equivalent of the 60-day and 90-day
rates on such commercial paper; (iv) 85 or more days but fewer than 99 days,
such rate shall be the Interest Equivalent of the 90-day rate on such commercial
paper; (v) 99 or more days but fewer than 120 days, such rate shall be the
arithmetic average of the Interest Equivalent of the 90-day and 120-day rates on
such commercial paper; (vi) 120 or more days but fewer than 141 days, such rate
shall be the Interest Equivalent of the 120-day rate on such commercial paper;
(vii) 141 or more days but fewer than 162 days, such rate shall be the
arithmetic average of the Interest Equivalent of the 120-day and 180-day rates
on such commercial paper; and (viii) 162 or more days but fewer than 183 days,
such rate shall be the Interest Equivalent of the 180-day rate on such
commercial paper.
"Taxable Equivalent of the Short-Term Municipal Bond Rate" on any date
means 90% of the quotient of (A) the per annum rate expressed on an Interest
Equivalent basis equal to the Kenny S&P 30-day High Grade Index or any
comparable index based upon 30-day yield evaluations at par of bonds the
interest on which is excludable for regular Federal income tax purposes under
the Code of "high grade" component issuers selected by Kenny Information Systems
Inc. or any successor thereto from time to time selected by the Fund in its
discretion, which component issuers shall include, without limitation, issuers
of general obligation bonds but shall exclude any bonds the interest on which
constitutes an item of tax preference under Section 57(a)(5) of the Code, or
successor provisions, for purposes of the "alternative minimum tax" (as defined
in the Code) (the "Kenny Index"), made available for the Business Day
immediately preceding such date but in any event not later than 8:30 a.m., New
York City time, on such date by Kenny Information Systems Inc. or any successor
thereto, divided by (B) 1.00 minus the Marginal Tax Rate (expressed as a
decimal); provided, however, that if the Kenny Index is not made so available by
8:30 a.m., New York City time, on such date by Kenny Information Systems Inc. or
any successor, the Taxable Equivalent of the Short-Term Municipal Bond Rate
shall mean the quotient of (A) the per annum rate expressed on an Interest
Equivalent basis equal to the most recent Kenny Index so made available divided
by (B) 1.00 minus the Marginal Tax Rate (expressed as a decimal).
"U.S. Treasury Bill Rate" on any date means (i) the Interest Equivalent of
the rate on the actively traded Treasury Bill with a maturity most nearly
comparable to the length of the related Dividend Period, as such rate is made
available on a discount basis or otherwise on the Business Day immediately
preceding such date by the Federal Reserve Bank of New York in its Composite
3:30 p.m. Quotations for U.S. Government Securities report for such Business
Day, or (ii) if such yield as so calculated is not available, the Alternate
Treasury Bill Rate on such date. "Alternate Treasury Bill Rate" on any date
means the Interest Equivalent of the yield as calculated by reference to the
arithmetic average of the bid price quotations of the actively traded Treasury
Bill with a maturity most nearly comparable to the length of the related
Dividend Period, as determined by bid price quotations as of any time on the
Business Day immediately preceding such date, obtained from at least three
recognized primary U.S. Government securities dealers selected by the
Remarketing Agent.
"U.S. Treasury Note Rate" on any date means (i) the yield as calculated by
reference to the bid price quotation of the actively traded, current coupon
Treasury Note with a maturity most nearly comparable to the length of the
related Dividend Period, as such bid price quotation is published on the
Business Day immediately preceding such date by the Federal Reserve Bank of New
York in its Composite 3:30 p.m. Quotations for U.S. Government Securities report
for such Business Day, or (ii) if such yield as so calculated
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<PAGE> 38
is not available, the Alternate Treasury Note Rate on such date. "Alternate
Treasury Note Rate" on any date means the yield as calculated by reference to
the arithmetic average of the bid price quotations of the actively traded,
current coupon Treasury Note with a maturity most nearly comparable to the
length of the related Dividend Period, as determined by the bid price quotations
as of any time on the Business Day immediately preceding such date, obtained
from at least three recognized primary U.S. Government securities dealers
selected by the Remarketing Agent.
<TABLE>
The Maximum Dividend Rate for Preferred Shares will depend on the credit
rating or ratings assigned to such shares. The Applicable Percentage for the
Preferred Shares on each Remarketing Date will be determined based on the lower
of the credit rating or ratings assigned on such date to the Preferred Shares by
Moody's and S&P (or if Moody's or S&P or both shall not make such rating
available, the equivalent of either or both of such ratings by a Substitute
Rating Agency or two Substitute Rating Agencies or, in the event that only one
such rating shall be available, such rating), as follows:
<CAPTION>
APPLICABLE
PERCENTAGE
OF REFERENCE
MOODY'S S&P RATE
------- --- ------------
<S> <C> <C>
"aa3" or higher AA- or higher 110%
"a3" to "a1" A- to A+ 125%
"baa3" to "baa1" BBB- to BBB+ 150%
"ba3" to "ba1" BB- to BB+ 200%
Below "ba3" Below BB- 250%
</TABLE>
provided, however, that in the event the Fund has notified the Paying Agent and
the Remarketing Agent of its intent to allocate income taxable for federal
income tax purposes to the Preferred Shares prior to the Remarketing Agent
establishing the Applicable Dividend Rate for such shares, the applicable
percentage in the foregoing table shall be divided by the quantity 1 minus the
Gross-Up Tax Rate (as hereinafter defined). If the ratings for the Preferred
Shares are split between two of the foregoing credit rating categories, the
lower rating will determine the prevailing rating.
There is no minimum Applicable Dividend Rate in respect of any Dividend
Period.
Allocation of Shares; Failure to Remarket at $50,000 Per Share. If, in a
Remarketing of the Preferred Shares, the Remarketing Agent is unable to remarket
by 3:00 p.m., New York City time, on the Remarketing Date all Preferred Shares
tendered to it in such Remarketing (which are subject to Tender and Dividend
Reset in such Remarketing) at a price of $50,000 per share, (i) each holder that
tendered shares for sale will sell a number of Preferred Shares on a pro rata
basis, to the extent practicable, or by lot, as determined by the Remarketing
Agent in its sole discretion, based on the number of orders to purchase
Preferred Shares in such Remarketing, and (ii) the next Dividend Period for
Preferred Shares will be a 28-day Dividend Period and the Applicable Dividend
Rate for such Dividend Period will be the Maximum Dividend Rate for a 28-day
Dividend Period.
If the allocation procedures described above would result in the sale of a
fraction of a Preferred Share, the Remarketing Agent will, in its sole
discretion, round up or down the number of Preferred Shares sold by each holder
on the applicable Remarketing Date so that each share sold by each holder shall
be a whole Preferred Share, and the total number of shares sold equals the total
number of shares purchased on such Remarketing Date.
Notification of Results; Settlement. By telephone at approximately 3:30
p.m., New York City time, on each Remarketing Date with respect to Preferred
Shares, the Remarketing Agent will advise each holder of tendered Preferred
Shares and each purchaser thereof (or the Agent Member thereof who in turn will
advise such holder or purchaser) (i) of the number of shares such holder or
purchaser is to sell or purchase and (ii) to give instructions to its Agent
Member to deliver such shares against payment therefor or to pay the purchase
price against delivery as appropriate. The Remarketing Agent will also advise
each holder or purchaser that is to continue to hold, or to purchase, shares
with a Dividend Period beginning on the Business Day following such Remarketing
Date of the Applicable Dividend Rate.
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<PAGE> 39
The transactions described above will be executed on the Settlement Date
through the Securities Depository in accordance with the Securities Depository's
procedures, and the accounts of the respective Agent Members of the Securities
Depository will be debited and credited and shares delivered by book entry as
necessary to effect the purchases and sales of Preferred Shares, in each case as
determined in the related Remarketing. Purchasers of Preferred Shares will make
payment through their Agent Members in same-day funds to the Securities
Depository against delivery by book entry of Preferred Shares through their
Agent members. The Securities Depository will make payment in accordance with
its procedures, which currently provide for payment in same-day funds. If the
certificates for Preferred Shares are not held by the Securities Depository or
its nominee, payment with respect to such shares will be made in same-day funds
to the Paying Agent against delivery of such certificates.
If any holder selling Preferred Shares in a Remarketing fails to deliver
such shares, the Agent Member of such selling holder and of any other person
that was to have purchased Preferred Shares in such Remarketing may deliver to
any such other person a number of whole Preferred Shares that is less than the
number of shares that otherwise was to be purchased by such person. In such
event, the number of Preferred Shares to be so delivered will be determined by
such Agent Member. Delivery of such lesser number of Preferred Shares will
constitute good delivery.
As long as the Securities Depository or Cede or any other nominee therefor
holds the certificate or certificates representing the Preferred Shares, no
share certificates will need to be delivered by any selling holder to reflect
any transfer of Preferred Shares effected in a Remarketing.
The Remarketing Agent may, in its sole discretion, modify the settlement
procedures set forth above with respect to any Remarketing of Preferred Shares
so long as any such modification does not adversely affect any holders of such
shares.
DESCRIPTION OF PREFERRED SHARES
The following is a brief description of the terms of the Preferred Shares.
This description does not purport to be complete and is subject to and qualified
in its entirety by reference to the Fund's Bylaws. A copy of the Bylaws has been
filed as an exhibit to the Registration Statement of which this Prospectus is a
part and may be inspected, and copies thereof may be obtained, as described
under "Additional Information". Capitalized terms used herein and not otherwise
defined shall have the meanings ascribed to them in the Glossary immediately
preceding the Appendices hereto, or in Appendix B.
GENERAL
The Agreement and Declaration of Trust currently authorizes the issuance of
an unlimited number of shares of beneficial interest in the Fund in such classes
and series as may be provided for in the Bylaws. The Agreement and Declaration
of Trust provides for the issuance of an unlimited number of Common Shares, and
currently the Bylaws provide for the issuance of up to 6,000 shares of Preferred
Shares. All Preferred Shares will have a liquidation preference of $50,000 per
share plus an amount equal to accumulated but unpaid dividends (whether or not
earned or declared). As of the date of this Prospectus, there were issued and
outstanding 4,007,092 Common Shares. See "Description of Common Shares" for
additional information as to the Common Shares.
The Preferred Shares, when issued and sold through this offering, will,
except as described below under "Description of Preferred Shares -- Certain
Provisions in the Agreement and Declaration of Trust", be fully paid and
nonassessable, will not be convertible into Common Shares or other capital
shares of the Fund and will have no preemptive rights. The Preferred Shares will
not be subject to any sinking fund but will be redeemable under the
circumstances described below under "Description of Preferred Shares --
Redemption".
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<PAGE> 40
DIVIDENDS
General. The Bylaws provide generally that holders of Preferred Shares
will be entitled to receive, when, as and if declared by the Fund, out of funds
legally available therefor, cumulative cash dividends, at the rate per annum set
forth on the cover page hereof for the Initial Dividend Period, and thereafter
at the Applicable Dividend Rate for the applicable Dividend Period, payable on
the respective dates set forth below and, except as described below, set by the
Remarketing Agent in accordance with the remarketing procedures described under
"Remarketing". See "Remarketing -- Remarketing Procedures -- Applicable Dividend
Rates" and Appendix A.
Initial Dividend Payment Dates and Dividend Period. The Initial Dividend
Period for the Preferred Shares will commence on the Date of Original Issue and
end on February 9, 1995. Dividends for the Initial Dividend Period for Preferred
Shares will be paid when, as and if declared, on March 1, 1994 (the "First
Initial Dividend Payment Date"), the first day of each calendar month thereafter
during the Initial Dividend Period through the first day of the last calendar
month in the Initial Dividend Period, subject to certain exceptions, and on
February 10, 1995 (the "Last Initial Dividend Payment Date", together with the
First Initial Dividend Payment Date and the other Dividend Payment Dates
referred to in this sentence, the "Initial Dividend Payment Dates"). Dividends
for each Dividend Period for Preferred Shares thereafter will be payable when,
as and if declared, on each Dividend Payment Date, subject to certain
exceptions.
Subsequent Dividend Periods for the Preferred Shares. After the Initial
Dividend Period for each Preferred Share, a Dividend Period therefor will
commence on each (but not the final) Dividend Payment Date for such share;
provided, however, that any Dividend Payment Date, other than the last Dividend
Payment Date during such Dividend Period, occurring after commencement of and
during a Special Dividend Period of more than 35 days will not give rise to a
new Dividend Period. Each subsequent Dividend Period for Preferred Shares will
comprise, beginning with and including the date on which it commences, 28
consecutive days or, in the event the Fund has designated such Dividend Period
as a Special Dividend Period, such number of consecutive days as specified by
the Fund; provided that such number of days to be specified shall be a multiple
of seven and not more than 364 in the case of a Short Term Dividend Period and
shall consist of at least one full year (but not more than five years) in the
case of a Long Term Dividend Period. Notwithstanding the foregoing, any
adjustment of the remarketing schedule or of the length of a Dividend Period as
provided herein shall cause an adjustment of the relevant Settlement Date, if
necessary, so that such Settlement Date will be the first day of the next
Dividend Period.
Except during a Non-Payment Period, by 12:00 noon, New York City time, on
the Remarketing Date at the end of the Initial Dividend Period applicable to a
Preferred Share, and by 12:00 noon on the Remarketing Date at the end of each
subsequent Dividend Period applicable to a Preferred Share, the holder of such
share may elect to tender such share or to hold such share for the next Dividend
Period (i.e., a 28-day Dividend Period or a Special Dividend Period, as the case
may be). If the holder of such Preferred Share elects to hold such share for the
next Dividend Period or fails to elect to tender or hold such share on such
Remarketing Date, such holder will continue to hold such share at the Applicable
Dividend Rate determined in such Remarketing for the next Dividend Period;
provided that, (i) if there is no Remarketing Agent, the Remarketing Agent is
not required to conduct a Remarketing or the Remarketing Agent is unable to
remarket in the Remarketing on such Remarketing Date all Preferred Shares
tendered to it at a price of $50,000 per share, then the next Dividend Period
for such share and for all other Preferred Shares will be a 28-day Dividend
Period and the Applicable Dividend Rate therefor will be the Maximum Dividend
Rate for a 28-day Dividend Period, and (ii) if such current Dividend Period is a
Special Dividend Period of more than 90 days or the succeeding Dividend Period
has been designated by the Trustees as a Special Dividend Period of more than 90
days, then a holder who fails to elect to tender or hold a Preferred Share will
be deemed to have elected to tender the shares. If a Preferred Share is tendered
(or deemed tendered) but not sold in a Remarketing, the holder of such share
will hold such share for a 28-day Dividend Period at the Maximum Dividend Rate
therefor.
Special Dividend Periods for Preferred Shares. With respect to each
Dividend Period, the Fund may, at its sole option and to the extent permitted by
law, by telephonic or written notice (a "Request for Special
40
<PAGE> 41
Dividend Period") to the Remarketing Agent, request that the next succeeding
Dividend Period for Preferred Shares will be a number of days (other than 28),
evenly divisible by seven, and not fewer than seven nor more than 364 in the
case of a Short Term Dividend Period or a period of not less than one whole year
and not greater than five years in the case of a Long Term Dividend Period,
specified in such notice, provided that the Fund may not give a Request for a
Special Dividend Period of greater than 28 days (and any such request shall be
null and void) unless the Fund has given written notice thereof to Moody's and
S&P and unless, with respect to the Preferred Shares, full cumulative dividends,
any amounts due with respect to redemptions, and any Additional Dividends
payable prior to such date have been paid in full and, for any Remarketing
occurring after the initial Remarketing, all shares tendered were remarketed in
the last occurring Remarketing. Such Request for Special Dividend Period, in the
case of a Short Term Dividend Period, shall be given on or prior to the fourth
Business Day but not more than seven Business Days prior to a Remarketing Date
for the Preferred Shares and, in the case of a Long Term Dividend Period, shall
be given on or prior to the 14th day but not more than 28 days prior to a
Remarketing Date for Preferred Shares. Upon receiving such a Request for Special
Dividend Period, the Remarketing Agent shall determine (i) whether given the
factors set forth below it is advisable that the Fund issue a Notice of Special
Dividend Period for Preferred Shares as contemplated by such Request for Special
Dividend Period, (ii) the Optional Redemption Price of the Preferred Shares
during such Special Dividend Period and, (iii) the Specific Redemption
Provisions and shall give the Fund written notice (a "Response") of its
determination by no later than the third Business Day prior to such Remarketing
Date. In making such determination, the Remarketing Agent will consider (i)
existing short-term and long-term market rates and indices of such short-term
and long-term rates, (ii) existing market supply and demand for short-term and
long-term securities, (iii) existing yield curves for short-term and long-term
securities comparable to the Preferred Shares, (iv) industry and financial
conditions which may affect the Preferred Shares, (v) the investment objective
of the Fund, and (vi) the Dividend Periods and dividend rates at which current
and potential beneficial holders of Preferred Shares would remain or become
beneficial holders. If the Remarketing Agent shall not give the Fund a Response
by such third Business Day or if the Response states that given the factors set
forth above it is not advisable that the Fund give a Notice of Special Dividend
Period for Preferred Shares, the Fund may not give a Notice of Special Dividend
Period in respect of such Request for Special Dividend Period. In the event the
Response indicates that it is advisable that the Fund give a Notice of Special
Dividend Period for the Preferred Shares, the Fund may by no later than the
second Business Day prior to such Remarketing Date give a notice (a "Notice of
Special Dividend Period") to the Remarketing Agent, the Paying Agent and to the
Securities Depository, which notice will specify (i) the duration of the Special
Dividend Period, (ii) the Optional Redemption Price as specified in the related
Response, and (iii) the Specific Redemption Provisions, if any, as specified in
the related Response. The Fund shall not give a Notice of Special Dividend
Period, or, if such Notice of Special Dividend Period shall have already been
given, shall give telephonic or written notice of its revocation (a "Notice of
Revocation") to the Remarketing Agent (in the case of clauses (x) and (y)) and
the Securities Depository (in the case of clauses (x), (y) and (z)) on or prior
to the Business Day prior to the relevant Remarketing Date if (x) either the
1940 Act Preferred Shares Asset Coverage is not satisfied or the Fund shall fail
to maintain S&P Eligible Assets and Moody's Eligible Assets each with an
aggregate Discounted Value at least equal to the Preferred Shares Basic
Maintenance Amount, in each case on each of the two Valuation Dates immediately
preceding the Business Day prior to the relevant Remarketing Date on an actual
basis and on a pro forma basis giving effect to the proposed Special Dividend
Period (using as a pro forma dividend rate with respect to such Special Dividend
Period the dividend rate which the Remarketing Agent shall advise the Fund is an
approximately equal rate for securities similar to the Preferred Shares with an
equal dividend period), provided that (unless Moody's advises the Fund to the
contrary), in calculating the aggregate Discounted Value of Moody's Eligible
Assets for this purpose, the Moody's Exposure Period shall be deemed to be one
week longer than the Moody's Exposure Period that would otherwise apply as of
the date of the Notice, (y) sufficient funds for the payment of dividends
payable on the immediately succeeding Dividend Payment Date for the Preferred
Shares have not been irrevocably deposited with the Paying Agent by the close of
business on the third Business Day preceding the Remarketing Date or (z) the
Remarketing Agent advises the Fund that after consideration of the factors
listed above it has concluded that it is advisable to give a Notice of
Revocation. If the Fund is prohibited from giving a Notice of Special Dividend
Period as a result of the factors enumerated in clause (x), (y), or (z) of the
preceding sentence or if the Fund gives a Notice of Revocation
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<PAGE> 42
with respect to a Notice of Special Dividend Period for Preferred Shares, the
next succeeding Dividend Period for Preferred Shares will be a 28-day Dividend
Period, provided that if the then-current Dividend Period is a Special Dividend
Period of less than 28 days, the next succeeding Dividend Period for such shares
will be the same length as the current Dividend Period.
In the event all Preferred Shares for which the Fund has given a Notice of
Special Dividend Period tendered are not remarketed or a Remarketing is not held
for any reason, the Fund may not again give a Notice of Special Dividend Period
(and any such attempted notice shall be null and void) until all Preferred
Shares tendered in any subsequent Remarketing with respect to a 28-day Dividend
Period have been remarketed.
Dividend Payment Dates. Dividends on each Preferred Share will accumulate
from its Date of Original Issue and will be payable, when, as and if declared by
the Trustees, on the applicable Dividend Payment Dates. The Dividend Payment
Dates will be: (i) with respect to the Initial Dividend Period for Preferred
Shares, the Initial Dividend Payment Dates, (ii) with respect to any 28-day
Dividend Period and any Short Term Dividend Period of 35 or fewer days, the day
next succeeding the last day thereof; and (iii) with respect to any Short Term
Dividend Period of more than 35 days and with respect to any Long Term Dividend
Period, the first Business Day of each calendar month during such Short Term
Dividend Period or Long Term Dividend Period and the day next succeeding the
last day of such period (each such date referred to in clause (i), (ii) or (iii)
being herein referred to as a "Normal Dividend Payment Date"), except that if
such Normal Dividend Payment Date is not a Business Day, then (i) the Dividend
Payment Date shall be the first Business Day next succeeding such Normal
Dividend Payment Date if such Normal Dividend Payment Date is a Monday, Tuesday,
Wednesday or Thursday, or (ii) the Dividend Payment Date shall be the first
Business Day next preceding such Normal Dividend Payment Date if such Normal
Dividend Payment Date is a Friday, and in each case the length of the current
Dividend Period will be adjusted accordingly. If, however, in the case of clause
(ii) in the preceding sentence the Securities Depository shall make available to
its participants and members in funds immediately available in New York City on
Dividend Payment Dates the amount due as dividends on such Dividend Payment
Dates (and the Securities Depository shall have so advised the Fund), and if the
Normal Dividend Payment Date is not a Business Day, then the Dividend Payment
Date shall be the next succeeding Business Day and the length of the current
Dividend Period will be adjusted accordingly. Although any particular Dividend
Payment Date may not occur on the originally scheduled date because of the
exceptions discussed above, the next succeeding Dividend Payment Date, subject
to such exceptions, will occur on the next following originally scheduled date.
If for any reason a Dividend Payment Date cannot be fixed as described above,
then the Trustees shall fix the Dividend Payment Date and the length of the
current Dividend Period will be adjusted accordingly, if necessary. The Initial
Dividend Period, 28-day Dividend Periods and Special Dividend Periods are
hereinafter sometimes referred to as "Dividend Periods." Each dividend payment
date determined as provided above is hereinafter referred to as a "Dividend
Payment Date."
Dividend Payments. So long as there is a Securities Depository with
respect to the Preferred Shares, each dividend on Preferred Shares will be paid
to the Securities Depository or its nominee as the record holder of all such
shares, and such payment shall for all purposes discharge the Fund's obligations
in respect of such payment. The Securities Depository is responsible for
crediting the accounts of the Agent Members of the beneficial owners of
Preferred Shares in accordance with the Securities Depository's procedures. Each
Agent Member will be responsible for holding or disbursing such payments to the
holders of the Preferred Shares for which it is acting in accordance with the
instructions of such holders. If, and as long as, neither the Securities
Depository nor its nominee is the record holder of a Preferred Share, dividends
thereon will be paid in same-day funds directly to the record holder thereof in
accordance with the instructions of such holder. Dividends on any share in
arrears with respect to any past Dividend Payment Date may be declared and paid
at any time, without reference to any regular Dividend Payment Date, to the
holders thereof as of a date not exceeding five Business Days preceding the date
of payment thereof as may be fixed by the Trustees. Any dividend payment made on
Preferred Shares will be first credited against the dividends accumulated but
unpaid (whether or not earned or declared) with respect to the earliest Dividend
Payment Date on which dividends were not paid. Holders of Preferred Shares will
not be entitled to any dividends, whether payable in cash, property or shares,
in excess of full cumulative dividends thereon. Except for the late charge
described under "Description of
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<PAGE> 43
Preferred Shares -- Dividends -- Non-Payment Period; Late Charge" below and
Additional Dividends described under "Description of Preferred Shares --
Dividends -- Additional Dividends" below, holders of Preferred Shares will not
be entitled to any additional amount in respect of any dividend payment on any
Preferred Shares which may be in arrears.
The amount of cash dividends per Preferred Share payable (if declared) on
each Dividend Payment Date for each 28-day Dividend Period and the Dividend
Payment Date or Dates for each Short Term Dividend Period shall be computed by
the Fund by multiplying the Applicable Dividend Rate for such Dividend Period by
a fraction, the numerator of which will be the number of days in such Dividend
Period such shares were outstanding from and including the Date of Original
Issue or the preceding Dividend Payment Date, as the case may be, to and
including the day preceding such Dividend Payment Date and the denominator of
which will be 365, multiplying the amount so obtained by $50,000, and rounding
the amount so obtained to the nearest cent. During the Initial Dividend Period
and any Long Term Dividend Period, the amount of dividends per share payable on
any Dividend Payment Date shall be computed by multiplying the Applicable
Dividend Rate by a fraction, the numerator of which shall be the number of days
from either the Date of Original Issue, with respect to the First Initial
Dividend Payment Date, or otherwise from the last Dividend Payment Date, and the
denominator of which is 360, multiplying the amount so obtained by $50,000, and
rounding the amount so obtained to the nearest cent.
In the event that the Remarketing Agent, the Paying Agent, the Securities
Depository, any Agent Member, and any beneficial owner fails for any reason to
perform any of its obligations in respect of a remarketing or otherwise, no
holder of record of, or of any beneficial interest in, any Preferred Shares
shall have any right in respect thereof against the Fund or any Trustee or
officer of the Fund, and the sole obligation of the Fund in respect of the
determination of the amount and the payment of any dividend shall be to pay to
the Paying Agent, for the benefit of the holders of record of the Preferred
Shares, dividends when due at the Applicable Dividend Rate notified to it from
time to time.
Non-Payment Period; Late Charge. A Non-Payment Period will commence on and
include the day on which the Fund fails to (i) declare, prior to 12:00 noon, New
York City time, on any Dividend Payment Date for a Preferred Share, for payment
on or (to the extent permitted below) within three Business Days after such
Dividend Payment Date to the person who held such share as of 12:00 noon, New
York City time, on the Business Day preceding such Dividend Payment Date, the
full amount of any dividend on such Preferred Share payable on such Dividend
Payment Date or (ii) deposit, irrevocably in trust, in same-day funds, with the
Paying Agent by 12:00 noon, New York City time, (A) on or (to the extent
permitted below) within three Business Days after any Dividend Payment Date for
a Preferred Share the full amount of any dividend on such share (whether or not
earned or declared) payable on such Dividend Payment Date or (B) on or (to the
extent permitted below) within three Business Days after any redemption date for
a Preferred Share called for redemption, the redemption price of $50,000 per
share plus the full amount of any dividends thereon (whether or not earned or
declared) accumulated but unpaid to such redemption date plus, in the case of an
optional redemption, the premium, if any, payable as the result of the
designation of a Premium Call Period. Such Non-Payment Period will end on and
include the Business Day on which, by 12:00 noon, New York City time, all unpaid
dividends and unpaid redemption prices shall have been so deposited or shall
have otherwise been made available to the applicable holders in same-day funds;
provided that a Non-Payment Period will not end during the first seven days
thereof unless the Fund shall have given at least three days' written notice to
the Paying Agent, the Remarketing Agent and the Securities Depository and
thereafter will not end unless the Fund shall have given at least fourteen days'
written notice to the Paying Agent, the Remarketing Agent, the Securities
Depository and all holders of shares. The Applicable Dividend Rate for each
Dividend Period for Preferred Shares, commencing during a Non-Payment Period,
will be equal to the Non-Payment Period Rate and any Preferred Shares for which
a Special Dividend Period would otherwise have commenced on the first day of or
during a Non-Payment Period will have a 28-day Dividend Period. The "Non-Payment
Period Rate", initially, will be 250% of the applicable Reference Rate (or 300%
of such rate if the Fund has provided notification to the Remarketing Agent
prior to the Remarketing Date establishing the Applicable Dividend Rate for any
dividend that net capital gain or other taxable income will be included in such
dividend on Preferred Shares). The initial Non-Payment Period Rate may be
changed from time to time by the Fund without shareholder approval, but only in
the event the Fund receives written confirmation from Moody's and S&P that any
such change would not impair the ratings then assigned by Moody's and S&P to
Preferred
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<PAGE> 44
Shares. Any dividend on Preferred Shares due on any Dividend Payment Date for
such shares (if, prior to 12:00 noon, New York City time, on such Dividend
Payment Date, the Fund has declared such dividend payable on or within three
Business Days after such Dividend Payment Date to the persons who held such
shares as of 12:00 noon, New York City time, on the Business Day preceding such
Dividend Payment Date) or redemption price with respect to such shares not paid
to such persons when due may (if such non-payment occurs because the Fund is
prevented from doing so by the Bylaws or applicable law) be paid pro rata to
such persons in the same form of funds by 12:00 noon, New York City time, on any
of the first three Business Days after such Dividend Payment Date or due date,
as the case may be, and will incur a late charge to be paid therewith to such
persons and calculated for such period of non-payment at the Non-Payment Period
Rate applied to the amount of such non-payment based on the actual number of
days comprising such period divided by 365; such late charge will be taxable as
interest. If the Fund fails to pay a dividend on a Dividend Payment Date or to
redeem any Preferred Shares on the date set for such redemption (otherwise than
because it is prevented from doing so by the Bylaws or by applicable law), the
preceding sentence shall not apply and the Applicable Dividend Rate for the
Dividend Period commencing during such Non-Payment Period resulting from such
failure shall be the Non-Payment Period Rate. During a Non-Call Period,
Preferred Shares subject to such Non-Call Period will not be subject to
redemption at the option of the Fund, but may be subject to mandatory redemption
as provided below. See "Description of Preferred Shares -- Redemption" below.
Restrictions on Dividends and Other Payments. Under the 1940 Act, the Fund
may not declare dividends or make other distributions on the Common Shares or
purchase any such shares if, at the time of the declaration, distribution or
purchase, as applicable (and after giving effect thereto), asset coverage (as
defined in the 1940 Act) with respect to the outstanding Preferred Shares would
be less than 200% (or such other percentage as may in the future be required by
law). Based on the composition of the Fund's portfolio at December 31, 1993,
asset coverage with respect to Preferred Shares would have been approximately
672% after issuance of the Preferred Shares offered hereby.
In addition, for so long as any Preferred Shares are outstanding, the Fund
will not declare, pay or set apart for payment any dividend or other
distribution (other than a dividend or distribution paid in shares of, or
options, warrants or rights to subscribe for or purchase, Common Shares or other
shares, if any, ranking junior to the Preferred Shares as to dividends and upon
liquidation) in respect of Common Shares or any other shares of the Fund ranking
junior to or on a parity with the Preferred Shares as to dividends or upon
liquidation, or call for redemption, redeem, purchase or otherwise acquire for
consideration any Common Shares or any other such junior shares or parity shares
(except by conversion into or exchange for shares of the Fund ranking junior to
the Preferred Shares as to dividends and upon liquidation), unless (1) full
cumulative dividends on Preferred Shares through their most recent Dividend
Payment Date shall have been paid or shall have been declared and sufficient
funds for the payment thereof deposited with the Paying Agent, (2) the Fund has
redeemed the full number of Preferred Shares required to be redeemed by any
provision for mandatory redemption contained in the Bylaws, (3) immediately
after such transaction the aggregate Discounted Value of Moody's Eligible Assets
and S&P Eligible Assets would be at least equal to the Preferred Shares Basic
Maintenance Amount and (4) the Fund meets the requirements imposed by the 1940
Act. See "Investment Objective and Policies -- Asset Maintenance", "Description
of Preferred Shares -- Redemption" and Appendix B.
Under the Code the Fund must, among other things, distribute each year at
least 90% of the sum of its investment company taxable income and net tax-exempt
income in order to maintain its qualification for tax treatment as a regulated
investment company. The foregoing limitations on dividends, distributions and
purchases may under certain circumstances impair the Fund's ability to maintain
such qualification. See "Taxation".
Upon any failure by the Fund to pay dividends on the Preferred Shares for
two years or more, the holders of the Preferred Shares will acquire certain
additional voting rights. See "Description of Preferred Shares -- Voting Rights"
below. Such rights shall be the exclusive remedy of the holders of Preferred
Shares upon any failure to pay dividends on shares of the Fund.
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<PAGE> 45
Additional Dividends. In the event of a redemption of all or a portion of
the outstanding Preferred Shares or the liquidation of the Fund, the Fund may,
after the close of its taxable year, be required, in order to comply with the
published position of the Internal Revenue Service described earlier in this
Prospectus concerning the allocation of various types of income between a fund's
classes and series of shares, to characterize all or a portion of a dividend
paid to holders of Preferred Shares during such taxable year as net capital gain
or other income subject to regular Federal income tax, without having either
given advance notice of the inclusion of such income in such dividend prior to
the setting of the Applicable Dividend Rate for such dividend or included an
additional amount in the dividend to offset the tax effect of the inclusion
therein of such taxable income. Accordingly, if the Fund characterizes
retroactively all or a portion of a dividend already paid on Preferred Shares as
consisting of net capital gain or other income subject to regular Federal income
tax solely because (i) the Fund has redeemed all or a portion of the outstanding
Preferred Shares or has liquidated and (ii) the Fund, in its judgment, believes
it is required, in order to comply with the published position of the Internal
Revenue Service described above, to allocate such taxable income to the
Preferred Shares (the amount so characterized referred to herein as a
"Retroactive Taxable Allocation"), the Fund will, within 90 days after the end
of such taxable year, provide notice of the Retroactive Taxable Allocation made
with respect to the dividend to the Paying Agent and to each holder who received
such dividend (initially Cede as nominee of the Securities Depository) at such
holder's address as the same appears or last appeared on the share books of the
Fund. The Fund will, within 30 days after such notice is given to the Paying
Agent, pay to the Paying Agent (who will then distribute to such holders), out
of funds legally available therefor, an amount equal to the aggregate of the
Additional Dividends (as defined below) payable to holders of Preferred Shares
in respect of such dividend. See "Taxation".
An "Additional Dividend" in respect of any dividend means payment to a
present or former holder of a Preferred Share of an amount which, giving effect
to the Retroactive Taxable Allocation made with respect to such dividend, would
cause such holder's after-tax return (taking into account both the dividend and
the Additional Dividend and assuming such holder is taxable at the Gross-Up Tax
Rate) to be equal to the after-tax return which the holder would have realized
if such retroactive allocation of taxable income had not been made. Such
Additional Dividend shall be calculated (i) without consideration being given to
the time value of money, (ii) assuming that no holder of Preferred Shares is
subject to the Federal alternative minimum tax with respect to dividends
received from the Fund, and (iii) assuming that the holder of the Preferred
Share in respect of which a Retroactive Taxable Allocation was made is taxable
at the Gross-Up Tax Rate. An Additional Dividend will not include any amount to
compensate for the fact that either the Additional Dividend or the Retroactive
Taxable Allocation may be subject to state and local taxes. (For a description
of the Gross-Up Tax Rate, see "Remarketing -- Remarketing Schedule; Advance
Notice of Allocation of Taxable Income; Inclusion of Taxable Income in
Dividend.") Except as provided in this "Description of Preferred Shares --
Dividends -- Additional Dividends," the Fund will not distribute any additional
amounts with respect to dividends previously paid to holders of Preferred
Shares. See "Taxation".
Special Dividends. The Fund may declare "special dividends" on Preferred
Shares in order to comply with any distribution requirements or the Code,
provided that the declaration of a special dividend shall not cause the Fund to
fail to maintain the Preferred Shares Basic Maintenance Amount or the 1940 Act
Preferred Shares Asset Coverage. See "Taxation".
REDEMPTION
Optional Redemption. The Fund may at its option after giving the requisite
Notice of Redemption, redeem Preferred Shares, in whole or in part, on the next
succeeding scheduled Dividend Payment Date applicable to those Preferred Shares
called for redemption, out of funds legally available therefor, at a redemption
price (the "Optional Redemption Price") of $50,000 per share plus an amount
equal to dividends thereon accumulated but unpaid to the date fixed for
redemption plus the premium, if any, resulting from the designation of a Premium
Call Period; provided that no Preferred Share may be redeemed at the option of
the Fund during (A) the Initial Dividend Period with respect to such share or
(B) a Non-Call Period to which such share is subject; provided further that
optional redemptions pursuant to this paragraph shall not cause the Fund to fail
to maintain the Preferred Shares Basic Maintenance Amount or the 1940 Act
Preferred Shares
45
<PAGE> 46
Asset Coverage. In addition, holders of Preferred Shares may be entitled to
receive Additional Dividends in the event of the redemption of such Preferred
Shares to the extent provided above under "Description of Preferred Shares --
Dividends -- Additional Dividends". For so long as S&P rates the Preferred
Shares, the Fund may not give a Notice of Redemption relating to an optional
redemption as described in this paragraph unless, at the time of giving such
Notice of Redemption, the Fund has available Deposit Securities with maturity or
tender dates not later than the day preceding the applicable redemption date and
having a Discounted Value not less than the amount due by reason of the
redemption of Preferred Shares on such redemption date.
Mandatory Redemption. The Fund will be required to redeem, at a redemption
price (the "Mandatory Redemption Price") equal to $50,000 per share plus an
amount equal to accumulated but unpaid dividends (whether or not earned or
declared) to the date fixed by the Trustees for redemption, certain of the
Preferred Shares to the extent permitted under the 1940 Act and Massachusetts
law, if the Fund fails to maintain the Preferred Shares Basic Maintenance Amount
or the 1940 Act Preferred Shares Asset Coverage and such failure is not cured on
or before the Preferred Shares Basic Maintenance Cure Date or the 1940 Act Cure
Date (herein referred to as a "Cure Date"), as the case may be. In addition,
holders of Preferred Shares may be entitled to receive Additional Dividends in
the event of the redemption of such Preferred Shares to the extent provided
above under "Description of Preferred Shares -- Dividends -- Additional
Dividends". The number of Preferred Shares to be redeemed will be equal to the
lesser of (a) the minimum number of Preferred Shares the redemption of which, if
deemed to have occurred immediately prior to the opening of business on such
Cure Date, would, together with all other shares of beneficial interest of the
Fund having preference rights subject to redemption or retirement, result in the
satisfaction of the Preferred Shares Basic Maintenance Amount or the 1940 Act
Preferred Shares Asset Coverage, as the case may be, on such Cure Date (provided
that, if there is no such minimum number of shares the redemption of which would
have such result, all Preferred Shares then outstanding will be redeemed), and
(b) the maximum number of Preferred Shares, together with all other shares of
beneficial interest of the Fund having preference rights subject to redemption
and retirement, that can be redeemed out of funds expected to be legally
available therefor.
The Fund is required to effect such a Mandatory Redemption not later than
35 days after such Cure Date, except that if the Fund does not have funds
legally available for the redemption of all of the required number of Preferred
Shares which are subject to Mandatory Redemption or the Fund otherwise is unable
to effect such redemption on or prior to 35 days after such Cure Date, the Fund
will redeem those Preferred Shares which it was unable to redeem on the earliest
practicable date on which it is able to effect such redemption.
Any Preferred Share will be subject to Mandatory Redemption regardless of
whether such share is subject to a Non-Call Period, provided that Preferred
Shares subject to a Non-Call Period will only be subject to redemption to the
extent that other preferred shares (not subject to a Non-Call Period) are not
available to satisfy the number of shares required to be redeemed. In such
event, such shares subject to a Non-Call Period will be selected for redemption
in an ascending order of outstanding Non-Call Period (with shares with the
lowest number of days remaining in the Non-Call Period to be called first) and
by lot in the event of shares having equal outstanding Non-Call Periods.
Allocation. If fewer than all the outstanding Preferred Shares are to be
redeemed, the number of Preferred Shares to be so redeemed will be a whole
number of shares and will be determined by the Trustees (subject to the
provisions described above under "Description of Preferred Shares -- Redemption
- -- Mandatory Redemption"), provided that (i) no such Preferred Share will be
subject to optional redemption on any Dividend Payment Date during a Non-Call
Period to which it is subject and (ii) Preferred Shares subject to a Non-Call
Period will be subject to Mandatory Redemption only on the basis described above
under "Description of Preferred Shares -- Redemption -- Mandatory Redemption".
Unless certificates representing Preferred Shares are held by persons other than
the Securities Depository or its nominee, the Securities Depository, upon
receipt of such Notice of Redemption, will determine by lot (or otherwise in
accordance with procedures in effect at that time) the number of Preferred
Shares to be redeemed from the account of each Agent Member (which may include
an Agent Member, including the Remarketing Agent, holding shares for its own
account) and notify the Paying Agent of such determination. The Paying Agent,
46
<PAGE> 47
upon receipt of such notice, will in turn determine by lot the number of shares
to be redeemed from the accounts of the holders of the shares whose Agent
Members have been selected by the Securities Depository. In doing so, the Paying
Agent may determine that shares will be redeemed from the accounts of some
holders, which may include the Remarketing Agent, without shares being redeemed
from the accounts of other holders. Notwithstanding the foregoing, if any
certificates for Preferred Shares are not held by the Securities Depository or
its nominee, the Preferred Shares to be redeemed will be selected by the Paying
Agent by lot.
Notice of Redemption. Any Notice of Redemption with respect to Preferred
Shares will be given by the Fund via telephone to the Paying Agent, the
Securities Depository (and any other registered holder of such shares) and the
Remarketing Agent not later than 1:00 p.m., New York City time (and later
confirmed in writing), on a day not less than 20 nor more than 30 days, or such
shorter period as may be provided for under applicable law, prior to the
earliest date upon which any such redemption may occur and, in the case of a
Mandatory Redemption, not less than 20 nor more than 30 days prior to the
redemption date established by the Trustees and specified in such notice. In the
case of a partial redemption, the Paying Agent will use its reasonable efforts
to provide telephonic notice to each beneficial holder (as shown on the records
of such ownership maintained by it) of Preferred Shares called for redemption
not later than the close of business on the Business Day on which the Paying
Agent determines the shares to be redeemed (as described above) (or, during a
Non-Payment Period with respect to such shares, not later than the close of
business on the Business Day immediately following the day on which the Paying
Agent receives Notice of Redemption from the Fund). Such telephonic notice will
be confirmed promptly in writing to each such beneficial holder of Preferred
Shares called for redemption, the Remarketing Agent and the Securities
Depository not later than the close of business on the Business Day immediately
following the day on which the Paying Agent determines the shares to be
redeemed. In the case of a redemption in whole, the Paying Agent will use its
reasonable efforts to provide telephonic notice to each holder of Preferred
Shares called for redemption not later than the close of business on the
Business Day immediately following the day on which the Paying Agent receives a
Notice of Redemption from the Fund. Such telephonic notice will be confirmed
promptly in writing to each holder of Preferred Shares called for redemption,
the Remarketing Agent and the Securities Depository not later than the close of
business on the second Business Day following the day on which the Paying Agent
receives notice of redemption.
Every Notice of Redemption and other redemption notice with respect to the
Preferred Shares will state: (a) the redemption date, (b) the number of
Preferred Shares to be redeemed, (c) the redemption price, (d) that dividends on
the Preferred Shares to be redeemed will cease to accumulate as of such
redemption date and (e) the provision of the Agreement and Declaration of Trust
or the Bylaws pursuant to which such shares are being redeemed. No defect in the
Notice of Redemption or other redemption notice or in the transmittal or the
mailing thereof will affect the validity of the redemption proceedings, except
as required by applicable law. The Paying Agent will use its reasonable efforts
to cause the publication of a redemption notice in an Authorized Newspaper
within two Business Days of the date of the Notice of Redemption, but failure so
to publish such notification will not affect the validity or effectiveness of
any such redemption proceedings.
Other Redemption Procedures. To the extent that any redemption for which
Notice of Redemption has been given is not made by reason of the absence of
legally available funds therefor, such redemption will be made as soon as
practicable to the extent such funds become available. Failure to redeem
Preferred Shares will be deemed to exist at any time after the date specified
for redemption in a Notice of Redemption when the Fund shall have failed, for
any reason whatsoever, to deposit with the Paying Agent funds with respect to
any shares for which such Notice of Redemption has been given.
Upon the deposit of funds sufficient to redeem Preferred Shares with the
Paying Agent and the giving of Notice of Redemption, all rights of the holders
of the shares so called for redemption will cease and terminate, except the
right of the holders thereof to receive the Optional Redemption Price or
Mandatory Redemption Price, as the case may be, but without any interest or
other additional amount (except for Additional Dividends described above under
"Description of Preferred Shares -- Dividends -- Additional Dividends"), and
such shares will no longer be deemed outstanding for any purpose. The Fund will
be entitled to receive from the Paying Agent, promptly after the date fixed for
redemption, any cash deposited with the Paying Agent in excess of (i) the
aggregate redemption price of the Preferred Shares called for redemption on such
47
<PAGE> 48
date and (ii) all other amounts to which holders of Preferred Shares called for
redemption may be entitled. The Fund will be entitled to receive, from time to
time after the date fixed for redemption, any interest on the funds so
deposited. Any funds that are unclaimed at the end of 90 days from such
redemption date will, to the extent permitted by law, be repaid to the Fund,
after which time the holders of Preferred Shares so called for redemption will
look only to the Fund for payment of the redemption price and all other amounts
to which they may be entitled. If any such unclaimed funds are repaid to the
Fund, the Fund shall invest such unclaimed funds in Deposit Securities with a
maturity of no more than one Business Day.
Except as described above with respect to redemptions, nothing contained in
the Bylaws limits any legal right of the Fund or any affiliate of the Fund to
purchase or otherwise acquire any Preferred Shares at any price.
The Fund has the right in certain circumstances to arrange for others to
purchase from the holders thereof Preferred Shares which are to be redeemed as
described above.
The Remarketing Agent may, in its sole discretion, modify the procedures
concerning notification of redemption described above with respect to Preferred
Shares so long as any such modification does not adversely affect the holders of
the Preferred Shares or materially alter the obligation of the Paying Agent
without obtaining its consent and so long as the Fund receives written
confirmation from S&P that any such modifications would not impair the ratings
then assigned by S&P to the Preferred Shares.
LIQUIDATION/BANKRUPTCY
Upon a liquidation, dissolution or winding up of the affairs of the Fund,
whether voluntary or involuntary, the holders of Preferred Shares then
outstanding will be entitled, whether from capital or surplus, before any assets
of the Fund will be distributed among or paid over to the holders of the Common
Shares or any other class or series of shares of the Fund ranking junior to the
Preferred Shares as to liquidation payments, to be paid an amount equal to the
liquidation preference with respect to such shares. The liquidation preference
for the Preferred Shares is $50,000 per share plus an amount equal to all
dividends thereon (whether or not earned or declared) accumulated but unpaid to
but excluding the date of final distribution in same-day funds. After any such
payment, the holders of Preferred Shares will not be entitled to any further
participation in any distribution of assets of the Fund, except to the extent
that they may be entitled to Additional Dividends to the extent provided above
in "Description of Preferred Shares -- Dividends -- Additional Dividends." If,
upon any such liquidation, dissolution or winding up of the Fund, the assets of
the Fund shall be insufficient to make such full payment to the holders of
Preferred Shares and to the holders of any shares of beneficial interest of the
Fund having preference rights ranking as to liquidation, dissolution or winding
up on a parity with the Preferred Shares, then such assets will be distributed
among the holders of Preferred Shares and such parity holders ratably in
accordance with the respective amounts which would by payable on such Preferred
Shares and any other such preferred shares if all amounts thereof were paid in
full.
Neither the consolidation nor the merger of the Fund with or into any
entity or entities nor a reorganization of the Fund alone nor the sale, lease or
transfer by the Fund of all or substantially all of its assets shall be deemed
to be a dissolution or liquidation of the Fund.
The Fund has no intention to file a voluntary petition in bankruptcy so
long as the value of its assets is, and is reasonably foreseen as being, greater
than its liabilities.
VOTING RIGHTS
Except as indicated below and as set forth below under "Description of
Preferred Shares -- Certain Provisions in the Agreement and Declaration of
Trust" or except as expressly required by applicable law or expressly set forth
in the Agreement and Declaration of Trust or Bylaws, each holder of Preferred
Shares and each holder of Common Shares shall be entitled to one vote for each
share held on each matter submitted to a vote of shareholders of the Trust, and
the holders of outstanding Preferred Shares and of Common Shares shall vote
together as a single class.
48
<PAGE> 49
Holders of Preferred Shares (along with the holders of any other preferred
shares of the Fund), voting as a class, will be entitled to elect two of the
Fund's Trustees and the remaining Trustees will be elected by holders of the
Common Shares and the Preferred Shares (along with the holders of any other
preferred shares of the Fund) voting together as a single class. If at any time
dividends on the Fund's Preferred Shares shall be unpaid in an amount equal to
two full years' dividends thereon or if at any time holders of any preferred
shares of the Fund other than the Preferred Shares are entitled to elect a
majority of the Trustees of the Fund, then the number of Trustees shall
automatically be increased by the smallest number that, when added to the two
Trustees elected exclusively by the holders of Preferred Shares as described
above, would constitute a majority of the Trustees as so increased and at a
special meeting of shareholders which will be called and held as soon as
practicable, and at all subsequent meetings at which Trustees are to be elected,
the holders of Preferred Shares (along with the holders of any other preferred
shares of the Fund), voting as a separate class, will be entitled to elect the
smallest number of additional Trustees that, together with the two Trustees
which such holders will be in any event entitled to elect, constitutes a
majority of the total number of Trustees of the Fund as so increased. The terms
of office of the persons who are Trustees at the time of that election will
continue. If the Fund thereafter shall pay, or declare and set apart for
payment, in full all dividends payable on all outstanding Preferred Shares for
all past Dividend Periods, the voting rights stated in the preceding sentence
shall cease (subject always to revesting in the event of the further occurrence
of the circumstances described above), and the terms of office of all the
additional Trustees elected by the holders of Preferred Shares (but not of the
Trustees with respect to whose election the holders of Common Shares were
entitled to vote or the two Trustees the holders of Preferred Shares have the
right to elect in any event) will terminate automatically.
The affirmative vote of the holders of a majority of the outstanding
Preferred Shares, voting separately as a class, would be required to amend,
alter or repeal any of the preferences, rights or powers of the Preferred Shares
so as to affect materially and adversely such preferences, rights or powers, or
increase or decrease the number of Preferred Shares authorized to be issued.
Unless a higher percentage is provided for as described below under "Description
of Preferred Shares -- Certain Provisions in the Agreement and Declaration of
Trust", the affirmative vote of the holders of a majority of the outstanding
Preferred Shares, voting as a class, will be required to approve any plan of
reorganization adversely affecting such shares or any action requiring a vote of
security holders under Section 18(a) of the 1940 Act including, among other
things, changes in the investment restrictions described under "Investment
Restrictions".
The foregoing voting provisions will not apply if, at or prior to the time
when the act with respect to which such vote would otherwise be required shall
be effected, all outstanding Preferred Shares shall have been redeemed or shall
no longer be deemed to be outstanding.
CERTAIN PROVISIONS IN THE AGREEMENT AND DECLARATION OF TRUST
The Agreement and Declaration of Trust and Bylaws include provisions that
could have the effect of limiting the ability of other entities or persons to
acquire control of the Fund, or to cause it to engage in certain transactions or
to modify its structure. The affirmative vote of at least two-thirds of the
outstanding Common Shares and Preferred Shares, each voting separately as a
class, is required to authorize any of the following actions: (1) merger or
consolidation of the Fund, (2) sale of all or substantially all of the assets of
the Fund, (3) liquidation or dissolution of the Fund, (4) conversion of the Fund
to an open-end investment company, or (5) amendment of the Agreement and
Declaration of Trust to reduce the two-thirds vote required to authorize the
actions in (1) through (5), unless with respect to any of the foregoing such
action has been authorized by the affirmative vote of two-thirds of the total
number of Trustees then in office, in which case the affirmative vote of a
majority of the outstanding shares of each class is required.
The Trustees have determined that the two-thirds voting requirements
described above, which are greater than the minimum requirements under the 1940
Act, are in the best interests of the Fund and its shareholders generally.
Under Massachusetts law, shareholders of the Fund could, under certain
circumstances, be held personally liable for the obligations of the Fund.
However, the Agreement and Declaration of Trust disclaims shareholder liability
for acts or obligations of the Fund and requires that notice of such disclaimer
be given in
49
<PAGE> 50
each agreement, obligation or instrument entered into or executed by the Fund or
the Trustees. The Agreement and Declaration of Trust provides for
indemnification out of Fund property for all loss and expense of any shareholder
held personally liable for the obligations of the Fund. Thus, the risk of a
shareholder's incurring financial loss on account of shareholder liability is
limited to circumstances in which the Fund would be unable to meet its
obligations. The likelihood of such circumstances is remote.
REPURCHASE OF SHARES; CONVERSION TO OPEN-END STATUS
Shares of closed-end investment companies often trade at a discount to
their net asset values, and the Fund's Common Shares may likewise trade at a
discount to their net asset value. The market price of the Fund's Common Shares
will be determined by such factors as relative demand for and supply of such
Common Shares in the market, the Fund's net asset value, general market and
economic conditions, and other factors beyond the control of the Fund. Although
the Fund's Common shareholders will not have the right to redeem their Shares,
the Fund may take action to repurchase Common Shares in the open market or make
tender or repurchase offers for its Common Shares at their net asset value. This
may have the effect of reducing any market discount from net asset value. The
Fund's ability to repurchase or to tender for its Common Shares may be limited
by asset coverage requirements and other restrictions in respect of the
Preferred Shares outstanding at the time. The Fund may, by vote of its Common
shareholders and holders of Preferred Shares (each voting as a separate class),
be converted to an open-end investment company, which would make the Fund's
Common Shares redeemable upon demand of shareholders at the Common Shares' net
asset value. Conversion to an open-end company would require the redemption of
the Preferred Shares. Certain provisions of the Fund's Agreement and Declaration
of Trust discussed above may have the effect of depriving Common shareholders of
an opportunity to sell their Shares at a premium over prevailing market prices
and may have the effect of inhibiting the Fund's conversion to open-end status.
The Fund has no present intention of taking any such action. There is no
assurance that if action is undertaken to repurchase or tender for Common
Shares, that such action will result in the Common Shares' trading at a price
which approximates their net asset value. Although Common Share repurchases and
tenders could have a favorable effect on the market price of the Fund's Common
Shares, it should be recognized that the acquisition of Common Shares by the
Fund will decrease the total assets of the Fund and, therefore, have the effect
of increasing the Fund's expense ratio. Any Common Share repurchases or tender
offers will be made in accordance with requirements of the Securities Exchange
Act of 1934, as amended, and the 1940 Act. If the Fund were to make a tender or
repurchase offer for its Common Shares, Shareholders would receive any notice
thereof required by applicable law, including any required information
describing the offer and the means by which Shareholders might submit their
Common Shares. If the Fund converted to an open-end company, it could be
required to liquidate its portfolio investments to meet requests for redemption,
and its Common Shares would no longer be listed on the American Stock Exchange.
HOLDERS OF RECORD; HOLDERS OF BENEFICIAL INTEREST
The Fund shall have no obligation, including without limitation any
obligation to provide notice or to make any payment (in respect of any dividend
or otherwise), to any person (including without limitation any holder of any
beneficial interest in Preferred Shares, whether or not such interest is
reflected on the share transfer books of the Paying Agent) other than the
holders of record of the Preferred Shares shown on the share records of the
Paying Agent from time to time. The record books of the Fund as kept by the
Paying Agent shall be conclusive as to who is the holder of record of any
Preferred Share at any time and as to the number of Preferred Shares held from
time to time by any such holder. No Remarketing Agent, Paying Agent, Securities
Depository, or Agent Member will have any obligation to any person having any
interest in any Preferred Shares other than the holder of record and the
beneficial owner thereof as shown from time to time on the share transfer books
kept by the Paying Agent. The Paying Agent shall have no obligation to record
any transfer of record or beneficial ownership in any share unless and until it
shall have received proper notice and evidence of such transfer and the right of
the transferee in accordance with the Paying Agent's procedures in effect from
time to time.
50
<PAGE> 51
SPECIAL CONSIDERATIONS RELATING TO PREFERRED SHARES
The 1940 Act Preferred Shares Asset Coverage requirement and the rating
agency asset maintenance guidelines require that the Fund maintain certain asset
levels with respect to the Preferred Shares. See "Investment Objective and
Policies -- Asset Maintenance" and Appendix B. In the event that the Fund's
assets fall below these levels, the Fund may be required to redeem some or all
of the then outstanding Preferred Shares. See "Description of Preferred Shares
- -- Redemption".
The credit rating of the Preferred Shares could be reduced while an
investor holds the Preferred Shares. A decrease in the rating of the Preferred
Shares may reflect a reduction in the Fund's ability to pay dividends and/or the
redemption price and liquidation value in respect of the Preferred Shares in
accordance with the terms of the Preferred Shares.
The actual Applicable Dividend Rate for any dividend period after the
Initial Dividend Period for Preferred Shares may be greater than or less than
the rate indicated in the non-binding indications of the Applicable Dividend
Rate furnished to holders of Preferred Shares (but, except during a Non-Payment
Period, not greater than the applicable Maximum Dividend Rate) and will not be
determined until after a holder is required to elect to hold or tender its
Preferred Shares.
There can be no assurance that the Remarketing Agent will be able to
remarket all Preferred Shares tendered in a Remarketing. If any Preferred Shares
tendered in a Remarketing are not remarketed, a holder thereof may be required
to hold some or all of its shares at least until the end of the next Dividend
Period therefor (or longer if Remarketings continue to fail) or to sell its
shares outside a Remarketing. In such case, the remarketing procedures may
require an allocation of Preferred Shares on a pro rata basis, to the extent
practicable, or by lot, as determined by the Remarketing Agent in its sole
discretion, which may result in a holder's selling a number of Preferred Shares
that is less than the number of Preferred Shares specified in such holder's
tender order. Thus, under certain circumstances, Preferred Shares may be
illiquid investments. See "Remarketing -- Remarketing Procedures -- Allocation
of Shares; Failure to Remarket at $50,000 Per Share," "Remarketing --
Restrictions on Transfer" and "Remarketing -- The Remarketing Agent".
Neither the Remarketing Agent nor the Fund is obligated to purchase
Preferred Shares in a Remarketing or otherwise, nor is the Fund required to
redeem Preferred Shares in the event of failed Remarketings.
The Remarketing Agent has advised the Fund that it currently intends to
maintain a secondary trading market in the Preferred Shares outside of
Remarketings; however, it has no obligation to do so and there can be no
assurance that a secondary market for the Preferred Shares will develop or, if
it does develop, that it will provide liquidity of investment. The Preferred
Shares will not be registered on any stock exchange or on the National
Association of Securities Dealers Automated Quotation system.
DESCRIPTION OF COMMON SHARES
The Trustees of the Fund have authority to issue an unlimited number of
Common Shares. The Common Shares outstanding are fully paid and nonassessable by
the Fund, except as set forth under "Description of Preferred Shares -- Certain
Provisions in the Agreement and Declaration of Trust." The Fund's Common Shares
have no preemptive, conversion, exchange or redemption rights. Each Common Share
has one vote, with fractional shares voting proportionately. Common Shares are
freely transferable.
The Fund has no present intention of offering additional Common Shares in
addition to the shares already issued. Any offerings of its Common Shares, if
made, will require approval of the Fund's Trustees. Any additional offering will
not be sold at a price per Common Share below the then current net asset value
per share (exclusive of underwriting discounts and commissions) except in
connection with an offering to existing Common shareholders or with the consent
of a majority of the Fund's outstanding Common Shares.
The Common Shares have traded on the American Stock Exchange (the
"Exchange") since November 19, 1993. For the period November 19, 1993
(commencement of trading) through January 21, 1994, the average weekly trading
volume of the Common Shares was 50,633 shares.
51
<PAGE> 52
At January 21, 1994, the net asset value per Common Share was $14.35 and
the closing price per share of Common Shares on the Exchange was $13.50.
<TABLE>
The following table shows the amount of (i) shares authorized, (ii) shares
held by the Fund for its own account and (iii) shares outstanding for each class
of authorized securities of the Fund as of the date of this Prospectus.
<CAPTION>
AMOUNT
OUTSTANDING
AMOUNT HELD (EXCLUSIVE OF
BY FUND FOR AMOUNT HELD
AMOUNT ITS OWN BY FUND FOR
TITLE OF CLASS AUTHORIZED ACCOUNT ITS OWN ACCOUNT)
-------------- ----------- ----------- ----------------
<S> <C> <C> <C>
Common Shares..................... Unlimited -0- 4,007,092
Preferred Shares.................. 6,000 -0- -0-
</TABLE>
TAXATION
The following discussion is based on the advice of Ropes & Gray and
reflects provisions of the Internal Revenue Code of 1986, as amended (the
"Code"), existing Treasury regulations, rulings published by the Internal
Revenue Service, and other applicable authority as of the date of this
Prospectus. These authorities are subject to change by legislative or
administrative action. The following discussion is only a summary of some of the
important federal tax considerations generally applicable to investments in the
Fund. There may be other federal tax considerations applicable to particular
investors. In addition, income earned through an investment in the Fund may be
subject to state and local taxes. Prospective shareholders are therefore urged
to consult their tax advisors with respect to the tax consequences to them of an
investment in the Fund.
TAXATION OF THE FUND
The Fund intends to qualify each year for taxation as a regulated
investment company under Subchapter M of the Code. If the Fund so qualifies, the
Fund will not be subject to federal income tax on income distributed timely to
its Shareholders in the form of dividends or capital gain distributions.
Qualification for taxation as a regulated investment company under the Code
requires, among other things, that the Fund distribute to its Shareholders each
year (or in distributions attributable to such year) at least 90% of the sum of
its net exempt-interest income, its taxable net investment income (including,
generally, taxable interest, dividends and certain other income, less certain
expenses), and the excess, if any, of net short-term capital gains over net
long-term capital losses (the "Distribution Requirement"). If the Fund does not
qualify for taxation as a regulated investment company, the Fund's income will
be taxed at the Fund level, and all distributions from earnings and profits,
including distributions of net exempt-interest income and the excess of net
long-term capital gains over net short-term capital losses, will be taxable to
Shareholders as ordinary income. In addition, in order to requalify as a
regulated investment company, the Fund may be required to recognize unrealized
gains, pay substantial taxes and interest, and make certain distributions.
If at any time when Preferred Shares are outstanding the Fund does not meet
applicable asset coverage requirements, the Fund will be required to suspend
distributions to Common Shareholders until the requisite asset coverage is
restored. Any such suspension may prevent the Fund from satisfying the
Distribution Requirement and may cause the Fund to pay a 4% federal excise tax
(imposed on regulated investment companies that fail to distribute for a given
calendar year, generally, at least 98% of their net investment income for such
calendar year and capital gain net income for the one-year period ending October
31st of such year). The Fund may redeem Preferred Shares or pay "special
dividends" to the holders of the Preferred Shares in an effort to comply with
the Distribution Requirement and to avoid the excise tax. See "Description of
Preferred Shares."
The Fund's investments and hedging activities are subject to certain
special tax rules. One such rule provides that in order to qualify for taxation
as a regulated investment company, less than 30% of the Fund's gross income must
be derived from the sale or other disposition of certain assets (including tax
exempt securities, financial futures contracts and options) held for less than
three months (the "Three-Month Rule").
52
<PAGE> 53
Accordingly, the Fund will be restricted in selling assets held, or considered
to have been held, for less than three months. Certain Code rules governing the
Fund's hedging transactions may affect the Fund's holding periods in its assets
and may, therefore, affect the Fund's ability to comply with the Three-Month
Rule. Code rules may also alter the timing and character of certain income,
gains and losses realized by the Fund with respect to its transactions in
futures contracts, options and certain other investments. These rules could
affect the amount, timing and character of distributions to Shareholders. In
addition, the Fund's investment in securities issued at a discount and certain
other obligations will (and investments in securities purchased at a discount
may) require the Fund to accrue and distribute income not yet received. In order
to generate sufficient cash to make the requisite distributions, the Fund may be
required to sell securities in its portfolio that it otherwise would have
continued to hold.
TAXATION OF SHAREHOLDERS
Dividends and Other Distributions. Assuming that the Fund qualifies for
taxation as a regulated investment company under subchapter M of the Code and
that, at the close of each quarter of the Fund's taxable year, at least 50% of
the value of the Fund's total assets consists of obligations the interest on
which is exempt from federal income tax under Code Section 103(a), the Fund will
qualify to pay "exempt-interest dividends" to its Shareholders to the extent of
its exempt-interest income (less applicable expenses). Distributions that the
Fund properly designates as exempt-interest dividends are treated by
Shareholders as interest excludable from their gross income for federal income
tax purposes but may be taxable for federal alternative minimum tax purposes
(discussed below) and state and local tax purposes.
In order for any distributions to holders of Preferred Shares to be
eligible to be treated as exempt-interest dividends, the Preferred Shares must
be treated as equity for Federal income tax purposes. Based in part on certain
representations made by the Fund to Ropes & Gray relating to the lack of any
present intention to redeem or purchase Preferred Shares at any time in the
future, it is the opinion of Ropes & Gray that the Preferred Shares will
constitute equity for Federal income tax purposes. This opinion relies in part
on a published ruling of the Internal Revenue Service stating that certain
auction rate preferred stock similar in many material respects to the Preferred
Shares represents equity. The opinion of Ropes & Gray represents only its best
legal judgment and is not binding on the Internal Revenue Service or the courts.
If the Internal Revenue Service were successfully to assert that variable rate
preferred stock such as the Preferred Shares should be treated as debt for
Federal income tax purposes, dividends on Preferred Shares would be treated as
taxable interest for Federal income tax purposes. In such event, dividends on
Preferred Shares would not be increased by the Fund and holders of Preferred
Shares would not be entitled to any additional distributions from the Fund
(including any Additional Dividends) to offset the effect of paying Federal
income tax on Fund distributions so recharacterized as interest. Ropes & Gray
has advised the Fund that, should the Internal Revenue Service pursue in court
the position that the Preferred Shares should be treated as debt for Federal
income tax purposes, the Internal Revenue Service would be unlikely to prevail.
The receipt of exempt-interest dividends may affect the portion, if any, of
a person's Social Security and Railroad Retirement benefits that will be
includible in gross income subject to federal income tax. Under current law, up
to one-half of Social Security and Railroad Retirement benefits may be included
in gross income in cases where the recipient's combined income, consisting of
adjusted gross income (with certain adjustments), tax exempt interest income and
one-half of any Social Security and Railroad Retirement benefits, exceeds a base
amount ($25,000 for a single individual and $32,000 for married individuals
filing a joint return). In addition, effective beginning in 1994, up to 85% of a
recipient's benefits may be included in gross income if the recipient's combined
income, measured as under current law, exceeds a higher base amount ($34,000 for
a single individual and $44,000 for married individuals filing a joint return).
Shareholders receiving Social Security or Railroad Retirement benefits should
consult their tax advisors.
Under the Code, the interest on certain "private activity bonds" issued
after August 7, 1986 is treated as a preference item and is (after reduction by
applicable expenses) included in alternative minimum taxable income. The Fund
will furnish to Shareholders annually a report indicating the percentage of Fund
income treated as a preference item for alternative minimum tax purposes. In
addition, for corporations, alternative minimum taxable income is increased by a
percentage of the amount by which an alternative measure of
53
<PAGE> 54
income that includes interest on all tax exempt securities exceeds the amount
otherwise determined to be alternative minimum taxable income. Accordingly, the
portion of the Fund's dividends that would otherwise be tax exempt to the
Shareholders may cause an investor to be subject to the federal alternative
minimum tax or may increase the tax liability of an investor who is subject to
such tax. Investors should thus consider the possible effect of an investment in
the Fund on their federal alternative minimum tax liability.
The Code imposes a deductible tax (the "Environmental Tax") at a rate of
0.12% on a corporation's alternative minimum taxable income (computed without
regard to the alternative minimum tax net operating loss deduction) in excess of
$2,000,000. Exempt-interest dividends paid by the Fund that are included in a
corporate Shareholder's alternative minimum taxable income may subject corporate
Shareholders of the Fund to the Environmental Tax.
Exempt-interest dividends attributable to interest received on certain
private activity bonds and certain industrial development bonds will not be tax
exempt to any Shareholders who are, within the meaning of Section 147(a) of the
Code, "substantial users" of the facilities financed by such obligations or
bonds or who are "related persons" of such substantial users.
All or a portion of interest on indebtedness incurred or continued by a
Shareholder to purchase or carry Fund Shares will not be deductible by the
Shareholder. The portion of interest that is not deductible is equal to the
total interest paid or accrued on the indebtedness multiplied by the percentage
of the Fund's total distributions (which does not include distributions of the
excess of net long-term capital gains over net short-term capital losses) paid
to the Shareholder that are exempt-interest dividends. Under rules used by the
Internal Revenue Service for determining when borrowed funds are considered used
for the purpose of purchasing or carrying particular assets, the purchase of
Preferred Shares may be considered to have been made with borrowed funds even
though such funds are not directly traceable to the purchase of Preferred
Shares.
Distributions of net investment income that do not qualify as
exempt-interest dividends, and distributions of certain other ordinary income
and the excess, if any, of net short-term capital gains over net long-term
capital losses, will be taxable to Shareholders as ordinary income, and will not
qualify for the corporate dividends-received deduction. Distributions of the
excess, if any, of net long-term capital gains over net short-term capital
losses will be taxable to Shareholders as long-term capital gains, without
regard to how long a Shareholder has held shares of the Fund, and will not
qualify for the corporate dividends-received deduction.
Due to certain of the Fund's hedging and other investment activities, the
net investment income calculated for accounting purposes and distributed to
Shareholders may in certain circumstances exceed or be less than the Fund's net
tax exempt and taxable income. If the Fund distributes amounts in excess of the
Fund's earnings and profits (which provides the measure of the Fund's dividend
paying capacity for tax purposes) such distributions to Shareholders will be
treated as a return of capital to the extent of the Shareholder's basis in his
or her Preferred Shares, and thereafter as gain from the sale or exchange of a
capital asset. A return of capital is not taxable to a Shareholder and has the
effect of reducing the Shareholder's basis in the relevant shares. However,
because Fund expenses attributable to earning tax exempt income do not reduce
the Fund's current earnings and profits, a portion of any distribution in excess
of the Fund's net tax exempt and taxable income may be considered paid out of
the Fund's earnings and profits and may therefore be taxable as a dividend (even
though that portion economically represents a return of the Fund's capital).
The Internal Revenue Service has taken the position in a published revenue
ruling indicating that the Fund is required to designate distributions paid with
respect to each of its two classes of shares -- the Common and the Preferred
Shares -- as consisting of a portion of each type of income distributed by the
Fund. The portion of each type of income deemed received by the holders of each
class of shares will be equal to the portion of total Fund distributions
received by such class. Thus, the Fund will designate dividends paid as
exempt-interest dividends in a manner that allocates such dividends among the
holders of the Common Shares and the Preferred Shares in proportion to the total
dividends paid to each such class during or with respect to the taxable year, or
otherwise as required by applicable law. Capital gain distributions and other
income subject to regular Federal income tax will similarly be allocated between
the two classes. In the opinion of Ropes & Gray, under current law, the manner
in which the Fund intends to allocate items of its tax
54
<PAGE> 55
exempt interest income, net capital gain, and other income subject to regular
Federal income tax, if any, between its two classes of shares will be respected
for Federal income tax purposes. Whenever the Fund intends to include any net
capital gain or other income subject to regular Federal income tax in a dividend
on Preferred Shares solely because the Fund, in its judgment, believes it is
required, in order to comply with the published position of the Internal Revenue
Service, to allocate such income to such shares, the Fund may notify the
Remarketing Agent of the amount of taxable income to be so included prior to the
Remarketing establishing the Applicable Dividend Rate for such dividend.
Alternatively, if the Fund has not provided the notice referred to in the
preceding sentence, and nevertheless intends to include such income in a
dividend on Preferred Shares solely because the Fund, in its judgment, believes
it is required, in order to comply with the published position of the Internal
Revenue Service, to allocate such income to such shares, it will increase the
dividend by an amount such that the return to a holder of Preferred Shares with
respect to such dividend (as so increased and after giving effect to Federal
income tax at the Gross-Up Tax Rate) equals the Applicable Dividend Rate. If the
Fund has provided notice of an inclusion of taxable income in an upcoming
dividend on Preferred Shares as referred to above, yet, after giving such notice
the Fund intends to include additional taxable income in such dividend solely
because, in the judgment of the Fund, it is required to do so in order to comply
with the IRS's published rulings, the Fund will (i) increase the dividend by an
amount such that the return to a holder of Preferred Shares with respect to such
dividend (as so increased and after giving effect to Federal income tax at the
Gross-Up Tax Rate) shall equal the return such holder of Preferred Shares would
have received, after application of Federal income tax (at the greater of the
maximum regular Federal individual or corporate income tax rate applicable to
the character of the income reflected in the notice), if such additional amount
of taxable income had not been included in such dividend (and such dividend had
not been increased to take account of any additional amount of taxable income)
and (ii) notify the Paying Agent of the additional amount to be included in the
dividend at least five Business Days prior to the applicable Dividend Payment
Date. Neither the underlying dividend nor the additional amounts referred to in
the preceding two sentences will be increased to compensate for the fact that
they may be subject to state and local taxes. If for any reason it is determined
after the payment of any dividend that a portion of that dividend was subject to
Federal income tax, the Fund will not be required to pay any additional amount
to compensate for any tax payable on the dividend (other than Additional
Dividends payable under the circumstances described in this Prospectus). If the
Fund characterizes retroactively all or a portion of a dividend already paid on
Preferred Shares as consisting of net capital gain or other income subject to
regular Federal income tax solely because (i) the Fund has redeemed all or a
portion of the outstanding Preferred Shares or has liquidated and (ii) the Fund,
in its judgment, believes it is required, in order to comply with the published
position of the Internal Revenue Service, to allocate such taxable income to the
Preferred Shares, the Fund will pay Additional Dividends (calculated assuming a
rate of tax equal to the Gross-Up Tax Rate) to holders of Preferred Shares whose
dividends were so recharacterized. Such Additional Dividends will not include
any amount to compensate for the fact that the Additional Dividends or the
Retroactive Taxable Allocation may themselves be subject to state and local
taxes. The Fund will not be required to provide any notice of the prospective
inclusion of, or increase any dividend on Preferred Shares (including through
the payment of an Additional Dividend) as a result of the inclusion of, any
taxable income in any dividend other than in the circumstances described above.
No provision will be made to compensate holders of Preferred Shares for any
alternative minimum tax liability in respect of distributions on Preferred
Shares.
Existing authorities, including the revenue ruling discussed in the above
paragraph, do not specifically address whether dividends (including Additional
Dividends) that are paid following the close of a taxable year, but that are
treated for tax purposes as derived from the income of such prior taxable year,
are treated as dividends "paid" during such prior taxable year for purposes of
determining each class's proportionate share of a particular type of income. The
Fund currently intends to treat such dividends as having been "paid" in the
prior taxable year for purposes of determining each class's proportionate share
of a particular type of income with respect to such prior taxable year. Existing
authorities also do not specifically address the allocation of taxable income
among the dividends paid to holders of a class of shares during or with respect
to a taxable year. It is possible that the Internal Revenue Service could
disagree with the Fund's position concerning the treatment of dividends paid
after the close of a taxable year or with the Fund's method of allocation, in
which case the Internal Revenue Service could attempt to recharacterize a
portion of the dividends paid to the
55
<PAGE> 56
holders of Preferred Shares and designated by the Fund as exempt-interest
dividends as consisting instead of capital gains or other taxable income. If the
Internal Revenue Service were to prevail with respect to any such attempted
recharacterization, holders of Preferred Shares could be subject to tax on
amounts so recharacterized and the Fund could be subject to Federal income and
excise tax. In such event, no additional amounts (including Additional
Dividends) would be paid by the Fund with respect to dividends so
recharacterized to compensate for any additional tax owed by holders of
Preferred Shares. Ropes & Gray has advised the Fund that, should the Internal
Revenue Service attempt to so recharacterize amounts allocated by the Fund to
Preferred Shares, the Internal Revenue Service would be unlikely to prevail.
However, such advice represents only Ropes & Gray's best legal judgment and is
not binding on the Internal Revenue Service or the courts.
Any dividend declared by the Fund in October, November or December and
payable to holders of Preferred Shares of record on a date in such a month
generally is deemed to have been received by such holder on December 31 of such
year, provided that the dividend actually is paid during January of the
following year.
The Fund will notify Shareholders each year of the amount and tax status of
dividends and other distributions, including the amount of any distribution of
net capital gains.
The Code provides that every Shareholder required to file a tax return must
include for information purposes on such return the amount of exempt-interest
dividends received from all sources (including the Fund) during the taxable
year.
Sale or Redemption of Shares. In certain circumstances, the sale or
exchange of Preferred Shares may give rise to gain or loss. In general, any gain
or loss realized upon a taxable disposition of Preferred Shares by a shareholder
will be treated as long-term capital gain or loss if the shares have been held
for more than twelve months, and otherwise as short-term capital gain or loss.
However, if a shareholder buys Preferred Shares and sells them at a loss within
six months, any loss will be disallowed for Federal income tax purposes to the
extent of any exempt-interest dividends received on such shares. In addition,
any loss (not already disallowed as provided in the preceding sentence) realized
upon a taxable disposition of Preferred Shares held for six months or less will
be treated as long-term, rather than short-term, capital loss to the extent of
any capital gain distributions received by the shareholder with respect to those
shares. All or a portion of any loss realized upon a taxable disposition of
Preferred Shares will be disallowed if other Preferred Shares are purchased
within 30 days before or after the disposition. In such a case, the basis of the
newly purchased Preferred Shares will be adjusted to reflect the disallowed
loss.
The Fund may, at its option, redeem Preferred Shares in whole or in part,
and may be required to redeem Preferred Shares in order to maintain the
requisite Preferred Shares Basic Maintenance Amount and the 1940 Act Preferred
Shares Asset Coverage. Gain or loss, if any, resulting from a redemption of
Preferred Shares will generally be treated as gain or loss from the sale or
exchange of a capital asset under Code section 302, but in certain circumstances
the amount distributed in redemption may be treated instead as a distribution of
cash which is taxable to the extent of Fund earnings and profits as an ordinary
dividend.
From time to time the Fund may make a tender or repurchase offer for its
Common Shares. It is expected that the terms of any such offer will require a
tendering shareholder to tender all Common Shares, and dispose of all Preferred
Shares, held or considered under Code rules to be held by such shareholder.
Shareholders who tender all Common Shares and dispose of all Preferred Shares
held, or considered held, by them will be treated as having sold such shares and
generally will realize a capital gain or loss. If, however, a shareholder
tenders fewer than all of its Common Shares, or retains a substantial portion of
its Preferred Shares, such shareholder may be treated as having received a
taxable dividend upon the tender of its Common Shares. In such a case, there is
a remote risk that non-tendering shareholders (including holders of Preferred
Shares) will be treated as having received taxable distributions from the Fund.
Likewise, if the Fund redeems some but not all of the Preferred Shares held by a
holder of Preferred Shares and such holder of Preferred Shares is treated as
having received a taxable dividend upon such redemption, there is a remote risk
that holders of Common Shares and non-redeeming holders of Preferred Shares will
be treated as having received taxable distributions from the Fund.
56
<PAGE> 57
If, in connection with the selection of a Long-Term Dividend Period, the
Fund provides that a Premium Call Period will follow a Non-Call Period, and the
premium to be paid upon redemption during the Premium Call Period exceeds a
reasonable penalty for early redemption, it is possible that the holders of
Preferred Shares will be required to accrue such premium as a dividend (to the
extent of Fund earnings and profits) over the term of the Non-Call Period under
regulations to be issued by the Treasury Department.
Backup Withholding. The Fund generally is required to withhold and remit
to the U.S. Treasury 31% of the taxable dividends and other distributions paid
to any individual and other non-corporate Shareholder who fails to furnish the
Fund with a correct taxpayer identification number, who has underreported
dividends or interest income, or who fails to certify to the Fund that he or she
is not subject to such withholding. An individual's taxpayer identification
number is his or her social security number.
UNDERWRITING
UNDERWRITERS
Subject to the terms and conditions of the Underwriting Agreement relating
to the Preferred Shares (the "Underwriting Agreement"), the Fund has agreed to
sell to Smith Barney Shearson Inc., 1345 Avenue of the Americas, New York, New
York 10105 (the "Underwriter") and the Underwriter has agreed to purchase from
the Fund all of the number of Preferred Shares, if any Preferred Shares are
taken, set forth opposite its name below:
<TABLE>
<CAPTION>
NUMBER OF
PREFERRED
UNDERWRITER SHARES
----------- ---------
<S> <C>
Smith Barney Shearson Inc............................... 200
---
Total......................................... 200
===
</TABLE>
The Underwriter proposes to offer the Preferred Shares in part directly to
the public at the initial public offering set forth on the cover page of this
Prospectus. The sales load of $750 per share is equal to 1.50% of the initial
public offering price. After the Preferred Shares are released for sale to the
public, the offering price and other selling terms may from time to time be
varied by the Underwriter.
The Fund and Putnam have agreed to indemnify the Underwriter against
certain liabilities, including liabilities under the Securities Act of 1933.
The Underwriter may enter into agreements with other broker-dealers who are
members of the National Association of Securities Dealers, Inc. ("Selected
Dealers") who will purchase Preferred Shares from the Underwriter.
Smith Barney Shearson Inc. will act as the initial Remarketing Agent and
may also provide information to be used in ascertaining the applicable AA
Composite Commercial Paper Rate. The Fund anticipates that the Underwriter may
act as broker or dealer in connection with the execution of portfolio
transactions from the Fund after it has ceased to be an Underwriter and may act
as broker while it is an Underwriter.
Putnam has entered into an agreement to purchase various services from
Smith Barney Shearson Inc. See "Investment Management Contract."
INITIAL SETTLEMENT
Payment by each initial purchaser of Preferred Shares will be made by such
purchaser's Agent Member on the Date of Original Issue of such shares to the
Underwriter in same-day funds. At the closing date, the Underwriter will accept
delivery of the Preferred Shares offered hereby and will thereafter deposit such
shares in the Underwriter's account at the Securities Depository. Immediately
thereafter, on such Date of Original Issue, the Securities Depository will
deliver (by book entry) the Preferred Shares purchased by each purchaser from
the Underwriter's Account to the account of such purchaser's Agent Member
against payment
57
<PAGE> 58
for such Preferred Shares to the account of the Underwriter of an amount equal
to the purchase price from the account of such Agent Member.
CUSTODIAN, TRANSFER AGENT, DIVIDEND DISBURSING AGENT, AND REGISTRAR
The Fund's custodian is Putnam Fiduciary Trust Company, an affiliate of
Putnam (the "Custodian"). The transfer agent, dividend disbursing agent and
registrar for the Common Shares is Putnam Investor Services, a division of
Putnam Fiduciary Trust Company (the "Transfer Agent"). The principal business
address of the Custodian and the Transfer Agent is One Post Office Square,
Boston, Massachusetts 02109. The transfer agent, dividend disbursing agent and
registrar for the Preferred Shares will be IBJ Schroeder Bank & Trust Company.
LEGAL MATTERS
Certain legal matters in connection with the Common Shares offered hereby
will be passed upon for the Fund by Ropes & Gray, Boston, Massachusetts and for
the Underwriters by Skadden, Arps, Slate, Meagher & Flom, Chicago, Illinois.
Skadden, Arps, Slate, Meagher & Flom also acts as counsel to Putnam Investment
Management, Inc. and certain of its affiliates in connection with other matters.
EXPERTS
The November 10, 1993 Statement of Assets and Liabilities of the Fund
included in this Prospectus has been so included in reliance on the report of
Coopers & Lybrand, independent accountants, given on the authority of said firm
as experts in accounting and auditing.
ADDITIONAL INFORMATION
Further information concerning these securities may be found in the
Registration Statement, of which this Prospectus constitutes a part, on file
with the Securities and Exchange Commission.
58
<PAGE> 59
REPORT OF INDEPENDENT ACCOUNTANTS
To the Trustees of
Putnam Investment Grade Municipal Trust III:
We have audited the accompanying statement of assets and liabilities of
Putnam Investment Grade Municipal Trust III as of November 10, 1993. This
financial statement is the responsibility of the Fund's management. Our
responsibility is to express an opinion on this financial statement based on our
audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the statement of assets and liabilities is
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the statement of assets and
liabilities. Our procedures included confirmation of cash held by the custodian
as of November 10, 1993. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall statement of assets and liabilities presentation. We
believe that our audit of the statement of assets and liabilities provides a
reasonable basis for our opinion.
In our opinion, the statement of assets and liabilities referred to above
presents fairly, in all material respects, the financial position of Putnam
Investment Grade Municipal Trust III as of November 10, 1993 in conformity with
generally accepted accounting principles.
COOPERS & LYBRAND
Boston, Massachusetts
November 11, 1993
59
<PAGE> 60
<TABLE>
PUTNAM INVESTMENT GRADE MUNICIPAL TRUST III
STATEMENT OF ASSETS AND LIABILITIES
November 10, 1993
<S> <C>
ASSETS
Cash........................................................................... $100,000.00
Deferred organization expenses (Note 1)........................................ $ 27,157.00
-----------
$127,157.00
LIABILITIES
Accrued expenses............................................................... $ 27,157.00
Commitments (Notes 1 and 2).................................................... $ --
-----------
$ 27,157.00
NET ASSETS, applicable to 7,092.199 common shares of beneficial interest
without par value issued and outstanding; unlimited number of common shares
authorized................................................................... $100,000.00
-----------
NET ASSET VALUE PER COMMON SHARE............................................... $ 14.10
===========
</TABLE>
NOTES TO FINANCIAL STATEMENT
NOTE 1. ORGANIZATION
The Fund was organized as a Massachusetts business trust on September 23,
1993, and is registered under the Investment Company Act of 1940, as amended, as
a closed-end, diversified management investment company. The Fund has had no
operations other than those relating to organizational matters, and the initial
capital contribution of $100,000 has been made by Putnam Investments, Inc.
Certain expenses incurred by the Fund in connection with its organization and
its initial public offering have been or will be paid initially by Putnam
Investment Management, Inc. ("Putnam"), the Fund's investment manager; however,
the Fund will reimburse Putnam for such costs. Organizational costs, estimated
at $27,157, have been capitalized and will be amortized by the Fund over a
period not to exceed 60 months from the date the Fund commences operations;
offering costs will be charged to capital upon completion of this offering.
NOTE 2. MANAGEMENT CONTRACT AND ADMINISTRATIVE SERVICES CONTRACT
The Fund has entered into a Management Contract with Putnam. As
compensation for the services rendered, facilities furnished, and expenses borne
by Putnam, the Fund will pay Putnam a fee, computed and paid quarterly, at the
annual rate of 0.50% of the first $500 million of the average net asset value of
the Fund, 0.43% of the next $500 million, 0.39% of the next $500 million, and
0.35% of any excess over $1.5 billion of such average net asset value.
The Fund has entered into an Administrative Services Contract with Putnam.
As compensation for the services rendered, facilities furnished, and expenses
borne by Putnam, the Fund will pay Putnam a fee, computed and paid quarterly, at
the annual rate of 0.20% of the first $500 million of the average net asset
value of the Fund, 0.17% of the next $500 million, 0.16% of the next $500
million, and 0.15% of any excess over $1.5 billion of such average net asset
value.
NOTE 3. PREFERRED SHARES
The Fund intends to issue preferred shares in one or more series or
classes. It is anticipated that the terms of any such preferred shares would
likely provide for a dividend rate which is based on short-or medium-term
interest rates and for the periodic redetermination of the dividend rate at
short-or medium-term intervals through an auction or remarketing procedure. Such
procedures are expected to involve the payment of fees by the Fund to its agents
in connection with such procedures. At all times when preferred shares are
outstanding, the Fund will be required to meet the asset coverage requirements
of the Investment Company Act of 1940 and the guidelines established by a rating
agency which may undertake to rate such preferred shares.
60
<PAGE> 61
<TABLE>
PUTNAM INVESTMENT GRADE MUNICIPAL TRUST III
PORTFOLIO OF INVESTMENTS OWNED
DECEMBER 31, 1993 (UNAUDITED)
MUNICIPAL BONDS AND NOTES (98.1%)(A)
- --------------------------------------------------------------------------------------------------
<CAPTION>
PRINCIPAL
AMOUNT RATINGS(B) VALUE
- --------- ---------- -----
<C> <S> <C> <C>
ALASKA (6.9%)
$3,500,000 Valdez Marine Term Rev. Bonds, 7 1/8s, 12/1/25............ A $ 3,976,875
-----------
CALIFORNIA (20.6%)
5,000,000 Beverly Hills Pub. Fin. Auth. Lease Rev. Bonds, Ser. A,
Municipal Bond Insurance Assn. (MBIA), 5.65s, 6/1/15.... AAA 5,250,000
2,500,000 CA Edl. Fac. Auth. Rev. (Pepperdine Univ.), MBIA 5 1/2s,
6/1/19.................................................. AAA 2,509,375
3,000,000 Orange Cnty. Ser. C, Financial Guaranty Insurance Co.
(FGIC), Variable Rate Demand Note 4.25s, 8/1/17......... VMIG1 3,000,000
1,000,000 San Diego Cnty. Wtr. Auth. Rev. Bonds, FGIC, 8.548s,
4/23/08................................................. AAA 1,107,500
-----------
11,866,875
-----------
ILLINOIS (4.3%)
2,000,000 IL Hlth. Fac. Auth. Rev. Bonds (Glenoaks), Ser. D, 9 1/2s,
11/15/15................................................ Baa 2,447,500
-----------
MAINE (3.5%)
2,000,000 Skowhegan Poll. Control Rev. Bonds (Scott Paper Co.
Project), 5.9s, 11/1/13................................. A 2,042,500
-----------
MASSACHUSETTS (15.3%)
4,300,000 MA State Hlth. & Edl. Fac. Auth. Rev. Bonds (New England
Baptist Hosp.) Ser. B, 7.35s, 7/1/17.................... A 4,891,250
3,725,218 MA State Hsg. Fin. Agcy., Ser. A, 6 3/8s, 4/1/21.......... A 3,925,218
-----------
8,816,468
-----------
MINNESOTA (5.8%)
3,000,000 Minneapolis & St. Paul Hsg. & Redev. Auth. Hlth Care Sys.
Rev. Bonds, Ser. A, MBIA, 6 3/4s, 8/15/14............... AAA 3,337,500
-----------
NEVADA (3.3%)
1,700,000 Clark Cnty. Indl. Rev. Bonds (Nevada Power Co. Project)
Ser. C, 7.2s, 10/1/22................................... Baa 1,887,000
-----------
NEW YORK (10.6%)
4,000,000 NY City, General Obligation Bonds, Ser. D, 5 3/4s,
8/15/15................................................. A 3,985,000
2,000,000 NY City Hlth. & Hosp. Auth. Loc. Gov't. Rev. Bonds, Ser.
A, 6.3s, 2/15/20........................................ Baa 2,107,500
-----------
6,092,500
-----------
SOUTH CAROLINA (8.7%)
5,000,000 SC State Pub. Svc. Auth. Rev. Bonds, 7.79s, 7/1/21 (c).... AAA/P 4,981,250
-----------
SOUTH DAKOTA (5.7%)
3,000,000 SD Student Loan Assistance Corp. Student Loan Rev. Bonds,
Ser. B, 7 5/8s, 8/1/06.................................. A 3,292,500
-----------
TEXAS (3.9%)
2,000,000 Gulf Coast Waste Disp. Auth. Rev. Bonds, 7.45s, 5/1/26.... Baa 2,220,000
-----------
WASHINGTON (5.8%)
3,000,000 WA State Pub. Pwr. Supply Syst. Rev. Bonds (Nuclear
Project No. 2), Ser. B 7s, 7/1/21....................... AA 3,333,750
-----------
</TABLE>
61
<PAGE> 62
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT RATINGS(B) VALUE
- --------- ---------- -----
<C> <S> <C> <C>
WEST VIRGINIA (3.7%)
$2,000,000 Mason Cnty. Poll. Control Rev. Bonds (Appalachian Pwr. Co.
Project), Ser. J, 6.6s, 10/1/22......................... A $ 2,167,501
-----------
Total Investments (cost $55,439,382)...................... $56,462,219
===========
<FN>
NOTES
(a) Percentages indicated are based on total net assets of $57,559,156, which
correspond to a net asset value per share of $14.36.
(b) The Moody's and Standard & Poor's ratings indicated are believed to be the
most recent ratings available at December 31, 1993 for the securities
listed. Ratings are generally ascribed to securities at the time of
issuance. While the agencies may from time to time revise such ratings, they
undertake no obligation to do so, and the ratings do not necessarily
represent ratings the agencies would ascribe to these securities at December
31, 1993. Securities rated by Putnam and unrated by Moody's or Standard &
Poor's are indicated by "/P".
(c) Restricted as to public resale. At the date of acquisition these securities
were valued at cost. There were no outstanding unrestricted securities of
the same class as those held. Total market value of restricted securities
owned at December 31, 1993 was $4,981,250 or 8.7% of net assets.
The rates shown on Variable Rate Demand Notes (VRDN) are the current rates
at December 31, 1993 which are subject to change based on the terms of the
security.
</TABLE>
62
<PAGE> 63
<TABLE>
PUTNAM INVESTMENT GRADE MUNICIPAL TRUST III
STATEMENT OF ASSETS AND LIABILITIES
DECEMBER 31, 1993 (UNAUDITED)
<S> <C> <C>
ASSETS
Investments in securities, at value (identified cost $55,439,382).............. $56,462,219
Cash........................................................................... 2,742,677
Interest receivable............................................................ 1,058,337
Unamortized organization expense............................................... 26,666
-----------
Total assets......................................................... 60,289,899
LIABILITIES
Payable for securities purchased................................... $2,448,069
Payable for compensation of Trustees............................... 271
Payable for investor servicing and custodian fees.................. 8,137
Payable for administrative services................................ 633
Payable for organization expense................................... 270,620
Other accrued expenses............................................. 3,013
----------
Total liabilities.................................................... 2,730,743
-----------
Net Assets..................................................................... $57,559,156
===========
REPRESENTED BY
Paid-in capital................................................................ $56,256,537
Undistributed net investment income............................................ 281,822
Accumulated net realized loss on investments................................... (2,040)
Net unrealized appreciation of investments..................................... 1,022,837
-----------
Total-Representing net assets applicable to capital shares outstanding......... $57,559,156
===========
Net asset value per share ($57,559,156 divided by 4,007,092 shares)............ $14.36
===========
</TABLE>
NOTES TO FINANCIAL STATEMENT (UNAUDITED)
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements. The
policies are in conformity with generally accepted accounting principles.
(A) SECURITY VALUATION The Fund's investments are valued in accordance
with the procedures stated under "Determination of Net Asset Value" in this
Prospectus.
(B) SECURITY TRANSACTIONS AND RELATED INVESTMENT INCOME Security
transactions are accounted for on trade date (date the order to buy or sell is
executed). Interest income is recorded on the accrual basis.
Any premium resulting from the purchase of securities in excess of maturity
value is amortized on a yield to maturity basis. Discount on zero-coupon bonds,
original issue discount bonds and step-up bonds is accreted according to the
effective yield method.
(C) FEDERAL TAXES It is the policy of the Fund to distribute all of its
income within the prescribed time and otherwise comply with the provisions of
the Internal Revenue Code applicable to regulated investment companies. It is
also the intention of the Fund to distribute an amount sufficient to avoid
imposition of any excise tax under Section 4982 of the Internal Revenue Code of
1986. Therefore, no provision has been made for federal taxes on income, capital
gains or unrealized appreciation of securities held and excise tax on income and
capital gains.
(D) DISTRIBUTIONS TO SHAREHOLDERS Distributions to shareholders are
recorded by the Fund on the ex-dividend date.
63
<PAGE> 64
(E) UNAMORTIZED ORGANIZATION EXPENSES Expenses incurred by the Fund in
connection with its organization aggregated $27,157. These expenses are being
amortized on a straight-line basis over a five year period.
NOTE 2. ORGANIZATION AND INITIAL PUBLIC OFFERING
See "The Fund" in this Prospectus for information concerning the
organization of the Fund and the initial offering of common shares.
NOTE 3. MANAGEMENT FEE, ADMINISTRATIVE SERVICES, AND OTHER TRANSACTIONS
See "Investment Management Contract" in this Prospectus for information
concerning the compensation of Putnam Investment Management, Inc. (the
"Manager") for management and investment advisory services, and for
reimbursement of the Manager for compensation and related expenses of certain
officers of the Fund; "Trustees and Officers" for information concerning
Trustees' fees; and "Custodian, Transfer Agent, Dividend Disbursing Agent and
Registrar" for information concerning affiliated custodial and transfer agent
services.
See "Prospectus Summary -- Management Fees" for information concerning a
three month voluntary waiver of management fees commencing November 26, 1993.
64
<PAGE> 65
GLOSSARY
" 'AA' Composite Commercial Paper Rate" has the meaning specified on page
36 of this Prospectus.
"Additional Dividend" has the meaning specified on page 45 of this
Prospectus.
"Agent Member" means a designated member of the Securities Depository that
will maintain records for a beneficial owner of one or more Preferred Shares.
"Applicable Dividend Rate" means, with respect to the Initial Dividend
Period, the rate of dividend per annum established by the Trustees, by a duly
authorized committee thereof or by any of the President, the Vice Chairman, any
Executive Vice President or the Treasurer of the Fund and, for each subsequent
Dividend Period, means the rate of dividend per annum that (i) except for a
Dividend Period commencing during a Non-Payment Period, will be equal to the
lower of the rate of dividend per annum that the Remarketing Agent advises
results on the Remarketing Date preceding the first day of such Dividend Period
from implementation of the remarketing procedures set forth in the Bylaws and
the Maximum Dividend Rate or (ii) for each Dividend Period commencing during a
Non-Payment Period, will be equal to the Non-Payment Period Rate.
"Applicable Percentage" has the meaning described on page 38 of this
Prospectus.
"Authorized Newspaper" means a newspaper of general circulation in the
English language generally published on Business Days in The City of New York.
"Business Day" means a day on which the New York Stock Exchange, Inc. is
open for trading, and is not a day on which banks in The City of New York are
authorized or obligated by law to close.
"Bylaws" means the Bylaws of the Trust, as amended from time to time.
"Cede" means Cede & Co., the nominee of DTC in whose name the Preferred
Shares initially will be registered.
"Closing Transaction" means the termination of a futures contract or option
position by taking a position opposite thereto.
"Code" means the Internal Revenue Code of 1986, as amended.
"Commercial Paper Dealers" means Smith Barney Shearson Inc. and such other
dealers as the Fund may from time to time appoint, or in lieu of any thereof,
their respective affiliates or successors.
"Commission" means the Securities and Exchange Commission.
"Common Shares" means the common shares of beneficial interest of the Fund.
"Date of Original Issue" means, with respect to any Preferred Shares, the
date on which the Fund originally issues such share.
"Deposit Securities" has the meaning set forth on page B-1 of this
Prospectus.
"Discount Factor" means a Moody's Discount Factor or a S&P Discount Factor,
as the case may be.
"Discounted Value" has the meaning set forth on page B-1 of this
Prospectus.
"Dividend Coverage Amount" has the meaning set forth on page B-1 of this
Prospectus.
"Dividend Coverage Assets" has the meaning set forth on page B-1 of this
Prospectus.
"Dividend Payment Date" has the meaning set forth on page 42 of this
Prospectus.
"Dividend Period" has the meaning set forth on pages 3 and 40 of this
Prospectus.
"DTC" means The Depository Trust Company.
"Exempt-Interest Dividend" has the meaning set forth on page 53 of this
Prospectus.
65
<PAGE> 66
"First Initial Dividend Payment Date" has the meaning set forth on page 40
of this Prospectus.
"Forward Commitment" has the meaning set forth on page 22 of this
Prospectus.
"Fund" means Putnam Investment Grade Municipal Trust III, a Massachusetts
business trust, which is the issuer of the Preferred Shares.
"Gross-Up Tax Rate" has the meaning set forth on pages 8 and 31-32 of this
Prospectus.
A "Holder" of Preferred Shares means, unless the context otherwise
requires, a person who is listed in the records of the Paying Agent as the
beneficial owner of one or more Preferred Shares.
"Initial Dividend Payment Date" and "Initial Dividend Payment Dates" have
the meanings set forth on page 40 of this Prospectus.
"Initial Dividend Period" means, with respect to Preferred Shares, the
period commencing on and including the Date of Original Issue thereof and ending
on the date set forth on the front cover of this Prospectus.
"Initial Margin" means the amount of cash or securities deposited with a
broker as a margin payment at the time of purchase or sale of a futures contract
or an option hereon.
"Interest Equivalent" means a yield on a 360-day basis of a discount basis
security which is equal to the yield on an equivalent interest-bearing security.
"IRS" means the Internal Revenue Service.
"Last Initial Dividend Payment Date" has the meaning set forth on page 40
of this Prospectus.
"Long Term Dividend Period" has the meaning set forth on page 6 of this
Prospectus.
"Mandatory Redemption Price" has the meaning set forth on page 46 of this
Prospectus.
"Marginal Tax Rate" means the maximum marginal regular Federal individual
income tax rate applicable to ordinary income or the maximum marginal regular
Federal corporate income tax rate, whichever is greater.
"Maximum Dividend Rate" has the meaning set forth on page 36 of this
Prospectus.
"Maximum Potential Additional Dividend Liability" has the meaning set forth
on page B-2 of this Prospectus.
"Minimum Liquidity Level" has the meaning set forth on page B-2 of this
Prospectus.
"Moody's" means Moody's Investors Service, Inc.
"Moody's Discount Factor" has the meaning set forth on page B-2 of this
Prospectus.
"Moody's Eligible Asset" has the meaning set forth on page B-3 of this
Prospectus.
"Moody's Exposure Period" has the meaning set forth on page B-3 of this
Prospectus.
"Moody's Hedging Transaction" has the meaning set forth on page B-3 of this
Prospectus.
"Moody's Volatility Factor" has the meaning set forth on page B-4 of this
Prospectus.
"Municipal Index" means The Bond Buyer Municipal Bond Index.
"1940 Act" means the Investment Company Act of 1940, as amended.
"1940 Act Cure Date" has the meaning set forth on page 20 of this
Prospectus.
"1940 Act Preferred Shares Asset Coverage" has the meaning set forth on
page 20 of this Prospectus.
"Non-Call Period" has the meaning described under "Specific Redemption
Provisions" below.
"Non-Payment Period" has the meaning set forth on page 43 of this
Prospectus.
66
<PAGE> 67
"Non-Payment Period Rate" has the meaning set forth on pages 43-44 of this
Prospectus.
"Notice of Redemption" has the meaning set forth on page 47 of this
Prospectus.
"Notice of Revocation" has the meaning set forth on page 41 of this
Prospectus.
"Notice of Special Dividend Period" has the meaning set forth on page 41 of
this Prospectus.
"Optional Redemption Price" has the meaning set forth on page 45 of this
Prospectus.
"Paying Agent" means IBJ Schroeder Bank & Trust Company, or any successor
company or entity, which has entered into a Paying Agent Agreement with the Fund
to act, among other things, as the transfer agent, registrar, dividend and
redemption price disbursing agent, settlement agent and agent for certain
notifications for the Fund in connection with the Preferred Shares of each
series in accordance with such agreement.
"Paying Agent Agreement" has the meaning set forth on page 30 of this
Prospectus.
"Preferred Shares" means the Municipal Income Preferred Shares.
"Premium Call Period" has the meaning specified in "Specific Redemption
Provisions" below.
"Preferred Shares Basic Maintenance Amount" has the meaning set forth on
page B-4 of this Prospectus.
"Receivables for Municipal Bonds Sold," for purposes of determining Moody's
Eligible Assets and, for purposes of determining S&P Eligible Assets, has the
meaning set forth on pages B-2 and B-5, respectively, of this Prospectus.
A "record holder" of Preferred Shares shall mean the Securities Depository
or its nominee or such other person or persons listed in the share transfer
books of the Fund as the registered holder of one or more Preferred Shares.
"Reference Rate" has the meaning set forth on page 7 of this Prospectus.
"Remarketing" means each periodic operation of the process for remarketing
Preferred Shares, as described in this Prospectus.
"Remarketing Agent" means Smith Barney Shearson Inc. and any additional or
successor companies or entities which have entered into an agreement with the
Fund to follow the remarketing procedures for the purposes of determining the
Applicable Dividend Rate.
"Remarketing Agreement" has the meaning set forth on page 32 of this
Prospectus.
"Remarketing Date" means any date on which (i) each holder of Preferred
Shares must provide to the Remarketing Agent irrevocable telephonic notice of
intent to tender shares in a Remarketing, and (ii) the Remarketing Agent (a)
determines the Applicable Dividend Rate for the ensuing Dividend Period, (b)
notifies holders, purchasers and tendering holders of Preferred Shares by
telephone, telex or otherwise of the results of the Remarketing and (c)
announces the Applicable Dividend Rate.
"Request for Special Dividend Period" has the meaning set forth on pages
40-41 of this Prospectus.
"Response" has the meaning set forth on page 41 of this Prospectus.
"Retroactive Taxable Allocation" has the meaning set forth on page 45 of
this Prospectus.
"S&P" means Standard & Poor's Corporation.
"S&P Discount Factor" has the meaning set forth on page B-5 of this
Prospectus.
"S&P Eligible Asset" has the meaning set forth on page B-5 of this
Prospectus.
"S&P Exposure Period" has the meaning set forth on page B-6 of this
Prospectus.
"S&P Hedging Transaction" has the meaning set forth on page B-6 of this
Prospectus.
67
<PAGE> 68
"S&P Volatility Factor" has the meaning set forth on page B-6 of this
Prospectus.
"Securities Depository" means DTC or any successor company or other entity
selected by the Fund as securities depository for Preferred Shares that agrees
to follow the procedures required to be followed by such securities depository
in connection with the shares of such series of Preferred Shares.
"Settlement Date" means the first Business Day after a Remarketing Date
applicable to a Preferred Share.
"Short Term Dividend Period" has the meaning set forth on page 6 of this
Prospectus.
"Special Dividend Period" means a Dividend Period established by the Fund
for Preferred Shares as described on page 6 of this Prospectus.
"Specific Redemption Provisions" means, with respect to a Special Dividend
Period of 365 or more days, either, or any combination of, the designation of
(i) a period (a "Non-Call Period") determined by the Trustees, after
consultation with the Remarketing Agent, during which the Preferred Shares
subject to such Dividend Period shall not be subject to redemption at the option
of the Fund and (ii) a period (a "Premium Call Period"), consisting of a number
of whole years and determined by the Trustees, after consultation with the
Remarketing Agent, during each year of which the Preferred Shares subject to
such Dividend Period shall be redeemable at the Trust's option at a price per
share equal to $50,000 plus accumulated but unpaid dividends plus an applicable
premium, as determined by the Trustees after consultation with the Remarketing
Agent.
"Substitute Commercial Paper Dealers" means such substitute commercial
paper dealers as the Trust may from time to time appoint or, in lieu of any
thereof, their respective affiliates or successors.
"Substitute Rating Agency" and "Substitute Rating Agencies" shall mean a
nationally recognized statistical rating organization or two nationally
recognized statistical rating organizations selected by the Fund to act as the
substitute rating agency or substitute rating agencies, as the case may be, to
determine the credit ratings of the Preferred Shares.
"Taxable Equivalent of the Short-Term Municipal Bond Rate" has the meaning
set forth on page 37 of this Prospectus.
"Tender and Dividend Reset" means the process pursuant to which Preferred
Shares may be tendered in a Remarketing or held and become subject to the new
Applicable Dividend Rate determined by the Remarketing Agents in such
Remarketing.
"Treasury Bonds" means United States Treasury Bonds with remaining
maturities of ten years or more.
"Trustees" means the Trustees of the Fund.
"28-Day Dividend Period" has the meaning set forth on page 6 of this
Prospectus.
"U.S. Treasury Bill Rate" has the meaning set forth on page 37 of this
Prospectus.
"U.S. Treasury Note Rate" has the meaning set forth on page 37 of this
Prospectus.
"Valuation Date" has the meaning set forth on page B-6 of this Prospectus.
"Variation Margin" has the meaning set forth on page B-6 of this
Prospectus.
68
<PAGE> 69
<TABLE>
APPENDIX A
NORMAL SCHEDULE FOR REMARKETING PREFERRED SHARES
The normal schedule for remarketing Preferred Shares is described below. As
described in this Prospectus, the events occurring on each day of a normal
remarketing schedule are subject to change in the event that certain days are
not Business Days. All references herein to a particular time of day shall be to
New York City time.
<S> <C>
Remarketing Date
9:00 a.m. Deadline for the Remarketing Agent to make available to holders of
Preferred Shares non-binding indications of Applicable Dividend Rate
for the next succeeding 28-day Dividend Period or, if applicable,
Special Dividend Period.
12:00 noon Deadline for each holder of Preferred Shares to provide to the
Remarketing Agent irrevocable telephonic notice of intent to tender
Preferred Shares for sale in the current Remarketing. Remarketing of
tendered shares of Preferred Shares formally commences.
3:00 p.m. Deadline for completion of Remarketing. The Remarketing Agent
determines the Applicable Dividend Rate for the Dividend Period.
3:30 p.m. The Remarketing Agent notifies holders, purchasers and tendering
holders of Preferred Shares by telephone, telex or otherwise of the
results of the Remarketing. Applicable Dividend Rate is announced.
Settlement Date (next New Dividend Period begins. In addition, Preferred Shares which have
following Business Day) been tendered and sold in a Remarketing are delivered against
payment through the Securities Depository.
</TABLE>
A-1
<PAGE> 70
APPENDIX B
RATING AGENCY REQUIREMENTS
This Appendix sets out certain procedures from the Bylaws of the Fund
containing conditions determined by S&P and Moody's which the Fund must meet in
order to maintain its AAA/"aaa" rating. Generally, these requirements, among
other things, impose limitations on the securities in which the Fund may invest
(and the amount of its portfolio which may be invested in various types of
securities and securities of various issuers), limit the Fund's use of futures,
options and forward commitments and may require the Fund to redeem Preferred
Shares as described generally in the Prospectus under "Description of Preferred
Shares -- Redemption." Any capitalized terms used in this Appendix but not
defined herein are defined elsewhere in the Prospectus.
DEFINITIONS
"Anticipation Notes" shall mean the following Municipal Bonds: revenue
anticipation notes, tax anticipation notes, tax and revenue anticipation notes,
grant anticipation notes and bond anticipation notes.
"Deposit Securities" means cash and Municipal Bonds rated at least AAA,
A-1+ or SP-1+ by S&P.
"Discounted Value" means (i) with respect to an S&P Eligible Asset, the
quotient of the Market Value thereof divided by the applicable S&P Discount
Factor and (ii) with respect to a Moody's Eligible Asset, the lower of par and
the quotient of the Market Value thereof divided by the applicable Moody's
Discount Factor.
"Dividend Coverage Amount," as of any Valuation Date, means (A) (i) the
aggregate amount of cash dividends that will accumulate on all Preferred Shares
and Other Preferred Shares, in each case to (but not including) the Business Day
following the first Dividend Payment Date for Preferred Shares that follows such
Valuation Date plus (ii) the aggregate amount of all liabilities existing on
such Valuation Date which are payable on or prior to the Business Day following
such first Dividend Payment Date less (B) the sum of (i) the combined Market
Value of Deposit Securities irrevocably deposited with the Paying Agent for the
payment of cash dividends on all Preferred Shares and Other Preferred Shares,
(ii) the book value of receivables for Municipal Bonds sold as of or prior to
such Valuation Date, if such receivables are due within five Business Days of
such Valuation Date and in any event on or prior to such Dividend Payment Date,
and (iii) interest on Municipal Bonds owned by the Fund which is scheduled to be
paid on or prior to such Dividend Payment Date.
"Dividend Coverage Assets," as of any Valuation Date, means Deposit
Securities with maturity or tender payment dates not later than the day
preceding the Business Day following the first Dividend Payment Date for
Preferred Shares that follows such Valuation Date.
"Independent Accountant" means a nationally recognized accountant, or firm
of accountants, that is, with respect to the Fund, an independent public
accountant or firm of independent public accountants under the Securities Act of
1933, as amended.
"Initial Margin" means the amount of cash or securities deposited with a
broker as a margin payment at the time of purchase or sale of a futures contract
or an option thereon.
"Market Value" of any asset of the Fund means the market value thereof
determined by the Pricing Service. The Market Value of any asset shall include
any interest accrued thereon. The Pricing Service shall value portfolio
securities at the mean between the quoted bid and asked price or the yield
equivalent when quotations are readily available. Securities for which
quotations are not readily available shall be valued at fair value as determined
by the Pricing Service using methods which include consideration of: yields or
prices of municipal bonds of comparable quality, type of issue, coupon, maturity
and rating; indications as to value from dealers; and general market conditions.
The Pricing Service may employ electronic data processing techniques and/or a
matrix system to determine valuations. In the event the Pricing Service is
unable to value a security, the security shall be valued at the lower of two
dealer bids obtained by the Fund from dealers who are
B-1
<PAGE> 71
members of the National Association of Securities Dealers, Inc. and make a
market in the security, at least one of which shall be in writing. Futures
contracts and options are valued at closing prices for such instruments
established by the exchange or board of trade on which they are traded, or if
market quotations are not readily available, are valued at fair value on a
consistent basis using methods determined in good faith by the Trustees.
"Maximum Potential Additional Dividend Liability," as of any Valuation
Date, means the aggregate amount of Additional Dividends that would be payable
with respect to the Preferred Shares if the Fund were to make Retroactive
Taxable Allocations, with respect to any fiscal year, estimated based upon
dividends paid and the amount of undistributed realized net capital gain and
other income subject to regular Federal income tax earned by the Fund, as of the
end of the calendar month immediately preceding such Valuation Date and assuming
such Additional Dividends are fully taxable.
"Minimum Liquidity Level" means, as of any Valuation Date, an aggregate
Market Value of Dividend Coverage Assets not less than the Dividend Coverage
Amount.
<TABLE>
"Moody's Discount Factor" means, for purposes of determining the Discounted
Value of any Municipal Bond which constitutes a Moody's Eligible Asset, the
percentage determined by reference to (a) the rating by Moody's or S&P on such
Bond and (b) the Moody's Exposure Period, in accordance with the table set forth
below:
RATING CATEGORY
<CAPTION>
MOODY'S EXPOSURE PERIOD AAA(1) AA(1) A(1) BAA(1) OTHER(2) VMIG-1(1),(3) SP-1+(4)
----------------------- ------ ----- ---- ------ -------- ------------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
7 weeks or less...... 151% 159% 168% 202% 229% 136% 148%
8 weeks or less but
greater than 7 weeks 154 164 173 205 235 137 149
9 weeks or less but
greater than 8 weeks 158 169 179 209 242 138 150
- ---------------
<FN>
(1) Moody's rating.
(2) Municipal Bonds not rated by Moody's but rated BBB-, BBB or BBB+ by S&P.
(3) Municipal Bonds rated MIG-1, VMIG-1 or P-1 by Moody's, which do not mature
or have a demand feature at par exercisable within the Moody's Exposure
Period and which do not have a long-term rating. For the purpose of the
definition of Moody's Eligible Assets, these securities will have an
assumed rating of "A" by Moody's.
(4) Municipal Bonds rated SP-1+ or A-1+ by S&P which do not mature or have a
demand feature at par exercisable within the Moody's Exposure Period and
which do not have a long-term rating. For the purpose of the definition of
Moody's Eligible Assets, these securities will have an assumed rating of "A"
by Moody's.
</TABLE>
Notwithstanding the foregoing, (i) no Moody's Discount Factor will be
applied to short-term Municipal Bonds, so long as such Municipal Bonds are rated
at least MIG-1, VMIG-1 or P-1 by Moody's and mature or have a demand feature at
par exercisable within the Moody's Exposure Period, and the Moody's Discount
Factor for such Bonds will be 125% if such Bonds are not rated by Moody's but
are rated A-1+ or SP-1+ or AA by S&P and mature or have a demand feature at par
exercisable within the Moody's Exposure Period, and (ii) no Moody's Discount
Factor will be applied to cash or to Receivables for Municipal Bonds Sold.
"Receivables for Municipal Bonds Sold," for purposes of calculating Moody's
Eligible Assets as of any Valuation Date, means the aggregate of the following:
(i) the book value of receivables for Municipal Bonds sold as of or prior to
such Valuation Date if such receivables are due within five Business Days of
such Valuation Date, and if the trades which generated such receivables are (x)
settled through clearing house firms with respect to which the Fund has received
prior written authorization from Moody's or (y) with counterparties having a
Moody's long-term debt rating of at least Baa3; and (ii) the Discounted Value of
Municipal Bonds sold (applying the relevant Moody's Discount Factor to such
Bonds) as of or prior to such
B-2
<PAGE> 72
Valuation Date which generated such receivables, if such receivables are due
within five Business Days of such Valuation Date but do not comply with either
of conditions (x) or (y) of the preceding clause (i).
<TABLE>
"Moody's Eligible Asset" means cash, Receivables for Municipal Bonds Sold,
a short-term Municipal Bond rated VMIG-1, MIG-1 or P-1 by Moody's or SP-1+ or
A-1+ by S&P or a Municipal Bond that (i) pays interest in cash; (ii) is publicly
rated Baa or higher by Moody's or, if not rated by Moody's but rated by S&P, is
rated at least BBB-by S&P (provided that, for purposes of determining the
Moody's Discount Factor applicable to any such S&P-rated Municipal Bond, such
Municipal Bond (excluding any short-term Municipal Bond and any Municipal Bond
rated BBB-, BBB or BBB+) will be deemed to have a Moody's rating which is one
full rating category lower than its S&P rating); (iii) does not have its Moody's
rating suspended by Moody's; and (iv) is part of an issue of Municipal Bonds of
at least $10,000,000. In addition, Municipal Bonds in the Fund's portfolio will
be included as Moody's Eligible Assets only to the extent they meet the
following diversification requirements:
<CAPTION>
MAXIMUM STATE
MINIMUM MAXIMUM OR TERRITORY
ISSUE SIZE UNDERLYING CONCENTRATION
RATING ($ MILLIONS) OBLIGOR (%)(1) (%)(1)(3)
- ------ ------------ -------------- -------------
<S> <C> <C> <C>
Aaa............................................ 10 100 100
Aa............................................. 10 20 60
A.............................................. 10 10 40
Baa............................................ 10 6 20
Other(2)....................................... 10 4 12
- ---------------
<FN>
(1) The referenced percentages represent maximum cumulative totals for the
related rating category and each lower rating category.
(2) Municipal Bonds not rated by Moody's but rated BBB-, BBB or BBB+ by S&P.
(3) Territorial bonds (other than those issued by Puerto Rico and counted
collectively) of any territory are limited to 10% of Moody's Eligible
Assets.
</TABLE>
For purposes of the maximum underlying obligor requirement described above,
any such Bond backed by a guaranty, letter of credit or insurance issued by a
third party will be deemed to be issued by such third party if the issuance of
such third party credit is the sole determinant of the rating on such Bond.
When the Fund sells a Municipal Bond and agrees to repurchase it at a
future date, such Bond will constitute a Moody's Eligible Asset and the amount
the Fund is required to pay upon repurchase of such Bond will count as a
liability for purposes of calculating the Preferred Shares Basic Maintenance
Amount. When the Fund purchases a Municipal Bond and agrees to sell it at a
future date to another party, cash receivable by the Fund in connection
therewith will constitute a Moody's Eligible Asset if the long-term debt of such
other party is rated at least A2 by Moody's and such agreement has a term of 30
days or less; otherwise such Bond will constitute a Moody's Eligible Asset.
Notwithstanding the foregoing, an asset will not be considered a Moody's
Eligible Asset if it is (i) held in a margin account, (ii) subject to any
material lien, mortgage, pledge, security interest or security agreement of any
kind, (iii) held for the purchase of a security pursuant to a Forward Commitment
or (iv) irrevocably deposited by the Fund for the payment of dividends or
redemption.
"Moody's Exposure Period" means the period commencing on and including a
given Valuation Date and ending 48 days thereafter.
"Moody's Hedging Transaction" has the meaning described on page B-9 of this
Prospectus.
B-3
<PAGE> 73
<TABLE>
"Moody's Volatility Factor" means 302% as long as there has not been
enacted an increase to the Marginal Tax Rate. If an increase is enacted to the
Marginal Tax Rate but not yet implemented, the Moody's Volatility Factor shall
be as follows:
<CAPTION>
% CHANGE IN MOODY'S VOLATILITY
MARGINAL TAX RATE FACTOR
----------------- ------------------
<S> <C>
5%............................................ 323%
5% but 10%............................................ 347%
10% but 15%............................................ 373%
15% but 20%............................................ 402%
20% but 25%............................................ 436%
25% but 30%............................................ 474%
30% but 35%............................................ 518%
35% but 40%............................................ 570%
</TABLE>
Notwithstanding the foregoing, the Moody's Volatility Factor may mean such
other potential dividend rate increase factor as Moody's advises the Fund in
writing is applicable.
"Other Preferred Shares" means all Municipal Income Preferred Shares of the
Fund other than the Preferred Shares offered here.
"Preferred Shares Basic Maintenance Amount," as of any Valuation Date,
means the dollar amount equal to (i) the sum of (A) the product of the number of
Preferred Shares and Other Preferred Shares outstanding on such Valuation Date
multiplied by the sum of (a) $50,000 and (b) any applicable redemption premium
per share attributable to the designation of a Premium Call Period; (B) the
aggregate amount of cash dividends (whether or not earned or declared) that will
have accumulated for each Preferred Share and Other Preferred Shares
outstanding, in each case, to (but not including) the end of the Dividend Period
for Preferred Shares and Other Preferred Shares in which such Valuation Date
occurs or to (but not including) the 49th day after such Valuation Date,
whichever is sooner; (C) the aggregate amount of cash dividends that would
accumulate at the Maximum Dividend Rate applicable to a Dividend Period of 28
days on any Preferred Shares and Other Preferred Shares outstanding from the end
of such Dividend Period through the 49th day after such Valuation Date,
multiplied by the larger of the Moody's Volatility Factor and the S&P Volatility
Factor, determined from time to time by Moody's and S&P, respectively (except
that if such Valuation Date occurs during a Non-Payment Period, the cash
dividend for purposes of calculation would accumulate at the then current
Non-Payment Period Rate); (D) the amount of anticipated expenses of the Fund for
the 90 days subsequent to such Valuation Date; (E) the amount of the Fund's
Maximum Potential Additional Dividend Liability as of such Valuation Date; and
(F) any current liabilities as of such Valuation Date to the extent not
reflected in any of (i)(A) through (i)(E) (including, without limitation, any
amounts due and payable by the Fund pursuant to repurchase agreements and any
payables for Municipal Bonds purchased as of such Valuation Date) less (ii)
either (A) the Discounted Value of any of the Fund's assets, or (B) the face
value of any of the Fund's assets if such assets mature prior to or on the date
of redemption of Preferred Shares or payment of a liability and are either
securities issued or guaranteed by the United States Government or, with respect
to Moody's, have a rating assigned by Moody's of at least Aaa, P-1, VMIG-1 or
MIG-1 and, with respect to S&P, have a rating assigned by S&P of at least AAA,
SP-1+ or A-1+, in both cases irrevocably deposited by the Fund for the payment
of the amount needed to redeem Preferred Shares subject to redemption or any of
(i)(B) through (i)(F).
"Preferred Shares Basic Maintenance Cure Date," with respect to the failure
by the Fund to satisfy the Preferred Shares Basic Maintenance Amount as of a
given Valuation Date, means the sixth Business Day following such Valuation
Date.
"Preferred Shares Basic Maintenance Report" means a report signed by the
President, Treasurer or any Executive Vice President or Vice President of the
Fund which sets forth, as of the related Valuation Date, the assets of the Fund,
the Market Value and the Discounted Value thereof (seriatim and in the
aggregate), and the Preferred Shares Basic Maintenance Amount.
B-4
<PAGE> 74
"Pricing Service" means Muller Investdata Corp., or any successor company
or entity, or any other entity designated from time to time by the Trustees.
Notwithstanding the foregoing, the Trustees will not designate a new Pricing
Service unless the Fund has received a written confirmation from Moody's and S&P
that such action would not impair the ratings then assigned by Moody's and S&P
to Preferred Shares.
"Quarterly Valuation Date" means the last Business Day of each fiscal
quarter of the Fund in each fiscal year of the Fund, commencing April 30, 1994.
<TABLE>
"S&P Discount Factor" means, for purposes of determining the Discounted
Value of any Municipal Bond which constitutes an S&P Eligible Asset, the
percentage determined by reference to (a) the rating by S&P or Moody's on such
Bond and (b) the S&P Exposure Period, in accordance with the table set forth
below:
<CAPTION>
S&P RATING CATEGORY
---------------------------------
S&P EXPOSURE PERIOD AAA AA A BBB
------------------- --- --- --- ---
<S> <C> <C> <C> <C>
40 Business Days.......................................... 190% 195% 210% 250%
22 Business Days.......................................... 170 175 190 230
10 Business Days.......................................... 155 160 175 215
7 Business Days.......................................... 150 155 170 210
3 Business Days.......................................... 130 135 150 190
</TABLE>
Notwithstanding the foregoing, (i) the S&P Discount Factor for
short-term Municipal Bonds will be 115%, so long as such Municipal Bonds are
rated A-1+ or SP-1+ by S&P and mature or have a demand feature exercisable in
30 days or less, or 125% if such Municipal Bonds are not rated by S&P but are
rated VMIG-1, P-1 or MIG-1 by Moody's and such short-term Municipal Bonds
referred to in this clause (i) shall qualify as S&P Eligible Assets; provided,
however, such short-term Municipal Bonds rated by Moody's but not rated by S&P
having a demand feature exercisable in 30 days or less must be backed by a
letter of credit, liquidity facility or guarantee from a bank or other
financial institution having a short-term rating of at least A-1+ from S&P; and
further provided that such short-term Municipal Bonds rated by Moody's but not
rated by S&P may comprise no more than 50% of short-term Municipal Bonds that
qualify as S&P Eligible Assets and (ii) no S&P Discount Factor will be applied
to cash or to Receivables for Municipal Bonds Sold. "Receivables for Municipal
Bonds Sold," for purposes of calculating S&P Eligible Assets as of any
Valuation Date, means the book value of receivables for Municipal Bonds sold as
of or prior to such Valuation Date if such receivables are due within five
Business Days of such Valuation Date. For purposes of the foregoing,
Anticipation Notes rated SP-1+ or, if not rated by S&P, rated VMIG-1 by
Moody's, whether or not they mature or have a demand feature exercisable in 30
days and which do not have a long-term rating, shall be considered to be
short-term Municipal Bonds and shall qualify as S&P Eligible Assets.
"S&P Eligible Asset" means cash, Receivables for Municipal Bonds Sold or a
Municipal Bond that (i) is issued by any of the 50 states, any territory or
possession of the United States, the District of Columbia, and any political
subdivision, instrumentality, county, city, town, village, school district or
agency (such as authorities and special districts created by the states) of any
of the foregoing and certain federally sponsored agencies such as local housing
authorities; (ii) is interest bearing and pays interest at least semi-annually;
(iii) is payable with respect to principal and interest in United States
Dollars; (iv) is publicly rated BBB or higher by S&P or, except in the case of
Anticipation Notes that are grant anticipation notes or bond anticipation notes
which must be rated by S&P to be included in S&P Eligible Assets, if not rated
by S&P but rated by Moody's, is rated at least A by Moody's (provided that such
Moody's-rated Municipal Bonds will be included in S&P Eligible Assets only to
the extent the Market Value of such Municipal Bonds does not exceed 50% of the
aggregate Market Value of the S&P Eligible Assets; and further provided that,
for purposes of determining the S&P Discount Factor applicable to any such
Moody's-rated Municipal Bond, such Municipal Bond will be deemed to have an S&P
rating which is one full rating category lower than its Moody's rating); (v) is
not part of a private placement of Municipal Bonds; and (vi) is part of an issue
of Municipal Bonds with an original issue size of at least $20 million or, if of
an issue with an original issue size below $20 million (but in no event below
$10 million), is issued by an issuer with a total of at least $50 million of
securities outstanding. Notwithstanding the foregoing:
B-5
<PAGE> 75
(1) Municipal Bonds of any one issuer will be considered S&P Eligible
Assets only to the extent the Market Value of such Municipal Bonds does not
exceed 10% of the aggregate Market Value of the S&P Eligible Assets,
provided that 2% is added to the applicable S&P Discount Factor for every
1% by which the Market Value of such Municipal Bonds exceeds 5% of the
aggregate Market Value of the S&P Eligible Assets; and
(2) Municipal Bonds issued by issuers in any one state or territory
will be considered S&P Eligible Assets only to the extent the Market Value
of such Municipal Bonds does not exceed 20% of the aggregate Market Value
of S&P Eligible Assets.
"S&P Exposure Period" means the maximum period of time following a
Valuation Date, including the Valuation Date and the Preferred Shares Basic
Maintenance Cure Date, that the Fund has to cure any failure to maintain, as of
such Valuation Date, a Discounted Value of its portfolio at least equal to the
Preferred Shares Basic Maintenance Amount.
"S&P Hedging Transactions" has the meaning described below.
<TABLE>
"S&P Volatility Factor" means 198% during the Initial Dividend Period.
Thereafter, "S&P Volatility Factor" means, depending on the applicable Reference
Rate, the following:
<CAPTION>
REFERENCE RATE
--------------
<S> <C>
Taxable Equivalent of the Short-Term Municipal Bond Rate........... 277%
30-day "AA" Composite Commercial Paper Rate........................ 228%
60-day "AA" Composite Commercial Paper Rate........................ 228%
90-day "AA" Composite Commercial Paper Rate........................ 222%
120-day "AA" Composite Commercial Paper Rate....................... 222%
180-day "AA" Composite Commercial Paper Rate....................... 217%
1-year U.S. Treasury Bill Rate..................................... 198%
2-year U.S. Treasury Note Rate..................................... 185%
3-year U.S. Treasury Note Rate..................................... 178%
4-year U.S. Treasury Note Rate..................................... 171%
5-year U.S. Treasury Note Rate..................................... 169%
</TABLE>
Notwithstanding the foregoing, the S&P Volatility Factor may mean such other
potential dividend rate increase factor as S&P advises the Trust in writing is
applicable.
"Valuation Date" means, for purposes of determining whether the Fund is
maintaining the Preferred Shares Basic Maintenance Amount and the Minimum
Liquidity Level, each Business Day commencing with the Date of Original Issue.
"Variation Margin" means, in connection with an outstanding futures
contract or option thereon owned or sold by the Fund, the amount of cash or
securities paid to or received from a broker (subsequent to the Initial Margin
payment) from time to time as the price of such futures contract or option
fluctuates.
Notwithstanding the foregoing, the Trustees may, without the vote or
consent of the Holders of Preferred Shares, from time to time amend, alter or
repeal certain of the foregoing definitions (or definitions of other terms
contained in the Fund's Bylaws) and any such amendment, alteration or repeal
will be deemed not to affect the preferences, rights or powers of Preferred
Shares or the Holders thereof, provided the Trustees receive written
confirmation from both Moody's and S&P, that any such amendment, alteration or
repeal would not impair the ratings then assigned to Preferred Shares by the
rating agency providing such confirmation.
PREFERRED SHARES BASIC MAINTENANCE AMOUNT
BASIC REQUIREMENT. The Fund shall maintain, on each Valuation Date, and
shall verify to its satisfaction that it is maintaining on such Valuation Date,
S&P Eligible Assets having an aggregate Discounted Value equal to or greater
than the Preferred Shares Basic Maintenance Amount and Moody's Eligible Assets
having an aggregate Discounted Value equal to or greater than the Preferred
Shares Basic
B-6
<PAGE> 76
Maintenance Amount. Upon any failure to maintain the required Discounted Value,
the Fund will use its best efforts to alter the composition of its portfolio to
reattain the Preferred Shares Basic Maintenance Amount on or prior to the
Preferred Shares Basic Maintenance Cure Date. If, on any Valuation Date, the
Fund shall have Moody's Eligible Assets with a Discounted Value which exceeds
the Preferred Shares Basic Maintenance Amount by not more than 5%, the Adviser
shall not alter the composition of the Fund's portfolio unless it determines
that such action will not cause the Fund to have Moody's Eligible Assets with a
Discounted Value less than the Preferred Shares Basic Maintenance Amount.
REPORTING REQUIREMENTS. The Fund will deliver a Preferred Shares Basic
Maintenance Report to the Remarketing Agent, the Paying Agent, Moody's and S&P
as of (i) each Quarterly Valuation Date, (ii) the first day of a Special
Dividend Period, and (iii) any other time when specifically requested by either
Moody's or S&P, in each case at or before 5:00 p.m., New York City time, on the
third Business Day after such day.
At or before 5:00 p.m., New York City time, on the third Business Day after
a Valuation Date on which the Fund fails to maintain Moody's Eligible Assets or
S&P Eligible Assets, as the case may be, with an aggregate Discounted Value
which exceeds the Preferred Shares Basic Maintenance Amount by 5% or more or to
satisfy the Preferred Shares Basic Maintenance Amount, the Fund shall complete
and deliver to the Remarketing Agent, the Paying Agent, Moody's and S&P a
Preferred Shares Basic Maintenance Report as of the date of such failure.
At or before 5:00 p.m., New York City time, on the third Business Day after
a Valuation Date on which the Fund cures any failure to satisfy the Preferred
Shares Basic Maintenance Amount, the Fund shall complete and deliver to the
Remarketing Agent, the Paying Agent, Moody's and S&P a Preferred Shares Basic
Maintenance Report as of the date of such cure.
A Preferred Shares Basic Maintenance Report or Accountant's Confirmation
will be deemed to have been delivered to the Remarketing Agents, the Paying
Agent, Moody's and S&P if the Remarketing Agent, the Paying Agent, Moody's and
S&P receive a copy or telecopy, telex or other electronic transcription thereof
and on the same day the Fund mails to the Remarketing Agent, the Paying Agent,
Moody's and S&P for delivery on the next Business Day the full Preferred Shares
Basic Maintenance Report. A failure by the Fund to deliver a Preferred Shares
Basic Maintenance Report shall be deemed to be delivery of a Preferred Shares
Basic Maintenance Report indicating that the Discounted Value for all assets of
the Fund is less than the Preferred Shares Basic Maintenance Amount, as of the
relevant Valuation Date.
Whenever the Fund delivers a Preferred Shares Basic Maintenance Report to
S&P as described above, it shall also deliver a Certificate of Minimum Liquidity
to the Remarketing Agent and the Paying Agent.
Within ten Business Days after the date of delivery to the Remarketing
Agents, the Paying Agent, S&P and Moody's of a Preferred Shares Basic
Maintenance Report relating to a Quarterly Valuation Date, the Independent
Accountant will confirm in writing to the Remarketing Agent, the Paying Agent,
S&P and Moody's (i) the mathematical accuracy of the calculations reflected in
such Report (and in any other Preferred Shares Basic Maintenance Report,
randomly selected by the Independent Accountant, that was delivered by the Fund
during the quarter ending on such Quarterly Valuation Date); (ii) that, in such
Report (and in such randomly selected Report), (a) the Fund determined in
accordance with the Bylaws whether the Fund had, at such Quarterly Valuation
Date (and at the Valuation Date addressed in such randomly selected Report), S&P
Eligible Assets of an aggregate Discounted Value at least equal to the Preferred
Shares Basic Maintenance Amount and Moody's Eligible Assets of an aggregate
Discounted Value at least equal to the Preferred Shares Basic Maintenance
Amount, (b) the aggregate amount of Dividend Coverage Assets equals or exceeds
the Dividend Coverage Amount, and (c) it has obtained confirmation from the
Pricing Service that the Market Value of portfolio securities as determined by
the Pricing Service equals the mean between the quoted bid and asked prices or
the yield equivalent (when quotations are readily available); (iii) that the
Fund has excluded from the Preferred Shares Basic Maintenance Report assets not
qualifying as Eligible Assets; and (iv) with respect to such confirmation to
Moody's, that the Fund has satisfied the requirements described below imposed by
Moody's with respect to transactions in options, futures and forward commitments
as of the Quarterly Valuation Date (and at the Valuation Date addressed in such
randomly selected Report) (such confirmation is herein called the "Accountant's
Confirmation"). In preparing the Accountant's Confirmation,
B-7
<PAGE> 77
the Independent Accountant shall be entitled to rely, without further
investigation, on such interpretations of law by the Fund as may have been
necessary for the Fund to perform the computations contained in the Preferred
Shares Basic Maintenance Report.
Within ten Business Days after the date of delivery to the Remarketing
Agent, the Paying Agent, S&P and Moody's of a Preferred Shares Basic Maintenance
Report relating to any Valuation Date on which the Fund failed to satisfy the
Preferred Shares Basic Maintenance Amount, the Independent Accountant will
provide to the Remarketing Agents, the Paying Agent, S&P and Moody's an
Accountant's Confirmation as to such Preferred Shares Basic Maintenance Report.
Within ten Business Days after the date of delivery to the Remarketing
Agent, the Paying Agent, S&P and Moody's of a Preferred Shares Basic Maintenance
Report relating to any Valuation Date on which the Fund cured any failure to
satisfy the Preferred Shares Basic Maintenance Amount, the Independent
Accountant will provide to the Remarketing Agents, the Paying Agent, S&P and
Moody's an Accountant's Confirmation as to such Preferred Shares Basic
Maintenance Report.
If any Accountant's Confirmation delivered as required above shows that an
error was made in the Preferred Shares Basic Maintenance Report for a particular
Valuation Date for which such Accountant's Confirmation was required to be
delivered, or shows that a lower aggregate Discounted Value for the aggregate of
all S&P Eligible Assets or Moody's Eligible Assets, as the case may be, of the
Fund was determined by the Independent Accountant, the calculation or
determination made by such Independent Accountant shall be final and conclusive
and shall be binding on the Fund, and the Fund shall accordingly amend and
deliver the Preferred Shares Basic Maintenance Report to the Remarketing Agents,
the Paying Agent, S&P and Moody's promptly following receipt by the Fund of such
Accountant's Confirmation.
At or before 5:00 p.m., New York City time, on the first Business Day after
the Date of Original Issue of the Preferred Shares, the Fund will complete and
deliver to Moody's and S&P a Preferred Shares Basic Maintenance Report as of the
close of business on such Date of Original Issue. Within five Business Days of
such Date of Original Issue, the Independent Accountant will provide to Moody's
and S&P an Accountant's Confirmation as to such Preferred Shares Basic
Maintenance Report.
At or before 5:00 p.m., New York City time, on the first Business Day
following any date on which the Fund repurchases any outstanding Common Shares,
the Fund will complete and deliver to Moody's and S&P a Preferred Shares Basic
Maintenance Report as of the close of business on the date of the repurchase.
MINIMUM LIQUIDITY LEVEL
For so long as any Preferred Shares are rated by S&P, the Fund shall be
required to maintain the Minimum Liquidity Level.
As of each Valuation Date, as long as any Preferred Shares are rated by
S&P, the Fund shall determine (i) the Market Value of the Dividend Coverage
Assets owned by the Fund as of that Valuation Date, (ii) the Dividend Coverage
Amount on that Valuation Date, and (iii) whether the Minimum Liquidity Level is
met as of that Valuation Date. The calculations of the Dividend Coverage Assets,
the Dividend Coverage Amount and whether the Minimum Liquidity Level is met
shall be set forth in a certificate (a "Certificate of Minimum Liquidity") dated
as of the Valuation Date and deliverable to S&P as provided herein. The
Preferred Shares Basic Maintenance Report and the Certificate of Minimum
Liquidity may be combined in one certificate. The Fund shall cause a Certificate
of Minimum Liquidity to be delivered to S&P not later than the close of business
on the third Business Day after a Valuation Date with respect to which a
Preferred Shares Basic Maintenance Report must be delivered. The Minimum
Liquidity Level shall be deemed to be met as of any Valuation Date if the Fund
has timely delivered a Certificate of Minimum Liquidity relating to such date
which states that the same has been met and which is not manifestly inaccurate.
In the event that a Certificate of Minimum Liquidity is not delivered to S&P
when required, the Minimum Liquidity Level shall be deemed not to have been met
as of the applicable date.
B-8
<PAGE> 78
If the Minimum Liquidity Level is not met as of any Valuation Date, then
the Fund shall purchase or otherwise acquire Dividend Coverage Assets to the
extent necessary so that the Minimum Liquidity Level is met as of the fifth
Business Day following such Valuation Date. The Fund shall, by such fifth
Business Day, provide to S&P a Certificate of Minimum Liquidity setting forth
the calculations of the Dividend Coverage Assets and the Dividend Coverage
Amount and showing that the Minimum Liquidity Level is met as of such fifth
Business Day together with a report of the custodian of the Fund's assets
confirming the amount of the Fund's Dividend Coverage Assets as of such fifth
Business Day.
FUTURES AND OPTIONS TRANSACTIONS; FORWARD CONTRACTS
S&P GUIDELINES. For so long as any Preferred Shares are rated by S&P, the
Fund will not purchase or sell futures contracts, write, purchase or sell
options on futures contracts or write put options (except covered put options)
or call options (except covered call options) on portfolio securities unless it
receives written confirmation from S&P that engaging in such transactions will
not impair the rating then assigned to the Preferred Shares by S&P, except that
the Fund may purchase or sell futures contracts based on the Bond Buyer
Municipal Bond Index (the "Municipal Index") or United States Treasury Bonds
with remaining maturities of ten years or more ("Treasury Bonds") and write,
purchase or sell put and call options on such contracts (collectively "S&P
Hedging Transactions"), subject to the following limitations:
(A) the Fund will not engage in any S&P Hedging Transaction based on
the Municipal Index (other than transactions which terminate a futures
contract or option held by the Fund by the Fund's taking an opposite
position thereto ("Closing Transactions")), which would cause the Fund at
the time of such transaction to own or have sold (1) 1,001 or more
outstanding futures contracts based on the Municipal Index, (2) outstanding
futures contracts based on the Municipal Index and on Treasury Bonds
exceeding in number 25% of the quotient of the Market Value of the Fund's
total assets divided by $100,000 or (3) outstanding futures contracts based
on the Municipal Index exceeding in number 10% of the average number of
daily traded futures contracts based on the Municipal Index in the thirty
days preceding the time of effecting such transaction as reported by The
Wall Street Journal;
(B) the Fund will not engage in any S&P Hedging Transaction based on
Treasury Bonds (other than Closing Transactions) which would cause the Fund
at the time of such transaction to own or have sold (1) outstanding futures
contracts based on Treasury Bonds and on the Municipal Index exceeding in
number 25% of the quotient of the Market Value of the Fund's total assets
divided by $100,000 or (2) outstanding futures contracts based on Treasury
Bonds exceeding in number 10% of the average number of daily traded futures
contracts based on Treasury Bonds in the thirty days preceding the time of
effecting such transaction as reported by The Wall Street Journal;
(C) the Fund will engage in Closing Transactions to close out any
outstanding futures contract which the Fund owns or has sold or any
outstanding option thereon owned by the Fund in the event (i) the Fund does
not have S&P Eligible Assets with an aggregate Discounted Value equal to or
greater than the Preferred Shares Basic Maintenance Amount on two
consecutive Valuation Dates and (ii) the Fund is required to pay Variation
Margin on the second such Valuation Date;
(D) the Fund will engage in a Closing Transaction to close out any
outstanding futures contract or option thereon in the month prior to the
delivery month under the terms of such futures contract or option thereon
unless the Fund holds the securities deliverable under such terms; and
(E) when the Fund writes a futures contract or option thereon
(including a futures contract or option thereon which requires delivery of
an underlying security), it will either maintain an amount of cash, cash
equivalents or short-term, fixed-income securities in a segregated account
with the Fund's custodian, so that the amount so segregated plus the amount
of Initial Margin and Variation Margin held in the account of or on behalf
of the Fund's broker with respect to such futures contract or option equals
the Market Value of the futures contract or option, or, in the event the
Fund writes a futures contract or option thereon which requires delivery of
an underlying security, it shall hold such underlying security in its
portfolio.
B-9
<PAGE> 79
For purposes of determining whether the Fund has S&P Eligible Assets with a
Discounted Value that equals or exceeds the Preferred Shares Basic Maintenance
Amount, such Discounted Value shall, unless the Fund receives written
confirmation from S&P to the contrary, be reduced by an amount equal to (i) 30%
of the aggregate settlement value, as marked to market, of any outstanding
futures contracts based on the Municipal Index which are owned by the Fund plus
(ii) 25% of the aggregate settlement value, as marked to market, of any
outstanding futures contracts based on Treasury Bonds which contracts are owned
by the Fund.
MOODY'S GUIDELINES. For so long as any Preferred Shares are rated by
Moody's, the Fund will not buy or sell futures contracts, write, purchase or
sell put or call options on futures contracts or write put or call options
(except covered call or put options) on portfolio securities unless it receives
written confirmation from Moody's that engaging in such transactions would not
impair the rating then assigned to the Preferred Shares by Moody's, except that
the Fund may purchase or sell exchange-traded futures contracts based on the
Municipal Index or Treasury Bonds and purchase, write or sell exchange-traded
put options on such futures contracts and purchase, write or sell
exchange-traded call options on such futures contracts (collectively "Moody's
Hedging Transactions"), subject to the following limitations:
(A) the Fund will not engage in any Moody's Hedging Transaction based
on the Municipal Index (other than Closing Transactions) which would cause
the Fund at the time of such transaction to own or have sold (1)
outstanding futures contracts based on the Municipal Index exceeding in
number 10% of the average number of daily traded futures contracts based on
the Municipal Index in the thirty days preceding the time of effecting such
transaction as reported by The Wall Street Journal or (2) outstanding
futures contracts based on the Municipal Index having a Market Value
exceeding the Market Value of Municipal Bonds constituting Moody's Eligible
Assets owned by the Fund;
(B) the Fund will not engage in any Moody's Hedging Transaction based
on Treasury Bonds (other than Closing Transactions) which would cause the
Fund at the time of such transaction to own or have sold in the aggregate
(1) outstanding futures contracts based on Treasury Bonds having an
aggregate Market Value exceeding 10% of the aggregate Market Value of all
Moody's Eligible Assets owned by the Fund and rated Aaa by Moody's, (2)
outstanding futures contracts based on Treasury Bonds having an aggregate
Market Value exceeding 50% of the aggregate Market Value of Moody's
Eligible Assets owned by the Fund and rated Aa by Moody's (or, if not rated
by Moody's but rated by S&P, rated AAA by S&P) or (3) outstanding futures
contracts based on Treasury Bonds having an aggregate Market Value
exceeding 90% of the aggregate Market Value of Moody's Eligible Assets
owned by the Fund and rated Baa or A by Moody's (or, if not rated by
Moody's but rated by S&P, rated A or AA by S&P) (for purposes of the
foregoing clauses (A) and (B), the Fund shall be deemed to own the number
of futures contracts that underlie any outstanding options written by the
Fund);
(C) the Fund will engage in Closing Transactions to close out any
outstanding futures contract based on the Municipal Index if the amount of
open interest in the Municipal Index as reported by The Wall Street Journal
is less than 5,000;
(D) the Fund will engage in a Closing Transaction to close out any
outstanding futures contract by no later than the fifth Business Day of the
month in which such contract expires and will engage in a Closing
Transaction to close out any outstanding option on a futures contract by no
later than the first Business Day of the month in which such option
expires;
(E) the Fund will engage in Moody's Hedging Transactions only with
respect to futures contracts or options thereon having the next settlement
date for such type of futures contract or option, or the settlement date
immediately thereafter;
(F) the Fund will not engage in options and futures transactions for
leveraging or speculative purposes unless Moody's shall advise the Fund
that to do so would not adversely affect Moody's then current rating of the
Preferred Shares; provided, however, that the Fund will not be deemed to
have engaged in a futures or options transaction for leveraging or
speculative purposes so long as it has done so otherwise in accordance with
the foregoing; and
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<PAGE> 80
(G) the Fund will not enter into an option or futures transaction
unless, after giving effect thereto, the Fund would continue to have
Moody's Eligible Assets with an aggregate Discounted Value equal to or
greater than the Preferred Shares Basic Maintenance Amount.
For purposes of determining whether the Fund has Moody's Eligible Assets
with an aggregate Discounted Value that equals or exceeds the Preferred Shares
Basic Maintenance Amount, the Discounted Value of Moody's Eligible Assets which
the Fund is obligated to deliver or receive pursuant to an outstanding futures
contract or option shall be as follows (unless the Fund receives written
confirmation to the contrary from Moody's): (i) assets subject to call options
written by the Fund which are either exchange-traded and "readily reversible" or
which expire within 48 days after the date as of which such valuation is made
shall be valued at the lesser of (a) Discounted Value and (b) the exercise price
of the call option written by the Fund; (ii) assets subject to call options
written by the Fund not meeting the requirements of clause (i) of this sentence
shall have no value; (iii) assets subject to put options written by the Fund
shall be valued at the lesser of (a) the exercise price and (b) the Discounted
Value of such security; and (iv) futures contracts shall be valued at the lesser
of (a) settlement price and (b) the Discounted Value of the subject security,
provided that, if a contract matures within 48 days after the date as of which
such valuation is made, where the Fund is the seller the contract may be valued
at the settlement price and where the Fund is the buyer the contract may be
valued at the Discounted Value of the subject securities.
For purposes of determining whether the Fund has Moody's Eligible Assets
with an aggregate Discounted Value that equals or exceeds the Preferred Shares
Basic Maintenance Amount, the following amounts shall be added to the Preferred
Shares Basic Maintenance Amount required to be maintained by the Fund (unless
the Fund receives written confirmation to the contrary from Moody's): (i) 10% of
the exercise price of a written call option; (ii) the exercise price of any
written put option; (iii) where the Fund is the seller under a futures contract,
10% of the settlement price of the futures contract; (iv) where the Fund is the
purchaser under a futures contract, the settlement price of assets to be
purchased under such futures contract; (v) the settlement price of the
underlying futures contract if the Fund writes put options on a futures
contract; and (vi) 105% of the Market Value of the underlying futures contracts
if the Fund writes call options on futures contracts and does not own the
underlying contract.
For so long as any Preferred Shares are rated by Moody's, the Fund will not
enter into any contract to purchase securities for a fixed price at a future
date beyond customary settlement time (other than such contracts that constitute
Moody's Hedging Transactions that are permitted above) unless it receives
written confirmation from Moody's that engaging in such transactions would not
impair the rating then assigned to the Preferred Shares by Moody's except that
the Fund may enter into such contracts to purchase newly-issued securities on
the date such securities are issued ("Forward Commitments"), subject to the
following limitations:
(A) the Fund will maintain in a segregated account with its custodian
cash, cash equivalents or short-term, fixed income securities rated P-1,
MIG-1 or VMIG-1 by Moody's and maturing prior to the date of the Forward
Commitment with a face value that equals or exceeds the amount of the
Fund's obligations under any Forward Commitments to which it is from time
to time a party or long-term fixed income securities with a Discounted
Value that equals or exceeds the amount of the Fund's obligations under any
Forward Commitments to which it is from time to time a party; and
(B) the Fund will not enter into a Forward Commitment unless, after
giving effect thereto, the Fund would continue to have Moody's Eligible
Assets with an aggregate Discounted Value equal to or greater than the
Preferred Shares Basic Maintenance Amount.
For purposes of determining whether the Fund has Moody's Eligible Assets
with an aggregate Discounted Value that equals or exceeds the Preferred Shares
Basic Maintenance Amount, the Discounted Value of all Forward Commitments to
which the Fund is a party and of all securities deliverable to the Fund pursuant
to such Forward Commitments shall be zero.
B-11
<PAGE> 81
APPENDIX C
DESCRIPTION OF BOND RATINGS
Moody's Investors Service, Inc. describes classifications of bonds as
follows:
AAA--Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt edge." Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements are
likely to change, such changes as can be visualized are most unlikely to impair
the fundamentally strong position of such issues.
AA--Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known as
high grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude or there may be other elements present
which make the long-term risks appear somewhat larger than in Aaa securities.
A--Bonds which are rated A possess many favorable investment attributes and
are to be considered as upper medium grade obligations. Factors giving security
to principal and interest are considered adequate but elements may be present
which suggest a susceptibility to impairment sometime in the future.
BAA--Bonds which are rated Baa are considered as medium grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Standard & Poor's Corporation describes classifications of bonds as
follows:
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, and in the majority of instances
they differ from the AAA issues only in small degree.
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 higher rated categories.
Fitch Investors Service, Inc. describes classifications of bonds as
follows:
AAA--Bonds considered to be investment grade and of the highest credit
quality. The obligor has an exceptionally strong ability to pay interest and
repay principal, which is unlikely to be affected by reasonably foreseeable
events.
AA--Bonds considered to be investment grade and of very high quality. The
obligor's ability to pay interest and repay principal is very strong, although
not as strong as bonds rated "AAA." Because bonds rated in the "AAA" and "AA"
categories are not significantly vulnerable to foreseeable future developments,
short-term debt of these issuers is generally rated "F-1+."
A--Bonds considered to be investment grade and of high credit quality. The
obligor's ability to pay interest and repay principal is considered to be
strong, but may be more vulnerable to adverse changes in economic conditions and
circumstances than bonds with higher ratings.
BBB--Bonds considered to be investment grade and of satisfactory credit
quality. The obligor's ability to pay interest and repay principal is considered
to be adequate. Adverse changes in economic conditions and circumstances,
however, are more likely to have adverse impact on the bonds, and therefore,
impair timely payment.
C-1
<PAGE> 82
APPENDIX D
FUTURES AND RELATED OPTIONS
GENERAL CHARACTERISTICS OF FUTURES CONTRACTS AND RELATED OPTIONS
Subject to the limitations described in Appendix B and elsewhere in this
Prospectus, the Fund may purchase and sell financial futures contracts and
related options in order to hedge against a change in the values of securities
that the Fund owns or expects to purchase.
The sale of a financial futures contract generally creates an obligation by
the seller to deliver the type of financial instrument called for in the
contract in a specified delivery month for a stated price. (As described below,
however, index futures contracts do not require actual delivery of securities
making up an index.) The purchase of a financial futures contract creates an
obligation by the purchaser to take delivery of the underlying financial
instrument in a specified delivery month at a stated price. The specific
instruments delivered or taken, respectively, at settlement date are not
determined until at or near that date. The determination is made in accordance
with the rules of the exchange or board of trade on which the sale or purchase
of the futures contract was made. Futures contracts are traded only on commodity
exchanges or boards of trade -- known as "contracts markets" -- approved for
such trading by the Commodity Futures Trading Commission, and must be executed
through a futures commission merchant, or brokerage firm, which is a member of
the relevant contract market.
Although most futures contracts by their terms call for actual delivery or
acceptance of commodities or securities, in most cases the contracts are closed
out before the settlement date without the making or taking of delivery. Closing
out a futures contract sale is effected by purchasing a futures contract for the
same aggregate amount of the specific type of financial instrument or commodity
and with the same delivery date. If the price of the initial sale of the futures
contract exceeds the price of the offsetting purchase, the seller is paid the
difference and realizes a gain. Conversely, if the price of the offsetting
purchase exceeds the price of the initial sale, the seller realizes a loss.
Similarly, the closing out of a futures contract purchase is effected by the
purchaser entering into a futures contract sale. If the offsetting sale price
exceeds the purchase price, the purchaser realizes a gain, and if the purchase
price exceeds the offsetting sale price, he realizes a loss.
When the Fund purchases or sells a futures contract, it is required to
deposit with the Fund's custodian an amount of cash and/or securities. This
amount is known as "initial margin." The nature of initial margin is similar to
a performance bond or good faith deposit that is returned to the Fund upon
termination of the contract, assuming the Fund satisfies its contractual
obligations.
Subsequent payments to and from the broker involved in the transaction
occur on a daily basis in a process known as "marking to market." These payments
are called "variation margin" and are made as the value of the futures contract
fluctuates. For example, when the Fund has purchased a futures contract and the
price of the underlying index or security has risen, that position may have
increased in value, in which event the Fund would receive from the broker a
variation margin payment. Conversely, when the Fund has purchased a futures
contract and the price of the underlying index or security has declined, the
position may be less valuable, in which event the Fund would be required to make
a variation margin payment to the broker.
When the Fund terminates a position in a futures contract, a final
determination of variation margin is made, additional cash is paid by or to the
Fund, and the Fund realizes a loss or a gain. Such closing transactions involve
additional commission costs.
INDEX FUTURES CONTRACTS AND OPTIONS. An index futures contract is a
contract to buy or sell units of a specified index at a specified future date at
a price agreed upon when the contract is made. Entering into a contract to buy
units of an index is commonly referred to as buying a contract or holding a long
position in the index. Entering into a contract to sell units of an index is
commonly referred to as selling a contract or holding a short position. A unit
is based on the current value of the index. For example, the Municipal Bond
Index futures contract currently traded on the Chicago Board of Trade is based
on The Bond Buyer Long-Term Municipal Bond Index. This Index is composed of 40
high quality federally tax exempt municipal securities with a remaining maturity
of 19 years or longer on the date of initial inclusion in the Index. The Index
assigns
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<PAGE> 83
relative weightings to the tax exempt municipal securities included in the
Index, and the Index fluctuates with changes in the market values of those
bonds. The Long-Term Municipal Bond Index futures contract trades in units equal
to $1,000 times the value of the Index. Unlike U.S. Treasury securities futures
contracts which require the actual delivery of the underlying Treasury security
at a future date, no delivery of the actual bonds making up the Index will take
place under an index futures contract. Instead, settlement in cash must occur
upon the termination of the contract, with the settlement being based on the
difference between the contract price and the actual level of the Index at the
expiration of the contract. For example, if the Fund enters into a futures
contract to buy 50 units of the Index at a specified future date at a value of
90 and the value of the Index is 95 on that future date, the Fund will gain
$250,000 (50 units times a gain of 5 times $1,000).
Options on index futures contracts are similar to options on securities
except that options on index futures contracts give the purchaser (holder) the
right in return for the premium paid to assume a position in an index 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 the
specified exercise price at any time during the period of the option. Upon
exercise of the option, the delivery of the index futures position by the writer
of the option to the holder of the option will be accompanied by delivery of the
accumulated balance in the writer's futures margin account maintained with
respect to the option, which represents the amount by which the market price of
the index 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 index
futures contract. If an option is exercised on the last trading day prior to the
expiration date of the option, the settlement will be made on the expiration
date entirely in cash based on the difference between the exercise price of the
option and the closing level of the index on which the futures contracts are
based. Purchasers of options who fail to exercise their options prior to
expiration suffer a loss of the premium paid.
As an alternative to purchasing and selling call and put options on index
futures contracts, the Fund may purchase and sell call and put options on the
underlying indices themselves to the extent that such options are traded on
national securities exchanges. Such options would be used in a manner identical
to the use of options on index futures contracts.
U.S. TREASURY SECURITY FUTURES CONTRACTS AND RELATED OPTIONS. The Fund may
purchase and sell futures contracts and related options on U.S. Treasury
securities when, in the opinion of Putnam, price movements in Treasury security
futures and related options will correlate closely with price movements of the
tax exempt securities which are the subject of a hedge. U.S. Treasury securities
futures contracts require the seller to deliver, or the purchaser to take
delivery of, the type of U.S. Treasury security called for in the contract at a
specified date and price. Options on U.S. Treasury security futures contracts
give the purchaser the right in return for the premium paid to assume a position
in a U.S. Treasury futures contract at the specified option exercise price at
any time during the period of the option.
SPECIAL RISKS OF TRANSACTIONS IN FUTURES CONTRACTS AND RELATED OPTIONS
HEDGING RISKS. There are several risks in connection with the use by the
Fund of futures contracts and options on such contracts as a hedging device. One
risk arises in connection with the use of index futures contracts and options
because of the imperfect correlation between movements in the prices of the
index futures contracts and movements in the prices of securities which are the
subject of a hedge. In addition, to the extent the credit quality, maturity, and
other characteristics of the securities making up a bond index vary from those
of the Fund's portfolio securities, the correlation between changes in the
values of such indices and changes in the values of the Fund's portfolio
securities will be limited. As a result, the Fund's hedging transactions based
on such indices may not achieve their intended purposes and may result in losses
to the Fund. Putnam will attempt to reduce these risks by purchasing and
selling, to the extent possible, futures contracts and options, the movements of
which will, in its judgment, correlate closely with movements in the prices of
the Fund's portfolio securities sought to be hedged.
Successful use of index futures contracts and related options by the Fund
for hedging purposes is also subject to Putnam's ability to predict correctly
movements in the direction of the market. For example, it is possible that,
where the Fund has sold futures to hedge its portfolio against a decline in the
market, the index
D-2
<PAGE> 84
on which the futures are written may advance and the value of securities held in
the Fund's portfolio may decline. If this occurred, the Fund would lose money on
its futures positions and also experience a decline in value in its portfolio
securities. In addition, the prices of index futures and related options may not
correlate perfectly with movements in the underlying index due to certain market
distortions. First, all participants in the futures market are subject to margin
deposit requirements. Such requirements may cause investors to close futures
contracts through offsetting transactions which could distort the normal
relationship between the index and futures markets. Second, the margin
requirements in the futures market are less onerous than margin requirements in
the securities market in general, and as a result the futures market may attract
more speculators than the securities market does. Increased participation by
speculators in the futures market may also cause temporary price distortions.
Due to the possibility of price distortion, even a correct forecast of general
market trends by Putnam may still not result in a successful hedging transaction
over a short time period. However, while this could occur to a certain degree,
Putnam believes that over time the value of the Fund's portfolio will tend to
move in the same direction as the market indices which are intended to correlate
with the price movements of such securities.
Similarly, successful use of U.S. Treasury security futures contracts or
options on U.S. Government securities by the Fund is subject to Putnam's ability
to predict correctly movements in the direction of interest rates and other
factors affecting markets for debt securities. For example, if the Fund has sold
U.S. Treasury security futures contracts or bought put options in order to hedge
against the possibility of an increase in interest rates which would adversely
affect tax exempt securities held in its portfolio, and the price of the Fund's
tax exempt securities increase instead as a result of a decline in interest
rates, the Fund will lose part or all of the benefit of the increased value of
its securities which it has hedged because it will have offsetting losses in its
futures or options positions. In addition, in such situations, if the Fund has
insufficient cash, it may have to sell securities to meet daily maintenance
margin requirements at a time when it may be disadvantageous to do so.
There is also a risk that price movements in U.S. Treasury security futures
contracts and options will not correlate closely with price movements in markets
for tax exempt securities. For example, if the Fund has hedged against a decline
in the values of tax exempt securities by selling Treasury security futures or
buying put options and the values of treasury securities subsequently increase
while values of tax exempt securities decrease, the Fund would incur losses on
both the Treasury security futures contracts written by it or put options bought
by it and on tax exempt securities held in its portfolio. Putnam will seek to
reduce this risk by monitoring movements in markets for U.S. Treasury security
futures and options and for tax exempt securities closely. The Fund will only
purchase or sell Treasury security futures or options when, in the opinion of
Putnam, price movements in Treasury security futures and options will correlate
closely with price movements in tax exempt securities.
Compared to the purchase or sale of futures contracts, the purchase of call
or put options on futures contracts or on U.S. Government securities involves
less potential risk to the Fund because the maximum amount at risk is the
premium paid for the options (plus transaction costs). However, there may be
circumstances when the purchase of a call or put option would result in a loss
to the Fund when the purchase or sale of a futures contract would not, such as
when there is no movement in the price of the underlying securities or index.
The writing of an option on a futures contract or security involves risks
similar to those risks relating to the sale of futures contracts.
There is no assurance that higher than anticipated trading activity or
other unforeseen events might not, at times, render certain market clearing
facilities inadequate, and thereby result in the institution by exchanges of
special procedures which may interfere with the timely execution of customer
orders.
The Fund's use of hedging strategies may result in a higher portfolio
turnover rate and additional brokerage costs.
LIQUIDITY RISKS. To reduce or eliminate a hedge position held by the Fund
(including for the purpose of taking a subsequent position in the same futures
contract), the Fund may seek to close out a position. Trading in certain futures
contracts and options began only recently. The ability to establish and close
out positions will be subject to the development and maintenance of a liquid
market. It is not certain that this market will
D-3
<PAGE> 85
develop or continue to exist. Reasons for the absence of a liquid market on an
exchange include the following: (i) there may be insufficient trading interest
in certain contracts or 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 contracts or options, or underlying securities; (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 contracts or options (or a particular
class or series of contracts or options), in which event the market on that
exchange (or in the class or series of contracts or options) would cease to
exist, although outstanding contracts or 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. If a trading market
were to become unavailable, the Fund could no longer engage in closing
transactions, and may be required to maintain a position in a hedging instrument
at a time when Putnam would otherwise have closed out the position. As a result,
the Fund may be unable to limit the amount of any loss resulting from its
positions in such an instrument.
REGULATORY MATTERS
The Fund will not enter into any transactions involving futures or related
options until it has received all necessary regulatory approvals, including from
the Commodity Futures Trading Commission. There can be no assurance that such
approvals will be obtained.
D-4
<PAGE> 86
===============================================================================
NO DEALER, SALESPERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS IN CONNECTION WITH THE OFFER MADE BY THIS PROSPECTUS AND, IF GIVEN OR
MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED BY THE FUND, PUTNAM OR THE UNDERWRITER. THIS PROSPECTUS DOES NOT
CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF ANY OFFER TO BUY ANY SECURITY
OTHER THAN THE PREFERRED SHARES OFFERED BY THIS PROSPECTUS, NOR DOES IT
CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF ANY OFFER TO BUY THE PREFERRED
SHARES BY ANYONE IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION IS NOT
AUTHORIZED OR IN WHICH THE PERSON MAKING SUCH OFFER OR SOLICITATION IS NOT
QUALIFIED TO DO SO OR TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER OR
SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE
HEREUNDER SHALL UNDER ANY CIRCUMSTANCES CREATE ANY IMPLICATION THAT THE
INFORMATION PROVIDED HEREIN IS CORRECT AT ANY TIME SUBSEQUENT TO THE DATE
HEREOF. HOWEVER, IF ANY MATERIAL CHANGE OCCURS WHILE THIS PROSPECTUS IS REQUIRED
BY LAW TO BE DELIVERED, THIS PROSPECTUS WILL BE AMENDED OR SUPPLEMENTED
ACCORDINGLY.
<TABLE>
------------------------
TABLE OF CONTENTS
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary.......................... 3
The Fund.................................... 13
Investment Manager and Administrator........ 13
Use of Proceeds............................. 13
Capitalization.............................. 14
Portfolio Composition....................... 14
Investment Objective and Policies........... 14
Other Investment Practices.................. 21
Investment Restrictions..................... 23
Trustees and Officers....................... 24
Principal Holders of Securities............. 26
Investment Management Contract.............. 27
Administrative Services Contract............ 28
Portfolio Transactions...................... 28
Determination of Net Asset Value............ 30
Remarketing................................. 30
Description of Preferred Shares............. 39
Description of Common Shares................ 51
Taxation.................................... 52
Underwriting................................ 57
Custodian, Transfer Agent, Dividend
Disbursing Agent and Registrar............ 58
Legal Matters............................... 58
Experts..................................... 58
Additional Information...................... 58
Report of Independent Accountants........... 59
Financial Statements........................ 60
Glossary.................................... 65
Appendix A.................................. A-1
Appendix B.................................. B-1
Appendix C.................................. C-1
Appendix D.................................. D-1
===============================================================================
</TABLE>
===============================================================================
$10,000,000
PUTNAM INVESTMENT
GRADE MUNICIPAL TRUST III
MUNICIPAL INCOME
PREFERRED SHARES
200 SHARES
LIQUIDATION PREFERENCE
$50,000 PER SHARE
------------------------
PROSPECTUS
------------------------
SMITH BARNEY SHEARSON INC.
FEBRUARY 7, 1994
===============================================================================
