FEDERATED EQUITY INCOME FUND II
(A PORTFOLIO OF FEDERATED INSURANCE SERIES)
PROSPECTUS
This prospectus offers shares of Federated Equity Income Fund II (the "Fund"),
which is a diversified investment portfolio of Federated Insurance Series (the
"Trust"), an open-end management investment company. The Fund's investment
objective is to provide above average income and capital appreciation. Shares of
the Fund may be sold only to separate accounts of insurance companies to serve
as the investment medium for variable life insurance policies and variable
annuity contracts issued by the insurance companies.
THE SHARES OFFERED BY THIS PROSPECTUS ARE NOT DEPOSITS OR OBLIGATIONS OF ANY
BANK, ARE NOT ENDORSED OR GUARANTEED BY ANY BANK, AND ARE NOT INSURED BY THE
FEDERAL DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD, OR ANY OTHER
GOVERNMENT AGENCY. INVESTMENT IN THESE SHARES INVOLVES INVESTMENT RISK,
INCLUDING THE POSSIBLE LOSS OF PRINCIPAL.
This prospectus contains the information you should read and know before you
invest in the Fund through the variable life insurance policies and variable
annuity contracts offered by insurance companies which provide for investment in
the Fund. Keep this prospectus for future reference.
The Fund has also filed a Statement of Additional Information dated December 16,
1996, with the Securities and Exchange Commission ("SEC"). The information
contained in the Statement of Additional Information is incorporated by
reference into this prospectus. You may request a copy of the Statement of
Additional Information or a paper copy of this prospectus, if you have received
your prospectus electronically, free of charge by calling 1-800-341-7400. To
obtain other information or to make inquiries about the Fund, contact the Fund
at the address listed in the back of this prospectus. The Statement of
Additional Information, material incorporated by reference into this document,
and other information regarding the Fund is maintained electronically with the
SEC at Internet Web site (http://www.sec.gov).
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED UPON
THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
FUND SHARES ARE AVAILABLE EXCLUSIVELY AS A FUNDING VEHICLE FOR LIFE INSURANCE
COMPANIES WRITING VARIABLE LIFE INSURANCE POLICIES AND VARIABLE ANNUITY
CONTRACTS. THIS PROSPECTUS SHOULD BE ACCOMPANIED BY THE PROSPECTUSES FOR SUCH
CONTRACTS.
Prospectus dated December 16, 1996
TABLE OF CONTENTS
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GENERAL INFORMATION 1
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INVESTMENT INFORMATION 1
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Investment Objective 1
Investment Policies 1
Portfolio Turnover 6
Investment Limitations 7
Hub and Spoke Option 7
NET ASSET VALUE 8
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INVESTING IN THE FUND 8
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Purchases and Redemptions 8
What Shares Cost 8
Dividends 9
FUND INFORMATION 9
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Management of the Fund 9
Distribution of Fund Shares 10
Administration of the Fund 10
Brokerage Transactions 11
Expenses of the Fund 11
SHAREHOLDER INFORMATION 11
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Voting Rights 11
TAX INFORMATION 12
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Federal Taxes 12
State and Local Taxes 12
PERFORMANCE INFORMATION 12
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APPENDIX 14
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ADDRESSES 18
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GENERAL INFORMATION
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The Fund is a portfolio of Federated Insurance Series, which was established as
Insurance Management Series, a Massachusetts buisness trust, under a Declaration
of Trust dated September 15, 1993. The Declaration of Trust permits the Trust to
offer separate series of shares of beneficial interest in separate portfolios of
securities, including the Fund. The shares in any one portfolio may be offered
in separate classes. As of the date of this prospectus, the Board of Trustees
("Trustees") have not established separate classes of shares.
Shares of the Fund are sold only to insurance companies as funding vehicles for
variable annuity contracts and variable life insurance policies issued by the
insurance companies. Shares of the Fund are sold at net asset value as described
in the section entitled "What Shares Cost." Shares of the Fund are redeemed at
net asset value.
INVESTMENT INFORMATION
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INVESTMENT OBJECTIVE
The investment objective of the Fund is to provide above average income and
capital appreciation. The investment objective cannot be changed without
approval of shareholders. While there is no assurance that the Fund will achieve
its investment objective, it endeavors to do so by following the investment
policies described in this prospectus.
INVESTMENT POLICIES
The investment policies described below may be changed by the Trustees without
shareholder approval. Shareholders will be notified before any material change
in these policies becomes effective.
ACCEPTABLE INVESTMENTS. The Fund attempts to achieve its objectives by
investing at least 65% of its assets in income-producing equity securities.
Equity securities include common stocks, preferred stocks, and securities
(including debt securities) that are convertible into common stocks. The portion
of the Fund's total assets invested in common stocks, preferred stocks, and
convertible securities will vary according to the Fund's assessment of market
and economic conditions and outlook.
The Fund's stock selection emphasizes those common stocks in each sector that
have good value, attractive yield, and dividend growth potential. The Fund will
utilize convertible securities because such securities typically offer high
yields and good potential for capital appreciation.
CONVERTIBLE SECURITIES. Convertible securities are fixed-income securities
which may be exchanged or converted into a predetermined number of the issuer's
underlying common stock at the option of the holder during a specified time
period. Convertible securities may take the form of convertible preferred stock,
convertible bonds or debentures, units consisting of "usable" bonds and warrants
or a combination of the features of several of these securities. The Fund
invests in convertible bonds rated "B" or higher by Standard & Poor's Rating
Group ("Standard & Poor's"),
or Moody's Investors Service, Inc. ("Moody's") at the time of investment, or if
unrated, of comparable quality. If a convertible bond is rated below "B"
according to the characteristics set forth here after the Fund has purchased it,
the Fund is not required to drop the convertible bond from the portfolio, but
will consider appropriate action. The investment characteristics of each
convertible security vary widely, which allows convertible securities to be
employed for different investment objectives.
Convertible bonds and convertible preferred stocks are fixed-income securities
that generally retain the investment characteristics of fixed-income securities
until they have been converted but also react to movements in the underlying
equity securities. The holder is entitled to receive the fixed-income of a bond
or the dividend preference of a preferred stock until the holder elects to
exercise the conversion privilege. Usable bonds are corporate bonds that can be
used in whole or in part, customarily at full face value, in lieu of cash to
purchase the issuer's common stock. When owned as part of a unit along with
warrants, which are options to buy the common stock, they function as
convertible bonds, except that the warrants generally will expire before the
bond's maturity. Convertible securities are senior to equity securities and,
therefore, have a claim to assets of the corporation prior to the holders of
common stock in the case of liquidation. However, convertible securities are
generally subordinated to similar nonconvertible securities of the same company.
The interest income and dividends from convertible bonds and preferred stocks
provide a stable stream of income with generally higher yields than common
stocks, but lower than nonconvertible securities of similar quality.
The Fund will exchange or convert the convertible securities held in its
portfolio into shares of the underlying common stock in instances in which, in
the opinion of the investment adviser to the Fund, the investment
characteristics of the underlying common shares will assist the Fund in
achieving its investment objectives. Otherwise, the Fund will hold or trade the
convertible securities. In selecting convertible securities for the Fund, the
adviser evaluates the investment characteristics of the convertible security as
a fixed-income instrument, and the investment potential of the underlying equity
security for capital appreciation. In evaluating these matters with respect to a
particular convertible security, the adviser considers numerous factors,
including the economic and political outlook, the value of the security relative
to other investment alternatives, trends in the determinants of the issuer's
profits, and the issuer's management capability and practices.
ZERO COUPON CONVERTIBLE SECURITIES. Zero coupon convertible securities are debt
securities which are issued at a discount to their face amount and do not
entitle the holder to any periodic payments of interest prior to maturity.
Rather, interest earned on zero coupon convertible securities accretes at a
stated yield until the security reaches its face amount at maturity. Zero coupon
convertible securities are convertible into a specific number of shares of the
issuer's common stock. In addition, zero coupon convertible securities usually
have put features that provide the holder with the opportunity to sell the bonds
back to the issuer at a stated price before maturity. Generally, the prices of
zero coupon convertible securities may be more sensitive to market interest rate
fluctuations than conventional convertible securities.
Federal income tax law requires the holder of a zero coupon convertible security
to recognize income from the security prior to the receipt of cash payments. To
maintain its qualification as a regulated investment company and avoid liability
of federal income taxes, the Fund will be required
to distribute income accrued from zero coupon convertible securities which it
owns, and may have to sell portfolio securities (perhaps at disadvantageous
times) in order to generate cash to satisfy these distribution requirements.
TEMPORARY INVESTMENTS. The Fund may also invest temporarily, in amounts of 35%
or less of the Fund's assets, in cash and cash items during times of unusual
market conditions to maintain liquidity. Cash items may include the following
short-term obligations:
commercial paper and Europaper (dollar denominated commercial paper
issued outside the United States);
instruments of domestic and foreign banks and savings associations (such
as certificates of deposit, demand and time deposits, savings shares, and
bankers' acceptances);
obligations of the U.S. government or its agencies or instrumentalities;
repurchase agreements; and other short-term instruments.
REPURCHASE AGREEMENTS. Repurchase agreements are arrangements in which banks,
broker/dealers, and other recognized financial institutions sell U.S. government
or other securities to the Fund and agree at the time of sale to repurchase them
at a mutually agreed upon time and price.
WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS. The Fund may purchase securities
on a when-issued or delayed delivery basis. These transactions are arrangements
in which the Fund purchases securities with payment and delivery scheduled for a
future time. The seller's failure to complete these transactions may cause the
Fund to miss a price or yield considered to be advantageous. Settlement dates
may be a month or more after entering into these transactions, and the market
values of the securities purchased may vary from the purchase prices.
The Fund may dispose of a commitment prior to settlement if the adviser deems it
appropriate to do so. In addition, the Fund may enter in transactions to sell
its purchase commitments to third parties at current market values and
simultaneously acquire other commitments to purchase similar securities at later
dates. The Fund may realize short-term profits or losses upon the sale of such
commitments.
LENDING OF PORTFOLIO SECURITIES. In order to generate additional income, the
Fund may lend portfolio securities, on a short-term or a long-term basis, up to
one-third of the value of its total assets to broker/dealers, banks, or other
institutional borrowers of securities. The Fund will only enter into loan
arrangements with broker/dealers, banks, or other institutions which the adviser
has determined are creditworthy and will receive collateral in the form of cash
or U.S. government securities equal to at least 100% of the value of the
securities loaned.
There is the risk that when lending portfolio securities, the securities may not
be available to the Fund on a timely basis and the Fund may, therefore, lose the
opportunity to sell the securities at a desirable price. In addition, in the
event that a borrower of securities would file for bankruptcy or become
insolvent, disposition of the securities may be delayed pending court action.
PUT AND CALL OPTIONS. The Fund may purchase put options on its portfolio
securities. These options will be used as a hedge to attempt to protect
securities which the Fund holds against decreases in value. The Fund may also
write call options on all or any portion of its portfolio to
generate income for the Fund. The Fund will write call options on securities
either held in its portfolio or for which it has the right to obtain without
payment of further consideration or for which it has segregated cash in the
amount of any additional consideration.
The Fund may generally purchase and write over-the-counter options on portfolio
securities in negotiated transactions with the buyers or writers of the options
since options on the portfolio securities held by the Fund are not traded on an
exchange. The Fund purchases and writes options only with investment dealers and
other financial institutions (such as commercial banks or savings associations)
deemed creditworthy by the adviser.
Over-the-counter options are two party contracts with price and terms negotiated
between buyer and seller. In contrast, exchange-traded options are third party
contracts with standardized strike prices and expiration dates and are purchased
from a clearing corporation. Exchange-traded options have a continuous liquid
market while over-the-counter options may not. The Fund will not buy call
options or write put options without further notification to shareholders.
FINANCIAL FUTURES AND OPTIONS ON FUTURES. The Fund may purchase and sell
financial futures contracts to hedge all or a portion of its portfolio against
changes in interest rates. Financial futures contracts call for the delivery of
particular debt instruments at a certain time in the future. The seller of the
contract agrees to make delivery of the type of instrument called for in the
contract and the buyer agrees to take delivery of the instrument at the
specified future time.
The Fund may also write call options and purchase put options on financial
futures contracts as a hedge to attempt to protect securities in its portfolio
against decreases in value. When the Fund writes a call option on a futures
contract, it is undertaking the obligation of selling a futures contract at a
fixed price at any time during a specified period if the option is exercised.
Conversely, as purchaser of a put option on a futures contract, the Fund is
entitled (but not obligated) to sell a futures contract at the fixed price
during the life of the option.
The Fund may not purchase or sell futures contracts or related options if
immediately thereafter the sum of the amount of margin deposits on the Fund's
existing futures positions and premiums paid for related options would exceed 5%
of the market value of the Fund's total assets. When the Fund purchases futures
contracts, an amount of cash and U.S. Treasury securities, equal to the
underlying commodity value of the futures contracts (less any related margin
deposits), will be deposited in a segregated account with the Fund's custodian
(or the broker, if legally permitted) to collateralize the position and thereby
insure that the use of such futures contract is unleveraged.
RISKS. When the Fund uses financial futures and options on financial futures as
hedging devices, much depends on the ability of the portfolio manager to predict
market conditions based upon certain economic analysis and factors. There is a
risk that the prices of the securities subject to the futures contracts may not
correlate perfectly with the prices of the securities in the Fund's portfolio.
This may cause the futures contract and any related options to react differently
than the portfolio securities to market changes. In addition, the portfolio
manager could be incorrect in its expectations about the direction or extent of
market factors such as interest rate movements. In these events, the Fund may
lose money on the futures contract or option.
It is not certain that a secondary market for positions in futures contracts or
for options will exist at all times. Although the portfolio manager will
consider liquidity before entering into options transactions, there is no
assurance that a liquid secondary market on an exchange or otherwise will exist
for any particular futures contract or option at any particular time. The Fund's
ability to establish and close out futures and options positions depends on this
secondary market.
RESTRICTED AND ILLIQUID SECURITIES. The Fund intends to invest in restricted
securities. Restricted securities are any securities in which the Fund may
otherwise invest pursuant to its investment objective and policies but which are
subject to restriction on resale under federal securities law. However, the Fund
will limit investments in illiquid securities, including certain restricted
securities determined by the Trustees to be illiquid, non-negotiable time
deposits and repurchase agreements providing for settlement in more than seven
days after notice, to 15% of its net assets.
The Fund may invest in commercial paper issued in reliance on the exemption from
registration afforded by Section 4(2) of the Securities Act of 1933. Section
4(2) commercial paper is restricted as to disposition under federal securities
law and is generally sold to institutional investors, such as the Fund, who
agree that they are purchasing the paper for investment purposes and not with a
view to public distribution. Any resale by the purchaser must be in an exempt
transaction. Section 4(2) commercial paper is normally resold to other
institutional investors like the Fund through or with the assistance of the
issuer or investment dealers who make a market in Section 4(2) commercial paper,
thus providing liquidity.
FOREIGN SECURITIES. The Fund reserves the right to invest in foreign securities
which are traded publicly in the United States. Investments in foreign
securities, particularly those of non-governmental issuers, involve
considerations which are not ordinarily associated with investments in domestic
issuers. These considerations include the possibility of expropriation, the
unavailability of financial information or the difficulty of interpreting
financial information prepared under foreign accounting standards, less
liquidity and more volatility in foreign securities markets, the impact of
political, social, or diplomatic developments, and the difficulty of assessing
economic trends in foreign countries. It may also be more difficult to enforce
contractual obligations abroad than would be the case in the United States
because of differences in the legal systems. Transaction costs in foreign
securities may be higher. The adviser will consider these and other factors
before investing in foreign securities and will not make such investments
unless, in its opinion, such investments will meet the Fund's standards and
objectives. The Fund will only purchase securities issued in U.S. dollar
denominations.
HIGH-YIELD CORPORATE DEBT OBLIGATIONS. The Fund may invest up to 35% of the
value of its total assets in corporate debt obligations that are not investment
grade bonds or are not rated but are determined by the adviser to be of
comparable quality. Securities which are rated BBB or lower by Standard & Poor's
or Baa or lower by Moody's either have speculative characteristics or are
speculative with respect to capacity to pay interest and repay principal in
accordance with the terms of the obligations. A description of the rating
categories is contained in the Appendix to this prospectus. There is no lower
limit with respect to rating categories for securities in which the Fund may
invest.
Corporate debt obligations that are not determined to be investment grade are
high-yield, high-risk bonds, typically subject to greater market fluctuations
and greater risk of loss of income and principal due to an issuer's default. To
a greater extent than investment grade bonds, lower rated bonds tend to reflect
short-term corporate, economic and market developments, as well as investor
perceptions of the issuer's credit quality. In addition, lower rated bonds may
be more difficult to dispose of or to value than high-rated, lower-yielding
bonds. The Fund does not intend to invest more than 5% of its assets in
corporate debt obligations that are not investment-grade bonds (excluding
securities convertible into equity securities) during the current fiscal year.
The adviser attempts to reduce the risks described above through diversification
of the portfolio and by credit analysis of each issuer as well as by monitoring
broad economic trends and corporate and legislative developments.
PORTFOLIO TURNOVER
Securities in the Fund's portfolio will be sold whenever the adviser believes it
is appropriate to do so in light of the Fund's investment objective, without
regard to the length of time a particular security may have been held. The
adviser to the Fund does not anticipate that portfolio turnover will result in
adverse tax consequences. Any such trading will increase the Fund's portfolio
turnover rate and transaction costs.
VARIABLE ASSET REGULATIONS. The Fund is also subject to variable contract asset
regulations prescribed by the U.S. Treasury Department under Section 817(h) of
the Internal Revenue Code. After a one year start-up period, the regulations
generally require that, as of the end of each calendar quarter or within 30 days
thereafter, no more than 55% of the total assets of the Fund may be represented
by any one investment, no more than 70% of the total assets of the Fund may be
represented by any two investments, no more than 80% of the total assets of the
Fund may be represented by any three investments, and no more than 90% of the
total assets of the Fund may be represented by any four investments. In applying
these diversification rules, all securities of the same issuer, all interests in
the same real property project, and all interests in the same commodity are each
treated as a single investment. In the case of government securities, each
government agency or instrumentality shall be treated as a separate issuer. If
the Fund fails to achieve the diversification required by the regulations,
unless relief is obtained from the Internal Revenue Service, the contracts
invested in the Fund will not be treated as annuity, endowment, or life
insurance contracts.
The Fund will be operated at all times so as to comply with the forgoing
diversification requirements.
STATE INSURANCE REGULATION. The Fund is intended to be a funding vehicle for
variable annuity contracts and variable life insurance policies offered by
certain insurance companies. The contracts will seek to be offered in as many
jurisdictions as possible. Certain states have regulations concerning, among
other things, the concentration of investments, sales and purchases of futures
contracts, and short sales of securities. If applicable, the Fund may be limited
in its ability to engage in such investments and to manage its portfolio with
desired flexibility. The Fund will operate in material compliance with the
applicable insurance laws and regulations of each jurisdiction in which
contracts will be offered by the insurance companies which invest in the Fund.
INVESTMENT LIMITATIONS
The Fund will not:
borrow money directly or through reverse repurchase agreements
(arrangements in which the Fund sells a portfolio instrument for a
percentage of its cash value with an agreement to buy it back on a set
date) or pledge securities except that under certain circumstances the
Fund may borrow up to one-third of the value of its total assets and
pledge up to 10% of the value of its total assets to secure such
borrowings;
sell securities short except, under strict limitations, it may maintain
open short positions so long as not more than 10% of the value of its net
assets is held as collateral for those positions;
invest more than 5% of the value of its total assets in securities of one
issuer (except cash and cash items, repurchase agreements, and U.S.
government obligations) or acquire more than 10% of any class of voting
securities of any issuer; or
purchase portfolio instruments if, as a result of such purchase, 25% or
more of the value of its total assets would be invested in any one
industry.
The above investment limitations cannot be changed without shareholder approval.
The following limitations, however, may be changed by the Trustees without
shareholder approval. Shareholders will be notified before any material change
in these limitations becomes effective.
The Fund will not:
commit more than 5% of the value of its total assets to premiums on open
put option positions; or
invest more than 5% of its total assets in warrants.
HUB AND SPOKE OPTION
If the Trustees determine it to be in the best interest of the Fund and its
shareholders, the Fund may in the future seek to achieve its investment
objective by investing all of its assets in another investment company having
the same investment objective and substantially the same investment policies and
restrictions as those applicable to the Fund. It is expected that any such
investment company would be managed in substantially the same manner as the
Fund.
The initial shareholder of the Fund (which is an affiliate of Federated
Securities Corp.) voted to vest authority to use this investment structure in
the sole discretion of the Trustees. No further approval of shareholders is
required. Shareholders will receive at least 30 days prior notice of any such
investment.
In making its determination, the Trustees will consider, among other things, the
benefits to shareholders and/or the opportunity to reduce costs and achieve
operational efficiencies. Although it is expected that the Trustees will not
approve an arrangement that is likely to result in higher costs, no assurance is
given that costs will remain the same or be materially reduced if this
investment structure is implemented.
NET ASSET VALUE
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The net asset value per share of the Fund fluctuates. It is determined by
dividing the sum of the market value of all securities and other assets of the
Fund, less liabilities, by the number of shares outstanding.
INVESTING IN THE FUND
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PURCHASES AND REDEMPTIONS
Shares of the Fund are not sold directly to the general public. The Fund's
shares are used solely as the investment vehicle for separate accounts of
insurance companies offering variable life insurance policies and variable
annuity contracts. The use of Fund shares as investments for both variable life
insurance policies and variable annuity contracts is referred to as "mixed
funding." The use of Fund shares as investments by separate accounts of
unaffiliated life insurance companies is referred to as "shared funding."
The Fund intends to engage in mixed funding and shared funding in the future.
Although the Fund does not currently foresee any disadvantage to contract owners
due to differences in redemption rates, tax treatment, or other consideration,
resulting from mixed funding or shared funding, the Trustees of the Fund will
closely monitor the operation of mixed funding and shared funding and will
consider appropriate action to avoid material conflicts and take appropriate
action in response to any material conflicts which occur. Such action could
result in one or more participating insurance companies withdrawing their
investment in the Fund.
Shares of the Fund are purchased or redeemed on behalf of participating
insurance companies at the next computed net asset value after an order is
received on days on which the New York Stock Exchange is open.
WHAT SHARES COST
The net asset value is determined at the close of trading (normally 4:00 p.m.
Eastern time), on the New York Stock Exchange, Monday through Friday, except on:
(i) days on which there are not sufficient changes in the value of the Fund's
portfolio securities that its net asset value might be materially affected; (ii)
days during which no shares are tendered for redemption and no orders to
purchase shares are received; or (iii) the following holidays: New Year's Day,
Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving Day, and Christmas Day.
Purchase orders from separate accounts investing in the Fund which are received
by the insurance companies by 4:00 p.m. (Eastern time) will be computed at the
net asset value of the Fund determined on that day, as long as such purchase
orders are received by the Fund in proper form and in accordance with applicable
procedures by 8:00 a.m. (Eastern time) on the next business day and as long as
federal funds in the amount of such orders are received by the Fund on the next
business day. It is the responsibility of each insurance company which invests
in the Fund to properly transmit purchase orders and federal funds in accordance
with the procedures described above.
DIVIDENDS
Dividends on shares of the Fund are declared and paid monthly.
Shares of the Fund begin earning dividends if owned on the record date.
Dividends of the Fund are automatically reinvested in additional shares of such
Fund on payment dates at the ex-dividend date net asset value.
FUND INFORMATION
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MANAGEMENT OF THE FUND
BOARD OF TRUSTEES. The Trust is managed by a Board of Trustees. The Trustees
are responsible for managing the Trust's business affairs and for exercising all
the Trust's powers except those reserved for the shareholders. An Executive
Committee of the Board of Trustees handles the Board's responsibilities between
meetings of the Board.
INVESTMENT ADVISER. Investment decisions for the Fund are made by Federated
Advisers, the Fund's investment adviser, subject to direction by the Trustees.
The adviser continually conducts investment research and supervision for the
Fund and is responsible for the purchase or sale of portfolio instruments, for
which it receives an annual fee from the Fund.
ADVISORY FEES. The adviser receives an annual investment advisory fee
equal to 0.75% of the Fund's average daily net assets. The adviser may
voluntarily waive a portion of its fee or reimburse the Fund for certain
operating expenses. The adviser can terminate this voluntary waiver at any
time at its sole discretion.
ADVISER'S BACKGROUND. Federated Advisers, a Delaware business trust
organized on April 11, 1989, is a registered investment adviser under the
Investment Advisers Act of 1940. It is a subsidiary of Federated Investors.
All of the Class A (voting) shares of Federated Investors are owned by a
trust, the trustees of which are John F. Donahue, Chairman and Trustee of
Federated Investors, Mr. Donahue's wife, and Mr. Donahue's son, J.
Christopher Donahue, who is President and Trustee of Federated Investors.
Federated Advisers and other subsidiaries of Federated Investors serve as
investment advisers to a number of investment companies and private
accounts. Certain other subsidiaries also provide administrative services
to a number of investment companies. With over $80 billion invested across
more than 250 funds under management and/or administration by its
subsidiaries, as of December 31, 1995, Federated Investors is one of the
largest mutual fund investment managers in the United States. With more
than 1,800 employees, Federated continues to be led by the management who
founded the company in 1955. Federated funds are presently at work in and
through 4,000 financial institutions nationwide. More than 100,000
investment professionals have selected Federated funds for their clients.
Both the Fund and the adviser have adopted strict codes of ethics governing the
conduct of all employees who manage the Fund and its portfolio securities. These
codes recognize that such
persons owe a fiduciary duty to the Fund's shareholders and must place the
interests of shareholders ahead of the employees' own interests. Among other
things, the codes: require preclearance and periodic reporting of personal
securities transactions; prohibit personal transactions in securities being
purchased or sold, or being considered for purchase or sale, by the Fund;
prohibit purchasing securities in initial public offerings; and prohibit taking
profits on securities held for less than sixty days. Violations of the codes are
subject to review by the Trustees, and could result in severe penalties.
Christopher H. Wiles has been the Fund's portfolio manager since inception. Mr.
Wiles joined Federated Investors in 1990 and has been a Vice President of the
Fund's investment adviser since 1992. Mr. Wiles served as Assistant Vice
President of the Fund's investment adviser in 1991. Mr. Wiles is a Chartered
Financial Analyst and received his M.B.A. in Finance from Cleveland State
University.
DISTRIBUTION OF FUND SHARES
Federated Securities Corp. is the principal distributor for shares of the Fund.
It is a Pennsylvania corporation organized on November 14, 1969, and is the
principal distributor for a number of investment companies. Federated Securities
Corp. is a subsidiary of Federated Investors.
DISTRIBUTION PLAN. Under a distribution plan adopted in accordance with Rule
12b-1 under the Investment Company Act of 1940 (the "Plan"), the distributor may
be paid a fee by the Fund in an amount computed at an annual rate of up to .25%
of the average daily net asset value of the Fund. The distributor may select
financial institutions such as banks, fiduciaries, custodians for public funds,
investment advisers, and broker/dealers to provide sales services or
distribution-related support services as agents for their clients or customers.
Financial institutions will receive fees based upon shares owned by their
clients or customers. The schedules of such fees will be determined from time to
time by the distributor. The Fund is not currently paying any 12b-1 fees under
the Plan. Should the Fund begin to pay these fees, shareholders will be
notified.
The Plan is a compensation-type Plan. As such, the Fund makes no payments to the
distributor except as described above. Therefore, the Fund does not pay for
unreimbursed expenses of the distributor, including amounts expended by the
distributor in excess of amounts received by it from the Fund, interest,
carrying or other financing charges in connection with excess amounts expended,
or the distributor's overhead expenses. However, the distributor may be able to
recover such amounts or may earn a profit from future payments made by the Fund
under the Plan.
ADMINISTRATION OF THE FUND
ADMINISTRATIVE SERVICES. Federated Services Company, a subsidiary of Federated
Investors, provides administrative personnel and services (including certain
legal and financial reporting services) necessary to operate the Fund. Federated
Services Company provides these at an annual rate which relates to the average
aggregate daily net assets of all funds advised by affiliates of Federated
Investors as specified below:
<TABLE>
<CAPTION>
MAXIMUM
ADMINISTRATIVE FEE AVERAGE AGGREGATE DAILY NET ASSETS
<S> <C>
0.15% on the first $250 million
0.125% on the next $250 million
0.10% on the next $250 million
0.075% on assets in excess of $750 million
</TABLE>
The administrative fee received during any fiscal year shall be at least
$125,000 per portfolio and $30,000 per each additional class of shares.
Federated Services Company may choose voluntarily to waive a portion of its fee.
BROKERAGE TRANSACTIONS
When selecting brokers and dealers to handle the purchase and sale of portfolio
instruments, the adviser looks for prompt execution of the order at a favorable
price. In working with dealers, the adviser will generally utilize those who are
recognized dealers in specific portfolio instruments, except when a better price
and execution of the order can be obtained elsewhere. In selecting among firms
believed to meet these criteria, the adviser may give consideration to those
firms which have sold or are selling shares of the Fund and other funds
distributed by Federated Securities Corp. The adviser makes decisions on
portfolio transactions and selects brokers and dealers subject to review by the
Trustees.
EXPENSES OF THE FUND
Holders of shares of the Fund pay their allocable portion of Trust and Fund
expenses.
The Trust expenses for which holders of shares of the Fund pay their allocable
portion include, but are not limited to the cost of: organizing the Trust and
continuing its existence; registering the Trust with federal and state
securities authorities; Trustees' fees; auditors' fees; meetings of Trustees and
shareholders and proxy solicitations therefor; legal fees of the Trust;
association membership dues; and such non-recurring and extraordinary items as
may arise from time to time.
The Fund expenses for which holders of shares of the Fund pay their allocable
portion include, but are not limited to: registering the portfolio and shares of
the portfolio; investment advisory services; taxes and commissions; custodian
fees; insurance premiums; auditors' fees; and such non-recurring and
extraordinary items as may arise from time to time.
SHAREHOLDER INFORMATION
- --------------------------------------------------------------------------------
VOTING RIGHTS
The insurance company separate accounts, as shareholders of the Fund, will vote
the Fund shares held in their separate accounts at meetings of the shareholders.
Voting will be in accordance with instructions received from contract owners of
the separate accounts, as more fully outlined in the prospectus of the separate
account.
Each share of the Fund gives the shareholder one vote in Trustee elections and
other matters submitted to shareholders for vote. All shares of each portfolio
in the Trust have equal voting rights
except that only shares of the Fund are entitled to vote on matters affecting
only the Fund. As a Massachusetts business trust, the Trust is not required to
hold annual shareholder meetings. Shareholder approval will be sought only for
certain changes in the Trust's or the fund's operation and for the election of
the Trustees in certain circumstances.
Trustees may be removed by the Trustees or by shareholders at a special meeting.
A special meeting of shareholders shall be called by the Trustees upon the
written request of shareholders owning at least 10% of the outstanding shares of
all series of the Trust.
TAX INFORMATION
- --------------------------------------------------------------------------------
FEDERAL INCOME TAX
The Fund will pay no federal income tax because it expects to meet requirements
of the Internal Revenue Code, applicable to regulated investment companies and
to receive the special tax treatment afforded to such companies.
The Fund will be treated as a single, separate entity for federal income tax
purposes so that income (including capital gains) and losses realized by the
Trust's other portfolios will not be combined for tax purposes with those
realized by the Fund.
The Fund intends to comply with the variable asset diversification regulations
which are described earlier in this prospectus. If the Fund fails to comply with
these regulations, contracts invested in the Fund shall not be treated as
annuity, endowment, or life insurance contracts under the Internal Revenue Code.
Contract owners should review the applicable contract prospectus for information
concerning the federal income tax treatment of their contracts and distributions
from the Fund to the separate accounts.
STATE AND LOCAL TAXES
Contract owners are urged to consult their own tax advisers regarding the status
of their contracts under state and local tax laws.
PERFORMANCE INFORMATION
- --------------------------------------------------------------------------------
From time to time, the Fund advertises total return and yield.
Total return represents the change, over a specific period of time, in the value
of an investment in each class of shares after reinvesting all income and
capital gains distributions. It is calculated by dividing that change by the
initial investment and is expressed as a percentage.
The yield of each class of shares is calculated by dividing the net investment
income per share (as defined by the Securities and Exchange Commission) earned
by the Fund over a thirty-day period by the maximum offering price per share of
the Fund on the last day of the period. This number is then annualized using
semi-annual compounding. The yield does not necessarily reflect income
actually earned by the Fund and, therefore, may not correlate to the dividends
or other distributions paid to shareholders.
Performance information will not reflect the charges and expenses of a variable
annuity or variable life insurance contract. Because shares of the Fund can only
be purchased by a separate account of an insurance company offering such a
contract, you should review the performance figures of the contract in which you
are invested, which performance figures will accompany any advertisement of the
Fund's performance.
From time to time, advertisements for the Fund may refer to ratings, rankings,
and other information in certain financial publications and/or compare the
Fund's performance to certain indices.
APPENDIX
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STANDARD AND POOR'S RATINGS GROUP LONG-TERM DEBT RATINGS
AAA--Debt rated AAA has the highest rating assigned by Standard & Poor's.
Capacity to pay interest and repay principal is extremely strong.
AA--Debt rated AA has a very strong capacity to pay interest and repay principal
and differs from the higher rated issues only in small degree.
A--Debt rated A has a strong capacity to pay interest and repay principal
although it is somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in higher rated categories.
BBB--Debt rated BBB is regarded as having an adequate capacity to pay interest
and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher rated categories.
BB--Debt rated BB has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure to
adverse business, financial, or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments. The BB
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied BBB- rating.
B--Debt rated B has greater vulnerability to default but currently has the
capacity to meet interest payments and principal repayments. Adverse business,
financial, or economic conditions will likely impair capacity or willingness to
pay interest and repay principal. The B rating category is also used for debt
subordinated to senior debt that is assigned an actual or implied BB or BB-
rating.
CCC--Debt rated CCC has currently identifiable vulnerability to default and is
dependent upon favorable business, financial, and economic conditions to meet
timely payment of interest and repayment of principal. In the event of adverse
business, financial, or economic conditions, it is not likely to have the
capacity to pay interest and repay principal. The CCC rating category is also
used for debt subordinated to senior debt that is assigned an actual or implied
B or B- rating.
CC--The rating CC typically is applied to debt subordinated to senior debt that
is assigned an actual or implied CCC debt rating.
C--The rating C typically is applied to debt subordinated to senior debt which
is assigned an actual or implied CCCdebt rating. The C rating may be used to
cover a situation where a bankruptcy petition has been filed, but debt service
payments are continued.
CI--The rating CI is reserved for income bonds on which no interest is being
paid.
D--Debt rated D is in payment default. The D rating category is used when
interest payments or principal payments are not made on the date due even if the
applicable grace period has not expired, unless S&P believes that such payments
will be made during such grace period. The D
rating also will be used upon the filing of a bankruptcy petition if debt
service payments are jeopardized.
MOODY'S INVESTORS SERVICE, INC., CORPORATE BOND RATINGS
AAA--Bonds which are rated Aaa are judged to be of the best quality. They carry
the smallest degree of investment risk and are generally referred to as "gilt
edged." 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 some time in the future.
BAA--Bonds which are rated Baa are considered as medium-grade obligations, i.e.,
they are neither highly protected nor poorly secured. Interest payments and
principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and, in
fact, have speculative characteristics as well.
BA--Bonds which are Ba are judged to have speculative elements; their future
cannot be considered as well-assured. Often the protection of interest and
principal payments may be very moderate and thereby not well safeguarded during
both good and bad times over the future. Uncertainty of position characterizes
bonds in this class.
B--Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
CAA--Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal or
interest.
CA--Bonds which are rated Ca represent obligations which are speculative in a
high degree. Such issues are often in default or have other marked shortcomings.
C--Bonds which are rated C are the lowest rated class of bonds and issues so
rated can be regarded as having extremely poor prospects of ever attaining any
real investment standing.
FITCH INVESTORS SERVICE, INC., LONG-TERM DEBT RATINGS
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 quite as strong as bonds rated AAA. Because bonds rated in the AAA and AA
categories are not significantly vulnerable to foreseeable future developments,
short-term debt of these issuers is generally rated F-1+.
A--Bonds considered to be investment grade and of high credit quality. The
obligor's ability to pay interest and repay principal is considered to be
strong, but may be more vulnerable to adverse changes in economic conditions and
circumstances than bonds with higher ratings.
BBB--Bonds considered to be investment grade and of satisfactory credit quality.
The obligor's ability to pay interest and repay principal is considered to be
adequate. Adverse changes in economic conditions and circumstances, however, are
more likely to have adverse impact on these bonds and, therefore, impair timely
payment. The likelihood that the ratings of these bonds will fall below
investment grade is higher than for bonds with higher ratings.
BB--Bonds are considered speculative. The obligor's ability to pay interest and
repay principal may be affected over time by adverse economic changes. However,
business and financial alternatives can be identified which could assist the
obligor in satisfying its debt service requirements.
B--Bonds are considered highly speculative. While bonds in this class are
currently meeting debt service requirements, the probability of continued timely
payment of principal and interest reflects the obligor's limited margin of
safety and the need for reasonable business and economic activity throughout the
life of the issue.
CCC--Bonds have certain identifiable characteristics which, if not remedied, may
lead to default. The ability to meet obligations requires an advantageous
business and economic environment.
CC--Bonds are minimally protected. Default in payment of interest and/or
principal seems probable over time.
C--Bonds are in imminent default in payment of interest or principal.
DDD, DD, AND D--Bonds are in default on interest and/or principal payments. Such
bonds are extremely speculative and should be valued on the basis of their
ultimate recovery value in liquidation or reorganization of the obligor. DDD
represents the highest potential for recovery on these bonds, and D represents
the lowest potential for recovery.
NR--NR indicates that Fitch does not rate the specific issue.
PLUS (+) OR MINUS (-): Plus or minus signs are used with a rating symbol to
indicate the relative position of a credit within the rating category. Plus and
minus signs, however, are not used in the AAA category.
MOODY'S INVESTORS SERVICE, INC. COMMERCIAL PAPER RATINGS
PRIME-1--Issuers rated Prime-1 (or related supporting institutions) have a
superior capacity for repayment of short-term promissory obligations. Prime-1
repayment capacity will normally be evidenced by the following characteristics:
Leading market positions in well established industries.
High rates of return on funds employed.
Conservative capitalization structure with moderate reliance on debt and
ample asset protection.
Broad margins in earning coverage of fixed financial charges and high
internal cash generation.
Well established access to a range of financial markets and assured
sources of alternate liquidity.
PRIME-2--Issuers rated Prime-2 (or related supporting institutions) have a
strong capacity for repayment of short-term promissory obligations. This will
normally be evidenced by many of the characteristics cited above, but to a
lesser degree. Earnings trends and coverage ratios, while sound, will be more
subject to variation. Capitalization characteristics, while still appropriate,
may be more affected by external conditions. Ample alternate liquidity is
maintained.
STANDARD AND POOR'S RATINGS GROUP COMMERCIAL PAPER RATINGS
A-1--This designation indicates that the degree of safety regarding timely
payment is strong. Those issues determined to possess extremely strong safety
characteristics are denoted with a plus sign (+) designation.
A-2--Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designated A-1.
FITCH INVESTORS SERVICE, INC. COMMERCIAL PAPER RATING DEFINITIONS
FITCH-1--(Highest Grade) Commercial paper assigned this rating is regarded as
having the strongest degree of assurance for timely payment.
FITCH-2--(Very Good Grade) Issues assigned this rating reflect an assurance of
timely payment only slightly less in degree than the strongest issues.
ADDRESSES
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
Federated Equity Income Fund II
Federated Investors Tower
Pittsburgh, Pennsylvania 15222-3779
- -----------------------------------------------------------------------------------------------------------------------
Distributor
Federated Securities Corp. Federated Investors Tower
Pittsburgh, Pennsylvania 15222-3779
- -----------------------------------------------------------------------------------------------------------------------
Investment Adviser
Federated Advisers Federated Investors Tower
Pittsburgh, Pennsylvania 15222-3779
- -----------------------------------------------------------------------------------------------------------------------
Custodian
State Street Bank and P.O. Box 8600
Trust Company Boston, Massachusetts 02266-8600
- -----------------------------------------------------------------------------------------------------------------------
Transfer Agent and Dividend Disbursing Agent
Federated Shareholder Services Company P.O. Box 8600
Boston, Massachusetts 02266-8600
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Independent Auditors
Deloitte & Touche LLP 2500 One PPG Place
Pittsburgh, Pennsylvania 15222-5401
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</TABLE>
FEDERATED EQUITY
INCOME FUND II
PROSPECTUS
A Diversified Portfolio of
Federated Insurance Series,
An Open-End, Management
Investment Company
December 16, 1996
[LOGO OF FEDERATED INVESTORS]
Federated Investors Tower
Pittsburgh, PA 15222-3779
Federated Securities Corp. is the distributor of the fund
and a subsidiary of Federated Investors.
Cusip 313916801
G01298-01 (12/96)
FEDERATED EQUITY INCOME FUND II
(A PORTFOLIO OF FEDERATED INSURANCE SERIES)
STATEMENT OF ADDITIONAL INFORMATION
This Statement of Additional Information should be read with the
prospectus for Federated Equity Income Fund II (the ``Fund'), a
portfolio of Federated Insuance Series (the ``Trust') dated December
16, 1996. This Statement is not a prospectus itself. You may request a
copy of a prospectus or a paper copy of this Statement, if you received
it electronically, free of charge by calling 1-800-341-7400.
Statement dated December 16, 1996
FEDERATED INVESTORS
Federated Investors Tower
Pittsburgh, PA 15222-3779
Federated Securities Corp. is the distributor of the Fund
and is a subsidiary of Federated Investors.
Cusip 313916801
G01298-02 (12/96)
GENERAL INFORMATION ABOUT THE FUND 1
INVESTMENT OBJECTIVES AND POLICIES 1
CONVERTIBLE SECURITIES 1
TEMPORARY INVESTMENTS 1
WARRANTS 2
WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS 2
REPURCHASE AGREEMENTS 2
FUTURES AND OPTIONS TRANSACTIONS 2
RESTRICTED AND ILLIQUID SECURITIES 4
LENDING OF PORTFOLIO SECURITIES 4
REVERSE REPURCHASE AGREEMENTS 4
PORTFOLIO TURNOVER 4
INVESTMENT LIMITATIONS 4
FEDERATED INSURANCE SERIES MANAGEMENT 7
FUND OWNERSHIP 11
TRUSTEES COMPENSATION 11
TRUSTEE LIABILITY 12
INVESTMENT ADVISORY SERVICES 12
ADVISER TO THE FUND 12
ADVISORY FEES 12
BROKERAGE TRANSACTIONS 12
OTHER SERVICES 12
FUND ADMINISTRATION 12
CUSTODIAN AND PORTFOLIO ACCOUNTANT 12
TRANSFER AGENT 13
INDEPENDENT AUDITORS 13
PURCHASING SHARES 13
DISTRIBUTION PLAN 13
DETERMINING NET ASSET VALUE 13
DETERMINING MARKET VALUE OF SECURITIES 13
MASSACHUSETTS PARTNERSHIP LAW 14
TAX STATUS 14
THE FUND'S TAX STATUS 14
SHAREHOLDERS' TAX STATUS 14
TOTAL RETURN 14
YIELD 14
PERFORMANCE COMPARISONS 15
ECONOMIC AND MARKET INFORMATION 16
ABOUT FEDERATED INVESTORS 16
MUTUAL FUND MARKET 16
GENERAL INFORMATION ABOUT THE FUND
The Fund is a portfolio of Federated Insurance Series (the `Trust''),
which was established as Insurance Management Series, a Massachusetts
business trust, under a Declaration of Trust dated September 15, 1993. At
a meeting of the Board of Trustees (the `Trustees'') held on November 14,
1995, the Trustees approved an amendment to the Declaration of Trust to
change the name of the Trust from `Insurance Management Series'' to
`Federated Insurance Series.'' The Declaration of Trust permits the Trust
to offer separate series of shares of beneficial interest in separate
portfolios of securities, including the Fund. The shares in any one
portfolio may be offered in separate classes. As of the date of this
Statement, the Trustees have not established separate classes of shares.
INVESTMENT OBJECTIVES AND POLICIES
The Fund's investment objective is to provide above average income and
capital appreciation. The investment objective cannot be changed without
approval of shareholders.
CONVERTIBLE SECURITIES
As with all fixed-income securities, various market forces influence the
market value of convertible securities, including changes in the level of
interest rates. As the level of interest rates increases, the market value
of convertible securities may decline and, conversely, as interest rates
decline, the market value of convertible securities may increase. The
unique investment characteristic of convertible securities, the right to be
exchanged for the issuer's common stock, causes the market value of
convertible securities to increase when the underlying common stock
increases. However, since securities prices fluctuate, there can be no
assurance of capital appreciation, and most convertible securities will not
reflect quite as much capital appreciation as their underlying common
stocks. When the underlying common stock is experiencing a decline, the
value of the convertible security tends to decline to a level approximating
the yield-to-maturity basis of straight nonconvertible debt of similar
quality, often called `investment value,'' and may not experience the same
decline as the underlying common stock.
Many convertible securities sell at a premium over their conversion values
(i.e., the number of shares of common stock to be received upon conversion
multiplied by the current market price of the stock). This premium
represents the price investors are willing to pay for the privilege of
purchasing a fixed-income security with a possibility of capital
appreciation due to the conversion privilege. If this appreciation
potential is not realized, the premium may not be recovered.
TEMPORARY INVESTMENTS
The temporary investments in which the Fund may invest include, but are not
limited to:
o commercial paper rated A-1 or A-2 by Standard & Poor's Ratings Group,
Prime-1 or Prime-2 by Moody's Investors Service, Inc., or F-1 or F-2
by Fitch Investors Service, Inc., and Europaper rated A-1, A-2, Prime-
1, or Prime-2. In the case where commercial paper or Europaper has
received different ratings from different rating services, such
commercial paper or Europaper is an acceptable temporary investment so
long as at least one rating is one of the preceding high-quality
ratings and provided the Fund's investment adviser has determined that
such investment presents minimal credit risks;
o instruments of domestic and foreign banks and savings associations if
they have capital, surplus, and undivided profits of over
$100,000,000, or if the principal amount of the instrument is insured
2
by the Federal Deposit Insurance Corporation. These instruments may
include Eurodollar Certificates of Deposits (`ECDs''), Yankee
Certificates of Deposit (`Yankee CDs''), and Eurodollar Time Deposits
(`ETDs'');
o obligations of the U.S. government or its agencies or
instrumentalities;
o repurchase agreements; and
o other short-term instruments which are not rated but are determined by
the adviser to be of comparable quality to the other temporary
obligations in which the Fund may invest.
INVESTMENT RISKS
ECDs, ETDs, Yankee CDs, and Europaper are subject to different risks
than domestic obligations of domestic banks or corporations. Examples
of these risks include international economic and political
developments, foreign governmental restrictions that may adversely
affect the payment of principal or interest, foreign withholding or
other taxes on interest income, difficulties in obtaining or enforcing
a judgment against the issuing entity, and the possible impact of
interruptions in the flow of international currency transactions.
Different risks may also exist for ECDs, ETDs, and Yankee CDs because
the banks issuing these instruments, or their domestic or foreign
branches, are not necessarily subject to the same regulatory
requirements that apply to domestic banks, such as reserve
requirements, loan limitations, examinations, accounting, auditing,
recordkeeping, and the public availability of information. These
factors will be carefully considered by the adviser in selecting
investments for the Fund.
WARRANTS
Warrants basically are options to purchase common stock at a specific price
(usually at a premium above the market value of the optioned common stock
at issuance) valid for a specific period of time. Warrants may have a life
ranging from less than a year to twenty years or may be perpetual. However,
warrants have expiration dates after which they are worthless. In addition,
if the market price of the common stock does not exceed the warrant's
exercise price during the life of the warrant, the warrant will expire as
worthless. Warrants have no voting rights, pay no dividends, and have no
rights with respect to the assets of the corporation issuing them. The
percentage increase or decrease in the market price of the warrant may tend
to be greater than the percentage increase or decrease in the market price
of the optioned common stock.
WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS
These transactions are made to secure what is considered to be an
advantageous price or yield for the Fund. No fees or other expenses, other
than normal transaction costs, are incurred. However, liquid assets of the
Fund sufficient to make payment for the securities to be purchased are
segregated on the Fund's records at the trade date. These assets are marked
to market daily and are maintained until the transaction has been settled.
The Fund does not intend to engage in when-issued and delayed delivery
transactions to an extent that would cause the segregation of more than 20%
of the total value of its assets.
REPURCHASE AGREEMENTS
The Fund or its custodian will take possession of the securities subject to
repurchase agreements, and these securities will be marked to market daily.
To the extent that the original seller does not repurchase the securities
from the Fund, the Fund could receive less than the repurchase price on any
4
sale of such securities. In the event that such a defaulting seller filed
for bankruptcy or became insolvent, disposition of such securities by the
Fund might be delayed pending court action. The Fund believes that under
the regular procedures normally in effect for custody of the Fund's
portfolio securities subject to repurchase agreements, a court of competent
jurisdiction would rule in favor of the Fund and allow retention or
disposition of such securities. The Fund will only enter into repurchase
agreements with banks and other recognized financial institutions, such as
broker/dealers, which are deemed by the adviser to be creditworthy pursuant
to guidelines established by the Board of Trustees (the `Trustees'').
FUTURES AND OPTIONS TRANSACTIONS
The Fund may attempt to hedge all or a portion of its portfolio by buying
and selling financial futures contracts, buying put options on portfolio
securities and listed put options on futures contracts, and writing call
options on futures contracts. The Fund may also write covered call options
on portfolio securities to attempt to increase its current income.
FINANCIAL FUTURES CONTRACTS
A futures contract is a firm commitment by two parties: the seller who
agrees to make delivery of the specific type of security called for in
the contract (`going short'') and the buyer who agrees to take
delivery of the security (`going long'') at a certain time in the
future.
In the fixed-income securities market, price moves inversely to
interest rates. A rise in rates means a drop in price. Conversely, a
drop in rates means a rise in price. In order to hedge its holdings of
fixed-income securities against a rise in market interest rates, the
Fund could enter into contracts to deliver securities at a
predetermined price (i.e., `go short'') to protect itself against the
possibility that the prices of its fixed-income securities may decline
during the Fund's anticipated holding period. The Fund would `go
long''(agree to purchase securities in the future at a predetermined
price) to hedge against a decline in market interest rates.
PUT OPTIONS ON FINANCIAL FUTURES CONTRACTS
The Fund may purchase listed put options on financial futures
contracts. Unlike entering directly into a futures contract, which
requires the purchaser to buy a financial instrument on a set date at
a specified price, the purchase of a put option on a futures contract
entitles (but does not obligate) its purchaser to decide on or before
a future date whether to assume a short position at the specified
price.
The Fund would purchase put options on futures contracts to protect
portfolio securities against decreases in value resulting from an
anticipated increase in market interest rates. Generally, if the
hedged portfolio securities decrease in value during the term of an
option, the related futures contracts will also decrease in value and
the option will increase in value. In such an event, the Fund will
normally close out its option by selling an identical option. If the
hedge is successful, the proceeds received by the Fund upon the sale
of the second option will be large enough to offset both the premium
paid by the Fund for the original option plus the decrease in value of
the hedged securities.
Alternatively, the Fund may exercise its put option. To do so, it
would simultaneously enter into a futures contract of the type
underlying the option (for a price less than the strike price of the
option) and exercise the option. The Fund would then deliver the
futures contract in return for payment of the strike price. If the
6
Fund neither closes out nor exercises an option, the option will
expire on the date provided in the option contract, and the premium
paid for the contract will be lost.
CALL OPTIONS ON FINANCIAL FUTURES CONTRACTS
In addition to purchasing put options on futures, the Fund may write
listed call options on futures contracts to hedge its portfolio
against an increase in market interest rates. When the Fund writes a
call option on a futures contract, it is undertaking the obligation of
assuming a short futures position (selling a futures contract) at the
fixed strike price at any time during the life of the option if the
option is exercised. As market interest rates rise, causing the prices
of futures to go down, the Fund's obligation under a call option on a
future (to sell a futures contract) costs less to fulfill, causing the
value of the Fund's call option position to increase.
In other words, as the underlying futures price goes down below the
strike price, the buyer of the option has no reason to exercise the
call, so that the Fund keeps the premium received for the option. This
premium can offset the drop in value of the Fund's fixed-income
portfolio which is occurring as interest rates rise.
Prior to the expiration of a call written by the Fund, or exercise of
it by the buyer, the Fund may close out the option by buying an
identical option. If the hedge is successful, the cost of the second
option will be less than the premium received by the Fund for the
initial option. The net premium income of the Fund will then offset
the decrease in value of the hedged securities.
The Fund will not maintain open positions in futures contracts it has
sold or call options it has written on futures contracts if, in the
aggregate, the value of the open positions (marked to market) exceeds
the current market value of its securities portfolio plus or minus the
unrealized gain or loss on those open positions, adjusted for the
correlation of volatility between the hedged securities and the
futures contracts. If this limitation is exceeded at any time, the
Fund will take prompt action to close out a sufficient number of open
contracts to bring its open futures and options positions within this
limitation.
``MARGIN'' IN FUTURES TRANSACTIONS
Unlike the purchase or sale of a security, the Fund does not pay or
receive money upon the purchase or sale of a futures contract. Rather,
the Fund is required to deposit an amount of `initial margin'' in
cash or U.S. Treasury bills with its custodian (or the broker, if
legally permitted). The nature of initial margin in futures
transactions is different from that of margin in securities
transactions in that futures contract initial margin does not involve
the borrowing of funds by the Fund to finance the transactions.
Initial margin is in the nature of a performance bond or good-faith
deposit on the contract which is returned to the Fund upon termination
of the futures contract, assuming all contractual obligations have
been satisfied.
A futures contract held by the Fund is valued daily at the official
settlement price of the exchange on which it is traded. Each day the
Fund pays or receives cash, called `variation margin,'' equal to the
daily change in value of the futures contract. This process is known
as `marking to market.'' Variation margin does not represent a
borrowing or loan by the Fund but is instead settlement between the
Fund and the broker of the amount one would owe the other if the
8
futures contract expired. In computing its daily net asset value, the
Fund will mark to market its open futures positions.
The Fund is also required to deposit and maintain margin when it
writes call options on futures contracts.
PURCHASING PUT OPTIONS ON PORTFOLIO SECURITIES
The Fund may purchase put options on portfolio securities to protect
against price movements in particular securities in its portfolio. A
put option gives the Fund, in return for a premium, the right to sell
the underlying security to the writer (seller) at a specified price
during the term of the option.
WRITING COVERED CALL OPTIONS ON PORTFOLIO SECURITIES
The Fund may also write covered call options to generate income. As
writer of a call option, the Fund has the obligation upon exercise of
the option during the option period to deliver the underlying security
upon payment of the exercise price. The Fund may only sell call
options either on securities held in its portfolio or on securities
which it has the right to obtain without payment of further
consideration (or has segregated cash in the amount of any additional
consideration).
RESTRICTED AND ILLIQUID SECURITIES
The Trustees may consider the following criteria in determining the
liquidity of certain restricted securities:
o the frequency of trades and quotes for the security;
o the number of dealers willing to purchase or sell the security and the
number of other potential buyers;
o dealer undertakings to make a market in the security; and
o the nature of the security and the nature of the marketplace trades.
LENDING OF PORTFOLIO SECURITIES
The collateral received when the Fund lends portfolio securities must be
valued daily and, should the market value of the loaned securities
increase, the borrower must furnish additional collateral to the Fund.
During the time portfolio securities are on loan, the borrower pays the
Fund any dividends or interest paid on such securities. Loans are subject
to termination at the option of the Fund or the borrower. The Fund may pay
reasonable administrative and custodial fees in connection with a loan and
may pay a negotiated portion of the interest earned on the cash or
equivalent collateral to the borrower or placing broker. The Fund does not
have the right to vote securities on loan, but would terminate the loan and
regain the right to vote if that were considered important with respect to
the investment.
REVERSE REPURCHASE AGREEMENTS
The Fund may also enter into reverse repurchase agreements. This
transaction is similar to borrowing cash. In a reverse repurchase agreement
the Fund transfers possession of a portfolio instrument to another person,
such as a financial institution, broker, or dealer, in return for a
percentage of the instrument's market value in cash, and agrees that on a
stipulated date in the future the Fund will repurchase the portfolio
instrument by remitting the original consideration plus interest at an
agreed upon rate. The use of reverse repurchase agreements may enable the
Fund to avoid selling portfolio instruments at a time when a sale may be
deemed to be disadvantageous, but the ability to enter into reverse
repurchase agreements does not ensure that the Fund will be able to avoid
selling portfolio instruments at a disadvantageous time.
10
When effecting reverse repurchase agreements, liquid assets of the Fund, in
a dollar amount sufficient to make payment for the obligations to be
purchased, are segregated at the trade date. These securities are marked to
market daily and maintained until the transaction is settled.
PORTFOLIO TURNOVER
The Fund will not attempt to set or meet a portfolio turnover rate since
any turnover would be incidental to transactions undertaken in an attempt
to achieve the Fund's investment objective. Securities in the Fund's
portfolio will be sold whenever the adviser believes it is appropriate to
do so in light of the Fund's investment objective, without regard to the
length of time a particular security may have been held. The adviser does
not anticipate that portfolio turnover will result in adverse tax
consequences. Any such trading will increase the Fund's portfolio turnover
rate and transaction costs.
INVESTMENT LIMITATIONS
The following limitations are fundamental [except that no investment
limitation of the Fund shall prevent the Fund from investing substantially
all of its assets (except for assets which are not considered `investment
securities''under the Investment Company Act of 1940, or assets exempted
by the Securities and Exchange Commission) in an open-end investment
company with substantially the same investment objectives]:
BUYING ON MARGIN
The Fund will not purchase any securities on margin but may obtain
such short-term credits as are necessary for clearance of
transactions. The deposit or payment by the Fund of initial or
variation margin in connection with financial futures contracts or
related options transactions is not considered the purchase of a
security on margin.
SELLING SHORT
The Fund will not sell securities short unless during the time the
short position is open, it owns an equal amount of the securities sold
or securities readily and freely convertible into or exchangeable,
without payment of additional consideration, for securities of the
same issue as, and equal in amount to, the securities sold short; and
not more than 10% of the Fund's net assets (taken at current value) is
held as collateral for such sales at any one time.
ISSUING SENIOR SECURITIES AND BORROWING MONEY
The Fund will not issue senior securities except that the Fund may
borrow money and engage in reverse repurchase agreements in amounts up
to one-third of the value of its total assets, including the amounts
borrowed.
The Fund will not borrow money or engage in reverse repurchase
agreements for investment leverage, but rather as a temporary,
extraordinary, or emergency measure or to facilitate management of the
portfolio by enabling the Fund to meet redemption requests when the
liquidation of portfolio securities is deemed to be inconvenient or
disadvantageous. The Fund will not purchase any securities while any
borrowings are outstanding.
PLEDGING ASSETS
The Fund will not mortgage, pledge, or hypothecate any assets except
to secure permitted borrowings. In those cases, it may pledge assets
having a market value not exceeding the lesser of the dollar amounts
borrowed or 10% of the value of total assets at the time of the
borrowing. Margin deposits for the purchase and sale of financial
futures contracts and related options are not deemed to be a pledge.
12
INVESTING IN REAL ESTATE
The Fund will not purchase or sell real estate, although it may invest
in securities of issuers whose business involves the purchase or sale
of real estate or in securities which are secured by real estate or
interest in real estate.
INVESTING IN COMMODITIES
The Fund will not purchase or sell commodities, except that the Fund
may purchase and sell financial futures contracts and related options.
UNDERWRITING
The Fund will not underwrite any issue of securities, except as it may
be deemed to be an underwriter under the Securities Act of 1933 in
connection with the sale of restricted securities which the Fund may
purchase pursuant to its investment objectives, policies, and
limitations.
LENDING CASH OR SECURITIES
The Fund will not lend any of its assets except portfolio securities
up to one-third of the value of its total assets. This shall not
prevent the purchase or holding of corporate bonds, debentures, notes,
certificates of indebtedness or other debt securities of an issuer,
repurchase agreements, or other transactions which are permitted by
the Fund's investment objectives and policies.
CONCENTRATION OF INVESTMENTS
The Fund will not purchase portfolio instruments if, as a result of
such purchase, 25% or more of the value of its total assets would be
invested in any one industry.
DIVERSIFICATION OF INVESTMENTS
The Fund will not invest more than 5% of the value of its total assets
in securities of one issuer (except cash and cash items, repurchase
agreements, and U.S. government obligations) or acquire more than 10%
of any class of voting securities of any issuer. For these purposes,
the Fund takes all common stock and all preferred stock of an issuer
each as a single class, regardless of priorities, series,
designations, or other differences.
The above investment limitations cannot be changed without shareholder
approval. The following limitations, however, may be changed by the
Trusteess without shareholder approval [except that no investment
limitation of the Fund shall prevent the Fund from investing substantially
all of its assets (except for assets which are not considered ``nvestment
securities''under the Investment Company Act of 1940, or assets exempted
by the Securities and Exchange Commision) in an open-end investment company
with substantially the same investment objectives]. Shareholders will be
notified before any material change in these limitations becomes effective.
INVESTING IN SECURITIES OF OTHER INVESTMENT COMPANIES
The Fund will not purchase securities of other investment companies
except as part of a merger, consolidation, or other acquisition.
ARBITRAGE TRANSACTIONS
The Fund will not engage in arbitrage transactions.
ACQUIRING SECURITIES
The Fund will not purchase securities of a company for the purpose of
exercising control or management. However, the Fund may purchase up to
10% of the voting securities of any one issuer and may exercise its
voting powers consistent with the best interests of the Fund. In
addition, the Fund, other companies advised by the adviser, and other
affiliated companies may together buy and hold substantial amounts of
voting stock of a company and may vote together in regard to such
company's affairs. In some cases, the Fund and its affiliates might
14
collectively be considered to be in control of such company. In some
cases, Trustees and other persons associated with the Fund and its
affiliates might possibly become directors of companies in which the
Fund holds stock.
WRITING COVERED CALL OPTIONS AND PURCHASING PUT OPTIONS
The Fund will not write call options on securities unless the
securities are held in the Fund's portfolio or unless the Fund is
entitled to them in deliverable form without further payment or after
segregating cash in the amount of any further payment. The Fund will
not purchase put options on securities unless the securities are held
in the Fund's portfolio. The Fund will not commit more than 5% of the
value of its total assets to premiums on open option positions.
INVESTING IN WARRANTS
The Fund will not invest more than 5% of its total assets in warrants.
No more than 2% of the Fund's net assets, to be included within the
overall 5% limit on investments in warrants, may be warrants which are
not listed on the New York or American Stock Exchange.
INVESTING IN RESTRICTED AND ILLIQUID SECURITIES
The Fund will not invest more than 15% of its net assets in illiquid
securities, including certain restricted securities (except for
Section 4(2) commercial paper and certain other restricted securities
which meet the criteria for liquidity as established by the Trustees),
non-negotiable time deposits, and repurchase agreements providing for
settlement in more than seven days after notice.
Except with respect to borrowing money, if a percentage limitation is
adhered to at the time of investment, a later increase or decrease in
percentage resulting from any change in value or net assets will not result
in a violation of such restriction.
The Fund has no present intention to borrow money, invest in reverse
repurchase agreements, pledge securities, or sell securities short in
excess of 5% of the value of its total assets during the current fiscal
year.
For purposes of its policies and limitations, the Fund considers
certificates of deposit and demand and time deposits issued by a U.S.
branch of a domestic bank or savings association having capital, surplus,
and undivided profits in excess of $100,000,000 at the time of investment
to be `cash items.''
FEDERATED INSURANCE SERIES MANAGEMENT
Officers and Trustees are listed with their addresses, birthdates, present
positions with Federated Insurance Series, and principal occupations.
John F. Donahue@*
Federated Investors Tower
Pittsburgh, PA
Birthdate: July 28, 1924
Chairman and Trustee
Chairman and Trustee, Federated Investors, Federated Advisers, Federated
Management, and Federated Research; Chairman and Director, Federated
Research Corp. and Federated Global Research Corp.; Chairman, Passport
Research, Ltd.; Chief Executive Officer and Director or Trustee of the
Funds. Mr. Donahue is the father of J. Christopher Donahue, President and
Trustee of the Trust.
16
Thomas G. Bigley
28th Floor, One Oxford Centre
Pittsburgh, PA
Birthdate: February 3, 1934
Trustee
Chairman of the Board, Children's Hospital of Pittsburgh; formerly, Senior
Partner, Ernst & Young LLP; Director, MED 3000 Group, Inc.; Trustee,
University of Pittsburgh; Director or Trustee of the Funds.
John T. Conroy, Jr.
Wood/IPC Commercial Department
John R. Wood and Associates, Inc., Realtors
3255 Tamiami Trail North
Naples, FL
Birthdate: June 23, 1937
Trustee
President, Investment Properties Corporation; Senior Vice-President, John
R. Wood and Associates, Inc., Realtors; President, Northgate Village
Development Corporation; Partner or Trustee in private real estate ventures
in Southwest Florida; Director or Trustee of the Funds; formerly,
President, Naples Property Management, Inc.
William J. Copeland
One PNC Plaza - 23rd Floor
Pittsburgh, PA
Birthdate: July 4, 1918
Trustee
Director and Member of the Executive Committee, Michael Baker, Inc.;
Director or Trustee of the Funds; formerly, Vice Chairman and Director, PNC
Bank, N.A., and PNC Bank Corp. and Director, Ryan Homes, Inc.
J. Christopher Donahue *
Federated Investors Tower
Pittsburgh, PA
Birthdate: April 11, 1949
President and Trustee
President and Trustee, Federated Investors, Federated Advisers, Federated
Management, and Federated Research; President and Director, Federated
Research Corp. and Federated Global Research Corp.; President, Passport
Research, Ltd.; Trustee, Federated Shareholder Services Company, and
Federated Shareholder Services; Director, Federated Services Company;
President or Executive Vice President of the Funds; Director or Trustee of
some of the Funds. Mr. Donahue is the son of John F. Donahue, Chairman and
Trustee of the Trust.
James E. Dowd
571 Hayward Mill Road
Concord, MA
Birthdate: May 18, 1922
Trustee
18
Attorney-at-law; Director, The Emerging Germany Fund, Inc.; Director or
Trustee of the Funds.
Lawrence D. Ellis, M.D.*
3471 Fifth Avenue, Suite 1111
Pittsburgh, PA
Birthdate: October 11, 1932
Trustee
Professor of Medicine and Member, Board of Trustees, University of
Pittsburgh; Medical Director, University of Pittsburgh Medical Center -
Downtown; Member, Board of Directors, University of Pittsburgh Medical
Center; formerly, Hematologist, Oncologist, and Internist, Presbyterian and
Montefiore Hospitals; Director or Trustee of the Funds.
Edward L. Flaherty, Jr.@
Miller, Ament, Henny & Kochuba
205 Ross Street
Pittsburgh, PA
Birthdate: June 18, 1924
Trustee
Attorney-at-law; Shareholder, Miller, Ament, Henny & Kochuba; Director,
Eat'N Park Restaurants, Inc., and Statewide Settlement Agency, Inc.;
Director or Trustee of the Funds; formerly, Counsel, Horizon Financial,
F.A., Western Region.
Peter E. Madden
Seacliff
562 Bellevue Avenue
Newport, RI
Birthdate: March 16, 1942
Trustee
Consultant; State Representative, Commonwealth of Massachusetts; Director
or Trustee of the Funds; formerly, President, State Street Bank and Trust
Company and State Street Boston Corporation.
Gregor F. Meyer
Miller, Ament, Henny & Kochuba
205 Ross Street
Pittsburgh, PA
Birthdate: October 6, 1926
Trustee
Attorney-at-law; Shareholder, Miller, Ament, Henny & Kochuba; Chairman,
Meritcare, Inc.; Director, Eat'N Park Restaurants, Inc.; Director or
Trustee of the Funds.
John E. Murray, Jr., J.D., S.J.D.
President, Duquesne University
Pittsburgh, PA
Birthdate: December 20, 1932
Trustee
President, Law Professor, Duquesne University; Consulting Partner, Mollica,
Murray and Hogue; Director or Trustee of the Funds.
20
Wesley W. Posvar
1202 Cathedral of Learning
University of Pittsburgh
Pittsburgh, PA
Birthdate: September 14, 1925
Trustee
Professor, International Politics and Management Consultant; Trustee,
Carnegie Endowment for International Peace, RAND Corporation, Online
Computer Library Center, Inc., and U.S. Space Foundation; Chairman, Czecho
Management Center; Director or Trustee of the Funds; President Emeritus,
University of Pittsburgh; founding Chairman, National Advisory Council for
Environmental Policy and Technology and Federal Emergency Management
Advisory Board.
Marjorie P. Smuts
4905 Bayard Street
Pittsburgh, PA
Birthdate: June 21, 1935
Trustee
Public relations/Marketing/Conference Planning, Manchester Craftsmen's
Guild; Restaurant Consultant, Frick Art & History Center; Conference
Coordinator, University of Pittsburgh Art History Department; Director or
Trustee of the Funds.
Edward C. Gonzales
Federated Investors Tower
Pittsburgh, PA
Birthdate: October 22, 1930
Executive Vice President
Vice Chairman, Treasurer, and Trustee, Federated Investors; Vice President,
Federated Advisers, Federated Management, Federated Research, Federated
Research Corp., Federated Global Research Corp. and Passport Research,
Ltd.; Executive Vice President and Director, Federated Securities Corp.;
Trustee, Federated Shareholder Services Company; Trustee or Director of
some of the Funds; President, Executive Vice President and Treasurer of
some of the Funds.
John W. McGonigle
Federated Investors Tower
Pittsburgh, PA
Birthdate: October 26, 1938
Executive Vice President, Secretary and Treasurer
Executive Vice President, Secretary, and Trustee, Federated Investors;
Trustee, Federated Advisers, Federated Management, and Federated Research;
Director, Federated Research Corp. and Federated Global Research Corp.;
Trustee, Federated Shareholder Services Company; Director, Federated
Services Company; President and Trustee, Federated Shareholder Services;
Director, Federated Securities Corp.; Executive Vice President and
Secretary of the Funds.
Richard B. Fisher
22
Federated Investors Tower
Pittsburgh, PA
Birthdate: May 17, 1923
Vice President
Executive Vice President and Trustee, Federated Investors; Chairman and
Director, Federated Securities Corp.; President or Vice President of some
of the Funds; Director or Trustee of some of the Funds.
* This Trustees is deemed to be an "interested person" as defined in the
Investment Company Act of 1940.
@ Member of the Executive Committee. The Executive Committee of the Board
of Trustees handles the responsibilities of the Board between meetings of
the Board.
As used in the table above, `The Funds'' and ``Funds'' mean the following
investment companies: 111 Corcoran Funds; Annuity Management Series; Arrow
Funds; Automated Government Money Trust; Blanchard Funds; Blanchard
Precious Metals Fund, Inc.; Cash Trust Series II; Cash Trust Series, Inc. ;
DG Investor Series; Edward Jones & Co. Daily Passport Cash Trust; Federated
Adjustable Rate U.S. Government Fund, Inc.; Federated American Leaders
Fund, Inc.; Federated ARMs Fund; Federated Equity Funds; Federated Equity
Income Fund, Inc.; Federated Fund for U.S. Government Securities, Inc.;
Federated GNMA Trust; Federated Government Income Securities, Inc.;
Federated Government Trust; Federated High Income Bond Fund, Inc.;
Federated High Yield Trust; Federated Income Securities Trust; Federated
Income Trust; Federated Index Trust; Federated Institutional Trust;
Federated Insurance Series; Federated Master Trust; Federated Investment
Portfolios; Federated Investment Trust; Federated Municipal Opportunities
Fund, Inc.; Federated Municipal Securities Fund, Inc.; Federated Municipal
Trust; Federated Short-Term Municipal Trust; Federated Short-Term U.S.
Government Trust; Federated Stock and Bond Fund, Inc.; Federated Stock
Trust; Federated Tax-Free Trust; Federated Total Return Series, Inc.;
Federated U.S. Government Bond Fund; Federated U.S. Government Securities
Fund: 1-3 Years; Federated U.S. Government Securities Fund: 2-5 Years;
Federated U.S. Government Securities Fund: 5-10 Years; Federated Utility
Fund, Inc.; First Priority Funds; Fixed Income Securities, Inc.; High Yield
Cash Trust; Intermediate Municipal Trust; International Series, Inc.;
Investment Series Funds, Inc.; Investment Series Trust; Liberty Term Trust,
Inc. - 1999; Liberty U.S. Government Money Market Trust; Liquid Cash Trust;
Managed Series Trust; Money Market Management, Inc.; Money Market
Obligations Trust; Money Market Trust; Municipal Securities Income Trust;
Newpoint Funds; Peachtree Funds; RIMCO Monument Funds; Targeted Duration
Trust; Tax-Free Instruments Trust; The Planters Funds; The Starburst Funds;
The Starburst Funds II; The Virtus Funds; Trust for Financial Institutions;
Trust for Government Cash Reserves; Trust for Short-Term U.S. Government
Securities; Trust for U.S. Treasury Obligations; and World Investment
Series, Inc.
FUND OWNERSHIP
Officers and Trustees as a group own less than 1% of the Fund's outstanding
shares.
TRUSTEES COMPENSATION
AGGREGATE
NAME , COMPENSATION
POSITION WITH FROM TOTAL COMPENSATION PAID
TRUST TRUST*# FROM FUND COMPLEX +
24
John F. Donahue, $0 $0 for the Fund and
Chairman and Trustee
54 other investment companies in the Fund Complex
Thomas G. Bigley,++ $1,016
$86,331 for the Fund and
Trustee 54 other investment companies in the Fund
Complex
John T. Conroy, Jr., $1,116
$115,760 for the Fund and
Trustee 54 other investment companies in the Fund
Complex
William J. Copeland, $1,116
$115,760 for the Fund and
Trustees 54 other investment companies in the Fund
Complex
J. Christopher Donahue, $0
$0 for the Fund and
President and Trustee
16 other investment companies in the Fund Complex
James E. Dowd, $1,116 $115,760 for the Fund and
Trustee 64 other investment companies in the Fund
Complex
Lawrence D. Ellis, M.D., $1,016
$104,898 for the Fund and
Trustee 54 other investment companies in the Fund
Complex
Edward L. Flaherty, Jr., $1,116
$115,760 for the Fund and
Trustee 54 other investment companies in the Fund
Complex
Peter E. Madden, $1,016 $104,898 for the Fund and
Trustee 54 other investment companies in the Fund
Complex
Gregor F. Meyer, $1,016 $104,898 for the Fund and
Trustee 54 other investment companies in the Fund
Complex
John E. Murray, Jr., $1,016
$104,898 for the Fund and
Trustee 54 other investment companies in the Fund
Complex
Wesley W. Posvar,$1,016 $104,898 for the Fund and
Trustee 54 other investment companies in the Fund
Complex
Marjorie P. Smuts, $1,016
$104,898 for the Fund and
Trustee 54 other investment companies in the Fund
Complex
*Information is furnished for the fiscal year ended December 31, 1995.
#The aggregate compensation is provided for the Trust which is comprised of
seven portfolios.
+The information is provided for the last calendar year.
26
++ Mr. Bigley served on 39 investment companies in the Federated Funds
Complex from January 1 through September 30, 1995. On October 1, 1995, he
was appointed a Trustee of 15 additional Funds.
TRUSTEES LIABILITY
The Delaration of Trust provides that the Trustees will not be liable for
errors of judgment or mistakes of fact or law. However, they are not
protected against any liability to which they would otherwise be subject by
reason of willful misfeasance, bad faith, gross negligence, or reckless
disregard of the duties involved in the conduct of their office.
INVESTMENT ADVISORY SERVICES
ADVISER TO THE FUND
The Fund's investment adviser is Federated Advisers. It is a subsidiary of
Federated Investors. All the voting securities of Federated Investors are
owned by a trust, the trustees of which are John F. Donahue, his wife, and
his son, J. Christopher Donahue.
The adviser shall not be liable to the Fund or any shareholder for any
losses that may be sustained in the purchase, holding, or sale of any
security or for anything done or omitted by it, except acts or omissions
involving willful misfeasance, bad faith, gross negligence, or reckless
disregard of the duties imposed upon it by its contract with the Fund.
ADVISORY FEES
For its advisory services, the Federated Advisers receives an annual
investment advisory fee as described in the prospectus.
BROKERAGE TRANSACTIONS
The adviser may select brokers and dealers who offer brokerage and research
services. These services may be furnished directly to the Fund or to the
adviser and may include: advice as to the advisability of investing in
securities; security analysis and reports; economic studies; industry
studies; receipt of quotations for portfolio evaluations; and similar
services. Research services provided by brokers and dealers may be used by
the adviser or its affiliates in advising the Fund and other accounts. To
the extent that receipt of these services may supplant services for which
the adviser or its affiliates might otherwise have paid, it would tend to
reduce their expenses. The adviser and its affiliates exercise reasonable
business judgment in selecting brokers who offer brokerage and research
services to execute securities transactions. They determine in good faith
that commissions charged by such persons are reasonable in relationship to
the value of the brokerage and research services provided.
Although investment decisions for the Fund are made independently from
those of the other accounts managed by the adviser, investments of the type
the Fund may make may also be made by those other accounts. When the Fund
and one or more other accounts managed by the adviser are prepared to
invest in, or desire to dispose of, the same security, available
investments or opportunities for sales will be allocated in a manner
believed by the adviser to be equitable to each. In some cases, this
procedure may adversely affect the price paid or received by the Fund or
the size of the position obtained or disposed of by the Fund. In other
cases, however, it is believed that coordination and the ability to
participate in volume transactions will be to the benefit of the Fund.
OTHER SERVICES
FUND ADMINISTRATION
Federated Services Company, a subsidiary of Federated Investors, provides
administrative personnel and services to the Fund for a fee as described in
the prospectus.
CUSTODIAN AND PORTFOLIO ACCOUNTANT
28
State Street Bank and Trust Company, Boston, MA, is custodian for the
securities and cash of the Fund. Federated Services Company, Pittsburgh,
PA, provides certain accounting and recordkeeping services with respect to
the Fund's portfolio investments. The fee paid for this service is based
upon the level of the Fund's average net assets for the period plus out-of-
pocket expenses.
TRANSFER AGENT
Federated Services Company, through it registered transfer agent, Federated
Shareholder Services Company, maintains all necessary shareholder records.
For its services, the transfer agent receives a fee based on the size, type
and number of accounts and transactions made by shareholders.
INDEPENDENT AUDITORS
The independent auditors for the Fund are Deloitte & Touche LLP,
Pittsburgh, PA.
PURCHASES AND REDEMPTIONS
Shares are sold at their net asset value on days the New York Stock
Exchange is open for business. The procedure for purchasing and redeeming
shares of the Fund is explained in the prospectus under `Purchases and
Redemptions''and ``What Shares Cost.''
DISTRIBUTION PLAN
The Plan permits the payment of fees to financial institutions and the
distributor to stimulate distribution activities and to cause services to
be provided to shareholders by a representative who has knowledge of the
shareholder's particular circumstances and goals. These activities may
include, but are not limited to: marketing efforts; providing office space,
equipment, telephone facilities, and various clerical, supervisory,
computer, and other personnel as necessary or beneficial to establish and
maintain shareholder accounts and records; processing purchase and
redemption transactions and automatic investments of client account cash
balances; answering routine client inquiries; and assisting clients in
changing dividend options, account designations, and addresses.
By adopting the Plan, the Trustees expects that the Fund will be able to
achieve a more predictable flow of cash for investment purposes and to meet
redemptions. This will facilitate more efficient portfolio management and
assist the Fund in pursuing its investment objectives. By identifying
potential investors whose needs are served by the Fund's objective, and
properly servicing these accounts, the Fund may be able to curb sharp
fluctuations in rates of redemptions and sales.
Other benefits include: (1) an efficient and effective administrative
system; (2) a more efficient use of shareholder assets by having them
rapidly invested with a minimum of delay and administrative detail; and
efficient and reliable shareholder records system and prompt responses to
shareholder requests and inquiries concerning their accounts.
DETERMINING NET ASSET VALUE
Net asset value of the Fund generally changes each day. The days on which
net asset value is calculated by the Fund are described in the prospectus.
Divivdend income is recorded on the ex-dividend date, except certain
dividends from foreign securities where the ex-dividend date may have
passed, are recorded as soon as the Fund is informed of the ex-dividend
date.
DETERMINING MARKET VALUE OF SECURITIES
Market values of the Fund's portfolio securities are determined as follows:
o according to the last sale price on a national securities exchange, if
available. (If a security is traded on more than one exchange, the
price on the primary market for that security, as determined by the
adviser is used.);
30
o according to the last reported bid price, if no sale on the recognized
exchange is reported or if the security is traded over-the-counter;
o at fair value as determined in good faith by the Trustees; or
o for short-term obligations with remaining maturities of 60 days or
less at the time of purchase, at amortized cost, which approximates
value.
Prices provided by independent pricing services may be determined
without relying exclusively on quoted prices and may consider:
institutional trading in similar groups of securities; yield; quality;
coupon rate; maturity; type of issue; trading characteristics; and
other market data.
MASSACHUSETTS PARTNERSHIP LAW
Under certain circumstances, shareholders may be held personally liable as
partners under Massachusetts law for obligations of the Trust. To protect
its shareholders, the Trust has filed legal documents with Massachusetts
that expressly disclaim the liability of its shareholders for acts or
obligations of the Trust. These documents require notice of this disclaimer
to be given in each agreement, obligation, or instrument the Trust or its
Trustees enter into or sign.
In the unlikely event a shareholder is held personally liable for the
Trust's obligations, the Trust is required by the Declaration of Trust to
use its property to protect or compensate the shareholder. On request, the
Trust will defend any claim made and pay any judgment against a shareholder
for any act or obligation of the Trust. Therefore, financial loss resulting
from liability as a shareholder will occur only if the Trust itself cannot
meet its obligations to indemnify shareholders and pay judgments against
them.
TAX STATUS
THE FUND'S TAX STATUS
The Fund will pay no federal income tax because it expects to meet the
requirements of Subchapter M of the Internal Revenue Code applicable to
regulated investment companies and to receive the special tax treatment
afforded to such companies. To qualify for this treatment, the Fund must,
among other requirements:
o derive at least 90% of its gross income from dividends, interest, and
gains from the sale of securities;
o derive less than 30% of its gross income from the sale of securities
held less than three months;
o invest in securities within certain statutory limits; and
o distribute to its shareholders at least 90% of its net income earned
during the year.
SHAREHOLDERS' TAX STATUS
The Fund intends to comply with the variable asset diversification
regulations which are described in the prospectus and in this Statement of
Additional Information. If the Fund fails to comply with these
regualtions, contracts invested in the Fund shall not be treated as
annuity, endowment or life insurance contracts uner the Internal Revenue
Code.
Contract owners should review the contract prospectus for information
concerning the federal income tax treatment of their contracts and
distributions from the Fund to the separate accounts.
32
TOTAL RETURN
The average annual total return for the Fund is the average compounded rate
of return for a given period that would equate a $1,000 initial investment
to the ending redeemable value of that investment. The ending redeemable
value is computed by multiplying the number of shares owned at the end of
the period by the offering price per share at the end of the period. The
number of shares owned at the end of the period is based on the number of
shares purchased at the beginning of the period with $1,000, adjusted over
the period by any additional shares, assuming a monthly reinvestment of all
dividends and distributions. You should review the performance figures for
your insurance contract, which figures reflect the applicable charges and
expenses of the contract. Such performance figures will accompany any
advertisement of the Fund's performance.
YIELD
The yield for the Fund is determined by dividing the net investment income
per share (as defined by the Securities and Exchange Commission) earned by
the Fund over a thirty-day period by the maximum offering price per share
of the Fund on the last day of the period. This value is then annualized
using semi-annual compounding. This means that the amount of income
generated during the thirty-day period is assumed to be generated each
month over a twelve-month period and is reinvested every six months. The
yield does not necessarily reflect income actually earned by the Fund
because of certain adjustments required by the Securities and Exchange
Commission and, therefore, may not correlate to the dividends or other
distributions paid to shareholders. Also the yield does not reflect the
charges and expenses of an insurance contract. You should review the
performance figures for your insurance contract, which figures reflect the
applicable charges and expenses of the contract. Such performance figures
will accompany any advertisement of the Fund's performance.
To the extent that financial institutions and broker/dealers charge fees in
connection with services provided in conjunction with an investment in any
class of Shares, the performance will be reduced for those shareholders
paying those fees.
PERFORMANCE COMPARISONS
The Fund's performance depends upon such variables as:
o portfolio quality;
o average portfolio maturity;
o type of instruments in which the portfolio is invested;
o changes in interest rates and market value of portfolio securities;
o changes in the Fund's or a class of Shares' expenses; and
o various other factors.
The Fund's performance fluctuates on a daily basis largely because net
earnings and offering price per share fluctuate daily. Both net earnings
and offering price per share are factors in the computation of total
return.
Investors may use financial publications and/or indices to obtain a more
complete view of the Fund's performance. When comparing performance,
investors should consider all relevant factors such as the composition of
any index used, prevailing market conditions, portfolio compositions of
other funds, and methods used to value portfolio securities and compute
offering price. The financial publications and/or indices which the Fund
uses in advertising may include:
o LIPPER ANALYTICAL SERVICES, INC., ranks funds in various fund
categories by making comparative calculations using total return.
Total return assumes the reinvestment of all capital gains
34
distributions and income dividends and takes into account any change
in net asset value over a specific period of time. From time to time,
the Fund will quote its Lipper ranking in the convertible securities
and fixed income funds categories in advertising and sales literature.
o DOW JONES INDUSTRIAL AVERAGE (`DJIA'') represents share prices of
selected blue-chip industrial corporations as well as public utility
and transportation companies. The DJIA indicates daily changes in the
average price of stocks in any of its categories. It also reports
total sales for each group of industries. Because it represents the
top corporations of America, the DJIA index is a leading economic
indicator for the stock market as a whole.
o STANDARD & POOR'S RATINGS GROUP DAILY STOCK PRICE INDEX OF 500 COMMON
STOCKS is a composite index of common stocks in industry,
transportation, and financial and public utility companies which
compares total returns of funds whose portfolios are invested
primarily in common stocks. In addition, the Standard & Poor's index
assumes reinvestment of all dividends paid by stocks listed on the
index. Taxes due on any of these distributions are not included, nor
are brokerage or other fees calculated, in the Standard & Poor's
figures.
o MORNINGSTAR, INC., an independent rating service, is the publisher of
the bi-weekly Mutual Fund Values. Mutual Fund Values rates more than
1,000 NASDAQ-listed mutual funds of all types, according to their
risk-adjusted returns. The maximum rating is five stars, and ratings
are effective for two weeks.
In addition, the Fund will, from time to time, use the following standard
convertible securities indices against which it will compare its
performance: Goldman Sachs Convertible 100; Kidder Peabody Convertible Bond
Index; Value Line Convertible Bond Index; and Dow Jones Utility Index.
Advertisements and other sales literature for the Fund may quote total
returns which are calculated on nonstandardized base periods. These total
returns also represent the historic change in the value of an investment in
the Fund based on quarterly reinvestment of dividends over a specified
period of time.
From time to time as it deems appropriate, the Fund may advertise its
performance using charts, graphs, and descriptions, compared to federally
insured bank products, including certificates of deposit and time deposits,
and to money market funds using the Lipper Analytical Services money market
instruments average. In addition, advertising and sales literature for the
Fund may use charts and graphs to illustrate the principals of dollar-cost
averaging and may disclose the amount of dividends paid by the Fund over
certain periods of time.
Advertising and other promotional literature may include charts, graphs and
other illustrations using the Fund's returns, or returns in general, that
demonstrate basic investment concepts such as tax-deferred compounding,
dollar-cost averaging and systematic investment. In addition, the Fund can
compare its performance, or performance for the types of securities in
which it invests, to a variety of other investments, such as bank savings
accounts, certificates of deposit, and Treasury bills.
ECONOMIC AND MARKET INFORMATION
Advertising and sales literature for the Fund may include discussions of
economic, financial and political developments and their effect on the
securities market. Such discussions may take the form of commentary on
these developments by Fund portfolio managers and their views and analysis
on how such developments could affect the Fund. In addition, advertising
36
and sales literature may quote statistics and give general information
about the mutual fund industry, including the growth of the industry, from
sources such as the Investment Company Institute.
ABOUT FEDERATED INVESTORS
Federated Investors is dedicated to meeting investor needs which is
reflected in its investment decision making-structured, straightforward,
and consistent. This has resulted in a history of competitive performance
with a range of competitive investment products that have gained the
confidence of thousands of clients and their customers.
The company's disciplined security selection process is firmly rooted in
sound methodologies backed by fundamental and technical research.
Investment decisions are made and executed by teams of portfolio managers,
analysts, and traders dedicated to specific market sectors. These traders
handle trillions of dollars in annual trading volume.
In the equity sector, Federated Investors has more than 25 years'
experience. As of December 31, 1995, Federated managed 22 equity funds
totaling approximately $5.4 billion in assets across growth, value, equity
income, international, index and sector (i.e. utility) styles. Federated's
value-oriented management style combines quantitative and qualitative
analysis and features a structured, computer-assisted composite modeling
system that was developed in the 1970s.
J. Thomas Madden, Executive Vice President, oversees Federated's equity and
high yield corporate bond management while William D. Dawson, Executive
Vice President, oversees Federated's domestic fixed income management.
Henry A. Frantzen, Executive Vice President, oversees the management of
Federated's international portfolios.
MUTUAL FUND MARKET
Twenty-seven percent of American households are pursuing their financial
goals through mutual funds. These investors, as well as businesses and
institutions, have entrusted over $3 trillion to the more than 5,500 funds
available.*
Federated Investors, through its subsidiaries, distributes mutual funds for
a variety of investment applications. Specific markets include:
INSTITUTIONAL CLIENTS
Federated Investors meets the needs of more than 4,000 institutional
clients nationwide by managing and servicing separate accounts and
mutual funds for a variety of applications, including defined benefit and
defined contribution programs, cash management, and asset/liability
management. Institutional clients include corporations, pension
funds, tax-exempt entities, foundations/endowments, insurance companies,
and investment and financial advisors. The marketing effort to these
institutional clients is headed by John B. Fisher, President,
Institutional Sales Division.
TRUST ORGANIZATIONS
Other institutional clients include close relationships with more than
1,500 banks and trust organizations. Virtually all of the trust
divisions of the top 100 bank holding companies use Federated funds in
their clients' portfolios. The marketing effort to trust clients is
headed by Mark R. Gensheimer, Executive Vice President,
Bank Marketing & Sales.
38
*source: Investment Company Institute
BROKER/DEALERS AND BANK BROKER/DEALER SUBSIDIARIES
Federated funds are available to consumers through major brokerage
firms nationwide--including 200
New York Stock Exchange firms--supported by more wholesalers than any
other mutual fund distributor.
Federated's service to financial professionals and institutions has
earned it high rankings in several surveys
performed by DALBAR, Inc. DALBAR is recognized as the industry
benchmark for service quality
measurement. The marketing effort to these firms is headed by James
F. Getz, President, Broker/Dealer Division.
