PAGE 1
PAGE 1 CUNA Mutual Funds, Inc.
CUNA Mutual
Cornerstone Fund
Facts at a Glance
Contents
Objective
High total return 1 About the Fund
consisting of capital
appreciation and current Transaction Costs and
income. Fund Expenses 2
Investment Strategy Mutual Fund Investing:
The fund invests in a How it Works 3
diversified portfolio of
common stocks, bonds, and Fund and Market Characteristics:
money What to Expect 5
market securities. 2 About Your Account
Portfolio managers
regularly review the Pricing Shares;
fund's asset allocation Receiving Sale Proceeds 7
and may make gradual
changes, within defined Distributions and Taxes 7
limits, based on their
outlook for the economy, Transaction Procedures
interest rates, and and Special Requirements 9
financial markets. 3 More About the Fund
Risk/Reward Potential Organization and Management 11
Share price should
fluctuate more than an Understanding Fund Performance 13
all-bond portfolio but
less than an all-stock Investment Policies and Practices 14
portfolio. The return
potential is higher than 4 Investing With CUNA Mutual Funds
that of an all-bond
portfolio and lower than Meeting Requirements
that of an all-stock for New Accounts 20
portfolio.
Opening a New Account 20
UNLIKE CREDIT UNION
AND BANK ACCOUNTS, THE Purchasing Additional Shares 21
VALUE OF YOUR INVESTMENT
IN THIS FUND IS NOT Exchanging and Redeeming 22
INSURED. YOUR INVESTMENT
IS NOT A DEPOSIT OF, OR Shareholder Services 22
GUARANTEED BY, ANY CREDIT
UNION OR
This prospectus contains information you
PAGE 2 should know before investing. Please keep
GOVERNMENT AGENCY. YOUR it for future reference. A Statement
INVESTMENT INVOLVES of Additional Information about the Fund,
CERTAIN RISKS INCLUDING A dated December 30, 1993, has been filed
LOSS OF PRINCIPAL. with the Securities and Exchange Commission
and is incorporated by reference in this
Investor Profile prospectus. To obtain a free copy, call
Credit union members 1-800-756-FUND (3863).
seeking capital
appreciation with less
risk than is associated
with an all-stock
fund.
Fees and Charges
No load. No fees or
charges to buy or sell
shares or to reinvest
dividends. Free telephone
exchange between this and
other CUNA Mutual
Funds.
Investment Adviser
Founded in 1937, T. Rowe
Price Associates and its
affiliates have a staff
of over 82 professionals
who manage over $49
billion for approximately
2.5 million individual
and institutional
investor accounts. The
firm is one of the
largest providers of
no-load mutual funds in
the country.
THESE SECURITIES HAVE NOT
BEEN APPROVED OR
DISAPPROVED BY THE
SECURITIES AND EXCHANGE
COMMISSION, OR ANY STATE
SECURITIES COMMISSION,
NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION
PASSED UPON THE ACCURACY
OR ADEQUACY OF THIS
PROSPECTUS. ANY
REPRESENTATION TO THE
CONTRARY IS A CRIMINAL
OFFENSE
PAGE 3
Transaction Costs and Fund Expenses
1 About the Fund The fund has an all-inclusive fee covering
investment management and operating
expenses. This fee will not fluctuate. In
contrast, most mutual funds have a fixed
management fee plus a fee for operating
expenses that varies according to a number
of factors. (See "How are fund expenses
determined?" on page 12.)
You pay no direct costs to buy, sell, or
exchange shares. All the money you invest
in the fund goes to work for you.
The table below indicates how much it will
cost to operate the fund for a year. These
are costs you pay indirectly, because they
are deducted from the fund's total assets
before the daily share price is calculated
and before dividends and other
distributions are made. In other words, you
will not see these expenses on your account
statement.
______________________
The CUNA Mutual Funds are Annual Mutual Fund Expenses
no load. Percentage of Fiscal 1994 Average Net
Assets
Management Fee* 1.25%
Distribution (12b-1) Fee** 0.25
Other expenses* 0.00
Total Fund Expenses* 1.50%
*The management fee includes operating
expenses. The fund charges a $5 fee for
wire redemptions under $5,000, subject to
change without notice.
**Under rules of the National Association
of Securities Dealers, Inc. ("NASD"), a
12b-1 fee may be treated as a sales charge
in certain instances. Because the 12b-1 fee
is an annual fee charged against fund
assets, long-term shareholders may
indirectly pay more in total sales charges
than the economic equivalent of a maximum
front-end sales charge permitted by the
NASD.
Table 1
Hypothetical example: For each $1,000
you invest, assume you earn 5% annually and
close your account at the end of the time
periods shown. The 5% return does not
represent the fund's past or future
performance.
PAGE 4
_________________________
The table at right is Example of Fund Expenses Per $1,000
just an example and Invested
actual expenses can be 1 year 3 years
higher or lower than $15 $47
those shown. Table 2
Mutual Fund Investing: How it Works
_____________________
This question-and-answer What is a mutual fund?
section reviews some of As its name implies, a mutual fund pools
the basics of mutual fund money from many individuals who share
investing. similar investment goals. Your investment
in a mutual fund entitles you to shares of
the fund _ you are a direct owner of an
investment company. The fund, in turn,
takes the money received from its
shareholders and invests in individual
securities, such as stocks, bonds, or money
market instruments, in the interest of
achieving the fund's investment objectives.
So you are a direct owner of a mutual
fund's shares and an indirect owner of all
the securities in which the fund invests.
What is a prospectus?
A prospectus is a legal document prepared
for mutual fund investors. Its chief
purpose is to describe a fund's investment
objectives, the investment manager, and the
fund's policies, fees, and risks.
What are the benefits of investing in
mutual funds?
Mutual fund investing provides many
benefits:
Professional management. You gain
access to professional investment managers
who use a wide variety of information and
financial management tools to help a fund
achieve its investment objectives.
Diversification. Since mutual funds
pool your money with that of other
investors, you are investing in a large
portfolio of stocks and/or bonds. Investing
in a variety of securities generally
results in lower price fluctuation than
holding only a few individual securities.
Liquidity. You can sell your shares on
any business day and receive the value of
your investment. You do not need to find a
buyer _ the fund will redeem your shares.
Of course, the price you receive for
selling your shares may be more or less
than the price you paid (see "Pricing
Shares and Receiving Sale Proceeds" on page
7).
Professional record keeping and account
service. You will receive a concise,
easy-to-read account statement on a
quarterly basis. Furthermore, if you have
questions about your statement or of any
aspect of your investment, you can call
toll free 1-800-934-FUND (3863).
Is my investment insured?
No. Unlike credit union or bank accounts,
mutual fund investments are not insured.
Since mutual funds invest in securities
whose values fluctuate, there is no
assurance your investment will be equal to
its original value when you sell your
shares. Also, there is no guarantee that a
fund will meet its investment objective.
How can I measure my investment's progress?
Total return is the most widely used
measure of mutual fund performance. It
tells you how much an investment in a fund
has changed in value over a given time
period, reflecting any net increase or
decrease in the share price and assuming
that any dividends and capital gains paid
during the period were reinvested in
additional shares of the fund.
Detailed total return information for
various time periods__both absolute and
relative to comparable benchmarks__appears
in semiannual and annual reports sent to
you by your fund's management. The price
per share also appears in the business
section of most major daily newspapers and
will be listed under CUNA Mutual Funds.
What are some examples of mutual funds?
Money market funds. Money market funds
invest in short-term debt obligations
(usually with maturities less than a year)
of issuers such as the U.S. Government,
corporations, and municipalities. Because
of the high degree of safety they provide,
money market funds typically offer the
lowest return potential of any type of
mutual fund. Currently, the CUNA Mutual
Funds do not include a money market fund.
Bond funds. Like money market funds,
bond funds invest in a wide range of debt
obligations of issuers such as the U.S.
Government, corporations, and
municipalities. But, because they invest in
securities that may mature in three, five,
10, or 30 years, bond funds typically offer
a higher return potential than money market
funds but with higher risk due to price
fluctuations.
Stock funds. These funds invest in a
wide range of publicly traded stocks.
Historically, stock funds have offered the
highest long-term return potential of any
single type of fund
and have involved the highest degree of
risk because their share prices, and an
investor's principal, typically fluctuate
the most. Currently, the CUNA Mutual Funds
do not include a stock fund.
Asset allocation. Asset allocation
funds invest assets among various asset
classes (stock, bond, and money market
securities) according to the manager's
outlook for the economy, interest rates,
and financial markets. Such funds employ
this strategy as a way to reduce risk in
the hope that the good performance in one
asset class will offset lackluster
performance in another. However, it is
important to note that most asset
allocation funds normally keep a higher
percentage of assets in stocks, barring
unusual market conditions. Therefore, the
share price of an asset allocation fund
typically fluctuates more than a bond
fund's but less than a stock fund's.
_________________________
The fund or funds you What should I consider when selecting a
select should reflect fund?
your individual Review your own financial objectives _
investment goals, but primarily your need for access to your
should not represent your money, your time horizon, and your risk
complete investment tolerance _ before making an investment.
program. No fund should Generally, investors needing ready access
be used for short-term to their money should stay in shorter-term
trading purposes. investments that seek the highest degree of
income consistent with minimal or moderate
volatility (i.e., share price
fluctuation). Investors seeking to maximum
return should adopt a long-term time
horizon and be more comfortable with the
periodic principal declines that accompany
the potential for higher returns.
Fund and Market Characteristics: What to
Expect
_____________________
This section takes a What is the fund's investment objective?
closer look at stock, The fund's investment objective is to seek
bond, and money market a high total return consisting of capital
investing as well as the appreciation and current income.
fund's investment How will the fund's adviser invest assets
program--to help you to reach the investment objective?
decide if it is The investment adviser will allocate the
appropriate for you. fund's investments within specified ranges
as indicated in the table below. The
fund's neutral benchmark represents the
proportion of investments expected to be
allocated to each asset class over the long
term. The adviser regularly reviews the
asset allocation and may make gradual
changes, within the defined ranges, based
on its outlook for the economy, interest
rates, and financial markets.
Neutral
Asset Class Range Benchmark
Stocks 50-70% 60%
Bonds 20-50% 30%
Money Market
Securities 0-20% 10%
Table 3
The investment adviser will rely on its
proprietary research to select individual
securities within each asset class believed
to have the greatest potential for helping
the fund realize its goal of high total
return.
What types of securities are in the fund's
portfolio?
Stocks. Also known as equities, this
portion of the fund includes common stocks,
preferred stocks (including convertible
preferred stocks), warrants, rights, and
convertible debt securities.
This portion of the fund will be invested
in equity-related securities of large,
mid-size, and small companies. The stocks
of large, well-established companies can
produce increasing dividend income and
capital appreciation. Equity securities of
mid-size and small companies offer the
possibility of accelerating earnings and
even greater growth of capital; however,
the higher return potential of these
smaller companies is accompanied by greater
risk that their stock prices will decline.
PAGE 6
Bonds. The fixed income portion of the
fund will generally be diversified among
securities of the U.S. Government and its
agencies, as well as corporate,
asset-backed, mortgage-backed, and private
mortgage securities. While it is
anticipated that most of these securities
will carry an investment-grade credit
rating, the fund may invest up to 10% of
its assets in below-investment-grade
securities rated BB or B by a nationally
recognized rating agency or, if unrated,
the equivalent as determined by the
investment adviser. This policy does not
prohibit the fund from retaining a security
which is downgraded after purchase.
Investment-grade securities include a range
of securities from the highest rated to
medium quality (BBB). Securities in the BBB
category may be more susceptible to adverse
economic conditions or changing
circumstances and the securities at the
lower end of the BBB category have certain
speculative characteristics. Prices of
below-investment-grade (or "junk") bonds
are usually more affected by adverse
economic conditions or a deterioration in
the issuer's financial circumstances than
by overall changes in interest rates. To
compensate investors for higher credit risk
exposure, such bonds usually provide higher
income.
Money market instruments. The money market
portion of the portfolio will be invested
in investment-grade securities generally
maturing in 13 months or less, although
this asset
class may include securities backed by the
full faith and credit of the U.S.
Government with
a maturity of up to 25 months.
PAGE 7
________________________
The Fund may invest up to Foreign securities. The fund may also
20% and 10% of its total invest a portion of its assets in foreign
assets, respectively, in securities. Since foreign economies may be
non-U.S. dollar expanding when the U.S. economy is in a
denominated equity recession, the fund's international
securities and component provides additional
investment-grade debt diversification.
securities.
Why invest in stocks, bonds, and money
market securities in the same investment
portfolio?
By investing among these asset classes, the
fund takes the diversification philosophy
of mutual funds one step further. Stock,
bond, and money market instruments tend to
react differently to changes in economic
conditions and interest rate levels.
Diversifying among these asset types gives
the fund the flexibility to take advantage
of performance opportunities wherever they
may occur.
_____________________
This strategy also How can this particular fund benefit me?
reduces the risks This fund offers investors a moderately
associated with investing conservative investment program pursuing
in a single asset high total return. By mixing its investment
category. portfolio among stocks, bonds, and money
market securities, an investor can take
advantage of the long-term growth potential
of stocks _ whose long-term investment
returns are most likely to stay ahead of
inflation rates _ while reducing risk and
moderating share price fluctuations through
investments in bonds and money market
instruments.
_____________________
The fund should not be What risks are associated with the fund?
relied upon for short- The fund's share price will fluctuate with
term financial needs, nor changing market conditions and interest
used to play short-term rate
swings in the stock or levels__so your investment may be worth
bond markets. more or less when redeemed (sold) than when
purchased. The fund cannot guarantee it
will be successful in achieving its
investment objectives. There is also no
guarantee that the asset allocation
strategy used by the investment adviser
will be successful. For a further
discussion of the risks associated with the
types of securities
in which the fund invests _including
international securities and high-yield
bonds, see "Investment Programs and
Practices" on page 14.
PAGE 8
2 About Your Account
Pricing Shares and Receiving Sale Proceeds
______________________
The various ways you can Here are some procedures you should know
buy, sell, and exchange when investing in the fund.
shares are explained at
the end of this How and when shares are priced
prospectus and on the New The share price (also called "net asset
Account Form. value" or NAV per share) for the fund is
calculated at 4 p.m. ET each day the New
York Stock Exchange is open for business.
To calculate the NAV, the fund's assets are
priced and totaled, liabilities are
subtracted, and the balance,
called net assets, is divided by the number
of shares outstanding.
How your purchase, sale, or exchange price
is determined
_______________________ If we receive your request in correct form
When filing out the New before 4 p.m. ET, your transaction will be
Account Form, you may priced at that day's NAV. If we receive it
wish to give yourself the after 4 p.m., it will be priced at the next
widest range of options business day's NAV. (See "Meeting
for receiving proceeds Requirements for New Accounts" and "Opening
from a sale. a New Account" under "Investing in the CUNA
Mutual Funds.")
We're sorry, but we cannot accept orders
that request a particular day or price for
your transaction or any other special
conditions.
Note: The time at which transactions are
priced may be changed in case of an
emergency or if the New York Stock Exchange
closes at a time other than 4 p.m. ET. If
your redemption request cannot be accepted,
you will be notified and given further
instructions.
PAGE 9
________________________ How you can receive the proceeds from a
If for some reason we sale
cannot accept your
request to sell shares, If your request is received by 4 p.m. ET in
we will contact you. correct form, proceeds are usually sent on
the next business day. Proceeds can be sent
to you by mail, or to your credit union or
bank account by ACH or bank wire. Proceeds
sent by bank wire will be credited to your
account the next business day, and proceeds
sent by ACH transfer will be credited the
second day after the sale. ACH (Automated
Clearing House) is an automated method of
initiating payments from and receiving
payments in your financial institution
account. ACH is a payment system supported
by over 20,000 credit unions, banks and
savings banks which electronically exchange
the transactions primarily through the
Federal Reserve Banks.
Exception: Under unusual circumstances or
when deemed to be in the fund's best
interests, your proceeds may not be sent
for up to five business days after
receiving your sale or exchange request.
If, in either of these situations, you were
exchanging into another CUNA Mutual bond
fund, your new investment would not begin
to earn dividends until the sixth business
day.
Useful Information on Distributions and
Taxes
_____________________ Dividends and other distributions
The fund distributed all
net investment income and Dividend and capital gain distributions are
realized capital gains to reinvested in additional fund shares in
shareholders. your account unless you select another
option on your New Account Form. The
advantage of
reinvesting distributions arises from
compounding; that is, you receive interest
and capital gain distributions on a rising
number of shares.
Dividends not reinvested are paid by check
or transmitted to your credit union or bank
account via ACH. If the Post Office cannot
deliver your check, or if your check
remains uncashed for six months, the fund
reserves the right to reinvest your
distribution check in your account at the
then current NAV and to reinvest all
subsequent distributions in shares of the
fund.
Income dividends
The fund declares and pays dividends on
a quarterly basis.
All or part of the Fund's dividends
will be eligible for the 70% deduction for
dividends received by corporations.
Capital gains
A capital gain or loss is the
difference between the purchase and sale
price of a security.
If the fund has net capital gains for
the year (after subtracting any capital
losses), they are
usually "declared" and paid in December to
shareholders of record on a specified date
that month. If a second distribution is
necessary, it is usually declared and paid
during the first quarter of the following
year.
PAGE 10
____________________ Tax information
CUNA Mutual Funds send You need to be aware of the possible tax
timely information for consequences when:
your tax filing needs. the fund makes a distribution to your
account, or
you sell fund shares, including an
exchange from one fund to another.
_____________________
CUNA Mutual Funds furnish Taxes on fund redemptions. When you sell
average cost and capital shares in any fund, you may realize a gain
gain (loss) information or loss. An exchange from one fund to
on most share another is still a sale for tax purposes.
redemptions.
In January, CUNA Mutual Funds will send you
and the IRS Form 1099-B, indicating the
date and amount of each sale you made in
the fund during the prior year. We will
also tell you the average cost of the
shares you sold during the year. Average
cost information is not reported to the
IRS, and you do not have to use it. You may
calculate the cost basis using other
methods acceptable to the IRS, such as
"specific identification."
To help you maintain accurate records, we
send you a confirmation immediately
following each transaction you make and a
year-end statement detailing all your
transactions in each fund account during
the year.
______________________
Distributions are taxable Taxes on fund distributions. The following
whether reinvested in summary does not apply to retirement
additional shares or accounts, such as IRAs, which are
received in cash. tax-deferred until you withdraw money from
them.
In January, the CUNA Mutual Funds will send
you and the IRS Form 1099-DIV indicating
the tax status of any dividend and capital
gain distribution made to you. All
distributions made by the fund are taxable
to you for the year in which they were
paid. The only exception is that
distributions declared during the last
three months of the year and paid in
January are taxed as though they were paid
by December 31. CUNA Mutual Funds will also
send you any additional information you
need to determine your taxes on fund
distributions, such as the portion of your
dividend, if any, that may be exempt from
state income taxes.Short-term capital gains
are taxable as ordinary income and
long-term gains are taxable at the
applicable long-term gain rate. The gain is
long or short term depending on how long
the fund held the securities, not how long
you held shares in the fund.
Distributions resulting from the sale of
certain foreign currencies and debt
securities, to
the extent of foreign exchange gains, are
taxed as ordinary income or loss. If the
fund pays
nonrefundable taxes to foreign governments
during the year, the taxes will reduce the
fund's dividends.
Tax effect of buying shares before a
capital gain distribution. If you buy
shares near or on the "record date" _ the
date that establishes you as the person to
receive the upcoming distribution _ you
will receive, in the form of a taxable
distribution, a portion of the money you
just invested. Therefore, you may wish to
find out the fund's record date(s) before
investing. Of course, the fund's share
price will reflect undistributed capital
gains or unrealized appreciation, if any.
Transaction Procedures and Special
Requirements
PAGE 11
______________________ Purchase Conditions
Following these Nonpayment. If your payment is not received
procedures helps assure or you pay with a share draft, check or ACH
timely and accurate transfer that does not clear, your purchase
transactions. will be cancelled. You will be responsible
for any losses or expenses incurred by the
fund or transfer agent, and the fund can
redeem shares you own in this or another
identically registered CUNA Mutual Fund as
reimbursement. The fund and its agents have
the right to reject or cancel any purchase,
exchange, or redemption due to nonpayment.
U.S. Dollars. All purchases must be paid
for in U.S. dollars; share drafts or checks
must be drawn on U.S. financial
institutions.
Sale (Redemption) Conditions
10-day Hold. If you sell shares that you
just purchased and paid for by share draft,
check or ACH transfer, the fund will redeem
your shares at the price on the day the
request is received, but will generally
delay sending you the proceeds for up to 10
calendar days to allow the share draft,
check or transfer to clear. If you
requested a redemption by mail or mailgram,
the proceeds will be mailed no later than
the seventh day following receipt unless
the share draft, check or ACH transfer has
not cleared. (The 10-day hold does not
apply to purchases paid for by: bank wire;
cashier's, certified, or treasurer's
checks; or automatic purchases through your
paycheck.)
Telephone Transactions. Telephone exchange
and redemption are established
automatically when you sign the New Account
Form unless you check the box which states
that you do not want these services. The
fund uses reasonable procedures (including
shareholder identity verification) to
confirm that instructions given by
telephone are genuine. If these procedures
are not followed, it is the opinion of
certain regulatory agencies that a fund may
be liable for any losses that may result
from acting on the instructions given. All
conversations are recorded, and a
confirmation is sent within five business
days after the telephone transaction.
Redemptions over $250,000. Large sales can
adversely affect a portfolio manager's
ability to implement a fund's investment
strategy by causing the premature sale of
securities that would otherwise be held. If
in any 90-day period, you redeem (sell)
more than $250,000, or your sale amounts to
more than 1% of the fund's net assets, the
fund has the right to delay sending your
proceeds for up to five business days after
receiving your request, or to pay the
difference between the redemption amount
and the lesser of the two previously
mentioned figures with securities from the
fund. Brokerage costs would be incurred if
you later sold any such securities.
PAGE 12
______________________ Excessive Trading
CUNA Mutual Funds may bar
excessive traders from Frequent trades involving either
purchasing shares. substantial fund assets or a substantial
portion of your
account or accounts controlled by you, can
disrupt management of the fund and raise
its
expenses. We define "excessive trading" as
exceeding one purchase and sale involving
the same fund within any 120-day period.
For example, you are in fund A. You can
move substantial assets from fund A to fund
B, and, within the next 120 days, sell your
shares in fund B to return to fund A or
move to fund C.
If you exceed the number of trades
described above, you may be barred from
further purchases of CUNA Mutual Funds.
Systematic purchases or redemptions are
exempt from the excessive trading
guidelines (see "Shareholder Services").
PAGE 16
Keeping Your Account Open
Due to the relatively high cost of
maintaining small accounts, we ask you to
maintain an
account balance of at least $1,000. If your
balance is below $1,000 for three months or
longer, the fund has the right to close
your account after giving you 60 days in
which to increase your balance. (These
conditions may vary for retirement plan
accounts.)
Signature Guarantees
_______________________
A signature guarantee is You may need to have your signature
designed to protect you guaranteed in certain situations, such as:
and the fund from fraud
by verifying your Written requests to 1) redeem over
signature. $50,000 or 2) wire redemption proceeds.
Remitting redemption proceeds to any
person, address, credit union or bank
account not
on record.
Transferring redemption proceeds to a
CUNA Mutual Fund account with a different
registration from yours.
Establishing certain services after the
account is opened.
You can obtain a signature guarantee from
most credit unions, savings institutions,
banks, broker-dealers and other guarantors
acceptable to CUNA Mutual Funds. We cannot
accept guarantees from notaries public or
organizations that do not provide
reimbursement in the case of fraud.
PAGE 13
3 More About the Fund The Fund's Organization and Management
How is the fund organized?
The fund is a "diversified, open-end
investment company," or mutual fund. It is
one of a series of mutual funds of CUNA
Mutual Funds, Inc., incorporated in
Maryland in 1993. Mutual funds pool money
received from shareholders and invest it to
try to achieve specified objectives.
What is meant by "shares"?
As with all mutual funds, investors
purchase "shares" when they invest in a
fund. These shares are part of a fund's
authorized capital stock, but share
certificates are not issued.
Each share and fractional share entitles
the shareholder to:
receive a proportional interest in a
fund's income and capital gain
distributions;
cast one vote per share on certain fund
matters, including the election of fund
directors, changes in fundamental policies,
or approval of changes in a fund's
management contract.
Does the fund have an annual shareholder
meeting?
The fund is not required to hold a meeting
but will do so when certain matters, such
as a change in its fundamental policies,
are to be decided. In addition,
shareholders representing at least 10% of
all eligible votes may call a special
meeting if they wish for the purpose of
voting on the removal of any fund
director(s). If a meeting is held and you
cannot attend, you can vote by proxy. Well
before the meeting, the fund will send you
proxy materials that explain the issues to
be decided and include a voting card for
you to mail back.
PAGE 14
______________________ Who runs the fund?
All decisions regarding
the purchase and sale of General Oversight. The fund is governed by
fund investments are made a Board of Directors that meets regularly
by T. Rowe Price-- to review the fund's investments,
specifically by the performance, expenses, and other business
fund's portfolio affairs. The Board elects the fund's
managers. officers.
Portfolio Management. The fund has an
Investment Advisory Committee composed of
the
following members: Peter Van Dyke,
Chairman, Jerome Clark, Heather R. Landon,
James M. McDonald, Edmund M. Notzon, M.
David Testa, and Richard T. Whitney. The
Committee Chairman has day-to-day
responsibility for managing the fund and
works with the Committee in developing and
executing the fund's investment program.
Mr. Van Dyke has been managing investments
since joining T. Rowe Price in 1985.
What role do CUNA Mutual, CUNA and T. Rowe
Price have in running the fund?
CUNA Mutual Funds Management Company,
L.L.C., a Maryland limited liability
company whose sole members are CUNA Mutual
Investment Corporation, a wholly-owned
subsidiary of CUNA Mutual Insurance Society
("CUNA Mutual"), and CUNA Service Group,
Inc., an affiliate of Credit Union National
Association, Inc. ("CUNA"), have joined
together with
T. Rowe Price Management, Inc., a
wholly-owned subsidiary of T. Rowe Price
Associates, Inc. ("T. Rowe Price"), to form
a joint venture: CMC-T. Rowe Price
Management, LLC (the "Joint Venture"). The
Joint Venture, under an agreement with the
fund (the "Investment Management and
Administration Agreement"), is responsible
for providing, or negotiating on behalf of
the fund for third parties to provide,
investment management, shareholder
servicing, transfer agency, fund
accounting, custodial and other services
necessary for the operation of the fund.
The Joint Venture was formed in 1993 as a
Maryland limited liability company.
Investment Management. The Joint Venture
has entered into a sub-advisory agreement
with
the fund and T. Rowe Price (the
"Sub-Advisory Agreement") under which T.
Rowe Price is responsible for all decisions
regarding the purchase and sale of fund
investments and the selection of brokers
and dealers to effect such transactions.
For its sub-advisory activities,
T. Rowe Price is reimbursed for all of its
reasonable out-of-pocket expenses as well
as actual direct costs subject to the
limitations set forth in the agreement
establishing the Joint Venture (the "Joint
Venture Agreement"). T. Rowe Price and its
affiliates manage over $49 billion in
assets for 2.5 million individual and
institutional investor accounts. The firm
is one of the largest providers of no-load
mutual funds in the country.
PAGE 15
_____________________ Marketing. T. Rowe Price Investment
The address of T. Rowe Services, Inc., a wholly-owned subsidiary
Price Services is 100 of T. Rowe Price, and CUNA Brokerage
East Pratt St., Services, Inc., a member of CUNA Mutual
Baltimore, MD 21202. Insurance Group, (collectively the
"Distributors"), have entered into
agreements with the fund to sell
(distribute) shares of the fund.
Shareholder and Administrative Services.
The Joint Venture has entered into an
agreement with the fund and T. Rowe Price
Services, Inc., a wholly-owned subsidiary
of T. Rowe Price, to provide transfer and
dividend disbursing agent, shareholder and
administrative services to the fund. In
addition, T. Rowe Price will provide fund
accounting services under an agreement with
the fund and the Joint Venture.
How are fund expenses determined?
Under the Joint Venture Agreement, all
expenses of the fund's operation will be
paid by the Joint Venture, except 12b-1
fees; brokerage commissions and other costs
relating to the
purchase, sale or lending of the fund's
portfolio securities; interest; all taxes
or governmental fees payable by or with
respect to the fund; and nonrecurring or
extraordinary expenses. These other
expenses will be paid by the fund. The
Board of Directors of the fund reserves the
right to impose additional fees against
shareholder accounts to defray expenses
which would otherwise be paid by the Joint
Venture under the Joint Venture Agreement.
Such fees could be imposed if the fund's
custodial, transfer agent, accounting,
auditing or legal (collectively
"out-of-pocket") expenses were to increase
abruptly and significantly. The amount of
these fees would be limited to the increase
in the "out-of-pocket" expenses. The Board
does not anticipate levying such charges;
such a fee, if charged, may be retained by
the fund or paid to the Joint Venture.
Annual Fees. The fund pays the Joint
Venture an all inclusive fee at a rate of
1.25% of its average daily net assets. The
all inclusive fee covers both investment
management and operating expenses and is
calculated and accrued daily. This fee is
higher than the management fees of most
other mutual funds because it includes the
fund's operating expenses. Most other
mutual funds have a management fee and an
additional charge for operating expenses.
(See "Transaction Costs and Fund
Expenses.")
PAGE 17
The fund has adopted a distribution plan
under which the fund will pay a monthly fee
(equal to 0.25% annually of the fund's
average daily net assets) for costs and
expenses incurred in the distribution of
shares of the fund. Such a fee is usually
referred to as a 12b-1 fee. The types of
expenses it may cover include: (i)
advertising, including brochures, sales
literature, direct mail or any other form
of advertising; (ii) expenses of sales
employees or agents of the Distributors,
including salary, commissions, travel and
related expenses; (iii) payments to credit
unions and other financial institutions for
services in connection with the
distribution of shares, including fees
calculated with reference to the average
daily net asset value of shares held by
shareholders who have a service
relationship with the institution receiving
such fees; (iv) costs of printing
prospectuses and other materials to be
given or sent to prospective investors; and
(v) such other similar services as may be
reasonably calculated to result in the sale
of shares of the fund. In addition, all or
a portion of this fee may be paid to
broker-dealers or other financial
institutions as a service fee for
maintaining shareholder accounts or
providing personal service to shareholders
in the fund.
The fund's Distributors may incur expenses
in distributing shares of the fund which
will exceed the amounts paid to them by the
Joint Venture. These expenses will be borne
by each Distributor out of its own
resources.
Understanding Performance Information
This section should help you understand the
terms used to describe the fund's
performance. You will come across them in
shareholder reports you receive two times a
year, in "Investment Focus" articles, in
advertisements, and in the media.
PAGE 16
______________________ Total Return
Total return is the most This tells you how much an investment in a
widely used performance fund has changed in value over a given time
measure. Detailed period. It reflects any net increase or
performance information decrease in the share price and assumes
is included in the fund's that all dividends and capital gains (if
annual and semi-annual any) paid during the period were reinvested
shareholder reports. in additional shares. Reinvesting
distributions means that total return
numbers include the effect of compounding,
i.e., you receive income and capital gain
distributions on a rising number of shares.
Advertisements for the fund may include
cumulative or compound average annual total
return figures, which may be compared with
various indices, other performance
measures,
or other mutual funds.
Cumulative Total Return
This is the actual rate of return on an
investment for a specified period. A
cumulative return does not indicate how
much the value of the investment may have
fluctuated between the
beginning and the end of the period
specified.
Average Annual Total Return
This is always hypothetical. Working
backward from the actual cumulative return,
it tells
you what constant year-by-year return would
have produced the actual, cumulative
return. By smoothing out all the variations
in annual performance, it gives you an idea
of the investment's annual contribution to
your portfolio provided you held it for the
entire period in question.
PAGE 17
____________________ Yield
You will see frequent
references to the fund's The current or "dividend yield" on the fund
yield in our reports, or any investment tells you the
advertisements, in media relationship between the investment's
stories, and so on. current level of annual income and its
price on a particular day. The dividend
yield reflects the actual income paid to
shareholders for a given period,
annualized, and divided by the average
price during the given period. For example,
a fund providing $5 of annual income per
share and a price of $50 has a current
yield of 10%. Yields can be calculated for
any time period.
Investment Programs and Practices
This section takes a detailed look at some
of the types of securities the fund may
hold in its
portfolio and the various kinds of
investment practices that may be used in
day-to-day portfolio management. The fund's
investment program is subject to further
restrictions and risks described in the
"Statement of Additional Information."
Shareholder approval is required to
substantively change the fund's objective
(stated on
page 5) and to change certain investment
restrictions noted in the following section
as
"fundamental policies." The managers also
follow certain "operating policies" which
can be changed without shareholder
approval. However, significant changes are
discussed with shareholders in fund
reports.
Types of Portfolio Securities
PAGE 18 In seeking to meet its investment
____________________ objective, the fund may invest in any type
Fund managers have of security whose investment
considerable leeway in characteristics are consistent with the
choosing investment fund's investment program. These and some
strategies and selecting of the other investment techniques the fund
securities they believe may use are described in the following
will help the fund pages.
achieve its objectives.
Fundamental Policy. The fund will not
purchase a security if, as a result, with
respect to
75% of its total assets, more than 5% of
its total assets would be invested in
securities of the issuer, or more than 10%
of the voting securities of the issuer
would be held by the fund.
Bonds. A bond is an interest-bearing
security - an IOU - issued by companies or
governmental units. The issuer has a
contractual obligation to pay interest at a
stated rate on specific dates and to repay
principal (the bond's face value) on a
specified date. An issuer may have the
right to redeem or "call" a bond before
maturity, and the investor may have to
reinvest the proceeds at lower market
rates.
A bond's annual interest income, set by its
coupon rate, is usually fixed for the life
of the bond. Its yield (income as a percent
of current price) will fluctuate to reflect
changes in interest rate levels. A bond's
price rises when interest rates fall, and
vice versa so its yield stays current.
Bonds may be secured (backed by specified
collateral) or unsecured (backed by the
issuer's general creditworthiness).
Certain bonds have interest rates that are
adjusted periodically in order to minimize
fluctuations of their principal value. The
maturity of those securities may be
shortened under certain specified
conditions.
PAGE 19 Common and Preferred Stocks. Stocks
represent shares of ownership in a company.
Preferred stock, which has a specified
dividend, ranks after bonds and before
common stocks in its claim on income for
dividend payments and on assets should the
company be liquidated. After other claims
are satisfied, common stockholders
participate in company profits on a pro
rata basis; profits may be paid out in
dividends or reinvested in the company to
help it grow. Increases and decreases in
earnings are usually reflected in a
company's stock price, so common stocks
have the greatest appreciation and
depreciation potential of all corporate
securities.
Asset-backed Securities. An underlying pool
of assets, such as credit card or
automobile trade receivables or corporate
loans or bonds, backs these bonds and
provides the interest and principal
payments to investors. Credit quality
depends primarily on the quality of the
underlying assets and the level of credit
support, if any, provided by the issuer.
The underlying assets (i.e., loans) are
subject to prepayments which can shorten
the securities' weighted average life and
may lower their return. The value of these
securities also may change because of
actual or perceived changes in the
creditworthiness of the originator,
servicing agent, or of the financial
institution providing the credit support.
Convertible Securities and Warrants. The
fund may invest in debt or preferred equity
securities convertible into or exchangeable
for equity securities. Warrants are options
to buy a stated number of shares of common
stock at a specified price any time during
the life of the warrants (generally, two or
more years).
Mortgage-backed Securities. The fund may
invest in a variety of mortgage securities.
Mortgage lenders pool individual home
mortgages with similar characteristics to
back a certificate or bond, which is sold
to investors such as the fund. Interest and
principal payments generated by the
underlying mortgages are passed through to
the investors. The "big three" issuers are
Government National Mortgage Association
(GNMA), the Federal National Mortgage
Association (Fannie Mae), and the Federal
Home Loan Mortgage Corporation (Freddie
Mac). GNMA certificates are backed by the
full faith and credit of the U.S.
Government, while others, such as Fannie
Mae and Freddie Mac certificates, are only
supported by the ability to borrow from the
U.S. Treasury or supported only by the
credit of the agency. Private mortgage
bankers also issue mortgage-backed
securities.
Mortgage securities are subject to regular
principal prepayments as homeowners pay
down or pay off their mortgages. When
interest rates fall, the pace of mortgage
refinancings picks up. Refinanced mortgages
are paid off at face value (par), causing a
loss for any investor who may have
purchased the security at a price above
par. In such an environment, this risk
limits the potential price appreciation of
these securities and can negatively affect
the fund's net asset value. When rates
rise, however, mortgage-backed securities
have historically experienced smaller price
declines than comparable quality bonds.
Additional mortgage-related securities in
which the fund may invest include:
Collateralized Mortgage Obligations
(CMOs). CMOs are debt securities that are
fully collateralized by a portfolio of
mortgages or mortgage-backed securities.
All interest and principal
payments from the underlying mortgages are
passed through to the CMOs in such a way as
to create more definite maturities than is
the case with the underlying bonds. CMOs
may pay fixed or variable rates of
interest, and certain CMOs have priority
over others with respect to the receipt of
prepayments.
Stripped Mortgage Securities. Stripped
mortgage securities are created by
separating the interest and principal
payments generated by a pool of
mortgage-backed bonds to create two classes
of securities. Generally, one class
receives only interest payments (IOs) and
one principal payments (POs).
IOs and POs are acutely sensitive to
interest rate changes and to the rate of
principal prepayments. They are very
volatile in price and may have lower
liquidity than most mortgage-backed
securities. Certain CMOs may also exhibit
these qualities, especially those which pay
variable rates of interest which adjust
inversely with and more rapidly than
short-term interest rates. There is no
guarantee the fund's investment in CMOs,
IOs or POs will be successful, and the
fund's total return could be adversely
affected as a result.
Hybrid Instruments. These instruments can
have the characteristics of futures,
options and
debt securities. For example, the interest
or principal of a hybrid bond may be
determined by the value of a designated
currency, commodity, or foreign or domestic
securities index at a specified future
time. One type of hybrid instrument is a
cross currency linked bond whose coupon
yield varies based on the relationship
between two currencies. Another type could
pay a market rate of interest but have its
principal at maturity determined by a
multiple of an index. Under certain
conditions, the redemption value of such an
investment could be zero. Hybrids can have
volatile prices and limited liquidity.
Private Placements. These securities are
sold directly to a small number of
investors, usually institutions. Unlike
public offerings, such securities are not
registered with the SEC. Although certain
of these securities may be readily sold,
for example under Rule 144A, the sale of
others may involve substantial delays and
additional costs.
Operating Policy. The fund will not invest
more than 15% of its net assets in illiquid
securities.
Foreign Securities. The fund may invest in
securities denominated in non-U.S. dollar
currencies and U.S. dollar denominated
securities that are issued and principally
traded outside the U.S. Such investments
increase a portfolio's diversification and
may enhance return, but they also involve
some special risks such as exposure to
potentially adverse local political and
economic developments; nationalization and
exchange controls; potentially lower
liquidity and higher volatility; possible
problems arising from accounting,
disclosure, settlement, and regulatory
practices that differ from U.S. standards;
and for non-dollar denominated securities,
the chance that fluctuations in foreign
exchange rates will decrease the
investment's value (favorable changes can
increase its value).
Operating Policy. The fund may invest up to
30% of its total assets in securities
denominated in foreign currencies (20% in
equities and 10% in debt securities).
Types of Management Practices
Cash Position. The fund will hold a certain
portion of its assets in money market
securities
PAGE 20 in the two highest rating categories,
maturing in one year or less. For
temporary, defensive purposes, the fund may
invest without limitation in such
securities. This reserve position
provides flexibility in meeting
redemptions, expenses, and the timing of
new investments, and serves as a short-term
defense during periods of unusual market
volatility. Under normal market conditions,
the fund expects to hold approximately
0-20% of its total assets in cash.
Borrowing Money and Transferring Assets.
The fund can borrow money from banks as a
temporary measure for emergency purposes,
to facilitate redemption requests, or for
other purposes consistent with the fund's
investment objectives and program. Such
borrowings may be collateralized with fund
assets, subject to restrictions.
Fundamental Policy. Borrowings may not
exceed 33 1_3% of total fund assets.
Operating Policies. The fund may not
transfer as collateral any portfolio
securities except as necessary in
connection with permissible borrowings or
investments, and then such transfers may
not exceed 33 1_3% of the fund's total
assets. The fund may not purchase
additional securities when borrowings
exceed 5% of total assets.
Futures and Options. Futures are often used
to manage risk, because they enable the
investor to buy or sell an asset in the
future at an agreed upon price. Options
give the investor the right, but not the
obligation, to buy or sell an asset at a
predetermined price in the future. The fund
may buy and sell futures contracts (and
options on such contracts) to manage its
exposure to changes in interest rates,
stock and bond prices, and foreign
currencies; to adjust its overall exposure
to certain markets; and also to adjust the
portfolio's duration. The fund may
purchase, sell, or write call and put
options on securities, financial indices,
and foreign currencies.
Futures contracts and options may not
always be successful hedges; their prices
can be highly volatile; and using them
could lower the fund's total return.
Operating Policies. Futures: The fund will
not use futures contracts for speculation.
Initial margin deposits and premiums on
options used for non-hedging purposes will
not equal more than 5% of the fund's net
asset value. Options on securities: The
total market value of securities against
which the fund has written call or put
options may not exceed 25% of its total
assets.
Interest Rate Swaps. The fund may enter
into various interest rate transactions
such as interest rate swaps and the
purchase or sale of interest rate caps and
floors, to preserve a return or spread on a
particular investment or portion of its
portfolio, to create synthetic securities,
or to structure transactions designed for
other non-speculative purposes.
Operating Policy. The fund will not invest
more than 10% of its total assets in
interest rate swaps.
Managing Foreign Currency Risk. Investors
in non-U.S. dollar securities may "hedge"
their exposure to potentially unfavorable
currency changes by purchasing a contract
to exchange one currency for another on
some future date at a specified exchange
rate. In certain circumstances, a "proxy
currency" may be substituted for the
currency in which the investment is
denominated, a strategy known as "proxy
hedging." The fund might also use these
PAGE 20
contracts to create a synthetic bond issued
by a U.S. company but with the dollar
component transformed into a foreign
currency. Although foreign currency
transactions will be used primarily to
protect the fund's non-dollar securities
from adverse currency movements, they
involve the risk that anticipated currency
movements will not occur and the fund's
total return could be reduced.
Operating Policy. The fund will normally
conduct its foreign exchange transactions
in cash
or by entering into forward currency
contracts (not exceeding 30% of total
assets) expiring
in less than one year.
Repurchase Agreements. The fund may enter
into repurchase agreements (repos) with
well-established securities dealers or
banks that are members of the Federal
Reserve System. If a seller of repos is
unable to repurchase the securities, the
fund could experience extra costs, delays
in recovering its securities, or possibly a
capital loss.
Lending of Portfolio Securities. Like other
mutual funds, the fund may lend securities
to broker-dealers, other institutions, or
other persons to earn additional income.
The principal risk is the potential
insolvency of the broker-dealer or other
borrower. In this event, the fund could
experience delays in recovering its
securities and possibly capital losses.
Fundamental Policy. The value of loaned
securities may not exceed 33 1_3% of the
fund's total assets.
PAGE 21
When-Issued Securities and Forward
Commitment Contracts. The fund may purchase
securities on a when-issued or delayed
delivery basis or may purchase or sell
securities on a forward commitment basis.
The price of these securities is fixed at
the time of the commitment to buy, but
delivery and payment can take place a month
or more later. During the interim period,
the market value of the securities can
fluctuate, and no interest accrues to the
purchaser. At the time of delivery, the
value of the securities may be more or less
than the purchase or sale price. Depending
on the fund's other investments, purchase
of these securities could increase the
level of fluctuations in the fund's net
asset value.
Portfolio Transactions. The portfolio
turnover rate is not expected to exceed
120%. A high turnover rate may increase
transaction costs and result in taxable
capital gains distributed to shareholders.
In executing transactions, the fund's Board
has authorized T. Rowe Price to use certain
brokers who are indirectly related to T.
Rowe Price.
High Yield/High Risk Investing. The total
return and yield of lower quality (high
yield/high risk) bonds, commonly referred
to as "junk bonds," can be expected to
fluctuate more than the total return and
yield of higher quality, shorter-term
bonds. Junk bonds are regarded as
predominantly speculative with respect to
the issuer's continuing ability to meet
principal and interest payments. Successful
investment in low and lower-medium quality
bonds involves greater investment risk and
is highly dependent on T. Rowe Price's
credit analysis. A real or perceived
economic downturn or higher interest rates
could cause a decline in high yield bond
prices, because such events could lessen
the ability of issuers to make principal
and interest payments. These bonds are
thinly-traded and can be more difficult to
sell and value accurately than high-quality
bonds. Because objective pricing data may
be less available, judgment may play a
greater role in the valuation process.
Credit Quality Considerations. The credit
quality of most bond issues is evaluated by
rating agencies such as Moody's and
Standard & Poor's. Credit quality refers to
the issuer's ability to meet all required
interest and principal payments. The
highest ratings are assigned to issuers
perceived to be the best credit risks. T.
Rowe Price research analysts also evaluate
all portfolio holdings of the fund,
including those rated by outside agencies.
The lower the rating on a bond, the higher
the yield, other things being equal.
Table 4 shows the rating scale used by the
major rating agencies. T. Rowe Price
considers publicly available ratings, but
emphasizes its own credit analysis when
selecting investments.
Ratings of Corporate Debt Securities
Moody's Standard Fitch Definition
Investors & Poor's Investors
Service, Corp- Service, Inc.
Inc. oration
Long-Term Aaa AAA AAA
Highest quality
Aa AA AA High quality
A A A Upper medium
grade
Baa BBB BBB Medium grade
Ba BB BB Low grade
B B B Speculative
PAGE 21
Moody's S&P Fitch
Commercial P-1 Superior quality A-1+
Extremely strong
quality F-1+ Exceptionally strong quality
Paper A-1 Strong quality
F-1 Very strong quality
P-2 Strong quality A-2 Satisfactory
quality F-2 Good credit quality
P-3 Acceptable quality A-3 Adequate
quality F-3 Fair credit quality
B Speculative quality
F-S Weak credit quality
Table 4
4 Investing in the Meeting Requirements for New Accounts
CUNA Mutual Funds
Tax Identification Number
______________________
Always verify your We must have your correct social security
transactions by carefully or corporate tax identification number and
reviewing the a signed New Account Form or W-9 Form.
confirmation we send you. Otherwise, federal law requires the fund to
Please report any withhold a percentage (currently 31%) of
discrepancies to your dividends, capital gain distributions,
Shareholder Services at and redemptions, and may subject you to a
1-800-934-FUND (3863). fine. You will also be prohibited from
opening another account by exchange. If
this information is not received within 60
days after your account is established,
your account may be redeemed, priced at the
NAV on the date of redemption.
Unless you request otherwise, one
shareholder report will be mailed to
multiple account
owners with the same tax identification
number and same zip code and to those
shareholders who have requested that their
account be combined with someone else's for
financial reporting.
Opening a New Account: $2,500 minimum
initial investment; $1,000 for gifts or
transfers to minors (UGMA/UTMA) accounts
Account Registration
PAGE 22
If you own other CUNA Mutual Funds, be sure
_________________________ to register any new account just like your
Regular Mail existing accounts so you can exchange among
CUNA Mutual Funds them easily. (The name and account type
P.O. Box 17434 must be identical.)
Baltimore, MD
21298-9613 By Mail
Please make your share draft or check
payable to CUNA Mutual Funds (otherwise it
may be returned) and send it together with
the New Account Form to the address at
left.
By Wire
_______________________ Call Investor Services for an account
Mailgram, Express, number and use the wire address below.
Registered, or Certified Complete a New Account Form and mail it
Mail to the address listed at left.
CUNA Mutual Funds Give the following wire address to your
Account Services financial institution: Morgan Guaranty
10090 Red Run Blvd. Trust Co.
Owings Mills, MD of New York, ABA# 021000238, CUNA Mutual
21117 [fund name], AC-00153938. Provide fund
name, account name(s), and account number.
By Exchange
Call Shareholder Services. The new account
will have the same registration as the
account from which you are exchanging.
Services for the new account may be carried
over by telephone request if preauthorized
on the existing account. (See explanation
of "Excessive Trading" under "Transaction
Procedures.")
Note: The fund and its agents have the
right to waive or lower investment
minimums, to accept initial purchases by
telephone or mailgram, to cancel or reject
any purchase or exchange if the written
confirmation has not been received by the
shareholder, or to otherwise modify the
conditions of purchase or any services at
any time.
PAGE 23
Purchasing Additional Shares: $100 minimum
purchase
By ACH Transfer
Call Shareholder Services if you have
established electronic transfers using the
ACH network ($100 minimum).
By Wire
Call Shareholder Services or use the wire
address in "Opening a New Account."
By Mail
_________________________
Regular Mail Provide your account number and the
CUNA Mutual Funds fund name on your share draft or check.
Account Services
P.O. Box 89000 Mail the share draft or check to us at
Owings Mills, MD the address shown at left with an
21289-1500 investment form (located at the bottom of
your statement), a stub from a statement
confirming a prior transaction or a note
stating that you want to purchase shares in
that fund (provide account number).
By Systematic Investing
Fill out the Systematic Investing section
on the New Account or Shareholder Services
Form.
Exchanging and Redeeming Shares
_____________________
Regular Mail By Phone
CUNA Mutual Funds Call Shareholder Services. For exchange
Account Services policies, please see "Transaction
P.O. Box 89000 Procedures and Special Requirements _
Baltimore, MD Excessive Trading."
21289-0220
Redemption proceeds can be mailed to your
account address, wired to your credit union
or bank, or sent by ACH transfer. For
charges, see "Electronic Transfers _ By
Wire" on the next page.
PAGE 24
By Mail
________________ Provide account name(s) and numbers, fund
Mailgram, Express, name(s), and exchange or redemption amount.
Registered, or For exchanges, mail to the appropriate
Certified Mail address at left, indicate the fund you are
(See page 20.) exchanging from and the fund(s) you are
exchanging into. CUNA Mutual Funds require
the signatures
of all owners exactly as registered, and
possibly a signature guarantee (see
"Transaction Procedures and Special
Requirements _ Signature Guarantees").
Note: Redemptions from retirement accounts,
including IRAs, must be in writing.
Procedures for retirement accounts may
vary.
Shareholder Services
___________________
Investor Services Many services are available to you as a
1-800-756-FUND CUNA Mutual Fund shareholder; some you
receive automatically and others you must
authorize on the New Account Form. By
Shareholder Services signing up for services on the New Account
1-800-934-FUND Form rather than later on, you avoid having
to complete a separate form and obtain a
signature guarantee. This section reviews
some of the principal services currently
offered.
Shareholder Services. Buy, sell, or
exchange shares by calling one of our
service representatives.
Exchange Service
You can move money from one account to an
existing identically registered account, or
open
a new identically registered account.
Remember, exchanges are purchases and sales
for tax purposes.
Electronic Transfers
By ACH. With no charges to pay, you can
initiate a purchase or redemption for as
little as $100 or as much as $100,000
between your credit union or bank account
and fund account using the ACH network.
Call Shareholder Services.
By Wire. Electronic transfers can also be
conducted via bank wire. There is currently
a $5 fee for wire redemptions under $5,000,
and your credit union or bank may charge
for wire transfers regardless of size.
Systematic Investing
You can invest automatically in several
different ways, including:
Systematic Investing. You instruct us
to move $50 or more once a month or less
often from your credit union or bank
account, or you can instruct your employer
to send all or a portion of your paycheck,
to the fund or funds you designate.
Automatic Exchange. Enables you to set
up systematic investments from one fund
account into another, such as from a bond
fund into an asset allocation fund.
PAGE 25 Prospectus
To Open an Account
Investor Services CUNA Mutual Funds, Inc.
1-800-756-FUND CUNA Mutual
Cornerstone Fund
For Existing Accounts
Shareholder Services CUNA Mutual
1-800-934-FUND Funds, Inc.
Cornerstone Fund
December 30, 1993
To help credit union
members achieve their A single fund that diversifies its
financial goals, we offer investments across asset categories
an asset allocation fund, (stocks, bonds, and money market
a tax-free fund and a securities) in an effort to provide a high
U.S. Government bond total return.
fund, as well as
convenient services and
timely, informative
reports.
PAGE 1
CUNA Mutual Funds, Inc.
CUNA Mutual Tax-Free Intermediate-Term Fund
CUNA Mutual Funds, Inc.
Facts at a Glance CUNA Cutual Tax-Free Intermediate-Term Fund
December 30, 1993
Objective Prospectus
Highest level of tax-free Contents
income consistent with
modest share price 1 About the Fund
fluctuation. Transaction Costs and
Fund Expenses 2
Investment Strategy Mutual Fund Investing:
How It Works 3
The fund invests Fund and Market Characteristics:
primarily in What to Expect 5
investment-grade 2 About Your Account
municipal bonds whose Pricing Shares;
income is exempt from Receiving Sale Proceeds 8
federal income taxes. By Distributions and Taxes 8
limiting its average Transaction Procedures and
effective maturity to Special Requirements 10
between three and 10 3 More About the Fund
years, the fund seeks to Organization and Management 12
moderate share price Understanding Fund Performance 14
volatility while still Investment Policies and Practices 15
earning a high degree of 4 Investing With CUNA Mutual Funds
income. The fund may have Meeting Requirements
up to 20% of its income for New Accounts 20
subject to the Opening a New Account 20
alternative minimum tax Purchasing Additional Shares 21
(AMT). Exchanging and Redeeming 22
Shareholder Services 22
Risk/Reward Potential
Greater return
potential than a shorter This prospectus contains information you
maturity fund, should know before investing. Please keep
accompanied by greater it for future reference. A Statement
share price of Additional Information about the Fund,
fluctuation. dated December 30, 1993, has been filed
with the Securities and Exchange Commission
UNLIKE CREDIT UNION and is incorporated by reference in this
AND BANK ACCOUNTS, THE prospectus. To obtain a free copy, call
VALUE OF YOUR INVESTMENT 1-800-756-FUND (3863).
IN THIS FUND IS NOT
INSURED. YOUR INVESTMENT
IS NOT A
PAGE 2
DEPOSIT OF, OR GUARANTEED
BY, ANY CREDIT UNION OR
GOVERNMENT AGENCY. YOUR
INVESTMENT INVOLVES
CERTAIN RISKS INCLUDING A
LOSS OF PRINCIPAL.
Investor Profile
Credit union members
seeking the benefits of
income exempt from
federal taxes, and who
can accept some measure
of principal risk. A
portion of the fund's
income may be subject to
the alternative minimum
tax, though relatively
few taxpayers are
required to pay this
tax.
Fees and Charges
No load. No fees or
charges to buy or sell
shares or to reinvest
dividends. Free telephone
exchange between this and
other CUNA Mutual Funds.
Investment Adviser
Founded in 1937, T. Rowe
Price Associates and its
affiliates have a staff
of over 82 professionals
who manage over $49
billion for approximately
2.5 million individual
and institutional
investor accounts. The
firm is one of the
largest providers of
no-load mutual funds in
the country.
PAGE 3
THESE SECURITIES HAVE NOT
BEEN APPROVED OR
DISAPPROVED BY THE
SECURITIES AND EXCHANGE
COMMISSION, OR ANY STATE
SECURITES COMMISSION, NOR
HAS THE SECURITIES AND
EXCHANGE COMMISSION, OR
ANY STATE SECURITIES
COMMISSION, PASSED UPON
THE ACCURACY OR ADEQUACY
OF THIS PROSPECTUS.
1 About the Fund Transaction Costs and Fund Expenses
The fund has an all-inclusive fee covering
investment management and operating
expenses. This fee will not fluctuate. In
contrast, most mutual funds have a fixed
management fee plus
a fee for operating expenses that varies
according to a number of factors. (See "How
are fund expenses determined?" on page 13.)
You pay no direct costs to buy, sell, or
exchange shares. All the money you invest
in the fund goes to work for you.
The table below indicates how much it will
cost to operate the fund for a year. These
are
costs you pay indirectly, because they are
deducted from the fund's total assets
before the daily share price is calculated
and before dividends and other
distributions are made. In
other words, you will not see these
expenses on your account statement.
PAGE 4
_________________ Annual Mutual Fund Expenses
The CUNA Mutual Funds are Percentage of Fiscal 1994 Average Net
no load. Assets
Management Fee* 0.75%
Distribution (12b-1) Fee** 0.25
Other expenses* 0.00
Total Fund Expenses* 1.00%
*The management fee includes operating
expenses. The fund charges a $5 fee for
wire redemptions under $5,000, subject to
change without notice.
**Under rules of the National Association
of Securities Dealers, Inc. ("NASD"), a
12b-1 fee may be treated as a sales charge
in certain instances. Because the 12b-1 fee
is an annual fee charged against fund
assets, long-term shareholders may
indirectly pay more in total sales charges
than the economic equivalent of a maximum
front-end sales charge permitted by the
NASD.
Table 1
Hypothetical example: For each $1,000
you invest, assume you earn 5% annually and
close your account at the end of the time
periods shown. The 5% return does not
represent the fund's past or future
performance.
__________________
The table at right is Example of Fund Expenses Per $1,000
just an example and Invested
actual expenses can be 1 year 3 years
higher or lower than $10 $32
those shown. Table 2
Mutual Fund Investing: How It Works
PAGE 5
______________________ What is a mutual fund?
This question-and-answer As its name implies, a mutual fund pools
section reviews some of money from many individuals who share
the basics of mutual fund similar investment goals. Your investment
investing. in a mutual fund entitles you to shares of
the fund _ you are a direct owner of an
investment company. The fund, in turn,
takes the money received from its
shareholders and invests in individual
securities, such as stocks, bonds, or money
market instruments, in the interest of
achieving the fund's investment objectives.
So you are a direct owner of a mutual
fund's shares and an indirect owner of all
the securities in which the fund invests.
What is a prospectus?
A prospectus is a legal document prepared
for mutual fund investors. Its chief
purpose is to describe a fund's investment
objectives, the investment manager, and the
fund's policies, fees, and risks.
What are the benefits of investing in
mutual funds?
Mutual fund investing provides many
benefits:
Professional management. You gain
access to professional investment managers
who use a wide variety of information and
financial management tools to help a fund
achieve its
investment objectives.
Diversification. Since mutual funds
pool your money with that of other
investors, you are investing in a large
portfolio of stocks and/or bonds. Investing
in a variety of securities
generally results in lower price
fluctuation than holding only a few
individual securities.
Liquidity. You can sell your shares on
any business day and receive the value of
your investment. You do not need to find a
buyer _ the fund will redeem your shares.
Of course, the price you receive for
selling your shares may be more or less
than the price you paid (see "Pricing
Shares and Receiving Sale Proceeds" on page
8).
Professional record keeping and account
service. You will receive a concise,
easy-to-read account statement on a
quarterly basis. Furthermore, if you have
questions about your statement or of any
aspect of your investment, you can call
toll free 1-800-934-FUND (3863).
Is my investment insured?
No. Unlike credit union or bank accounts,
mutual fund investments are not insured.
Since mutual funds invest in securities
whose values fluctuate, there is no
assurance your investment will be equal to
its original value when you sell your
shares. Also, there is no guarantee that a
fund will meet its investment objective.
How can I measure my investment's progress?
Total return is the most widely used
measure of mutual fund performance. It
tells you how much an investment in a fund
has changed in value over a given time
period, reflecting any net increase or
decrease in the share price and assuming
that any dividends and capital gains paid
during the period were reinvested in
additional shares of the fund.
Detailed total return information for
various time periods _ both absolute and
relative to comparable benchmarks _ appears
in semiannual and annual reports sent to
you by your fund's management. The price
per share also appears in the business
section of most major daily newspapers and
will be listed under CUNA Mutual Funds.
Is the fund's yield the rate of return I
would get?
No. The fund's income, represented by the
dividend yield, is expected to be the major
component of your return, but it is not the
only component. Like its income, the fund's
share price will vary, causing an increase
or decrease in your principal investment.
This principal gain or loss combines with
the income paid to you by the fund to
produce your total return.
PAGE 6
What are some examples of mutual funds?
Money market funds. Money market funds
invest in short-term debt obligations
(usually with maturities less than a year)
of issuers such as the U.S. Government,
corporations, and municipalities. Because
of the high degree of safety they provide,
money market funds typically offer the
lowest return potential of any type of
mutual fund. Currently, the CUNA Mutual
Funds do not include a money market fund.
Bond funds. Like money market funds,
bond funds invest in a wide range of debt
obligations of issuers such as the U.S.
Government, corporations, and
municipalities. But, because they invest in
securities that may mature in three, five,
10, or 30 years, bond funds typically offer
a higher return potential than money market
funds but with higher risk due to price
fluctuations.
Stock funds. These funds invest in a
wide range of publicly traded stocks.
Historically, stock funds have offered the
highest long-term return potential of any
single type of fund and have involved the
highest degree of risk because their share
prices, and an investor's principal,
typically fluctuate the most. Currently,
the CUNA Mutual Funds do not include a
stock fund.
Asset allocation. Asset allocation
funds invest assets among various asset
classes (stock, bond, and money market
securities) according to the manager's
outlook for the economy, interest rates,
and financial markets. Such funds employ
this strategy as a way to reduce risk in
the hope that the good performance in one
asset class will offset lackluster
performance in another. However, it is
important to note that most asset
allocation funds normally keep a higher
percentage of assets in stocks, barring
unusual market conditions. Therefore, the
share price of an asset allocation fund
typically fluctuates more than a bond
fund's but less than a stock fund's.
PAGE 7
_____________________ What should I consider when selecting a
The fund or funds you fund?
select should reflect Review your own financial objectives _
your individual primarily your need for access to your
investment goals, but money, your time horizon, and your risk
should not represent your tolerance _ before making an investment.
complete investment Generally, investors needing ready access
program. No fund should to their money should stay in shorter-term
be used for short-term investments that seek the highest degree of
trading purposes. income consistent with minimal or moderate
volatility (i.e., share price
fluctuation). Investors seeking maximum
return should adopt a long-term time
horizon and be more comfortable with the
periodic principal declines that accompany
the potential for higher returns.
PAGE 8
______________________ Fund and Market Characteristics: What to
This section takes a Expect
closer look at fixed-
income market
characteristics, tax-free
investments and the
fund's investment
program--to help you
decide if it is
appropriate for you.
What is the fund's objective?
The fund's objective is to provide the
highest level of tax-free income consistent
with modest share price fluctuation.
What types of securities will the fund
purchase?
The fund will invest in investment-grade
municipal bonds rated from AAA to BBB by a
national rating agency or, if unrated, of
equivalent investment quality as determined
by the fund's investment adviser. This does
not prevent the fund from retaining a
security which is downgraded to
below-investment-grade after purchase.
There is no limit on the maturity of
individual securities, but the fund's
dollar-weighted average effective maturity
will normally vary between three and 10
years. Targeting effective maturity
provides additional flexibility in
portfolio management but, all else being
equal, could result in higher volatility
than of a fund targeting a stated maturity
or maturity range. Keep in mind the fund
may have up to 20% of its income subject to
the alternative minimum tax (AMT). However,
relatively few taxpayers are required to
pay this tax.
PAGE 9
Who issues tax-free securities?
State and local governments and
governmental authorities sell notes and
bonds (usually called "municipals") to pay
for public projects and services.
Who buys tax-free securities?
Individuals are the primary investors, and
a principal way they invest is through
mutual funds. Because mutual funds have
become a major source of demand, prices of
municipals may be affected by major changes
in flows of money into or out of municipal
bond and money market funds. For example
substantial and sustained redemptions from
municipal bond funds could result in lower
prices for these securities.
Why are yields on municipals usually below
those on otherwise comparable taxable
securities?
Since the income provided by most
municipals is exempt from federal taxation,
investors
can accept lower yields on a municipal bond
than on an otherwise similar taxable bond
and still have the potential for higher
after-tax income.
___________________
Here is some information How can I tell if a tax-free or taxable
to help you choose the fund is more suitable for me?
fund that's right for The primary factor is your expected federal
you. income tax rate. The higher your tax
bracket,
the more likely tax-frees will be
appropriate. If the after-tax yield on a
taxable bond or money market is less than a
municipal fund's tax-exempt yield, then
your income will be higher in the municipal
fund. To find what a taxable bond fund
would have to yield to equal the tax-free
yield on a municipal bond, divide the
municipal bond's yield by 1 minus your tax
rate. For quicker reference, the table
below shows a range of taxable equivalent
yields.
If your federal A tax-free yield of
tax rate is: 2% 3% 4% 5% 6%
equals a taxable yield of:
28% 2.8% 4.2% 5.6% 6.9% 8.3%
31 2.9% 4.3% 5.8% 7.2% 8.7%
36 3.1% 4.7% 6.3% 7.8% 9.4%
39.6 3.3% 5.0% 6.6% 8.3% 9.9%
Table 3 This is a hypothetical
example and does not reflect actual
performance in any CUNA Mutual Fund.
Is interest income from all municipal bonds
always exempt from federal taxes?
No. Since 1986, income from so-called
"private activity" municipals has been
subject to the federal alternative minimum
tax (AMT). For example, bonds financing
airports, stadiums, and student loan
programs fall in this category. The fund
may have up to 20% of its income
subject to the AMT computation.
Shareholders subject to the AMT must
include income derived from
private-activity bonds in their AMT
calculation. Relatively few taxpayers are
required to pay this tax. (For further
information, see "Taxes on Fund
Distributions.")
Did the 1993 tax legislation affect the
tax-exempt status of municipal securities?
Yes. Previously, the gain on a municipal
bond bought at a discount (price below par)
and sold or redeemed at a higher value was
classified and taxed as a capital gain. If
it were a long-term gain, the 28% capital
gains tax would apply. Under the new law, a
portion of that gain must be taxed at the
investor's personal income tax rate,
provided the original discount was
sufficiently large. Furthermore, the gain
cannot be offset by any capital losses.
This tax change increases the likelihood
that tax-exempt mutual funds will have to
make an annual taxable distribution to
their shareholders. Any such distributions
by the fund will be reported in the
year-end tax information sent to
shareholders.
PAGE 10 What are the main risks of tax-free bond
funds?
Interest rate or market risk - the
decline in bond prices that accompanies a
rise in overall interest rates.
Credit risk - the chance that any of a
fund's holdings will have its credit rating
downgraded or will default (fail to make
scheduled interest and principal payments),
potentially reducing the fund's income
level and/or share price.
What is "credit quality" and how does it
affect the fund's yield?
Credit quality refers to a bond issuer's
expected ability to make all required
interest and principal payments in a timely
manner. Because highly-rated bond issuers
present less risk, they can borrow at lower
interest rates than less creditworthy
issuers. Therefore, a fund invested
in high-quality securities should have a
lower yield than an otherwise comparable
fund investing in lower credit quality
securities. Investment-grade securities
include a range of securities from the
highest rated to medium quality (BBB).
Securities in the BBB category may be more
susceptible to adverse economic conditions
or changing circumstances and the
securities at the lower end of the BBB
category have certain speculative
characteristics.
What is meant by a bond or bond fund's
maturity?
Every bond has a stated maturity date when
the issuer must repay the bond's entire
principal value to the investor. Some types
of bonds may also have an "effective
maturity" that is shorter than the stated
date. Many corporate and municipal bonds
are "callable," meaning their principal can
be repaid before their stated maturity
dates on (or after) specified call dates.
Bonds are most likely to be called when
interest rates are falling, because the
issuer wants to refinance at a lower rate.
In such an environment, a bond's "effective
maturity" is usually its nearest call date.
A bond mutual fund has no maturity in the
strict sense of the word, but does have a
dollar-weighted average maturity. This
number is an average of the stated
maturities of the underlying bonds, with
each maturity "weighted" by the percentage
of fund assets it represents. Funds that
target effective maturities would use the
effective (rather than stated) maturities
of the underlying bonds when computing the
average.
How is a bond's price affected by changes
in interest rates?
When interest rate levels rise, a bond
price usually falls, and vice versa.
Generally speaking, the longer the bond's
maturity, the greater the potential
increase or decrease in response to a given
change in interest rates, as shown in the
table below.
PAGE 11
How Interest Rates Affect Bond Prices
Bond Maturity Coupon Price of $1,000
Bond If Interest Rates:
Increase Decrease
1% 2% 1% 2%
2 years 2.60% $990 $981 $1,010
$1,020
5 years 3.85 $956 $914 $1,046 $1,095
10 years 4.40 $924 $854 $1,084 $1,177
20 years 5.15 $886 $789 $1,135 $1,295
30 years 5.20 $866 $755 $1,170 $1,384
Table 4 Coupons reflect yields on
AAA-rated municipals as of 9/30/93. This is
an illustration and does not represent
expected yields or share-price changes in
any CUNA Mutual Fund.
How does the fund's investment adviser try
to reduce risk?
Consistent with the fund's investment
objective, the investment adviser actively
manages the portfolio to minimize risk and
increase total return. Risk management
tools include:
diversification of assets to reduce the
impact of a single holding on a fund's net
asset value;
thorough credit research by its own
credit analysts; and
maturity adjustments to reflect the
adviser's interest rate outlook.
PAGE 12
2 About Your Account Pricing Shares and Receiving Sale Proceeds
Here are some procedures you should know
when investing in the fund.
_________________________
The various ways you can
buy, sell, and exchange How and when shares are priced
shares are explained at The share price (also called "net asset
the end of this value" or NAV per share) for the fund is
prospectus and on the New calculated
Account Form. at 4 p.m. ET each day the New York Stock
Exchange is open for business. To calculate
______________________ the NAV, the fund's assets are priced and
When filing out the New totaled, liabilities are subtracted, and
Account Form, you may the balance,
wish to give yourself the called net assets, is divided by the number
widest range of options of shares outstanding.
for receiving proceeds
from a sale. How your purchase, sale, or exchange price
is determined
If we receive your request in correct form
before 4 p.m. ET, your transaction will be
priced at that day's NAV. If we receive it
after 4 p.m., it will be priced at the next
business day's NAV. (See "Meeting
Requirements for New Accounts" and "Opening
a New Account" under "Investing in the CUNA
Mutual Funds.")
We're sorry, but we cannot accept orders
that request a particular day or price for
your transaction or any other special
conditions.
Note: The time at which transactions are
priced may be changed in case of an
emergency or if the New York Stock Exchange
closes at a time other than 4 p.m. ET. If
your redemption request cannot be accepted,
you will be notified and given further
instructions.
PAGE 13
_______________________ How you can receive the proceeds from a
If for some reason we sale
cannot accept your
request to sell shares, If your request is received by 4 p.m. ET in
we will contact you. correct form, proceeds are usually sent on
the next business day. Proceeds can be sent
to you by mail, or to your credit union or
bank account by ACH or bank wire. Proceeds
sent by bank wire will be credited to your
account the next business day, and proceeds
sent by ACH transfer will be credited the
second day after the sale. ACH (Automated
Clearing House) is an automated method of
initiating payments from and receiving
payments in your financial institution
account. ACH is a payment system supported
by over 20,000 credit unions, banks and
savings banks which electronically exchange
the transactions primarily through the
Federal Reserve Banks.
Exception: Under unusual circumstances or
when deemed to be in the fund's best
interests, your proceeds may not be sent
for up to five business days after
receiving your sale or exchange request.
If, in either of these situations, you were
exchanging into another CUNA Mutual bond
fund, your new investment would not begin
to earn dividends until the sixth business
day.
PAGE 14
Useful Information on Distributions and
Taxes
Dividends and other distributions
______________________
The fund distributes all Dividend and capital gain distributions are
net investment income and reinvested in additional fund shares in
realized capital gains to your account unless you select another
shareholders. option on your New Account Form. The
advantage of
reinvesting distributions arises from
compounding; that is, you receive interest
and capital gain distributions on a rising
number of shares.
Dividends not reinvested are paid by check
or transmitted to your credit union or bank
account via ACH. If the Post Office cannot
deliver your check, or if your check
remains uncashed for six months, the fund
reserves the right to reinvest your
distribution check in your account at the
then current NAV and to reinvest all
subsequent distributions in shares
of the fund.
Income dividends
The fund declares income dividends
daily at 4 p.m. ET to shareholders of
record on the
previous business day.
The fund pays dividends on the last
business day of each month.
Capital gains
A capital gain or loss is the
difference between the purchase and sale
price of a security.
If the fund has net capital gains for
the year (after subtracting any capital
losses), they are
usually "declared" and paid in December to
shareholders of record on a specified date
that month. If a second distribution is
necessary, it is usually declared and paid
during the first quarter of the following
year.
PAGE 15
_____________________ Tax information
CUNA Mutual Funds send Although the regular monthly income
timely information for dividends you receive from the fund are
your tax filing needs. exempt from federal income taxes, you need
to be aware of the possible tax
consequences when:
you sell fund shares, including an
exchange from one fund to another, or
the fund makes a short- and/or
long-term capital gain distribution to you.
As a result of 1993 tax legislation, it is
more likely that municipal funds will pay
an annual short-term capital gain derived
from the amortization of market discounts
on bonds with original maturities beyond
one year. This payment, if any, will be
included in your December monthly dividend
and will be reported as ordinary income on
your 1099-DIV for that year.
_______________________
CUNA Mutual Funds furnish Taxes on fund redemptions. When you sell
average cost and capital shares in any fund, you may realize a gain
gain (loss) information or loss. An exchange from one fund to
on most share another is still a sale for tax purposes.
redemptions.
In January, CUNA Mutual Funds will send you
and the IRS Form 1099-B, indicating the
date and amount of each sale you made in
the fund during the prior year. We will
also tell you the average cost of the
shares you sold during the year. Average
cost information is not reported to the
IRS, and you do not have to use it. You may
calculate the cost basis using other
methods acceptable to the IRS, such as
"specific identification."
____________________
Capital gain To help you maintain accurate records, we
distributions are taxable send you a confirmation immediately
whether reinvested in following each transaction you make and a
additional shares or year-end statement detailing all your
received in cash. transactions in each fund account during
the year.
PAGE 16
Taxes on fund distributions
In January, the CUNA Mutual Funds will send
you and the IRS Form 1099-DIV indicating
the tax status of any capital gain
distribution made to you. Capital gain
distributions made
by the fund are taxable to you for the year
in which they were paid. The only exception
is that distributions declared during the
last three months of the year and paid in
January are taxed as though they were paid
by December 31. Dividends are expected to
be tax exempt.
Short-term capital gains are taxable as
ordinary income and long-term gains are
taxable at
the applicable long-term gain rate. The
gain is long or short term depending on how
long
the fund held the securities, not how long
you held shares in the fund.
The portion of your fund's income subject
to the AMT, if any, will be reported to you
in January.
Tax effect of buying shares before a
capital gain distribution. If you buy
shares near or on the "record date" _ the
date that establishes you as the person to
receive the upcoming distribution _ you
will receive, in the form of a taxable
distribution, a portion of the money you
just invested. Therefore, you may wish to
find out the fund's record date(s) before
investing. Of course, the fund's share
price will reflect undistributed capital
gains or unrealized appreciation, if any.
Transaction Procedures and Special
Requirements
PAGE 17
_________________________ Purchase Conditions
Following these
procedures helps assure Nonpayment. If your payment is not received
timely and accurate or you pay with a share draft, check or ACH
transactions. transfer that does not clear, your purchase
will be cancelled. You will be responsible
for any losses or expenses incurred by the
fund or transfer agent, and the fund can
redeem shares you own in this or another
identically registered CUNA Mutual Fund as
reimbursement. The fund and its agents have
the right to reject or cancel any purchase,
exchange, or redemption due to nonpayment.
U.S. Dollars. All purchases must be paid
for in U.S. dollars; share drafts or checks
must be drawn on U.S. financial
institutions.
Sale (Redemption) Conditions
10-day Hold. If you sell shares that you
just purchased and paid for by share draft,
check
or ACH transfer, the fund will redeem your
shares at the price on the day the request
is received, but will generally delay
sending you the proceeds for up to 10
calendar days to allow the share draft,
check or transfer to clear. If you
requested a redemption by mail or mailgram,
the proceeds will be mailed no later than
the seventh day following receipt unless
the share draft, check or ACH transfer has
not cleared. (The 10-day hold does not
apply to purchases paid for by: bank wire;
cashier's, certified, or treasurer's
checks; or automatic purchases through your
paycheck.)
Telephone Transactions. Telephone exchange
and redemption are established
automatically when you sign the New Account
Form unless you check the box which states
that you do
not want these services. The fund uses
reasonable procedures (including
shareholder identity verification) to
confirm that instructions given by
telephone are genuine. If these procedures
are not followed, it is the opinion of
certain regulatory agencies that a fund may
be liable for any losses that may result
from acting on the instructions given. All
conversations are recorded, and a
confirmation is sent within five business
days after the telephone transaction.
Redemptions over $250,000. Large sales can
adversely affect a portfolio manager's
ability to implement a fund's investment
strategy by causing the premature sale of
securities that would otherwise be held. If
in any 90-day period, you redeem (sell)
more than $250,000, or your sale amounts to
more than 1% of the fund's net assets, the
fund has the right to delay sending your
proceeds for up to five business days after
receiving your request, or to pay the
difference between the redemption amount
and the lesser of the two previously
mentioned figures
with securities from the fund. Brokerage
costs could be incurred if you later sold
any such securities.
PAGE 18
Excessive Trading
___________________ Frequent trades involving either
CUNA Mutual Funds may bar substantial fund assets or a substantial
excessive traders from portion of your
purchasing shares. account or accounts controlled by you, can
disrupt management of the fund and raise
its
expenses. We define "excessive trading" as
exceeding one purchase and sale involving
the same fund within any 120-day period.
For example, you are in fund A. You can
move substantial assets from fund A to fund
B, and, within the next 120 days, sell your
shares in fund B to return to fund A or
move to fund C.
PAGE 19
If you exceed the number of trades
described above, you may be barred from
further purchases of CUNA Mutual Funds.
Systematic purchases or redemptions are
exempt from the excessive trading
guidelines (see "Shareholder Services").
Keeping Your Account Open
Due to the relatively high cost of
maintaining small accounts, we ask you to
maintain an
account balance of at least $1,000. If your
balance is below $1,000 for three months or
longer, the fund has the right to close
your account after giving you 60 days in
which to increase your balance.
Signature Guarantees
PAGE 20
__________________ You may need to have your signature
A signature guarantee is guaranteed in certain situations, such as:
designed to protect you Written requests to 1) redeem over
and the fund from fraud $50,000 or 2) wire redemption proceeds.
by verifying your Remitting redemption proceeds to any
signature. person, address, credit union or bank
account not
on record.
Transferring redemption proceeds to a
CUNA Mutual Fund account with a different
registration from yours.
Establishing certain services after the
account is opened.
You can obtain a signature guarantee from
most credit unions, savings institutions,
banks, broker-dealers and other guarantors
acceptable to CUNA Mutual Funds. We cannot
accept guarantees from notaries public or
organizations that do not provide
reimbursement in the case of fraud.
3 More About the Fund The Fund's Organization and Management
PAGE 21
How is the fund organized?
The fund is a "diversified, open-end
investment company," or mutual fund. It is
one of a series of mutual funds of CUNA
Mutual Funds, Inc., incorporated in
Maryland in 1993. Mutual funds pool money
received from shareholders and invest it to
try to achieve specified objectives.
What is meant by "shares"?
As with all mutual funds, investors
purchase "shares" when they invest in a
fund. These shares are part of a fund's
authorized capital stock, but share
certificates are not issued.
Each share and fractional share entitles
the shareholder to:
receive a proportional interest in a
fund's income and capital gain
distributions;
cast one vote per share on certain fund
matters, including the election of fund
directors, changes in fundamental policies,
or approval of changes in a fund's
management contract.
Does the fund have an annual shareholder
meeting?
The fund is not required to hold a meeting
but will do so when certain matters, such
as a change in its fundamental policies,
are to be decided. In addition,
shareholders representing at least 10% of
all eligible votes may call a special
meeting if they wish for the purpose of
voting on the removal of any fund
director(s). If a meeting is held and you
cannot attend,
you can vote by proxy. Well before the
meeting, the fund will send you proxy
materials
that explain the issues to be decided and
include a voting card for you to mail back.
Who runs the fund?
PAGE 22
__________________ General Oversight. The fund is governed by
All decisions regarding a Board of Directors that meets regularly
the purchase and sale of to review the fund's investments,
fund investments are made performance, expenses, and other business
by T. Rowe Price-- affairs. The Board elects the fund's
specifically by the officers.
fund's portfolio
managers. Portfolio Management. The Fund has an
Investment Advisory Committee composed of
the
following members: Mary J. Miller,
Chairman, Patrice L. Berchtenbreiter,
Patricia S. Deford, Charles B. Hill,
Konstantine B. Mallas, Laura L. McAree, and
William T. Reynolds. The Chairman has
day-to-day responsibility for managing the
fund and works with the Committee in
developing and executing the fund's
investment program. Ms. Miller joined T.
Rowe Price in 1983 and has been managing
investments since 1987.
What role do CUNA Mutual, CUNA and T.
Rowe Price have in running the fund?
CUNA Mutual Funds Management Company,
L.L.C., a Maryland limited liability
company whose sole members are CUNA Mutual
Investment Corporation, a wholly-owned
subsidiary of CUNA Mutual Insurance Society
("CUNA Mutual"), and CUNA Service Group,
Inc., an affiliate of Credit Union National
Association, Inc. ("CUNA"), have joined
together with T. Rowe Price Management,
Inc., a wholly-owned subsidiary of T. Rowe
Price Associates, Inc. ("T. Rowe Price"),
to form a joint venture: CMC-T. Rowe Price
Management, LLC (the "Joint Venture"). The
Joint Venture, under an agreement with the
fund (the "Investment Management and
Administration Agreement"), is responsible
for providing, or negotiating on behalf of
the fund for third parties to provide,
investment management, shareholder
servicing, transfer agency, fund
accounting, custodial and other services
necessary for the operation of the fund.
The Joint Venture was formed in 1993 as a
Maryland limited liability company.
PAGE 23
Investment Management. The Joint Venture
has entered into a sub-advisory agreement
with
the fund and T. Rowe Price (the
"Sub-Advisory Agreement") under which T.
Rowe Price is responsible for all decisions
regarding the purchase and sale of fund
investments and the selection of brokers
and dealers to effect such transactions.
For its sub-advisory activities,
T. Rowe Price is reimbursed for all of its
reasonable out-of-pocket expenses as well
as actual direct costs subject to the
limitations set forth in the agreement
establishing the Joint Venture (the "Joint
Venture Agreement"). T. Rowe Price and its
affiliates manage over $49 billion in
assets for 2.5 million individual and
institutional investor accounts. The firm
is one of the largest providers of no-load
mutual funds in the country.
Marketing. T. Rowe Price Investment
Services, Inc., a wholly-owned subsidiary
of T. Rowe Price, and CUNA Brokerage
Services, Inc., a member of CUNA Mutual
Insurance Group,
(collectively the "Distributors"), have
entered into agreements with the fund to
sell (distribute) shares of the fund.
Shareholder and Administrative Services.
_____________________ The Joint Venture has entered into an
The address of T. Rowe agreement with the fund and T. Rowe Price
Price Services is 100 Services, Inc., a wholly-owned subsidiary
East Pratt St., of T. Rowe Price, to provide transfer and
Baltimore, MD 21202 dividend disbursing agent, shareholder and
administrative services to the fund. In
addition, T. Rowe Price will provide fund
accounting services under an agreement with
the fund and the Joint Venture.
How are fund expenses determined?
Under the Joint Venture Agreement, all
expenses of the fund's operation will be
paid by the Joint Venture, except 12b-1
fees; brokerage commissions and other costs
relating to the purchase, sale or lending
of the fund's portfolio securities;
interest; all taxes or governmental fees
payable by or with respect to the fund; and
nonrecurring or extraordinary expenses.
These other expenses will be paid by the
fund. The Board of Directors of the fund
reserves the right to impose additional
fees against shareholder accounts to defray
expenses which would
otherwise be paid by the Joint Venture
under the Joint Venture Agreement. Such
fees could be imposed if the fund's
custodial, transfer agent, accounting,
auditing or legal (collectively
"out-of-pocket") expenses were to increase
abruptly and significantly. The amount of
these fees would be limited to the increase
in the "out-of-pocket" expenses. The Board
does not anticipate levying such charges;
such a fee, if charged, may be retained by
the fund or paid
to the Joint Venture.
PAGE 24 Annual Fees. The fund pays the Joint
Venture an all inclusive fee at a rate of
0.75% of its average daily net assets. The
all inclusive fee covers both investment
management and operating expenses and is
calculated and accrued daily. This fee is
higher than the management fees of most
other mutual funds because it includes the
fund's operating expenses. Most other
mutual funds have a management fee and an
additional charge for operating expenses.
(See "Transaction Costs and Fund
Expenses.")
The fund has adopted a distribution plan
under which the fund will pay a monthly fee
(equal to 0.25% annually of the fund's
average daily net assets) for costs and
expenses incurred in the distribution of
shares of the fund. Such a fee is usually
referred to as a 12b-1 fee. The types of
expenses it may cover include: (i)
advertising, including brochures, sales
literature, direct mail or any other form
of advertising; (ii) expenses of sales
employees or agents of the Distributors,
including salary, commissions, travel and
related expenses; (iii) payments to credit
unions and other financial institutions for
services in connection with the
distribution of shares, including fees
calculated with reference to the average
daily net asset value of shares held by
shareholders who have a service
relationship with the institution receiving
such fees; (iv) costs of printing
prospectuses and other materials to be
given or sent to prospective investors; and
(v) such other similar services as may be
reasonably calculated to result in the sale
of shares of the fund. In addition, all or
a portion of this fee may be paid to
broker-dealers or other financial
institutions as a service fee for
maintaining shareholder accounts or
providing personal service to shareholders
in the fund.
The fund's Distributors may incur expenses
in distributing shares of the fund which
will exceed the amounts paid to them by the
Joint Venture. These expenses will be borne
by
each Distributor out of its own resources.
Understanding Performance Information
______________________
Total return is the most This section should help you understand the
widely used performance terms used to describe the fund's
measure. Detailed performance. You will come across them in
performance information shareholder reports you receive two times a
is included in the fund's year, in "Investment Focus" articles, in
annual and semiannual advertisements, and in the media.
PAGE 25
shareholder reports. Total Return
This tells you how much an investment in a
fund has changed in value over a given time
period. It reflects any net increase or
decrease in the share price and assumes
that all dividends and capital gains (if
any) paid during the period were reinvested
in additional shares. Reinvesting
distributions means that total return
numbers include the effect of compounding,
i.e., you receive income and capital gain
distributions on a rising number of shares.
Advertisements for a fund may include
cumulative or compound average annual total
return figures, which may be compared with
various indices, other performance
measures, or other mutual funds.
Cumulative Total Return
This is the actual rate of return on an
investment for a specified period. A
cumulative return does not indicate how
much the value of the investment may have
fluctuated between the
beginning and the end of the period
specified.
Average Annual Total Return
________________
You will see frequent This is always hypothetical. Working
references to the fund's backward from the actual cumulative return,
yield and tax equivalent it tells you what constant year-by-year
yield in our reports, return would have produced the actual,
advertisements, in media cumulative return. By
stories, and so on. smoothing out all the variations in annual
performance, it gives you an idea of the
investment's annual contribution to your
portfolio provided you held it for the
entire period in question.
Yield
The current or "dividend yield" on the fund
or any investment tells you the
relationship between the investment's
current level of annual income and its
price on a particular day.
The dividend yield reflects the actual
income paid to shareholders for a given
period, annualized, and divided by the
average price during the given period. For
example, a fund providing $5 of annual
income per share and a price of $50 has a
current yield of 10%. Yields can be
calculated for any time period.
PAGE 26
The advertised or "SEC yield" is found by
determining the net income per share (as
defined by the SEC) earned by the fund
during a 30-day base period and dividing
this amount by
the per-share price on the last day of the
base period. The "SEC yield" may differ
from the dividend yield.
Investment Programs and Practices
This section takes a detailed look at some
of the types of securities the fund may
hold in its portfolio and the various kinds
of investment practices that may be used in
day-to-day portfolio management. The fund's
investment program is subject to further
restrictions and risks described in the
"Statement of Additional Information."
_____________________
Fund managers have Shareholder approval is required to
considerable leeway in substantively change the fund's objective
choosing investment (stated on
strategies and selecting page 5) and to change certain investment
securities they believe restrictions noted in the following section
will help the fund as "fundamental policies." The managers
achieve its objectives. also follow certain "operating policies"
which can be changed without shareholder
approval. However, significant changes are
discussed with shareholders in fund
reports.
Types of Portfolio Securities
In seeking to meet its investment
objective, the fund may invest in any type
of interest-
bearing security whose yield, credit
quality, and maturity characteristics are
consistent with the fund's investment
program. These and some of the other
investment techniques the fund may use are
described in the following pages.
Municipal Securities. The fund's assets are
invested primarily in various
income-producing tax-free municipal debt
securities. The issuers have a contractual
obligation to pay interest at a stated rate
on specific dates and to repay principal
(the bond's face value) on a specified date
or dates. An issuer may have the right to
redeem or "call" a bond before maturity,
and the investor may have to reinvest the
proceeds at lower rates.
PAGE 27
_______________________
In purchasing municipals, There are two broad categories of municipal
the fund relies on the bonds. General obligation bonds are backed
opinion of the issuer's by the issuer's "full faith and credit,"
bond counsel regarding that is, its full taxing and revenue
the tax-exempt status of raising power. Revenue bonds usually rely
the investment. exclusively on a specific revenue source,
such as a bridge toll, to generate money
for debt service.
Fundamental Policy. The fund will not
purchase a security if, as a result with
respect to 75%
of its total assets, more than 5% of its
total assets would be invested in
securities of that issuer.
Private Activity Bonds. While income from
most municipals is exempt from federal
income taxes, the income from certain types
of so-called private activity bonds (a type
of revenue bond) may be subject to the
alternative minimum tax (AMT). Private
activity bonds may be issued for purposes
such as housing or airports or to benefit a
private company. (Being subject to the AMT
does not mean the investor necessarily pays
this tax. For further information, please
see "Distributions and Taxes.")
Fundamental Policy. The fund will not
purchase a bond subject to the AMT if, as a
result, over 20% of its income would be
subject to the AMT.
In addition to general obligation and
revenue bonds, the fund's investments may
include, but are not limited to, the
following types of securities:
Municipal Lease Obligations. A lease is
not a full faith and credit obligation of
the issuer and
is usually backed only by the borrowing
government's unsecured pledge to make
annual appropriation for lease payments.
There have been challenges to the legality
of lease financing in numerous states and,
from time to time, certain municipalities
have considered not appropriating money to
make lease payments. In deciding whether to
purchase a lease obligation, the fund would
assess the financial condition of the
borrower, the merits of the project, the
level of public support for the project,
and the legislative history of lease
financing in the state. These securities
may be less readily marketable than other
municipals. The fund may also purchase
unrated lease-obligations. Based on
information supplied by T. Rowe Price,
the fund's Board of Directors will
periodically review the credit quality of
non-rated leases and assess the likelihood
of their being cancelled.
Operating Policy. The fund may invest no
more than 20% of its assets in these
obligations.
PAGE 29
Securities with "Puts" or other Demand
Features. Some longer-term municipals give
the investor the right to "put" or sell the
security at par (face value) within a
specified number of days following the
investor's request_usually one to seven
days. This demand feature enhances a
security's liquidity by dramatically
shortening its effective maturity and
enables it to trade at a price equal to or
very close to par. If the demand feature
were terminated prior to being exercised,
the fund would hold the longer-term
security.
Securities with Credit Enhancements.
Letters of Credit. Letters of credit
are issued by a third party, usually a
bank, to enhance liquidity and/or ensure
repayment of principal and any accrued
interest if the underlying municipal
security should default.
Municipal Bond Insurance. This
insurance, which is purchased from a
private, nongovernmental insurance company,
provides an unconditional and irrevocable
guarantee that the insured bond's principal
and interest will be paid when due.
Insurance does not guarantee the price of a
bond or the share price of any fund. The
credit rating of an insured bond reflects
the credit rating of the insurer, based on
its claims paying ability. T. Rowe Price
periodically reviews the credit quality of
the insurer.
The obligation of a municipal bond
insurance company to pay a claim extends
over the life
of each insured bond. Although defaults on
insured municipal bonds have been low to
date and municipal insurers have met these
claims, there is no assurance this will
continue. A higher than expected default
rate could strain the insurer's loss
reserves and adversely affect its ability
to pay claims to bondholders, such as the
fund. The number of municipal bond insurers
is relatively small, and not all of them
have the highest rating.
Standby Repurchase Agreements. A
Standby Bond Purchase Agreement is a
liquidity facility provided to pay the
purchase price of bonds that cannot be
remarketed. The obligation of
the liquidity provider (usually a bank) is
only to advance funds to purchase tendered
bonds which cannot be remarketed and does
not cover principal or interest under any
other circumstances. The liquidity
provider's obligations under the SBPA are
usually subject to numerous conditions,
including the continued creditworthiness of
the underlying borrower.
Synthetic or Derivative Securities. These
securities are created from existing
municipal bonds:
Residual Interest Bonds. The income
stream provided by an underlying bond is
divided to
create two securities, one short-term and
one long-term. The interest rate on the
short-term component is reset by an index
or auction process normally every seven to
35 days. After income is paid on the
short-term securities at current rates, the
residual income goes to the long-term
securities. Therefore, rising short-term
interest rates result in lower income for
the longer-term portion, and vice versa.
The longer-term bonds can be very volatile
and may be less liquid than other
municipals of comparable maturity.
PAGE 30
Participation Interests. This term
covers various types of securities created
by converting fixed-rate bonds into
short-term, variable-rate certificates.
These securities have been developed in the
secondary market to meet the demand for
short-term, tax-exempt securities. The fund
will invest only in securities deemed
tax-exempt by a nationally recognized bond
counsel, but there is no guarantee the
interest will be exempt because the IRS has
not issued a definitive ruling on the
matter.
Embedded Interest Rate Swaps and Caps.
In a fixed-rate, long-term municipal bond
with an interest rate swap attached to it,
the bondholder usually receives the bond's
fixed-coupon payment as well as a variable
rate payment that represents the difference
between a fixed rate for the term of the
swap (which is typically shorter than the
bond it is attached to) and a variable rate
short-term municipal index. The bondholder
receives excess income when short-term
rates remain below the fixed interest rate
swap rate. If short-term rates rise above
the fixed-income swap rate, the
bondholder's income is reduced. At the end
of the interest rate swap term, the bond
reverts to a single fixed-coupon payment.
Embedded interest rate swaps enhance
yields, but also increase interest rate
risk.
An embedded interest rate cap allows the
bondholder to receive payments whenever
short-term rates rise above a level
established at the time of purchase. They
normally are used to hedge against rising
short-term interest rates.
Both instruments may be volatile and of
limited liquidity and their use may
adversely affect a fund's total return.
The fund may invest in other types of
derivative instruments as they become
available.
Private Placements. These securities are
sold through private negotiations, usually
to institutions or mutual funds, and may
have resale restrictions. Selling these
securities may involve delays and
additional costs.
PAGE 31
Operating Policy. The fund may not invest
more than 15% of its net assets in illiquid
securities, including unmarketable private
placements.
Types of Fund Management Practices
____________________
Cash reserves provide Cash Reserves. The fund will hold a portion
flexibility and serve as of its assets in short-term, tax-exempt
a short-term defense money market securities maturing in one
during periods of unusual year or less. The reserve position:
market volatility. provides flexibility in meeting
redemptions, expenses, and the timing of
new investments; can help in structuring a
fund's weighted average maturity; and
serves as a short-term defense during
periods of unusual market volatility. The
fund's cash reserve position will be
comprised of short-term, investment-grade
securities including tax-exempt commercial
paper, municipal notes and short- term
maturity bonds. Some of these securities
may have adjustable, variable or floating
rates.
When-Issued Securities and Forwards. New
issues of municipals are often sold on a
"when-issued" basis, that is, delivery and
payment take place 15-45 days after the
buyer has agreed to the purchase. Some
bonds, called "forwards," have longer than
standard settlement dates, in some cases
exceeding one to three years. When buying
these securities, the fund identifies cash
or high-grade marketable securities held by
its custodian equal in value to its
commitment for these securities. The fund
does not earn interest on when-issued and
forward securities until settlement, and
the value of the securities may fluctuate
between purchase and settlement. Municipal
"forwards" typically carry a substantial
yield premium to compensate the buyer for
their greater credit, interest rate,
market, and liquidity risks.
PAGE 32
Interest Rate Futures. Futures are often
used to manage risk, because they enable
the investor to buy or sell an asset in the
future at an agreed upon price.
Specifically, the fund may use futures (and
options on futures) to hedge against a
potentially unfavorable change in interest
rates and to adjust its exposure to the
municipal bond market. The fund will not
use futures for speculation. The use of
futures for hedging and non-hedging
purposes may not always be successful.
Their prices can be highly volatile, and
using them could lower the fund's total
return.
Operating Policy. Initial margin deposits
on futures and premiums on options used for
non-hedging purposes will not equal more
than 5% of the fund's net asset value.
Borrowing Money and Transferring Assets.
The fund can borrow money from banks as a
temporary measure for emergency purposes,
to facilitate redemption requests, or for
other proper purposes consistent with the
fund's investment objectives and program.
Such borrowings may be collateralized with
fund assets, subject to restrictions.
Fundamental Policy. Borrowings may not
exceed 33 1_3% of total fund assets.
Operating Policy. The fund may not transfer
as collateral any portfolio securities
except as necessary in connection with
permissible borrowings or investments and
then such transfers may not exceed 33 1_3%
of the fund's total assets. The fund may
not purchase additional securities when
borrowings exceed 5% of total assets.
Portfolio Turnover. Turnover is an
indication of trading frequency. The fund
generally purchases securities with the
intention of holding them. However, market
conditions or other circumstances may
warrant a sale without regard to the length
of time a security was held. Although the
fund does not expect to generate any
taxable income, a high turnover rate may
increase the possibility that the fund will
realize and distribute net short-term
capital gains, which are taxable to
shareholders. The fund's portfolio turnover
rate is not expected to exceed 200%.
Taxable Money Market Securities. During
periods of abnormal market conditions, the
fund is permitted to purchase securities
whose interest is taxable by the federal
government.
Operating Policy. The fund may invest
without limit in high-quality, short-term
taxable
securities for temporary, defensive
purposes.
Sector Concentration. It is possible that
the fund could have a considerable amount
of assets (25% or more) in securities that
would tend to respond similarly to
particular economic or political
developments. An example would be,
securities of issuers related to a single
industry, such as health care or nuclear
energy.
Operating Policy. The fund will not invest
more than 25% of total assets in any single
state or
in industrial development bonds of
similar-type projects. Bonds which are
refunded with escrowed U.S. Government
securities are not subject to the 25%
limitation.
Credit Quality Considerations. The credit
quality of most bond issues is evaluated by
rating agencies such as Moody's and
Standard & Poor's. Credit quality refers to
the issuer's ability to meet all required
interest and principal payments. The
highest ratings are assigned to issuers
perceived to be the best credit risks. T.
Rowe Price research analysts also evaluate
all portfolio holdings of the fund,
including those rated by outside agencies.
The lower the rating on a bond, the higher
the yield, other things being equal.
PAGE 33
Table 5 shows the rating scale used by the
major rating agencies. T. Rowe Price
considers publicly available ratings, but
emphasizes its own credit analysis when
selecting investments.
Ratings of Municipal Debt Securities
Moody's Standard Fitch Definition
Investors & Poor's Investors
Service, Cor- Service,
Inc. poration Inc.
Long-Term Aaa AAA AAA
Highest quality
Aa AA AA High quality
A A A Upper medium
grade
Baa BBB BBB Medium grade
Moody's S&P Fitch
Short-Term MIG1/VMIG1 Best quality
SP1+ Very strong quality F-1+
Exceptionally strong quality
SP1 Strong grade F-1
Very strong quality
MIG2/VMIG2 High quality SP2
Satisfactory grade F-2 Good credit quality
Commercial P-1 Superior quality A-1+
Extremely strong
quality F-1+ Exceptionally strong quality
Paper A-1 Strong quality
F-1 Very strong quality
P-2 Strong quality A-2 Satisfactory
quality F-2 Good credit quality
Table 5
PAGE 34
4 Investing in the CUNA
Mutual Funds
___________________ Meeting Requirements for New Accounts
Always verify your Tax Identification Number
transactions by carefully We must have your correct social security
reviewing the or corporate tax identification number and
confirmation we send you. a signed New Account Form or W-9 Form.
Please report any Otherwise, federal law requires the fund to
discrepancies to withhold a percentage (currently 31%) of
Shareholder Services at your dividends, capital gain distributions,
1-800-934-FUND (3863). and redemptions, and may subject you to a
fine. You will also be prohibited from
opening another account by exchange. If
this information is not received within 60
days after your account is established,
your account may be redeemed, priced at the
NAV on the date of redemption.
Unless you request otherwise, one
shareholder report will be mailed to
multiple account owners with the same tax
identification number and same zip code and
to those shareholders who have requested
that their account be combined with someone
else's for financial reporting.
Opening a New Account: $2,500 minimum
initial investment; $1,000 for gifts or
transfers to minors (UGMA/UTMA) accounts
PAGE 35
_______________________
Regular Mail
CUNA Mutual Funds
P.O. Box 17434
Baltimore, MD
21298-9613
Mailgram, Express,
Registered, or
Certified Mail
CUNA Mutual Funds
Account Services
10090 Red Run Blvd.
Owings Mills, MD
21117
Account Registration
If you own other CUNA Mutual Funds, be sure
to register any new account just like your
existing accounts so you can exchange among
them easily. (The name and account type
must be identical.)
By Mail
Please make your share draft or check
payable to CUNA Mutual Funds (otherwise it
may be returned) and send it together with
the New Account Form to the address at
left.
By Wire
Call Investor Services for an account
number and use the wire address below.
Complete a New Account Form and mail it
to the address listed at left.
Give the following wire address to your
financial institution: Morgan Guaranty
Trust Co.
of New York, ABA# 021000238, CUNA Mutual
[fund name], AC-00153938. Provide fund
name, account name(s), and account number.
By Exchange
Call Shareholder Services. The new account
will have the same registration as the
account from which you are exchanging.
Services for the new account may be carried
over by telephone request if preauthorized
on the existing account. (See explanation
of "Excessive Trading" under "Transaction
Procedures.")
Note: The fund and its agents have the
right to waive or lower investment
minimums,
to accept initial purchases by telephone or
mailgram, to cancel or reject any purchase
or exchange if the written confirmation has
not been received by the shareholder, or to
otherwise modify the conditions of purchase
or any services at any time.
PAGE 37
Purchasing Additional Shares: $100 minimum
purchase
By ACH Transfer
Call Shareholder Services if you have
established electronic transfers using the
ACH network ($100 minimum).
By Wire
Call Shareholder Services or use the wire
address in "Opening a New Account."
_____________________
Regular Mail By Mail
CUNA Mutual Funds Provide your account number and the
Account Services fund name on your share draft or check.
P.O. Box 89000 Mail the share draft or check to us at
Owings Mills, MD the address shown at left with an
21289-1500 investment form (located at the bottom of
your statement), a stub from a statement
confirming a prior transaction or a note
stating that you want to purchase shares in
that fund (provide account number).
By Systematic Investing
Fill out the Systematic Investing section
on the New Account or Shareholder Services
Form.
Exchanging and Redeeming Shares
___________________
Regular Mail By Phone
CUNA Mutual Funds
Account Services Call Shareholder Services. For exchange
P.O. Box 89000 policies, please see "Transaction
Baltimore, MD Procedures and Special Requirements _
21289-0220 Excessive Trading."
Mailgram, Express, Redemption proceeds can be mailed to your
Registered, or account address, wired to your credit union
Certified Mail or bank, or sent by ACH transfer. For
(See page 20.) charges, see "Electronic Transfers _ By
Wire" on the next page.
By Mail
PAGE 38 Provide account name(s) and numbers, fund
name(s), and exchange or redemption amount.
For exchanges, mail to the appropriate
address at left, indicate the fund you are
exchanging from and the fund(s) you are
exchanging into. CUNA Mutual Funds require
the signatures
of all owners exactly as registered, and
possibly a signature guarantee (see
"Transaction Procedures and Special
Requirements _ Signature Guarantees").
Shareholder Services
___________________
Investor Services Many services are available to you as a
1-800-756-FUND CUNA Mutual Fund shareholder; some you
receive automatically and others you must
authorize on the New Account Form. By
Shareholder Services signing up for services on the New Account
1-800-934-FUND Form rather than later on, you avoid having
to complete a separate form and obtain a
signature guarantee. This section reviews
some of the principal services currently
offered.
Shareholder Services. Buy, sell, or
exchange shares by calling one of our
service representatives.
Exchange Service
You can move money from one account to an
existing identically registered account, or
open
a new identically registered account.
Remember, exchanges are purchases and sales
for tax purposes.
Electronic Transfers
By ACH. With no charges to pay, you can
initiate a purchase or redemption for as
little as $100 or as much as $100,000
between your credit union or bank account
and fund account using the ACH network.
PAGE 38
Call Shareholder Services.
By Wire. Electronic transfers can also be
conducted via bank wire. There is currently
a $5 fee for wire redemptions under $5,000,
and your credit union or bank may charge
for wire transfers regardless of size.
Systematic Investing
You can invest automatically in several
different ways, including:
Systematic Investing. You instruct us
to move $50 or more once a month or less
often from your credit union or bank
account, or you can instruct your employer
to send all or a portion of your paycheck,
to the fund or funds you designate.
Automatic Exchange. Enables you to set
up systematic investments from one fund
account into another, such as from a bond
fund into an asset allocation fund.
Prospectus
CUNA Mutual Funds, Inc.
CUNA Mutual Tax-Free Intermediate-Term Fund
Prospectus
To Open an Account
Investor Services CUNA Mutual Funds, Inc.
1-800-756-FUND CUNA Mutual Tax-Free
Intermediate-Term fund
For Existing Accounts
Shareholder Services CUNA Mutual
1-800-934-FUND Funds, Inc.
Tax-Free
To help credit union Intermediate -
members achieve their Term Fund
financial goals, we offer December 30, 1993
an asset allocation fund,
a tax-free fund and a A municipal bond fund for investors seeking
U.S. Government bond income exempt from federal income taxes.
fund, as well as
convenient services and
timely informative
reports.
PAGE 1
CUNA Mutual Funds, Inc.
CUNA Mutual U.S.
Government Income Fund
Facts at a Glance CUNA Mutual
Funds, Inc.
Objective U.S. Government Income Fund
Highest level of December 30, 1993
current income consistent
with moderate share price A bond fund for investors seeking the
fluctuation. income potential and credit
safety of securities
Investment Strategy issued by the
The fund seeks to achieve U.S. Government and its agencies.
its objective by
investing in a portfolio
consisting primarily (at About the Fund
least 65%) of U.S. Transaction Costs and
Government and agency Fund Expenses 2
securities with an
effective maturity of Mutual Fund Investing:
three to 10 years. How it Works 3
Risk/Reward Potential Fund and Market Characteristics:
Greater return potential What to Expect 5
than a shorter maturity
fund, accompanied by About Your Account
greater share price Pricing Shares;
fluctuation. Receiving Sale Proceeds 8
UNLIKE CREDIT UNION Distributions and Taxes 8
AND BANK ACCOUNTS, THE
VALUE OF YOUR INVESTMENT Transaction Procedures
IN THIS FUND IS NOT and Special Requirements 10
INSURED. YOUR INVESTMENT
IS NOT A DEPOSIT OF, OR More About the Fund
GUARANTEED BY, ANY CREDIT Organization and Management 12
UNION OR GOVERNMENT
AGENCY. YOUR INVESTMENT Understanding Fund Performance 14
INVOLVES CERTAIN RISKS
INCLUDING A LOSS OF Investment Policies and Practices 15
PRINCIPAL.
Investing With CUNA Mutual Funds
Investor Profile Meeting Requirements
Credit union members for New Accounts 19
seeking above-average
income through Opening a New Account 19
high-quality debt
investments, and who can Purchasing Additional Shares 20
accept some measure of
principal risk. Exchanging and Redeeming 21
Fees and Charges Shareholder Services 21
No load. No fees or
charges to buy or sell
shares or to reinvest 1
dividends. Free telephone 2
exchange between this and 3
other CUNA Mutual Funds. 4
This prospectus contains information you
Investment Adviser should know before investing. Please keep
Founded in 1937, T. Rowe it for future reference. A Statement
Price Associates and its of Additional Information about the Fund,
affiliates manage over dated December 30, 1993, has been filed
$49 billion for with the Securities and Exchange Commission
approximately 2.5 million and is incorporated by reference in this
individual and prospectus. To obtain a free copy, call
institutional investor 1-800-756-FUND.
accounts. The firm is one
of the largest providers
of no-load mutual funds
in the country.
PAGE 2
THESE SECURITIES HAVE NOT
BEEN APPROVED OR
DISAPPROVED BY THE
SECURITIES AND EXCHANGE
COMMISSION, OR ANY STATE
SECURITIES COMMISSION,
NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION
PASSED UPON THE ACCURACY
OR ADEQUACY OF THIS
PROSPECTUS. ANY
REPRESENTATION TO THE
CONTRARY IS A CRIMINAL
OFFENSE.
PAGE 3
1 About the Fund Transaction Costs and Fund Expenses
The fund has an all-inclusive fee covering
investment management and operating
expenses. This fee will not fluctuate. In
contrast, most mutual funds have a fixed
management fee plus a fee for operating
expenses that varies according to a number
of factors. (See "How are fund expenses
determined?" on page 13.)
You pay no direct costs to buy, sell, or
exchange shares. All the money you invest
in the fund goes to work for you.
The table below indicates how much it will
cost to operate the fund for a year. These
are costs you pay indirectly, because they
are deducted from the fund's total assets
before the daily share price is calculated
and before dividends and other
distributions are made. In other words, you
will not see these expenses on your account
statement.
_________________________________________
_________________________
The CUNA Mutual Funds are
no load. Annual Mutual Fund Expenses
Percentage of Fiscal 1994 Average Net
Assets
Management Fee* 1.00%
Distribution (12b-1) Fee** 0.25
Other expenses* 0.00
Total Fund Expenses* 1.25%
*The management fee includes operating
expenses. The fund charges a $5 fee for
wire redemptions under $5,000, subject to
change without notice.
**Under rules of the National Association
of Securities Dealers, Inc. ("NASD"), a
12b-1 fee may be treated as a sales charge
in certain instances. Because the 12b-1 fee
is an annual fee charged against fund
assets, long-term shareholders may
indirectly pay more in total sales charges
than the economic equivalent of a maximum
front-end sales charge permitted by the
NASD.
Table 1
Hypothetical example: For each
$1,000 you invest, assume you earn 5%
annually and close your account at the end
of the time periods shown. The 5% return
does not represent the fund's past or
future performance.
__________________________________________
PAGE 4
________________________ Example of Fund Expenses Per $1,000
The table at right is Invested
just an example and 1 year 3 years
actual expenses can be $13 $40
higher or lower than Table 2
those shown.
______________________
This question-and-answer Mutual Fund Investing: How it Works
section reviews some of What is a mutual fund?
the basics of mutual fund As its name implies, a mutual fund pools
investing. money from many individuals who share
similar investment goals. Your investment
in a mutual fund entitles you to shares of
the fund _ you are a direct owner of an
investment company. The fund, in turn,
takes the money received from its
shareholders and invests in individual
securities, such as stocks, bonds, or money
market instruments, in the interest of
achieving the fund's investment objectives.
So you are a direct owner of a mutual
fund's shares and an indirect owner of all
the securities in which the fund invests.
What is a prospectus?
A prospectus is a legal document prepared
for mutual fund investors. Its chief
purpose is to describe a fund's investment
objectives, the investment manager, and the
fund's policies, fees, and risks.
What are the benefits of investing in
mutual funds?
Mutual fund investing provides many
benefits:
Professional management. You gain
access to professional investment managers
who use a wide variety of information and
financial management tools to help a fund
achieve its
investment objectives.
Diversification. Since mutual funds
pool your money with that of other
investors, you are investing in a large
portfolio of stocks and/or bonds. Investing
in a variety of securities generally
results in lower price fluctuation than
holding only a few individual securities.
Liquidity. You can sell your shares
on any business day and receive the value
of your investment. You do not need to find
a buyer _ the fund will redeem your shares.
Of course, the price you receive for
selling your shares may be more or less
than the price you paid (see "Pricing
Shares and Receiving Sale Proceeds" on page
8).
Professional record keeping and
account service. You will receive a
concise, easy-to-read account statement on
a quarterly basis. Furthermore, if you have
questions about your statement or of any
aspect of your investment, you can call
toll free 1-800-934-FUND (3863).
Is my investment insured?
No. Unlike credit union or bank accounts,
mutual fund investments are not insured.
Since mutual funds invest in securities
whose values fluctuate, there is no
assurance your investment will be equal to
its original value after you sell your
shares. Also, there is no guarantee that a
fund will meet its investment objective.
How can I measure my investment's progress?
Total return is the most widely used
measure of mutual fund performance. It
tells you how much an investment in a fund
has changed in value over a given time
period, reflecting any net increase or
decrease in the share price and assuming
that any dividends and capital gains paid
during the period were reinvested in
additional shares of the fund.
Detailed total return information for
various time periods__both absolute and
relative to
comparable benchmarks__appears in
semiannual and annual reports sent to you
by your fund's management. The price per
share also appears in the business section
of most major daily newspapers and will be
listed under CUNA Mutual Funds.
Is the fund's yield the rate of return I
would get?
No. The fund's income, represented by the
dividend yield, is expected to be the major
component of your return, but it is not the
only component. Like its income, the fund's
share price will vary, causing an increase
or decrease in your principal investment.
This principal gain or loss combines with
the income paid to you by the fund to
produce your total return.
What are some examples of mutual funds?
Money market funds. Money market
funds invest in short-term debt obligations
(usually with maturities less than a year)
of issuers such as the U.S. Government,
corporations, and municipalities. Because
of the high degree of safety they provide,
money market funds typically offer the
lowest return potential of any type of
mutual fund. Currently, the CUNA Mutual
Funds do not include a money market fund.
Bond funds. Like money market funds,
bond funds invest in a wide range of debt
obligations of issuers such as the U.S.
Government, corporations, and
municipalities. But, because they invest in
securities that may mature in three, five,
10, or 30 years, bond funds typically
offer
a higher return potential than money market
funds but with higher risk due to price
fluctuations.
Stock funds. These funds invest in a
wide range of publicly traded stocks.
Historically, stock funds have offered the
highest long-term return potential of any
single type of fund and have involved the
highest degree of risk because their share
prices, and an investor's principal,
typically fluctuate the most. Currently,
the CUNA Mutual Funds do not include a
stock fund.
Asset allocation. Asset allocation
funds invest assets among various asset
classes (stock, bond, and money market
securities) according to the manager's
outlook for the economy, interest rates,
and financial markets. Such funds employ
this strategy as a way to reduce risk in
the hope that the good performance in one
asset class will offset lackluster
performance in another. However, it is
important to note that most asset
allocation funds normally keep a higher
percentage of assets in stocks, barring
unusual market conditions. Therefore, the
share price of an asset allocation fund
typically fluctuates more than a bond
fund's but less than a stock fund's.
_______________________ What should I consider when selecting a
The fund or funds you fund?
select should reflect Review your own financial objectives _
your individual primarily your need for access to your
investment goals, but money, your time horizon, and your risk
should not represent your tolerance _ before making an investment.
complete investment Generally, investors needing ready access
program. No fund should to their money should stay in shorter-term
be used for short-term investments that seek the highest degree of
trading purposes. income consistent with minimal or moderate
volatility (i.e., share price
fluctuation). Investors seeking maximum
return should adopt a long-term time
horizon and be more comfortable with the
periodic principal declines that accompany
the potential for higher returns.
PAGE 6
________________________ Fund and Market Characteristics: What to
This section takes a Expect
closer look at fixed-
income market What is the fund's objective?
characteristics and the The fund's investment objective is to
fund's investment provide the highest level of current income
program--to help you consistent with moderate share price
decide if it is fluctuation.
appropriate for you.
What types of securities will the fund
purchase?
It will invest at least 65% of its total
assets in U.S. Treasury securities,
mortgage-backed certificates issued by the
Government National Mortgage Association
(GNMA), and other securities issued or
guaranteed by other U.S.
Government-sponsored agencies. These
securities carry the highest credit rating
as determined by a nationally recognized
rating agency, or, if unrated, the
equivalent as determined by the investment
adviser. Up to 35% of total assets can be
invested in other types of high-quality
(AA-rated or higher) debt such as
privately-issued mortgage securities and
corporate bonds. This policy does not
prohibit the fund from retaining a security
which is downgraded after purchase. There
is no limit on the maturity of individual
securities held by the fund, but the fund's
dollar-weighted average effective maturity
will normally vary between three and 10
years.
What is "credit quality" and how does it
affect the fund's yield?
Credit quality refers to a bond issuer's
expected ability to make all required
interest and
principal payments in a timely manner.
Because highly rated bond issuers present
less risk, they can borrow at lower
interest rates than less creditworthy
issuers. Therefore, a fund investing in
high-quality securities should have a lower
yield than an otherwise comparable fund
investing in lower credit-quality
securities.
What is meant by a bond or bond fund's
maturity?
Every bond has a stated maturity date when
the issuer must repay the bond's entire
principal value to the investor. Some types
of bonds may also have an "effective
maturity" that is shorter than the stated
date. The effective maturity of
mortgage-backed bonds is determined by the
rate at which homeowners pay down the
principal on the underlying mortgages. Many
corporate and municipal bonds are
"callable," meaning their principal can be
repaid before their stated maturity dates
on (or after) specified call dates. Bonds
are most likely to be called when interest
rates are falling, because the issuer wants
to refinance at a lower rate. In such an
environment, a bond's "effective maturity"
is usually its nearest call date.
A bond mutual fund has no maturity in the
strict sense of the word, but does have a
dollar-weighted average maturity. This
number is an average of the stated
maturities of the underlying bonds, with
each maturity "weighted" by the percentage
of fund assets it represents. Funds that
target effective maturities would use the
effective (rather than stated) maturities
of the underlying bonds when computing the
average. Targeting effective maturity
provides additional flexibility in
portfolio management but, all else being
equal, could result in higher volatility
than a fund targeting a stated maturity or
maturity range.
How is a bond's price affected by changes
in interest rates?
When interest rates rise, a bond's price
usually falls, and vice versa. Generally
speaking, the longer the bond's maturity,
the greater the price increase or decrease
in response to a given change in interest
rates, as shown in the table below.
How Interest Rates Affect Bond Prices
Bond Maturity Coupon Price of a
$1,000 Bond If Interest Rates:
Increase Decrease
1% 2% 1% 2%
1 Year 3.35% $990 $981 $1,010
$1,020
5 Years 4.80 957 916 1,045 1,093
10 Years 5.40 927 860 1,080 1,168
30 Years 6.05 876 775 1,154 1,346
Table 3 Coupons reflect yields on
Treasury securities as of 9/30/93. This is
an illustration and does not represent
expected yields or share-price changes of
any CUNA Mutual Fund.
What are the main risks of investing in
bond funds?
Interest rate or market risk - the
decline in bond and bond fund prices that
accompanies a rise in the overall level of
interest rates.
Credit risk - the chance that any of
a fund's holdings will have its credit
rating downgraded or will default (fail to
make scheduled interest and principal
payments), potentially reducing the fund's
income level and/or share price.
How does the fund's investment adviser try
to reduce risk?
Consistent with the fund's objective, the
investment adviser actively manages the
fund's portfolio to minimize risk and
increase total return. Risk management
tools include:
PAGE 6
diversification of assets to reduce
the impact of a single holding on a fund's
net asset value;
thorough credit research by its own
analysts; and
maturity adjustments to reflect the
adviser's interest rate outlook.
What are mortgage-backed securities and who
issues them?
PAGE 7
_________________________
Characteristics of Mortgage lenders pool individual home
mortgage-backed mortgages with similar characteristics to
securities. back a
certificate or bond, which is sold to
investors such as mutual funds. Interest
and principal payments generated by the
underlying mortgages are passed through to
the investors. The "big three" issuers are
Government National Mortgage Association
(Ginnie Mae), the Federal National Mortgage
Association (Fannie Mae), and the Federal
Home Loan Mortgage Corporation (Freddie
Mac). Private mortgage bankers also issue
mortgage-backed securities.
Do mortgage-backed securities usually
behave like other high-quality bonds?
Generally, yes _ with one important
exception. Mortgage securities are subject
to regular principal prepayments as
homeowners pay down or pay off their
mortgages. When interest rates fall, the
pace of mortgage refinancings picks up.
Refinanced mortgages are paid off at face
value (par), causing a loss for any
investor who may have purchased the
security at a price above par. In such an
environment, this risk limits the potential
price appreciation of these securities and
can negatively affect the fund's net asset
value. When interest rates rise, however,
mortgage-backed securities have
historically experienced smaller price
declines than comparable quality bonds.
Are securities backed by the U.S.
Government and its agencies risk free?
No. U.S. Treasury and Ginnie Mae securities
are free of credit risk, because they are
backed
by the full faith and credit of the U.S.
Government. Other securities, like Fannie
Maes and Freddie Macs are not guaranteed by
the U.S. Government, but are only supported
by the
ability to borrow from the U.S. Treasury or
supported only by the credit of the agency.
All of these securities are subject to
market risk, which means changes in
interest rates will cause the share price
of the fund to vary as the prices of
individual bonds fluctuate. To minimize the
effect of market risk, the fund's
investment adviser actively manages the
maturity of the fund's portfolio and
diversifies the assets over a broad range
of securities.
PAGE 8
_____________________ 2 About Your Account
The various ways you can
buy, sell, and exchange Pricing Shares and Receiving Sale Proceeds
shares are explained at
the end of this Here are some procedures you should know
prospectus and on the New when investing in the fund.
Account Form. How and when shares are priced
The share price (also called "net asset
_____________________ value" or NAV per share) for the fund is
When filing out the New calculated
Account Form, you may at 4 p.m. ET each day the New York Stock
wish to give yourself the Exchange is open for business. To calculate
widest range of options the NAV, the fund's assets are priced and
for receiving proceeds totaled, liabilities are subtracted, and
from a sale. the balance,
called net assets, is divided by the number
________________________ of shares outstanding.
If for some reason we
cannot accept your How your purchase, sale, or exchange price
request to sell shares, is determined
we will contact you. If we receive your request in correct form
before 4 p.m. ET, your transaction will be
priced at that day's NAV. If we receive it
after 4 p.m., it will be priced at the next
business day's NAV. (See "Meeting
Requirements for New Accounts" and "Opening
a New Account" under "Investing in the CUNA
Mutual Funds.")
We're sorry, but we cannot accept orders
that request a particular day or price for
your transaction or any other special
conditions.
Note: The time at which transactions are
priced may be changed in case of an
emergency or if the New York Stock Exchange
closes at a time other than 4 p.m. ET. If
your redemption request cannot be accepted,
you will be notified and given further
instructions.
How you can receive the proceeds from a
sale
If your request is received by 4 p.m. ET in
correct form, proceeds are usually sent on
the next business day. Proceeds can be sent
to you by mail, or to your credit union or
bank account by ACH or bank wire. Proceeds
sent by bank wire will be credited to your
account the next business day, and proceeds
sent by ACH transfer will be credited the
second day after the sale. ACH (Automated
Clearing House) is an automated method of
initiating payments from and receiving
payments in your financial institution
account. ACH is a payment system supported
by over 20,000 credit unions, banks and
savings banks which electronically exchange
the transactions primarily through the
Federal Reserve Banks.
Exception: Under unusual circumstances or
when deemed to be in the fund's best
interests, your proceeds may not be sent
for up to five business days after
receiving your sale or exchange request.
If, in either of these situations, you were
exchanging into another CUNA Mutual bond
fund, your new investment would not begin
to earn dividends until the sixth business
day.
Useful Information on Distributions and
Taxes
PAGE 9
____________________ Dividends and other distributions
The fund distributes all Dividend and capital gain distributions
net investment income and are reinvested in additional fund shares in
realized capital gains to your account unless you select another
shareholders. option on your New Account Form. The
advantage of
reinvesting distributions arises from
compounding; that is, you receive interest
and capital gain distributions on a rising
number of shares.
Dividends not reinvested are paid by check
or transmitted to your credit union or bank
account via ACH. If the Post Office cannot
deliver your check, or if your check
remains uncashed for six months, the fund
reserves the right to reinvest your
distribution check in your account at the
then current NAV and to reinvest all
subsequent distributions in shares of the
fund.
Income dividends
The fund declares income dividends
daily at 4 p.m. ET to shareholders of
record on the previous business day.
The fund pays dividends on the last
business day of each month.
Capital gains
A capital gain or loss is the
difference between the purchase and sale
price of a security.
If the fund has net capital gains
for the year (after subtracting any capital
losses), they are
usually "declared" and paid in December to
shareholders of record on a specified date
that month. If a second distribution is
necessary, it is usually declared and paid
during the first quarter of the following
year.
PAGE 10
______________________
CUNA Mutual Funds send Tax information
timely inforamtion for You need to be aware of the possible tax
your tax filing needs consequences when:
the fund makes a distribution to
your account, or
you sell fund shares, including an
exchange from one fund to another.
_________________________
CUNA Mutual Funds furnish Taxes on fund redemptions. When you sell
average cost and capital shares in any fund, you may realize a gain
gain (loss) information or loss. An exchange from one fund to
on most share another is still a sale for tax purposes.
redemptions. In January, CUNA Mutual Funds will send you
and the IRS Form 1099-B, indicating the
date and amount of each sale you made in
the fund during the prior year. We will
also tell you the average cost of the
shares you sold during the year. Average
cost information is not reported to the
IRS, and you do not have to use it. You may
calculate the cost basis using other
methods acceptable to the IRS, such as
"specific identification."
To help you maintain accurate records, we
send you a confirmation immediately
following each transaction you make and a
year-end statement detailing all your
transactions in each fund account during
the year.
______________________
Distributions are taxable Taxes on fund distributions. The
whether reinvested in following summary does not apply to
additional shares or retirement accounts, such as IRAs, which
received in cash. are tax-deferred until you withdraw money
from them.
In January, the CUNA Mutual Funds will send
you and the IRS Form 1099-DIV indicating
the tax status of any dividend and capital
gain distribution made to you. All
distributions made by the fund are taxable
to you for the year in which they were
paid. The only exception is that
distributions declared during the last
three months of the year and paid in
January are taxed as though they were paid
by December 31. CUNA Mutual Funds will also
send you any additional information you
need to determine your taxes on fund
distributions, such as the portion of your
dividend, if any, that may be exempt from
state income taxes.
Short-term capital gains are taxable as
ordinary income and long-term gains are
taxable at the applicable long-term gain
rate. The gain is long or short term
depending on how long the fund held the
securities, not how long you held shares in
the fund.
Tax effect of buying shares before a
capital gain distribution. If you buy
shares near or on the "record date" _ the
date that establishes you as the person to
receive the upcoming distribution _ you
will receive, in the form of a taxable
distribution, a portion of the money you
just invested. Therefore, you may wish to
find out the fund's record date(s) before
investing. Of course, the fund's share
price will reflect undistributed capital
gains or unrealized appreciation, if any.
Transaction Procedures and Special
Requirements
________________________
Following these Purchase Conditions
procedures helps assure Nonpayment. If your payment is not received
timely and accurate or you pay with a share draft, check or ACH
transactions. transfer that does not clear, your purchase
will be cancelled. You will be responsible
for any losses or expenses incurred by the
fund or transfer agent, and the fund can
redeem shares you own in this or another
identically registered CUNA Mutual Fund as
reimbursement. The fund and its agents have
the right to reject or cancel any purchase,
exchange, or redemption due to nonpayment.
U.S. Dollars. All purchases must be paid
for in U.S. dollars; share drafts or checks
must be drawn on U.S. financial
institutions.
Sale (Redemption) Conditions
10-day Hold. If you sell shares that you
just purchased and paid for by share draft,
check
or ACH transfer, the fund will redeem your
shares at the price on the day the request
is received, but will generally delay
sending you the proceeds for up to 10
calendar days to allow the share draft,
check or transfer to clear. If you
requested a redemption by mail or mailgram,
the proceeds will be mailed no later than
the seventh day following receipt unless
the share draft, check or ACH transfer has
not cleared. (The 10-day hold does not
apply to purchases paid for by: bank wire;
cashier's, certified, or treasurer's
checks; or automatic
purchases through your paycheck.)
Telephone Transactions. Telephone exchange
and redemption are established
automatically when you sign the New Account
Form unless you check the box which states
that you do
not want these services. The fund uses
reasonable procedures (including
shareholder identity verification) to
confirm that instructions given by
telephone are genuine. If these procedures
are not followed, it is the opinion of
certain regulatory agencies that a fund may
be liable for any losses that may result
from acting on the instructions given. All
conversations are recorded, and a
confirmation is sent within five business
days after the telephone transaction.
PAGE 11
Redemptions over $250,000. Large sales can
adversely affect a portfolio manager's
ability to implement a fund's investment
strategy by causing the premature sale of
securities that would otherwise be held. If
in any 90-day period, you redeem (sell)
more than $250,000, or your sale amounts to
more than 1% of the fund's net assets, the
fund has the right to delay sending your
proceeds for up to five business days after
receiving your request, or to pay the
difference between the redemption amount
and the lesser of the two previously
mentioned figures with securities from the
fund. Brokerage costs would be incurred if
you later sold any such securities.
_________________________
CUNA Mutual Funds may bar Excessive Trading
excessive traders from Frequent trades involving either
purchasing shares. substantial fund assets or a substantial
portion of your
account or accounts controlled by you, can
disrupt management of the fund and raise
its
expenses. We define "excessive trading" as
exceeding one purchase and sale involving
the same fund within any 120-day
period.
For example, you are in fund A. You can
move substantial assets from fund A to fund
B, and, within the next 120 days, sell your
shares in fund B to return to fund A or
move to fund C.
If you exceed the number of trades
described above, you may be barred from
further purchases of CUNA Mutual Funds.
Systematic purchases or redemptions are
exempt from the excessive trading
guidelines (see "Shareholder Services").
Keeping Your Account Open
Due to the relatively high cost of
maintaining small accounts, we ask you to
maintain an
account balance of at least $1,000. If your
balance is below $1,000 for three months or
longer, the fund has the right to close
your account after giving you 60 days in
which to increase your balance. (These
conditions may vary for retirement plan
accounts.)
_________________________
A signature guarantee is Signature Guarantees
designed to protect you You may need to have your signature
and the fund from fraud guaranteed in certain situations, such as:
by verifying your Written requests to 1) redeem over
signature. $50,000 or 2) wire redemption proceeds.
Remitting redemption proceeds to any
person, address, credit union or bank
account not
on record.
Transferring redemption proceeds to
a CUNA Mutual Fund account with a different
registration from yours.
Establishing certain services after
the account is opened.
You can obtain a signature guarantee from
most credit unions, savings institutions,
banks, broker-dealers and other guarantors
acceptable to CUNA Mutual Funds. We cannot
accept guarantees from notaries public or
organizations that do not provide
reimbursement in the case of fraud.
PAGE 12
3 More About the Fund
The Fund's Organization and Management
How is the fund organized?
The fund is a "diversified, open-end
investment company," or mutual fund. It is
one of a series of mutual funds of CUNA
Mutual Funds, Inc., incorporated in
Maryland in 1993. Mutual funds pool money
received from shareholders and invest it to
try to achieve specified objectives.
What is meant by "shares"?
As with all mutual funds, investors
purchase "shares" when they invest in a
fund. These shares are part of a fund's
authorized capital stock, but share
certificates are not issued.
Each share and fractional share entitles
the shareholder to:
receive a proportional interest in a
fund's income and capital gain
distributions;
cast one vote per share on certain
fund matters, including the election of
fund directors, changes in fundamental
policies, or approval of changes in a
fund's management contract.
Does the fund have an annual shareholder
meeting?
The fund is not required to hold a meeting
but will do so when certain matters, such
as a change in its fundamental policies,
are to be decided. In addition,
shareholders representing at least 10% of
all eligible votes may call a special
meeting if they wish for the purpose of
voting on the removal of any fund
director(s). If a meeting is held and you
cannot attend, you can vote by proxy. Well
before the meeting, the fund will send you
proxy materials that explain the issues to
be decided and include a voting card for
you to mail back.
PAGE 13
_________________
All decisions regarding Who runs the fund?
the purchaes and sale of General Oversight. The fund is governed by
fund investments are made a Board of Directors that meets regularly
by T. Rowe Price-- to review the fund's investments,
specifically by the performance, expenses, and other business
fund's portfolio affairs. The Board elects the fund's
managers. officers.
Portfolio Management. The fund has an
Investment Advisory Committee composed of
the
following members: Peter Van Dyke,
Chairman, Heather R. Landon, James M.
McDonald, Edmund M. Notzon, and Charles P.
Smith. The Committee Chairman has
day-to-day responsibility for managing the
fund and works with the Committee in
developing and executing the fund's
investment program. Mr. Van Dyke has been
managing investments since joining T. Rowe
Price in 1985.
What role do CUNA Mutual, CUNA and T.
Rowe Price have in running the fund?
CUNA Mutual Funds Management Company,
L.L.C., a Maryland limited liability
company whose sole members are CUNA Mutual
Investment Corporation, a wholly-owned
subsidiary of CUNA Mutual Insurance Society
("CUNA Mutual"), and CUNA Service Group,
Inc., an affiliate of Credit Union National
Association, Inc. ("CUNA"), have joined
together with
T. Rowe Price Management, Inc., a
wholly-owned subsidiary of T. Rowe Price
Associates, Inc. ("T. Rowe Price"), to form
a joint venture: CMC-T. Rowe Price
Management, LLC (the "Joint Venture"). The
Joint Venture, under an agreement with the
fund (the "Investment Management and
Administration Agreement"), is responsible
for providing, or negotiating on behalf of
the fund for third parties to provide,
investment management, shareholder
servicing, transfer agency, fund
accounting, custodial and other services
necessary for the operation of the fund.
The Joint Venture was formed in 1993 as a
Maryland limited liability company.
Investment Management. The Joint Venture
has entered into a sub-advisory agreement
with
the fund and T. Rowe Price (the
"Sub-Advisory Agreement") under which T.
Rowe Price is responsible for all decisions
regarding the purchase and sale of fund
investments and the selection of brokers
and dealers to effect such transactions.
For its sub-advisory activities,
T. Rowe Price is reimbursed for all of its
reasonable out-of-pocket expenses as well
as actual direct costs subject to the
limitations set forth in the agreement
establishing the Joint Venture (the "Joint
Venture Agreement"). T. Rowe Price and its
affiliates manage over $49 billion in
assets for 2.5 million individual and
institutional investor accounts. The firm
is one of the largest providers of no-load
mutual funds in the country.
Marketing. T. Rowe Price Investment
Services, Inc., a wholly-owned subsidiary
of T. Rowe Price, and CUNA Brokerage
Services, Inc., a member of CUNA Mutual
Insurance Group, (collectively the
"Distributors"), have entered into
agreements with the fund to sell
(distribute) shares of the fund.
_________________________
The address of T. Rowe Shareholder and Administrative Services.
Price Services is 100 The Joint Venture has entered into an
East Pratt St., agreement with the fund and T. Rowe Price
Baltimore, MD 21202 Services, Inc., a wholly-owned subsidiary
of T. Rowe Price, to provide transfer and
dividend disbursing agent, shareholder and
administrative services to the fund. In
addition, T. Rowe Price will provide fund
accounting services under an agreement with
the fund and the Joint Venture.
How are fund expenses determined?
Under the Joint Venture Agreement, all
expenses of the fund's operation will be
paid by the Joint Venture, except 12b-1
fees; brokerage commissions and other costs
relating to the
purchase, sale or lending of the fund's
portfolio securities; interest; all taxes
or governmental fees payable by or with
respect to the fund; and nonrecurring or
extraordinary expenses. These other
expenses will be paid by the fund. The
Board of Directors of the fund reserves the
right to impose additional fees against
shareholder accounts to defray expenses
which would otherwise be paid by the Joint
Venture under the Joint Venture Agreement.
Such fees could be imposed if the fund's
custodial, transfer agent, accounting,
auditing or legal (collectively
"out-of-pocket") expenses were to increase
abruptly and significantly. The amount of
these fees would be limited to the increase
in the "out-of-pocket" expenses. The Board
does not anticipate levying such charges;
such a fee, if charged, may be retained by
the fund or paid to the Joint Venture.
Annual Fees. The fund pays the Joint
Venture an all inclusive fee at a rate of
1.00% of its
average daily net assets. The all inclusive
fee covers both investment management and
oper-ating expenses and is calculated and
accrued daily. This fee is higher than the
management fees of most other mutual funds
because it includes the fund's operating
expenses. Most
other mutual funds have a management fee
and an additional charge for operating
expenses. (See "Transaction Costs and Fund
Expenses.")
The fund has adopted a distribution plan
under which the fund will pay a monthly fee
(equal to 0.25% annually of the fund's
average daily net assets) for costs and
expenses incurred in the distribution of
shares of the fund. Such a fee is usually
referred to as a 12b-1 fee. The types of
expenses it may cover include: (i)
advertising, including brochures, sales
literature, direct mail or any other form
of advertising; (ii) expenses of sales
employees or agents of the Distributors,
including salary, commissions, travel and
related expenses; (iii) payments to credit
unions and other financial institutions for
services in connection with the
distribution of shares, including fees
calculated with reference to the average
daily net asset value of shares held by
shareholders who have a service
relationship with the institution receiving
such fees; (iv) costs of printing
prospectuses and other materials to be
given or sent to prospective investors; and
(v) such other similar services as may be
reasonably calculated to result in the sale
of shares of the fund. In addition, all or
a portion of this fee may be paid to
broker-dealers or other financial
institutions as a service fee for
maintaining shareholder accounts or
providing personal service to shareholders
in the fund.
The fund's Distributors may incur expenses
in distributing shares of the fund which
will exceed the amounts paid to them by the
Joint Venture. These expenses will be borne
by each Distributor out of its own
resources.
Understanding Performance Information
This section should help you understand the
terms used to describe the fund's
performance. You will come across them in
shareholder reports you receive two times a
year, in "Investment Focus" articles, in
advertisements, and in the media.
Total Return
____________________
Total return is the most This tells you how much an investment in a
widely used performance fund has changed in value over a given time
measure. Detailed period. It reflects any net increase or
performance information decrease in the share price and assumes
is included in the fund's that all dividends and capital gains (if
annual and semiannual any) paid during the period were reinvested
shareholder reports. in additional shares. Reinvesting
distributions means that total return
numbers include the effect of compounding,
i.e., you receive income and capital gain
distributions on a rising number of shares.
Advertisements for the fund may include
cumulative or compound average annual total
return figures, which may be compared with
various indices, other performance
measures, or other mutual funds.
Cumulative Total Return
This is the actual rate of return on an
investment for a specified period. A
cumulative return does not indicate how
much the value of the investment may have
fluctuated between the
beginning and the end of the period
specified.
Average Annual Total Return
This is always hypothetical. Working
backward from the actual cumulative return,
it tells
you what constant year-by-year return would
have produced the actual, cumulative
return. By smoothing out all the variations
in annual performance, it gives you an idea
of the investment's annual contribution to
your portfolio provided you held it for the
entire period in question.
PAGE 15
__________________ Yield
You will see frequent The current or "dividend yield" on the fund
references to the fund's or any investment tells you the
yield in our reports, relationship between the investment's
advertisements, in media current level of annual income and its
stories, and so on. price on a particular day. The dividend
yield reflects the actual income paid to
shareholders for a given period,
annualized, and divided by the average
price during the given period. For example,
a fund providing $5
of annual income per share and a price of
$50 has a current yield of 10%. Yields can
be calculated for any time period.
The advertised or "SEC yield" is found by
determining the net income per share (as
defined by the SEC) earned by the fund
during a 30-day base period and dividing
this amount by
the per-share price on the last day of the
base period. The "SEC yield" may differ
from the dividend yield.
Investment Programs and Practices
This section takes a detailed look at some
of the types of securities the fund may
hold in its portfolio and the various kinds
of investment practices that may be used in
day-to-day portfolio management. The fund's
investment program is subject to further
restrictions and risks described in the
"Statement of Additional Information."
Shareholder approval is required to
substantively change the fund's objective
(stated on
page 5) and to change certain investment
restrictions noted in the following section
as
"fundamental policies." The managers also
follow certain "operating policies" which
can be changed without shareholder
approval. However, significant changes are
discussed with shareholders in fund
reports.
PAGE 16
_________________________ Types of Portfolio Securities
Fund managers have In seeking to meet its investment
considerable leeway in objective, the fund may invest in any type
choosing investment of interest-bearing security whose yield,
strategies and selecting credit quality, and maturity
securities they believe characteristics are consistent with the
will help the fund fund's investment program. These and some
achieve its objectives. of the other investment techniques the fund
may use are described in the following
pages.
Fundamental Policy. The fund will not
purchase a security if, as a result, with
respect to 75% of its total assets, more
than 5% of its total assets would be
invested in securities of the issuer.
Bonds. A bond is an interest-bearing
security - an IOU - issued by companies or
governmental units. The issuer has a
contractual obligation to pay interest at a
stated rate on specific dates and to repay
principal (the bond's face value) on a
specified date. An issuer may have the
right to redeem or "call" a bond before
maturity, and the investor may have to
reinvest the proceeds at lower market
rates.
A bond's annual interest income, set by its
coupon rate, is usually fixed for the life
of the bond. Its yield (income as a percent
of current price) will fluctuate to reflect
changes in interest rate levels. A bond's
price rises when interest rates fall, and
vice versa so its yield is current (see the
table on page 6).
Bonds may be secured (backed by specified
collateral) or unsecured (backed by the
issuer's general creditworthiness).
Certain bonds have interest rates that are
adjusted periodically in order to minimize
fluctuations of their principal value. The
maturity of those securities may be
shortened under certain specified
conditions.
Asset-backed Securities. An underlying pool
of assets, such as credit card or
automobile trade receivables or corporate
loans or bonds, backs these bonds and
provides the interest and principal
payments to investors. Credit quality
depends primarily on the quality of the
underlying assets and the level of credit
support, if any, provided by the issuer.
The underlying assets (i.e., loans) are
subject to prepayments which can shorten
the securities' weighted average life and
may lower their return. The value of these
securities also may change because of
actual or perceived changes in the
creditworthiness of the originator,
servicing agent, or of the financial
institution providing the credit support.
Mortgage Securities. The fund may invest in
a variety of mortgage securities. For a
general description of mortgage securities,
see pages 6 and 7. Additional
mortgage-related securities in which the
fund may invest include:
Collateralized Mortgage Obligations
(CMOs). CMOs are debt securities that are
fully collateralized by a portfolio of
mortgages or mortgage-backed securities.
All interest and principal
payments from the underlying mortgages are
passed through to the CMOs in such a way as
to create more definite maturities than is
the case with the underlying bonds. CMOs
may pay fixed or variable rates of
interest, and certain CMOs have priority
over others with respect to the receipt of
prepayments.
Stripped Mortgage Securities.
Stripped mortgage securities are created by
separating the interest and principal
payments generated by a pool of
mortgage-backed bonds to create two classes
of securities. Generally, one class
receives only interest payments (IOs) and
one principal
payments (POs).
IOs and POs are acutely sensitive to
interest rate changes and to the rate of
principal prepayments. They are very
volatile in price and may have lower
liquidity than most mortgage-backed
securities. Certain CMOs may also exhibit
these qualities, especially those which pay
variable rates of interest which adjust
inversely with and more rapidly than
short-term interest rates. There is no
guarantee the fund's investment in CMOs,
IOs or POs will be successful, and the
fund's total return could be adversely
affected as a result.
PAGE 17
Hybrid Instruments. These instruments can
have the characteristics of futures,
options and debt securities. For example,
the interest or principal of a hybrid bond
may be determined by the value of a
designated currency, commodity, or foreign
or domestic securities index at a specified
future time. One type of hybrid instrument
is a cross currency linked bond whose
coupon yield varies based on the
relationship between two currencies.
Another type could pay a market rate of
interest but have its principal at maturity
determined by a multiple of an index. Under
certain conditions, the redemption value of
such an investment could be zero. Hybrids
can have volatile prices and limited
liquidity.
Private Placements. These securities are
sold directly to a small number of
investors, usually institutions. Unlike
public offerings, such securities are not
registered with the SEC. Although certain
of these securities may be readily sold,
for example under Rule 144A, the sale of
others may involve substantial delays and
additional costs.
Operating Policy. The fund will not invest
more than 15% of its net assets in illiquid
securities.
Types of Management Practices
Cash Position. The fund will hold a certain
portion of its assets in money market
securities in the two highest rating
categories, maturing in one year or less.
For temporary, defensive purposes, the fund
may invest without limitation in such
securities. This reserve position provides
flexibility in meeting redemptions,
expenses, and the timing of new
investments, and serves as a short-term
defense during periods of unusual market
volatility. Under normal market conditions,
the fund expects to hold approximately 5%
of its total assets in cash.
Borrowing Money and Transferring Assets.
The fund can borrow money from banks as a
temporary measure for emergency purposes,
to facilitate redemption requests, or for
other purposes consistent with the fund's
investment objectives and program. Such
borrowings may be
collateralized with fund assets, subject to
restrictions.
Fundamental Policy. Borrowings may not
exceed 33 1_3% of total fund assets.
Operating Policies. The fund may not
transfer as collateral any portfolio
securities except as necessary in
connection with permissible borrowings or
investments, and then such transfers may
not exceed 33 1_3% of the fund's total
assets. The fund may not purchase
additional securities when borrowings
exceed 5% of total assets.
Futures and Options. Futures are often used
to manage risk, because they enable the
investor to buy or sell an asset in the
future at an agreed upon price. Options
give the investor the right, but not the
obligation, to buy or sell an asset at a
predetermined price in the future. The fund
may buy and sell futures contracts (and
options on such contracts) to manage its
exposure to changes in interest rates and
bond prices; to adjust its overall exposure
PAGE 18 to certain markets; and also to adjust the
portfolio's duration. The fund may
purchase, sell, or write call and put
options on securities and financial
indices.
Futures contracts and options may not
always be successful hedges; their prices
can be highly volatile; and using them
could lower the fund's total return.
Operating Policies. Futures: The fund will
not use futures contracts for speculation.
Initial margin deposits and premiums on
options used for non-hedging purposes will
not equal more than 5% of the fund's net
assets. Options on securities: The total
market value of securities against which
the fund has written call or put options
may not exceed 25% of its total assets.
Interest Rate Swaps. The fund may enter
into various interest rate transactions
such as interest rate swaps and the
purchase or sale of interest rate caps and
floors, to preserve a return or spread on a
particular investment or portion of its
portfolio, to create synthetic securities,
or to structure transactions designed for
other non-speculative purposes.
Operating Policy. The fund will not invest
more than 10% of its total assets in
interest rate swaps.
Repurchase Agreements. The fund may enter
into repurchase agreements (repos) with
well-established securities dealers or
banks that are members of the Federal
Reserve System. If a seller of repos is
unable to repurchase the securities, the
fund could experience extra costs, delays
in recovering its securities, or possibly a
capital loss.
Lending of Portfolio Securities. Like other
mutual funds, the fund may lend securities
to broker-dealers, other institutions, or
other persons to earn additional income.
The principal risk is the potential
insolvency of the broker-dealer or other
borrower. In this event, the fund could
experience delays in recovering its
securities and possibly capital losses.
Fundamental Policy. The value of loaned
securities may not exceed 33 1_3% of the
fund's total assets.
When-Issued Securities and Forward
Commitment Contracts. The fund may purchase
securities on a when-issued or delayed
delivery basis or may purchase or sell
securities on a forward commitment basis.
The price of these securities is fixed at
the time of the commitment to buy, but
delivery and payment can take place a month
or more later. During the interim period,
the market value of the securities can
fluctuate, and no interest accrues to the
purchaser. At the time of delivery, the
value of the securities may be more or less
than the purchase or sale price. Depending
on the fund's other investments, purchase
of these securities could increase the
level of fluctuations in the fund's net
asset value.
Portfolio Transactions. The fund's
portfolio turnover rate is not expected to
exceed 150%. A high turnover rate may
increase transaction costs and result in
taxable capital gains distributed to
shareholders.
PAGE 19
4 Investing in the
CUNA Mutual Funds Meeting Requirements for New Accounts
Tax Identification Number
______________________
Always verify your We must have your correct social security
transactions by carefully or corporate tax identification number and
reviewing the a signed New Account Form or W-9 Form.
confirmation we send you. Otherwise, federal law requires the fund to
Please report any withhold a percentage (currently 31%) of
discrepancies to your dividends, capital gain distributions,
Shareholder Services at and redemptions, and may subject you to a
1-800-934-FUND (3863). fine. You will also be prohibited from
opening another account by exchange. If
this information is not received within 60
days after your account is established,
your account may be redeemed, priced at the
NAV on the date of redemption.
Unless you request otherwise, one
shareholder report will be mailed to
multiple account
owners with the same tax identification
number and same zip code and to those
shareholders who have requested that their
account be combined with someone else's for
financial
reporting.
Opening a New Account: $2,500 minimum
initial investment; $1,000 for gifts or
transfers to minors (UGMA/UTMA) accounts
PAGE 20
Account Registration
If you own other CUNA Mutual Funds, be sure
to register any new account just like your
existing accounts so you can exchange among
them easily. (The name and account type
must be identical.)
______________________
Regular Mail
CUNA Mutual Funds By Mail
P.O. Box 17434 Please make your share draft or check
Baltimore, MD payable to CUNA Mutual Funds (otherwise it
21298-9613 may be returned) and send it together with
the New Account Form to the address at
Mailgram, Express, left.
Registered, or Certified By Wire
Mail Call Investor Services for an
CUNA Mutual Funds account number and use the wire address
Account Services below.
10090 Red Run Blvd. Complete a New Account Form and mail
Owings Mills, MD it to the address listed at left.
21117 Give the following wire address to
your financial institution: Morgan Guaranty
Trust Co.
of New York, ABA# 021000238, CUNA Mutual
[fund name], AC-00153938. Provide fund
name, account name(s), and account number.
By Exchange
Call Shareholder Services. The new account
will have the same registration as the
account from which you are exchanging.
Services for the new account may be carried
over by telephone request if preauthorized
on the existing account. (See explanation
of "Excessive Trading" under "Transaction
Procedures.")
Note: The fund and its agents have the
right to waive or lower investment
minimums, to accept initial purchases by
telephone or mailgram, to cancel or reject
any purchase or exchange if the written
confirmation has not been received by the
shareholder, or to otherwise modify the
conditions of purchase or any services at
any time.
Purchasing Additional Shares: $100 minimum
purchase
By ACH Transfer
Call Shareholder Services if you have
established electronic transfers using the
ACH network ($100 minimum).
By Wire
Call Shareholder Services or use the wire
address in "Opening a New Account."
____________________
Regular Mail By Mail
CUNA Mutual Funds Provide your account number and the
Account Services fund name on your share draft or check.
P.O. Box 89000 Mail the share draft or check to us
Owings Mills, MD at the address shown at left with an
21289-1500 investment form (located at the bottom of
your statement), a stub from a statement
confirming a prior transaction or a note
stating that you want to purchase shares in
that fund (provide account number).
By Systematic Investing
Fill out the Systematic Investing section
on the New Account or Shareholder Services
Form.
Exchanging and Redeeming Shares
PAGE 21
_________________
Regular Mail By Phone
CUNA Mutual Funds Call Shareholder Services. For exchange
Account Services policies, please see "Transaction
P.O. Box 89000 Procedures and Special Requirements _
Baltimore, MD Excessive Trading."
21289-0220
Redemption proceeds can be mailed to your
Mailgram, Express, account address, wired to your credit union
Registered, or or bank, or sent by ACH transfer. For
Certified Mail charges, see "Electronic Transfers _ By
(See page 19.) Wire" on the next page.
By Mail
Provide account name(s) and numbers, fund
name(s), and exchange or redemption amount.
For exchanges, mail to the appropriate
address at left, indicate the fund you are
exchanging from and the fund(s) you are
exchanging into. CUNA Mutual Funds require
the signatures
of all owners exactly as registered, and
possibly a signature guarantee (see
"Transaction Procedures and Special
Requirements _ Signature Guarantees").
Note: Redemptions from retirement accounts,
including IRAs, must be in writing.
Procedures for retirement accounts may
vary.
Shareholder Services
PAGE 21 Many services are available to you as a
______________________ CUNA Mutual Fund shareholder; some you
Investor Services receive automatically and others you must
1-800-756-FUND authorize on the New Account Form. By
signing up for services on the New Account
Shareholder Services Form rather than later on, you avoid having
1-800-934-FUND to complete a separate form and obtain a
signature guarantee. This section reviews
some of the principal services currently
offered.
Shareholder Services. Buy, sell, or
exchange shares by calling one of our
service representative.
Exchange Service
You can move money from one account to an
existing identically registered account, or
open a new identically registered account.
Remember, exchanges are purchases and sales
for tax purposes.
Electronic Transfers
By ACH. With no charges to pay, you can
initiate a purchase or redemption for as
little as $100 or as much as $100,000
between your credit union or bank account
and fund account using the ACH network.
Call Shareholder Services.
By Wire. Electronic transfers can also be
conducted via bank wire. There is
currently a $5 fee for wire redemptions
under $5,000, and your credit union or bank
may charge for wire transfers regardless of
size.
Sytematic Investing
You can invest automatically in several
different ways, including:
- Systematic Investing. You instruct us to
move $50 or more once a month or less often
from your credit union or bank account, or
you can instruct your employer to send all
or a portion of your paycheck, to the fund
or funds you designate.
- Automatic Exchange. Enables you to set
up systematic investments from one fund
account into another, such as from a bond
fund into an asset allocation fund.
PAGE 22
Prospectus
To Open an Account
Investor Services CUNA Mutual
1-800-756-FUND Funds, Inc.
CUNA Mutual U.S.
For Existing Accounts Government
Shareholder Services Income Fund
1-800-934-FUND
______________
To help credit A bond fund
union members CUNA Mutual for investors
achieve their Funds, Inc. seeking the
financial goals, U.S. Government income
we offer an assetIncome Fund potential and
allocation fund, December 31, credit
a tax-free fund 1993 safety of
and a U.S. securities
Government bond issued by the
fund, as well as U.S.
convenient Government and
services and its agencies.
timely,
informative
reports.
STATEMENT OF ADDITIONAL INFORMATION
CUNA MUTUAL FUNDS, INC.
CUNA Mutual Cornerstone Fund
(the "Fund")
This Statement of Additional Information is not a
prospectus but should be read in conjunction with the Fund's
prospectus dated December 30, 1993, which may be obtained from
T. Rowe Price Investment Services, Inc., 100 East Pratt Street,
Baltimore, Maryland 21202.
The date of this Statement of Additional Information is
December 30, 1993.
<PAGE>
PAGE 2
TABLE OF CONTENTS
Page Page
Capital Stock. . . . . . . . 55 Investment Restrictions . . .31
Custodian. . . . . . . . . . 41 Joint Venture . . . . . . . .38
Development of the Legal Counsel
56
CUNA Mutual Funds. . . . . 54 Lending of Portfolio
Dividends. . . . . . . . . . 47 Securities. . . . . . . . .16
Federal and State Management of Fund
36
Registration of Shares . . 56 Mortgage-Related Securities . 6
Foreign Currency Transactions28 Net Asset Value Per Share . .46
Foreign Futures and Options. 28 Options . . . . . . . . . . .17
Foreign Securities . . . . . .4 Portfolio Transactions. . . .41
Fund Distribution. . . . . . 40 Pricing of Securities . . . .46
Fund Management and Principal Holders of Securities
38
Administration . . . . . . 39 Ratings of Corporate Debt
Futures Contracts. . . . . . 22 Securities. . . . . . . . .35
Independent Accountants. . . 56 Repurchase Agreements . . . .16
Investment Objective and .Risk Factors3
Program (page 5 in Prospectus) 2Tax Status (page 7 in Prospectus)
47
Investment Objective and Policies. . . . . . . . . . . . . . . 2
When-Issued Securities and
Investment Performance . . . 48 Forward Commitment Contracts14
Investment Program . . . . . .5 Yield Information . . . . . .48
(page 14 in Prospectus)
INVESTMENT OBJECTIVE AND POLICIES
The following information supplements the discussion of the
Fund's investment objective and policies discussed on pages 5 and
14 through 19 of the prospectus. The Fund will not make a
material change in its investment objective without obtaining
shareholder approval. Unless otherwise specified, the investment
programs and restrictions of the Fund are not fundamental
policies. The Fund's operating policies are subject to change by
its Board of Directors without shareholder approval. However,
shareholders will be notified of a material change in an
operating policy. The Fund's fundamental policies may not be
changed without the approval of at least a majority of the
outstanding shares of the Fund or, if it is less, 67% of the
shares represented at a meeting of shareholders at which the
PAGE 3
holders of 50% or more of the shares are represented.
INVESTMENT OBJECTIVE AND PROGRAM
The investment objective of the Fund is to seek a high total
return consisting of capital appreciation and current income.
The Fund will invest in the three major asset classes of
securities in the following ranges: 50%-70% stocks; 20%-50%
bonds; and 0%-20% money market securities.
The Fund's share price will fluctuate with changing market
conditions and interest rate levels. Your investment may be
worth more or less when redeemed (sold) than when purchased. The
Fund should not be relied upon for short-term financial needs,
nor used to play short-term swings in the stock or bond markets.
The Fund cannot guarantee it will be successful in achieving its
investment objective.
After purchase by the Fund, a security may cease to be rated
or its rating may be reduced below the minimum required for
purchase by the Fund. Neither event will require a sale of such
security by the Fund. However, T. Rowe Price Associates, Inc.
("T. Rowe Price") will consider such event in its determination
of whether the Fund should continue to hold the security. To the
extent that the ratings given by Moody's Investors Service, Inc.
("Moody's"), Standard & Poor's Corporation ("S&P"), or Fitch
Investors Service, Inc. ("Fitch") may change as a result of
changes in such organizations or their rating systems, the Fund
will attempt to use comparable ratings as standards for
investments in accordance with the investment policies contained
in the prospectus. When purchasing unrated securities, T. Rowe
Price, under the supervision of the Fund's Board of Directors,
determines whether the unrated security is of a quality
comparable to that which the Fund is allowed to purchase.
RISK FACTORS
General
Because of its investment policy, the Fund may or may not be
suitable or appropriate for all investors. The Fund is not a
money market fund and is not an appropriate investment for those
whose primary objective is principal stability. The Fund will
normally have 50-70% of its assets in equity securities (e.g.,
PAGE 4
common stocks). This portion of the Fund's assets will be
subject to all of the risks of investing in the stock market. In
addition, the Fund's investment program permits it to purchase
below investment grade securities. Since investors generally
perceive that there are greater risks associated with investment
in lower quality securities, the yields from such securities
normally exceed those obtainable from higher quality securities.
However, the principal value of lower-rated securities generally
will fluctuate more widely than higher quality securities. Lower
quality investments entail a higher risk of default--that is, the
nonpayment of interest and principal by the issuer than higher
quality investments. There is risk in all investment. The value
of the portfolio securities of the Fund will fluctuate based upon
market conditions. Although the Fund seeks to reduce risk by
investing in a diversified portfolio, such diversification does
not eliminate all risk. There can, of course, be no assurance
that the Fund will achieve these results. Reference is also made
to the sections entitled "Types of Securities" and "Portfolio
Management Practices" for discussions of the risks associated
with the investments and practices described therein as they
apply to the Fund.
Debt Obligations
Yields on short, intermediate, and long-term securities are
dependent on a variety of factors, including the general
conditions of the money and bond markets, the size of a
particular offering, the maturity of the obligation, and the
credit quality and rating of the issue. Debt securities with
longer maturities tend to have higher yields and are generally
subject to potentially greater capital appreciation and
depreciation than obligations with shorter maturities and lower
yields. The market prices of debt securities usually vary,
depending upon available yields. An increase in interest rates
will generally reduce the value of portfolio investments, and a
decline in interest rates will generally increase the value of
portfolio investments. The ability of the Fund to achieve its
investment objective is also dependent on the continuing ability
of the issuers of the debt securities in which the Fund invests
to meet their obligations for the payment of interest and
principal when due. Although the Fund seeks to reduce risk by
portfolio diversification, credit analysis (considered by T. Rowe
Price to be among the most stringent in the investment management
industry), and attention to trends in the economy, industries and
financial markets, such efforts will not eliminate all risk.
There can, of course, be no assurance that the Fund will achieve
PAGE 5
its investment objective.
Special Risks of High Yield Investing
The Fund may invest up to 10% of its assets in low quality
bonds commonly referred to as "junk bonds." Junk bonds are
regarded as predominantly speculative with respect to the
issuer's continuing ability to meet principal and interest
payments. Because investment in low and lower-medium quality
bonds involves greater investment risk, to the extent the Fund
invests in such bonds, achievement of its investment objective
will be more dependent on T. Rowe Price's credit analysis than
would be the case if the Fund was investing in higher quality
bonds. High yield bonds may be more susceptible to real or
perceived adverse economic conditions than investment grade
bonds. A projection of an economic downturn, or higher interest
rates, for example, could cause a decline in high yield bond
prices because the advent of such events could lessen the ability
of highly leverage issuers to make principal and interest
payments on their debt securities. In addition, the secondary
trading market for high yield bonds may be less liquid than the
market for higher grade bonds, which can adversely affect the
ability of a Fund to dispose of its portfolio securities. Bonds
for which there is only a "thin" market can be more difficult to
value inasmuch as objective pricing data may be less available
and judgment may play a greater role in the valuation process.
Foreign Securities
The Fund may invest in U.S. dollar-denominated and non U.S.
dollar-denominated securities of foreign issuers. The Fund
currently intends to limit its non-dollar denominated equity and
debt securities to 20% and 10% of total assets, respectively.
Because the Fund may invest in foreign securities,
investment in the Fund involves risks that are different in some
respects from an investment in a fund which invests only in
securities of U.S. domestic issuers. Foreign investments may be
affected favorably or unfavorably by changes in currency rates
and exchange control regulations. There may be less publicly
available information about a foreign company than about a U.S.
company, and foreign companies may not be subject to accounting,
auditing, and financial reporting standards and requirements
comparable to those applicable to U.S. companies. There may be
less governmental supervision of securities markets, brokers and
issuers of securities. Securities of some foreign companies are
PAGE 6
less liquid or more volatile than securities of U.S. companies,
and foreign brokerage commissions and custodian fees are
generally higher than in the United States. Settlement practices
may include delays and may differ from those customary in United
States markets. Investments in foreign securities may also be
subject to other risks different from those affecting U.S.
investments, including local political or economic developments,
expropriation or nationalization of assets, restrictions on
foreign investment and repatriation of capital, imposition of
withholding taxes on dividend or interest payments, currency
blockage (which would prevent cash from being brought back to the
United States), and difficulty in enforcing legal rights outside
the U.S.
INVESTMENT PROGRAM
In addition to the investments described in the Fund's
prospectus, the Fund may invest in the following:
Type of Securities
Fixed income securities in which the Fund may invest
include, but are not limited to, those described below.
U.S. Government Obligations. Bills, notes, bonds and other
debt securities issued by the U.S. Treasury. These are direct
obligations of the U.S. Government and differ mainly in the
length of their maturities.
U.S. Government Agency Securities. Issued or guaranteed by
U.S. Government sponsored enterprises and federal agencies.
These include securities issued by the Federal National Mortgage
Association, Government National Mortgage Association, Federal
Home Loan Bank, Federal Land Banks, Farmers Home Administration,
Banks for Cooperatives, Federal Intermediate Credit Banks,
Federal Financing Bank, Farm Credit Banks, the Small Business
Association, and the Tennessee Valley Authority. Some of these
securities are supported by the full faith and credit of the U.S.
Treasury; and the remainder are supported only by the credit of
the instrumentality, which may or may not include the right of
the issuer to borrow from the Treasury.
Bank Obligations. Certificates of deposit, bankers'
acceptances, and other short-term debt obligations. Certificates
of deposit are short-term obligations of commercial banks. A
PAGE 7
bankers' acceptance is a time draft drawn on a commercial bank by
a borrower, usually in connection with international commercial
transactions. Certificates of deposit may have fixed or variable
rates. The Fund may invest in U.S. banks, foreign branches of
U.S. banks, U.S. branches of foreign banks, and foreign branches
of foreign banks.
Short-Term Corporate Debt Securities. Outstanding
nonconvertible corporate debt securities (e.g., bonds and
debentures) which have one year or less remaining to maturity.
Corporate notes may have fixed, variable, or floating rates.
Commercial Paper. Short-term promissory notes issued by
corporations primarily to finance short-term credit needs.
Certain notes may have floating or variable rates.
Foreign Government Securities. Issued or guaranteed by a
foreign government, province, instrumentality, political
subdivision or similar unit thereof.
Savings and Loan Obligations. Negotiable certificates of
deposit and other short-term debt obligations of savings and loan
associations.
Supranational Agencies. The Fund may also invest in the
securities of certain supranational entities, such as the
International Development Bank.
<PAGE>
PAGE 8
Mortgage-Related Securities
Mortgage-Backed Securities. Mortgage-backed securities are
securities representing an interest in a pool of mortgages. The
mortgages may be of a variety of types, including adjustable
rate, conventional 30-year fixed rate, graduated payment, and 15-
year. Principal and interest payments made on the mortgages in
the underlying mortgage pool are passed through to the Fund. This
is in contrast to traditional bonds where principal is normally
paid back at maturity in a lump sum. Unscheduled prepayments of
principal shorten the securities' weighted average life and may
lower their total return. (When a mortgage in the underlying
mortgage pool is prepaid, an unscheduled principal prepayment is
passed through to the Fund. This principal is returned to the
Fund at par. As a result, if a mortgage security were trading at
a premium, its total return would be lowered by prepayments, and
if a mortgage security were trading at a discount, its total
return would be increased by prepayments.) The value of these
securities also may change because of changes in the market's
perception of the creditworthiness of the federal agency that
issued them. In addition, the mortgage securities market in
general may be adversely affected by changes in governmental
regulation or tax policies.
The Fund may invest up to 50% of its total assets in
mortgage-backed securities. These securities include, but are
not limited to, those described below.
U.S. Government Agency Mortgage-Backed Securities. These
are obligations issued or guaranteed by the United States
Government or one of its agencies or instrumentalities, such as
the Government National Mortgage Association ("Ginnie Mae" or
"GNMA"), the Federal National Mortgage Association ("Fannie Mae"
or "FNMA") and the Federal Home Loan Mortgage Corporation
("Freddie Mac" or "FHLMC"). FNMA and FHLMC obligations are not
backed by the full faith and credit of the U.S. Government as
GNMA certificates are, but FNMA and FHLMC securities are
supported by the instrumentality's right to borrow from the
United States Treasury. U.S. Government Agency Mortgage-Backed
Certificates provide for the pass-through to investors of their
pro-rata share of monthly payments (including any prepayments)
made by the individual borrowers on the pooled mortgage loans,
net of any fees paid to the guarantor of such securities and the
servicer of the underlying mortgage loans. Each of GNMA, FNMA
and FHLMC guarantees timely distributions of interest to
certificate holders. GNMA and FNMA guarantee timely
distributions of scheduled principal. FHLMC has in the past
PAGE 9
guaranteed only the ultimate collection of principal of the
underlying mortgage loan; however, FHLMC now issues
Mortgage-Backed Securities (FHLMC Gold PCs) which also guarantee
timely payment of monthly principal reductions.
Ginnie Mae Certificates. Ginnie Mae is a wholly-owned
corporate instrumentality of the United States within the
Department of Housing and Urban Development. The National
Housing Act of 1934, as amended (the "Housing Act"), authorizes
Ginnie Mae to guarantee the timely payment of the principal of
and interest on certificates that are based on and backed by a
pool of mortgage loans insured by the Federal Housing
Administration under the Housing Act, or Title V of the Housing
Act of 1949 ("FHA Loans"), or guaranteed by the Department of
Veterans Affairs under the Servicemen's Readjustment Act of 1944,
as amended ("VA Loans"), or by pools of other eligible mortgage
loans. The Housing Act provides that the full faith and credit
of the United States government is pledged to the payment of all
amounts that may be required to be paid under any guaranty. In
order to meet its obligations under such guaranty, Ginnie Mae is
authorized to borrow from the United States Treasury with no
limitations as to amount.
Fannie Mae Certificates. Fannie Mae is a federally
chartered and privately owned corporation organized and existing
under the Federal National Mortgage Association Charter Act of
1938. FNMA Certificates represent a pro-rata interest in a group
of mortgage loans purchased by Fannie Mae. FNMA guarantees the
timely payment of principal and interest on the securities it
issues. The obligations of FNMA are not backed by the full faith
and credit of the U.S. Government.
Freddie Mac Certificates. Freddie Mac is a corporate
instrumentality of the United States created pursuant to the
Emergency Home Finance Act of 1970, as amended (the "FHLMC Act").
Freddie Mac Certificates represent a pro-rata interest in a group
of mortgage loans (a "Freddie Mac Certificate group") purchased
by Freddie Mac. Freddie Mac guarantees timely payment of
interest and principal on certain securities it issues and timely
payment of interest and eventual payment of principal on other
securities is issues. The obligations of Freddie Mac are
obligations solely of Freddie Mac and are not backed by the full
faith and credit of the U.S. Government.
When mortgages in the pool underlying a Mortgage-Backed
PAGE 10
Security are prepaid by mortgagors or by result of foreclosure,
such principal payments are passed through to the certificate
holders. Accordingly, the life of the Mortgage-Backed Security
is likely to be substantially shorter than the stated maturity of
the mortgages in the underlying pool. Because of such variation
in prepayment rates, it is not possible to predict the life of a
particular Mortgage-Backed Security, but FHA statistics indicate
that 25- to 30-year single family dwelling mortgages have an
average life of approximately 12 years. The majority of Ginnie
Mae Certificates are backed by mortgages of this type, and,
accordingly, the generally accepted practice treats Ginnie Mae
Certificates as 30-year securities which prepay full in the 12th
year. FNMA and Freddie Mac Certificates may have differing
prepayment characteristics.
Fixed Rate Mortgage-Backed Securities bear a stated "coupon
rate" which represents the effective mortgage rate at the time of
issuance, less certain fees to GNMA, FNMA and FHLMC for providing
the guarantee, and the issuer for assembling the pool and for
passing through monthly payments of interest and principal.
Payments to holders of Mortgage-Backed Securities consist of
the monthly distributions of interest and principal less the
applicable fees. The actual yield to be earned by a holder of
Mortgage-Backed Securities is calculated by dividing interest
payments by the purchase price paid for the Mortgage-Backed
Securities (which may be at a premium or a discount from the face
value of the certificate).
Monthly distributions of interest, as contrasted to semi-
annual distributions which are common for other fixed interest
investments, have the effect of compounding and thereby raising
the effective annual yield earned on Mortgage-Backed Securities.
Because of the variation in the life of the pools of mortgages
which back various Mortgage-Backed Securities, and because it is
impossible to anticipate the rate of interest at which future
principal payments may be reinvested, the actual yield earned
from a portfolio of Mortgage-Backed Securities will differ
significantly from the yield estimated by using an assumption of
a certain life for each Mortgage-Backed Security included in such
a portfolio as described above.
Stripped Agency Mortgage-Backed Securities. The Fund may
invest up to 10% of its total assets in stripped mortgage
securities.
PAGE 11
Stripped Agency Mortgage-Backed securities representing
interests in a pool of mortgages, the cash flow of which has been
separated into its interest and principal components. "IOs"
(interest only securities) receive the interest portion of the
cash flow while "POs" (principal only securities) receive the
principal portion. Stripped Agency Mortgage-Backed Securities
may be issued by U.S. Government Agencies or by private issuers
similar to those described below with respect to CMOs and
privately-issued mortgage-backed certificates. As interest rates
rise and fall, the value of IOs tends to move in the same
direction as interest rates. The value of the other
mortgage-backed securities described herein, like other debt
instruments, will tend to move in the opposite direction compared
to interest rates. Under the Internal Revenue Code of 1986, as
amended (the "Code"), POs may generate taxable income from the
current accrual of original issue discount, without a
corresponding distribution of cash to the Fund.
The cash flows and yields on IO and PO classes are extremely
sensitive to the rate of principal payments (including
prepayments) on the related underlying mortgage assets. For
example, a rapid or slow rate of principal payments may have a
material adverse effect on the prices of IOs or POs,
respectively. If the underlying mortgage assets experience
greater than anticipated prepayments of principal, an investor
may fail to recoup fully its initial investment in an IO class of
a stripped mortgage-backed security, even if the IO class is
rated AAA or Aaa or is derived from a full faith and credit
obligation. Conversely, if the underlying mortgage assets
experience slower than anticipated prepayments of principal, the
price on a PO class will be affected more severely than would be
the case with a traditional mortgage-backed security.
The staff of the Securities and Exchange Commission has
advised the Fund that it believes the Fund should treat IOs and
POs, other than government-issued IOs or POs backed by fixed rate
mortgages, as illiquid securities and, accordingly, limit its
investments in such securities, together with all other illiquid
securities, to 15% of the Fund's net assets. Under the Staff's
position, the determination of whether a particular
government-issued IO and PO backed by fixed rate mortgages may be
made on a case by case basis under guidelines and standards
established by the Fund's Board of Directors. The Fund's Board
of Directors has delegated to T. Rowe Price the authority to
determine the liquidity of these investments based on the
following guidelines: the type of issuer; type of collateral,
PAGE 12
including age and prepayment characteristics; rate of interest on
coupon relative to current market rates and the effect of the
rate on the potential for prepayments; complexity of the issue's
structure, including the number of tranches; size of the issue
and the number of dealers who make a market in the IO or PO. The
Fund will treat non-government-issued IOs and POs not backed by
fixed or adjustable rate mortgages as illiquid unless and until
the Securities and Exchange Commission modifies its position.
Collateralized Mortgage Obligations (CMOs). The Fund may
invest up to 50% of its total assets in collateralized mortgage
obligations (CMOs).
CMOs are bonds that are collateralized by whole loan
mortgages or mortgage pass-through securities. The bonds issued
in a CMO deal are divided into groups, and each group of bonds is
referred to as a "tranche." Under the traditional CMO structure,
the cash flows generated by the mortgages or mortgage pass-
through securities in the collateral pool are used to first pay
interest and then pay principal to the CMO bondholders. The
bonds issued under a CMO structure are retired sequentially as
opposed to the pro rata return of principal found in traditional
pass-through obligations. Subject to the various provisions of
individual CMO issues, the cash flow generated by the underlying
collateral (to the extent it exceeds the amount required to pay
the stated interest) is used to retire the bonds. Under the CMO
structure, the repayment of principal among the different
tranches is prioritized in accordance with the terms of the
particular CMO issuance. The "fastest-pay" tranche of bonds, as
specified in the prospectus for the issuance, would initially
receive all principal payments. When that tranche of bonds is
retired, the next tranche, or tranches, in the sequence, as
specified in the prospectus, receive all of the principal
payments until they are retired. The sequential retirement of
bond groups continues until the last tranche, or group of bonds,
is retired. Accordingly, the CMO structure allows the issuer to
use cash flows of long maturity, monthly-pay collateral to
formulate securities with short, intermediate and long final
maturities and expected average lives.
In recent years, new types of CMO structures have evolved.
These include floating rate CMOs, planned amortization classes,
accrual bonds and CMO residuals. These newer structures affect
the amount and timing of principal and interest received by each
tranche from the underlying collateral. Under certain of these
new structures, given classes of CMOs have priority over others
PAGE 13
with respect to the receipt of prepayments on the mortgages.
Therefore, depending on the type of CMOs in which the Fund
invests, the investment may be subject to a greater or lesser
risk of prepayment than other types of mortgage-related
securities.
The primary risk of any mortgage security is the uncertainty
of the timing of cash flows. For CMOs, the primary risk results
from the rate of prepayments on the underlying mortgages serving
as collateral. An increase or decrease in prepayment rates
(resulting from a decrease or increase in mortgage interest
rates) will affect the yield, average life and price of CMOs.
The prices of certain CMOs, depending on their structure and the
rate of prepayments, can be volatile. Some CMOs may also not be
as liquid as other securities.
U.S. Government Agency Multiclass Pass-Through Securities.
Unlike CMOs, U.S. Government Agency Multiclass Pass-Through
Securities, which include FNMA Guaranteed REMIC Pass-Through
Certificates and FHLMC Multi-Class Mortgage Participation
Certificates, are ownership interests in a pool of Mortgage
Assets. Unless the context indicates otherwise, all references
herein to CMOs include multiclass pass-through securities.
Multi-Class Residential Mortgage Securities. Such
securities represent interests in pools of mortgage loans to
residential home buyers made by commercial banks, savings and
loan associations or other financial institutions. Unlike GNMA,
FNMA and FHLMC securities, the payment of principal and interest
on Multi-Class Residential Mortgage Securities is not guaranteed
by the U.S. Government or any of its agencies. Accordingly,
yields on Multi-Class Residential Mortgage Securities have been
historically higher than the yields on U.S. government mortgage
securities. However, the risk of loss due to default on such
instruments is higher since they are not guaranteed by the U.S.
Government or its agencies. Additionally, pools of such
securities may be divided into senior or subordinated segments.
Although subordinated mortgage securities may have a higher yield
than senior mortgage securities, the risk of loss of principal is
greater because losses on the underlying mortgage loans must be
borne by persons holding subordinated securities before those
holding senior mortgage securities.
Privately-Issued Mortgage-Backed Certificates. The Fund may
also invest in pass-through certificates issued by non-
governmental issuers. Pools of conventional residential mortgage
PAGE 14
loans created by such issuers generally offer a higher rate of
interest than government and government-related pools because
there are no direct or indirect government guarantees of payment.
Timely payment of interest and principal of these pools is,
however, generally supported by various forms of insurance or
guarantees, including individual loan, title, pool and hazard
insurance. The insurance and guarantees are issued by government
entities, private insurance or the mortgage poolers. Such
insurance and guarantees and the creditworthiness of the issuers
thereof will be considered in determining whether a mortgage-
related security meets the Fund's quality standards. The Fund
may buy mortgage-related securities without insurance or
guarantees if through an examination of the loan experience and
practices of the poolers, the investment manager determines that
the securities meet the Fund's quality standards.
The Fund expects that governmental, government-related or
private entities may create mortgage loan pools offering pass-
through investments in addition to those described above. The
mortgages underlying these securities may be alternative mortgage
instruments, that is, mortgage instruments whose principal or
interest payments may vary or whose terms to maturity may differ
from customary long-term fixed rate mortgages. As new types of
mortgage-related securities are developed and offered to
investors, the investment manager will, consistent with the
Fund's objective, policies and quality standards, consider making
investments in such new types of securities.
Adjustable Rate Mortgage Securities ("ARMs"). ARMs, like
fixed rate mortgages, have a specified maturity date, and the
principal amount of the mortgage is repaid over the life of the
mortgage. Unlike fixed rate mortgages, the interest rate on ARMs
is adjusted at regular intervals based on a specified, published
interest rate "index" such as a Treasury rate index. The new
rate is determined by adding a specific interest amount, the
"margin," to the interest rate of the index. Investment in ARM
securities allows the Fund to participate in changing interest
rate levels through regular adjustments in the coupons of the
underlying mortgages, resulting in more variable current income
and lower price volatility than longer term fixed rate mortgage
securities. The ARM securities in which the Fund expects to
invest will generally adjust their interest rates at regular
intervals of one year or less. ARM securities are a less
effective means of locking in long-term rates than fixed rate
mortgages since the income from adjustable rate mortgages will
PAGE 15
increase during periods of rising interest rates and decline
during periods of falling rates.
Characteristics of Adjustable Rate Mortgage Securities. The
interest rates paid on the mortgages underlying ARM securities
are reset at regular intervals by adding an interest rate margin
to a specified interest rate index. There are three main
categories of indices: those based on U.S. Treasury securities
such as the constant maturity treasury rate (CMT); those derived
from a calculated measure such as a cost of funds index (COFI) or
a moving average of mortgage rates; and those based on certain
actively traded or prominent short-term rates such as the LIBOR.
Some indices, such as the one-year constant maturity Treasury
rate, closely mirror changes in interest rate levels. Others,
such as COFI tend to lag behind changes in market rate levels but
reset monthly thus tending to be somewhat less volatile. Such a
delay in adjusting to changes in interest rates may cause
securities owned by the Fund to increase or decrease in value,
particularly during periods between interest adjustment dates.
ARMs will frequently have caps and floors which limit the
maximum amount by which the interest rate to the residential
borrower may move up or down, respectively, each adjustment
period and over the life of the loan. Interest rate caps on ARM
securities may cause them to decrease in value in an increasing
interest rate environment. Such caps may also prevent their
income from increasing to levels commensurate with prevailing
interest rates. Conversely, interest rate floors on ARM
securities may cause their income to remain higher than
prevailing interest rate levels and result in an increase in the
value of such securities. However, this increase may be tempered
by the acceleration of prepayments.
Mortgage securities generally have a maximum maturity of up
to 30 years. However, due to the adjustable rate feature of ARM
securities, their prices are considered to have volatility
characteristics which approximate the average period of time
until the next adjustment of the interest rate. As a result, the
principal volatility of ARM securities may be more comparable to
short- and intermediate-term securities than to longer term fixed
rate mortgage securities. Prepayments however, will increase
their principal volatility. See also the discussion of Mortgage-
Backed Securities on page 6.
Asset-Backed Securities
PAGE 16
The Fund may invest up to 50% of its total assets in debt
obligations known as asset-backed securities.
The credit quality of most asset-backed securities depends
primarily on the credit quality of the assets underlying such
securities, how well the entity issuing the security is insulated
from the credit risk of the originator or any other affiliated
entities and the amount and quality of any credit support
provided to the securities. The rate of principal payment on
asset-backed securities generally depends on the rate of
principal payments received on the underlying assets which in
turn may be affected by a variety of economic and other factors.
As a result, the yield on any asset-backed security is difficult
to predict with precision and actual yield to maturity may be
more or less than the anticipated yield to maturity. Asset-
backed securities may be classified as pass-through certificates
or collateralized obligations.
Pass-through certificates are asset-backed securities which
represent an undivided fractional ownership interest in an
underlying pool of assets. Pass-through certificates usually
provide for payments of principal and interest received to be
passed through to their holders, usually after deduction for
certain costs and expenses incurred in administering the pool.
Because pass-through certificates represent an ownership interest
in the underlying assets, the holders thereof bear directly the
risk of any defaults by the obligors on the underlying assets not
covered by any credit support. See "Types of Credit Support".
Asset-backed securities issued in the form of debt
instruments, also known as collateralized obligations, are
generally issued as the debt of a special purpose entity
organized solely for the purpose of owning such assets and
issuing such debt. Such assets are most often trade, credit card
or automobile receivables. The assets collateralizing such
asset-backed securities are pledged to a trustee or custodian for
the benefit of the holders thereof. Such issuers generally hold
no assets other than those underlying the asset-backed securities
and any credit support provided. As a result, although payments
on such asset-backed securities are obligations of the issuers,
in the event of defaults on the underlying assets not covered by
any credit support (see "Types of Credit Support"), the issuing
entities are unlikely to have sufficient assets to satisfy their
obligations on the related asset-backed securities.
Methods of Allocating Cash Flows. While many asset-backed
PAGE 17
securities are issued with only one class of security, many
asset-backed securities are issued in more than one class, each
with different payment terms. Multiple class asset-backed
securities are issued for two main reasons. First, multiple
classes may be used as a method of providing credit support.
This is accomplished typically through creation of one or more
classes whose right to payments on the asset-backed security is
made subordinate to the right to such payments of the remaining
class or classes. See "Types of Credit Support". Second,
multiple classes may permit the issuance of securities with
payment terms, interest rates or other characteristics differing
both from those of each other and from those of the underlying
assets. Examples include so-called "strips" (asset-backed
securities entitling the holder to disproportionate interests
with respect to the allocation of interest and principal of the
assets backing the security), and securities with class or
classes having characteristics which mimic the characteristics of
non-asset-backed securities, such as floating interest rates
(i.e., interest rates which adjust as a specified benchmark
changes) or scheduled amortization of principal.
Asset-backed securities in which the payment streams on the
underlying assets are allocated in a manner different than those
described above may be issued in the future. The Fund may invest
in such asset-backed securities if such investment is otherwise
consistent with its investment objectives and policies and with
the investment restrictions of the Fund.
Types of Credit Support. Asset-backed securities are often
backed by a pool of assets representing the obligations of a
number of different parties. To lessen the effect of failures by
obligors on underlying assets to make payments, such securities
may contain elements of credit support. Such credit support
falls into two classes: liquidity protection and protection
against ultimate default by an obligor on the underlying assets.
Liquidity protection refers to the provision of advances,
generally by the entity administering the pool of assets, to
ensure that scheduled payments on the underlying pool are made in
a timely fashion. Protection against ultimate default ensures
ultimate payment of the obligations on at least a portion of the
assets in the pool. Such protection may be provided through
guarantees, insurance policies or letters of credit obtained from
third parties, through various means of structuring the
transaction or through a combination of such approaches.
Examples of asset-backed securities with credit support arising
out of the structure of the transaction include "senior-
PAGE 18
subordinated securities" (multiple class asset-backed securities
with certain classes subordinate to other classes as to the
payment of principal thereon, with the result that defaults on
the underlying assets are borne first by the holders of the
subordinated class) and asset-backed securities that have
"reserve funds" (where cash or investments, sometimes funded from
a portion of the initial payments on the underlying assets, are
held in reserve against future losses) or that have been "over
collateralized" (where the scheduled payments on, or the
principal amount of, the underlying assets substantially exceeds
that required to make payment of the asset-backed securities and
pay any servicing or other fees). The degree of credit support
provided on each issue is based generally on historical
information respecting the level of credit risk associated with
such payments. Delinquency or loss in excess of that anticipated
could adversely affect the return on an investment in an asset-
backed security.
Automobile Receivable Securities. The Fund may invest in
Asset Backed Securities which are backed by receivables from
motor vehicle installment sales contracts or installment loans
secured by motor vehicles ("Automobile Receivable Securities").
Since installment sales contracts for motor vehicles or
installment loans related thereto ("Automobile Contracts")
typically have shorter durations and lower incidences of
prepayment, Automobile Receivable Securities generally will
exhibit a shorter average life and are less susceptible to
prepayment risk.
Most entities that issue Automobile Receivable Securities
create an enforceable interest in their respective Automobile
Contracts only by filing a financing statement and by having the
servicer of the Automobile Contracts, which is usually the
originator of the Automobile Contracts, take custody thereof. In
such circumstances, if the servicer of the Automobile Contracts
were to sell the same Automobile Contracts to another party, in
violation of its obligation not to do so, there is a risk that
such party could acquire an interest in the Automobile Contracts
superior to that of the holders of Automobile Receivable
Securities. Also although most Automobile Contracts grant a
security interest in the motor vehicle being financed, in most
states the security interest in a motor vehicle must be noted on
the certificate of title to create an enforceable security
interest against competing claims of other parties. Due to the
large number of vehicles involved, however, the certificate of
title to each vehicle financed, pursuant to the Automobile
Contracts underlying the Automobile Receivable Security, usually
PAGE 19
is not amended to reflect the assignment of the seller's security
interest for the benefit of the holders of the Automobile
Receivable Securities. Therefore, there is the possibility that
recoveries on repossessed collateral may not, in some cases, be
available to support payments on the securities. In addition,
various state and federal securities laws give the motor vehicle
owner the right to assert against the holder of the owner's
Automobile Contract certain defenses such owner would have
against the seller of the motor vehicle. The assertion of such
defenses could reduce payments on the Automobile Receivable
Securities.
Credit Card Receivable Securities. The Fund may invest in
Asset Backed Securities backed by receivables from revolving
credit card agreements ("Credit Card Receivable Securities").
Credit balances on revolving credit card agreements ("Accounts")
are generally paid down more rapidly than are Automobile
Contracts. Most of the Credit Card Receivable Securities issued
publicly to date have been Pass-Through Certificates. In order
to lengthen the maturity of Credit Card Receivable Securities,
most such securities provide for a fixed period during which only
interest payments on the underlying Accounts are passed through
to the security holder and principal payments received on such
Accounts are used to fund the transfer to the pool of assets
supporting the related Credit Card Receivable Securities of
additional credit card charges made on an Account. The initial
fixed period usually may be shortened upon the occurrence of
specified events which signal a potential deterioration in the
quality of the assets backing the security, such as the
imposition of a cap on interest rates. The ability of the issuer
to extend the life of an issue of Credit Card Receivable
Securities thus depends upon the continued generation of
additional principal amounts in the underlying accounts during
the initial period and the non-occurrence of specified events.
An acceleration in cardholders' payment rates or any other event
which shortens the period during which additional credit card
charges on an Account may be transferred to the pool of assets
supporting the related Credit Card Receivable Security could
shorten the weighted average life and yield of the Credit Card
Receivable Security.
Credit cardholders are entitled to the protection of a
number of state and federal consumer credit laws, many of which
give such holder the right to set off certain amounts against
balances owed on the credit card, thereby reducing amounts paid
on Accounts. In addition, unlike most other Asset Backed
PAGE 20
Securities, Accounts are unsecured obligations of the cardholder.
Other Assets. T. Rowe Price anticipates that Asset Backed
Securities backed by assets other than those described above will
be issued in the future. The Fund may invest in such securities
in the future if such investment is otherwise consistent with its
investment objective and policies.
When-Issued Securities and Forward Commitment Contracts
The Fund may purchase securities on a "when-issued" or
delayed delivery basis ("When-Issueds") and may purchase
securities on a forward commitment basis ("Forwards"). The Fund
may invest without limitation in When-Issueds and Forwards. The
price of such securities, which may be expressed in yield terms,
is fixed at the time the commitment to purchase is made, but
delivery and payment take place at a later date. Normally, the
settlement date occurs within 90 days of the purchase for When-
Issueds, but may be substantially longer for Forwards. During
the period between purchase and settlement, no payment is made by
the Fund to the issuer and no interest accrues to the Fund. The
purchase of these securities will result in a loss if their value
declines prior to the settlement date. This could occur, for
example, if interest rates increase prior to settlement. The
longer the period between purchase and settlement, the greater
the risks are. At the time the Fund makes the commitment to
purchase these securities, it will record the transaction and
relfect the value of the security in determining its net asset
value. The Fund will cover these securities by maintaining cash
and/or liquid, high-grade debt securities with its custodian bank
equal in value to commitments for them during the time between
the purchase and the settlement. Therefore, the longer this
period, the longer the period during which alternative investment
options are not available to the Fund (to the extent of the
securities used for cover). Such securities either will mature
or, if necessary, be sold on or before the settlement date.
To the extent the Fund remains fully or almost fully
invested (in securities with a remaining maturity of more than
one year) at the same time it purchases these securities, there
will be greater fluctuations in the Fund's net asset value than
if the Fund did not purchase them.
Hybrid Instruments
The Fund may invest up to 10% of its total assets in hybrid
PAGE 21
instruments.
Hybrid Instruments have recently been developed and combine
the elements of futures contracts or options with those of debt,
preferred equity or a depository instrument (hereinafter "Hybrid
Instruments"). Often these Hybrid Instruments are indexed to the
price of a commodity, particular currency, or a domestic or
foreign debt or equity securities index. Hybrid Instruments may
take a variety of forms, including, but not limited to, debt
instruments with interest or principal payments or redemption
terms determined by reference to the value of a currency or
commodity or securities index at a future point in time,
preferred stock with dividend rates determined by reference to
the value of a currency, or convertible securities with the
conversion terms related to a particular commodity.
The risks of investing in Hybrid Instruments reflect a
combination of the risks from investing in securities, options,
futures and currencies, including volatility and lack of
liquidity. Reference is made to the discussion of futures,
options, and forward contracts herein for a discussion of these
risks. Further, the prices of the Hybrid Instrument and the
related commodity or currency may not move in the same direction
or at the same time. Hybrid Instruments may bear interest or pay
preferred dividends at below market (or even relatively nominal)
rates. Alternatively, Hybrid Instruments may bear interest at
above market rates but bear an increased risk of principal loss
(or gain). In addition, because the purchase and sale of Hybrid
Instruments could take place in an over-the-counter market or in
a private transaction between the Fund and the seller of the
Hybrid Instrument, the creditworthiness of the contra party to
the transaction would be a risk factor which the Fund would have
to consider. Hybrid Instruments also may not be subject to
regulation of the Commodities Futures Trading Commission
("CFTC"), which generally regulates the trading of commodity
futures by U.S. persons, the SEC, which regulates the offer and
sale of securities by and to U.S. persons, or any other
governmental regulatory authority.
Illiquid or Restricted Securities
Restricted securities may be sold only in privately
negotiated transactions or in a public offering with respect to
which a registration statement is in effect under the Securities
Act of 1933 (the "1933 Act"). Where registration is required,
the Fund may be obligated to pay all or part of the registration
PAGE 22
expenses and a considerable period may elapse between the time of
the decision to sell and the time the Fund may be permitted to
sell a security under an effective registration statement. If,
during such a period, adverse market conditions were to develop,
the Fund might obtain a less favorable price than prevailed when
it decided to sell. Restricted securities will be priced at fair
value as determined in accordance with procedures prescribed by
the Fund's Board of Directors. If through the appreciation of
illiquid securities or the depreciation of liquid securities, the
Fund should be in a position where more than 15% of the value of
its net assets are invested in illiquid assets, including
restricted securities, the Fund will take appropriate steps to
protect liquidity.
Notwithstanding the above, the Fund may purchase securities
which, while privately placed, are eligible for purchase and sale
under Rule 144A under the 1933 Act. This rule permits certain
qualified institutional buyers, such as the Fund, to trade in
privately placed securities even though such securities are not
registered under the 1933 Act. T. Rowe Price under the
supervision of the Fund's Board of Directors, will consider
whether securities purchased under Rule 144A are illiquid and
thus subject to the Fund's restriction of investing no more than
15% of its assets in illiquid securities. A determination of
whether a Rule 144A security is liquid or not is a question of
fact. In making this determination, T. Rowe Price will consider
the trading markets for the specific security taking into account
the unregistered nature of a Rule 144A security. In addition, T.
Rowe Price could consider the (1) frequency of trades and quotes,
(2) number of dealers and potential purchases, (3) dealer
undertakings to make a market, and (4) the nature of the security
and of marketplace trades (e.g., the time needed to dispose of
the security, the method of soliciting offers and the mechanics
of transfer). The liquidity of Rule 144A securities would be
monitored, and if as a result of changed conditions it is
determined that a Rule 144A security is no longer liquid, the
Fund's holdings of illiquid securities would be reviewed to
determine what, if any, steps are required to assure that the
Fund does not invest more than 15% of its assets in illiquid
securities. Investing in Rule 144A securities could have the
effect of increasing the amount of the Fund's assets invested in
illiquid securities if qualified institutional buyers are
unwilling to purchase such securities.
There are, of course, other types of securities that are, or
may become available, which are similar to the foregoing and the
PAGE 23
Fund may invest in these securities.
PORTFOLIO MANAGEMENT PRACTICES
Lending of Portfolio Securities
For the purpose of realizing additional income, the Fund may
make secured loans of portfolio securities amounting to not more
than 33 1/3% of its total assets. This policy is a fundamental
policy. Securities loans are made to broker-dealers or
institutional investors or other persons, pursuant to agreements
requiring that the loans be continuously secured by collateral at
least equal at all times to the value of the securities lent
marked to market on a daily basis. The collateral received will
consist of cash, U.S. government securities, letters of credit or
such other collateral as may be permitted under its investment
program. While the securities are being lent, the Fund will
continue to receive the equivalent of the interest or dividends
paid by the issuer on the securities, as well as interest on the
investment of the collateral or a fee from the borrower. The
Fund has a right to call each loan and obtain the securities on
five business days' notice or, in connection with securities
trading on foreign markets, within such longer period of time
which coincides with the normal settlement period for purchases
and sales of such securities in such foreign markets. The Fund
will not have the right to vote securities while they are being
lent, but it will call a loan in anticipation of any important
vote. The risks in lending portfolio securities, as with other
extensions of secured credit, consist of possible delay in
receiving additional collateral or in the recovery of the
securities or possible loss of rights in the collateral should
the borrower fail financially. Loans will only be made to firms
deemed by T. Rowe Price to be of good standing and will not be
made unless, in the judgment of T. Rowe Price, the consideration
to be earned from such loans would justify the risk.
Other Lending/Borrowing
Subject to approval by the Securities and Exchange
Commission and certain state regulatory agencies, the Fund may
make loans to, or borrow funds from, other mutual funds sponsored
or advised by T. Rowe Price or Price-Fleming (collectively,
"Price Funds"). The Fund has no current intention of engaging in
these practices at this time.
PAGE 24
Repurchase Agreements
The Fund may enter into a repurchase agreement through which
an investor (such as the Fund) purchases a security (known as the
"underlying security") from a well-established securities dealer
or a bank that is a member of the Federal Reserve System. Any
such dealer or bank will be on T. Rowe Price's approved list and
have a credit rating with respect to its short-term debt of at
least A1 by Standard & Poor's Corporation, P1 by Moody's
Investors Service, Inc., or the equivalent rating by T. Rowe
Price. At that time, the bank or securities dealer agrees to
repurchase the underlying security at the same price, plus
specified interest. Repurchase agreements are generally for a
short period of time, often less than a week. Repurchase
agreements which do not provide for payment within seven days
will be treated as illiquid securities. The Fund will only enter
into repurchase agreements where (i) the underlying securities
are of the type (excluding maturity limitations) which the Fund's
investment guidelines would allow it to purchase directly, (ii)
the market value of the underlying security, including interest
accrued, will be at all times equal to or exceed the value of the
repurchase agreement, and (iii) payment for the underlying
security is made only upon physical delivery or evidence of book-
entry transfer to the account of the custodian or a bank acting
as agent. In the event of a bankruptcy or other default of a
seller of a repurchase agreement, the Fund could experience both
delays in liquidating the underlying security and losses,
including: (a) possible decline in the value of the underlying
security during the period while the Fund seeks to enforce its
rights thereto; (b) possible subnormal levels of income and lack
of access to income during this period; and (c) expenses of
enforcing its rights.
Options
Writing Covered Call Options
The Fund may write (sell) "covered" call options and
purchase options to close out options previously written by a
Fund. In writing covered call options, the Fund expects to
generate additional premium income which should serve to enhance
the Fund's total return and reduce the effect of any price
decline of the security or currency involved in the option.
Covered call options will generally be written on securities or
currencies which, in T. Rowe Price's opinion, are not expected to
have any major price increases or moves in the near future but
PAGE 25
which, over the long term, are deemed to be attractive
investments for the Fund.
A call option gives the holder (buyer) the "right to
purchase" a security or currency at a specified price (the
exercise price) at expiration of the option (European style) or
at any time until a certain date (the expiration date) (American
style). So long as the obligation of the writer of a call option
continues, he may be assigned an exercise notice by the broker-
dealer through whom such option was sold, requiring him to
deliver the underlying security or currency against payment of
the exercise price. This obligation terminates upon the
expiration of the call option, or such earlier time at which the
writer effects a closing purchase transaction by repurchasing an
option identical to that previously sold. To secure his
obligation to deliver the underlying security or currency in the
case of a call option, a writer is required to deposit in escrow
the underlying security or currency or other assets in accordance
with the rules of a clearing corporation. The Fund will write
only covered call options. This means that the Fund will own the
security or currency subject to the option or an option to
purchase the same underlying security or currency, having an
exercise price equal to or less than the exercise price of the
"covered" option, or will establish and maintain with its
custodian for the term of the option, an account consisting of
cash, U.S. government securities or other liquid high-grade debt
obligations having a value equal to the fluctuating market value
of the optioned securities or currencies. In order to comply
with the requirements of several states, the Fund will not write
a covered call option if, as a result, the aggregate market value
of all portfolio securities or currencies covering call or put
options exceeds 25% of the market value of the Fund's net assets.
Should these state laws change or should the Fund obtain a waiver
of its application, the Fund reserves the right to increase this
percentage. In calculating the 25% limit, the Fund will offset,
against the value of assets covering written calls and puts, the
value of purchased calls and puts on identical securities or
currencies with identical maturity dates.
Portfolio securities or currencies on which call options may
be written will be purchased solely on the basis of investment
considerations consistent with the Fund's investment objective.
The writing of covered call options is a conservative investment
technique believed to involve relatively little risk (in contrast
to the writing of naked or uncovered options, which the Fund will
not do), but capable of enhancing the Fund's total return. When
PAGE 26
writing a covered call option, a Fund, in return for the premium,
gives up the opportunity for profit from a price increase in the
underlying security or currency above the exercise price, but
conversely retains the risk of loss should the price of the
security or currency decline. Unlike one who owns securities or
currencies not subject to an option, the Fund has no control over
when it may be required to sell the underlying securities or
currencies, since it may be assigned an exercise notice at any
time prior to the expiration of its obligation as a writer. If a
call option which the Fund has written expires, the Fund will
realize a gain in the amount of the premium; however, such gain
may be offset by a decline in the market value of the underlying
security or currency during the option period. If the call
option is exercised, the Fund will realize a gain or loss from
the sale of the underlying security or currency. The Fund does
not consider a security or currency covered by a call to be
"pledged" as that term is used in the Fund's policy which limits
the pledging or mortgaging of its assets.
The premium received is the market value of an option. The
premium the Fund will receive from writing a call option will
reflect, among other things, the current market price of the
underlying security or currency, the relationship of the exercise
price to such market price, the historical price volatility of
the underlying security or currency, and the length of the option
period. Once the decision to write a call option has been made,
T. Rowe Price, in determining whether a particular call option
should be written on a particular security or currency, will
consider the reasonableness of the anticipated premium and the
likelihood that a liquid secondary market will exist for those
options. The premium received by the Fund for writing covered
call options will be recorded as a liability of the Fund. This
liability will be adjusted daily to the option's current market
value, which will be the latest sale price at the time at which
the net asset value per share of the Fund is computed (close of
the New York Stock Exchange), or, in the absence of such sale,
the latest asked price. The option will be terminated upon
expiration of the option, the purchase of an identical option in
a closing transaction, or delivery of the underlying security or
currency upon the exercise of the option.
Closing transactions will be effected in order to realize a
profit on an outstanding call option, to prevent an underlying
security or currency from being called, or, to permit the sale of
the underlying security or currency. Furthermore, effecting a
closing transaction will permit the Fund to write another call
PAGE 27
option on the underlying security or currency with either a
different exercise price or expiration date or both. If the Fund
desires to sell a particular security or currency from its
portfolio on which it has written a call option, or purchased a
put option, it will seek to effect a closing transaction prior
to, or concurrently with, the sale of the security or currency.
There is, of course, no assurance that the Fund will be able to
effect such closing transactions at favorable prices. If the
Fund cannot enter into such a transaction, it may be required to
hold a security or currency that it might otherwise have sold.
When the Fund writes a covered call option, it runs the risk of
not being able to participate in the appreciation of the
underlying securities or currencies above the exercise price, as
well as the risk of being required to hold on to securities or
currencies that are depreciating in value. This could result in
higher transaction costs. The Fund will pay transaction costs in
connection with the writing of options to close out previously
written options. Such transaction costs are normally higher than
those applicable to purchases and sales of portfolio securities.
Call options written by the Fund will normally have
expiration dates of less than nine months from the date written.
The exercise price of the options may be below, equal to, or
above the current market values of the underlying securities or
currencies at the time the options are written. From time to
time, the Fund may purchase an underlying security or currency
for delivery in accordance with an exercise notice of a call
option assigned to it, rather than delivering such security or
currency from its portfolio. In such cases, additional costs may
be incurred.
The Fund will realize a profit or loss from a closing
purchase transaction if the cost of the transaction is less or
more than the premium received from the writing of the option.
Because increases in the market price of a call option will
generally reflect increases in the market price of the underlying
security or currency, any loss resulting from the repurchase of a
call option is likely to be offset in whole or in part by
appreciation of the underlying security or currency owned by the
Fund.
Writing Covered Put Options
The Fund may write American or European style covered put
options and purchase options to close out options previously
PAGE 28
written by the Fund. A put option gives the purchaser of the
option the right to sell, and the writer (seller) has the
obligation to buy, the underlying security or currency at the
exercise price during the option period (American style) or at
the expiration of the option (European style). So long as the
obligation of the writer continues, he may be assigned an
exercise notice by the broker-dealer through whom such option was
sold, requiring him to make payment of the exercise price against
delivery of the underlying security or currency. The operation
of put options in other respects, including their related risks
and rewards, is substantially identical to that of call options.
The Fund would write put options only on a covered basis,
which means that the Fund would maintain in a segregated account
cash, U.S. government securities or other liquid high-grade debt
obligations in an amount not less than the exercise price or the
Fund will own an option to sell the underlying security or
currency subject to the option having an exercise price equal to
or greater than the exercise price of the "covered" option at all
times while the put option is outstanding. (The rules of a
clearing corporation currently require that such assets be
deposited in escrow to secure payment of the exercise price.)
The Fund would generally write covered put options in
circumstances where T. Rowe Price wishes to purchase the
underlying security or currency for the Fund's portfolio at a
price lower than the current market price of the security or
currency. In such event the Fund would write a put option at an
exercise price which, reduced by the premium received on the
option, reflects the lower price it is willing to pay. Since the
Fund would also receive interest on debt securities or currencies
maintained to cover the exercise price of the option, this
technique could be used to enhance current return during periods
of market uncertainty. The risk in such a transaction would be
that the market price of the underlying security or currency
would decline below the exercise price less the premiums
received. Such a decline could be substantial and result in a
significant loss to the Fund. In addition, the Fund, because it
does not own the specific securities or currencies which it may
be required to purchase in exercise of the put, cannot benefit
from appreciation, if any, with respect to such specific
securities or currencies. In order to comply with the
requirements of several states, the Fund will not write a covered
put option if, as a result, the aggregate market value of all
portfolio securities or currencies covering put or call options
exceeds 25% of the market value of the Fund's net assets. Should
these state laws change or should the Fund obtain a waiver of its
PAGE 29
application, the Fund reserves the right to increase this
percentage. In calculating the 25% limit, the Fund will offset,
against the value of assets covering written puts and calls, the
value of purchased puts and calls on identical securities or
currencies with identical maturity dates.
Purchasing Put Options
The Fund may purchase American or European style put
options. As the holder of a put option, the Fund has the right
to sell the underlying security or currency at the exercise price
at any time during the option period (American style) or at the
expiration of the option (European style). The Fund may enter
into closing sale transactions with respect to such options,
exercise them or permit them to expire. The Fund may purchase
put options for defensive purposes in order to protect against an
anticipated decline in the value of its securities or currencies.
An example of such use of put options is provided below.
The Fund may purchase a put option on an underlying security
or currency (a "protective put") owned by the Fund as a defensive
technique in order to protect against an anticipated decline in
the value of the security or currency. Such hedge protection is
provided only during the life of the put option when the Fund, as
the holder of the put option, is able to sell the underlying
security or currency at the put exercise price regardless of any
decline in the underlying security's market price or currency's
exchange value. For example, a put option may be purchased in
order to protect unrealized appreciation of a security or
currency where T. Rowe Price deems it desirable to continue to
hold the security or currency because of tax considerations. The
premium paid for the put option and any transaction costs would
reduce any capital gain otherwise available for distribution when
the security or currency is eventually sold.
The Fund may also purchase put options at a time when the
Fund does not own the underlying security or currency. By
purchasing put options on a security or currency it does not own,
the Fund seeks to benefit from a decline in the market price of
the underlying security or currency. If the put option is not
sold when it has remaining value, and if the market price of the
underlying security or currency remains equal to or greater than
the exercise price during the life of the put option, the Fund
will lose its entire investment in the put option. In order for
the purchase of a put option to be profitable, the market price
PAGE 30
of the underlying security or currency must decline sufficiently
below the exercise price to cover the premium and transaction
costs, unless the put option is sold in a closing sale
transaction.
To the extent required by the laws of certain states, the
Fund may not be permitted to commit more than 5% of its assets to
premiums when purchasing put and call options. Should these
state laws change or should the Fund obtain a waiver of its
application, the Fund may commit more than 5% of its assets to
premiums when purchasing call and put options. The premium paid
by the Fund when purchasing a put option will be recorded as an
asset of the Fund. This asset will be adjusted daily to the
option's current market value, which will be the latest sale
price at the time at which the net asset value per share of the
Fund is computed (close of New York Stock Exchange), or, in the
absence of such sale, the latest bid price. This asset will be
terminated upon expiration of the option, the selling (writing)
of an identical option in a closing transaction, or the delivery
of the underlying security or currency upon the exercise of the
option.
Purchasing Call Options
The Fund may purchase American or European style call
options. As the holder of a call option, the Fund has the right
to purchase the underlying security or currency at the exercise
price at any time during the option period (American style) or at
the expiration of the option (European style). The Fund may
enter into closing sale transactions with respect to such
options, exercise them or permit them to expire. The Fund may
purchase call options for the purpose of increasing its current
return or avoiding tax consequences which could reduce its
current return. The Fund may also purchase call options in order
to acquire the underlying securities or currencies. Examples of
such uses of call options are provided below.
Call options may be purchased by the Fund for the purpose of
acquiring the underlying securities or currencies for its
portfolio. Utilized in this fashion, the purchase of call
options enables the Fund to acquire the securities or currencies
at the exercise price of the call option plus the premium paid.
At times the net cost of acquiring securities or currencies in
this manner may be less than the cost of acquiring the securities
or currencies directly. This technique may also be useful to the
Fund in purchasing a large block of securities or currencies that
PAGE 31
would be more difficult to acquire by direct market purchases.
So long as it holds such a call option rather than the underlying
security or currency itself, the Fund is partially protected from
any unexpected decline in the market price of the underlying
security or currency and in such event could allow the call
option to expire, incurring a loss only to the extent of the
premium paid for the option.
To the extent required by the laws of certain states, the
Fund may not be permitted to commit more than 5% of its assets to
premiums when purchasing call and put options. Should these
state laws change or should the Fund obtain a waiver of its
application, the Fund may commit more than 5% of its assets to
premiums when purchasing call and put options. The Fund may also
purchase call options on underlying securities or currencies it
owns in order to protect unrealized gains on call options
previously written by it. A call option would be purchased for
this purpose where tax considerations make it inadvisable to
realize such gains through a closing purchase transaction. Call
options may also be purchased at times to avoid realizing losses.
Dealer (Over-the-Counter) Options
The Fund may engage in transactions involving dealer
options. Certain risks are specific to dealer options. While
the Fund would look to a clearing corporation to exercise
exchange-traded options, if the Fund were to purchase a dealer
option, it would rely on the dealer from whom it purchased the
option to perform if the option were exercised. Failure by the
dealer to do so would result in the loss of the premium paid by
the Fund as well as loss of the expected benefit of the
transaction.
Exchange-traded options generally have a continuous liquid
market while dealer options have none. Consequently, the Fund
will generally be able to realize the value of a dealer option it
has purchased only by exercising it or reselling it to the dealer
who issued it. Similarly, when the Fund writes a dealer option,
it generally will be able to close out the option prior to its
expiration only by entering into a closing purchase transaction
with the dealer to which the Fund originally wrote the option.
While the Fund will seek to enter into dealer options only with
dealers who will agree to and which are expected to be capable of
entering into closing transactions with the Fund, there can be no
assurance that the Fund will be able to liquidate a dealer option
PAGE 32
at a favorable price at any time prior to expiration. Until the
Fund, as a covered dealer call option writer, is able to effect a
closing purchase transaction, it will not be able to liquidate
securities (or other assets) or currencies used as cover until
the option expires or is exercised. In the event of insolvency
of the contra party, the Fund may be unable to liquidate a dealer
option. With respect to options written by the Fund, the
inability to enter into a closing transaction may result in
material losses to the Fund. For example, since the Fund must
maintain a secured position with respect to any call option on a
security it writes, the Fund may not sell the assets which it has
segregated to secure the position while it is obligated under the
option. This requirement may impair a Fund's ability to sell
portfolio securities or currencies at a time when such sale might
be advantageous.
The Staff of the SEC has taken the position that purchased
dealer options and the assets used to secure the written dealer
options are illiquid securities. The Fund may treat the cover
used for written OTC options as liquid if the dealer agrees that
the Fund may repurchase the OTC option it has written for a
maximum price to be calculated by a predetermined formula. In
such cases, the OTC option would be considered illiquid only to
the extent the maximum repurchase price under the formula exceeds
the intrinsic value of the option. Accordingly, the Fund will
treat dealer options as subject to the Fund's limitation on
unmarketable securities. If the SEC changes its position on the
liquidity of dealer options, the Fund will change its treatment
of such instrument accordingly.
Futures Contracts
Transactions in Futures
The Fund may enter into financial futures contracts,
including stock index, interest rate and currency futures
("futures or futures contracts").
Stock index futures contracts may be used to provide a hedge
for a portion of the Fund's portfolio, as a cash management tool,
or as an efficient way for T. Rowe Price to implement either an
increase or decrease in portfolio market exposure in response to
changing market conditions. Stock index futures contracts are
currently traded with respect to the S&P 500 Index and other
broad stock market indices, such as the New York Stock Exchange
PAGE 33
Composite Stock Index and the Value Line Composite Stock Index.
The Fund may, however, purchase or sell futures contracts with
respect to any stock index. Nevertheless, to hedge the Fund's
portfolio successfully, the Fund must sell futures contacts with
respect to indices or subindices whose movements will have a
significant correlation with movements in the prices of the
Fund's portfolio securities.
Interest rate or currency futures contracts may be used as a
hedge against changes in prevailing levels of interest rates or
currency exchange rates in order to establish more definitely the
effective return on securities or currencies held or intended to
be acquired by the Fund. In this regard, the Fund could sell
interest rate or currency futures as an offset against the effect
of expected increases in interest rates or currency exchange
rates and purchase such futures as an offset against the effect
of expected declines in interest rates or currency exchange
rates.
The Fund will enter into futures contracts which are traded
on national or foreign futures exchanges, and are standardized as
to maturity date and underlying financial instrument. The
principal futures exchanges in the United States are the Board of
Trade of the City of Chicago, the Chicago Mercantile Exchange,
the New York Futures Exchange, and the Kansas City Board of
Trade. Futures exchanges and trading in the United States are
regulated under the Commodity Exchange Act by the Commodity
Futures Trading Commission ("CFTC"). Futures are traded in
London at the London International Financial Futures Exchange in
Paris at the MATIF and in Tokyo at the Tokyo Stock Exchange.
Although techniques other than the sale and purchase of futures
contracts could be used for the above-referenced purposes,
futures contracts offer an effective and relatively low cost
means of implementing the Fund's objectives in these areas.
Regulatory Limitations
The Fund will engage in futures contracts and options
thereon only for bona fide hedging, yield enhancement, and risk
management purposes, in each case in accordance with rules and
regulations of the CFTC, and not for speculation.
The Fund may not enter into futures contracts or options
thereon if, with respect to positions which do not qualify as
bona fide hedging under applicable CFTC rules, the sum of the
PAGE 34
amounts of initial margin deposits on the Fund's existing futures
and premiums paid for options on futures would exceed 5% of the
net asset value of the Fund after taking into account unrealized
profits and unrealized losses on any such contracts it has
entered into; provided, however, that in the case of an option
that is in-the-money at the time of purchase, the in-the-money
amount may be excluded in calculating the 5% limitation.
The Fund's use of futures contracts will not result in
leverage. Therefore, to the extent necessary, in instances
involving the purchase of futures contracts or call options
thereon or the writing of put options thereon by the Fund, an
amount of cash, U.S. government securities or other liquid, high-
grade debt obligations, equal to the market value of the futures
contracts and options thereon (less any related margin deposits),
will be identified in an account with the Fund's custodian to
cover the position, or alternative cover will be employed.
In addition, CFTC regulations may impose limitations on the
Fund's ability to engage in certain risk management strategies.
If the CFTC or other regulatory authorities adopt different
(including less stringent) or additional restrictions, the Fund
would comply with such new restrictions.
Trading in Futures Contracts
A futures contract provides for the future sale by one party
and purchase by another party of a specified amount of a specific
financial instrument (e.g., units of a debt security) for a
specified price, date, time and place designated at the time the
contract is made. Brokerage fees are incurred when a futures
contract is bought or sold and margin deposits must be
maintained. Entering into a contract to buy is commonly referred
to as buying or purchasing a contract or holding a long position.
Entering into a contract to sell is commonly referred to as
selling a contract or holding a short position.
Unlike when the Fund purchases or sells a security, no price
would be paid or received by the Fund upon the purchase or sale
of a futures contract. Upon entering into a futures contract,
and to maintain the Fund's open positions in futures contracts,
the Fund would be required to deposit with its custodian in a
segregated account in the name of the futures broker an amount of
cash, U.S. government securities, suitable money market
instruments, or liquid, high-grade debt securities, known as
"initial margin." The margin required for a particular futures
PAGE 35
contract is set by the exchange on which the contract is traded,
and may be significantly modified from time to time by the
exchange during the term of the contract. Futures contracts are
customarily purchased and sold on margins that may range upward
from less than 5% of the value of the contract being traded.
If the price of an open futures contract changes (by
increase in the case of a sale or by decrease in the case of a
purchase) so that the loss on the futures contract reaches a
point at which the margin on deposit does not satisfy margin
requirements, the broker will require an increase in the margin.
However, if the value of a position increases because of
favorable price changes in the futures contract so that the
margin deposit exceeds the required margin, the broker will pay
the excess to the Fund.
These subsequent payments, called "variation margin," to and
from the futures broker, are made on a daily basis as the price
of the underlying assets fluctuate making the long and short
positions in the futures contract more or less valuable, a
process known as "marking to the market." The Fund expects to
earn interest income on its margin deposits.
Although certain futures contracts, by their terms, require
actual future delivery of and payment for the underlying
instruments in practice most futures contracts are usually closed
out before the delivery date. Closing out an open futures
contract purchase or sale is effected by entering into an
offsetting futures contract purchase or sale, respectively, for
the same aggregate amount of the identical securities and the
same delivery date. If the offsetting purchase price is less
than the original sale price, the Fund realizes a gain; if it is
more, the Fund realizes a loss. Conversely, if the offsetting
sale price is more than the original purchase price, the Fund
realizes a gain; if it is less, the Fund realizes a loss. The
transaction costs must also be included in these calculations.
There can be no assurance, however, that the Fund will be able to
enter into an offsetting transaction with respect to a particular
futures contract at a particular time. If the Fund is not able
to enter into an offsetting transaction, the Fund will continue
to be required to maintain the margin deposits on the futures
contract.
For example, the Standard & Poor's 500 Stock Index is
composed of 500 selected common stocks, most of which are listed
on the New York Stock Exchange. The S&P 500 Index assigns
PAGE 36
relative weightings to the common stocks included in the Index,
and the Index fluctuates with changes in the market values of
those common stocks. In the case of the S&P 500 Index, contracts
are to buy or sell 500 units. Thus, if the value of the S&P 500
Index were $150, one contract would be worth $75,000 (500 units x
$150). The stock index futures contract specifies that no
delivery of the actual stock making up the index will take place.
Instead, settlement in cash occurs. Over the life of the
contract, the gain or loss realized by the Fund will equal the
difference between the purchase (or sale) price of the contract
and the price at which the contract is terminated. For example,
if the Fund enters into a futures contract to buy 500 units of
the S&P 500 Index at a specified future date at a contract price
of $150 and the S&P 500 Index is at $154 on that future date, the
Fund will gain $2,000 (500 units x gain of $4). If the Fund
enters into a futures contract to sell 500 units of the stock
index at a specified future date at a contract price of $150 and
the S&P 500 Index is at $152 on that future date, the Fund will
lose $1,000 (500 units x loss of $2).
Special Risks of Transactions in Futures Contracts
Volatility and Leverage. The prices of futures contracts
are volatile and are influenced, among other things, by actual
and anticipated changes in the market and interest rates, which
in turn are affected by fiscal and monetary policies and national
and international political and economic events.
Most United States futures exchanges limit the amount of
fluctuation permitted in futures contract prices during a single
trading day. The daily limit establishes the maximum amount that
the price of a futures contract may vary either up or down from
the previous day's settlement price at the end of a trading
session. Once the daily limit has been reached in a particular
type of futures contract, no trades may be made on that day at a
price beyond that limit. The daily limit governs only price
movement during a particular trading day and therefore does not
limit potential losses, because the limit may prevent the
liquidation of unfavorable positions. Futures contract prices
have occasionally moved to the daily limit for several
consecutive trading days with little or no trading, thereby
preventing prompt liquidation of futures positions and subjecting
some futures traders to substantial losses.
Because of the low margin deposits required, futures trading
involves an extremely high degree of leverage. As a result, a
PAGE 37
relatively small price movement in a futures contract may result
in immediate and substantial loss, as well as gain, to the
investor. For example, if at the time of purchase, 10% of the
value of the futures contract is deposited as margin, a
subsequent 10% decrease in the value of the futures contract
would result in a total loss of the margin deposit, before any
deduction for the transaction costs, if the account were then
closed out. A 15% decrease would result in a loss equal to 150%
of the original margin deposit, if the contract were closed out.
Thus, a purchase or sale of a futures contract may result in
losses in excess of the amount invested in the futures contract.
However, the Fund would presumably have sustained comparable
losses if, instead of the futures contract, it had invested in
the underlying financial instrument and sold it after the
decline. Furthermore, in the case of a futures contract
purchase, in order to be certain that the Fund has sufficient
assets to satisfy its obligations under a futures contract, the
Fund earmarks to the futures contract money market instruments
equal in value to the current value of the underlying instrument
less the margin deposit.
Liquidity. The Fund may elect to close some or all of its
futures positions at any time prior to their expiration. The
Fund would do so to reduce exposure represented by long futures
positions or increase exposure represented by short futures
positions. The Fund may close its positions by taking opposite
positions which would operate to terminate the Fund's position in
the futures contracts. Final determinations of variation margin
would then be made, additional cash would be required to be paid
by or released to the Fund, and the Fund would realize a loss or
a gain.
Futures contracts may be closed out only on the exchange or
board of trade where the contracts were initially traded.
Although the Fund intends to purchase or sell futures contracts
only on exchanges or boards of trade where there appears to be an
active market, there is no assurance that a liquid market on an
exchange or board of trade will exist for any particular contract
at any particular time. In such event, it might not be possible
to close a futures contract, and in the event of adverse price
movements, the Fund would continue to be required to make daily
cash payments of variation margin. However, in the event futures
contracts have been used to hedge the underlying instruments, the
Fund would continue to hold the underlying instruments subject to
the hedge until the futures contracts could be terminated. In
such circumstances, an increase in the price of underlying
PAGE 38
instruments, if any, might partially or completely offset losses
on the futures contract. However, as described below, there is
no guarantee that the price of the underlying instruments will,
in fact, correlate with the price movements in the futures
contract and thus provide an offset to losses on a futures
contract.
Hedging Risk. A decision of whether, when, and how to hedge
involves skill and judgment, and even a well-conceived hedge may
be unsuccessful to some degree because of unexpected market
behavior, market or interest rate trends. There are several
risks in connection with the use by the Fund of futures contracts
as a hedging device. One risk arises because of the imperfect
correlation between movements in the prices of the futures
contracts and movements in the prices of the underlying
instruments which are the subject of the hedge. T. Rowe Price
will, however, attempt to reduce this risk by entering into
futures contracts whose movements, in its judgment, will have a
significant correlation with movements in the prices of the
Fund's underlying instruments sought to be hedged.
Successful use of futures contracts by the Fund for hedging
purposes is also subject to T. Rowe Price's ability to correctly
predict movements in the direction of the market. It is possible
that, when the Fund has sold futures to hedge its portfolio
against a decline in the market, the index, indices, or
underlying instruments on which the futures are written might
advance and the value of the underlying instruments held in the
Fund's portfolio might decline. If this were to occur, the Fund
would lose money on the futures and also would experience a
decline in value in its underlying instruments. However, while
this might occur to a certain degree, T. Rowe Price believes that
over time the value of the Fund's portfolio will tend to move in
the same direction as the market indices which are intended to
correlate to the price movements of the underlying instruments
sought to be hedged. It is also possible that if the Fund were
to hedge against the possibility of a decline in the market
(adversely affecting the underlying instruments held in its
portfolio) and prices instead increased, the Fund would lose part
or all of the benefit of increased value of those underlying
instruments that it has hedged, because it would have offsetting
losses in its futures positions. In addition, in such
situations, if the Fund had insufficient cash, it might have to
sell underlying instruments to meet daily variation margin
requirements. Such sales of underlying instruments might be, but
would not necessarily be, at increased prices (which would
PAGE 39
reflect the rising market). The Fund might have to sell
underlying instruments at a time when it would be disadvantageous
to do so.
In addition to the possibility that there might be an
imperfect correlation, or no correlation at all, between price
movements in the futures contracts and the portion of the
portfolio being hedged, the price movements of futures contracts
might not correlate perfectly with price movements in the
underlying instruments due to certain market distortions. First,
all participants in the futures market are subject to margin
deposit and maintenance requirements. Rather than meeting
additional margin deposit requirements, investors might close
futures contracts through offsetting transactions which could
distort the normal relationship between the underlying
instruments and futures markets. Second, the margin requirements
in the futures market are less onerous than margin requirements
in the securities markets, and as a result the futures market
might attract more speculators than the securities markets do.
Increased participation by speculators in the futures market
might also cause temporary price distortions. Due to the
possibility of price distortion in the futures market and also
because of the imperfect correlation between price movements in
the underlying instruments and movements in the prices of futures
contracts, even a correct forecast of general market trends by T.
Rowe Price might not result in a successful hedging transaction
over a very short time period.
<PAGE>
PAGE 40
Options on Futures Contracts
Options on futures are similar to options on underlying
instruments except that options on futures give the purchaser the
right, in return for the premium paid, to assume a position in a
futures contract (a long position if the option is a call and a
short position if the option is a put), rather than to purchase
or sell the futures contract, at a specified exercise price at
any time during the period of the option. Upon exercise of the
option, the delivery of the futures position by the writer of the
option to the holder of the option will be accompanied by the
delivery of the accumulated balance in the writer's futures
margin account which represents the amount by which the market
price of the futures contract, at exercise, exceeds (in the case
of a call) or is less than (in the case of a put) the exercise
price of the option on the futures contract. Alternatively,
settlement may be made totally in cash. Purchasers of options
who fail to exercise their options prior to the exercise date
suffer a loss of the premium paid.
As an alternative to writing or purchasing call and put
options on stock index futures, the Fund may write or purchase
call and put options on stock indices. Such options would be
used in a manner similar to the use of options on futures
contracts. From time to time, a single order to purchase or sell
futures contracts (or options thereon) may be made on behalf of
the Fund and other T. Rowe Price Funds. Such aggregated orders
would be allocated among the Funds and the other T. Rowe Price
Funds in a fair and non-discriminatory manner.
Special Risks of Transactions in Options on Futures Contracts
The Fund may seek to close out an option position by writing
or buying an offsetting option covering the same index,
underlying instrument or contract and having the same exercise
price and expiration date. The ability to establish and close
out positions on such options will be subject to the maintenance
of a liquid secondary market. Reasons for the absence of a
liquid secondary market on an exchange include the following: (i)
there may be insufficient trading interest in certain options;
(ii) restrictions may be imposed by an exchange on opening
transactions or closing transactions or both; (iii) trading
halts, suspensions or other restrictions may be imposed with
respect to particular classes or series of options, or underlying
instruments; (iv) unusual or unforeseen circumstances may
interrupt normal operations on an exchange; (v) the facilities of
PAGE 41
an exchange or a clearing corporation may not at all times be
adequate to handle current trading volume; or (vi) one or more
exchanges could, for economic or other reasons, decide or be
compelled at some future date to discontinue the trading of
options (or a particular class or series of options), in which
event the secondary market on that exchange (or in the class or
series of options) would cease to exist, although outstanding
options on the exchange that had been issued by a clearing
corporation as a result of trades on that exchange would continue
to be exercisable in accordance with their terms. There is no
assurance that higher than anticipated trading activity or other
unforeseen events might not, at times, render certain of the
facilities of any of the clearing corporations inadequate, and
thereby result in the institution by an exchange of special
procedures which may interfere with the timely execution of
customers' orders.
Additional Futures and Options Contracts
Although the Fund has no current intention of engaging in
futures or options transactions other than those described above,
it reserves the right to do so. Such futures and options trading
might involve risks which differ from those involved in the
futures and options described above.
Foreign Futures and Options
Participation in foreign futures and foreign options
transactions involves the execution and clearing of trades on or
subject to the rules of a foreign board of trade. Neither the
National Futures Association nor any domestic exchange regulates
activities of any foreign boards of trade, including the
execution, delivery and clearing of transactions, or has the
power to compel enforcement of the rules of a foreign board of
trade or any applicable foreign law. This is true even if the
exchange is formally linked to a domestic market so that a
position taken on the market may be liquidated by a transaction
on another market. Moreover, such laws or regulations will vary
depending on the foreign country in which the foreign futures or
foreign options transaction occurs. For these reasons, customers
who trade foreign futures or foreign options contracts may not be
afforded certain of the protective measures provided by the
Commodity Exchange Act, the CFTC's regulations and the rules of
the National Futures Association and any domestic exchange,
PAGE 42
including the right to use reparations proceedings before the
Commission and arbitration proceedings provided by the National
Futures Association or any domestic futures exchange. In
particular, funds received from customers for foreign futures or
foreign options transactions may not be provided the same
protections as funds received in respect of transactions on
United States futures exchanges. In addition, the price of any
foreign futures or foreign options contract and, therefore, the
potential profit and loss thereon may be affected by any variance
in the foreign exchange rate between the time your order is
placed and the time it is liquidated, offset or exercised.
Foreign Currency Transactions
A forward foreign currency exchange contract involves an
obligation to purchase or sell a specific currency at a future
date, which may be any fixed number of days from the date of the
contract agreed upon by the parties, at a price set at the time
of the contract. These contracts are principally traded in the
interbank market conducted directly between currency traders
(usually large, commercial banks) and their customers. A forward
contract generally has no deposit requirement, and no commissions
are charged at any stage for trades.
The Fund may enter into forward contracts for a variety of
purposes in connection with the management of the foreign
securities portion of its portfolio. The Fund's use of such
contracts would include, but not be limited to, the following:
First, when the Fund enters into a contract for the purchase
or sale of a security denominated in a foreign currency, it may
desire to "lock in" the U.S. dollar price of the security. By
entering into a forward contract for the purchase or sale, for a
fixed amount of dollars, of the amount of foreign currency
involved in the underlying security transactions, the Fund will
be able to protect itself against a possible loss resulting from
an adverse change in the relationship between the U.S. dollar and
the subject foreign currency during the period between the date
the security is purchased or sold and the date on which payment
is made or received.
Second, when T. Rowe Price believes that one currency may
experience a substantial movement against another currency,
including the U.S. dollar, it may enter into a forward contract
to sell or buy the amount of the former foreign currency,
approximating the value of some or all of the Fund's portfolio
PAGE 43
securities denominated in such foreign currency. Alternatively,
where appropriate, the Fund may hedge all or part of its foreign
currency exposure through the use of a basket of currencies or a
proxy currency where such currency or currencies act as an
effective proxy for other currencies. In such a case, the Fund
may enter into a forward contract where the amount of the foreign
currency to be sold exceeds the value of the securities
denominated in such currency. The use of this basket hedging
technique may be more efficient and economical than entering into
separate forward contracts for each currency held in the Fund.
The precise matching of the forward contract amounts and the
value of the securities involved will not generally be possible
since the future value of such securities in foreign currencies
will change as a consequence of market movements in the value of
those securities between the date the forward contract is entered
into and the date it matures. The projection of short-term
currency market movement is extremely difficult, and the
successful execution of a short-term hedging strategy is highly
uncertain. T. Rowe Price does not intend to enter into such
forward contracts under this second circumstance if, as a result,
the Fund will have more than 30% of the value of its net assets
committed to the consummation of such contracts. Other than as
set forth above, and immediately below, the Fund will also not
enter into such forward contracts or maintain a net exposure to
such contracts where the consummation of the contracts would
obligate the Fund to deliver an amount of foreign currency in
excess of the value of the Fund's portfolio securities or other
assets denominated in that currency. The Fund, however, in order
to avoid excess transactions and transaction costs, may maintain
a net exposure to forward contracts in excess of the value of the
Fund's portfolio securities or other assets to which the forward
contracts relate (including accrued interest to the maturity of
the forwards on such securities provided the excess amount is
"covered" by liquid, high-grade debt securities, denominated in
any currency, at least equal at all times to the amount of such
excess. For these purposes "the securities or other assets to
which the forward contracts relate" may be securities or assets
denominated in a single currency, or where proxy forwards are
used, securities denominated in more than one currency). Under
normal circumstances, consideration of the prospect for currency
parities will be incorporated into the longer term investment
decisions made with regard to overall diversification strategies.
However, T. Rowe Price believes that it is important to have the
flexibility to enter into such forward contracts when it
determines that the best interests of the Fund will be served.
PAGE 44
Third, the Fund may use forward contracts when the Fund
wishes to hedge out of the dollar into a foreign currency in
order to create a synthetic bond or money market instrument --
the security would be issued in U.S. dollars but the dollar
component would be transformed into a foreign currency through a
forward contract.
At the maturity of a forward contract, the Fund may sell the
portfolio security and make delivery of the foreign currency, or
it may retain the security and either extend the maturity of the
forward contract (by "rolling" that contract forward) or may
initiate a new forward contract.
As indicated above, it is impossible to forecast with
absolute precision the market value of portfolio securities at
the expiration of the forward contract. Accordingly, it may be
necessary for the Fund to purchase additional foreign currency on
the spot market (and bear the expense of such purchase) if the
market value of the security is less than the amount of foreign
currency the Fund is obligated to deliver and if a decision is
made to sell the security and make delivery of the foreign
currency. Conversely, it may be necessary to sell on the spot
market some of the foreign currency received upon the sale of the
portfolio security if its market value exceeds the amount of
foreign currency the Fund is obligated to deliver. However, as
noted, in order to avoid excessive transactions and transaction
costs, the Fund may use liquid, high-grade debt securities
denominated in any currency, to cover the amount by which the
value of a forward contract exceeds the value of the securities
to which it relates.
If the Fund retains the portfolio security and engages in an
offsetting transaction, the Fund will incur a gain or a loss (as
described below) to the extent that there has been movement in
forward contract prices. If the Fund engages in an offsetting
transaction, it may subsequently enter into a new forward
contract to sell the foreign currency. Should forward prices
decline during the period between the Fund's entering into a
forward contract for the sale of a foreign currency and the date
it enters into an offsetting contract for the purchase of the
foreign currency, the Fund will realize a gain to the extent the
price of the currency it has agreed to sell exceeds the price of
the currency it has agreed to purchase. Should forward prices
increase, the Fund will suffer a loss to the extent of the price
of the currency it has agreed to purchase exceeds the price of
the currency it has agreed to sell.
PAGE 45
The Fund's dealing in forward foreign currency exchange
contracts will generally be limited to the transactions described
above. However, the Fund reserves the right to enter into
forward foreign currency contracts for different purposes and
under different circumstances. Of course, the Fund is not
required to enter into forward contracts with regard to its
foreign currency-denominated securities and will not do so unless
deemed appropriate by T. Rowe Price. It also should be realized
that this method of hedging against a decline in the value of a
currency does not eliminate fluctuations in the underlying prices
of the securities. It simply establishes a rate of exchange at a
future date. Additionally, although such contracts tend to
minimize the risk of loss due to a decline in the value of the
hedged currency, at the same time, they tend to limit any
potential gain which might result from an increase in the value
of that currency.
Although the Fund values its assets daily in terms of U.S.
dollars, it does not intend to convert its holdings of foreign
currencies into U.S. dollars on a daily basis. It will do so
from time to time, and investors should be aware of the costs of
currency conversion. Although foreign exchange dealers do not
charge a fee for conversion, they do realize a profit based on
the difference (the "spread") between the prices at which they
are buying and selling various currencies. Thus, a dealer may
offer to sell a foreign currency to the Fund at one rate, while
offering a lesser rate of exchange should the Fund desire to
resell that currency to the dealer.
Federal Tax Treatment of Options, Futures Contracts and Forward
Foreign Exchange Contracts
The Fund may enter into certain option, futures, and forward
foreign exchange contracts, including options and futures on
currencies, which will be treated as Section 1256 contracts or
straddles.
Transactions which are considered Section 1256 contracts
will be considered to have been closed at the end of the Fund's
fiscal year and any gains or losses will be recognized for tax
purposes at that time. Such gains or losses from the normal
closing or settlement of such transactions will be characterized
as 60% long-term capital gain or loss and 40% short-term capital
gain or loss regardless of the holding period of the instrument.
The Fund will be required to distribute net gains on such
PAGE 46
transactions to shareholders even though it may not have closed
the transaction and received cash to pay such distributions.
Options, futures and forward foreign exchange contracts,
including options and futures on currencies, which offset a
foreign dollar denominated bond or currency position may be
considered straddles for tax purposes in which case a loss on any
position in a straddle will be subject to deferral to the extent
of unrealized gain in an offsetting position. The holding period
of the securities or currencies comprising the straddle will be
deemed not to begin until the straddle is terminated. For
securities offsetting a purchased put, this adjustment of the
holding period may increase the gain from sales of securities
held less than three months. The holding period of the security
offsetting an "in-the-money qualified covered call" option on an
equity security will not include the period of time the option is
outstanding.
Losses on written covered calls and purchased puts on
securities, excluding certain "qualified covered call" options on
equity securities, may be long-term capital loss, if the security
covering the option was held for more than twelve months prior to
the writing of the option.
In order for the Fund to continue to qualify for federal
income tax treatment as a regulated investment company, at least
90% of its gross income for a taxable year must be derived from
qualifying income; i.e., dividends, interest, income derived from
loans of securities, and gains from the sale of securities or
currencies. Pending tax regulations could limit the extent that
net gain realized from option, futures or foreign forward
exchange contracts on currencies is qualifying income for
purposes of the 90% requirement. In addition, gains realized on
the sale or other disposition of securities, including option,
futures or foreign forward exchange contracts on securities or
securities indexes and, in some cases, currencies, held for less
than three months, must be limited to less than 30% of the Fund's
annual gross income. In order to avoid realizing excessive gains
on securities or currencies held less than three months, the Fund
may be required to defer the closing out of option, futures or
foreign forward exchange contracts) beyond the time when it would
otherwise be advantageous to do so. It is anticipated that
unrealized gains on Section 1256 option, futures and foreign
forward exchange contracts, which have been open for less than
three months as of the end of the Fund's fiscal year and which
are recognized for tax purposes, will not be considered gains on
PAGE 47
securities or currencies held less than three months for purposes
of the 30% test.
INVESTMENT RESTRICTIONS
Fundamental policies may not be changed without the approval
of the lesser of (1) 67% of the Fund's shares present at a
meeting of shareholders if the holders of more than 50% of the
outstanding shares are present in person or by proxy or (2) more
than 50% of the Fund's outstanding shares. Other restrictions in
the form of operating policies are subject to change by the
Fund's Board of Directors without shareholder approval. Any
investment restriction which involves a maximum percentage of
securities or assets shall not be considered to be violated
unless an excess over the percentage occurs immediately after,
and is caused by, an acquisition of securities or assets of, or
borrowings by, the Fund.
Fundamental Policies
As a matter of fundamental policy, the Fund may not:
(1) Borrowing. Borrow money except that the Fund may
(i) borrow for non-leveraging, temporary or
emergency purposes and (ii) engage in reverse
repurchase agreements and make other investments
or engage in other transactions, which may involve
a borrowing, in a manner consistent with the
Fund's investment objective and program, provided
that the combination of (i) and (ii) shall not
exceed 33 1/3% of the value of the Fund's total
assets (including the amount borrowed) less
liabilities (other than borrowings) or such other
percentage permitted by law. Any borrowings which
come to exceed this amount will be reduced in
accordance with applicable law. The Fund may
borrow from banks, other Price Funds or other
persons to the extent permitted by applicable law;
(2) Commodities. Purchase or sell physical
commodities; except that it may enter into futures
contracts and options thereon;
PAGE 48
(3) Industry Concentration. Purchase the securities
of any issuer if, as a result, more than 25% of
the value of the Fund's total assets would be
invested in the securities of issuers having their
principal business activities in the same
industry;
(4) Loans. Make loans, although the Fund may (i) lend
portfolio securities and participate in an
interfund lending program with other Price Funds
provided that no such loan may be made if, as a
result, the aggregate of such loans would exceed
33 1/3% of the value of the Fund's total assets;
(ii) purchase money market securities and enter
into repurchase agreements; and (iii) acquire
publicly-distributed or privately-placed debt
securities and purchase debt;
(5) Percent Limit on Assets Invested in Any One
Issuer. Purchase a security if, as a result, with
respect to 75% of the value of its total assets,
more than 5% of the value of the Fund's total
assets would be invested in the securities of a
single issuer, except securities issued or
guaranteed by the U.S. Government or any of its
agencies or instrumentalities;
(6) Percent Limit on Share Ownership of Any One
Issuer. Purchase a security if, as a result, with
respect to 75% of the value of the Fund's total
assets, more than 10% of the outstanding voting
securities of any issuer would be held by the Fund
(other than obligations issued or guaranteed by
the U.S. Government, its agencies or
instrumentalities);
(7) Real Estate. Purchase or sell real estate unless
acquired as a result of ownership of securities or
other instruments (but this shall not prevent the
Fund from investing in securities or other
instruments backed by real estate or securities of
companies engaged in the real estate business);
(8) Senior Securities. Issue senior securities except
in compliance with the Investment Company Act of
1940; or
PAGE 49
(9) Underwriting. Underwrite securities issued by
other persons, except to the extent that the Fund
may be deemed to be an underwriter within the
meaning of the Securities Act of 1933 in
connection with the purchase and sale of its
portfolio securities in the ordinary course of
pursuing its investment program.
With respect to investment restrictions (1) and (4), the
Fund will not borrow from or lend to any other Price
Fund (defined as any other mutual fund managed or for
which T. Rowe Price acts as adviser) unless they apply
for and receive an exemptive order from the SEC or the
SEC issues rules permitting such transactions. The Fund
has no current intention of engaging in any such
activity and there is no assurance the SEC would grant
any order requested by the Fund or promulgate any rules
allowing the transactions.
For purposes of investment restriction (3), U.S., state
or local governments, or related agencies or
instrumentalities, are not considered an industry.
Operating Policies
As a matter of operating policy, the Fund may not:
(1) Borrowing. The Fund will not purchase additional
securities when money borrowed exceeds 5% of its
total assets;
(2) Control of Portfolio Companies. Invest in
companies for the purpose of exercising management
or control;
(3) Futures Contracts. Purchase a futures contract or
an option thereon if, with respect to positions in
futures or options on futures which do not
represent bona fide hedging, the aggregate initial
margin and premiums on such positions would exceed
5% of the Fund's net asset value;
PAGE 50
(4) Illiquid Securities. Purchase illiquid securities
and securities of unseasoned issuers if, as a
result, more than 15% of its net assets would be
invested in such securities, provided that the
Fund will not invest more than 5% of its total
assets in restricted securities and not more than
5% in securities of unseasoned issuers.
Securities eligible for resale under Rule 144A of
the Securities Act of 1933 are not included in the
5% limitation but are subject to the 15%
limitation;
(5) Investment Companies. Purchase securities of
open-end or closed-end investment companies except
in compliance with the Investment Company Act of
1940 and applicable state law. Duplicate fees may
result from such purchases;
(6) Margin. Purchase securities on margin, except (i)
for use of short-term credit necessary for
clearance of purchases of portfolio securities and
(ii) it may make margin deposits in connection
with futures contracts or other permissible
investments;
(7) Mortgaging. Mortgage, pledge, hypothecate or, in
any manner, transfer any security owned by the
Fund as security for indebtedness except as may be
necessary in connection with permissible
borrowings or investments and then such
mortgaging, pledging or hypothecating may not
exceed 33 1/3% of the Fund's total assets at the
time of borrowing or investment;
(8) Oil and Gas Programs. Purchase participations or
other direct interests in or enter into leases
with respect to, oil, gas, or other mineral
exploration or development programs;
(9) Options, Etc. Invest in puts, calls, straddles,
spreads, or any combination thereof, except to the
extent permitted by the prospectus and Statement
of Additional Information;
PAGE 51
(10) Ownership of Portfolio Securities by Officers and
Directors. Purchase or retain the securities of
any issuer if, to the knowledge of the Fund's
management, those officers and directors of the
Fund, and of its investment manager, who each owns
beneficially more than .5% of the outstanding
securities of such issuer, together own
beneficially more than 5% of such securities;
(11) Short Sales. Effect short sales of securities;
(12) Unseasoned Issuers. Purchase a security (other
than obligations issued or guaranteed by the U.S.,
any foreign, state or local government, their
agencies or instrumentalities if, as a result,
more than 5% of the value of the Fund's total
assets would be invested in the securities of
issuers which at the time of purchase had been in
operation for less than three years (for this
purpose, the period of operation of any issuer
shall include the period of operation of any
predecessor or unconditional guarantor of such
issuer). This restriction does not apply to
securities of pooled investment vehicles or
mortgage or asset-backed securities; or
(13) Warrants. Invest in warrants if, as a result
thereof, more than 2% of the value of the total
assets of the Fund would be invested in warrants
which are not listed on the New York Stock
Exchange, the American Stock Exchange, or a
recognized foreign exchange, or more than 5% of
the value of the total assets of the Fund would be
invested in warrants whether or not so listed.
For purposes of these percentage limitations, the
warrants will be valued at the lower of cost or
market and warrants acquired by the Funds in units
or attached to securities may be deemed to be
without value.
For purposes of investment restriction (5), the Fund has
no current intention of purchasing the securities of
other investment companies.
Notwithstanding anything in the above fundamental and
PAGE 52
operating restrictions to the contrary, the Fund may invest all
of its assets in a single investment company or a series thereof
in connection with a "master-feeder" arrangement. Such an
investment would be made where the Fund (a "Feeder"), and one or
more other Funds with the same investment objective and program
as the Fund, sought to accomplish its investment objective and
program by investing all of its assets in the shares of another
investment company (the "Master"). The Master would, in turn,
have the same investment objective and program as the Fund. The
Fund would invest in this manner in an effort to achieve the
economies of scale associated with having a Master fund make
investments in portfolio companies on behalf of a number of
Feeder funds. In the event that the Fund exercises its right to
convert to a Master Fund/Feeder Fund structure, it will do so in
compliance with the Guidelines for Registration of a Master
Fund/Feeder Fund as established by the North American Securities
Administrators Association, Inc. ("NASAA").
RATINGS OF CORPORATE DEBT SECURITIES
Moody's Investors Services, Inc. (Moody's)
Aaa-Bonds rated Aaa are judged to be of the best
quality. They carry the smallest degree of investment risk and
are generally referred to as "gilt edge."
Aa-Bonds rated Aa are judged to be of high quality by
all standards. Together with the Aaa group they comprise what
are generally known as high grade bonds.
A-Bonds rated A possess many favorable investment
attributes and are to be considered as upper medium grade
obligations.
Baa-Bonds rated Baa are considered as medium grade
obligations, i.e., they are neither highly protected nor poorly
secured. Interest payments and principal security appear
adequate for the present but certain protective elements may be
lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as
well.
Ba-Bonds rated Ba are judged to have speculative
PAGE 53
elements: their futures cannot be considered as well assured.
Often the protection of interest and principal payments may be
very moderate and thereby not well safeguarded during both good
and bad times over the future. Uncertainty of position
characterize bonds in this class.
B-Bonds rated B gneerally lack the characteristics of a
desirable invesment. 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 rated Caa are of poor standing. Such issues
may be in default or there may be present elements of danger with
respect to principal or interest.
Ca-Bonds rated Ca represent obligations which are
speculative in a high degree. Such issues are often in default
or have other marked short-comings.
<PAGE>
PAGE 54
Standard & Poor's Corporation (S&P)
AAA-This is the highest rating assigned by Standard &
Poor's to a debt obligation and indicates an extremely strong
capacity to pay principal and interest.
AA-Bonds rated AA also qualify as high-quality debt
obligations. Capacity to pay principal and interest is very
strong.
A-Bonds rated A have a strong capacity to pay principal
and interest, although they are somewhat more susceptible to the
adverse effects of changes in circumstances and economic
conditions.
BBB-Bonds rated BBB are regarded as having an adequate
capacity to pay principal and interest. Whereas they normally
exhibit adequate protection parameters, adverse economic
conditions or changing circumstances are more likely to lead to a
weakened capacity to pay principal and interest for bonds in this
category than for bonds in the A category.
BB, C, CCC, CC-Bonds rated BB, B, CCC, and CC are
regarded on balance, as predominantly speculative with respect to
the issuer's capacity to pay interest and repay principal. BB
indicates the lowest degree of speculation and CC the highest
degree of speculation. While such bonds will likely have some
quality and protective characteristics, these are outweighed by
large uncertainties or major risk exposures to adverse
conditions.
Fitch Investors Service, Inc.
AAA-High grade, broadly marketable, suitable for
investment by trustees and fiduciary institutions, and liable to
but slight market fluctuation other than through changes in the
money rate. The prime feature of a "AAA" bond is the showing of
earnings several times or many times interest requirements for
such stability of applicable interest that safety is beyond
reasonable question whenever changes occur in conditions. Other
features may enter, such as a wide margin of protection through
collateral, security or direct lien on specific property.
Sinking funds or voluntary reduction of debt by call or purchase
or often factors, while guarantee or assumption by parties other
than the original debtor may influence their rating.
PAGE 55
AA-Of safety virtually beyond question and readily
salable. Their merits are not greatly unlike those of "AAA"
class but a bond so rated may be junior though of strong lien, or
the margin of safety is less strikingly broad. The issue may be
the obligation of a small company, strongly secured, but
influenced as to rating by the lesser financial power of the
enterprise and more local type of market.
MANAGEMENT OF FUND
The officers and directors of the Fund are listed below.
Unless otherwise noted, the address of each is 100 East Pratt
Street, Baltimore, Maryland 21202. Except as indicated, each has
been an employee of T. Rowe Price for more than five years. In
the list below, the Fund's directors who are considered
"interested persons" of T. Rowe Price as defined under
Section 2(a)(19) of the Investment Company Act of 1940 are noted
with an asterisk (*). These directors are referred to as inside
directors by virtue of their officership, directorship, and/or
employment with T. Rowe Price.
STEVEN S. CONNER, Director--Retired; formerly Executive Vice
President, Central Savings and Loan Association, San Diego,
California; Address: 910 Loma Court, El Cajon, California 92020
ROGER P. HAUCK, Director--President, Chief Executive Officer, and
Director, Marshall, Erdman & Associates, Inc., architect and
builder of ambulatory health care buildings, Director and member
of Executive Committee, University Health Care, Inc., and
Director, Madison-Kipp Corporation and Wisconsin Policy Research
Institute; Address: 3512 Blackhawk Drive, Shorewood Hills,
Wisconsin 53705
*RICHARD M. HEINS, PH.D., Director--President and Chief Executive
Officer, CUNA Mutual Insurance Group, Madison, Wisconsin;
Director, Chief Executive Officer and Vice Chairman, Century
Companies of America, Waverly, Iowa; Director, The CUMIS Group of
Companies (Canada); President, Filene Research Institute, Inc.;
Address: 5910 Mineral Point Road, P.O. Box 391, Madison,
Wisconsin 53701-0391
EMMETT J. RICE, Director--Retired; Director, The Ethyl
Corporation, Richmond, Virginia, Tredegar Industries, Inc.,
Richmond, Virginia, and Jardine Fleming China Region Fund, Inc.,
Baltimore, Maryland; Address: 1673 Myrtle Street, N.W.,
Washington, D.C. 20012
*JAMES S. RIEPE, President and Director, Managing Director, T.
PAGE 56
Rowe Price; Chairman of the Board, T. Rowe Price Services, Inc.,
T. Rowe Price Retirement Plan Services, Inc., and T. Rowe Price
Trust Company; President and Director, T. Rowe Price Investment
Services, Inc.; Member, Management Committee, CMC-T. Rowe Price
Management, LLC; Director, Rhone-Poulenc Rorer, Inc.
MARY J. MILLER, Executive Vice President--Managing Director, T.
Rowe Price
PETER VAN DYKE, Executive Vice President--Managing Director, T.
Rowe Price, Vice President, Rowe Price-Fleming International,
Inc. and T. Rowe Price Trust Company
DOROTHY L. BALLANTYNE, Vice President--Vice President, CUNA
Mutual Investment Corporation, LLC and Member, Management
Committee, CMC-T. Rowe Price Management, LLC
HENRY H. HOPKINS, Vice President--Managing Director, T. Rowe
Price; Vice President and Director, T. Rowe Price Investment
Services, Inc., T. Rowe Price Services, Inc., and T. Rowe Price
Trust Company; Vice President, Rowe Price-Fleming International,
Inc. and T. Rowe Price Retirement Plan Services, Inc.
BRADFORD L. MURPHY, Vice President--Executive Vice President,
CUNA Service Group, Inc. and Member, Management Committee, CMC-T.
Rowe Price Management, LLC
THOMAS O. OLSON, Vice President--Senior Vice President, CUNA
Mutual Investment Corporation, LLC and Member, Management
Committee, CMC-T. Rowe Price Management, LLC
CHARLES E. VIETH, Vice President--Managing Director, T. Rowe
Price; President and Director, T. Rowe Price Retirement Plan
Services, Inc.; Vice President and Director, T. Rowe Price
Services, Inc.; Member, Management Committee, CMC-T. Rowe Price
Management, LLC; Director, T. Rowe Price Investment Services,
Inc.
RICHARD T. WHITNEY, Vice President--Vice President, T. Rowe
Price; Chartered Financial Analyst
LENORA V. HORNUNG, Secretary--Vice President, T. Rowe Price
CARMEN F. DEYESU, Treasurer--Vice President, T. Rowe Price, T.
Rowe Price Services, Inc., and T. Rowe Price Trust Company
DAVID S. MIDDLETON, Controller--Vice President, T. Rowe Price, T.
Rowe Price Services, Inc., and T. Rowe Price Trust Company
ROGER L. FIERY, Assistant Vice President--Vice President, Rowe
Price-Fleming International, Inc.
EDWARD T. SCHNEIDER, Assistant Vice President--Vice President, T.
Rowe Price Services, Inc.
INGRID I. VORDEMBERGE, Assistant Vice President--Employee, T.
Rowe Price
The Fund's Executive Committee, comprised of Messrs. Heins
and Riepe, has been authorized by its respective Board of
PAGE 57
Directors to exercise all powers of the Board to manage the Fund
in the intervals between meetings of the Board, except the powers
prohibited by statute from being delegated.
PRINCIPAL HOLDERS OF SECURITIES
As of the date of the prospectus, the officers and directors
of the Fund, as a group, owned less than 1% of the outstanding
shares of the Fund.
JOINT VENTURE
T. Rowe Price Management, Inc. ("Price Management"), a
wholly-owned subsidiary of T. Rowe Price Associates, Inc. ("T.
Rowe Price"), and CUNA Mutual Funds Management Company L.L.C., a
Maryland limited liability company whose members are CUNA Mutual
Investment Corporation, a wholly-owned subsidiary of CUNA Mutual
Insurance Society ("CUNA Mutual"), and CUNA Service Group, Inc.,
an affiliate of Credit Union National Association, Inc. ("CUNA"),
have entered into an agreement (the "Joint Venture Agreement") to
form CMC-T. Rowe Price Management, L.L.C., a Maryland limited
liability company (the "Joint Venture"), in 1993 for the purpose
of establishing and operating a mutual fund program to be offered
to members of credit unions.
CUNA was founded in 1934 and is the national trade
association for credit unions. In addition, CUNA, together with
its affiliates, supplies products and services to credit unions
throughout the United States.
CUNA Mutual is a mutual insurance company established in
1935. CUNA Mutual and its affiliates serve the insurance,
financial and technology needs of credit unions and their members
in the United States and approximately 60 foreign countries.
T. Rowe Price is a registered investment adviser founded in
1937 by Thomas Rowe Price, Jr. T. Rowe Price serves as
investment manager to a variety of individuals and institutional
investors, including limited and real estate partnerships and
other mutual funds.
Under the Joint Venture Agreement, the Joint Venture is
responsible for providing, either directly or through contracts
PAGE 58
with others, investment management, fund accounting, transfer
agent and shareholder services, custodial and other services
necessary for the operation of the Fund. The Joint Venture has
entered into an Investment Management and Administration
Agreement with the Fund to perform or provide, or negotiate on
behalf of the Fund for third parties to perform or provide, these
services.
FUND MANAGEMENT AND ADMINISTRATION
The Joint Venture has entered into agreements with the Fund
and T. Rowe Price for the provision to the Fund of investment
advisory and fund accounting services; and the Fund and T. Rowe
Price Services, Inc. for fund transfer agent, dividend disbursing
and shareholder services. The Joint Venture has also entered
into an agreement with the Fund and State Street Bank and Trust
Company for fund custodial services.
The Fund pays the Joint Venture an annual all-inclusive fee
(the "Fee") of: 1.25%. The Fee is paid monthly to the Joint
Venture on the first business day of the next succeeding calendar
month and is the sum of the daily fee accruals for each month.
The daily fee accrual for any particular day is calculated by
multiplying the fraction of one (1) over the number of calendar
days in the year by the Fee and multiplying this product by the
net assets of the Fund for that day, as determined in accordance
with the Fund's prospectus as of the close of business on the
previous business day on which the Fund was open for business.
Under the all inclusive fee set forth in the Investment
Management and Administration Agreement, the Joint Venture bears
all expenses of the Fund's operations except: 12b-1 fees;
brokerage commissions and other costs incident to the purchase,
sale or lending of the Fund's portfolio securities; interest; all
taxes or governmental fees payable by or with respect to the
Fund, including stamp or other transfer taxes; and such
nonrecurring or extraordinary expenses that may arise, including
the costs of actions, suits or proceedings to which the Fund is a
party and the expenses the Fund might incur as a result of its
legal obligation to provide indemnification to its officers,
directors and agents.
Services Provided by T. Rowe Price
Under a Sub-Advisory Agreement between the Fund, the Joint
PAGE 59
Venture and T. Rowe Price, T. Rowe Price provides the Fund with
discretionary investment services. Specifically, T. Rowe Price
is responsible for supervising and directing the investments of
the Fund in accordance with its investment objective, programs,
and restrictions as provided in the prospectus and this Statement
of Additional Information. T. Rowe Price is also responsible for
effecting all security transactions on behalf of the Fund,
including the allocation of principal business and portfolio
brokerage and the negotiation of commissions. In addition to
these services, T. Rowe Price provides the Fund with certain
corporate administrative services, including: maintaining the
Fund's corporate existence, corporate records, and registering
and qualifying the Fund's shares under federal and state laws;
monitoring the financial, accounting, and administrative
functions of the Fund; maintaining liaison with the agents
employed by the Fund such as the Fund's custodian and transfer
agent; assisting the Fund in the coordination of such agents'
activities; and permitting T. Rowe Price's employees to serve as
officers, directors, and committee members of the Fund without
cost to the Fund.
The Sub-Advisory Agreement also provides that T. Rowe Price,
its directors, officers, employees, and certain other persons
performing specific functions for the Fund will only be liable to
the Fund for losses resulting from willful misfeasance, bad
faith, gross negligence, or reckless disregard of duty.
FUND DISTRIBUTION
T. Rowe Price Investment Services, Inc. ("Investment
Services"), a Maryland corporation formed in 1980 as a wholly-
owned subsidiary of T. Rowe Price, and CUNA Brokerage Services,
Inc. ("CUNA Brokerage"), a member of the CUNA Mutual Insurance
Group, under agreements with the Fund, serve as the distributors
of the Fund. Investment Services and CUNA Brokerage are
registered as broker-dealers under the Securities Exchange Act of
1934 and are
members of the National Association of Securities Dealers, Inc.
The offering of the Fund's shares is continuous.
Investment Services is located at the same address as the
Fund and T. Rowe T. Rowe Price--100 East Pratt Street, Baltimore,
Maryland 21202. CUNA Brokerage is located at 5910 Mineral Point
Road, Madison, Wisconsin 53701-0391.
PAGE 60
Investment Services and CUNA Brokerage serve as distributors
to the Fund pursuant to individual Underwriting Agreements
("Underwriting Agreements"), which provide that the Fund will pay
all fees and expenses in connection with: registering and
qualifying the Fund's shares under the various state "blue sky"
laws; preparing, setting in type, printing, and mailing its
prospectuses and reports to shareholders; and issuing its shares,
including expenses of confirming purchase orders. Investment
Services and CUNA Brokerage are responsible for all fees and
expenses in connection with the printing and distributing
prospectuses and reports for use in offering and selling shares
for the Fund; preparing, setting in type, printing, and mailing
all sales literature and advertising; Investment Services' and
CUNA Brokerage's federal and state registrations as a
broker-dealer; and offering and selling shares for the Fund,
except for those fees and expenses specifically assumed by the
Fund or paid for pursuant to the plan of distribution adopted by
the Fund. Investment Services' expenses are paid by T. Rowe
Price. CUNA Brokerage's expenses are paid by CMC. The Fund's
expenses are paid by the Joint Venture under the Investment
Management and Administration Agreement between the Fund and the
Joint Venture.
Investment Services and CUNA Brokerage act as the agents of
the Fund in connection with the sale of Fund shares in all states
in which the shares are qualified and in which Investment
Services and CUNA Brokerage are qualified as broker-dealers.
Under the Underwriting Agreements, orders for Fund shares are
accepted at net asset value. No sales charges are paid by
investors or the Fund.
Under a Distribution Plan (the "Plan") adopted by the Fund,
the Fund will transmit to the Joint Venture monthly, as paying
agent, an amount described in its prospectus for costs and
expenses of marketing the shares of the Fund. The Board of
Directors has concluded that there is a reasonable likelihood
that the Plan will benefit the Fund and its shareholders.
The Plan provides that it may not be amended to increase
materially the costs which the Fund may bear pursuant to the Plan
without shareholder approval and that other material amendments
of the Plan must be approved by the Board of Directors and the
Directors who are neither "interested persons" (as defined in the
1940 Act) of the Corporation ("Independent Directors"), nor have
any direct or indirect financial interest in the operation of the
Plan or in any related agreement, Independent Directors by vote
PAGE 61
cast in person at a meeting called for the purpose of considering
such amendments. The selection and nomination of the Independent
Directors of the Corporation have been committed to the
discretion of the Independent Directors. The Plan has been
approved and is subject to annual approval by the Board of
Directors and by the Independent Directors by vote cast in person
at a meeting called for the purpose of voting on the Plan. The
Board of Directors and the Independent Directors voted to approve
the Plan at a meeting held on December 21, 1993 and by a majority
of the outstanding shareholders of the Fund at a meeting held on
December 29, 1993. The Plan is terminable with respect to the
Fund at any time by a vote of a majority of the Independent
Directors or by vote of the holders of a majority of the shares
of the Fund.
Limitation on Fund Expenses
In compliance with certain state regulations, the Joint
Venture will reimburse the Fund for any expenses (excluding
interest, taxes, brokerage, other expenditures which are
capitalized in accordance with generally accepted accounting
principles, and extraordinary expenses) which in any year exceed
the limits prescribed by any state in which the Fund's shares are
qualified for sale. Presently, the most restrictive expense
ratio limitation imposed by any state is 2.5% of the first $30
million of the Fund's average daily net assets, 2% of the next
$70 million of such assets, and 1.5% of net assets in excess of
$100 million.
CUSTODIAN
State Street Bank and Trust Company is the custodian for the
Fund's securities and cash, but it does not participate in the
Fund's investment decisions. Portfolio securities purchased in
the U.S. are maintained in the custody of the Bank and may be
entered into the Federal Reserve Book Entry System, or the
security depository system of the Depository Trust Corporation.
The Fund has entered into a Custodian Agreement with The Chase
Manhattan Bank, N.A., London, pursuant to which portfolio
securities which are purchased outside the United States are
maintained in the custody of various foreign branches of The
Chase Manhattan Bank and such other custodians, including foreign
banks and foreign securities depositories as are approved by the
Fund's Board of Directors in accordance with regulations under
PAGE 62
the Investment Company Act of 1940. The Bank's main office is at
225 Franklin Street, Boston, Massachusetts 02110. The address
for The Chase Manhattan Bank, N.A., London is Woolgate House,
Coleman Street, London, EC2P 2HD, England.
PORTFOLIO TRANSACTIONS
Investment or Brokerage Discretion
Decisions with respect to the purchase and sale of portfolio
securities on behalf of the Fund are made by T. Rowe Price. T.
Rowe Price is also responsible for implementing these decisions,
including the negotiation of commissions and the allocation of
portfolio brokerage and principal business.
How Brokers and Dealers are Selected
Equity Securities
In purchasing and selling the Fund's portfolio securities,
it is T. Rowe Price's policy to obtain quality execution at the
most favorable prices through responsible brokers and dealers
and, in the case of agency transactions, at competitive
commission rates. However, under certain conditions, the Fund may
pay higher brokerage commissions in return for brokerage and
research services. As a general practice, over-the-counter
orders are executed with market-makers. In selecting among
market-makers, T. Rowe Price generally seeks to select those it
believes to be actively and effectively trading the security
being purchased or sold. In selecting broker-dealers to execute
the Fund's portfolio transactions, consideration is given to such
factors as the price of the security, the rate of the commission,
the size and difficulty of the order, the reliability, integrity,
financial condition, general execution and operational
capabilities of competing brokers and dealers, and brokerage and
research services provided by them. It is not the policy of T.
Rowe Price to seek the lowest available commission rate where it
is believed that a broker or dealer charging a higher commission
rate would offer greater reliability or provide better price or
execution.
Fixed Income Securities
Fixed income securities are generally purchased from the
issuer or a primary market-maker acting as principal for the
PAGE 63
securities on a net basis, with no brokerage commission being
paid by the client. Transactions placed through dealers serving
as primary market-makers reflect the spread between the bid and
asked prices. Securities may also be purchased from underwriters
at prices which include underwriting fees.
With respect to equity and fixed income securities, T. Rowe
Price may effect principal transactions on behalf of the Fund
with a broker or dealer who furnishes brokerage and/or research
services, designate any such broker or dealer to receive selling
concessions, discounts or other allowances, or otherwise deal
with any such broker or dealer in connection with the acquisition
of securities in underwritings.
How Evaluations are Made of the Overall Reasonableness of
Brokerage Commissions Paid
On a continuing basis, T. Rowe Price seeks to determine what
levels of commission rates are reasonable in the marketplace for
transactions executed on behalf of the Fund. In evaluating the
reasonableness of commission rates, T. Rowe Price considers: (a)
historical commission rates, both before and since rates have
been fully negotiable; (b) rates which other institutional
investors are paying, based on available public information; (c)
rates quoted by brokers and dealers; (d) the size of a particular
transaction, in terms of the number of shares, dollar amount, and
number of clients involved; (e) the complexity of a particular
transaction in terms of both execution and settlement; (f) the
level and type of business done with a particular firm over a
period of time; and (g) the extent to which the broker or dealer
has capital at risk in the transaction.
Description of Research Services Received from Brokers and
Dealers
T. Rowe Price receives a wide range of research services
from brokers and dealers. These services include information on
the economy, industries, groups of securities, individual
companies, statistical information, accounting and tax law
interpretations, political developments, legal developments
affecting portfolio securities, technical market action, pricing
and appraisal services, credit analysis, risk measurement
analysis, performance analysis and analysis of corporate
responsibility issues. These services provide both domestic and
international perspective. Research services are received
primarily in the form of written reports, computer generated
PAGE 64
services, telephone contacts and personal meetings with security
analysts. In addition, such services may be provided in the form
of meetings arranged with corporate and industry spokespersons,
economists, academicians and government representatives. In some
cases, research services are generated by third parties but are
provided to T. Rowe Price by or through broker-dealers.
Research services received from brokers and dealers are
supplemental to T. Rowe Price's own research effort and, when
utilized, are subject to internal analysis before being
incorporated by T. Rowe Price into its investment process. As a
practical matter, it would not be possible for T. Rowe Price's
Equity Research Division to generate all of the information
presently provided by brokers and dealers. T. Rowe Price pays
cash for certain research services received from external
sources. T. Rowe Price also allocates brokerage for research
services which are available for cash. While receipt of research
services from brokerage firms has not reduced T. Rowe Price's
normal research activities, the expenses of T. Rowe Price could
be materially increased if it attempted to generate such
additional information through its own staff. To the extent that
research services of value are provided by brokers or dealers, T.
Rowe Price may be relieved of expenses which it might otherwise
bear.
T. Rowe Price has a policy of not allocating brokerage
business in return for products or services other than brokerage
or research services. In accordance with the provisions of
Section 28(e) of the Securities Exchange Act of 1934, T. Rowe
Price may from time to time receive services and products which
serve both research and non-research functions. In such event,
T. Rowe Price makes a good faith determination of the anticipated
research and non-research use of the product or service and
allocates brokerage only with respect to the research component.
Commissions to Brokers who Furnish Research Services
Certain brokers who provide quality execution services also
furnish research services to T. Rowe Price. In order to be
assured of continuing to receive research services considered of
value to its clients, T. Rowe Price has adopted a brokerage
allocation policy embodying the concepts of Section 28(e) of the
Securities Exchange Act of 1934, which permits an investment
adviser to cause an account to pay commission rates in excess of
those another broker or dealer would have charged for effecting
the same transaction, if the adviser determines in good faith
PAGE 65
that the commission paid is reasonable in relation to the value
of the brokerage and research services provided. The
determination may be viewed in terms of either the particular
transaction involved or the overall responsibilities of the
adviser with respect to the accounts over which it exercises
investment discretion. Accordingly, while T. Rowe Price cannot
readily determine the extent to which commission rates or net
prices charged by broker-dealers reflect the value of their
research services, T. Rowe Price would expect to assess the
reasonableness of commissions in light of the total brokerage and
research services provided by each particular broker.
Internal Allocation Procedures
T. Rowe Price has a policy of not precommitting a specific
amount of business to any broker or dealer over any specific time
period. Historically, the majority of brokerage placement has
been determined by the needs of a specific transaction such as
market-making, availability of a buyer or seller of a particular
security, or specialized execution skills. However, T. Rowe
Price does have an internal brokerage allocation procedure for
that portion of its discretionary client brokerage business where
special needs do not exist, or where the business may be
allocated among several brokers which are able to meet the needs
of the transaction.
Each year, T. Rowe Price assesses the contribution of the
brokerage and research services provided by brokers, and attempts
to allocate a portion of its brokerage business in response to
these assessments. Research analysts, counselors, various
investment committees, and the Trading Department each seek to
evaluate the brokerage and research services they receive from
brokers and make judgments as to the level of business which
would recognize such services. In addition, brokers sometimes
suggest a level of business they would like to receive in return
for the various brokerage and research services they provide.
Actual brokerage received by any firm may be less than the
suggested allocations but can, and often does, exceed the
suggestions, because the total brokerage business is allocated on
the basis of all the considerations described above. In no case
is a broker excluded from receiving business from T. Rowe Price
because it has not been identified as providing research
services.
Miscellaneous
PAGE 66
T. Rowe Price's brokerage allocation policy is consistently
applied to all its fully discretionary accounts, which represent
a substantial majority of all assets under management. Research
services furnished by brokers through which T. Rowe Price effects
securities transactions may be used in servicing all accounts
(including non-Fund accounts) managed by T. Rowe Price.
Conversely, research services received from brokers which execute
transactions for the Fund are not necessarily used by T. Rowe
Price exclusively in connection with the management of the Fund.
From time to time, orders for clients may be placed through
a computerized transaction network.
The Fund does not allocate business to any broker-dealer on
the basis of its sales of the Fund's shares. However, this does
not mean that broker-dealers who purchase Fund shares for their
clients will not receive business from the Fund.
Some of T. Rowe Price's other clients have investment
objectives and programs similar to those of the Fund. T. Rowe
Price may occasionally make recommendations to other clients
which result in their purchasing or selling securities
simultaneously with the Fund. As a result, the demand for
securities being purchased or the supply of securities being sold
may increase, and this could have an adverse effect on the price
of those securities. It is T. Rowe Price's policy not to favor
one client over another in making recommendations or in placing
orders. T. Rowe Price frequently follows the practice of
grouping orders of various clients for execution which generally
results in lower commission rates being attained. In certain
cases, where the aggregate order is executed in a series of
transactions at various prices on a given day, each participating
client's proportionate share of such order reflects the average
price paid or received with respect to the total order. T. Rowe
Price has established a general investment policy that it will
ordinarily not make additional purchases of a common stock of a
company for its clients (including the T. Rowe Price Funds) if,
as a result of such purchases, 10% or more of the outstanding
common stock of such company would be held by its clients in the
aggregate.
To the extent possible, T. Rowe Price intends to recapture
solicitation fees paid in connection with tender offers through
T. Rowe Price Investment Services, Inc., the Fund's distributor.
At the present time, T. Rowe Price does not recapture commissions
PAGE 67
or underwriting discounts or selling group concessions in
connection with taxable securities acquired in underwritten
offerings. T. Rowe Price does, however, attempt to negotiate
elimination of all or a portion of the selling-group concession
or underwriting discount when purchasing tax-exempt municipal
securities on behalf of its clients in underwritten offerings.
Transactions with Related Brokers and Dealers
As provided in the Investment Management Agreement between
the Fund and T. Rowe Price, T. Rowe Price is responsible not only
for making decisions with respect to the purchase and sale of the
Fund's portfolio securities, but also for implementing these
decisions, including the negotiation of commissions and the
allocation of portfolio brokerage and principal business. It is
expected that T. Rowe Price may place orders for the Fund's
portfolio transactions with broker-dealers through the same
trading desk T. Rowe Price uses for portfolio transactions in
domestic securities. The trading desk accesses brokers and
dealers in various markets in which the Fund's foreign securities
are located. These brokers and dealers may include certain
affiliates of Robert Fleming Holdings Limited ("Robert Fleming
Holdings") and Jardine Fleming Group Limited ("JFG"), persons
indirectly related to T. Rowe Price. Robert Fleming Holdings,
through Copthall Overseas Limited, a wholly-owned subsidiary,
owns 25% of the common stock of Rowe Price-Fleming International,
Inc. ("RPFI"), an investment adviser registered under the
Investment Advisers Act of 1940. Fifty percent of the common
stock of RPFI is owned by TRP Finance, Inc., a wholly-owned
subsidiary of T. Rowe Price, and the remaining 25% is owned by
Jardine Fleming Holdings Limited, a subsidiary of JFG. JFG is
50% owned by Robert Fleming Holdings and 50% owned by Jardine
Matheson Holdings Limited. Orders for the Fund's portfolio
transactions placed with affiliates of Robert Fleming Holdings
and JFG will result in commissions being received by such
affiliates.
The Board of Directors of the Fund has authorized T. Rowe
Price to utilize certain affiliates of Robert Fleming and JFG in
the capacity of broker in connection with the execution of the
Fund's portfolio transactions. These affiliates include, but are
not limited to, Jardine Fleming Securities Limited ("JFS"), a
wholly-owned subsidiary of JFG, Robert Fleming & Co. Limited
("RF&Co."), Jardine Fleming Australia Securities Limited, and
Robert Fleming, Inc. (a New York brokerage firm). Other
affiliates of Robert Fleming Holding and JFG also may be used.
PAGE 68
Although it does not believe that the Fund's use of these brokers
would be subject to Section 17(e) of the Investment Company Act
of 1940, the Board of Directors of the Fund has agreed that the
procedures set forth in Rule 17(e)(1) under that Act will be
followed when using such brokers.
PRICING OF SECURITIES
Equity securities listed or regularly traded on a securities
exchange (including NASDAQ) are valued at the last quoted sales
price on the day the valuations are made. A security which is
listed or traded on more than one exchange is valued at the
quotation on the exchange determined to be the primary market for
such security. Other equity securities and those listed
securities that are not traded on a particular day are valued at
a price within the limits of the latest bid and asked prices
deemed by the Board of Directors, or by persons delegated by the
Board, best to reflect fair value.
Debt securities are generally traded in the over-the-counter
market and are valued at a price deemed best to reflect fair
value as quoted by dealers who make markets in these securities
or by an independent pricing service. Short-term debt securities
are valued at their cost in local currency which, when combined
with accrued interest, approximates fair value.
For purposes of determining the Fund's net asset value per
share, all assets and liabilities initially expressed in foreign
currencies are converted into U.S. dollars at the mean of the bid
and offer prices of such currencies against U.S. dollars quoted
by a major bank.
Assets and liabilities for which the above valuation
procedures are inappropriate or are deemed not to reflect fair
value are stated at fair value as determined in good faith by or
under the supervision of the officers of the Fund, as authorized
by the Board of Directors.
NET ASSET VALUE PER SHARE
The purchase and redemption price of the Fund's shares is
equal to the Fund's net asset value per share or share price.
The Fund determines its net asset value per share by subtracting
the Fund's liabilities (including accrued expenses and dividends
PAGE 69
payable) from its total assets (the market value of the
securities the Fund holds plus cash and other assets, including
income accrued but not yet received) and dividing the result by
the total number of shares outstanding. The net asset value per
share of the Fund is calculated as of the close of trading on the
New York Stock Exchange ("NYSE") every day the NYSE is open for
trading. The NYSE is closed on the following days: New Year's
Day, Washington's Birthday, Good Friday, Memorial Day,
Independence Day, Labor Day, Thanksgiving Day, and Christmas Day.
Determination of net asset value (and the offering, sale
redemption and repurchase of shares) for the Fund may be
suspended at times (a) during which the NYSE is closed, other
than customary weekend and holiday closings, (b) during which
trading on the NYSE is restricted, (c) during which an emergency
exists as a result of which disposal by the Fund of securities
owned by it is not reasonably practicable or it is not reasonably
practicable for the Fund fairly to determine the value of its net
assets, or (d) during which a governmental body having
jurisdiction over the Fund may by order permit such a suspension
for the protection of the Fund's shareholders; provided that
applicable rules and regulations of the Securities and Exchange
Commission (or any succeeding governmental authority) shall
govern as to whether the conditions prescribed in (b), (c), or
(d) exist.
DIVIDENDS
Unless you elect otherwise, the Fund's annual capital gain
distribution, if any, will be reinvested on the reinvestment date
using the NAV per share of that date. The reinvestment date
normally precedes the payment date by about 10 days although the
exact timing is subject to change.
TAX STATUS
The Fund intends to qualify as a "regulated investment
company" under Subchapter M of the Internal Revenue Code of 1986,
as amended ("Code").
A portion of the dividends paid by the Fund may be eligible
for the dividends-received deduction for corporate shareholders.
For tax purposes, it does not make any difference whether
dividends and capital gain distributions are paid in cash or in
PAGE 70
additional shares. The Fund must declare dividends equal to at
least 98% of ordinary income (as of December 31) and capital
gains (as of October 31) in order to avoid a federal excise tax
and distribute 100% of ordinary income and capital gains as of
December 31 to avoid federal income tax.
At the time of your purchase, the Fund's net asset value may
reflect undistributed capital gains or net unrealized
appreciation of securities held by the Fund. A subsequent
distribution to you of such amounts, although constituting a
return of your investment, would be taxable as a capital gain
distribution. For federal income tax purposes, the Fund is
permitted to carry forward its net realized capital losses, if
any, for eight years and realize net capital gains up to the
amount of such losses without being required to pay taxes on, or
distribute such gains.
If, in any taxable year, the Fund should not qualify as a
regulated investment company under the Code: (i) the Fund would
be taxed at normal corporate rates on the entire amount of its
taxable income, if any, without deduction for dividends or other
distributions to shareholders; and (ii) the Fund's distributions
to the extent made out of the Fund's current or accumulated
earnings and profits would be taxable to shareholders as ordinary
dividends (regardless of whether they would otherwise have been
considered capital gain dividends).
Taxation of Foreign Shareholders
The Code provides that dividends from net income will be
subject to U.S. tax. For shareholders who are not engaged in a
business in the U.S., this tax would be imposed at the rate of
30% upon the gross amount of the dividends in the absence of a
Tax Treaty providing for a reduced rate or exemption from U.S.
taxation. Distributions of net long-term capital gains realized
by the Fund are not subject to tax unless the foreign shareholder
is a nonresident alien individual who was physically present in
the U.S. during the tax year for more than 182 days.
To the extent the Fund invests in foreign securities, the
following would apply:
Passive Foreign Investment Companies
The Fund may purchase the securities of certain foreign
investment funds or trusts called passive foreign investment
PAGE 71
companies. Capital gains on the sale of such holdings will be
deemed to be ordinary income regardless of how long the Fund
holds its investment. In addition to bearing their proportionate
share of the funds expenses (management fees and operating
expenses) shareholders will also indirectly bear similar expenses
of such funds. In addition, the Fund may be subject to corporate
income tax and an interest charge on certain dividends and
capital gains earned from these investments, regardless of
whether such income and gains were distributed to shareholders.
In accordance with tax regulations, the Fund intends to
treat these securities as sold on the last day of the Fund's
fiscal year and recognize any gains for tax purposes at that
time; losses will not be recognized. Such gains will be
considered ordinary income which the Fund will be required to
distribute even though it has not sold the security and received
cash to pay such distributions.
Foreign Currency Gains and Losses
Foreign currency gains and losses, including the portion of
gain or loss on the sale of debt securities attributable to
foreign exchange rate fluctuations, are taxable as ordinary
income. If the net effect of these transactions is a gain, the
dividend paid by the Fund will be increased; if the result is a
loss, the income dividend paid by the Fund will be decreased.
Adjustments to reflect these gains and losses will be made at the
end of the Fund's taxable year.
YIELD INFORMATION
From time to time, the Fund may advertise a yield figure
calculated in the following manner:
An income factor is calculated for each security in the
portfolio, which in the case of bonds is based upon the
security's market value at the beginning of the period and yield-
to-maturity as determined in conformity with regulations of the
Securities and Exchange Commission, and in the case of stocks is
based upon the stated dividend rate. The income factors are then
totalled for all securities in the portfolio. Next, expenses of
the Fund for the period net of expected reimbursements are
deducted from the income to arrive at net income, which is then
converted to a per-share amount by dividing net income by the
average number of shares outstanding during the period. The net
PAGE 72
income per share is divided by the net asset value on the last
day of the period to produce a monthly yield which is then
annualized. Quoted yield factors are for comparison purposes
only, and are not intended to indicate future performance or
forecast the dividend per share of the Fund.
INVESTMENT PERFORMANCE
Total Return Performance
The Fund's calculation of total return performance includes
the reinvestment of all capital gain distributions and income
dividends for the period or periods indicated, without regard to
tax consequences to a shareholder in the Fund. Total return is
calculated as the percentage change between the beginning value
of a static account in the Fund and the ending value of that
account measured by the then current net asset value, including
all shares acquired through reinvestment of income and capital
gains dividends. The results shown are historical and should not
be considered indicative of the future performance of the Fund.
Each average annual compound rate of return is derived from the
cumulative performance of the Fund over the time period
specified. The annual compound rate of return for the Fund over
any other period of time will vary from the average.
From time to time, in reports and promotional literature,
one or more of the CUNA Mutual Funds, including the Fund, may
compare its performance or yield to Overnight Government
Repurchase Agreements, Treasury bills, notes, and bonds,
certificates of deposit, and six-month money market certificates.
Performance or yield may also be compared to (1) indices of broad
groups of managed and unmanaged securities considered to be
representative of or similar to Fund portfolio holdings (2) other
mutual funds or (3) other measures of performance set forth on
publications such as:
PAGE 73
Advertising News Service, Inc., "Bank Rate Monitor - The
Weekly Financial Rate Reporter" is a weekly publication
which lists the yields on various money market
instruments offered to the public by 100 leading banks
and thrift institutions in the U.S., including loan rates
offered by these banks. Bank certificates of deposit
differ from mutual funds in several ways: the interest
rate established by the sponsoring bank is fixed for the
term of a CD; there are penalties for early withdrawal
from CDs, and the principal on a CD is insured.
Donoghue Organization, Inc., "Donoghue's Money Fund
Report" is a weekly publication which tracks net assets,
yield, maturity, and portfolio holdings on approximately
380 money market mutual funds offered in the U.S. These
funds are broken down into various categories such as
U.S. Treasury, Domestic Prime and Euros, Domestic Prime
and Euros and Yankees, and Aggressive.
Lipper Analytical Services, Inc. Average of Balanced
Funds - a widely used independent research firm which
ranks mutual funds by overall performance, investment
objectives, and assets.
Lipper Analytical Services, Inc., "Lipper Mutual Fund
Performance Analysis" is a monthly publication which
tracks net assets, total return, principal return and
yield on approximately 950 fixed income mutual funds
offered in the United States. Fund categories include:
Growth, Mixed Income, and Flexible Portfolios.
Major Competitors - the average of the following mutual
funds: Fidelity Puritan, Vanguard Wellington, Twentieth
Century Balanced, or other similar mutual funds.
Merrill Lynch, Pierce, Fenner & Smith, Inc., "Taxable
Bond Indices" is a monthly publication which lists
principal, coupon and total return on over 100 different
taxable bond indices tracked by Merrill Lynch, together
with the par weighted characteristics of each Index. The
index used as a benchmark for the High Yield Fund is the
High Yield Index. The two indices used as benchmarks for
the Short-Term Bond Fund are the 91-Day Treasury Bill
Index and the 1-2.99 Year Treasury Note Index.
PAGE 74
Morningstar, Inc., is a widely used independent research
firm which rates mutual funds by overall performance,
investment objectives and assets.
Mutual Fund Values, published by Morningstar, Inc., is a
mutual fund tracking system which provides a top
performer list every two weeks based on performanced and
risk measurements.
Salomon Brothers Inc., "Market Performance" - a monthly
publication which tracks principal return, total return
and yield on the Salomon Brothers Broad Investment Grade
Bond Index and the components of the Index.
Salomon Brothers Broad Investment Grade Index - a widely
used index composed of U.S. domestic government,
corporate, and mortgage-backed fixed income securities.
Shearson Lehman Brothers, Inc. "The Bond Market Report" -
a monthly publication which tracks principal, coupon and
total return on the Shearson Lehman Govt./Corp. Index and
Shearson Lehman Aggregate Bond Index, as well as all the
components of these Indices.
Telerate Systems, Inc., a market data distribution
network computer system to which we subscribe which
tracks a broad range of financial markets including, the
daily rates on money market instruments, public corporate
debt obligations and public obligations of the U.S.
Treasury and agencies of the U.S. Government.
Wall Street Journal, is a national daily financial news
publication which lists the yields and current market
values on money market instruments, public corporate debt
obligations, public obligations of the U.S. Treasury and
agencies of the U.S. government as well as common stocks,
preferred stocks, convertible preferred stocks, options
and commodities; in addition to indices prepared by the
research departments of such financial organizations as
Shearson Lehman/American Express Inc. and Merrill Lynch,
Pierce, Fenner and Smith, Inc., including information
provided by the Federal Reserve Board.
<PAGE>
PAGE 75
From time to time, in reports and promotions literature:
(1) the Fund's total return performance or P/E ratio may be
compared to any one or combination of the following: (i) the
Standard & Poor's 500 Stock Index so that you may compare the
Fund's results with those of a group of unmanaged securities
widely regarded by investors as representative of the stock
market in general; (ii) other groups of mutual funds, including
T. Rowe Price Funds, tracked by: (A) Lipper Analytical Services,
a widely used independent research firm which ranks mutual funds
by overall performance, investment objectives, and assets; (B)
Morningstar, Inc., another widely used independent research firm
which ranks mutual funds; or (C) other financial or business
publications, such as Business Week, Money Magazine, Forbes and
Barron's, which provide similar information; (iii) indices of
stocks comparable to those in which the Fund invests; (2) the
Consumer Price Index (measure for inflation) may be used to
assess the real rate of return from an investment in the Fund;
(3) other government statistics such as GNP, and net import and
export figures derived from governmental publications, e.g., The
Survey of Current Business, may be used to illustrate investment
attributes of the Fund or the general economic, business,
investment, or financial environment in which the Fund operates;
(4) the effect of tax-deferred compounding on the Fund's
investment returns, or on returns in general, may be illustrated
by graphs, charts, etc. where such graphs or charts would
compare, at various points in time, the return from an investment
in the Fund (or returns in general) on a tax-deferred basis
(assuming reinvestment of capital gains and dividends and
assuming one or more tax rates) with the return on a taxable
basis; and (5) the sectors or industries in which the Fund
invests may be compared to relevant indices or surveys (e.g., S&P
Industry Surveys) in order to evaluate the Fund's historical
performance or current or potential value with respect to the
particular industry or sector. In connection with (4) above,
information derived from the following chart may be used:
IRA Versus Taxable Return
Assuming 9% annual rate of return, $2,000 annual
contribution and 28% tax bracket.
Year Taxable Tax Deferred
PAGE 76
10 $ 28,700 $ 33,100
15 51,400 64,000
20 82,500 111,500
25 125,100 184,600
30 183,300 297,200
IRAs
An IRA is a long-term investment whose objective is to
accumulate personal savings for retirement. Due to the long-term
nature of the investment, even slight differences in performance
will result in significantly different assets at retirement.
Mutual funds, with their diversity of choice, can be used for IRA
investments. Generally, individuals may need to adjust their
underlying IRA investments as their time to retirement and
tolerance for risk changes.
To assist investors in understanding the different returns
and risk characteristics of various investments, the
aforementioned guides will include presentation of historical
returns of various investments using published indices. An
example of this is shown on the next page.
Historical Returns for Different Investments
Annualized Returns for Periods Ended 12/31/92
50 Years 25 Years 10 Years 5 Years
Small company stocks 16.3% 12.4% 11.6% 13.6%
Large company stocks 12.6 10.6 16.2 15.9
Foreign stocks N/A N/A 17.1 1.6
Long-term corporate bonds5.4 8.8 13.1 12.5
Intermediate-Term U.S.
Gov't. bonds 5.6 9.0 11.0 10.3
Treasury bills 4.6 7.2 6.9 6.3
U.S. inflation 4.3 5.9 3.8 4.2
Source: Ibbotson Associates. Foreign stocks reflect performance
of The Morgan Stanley Capital International EAFE Index, which
includes some 1,000 companies representing the stock markets of
Europe, Australia, New Zealand, and the Far East. This chart is
for illustrative purposes only and should not be considered as
performance for any T. Rowe Price Fund. Past performance does
not guarantee future results.
PAGE 77
Also included will be various portfolios demonstrating how these
historical indices would have performed in various combinations
over a specified time period in terms of return. An example of
this is shown below.
Performance of Retirement Portfolios*
Asset Mix Annualized Returns Number of Value of
20 Years Years with $10,000
Ending 12/31/92 Negative Invest-
Returns ment
After
Period
___________________ _____________________________ ________
Best Worst
PortfolioGrowthIncomeSafety Average Year Year
I. Low
Risk 15% 35% 50% 9.0% 19.0%-0.2% 1 $ 56,451
II. Moderate
Risk 55% 30% 15% 10.4% 25.7%-7.5% 2 $ 72,918
III. High
Risk 85% 15% 0% 11.2% 34.5%-16.2% 5 $ 83,382
Source: T. Rowe Price Associates; data supplied by Ibbotson
Associates.
* Based on actual performance of stocks (Wilshire 5000),
Lehman Brothers Government/Corporate Bond Index, and
Treasury bills from January 1973 through December 1992.
Past performance does not guarantee future results. Figures
include changes in principal value and reinvested dividends.
This Exhibit is for illustrative purposes only and is not
representative of the performance of any T. Rowe Price Fund.
From time to time, publications of reports on specific
investment topics and strategies, may be included in the Fund's
fulfillment kit. Such reports may include information
concerning: calculating taxable gains and losses on mutual fund
transactions, coping with stock market volatility, benefiting
from dollar cost averaging, understanding international markets,
investing in high-yield "junk" bonds, growth stock investing,
conservative stock investing, value investing, investing in small
PAGE 78
companides, tax-free investing, fixed income investing, investing
in mortgage-backed securities, as well as other topics and
strategies.
Other Features and Benefits
The Fund is a member of the CUNA Mutual Funds and may help
investors achieve various long-term investment goals, such as
investing money for retirement, saving for a down payment on a
home, or paying college costs. To explain how the Fund could be
used to assist investors in planning for these goals and to
illustrate basic principles of investing, various worksheets and
guides prepared by T. Rowe Price, T. Rowe Price Investment
Services, Inc. and/or CUNA Brokerage Services, Inc. may be made
available. These may include: an Asset Mix Worksheet designed to
show shareholders how to reduce their investment risk by
developing a diversified investment plan: a College Planning
Guide which discusses various aspects of financial planning to
meet college expenses and assists parents in projecting the costs
of a college education for their children; the Retirement
Planning Kit (also available in a PC version) which includes a
detailed workbook to determine how much money you may need for
retirement and suggests how you might invest to reach your goal;
and the Retirees Financial Guide which includes a detailed
workbook to determine how much money you can afford to spend and
still preserve your purchasing power and suggest how you might
invest to reach your goal. From time to time, other worksheets
and guides may be made available as well. Of course, an
investment in the Fund cannot guarantee that such goals will be
met.
Redemptions in Kind
In the unlikely event a shareholder were to receive an in
kind redemption of portfolio securities of the Fund, brokerage
fees could be incurred by the shareholder in a subsequent sale of
such securities.
Issuance of Fund Shares for Securities
Transactions involving issuance of Fund shares for
securities or assets other than cash will be limited to (1) bona
fide reorganizations; (2) statutory mergers; or (3) other
acquisitions of portfolio securities that: (a) meet the
investment objective and policies of the Fund; (b) are acquired
for investment and not for resale except in accordance with
PAGE 79
applicable law; (c) have a value that is readily ascertainable
via listing on or trading in a recognized United States or
international exchange or market; and (d) are not illiquid.
DEVELOPMENT OF THE CUNA MUTUAL FUNDS
One and one-half trillion dollars has been deposited in
mutual funds since 1983, and mutual funds have been growing
faster than any other form of investment. Investors in mutual
funds include a quarter of all credit union households. In 1992,
for example, substantial amounts of credit union member funds
were transferred into mutual funds. The CUNA Mutual Funds were
started in order to allow the credit union system to offer its
own exclusive group of mutual funds. The mutual funds will
strengthen credit unions' ability to serve as a member's primary
financial institution. The CUNA Mutual Funds will help credit
unions maintain relationships with investors currently within
their membership through direct communications on a wide variety
of subjects, including fund investment strategy, safety, and
other factors to consider when examining mutual funds.
T. Rowe Price, established by Thomas Rowe Price in 1937,
will be the sub-advisor to the CUNA Mutual Funds. Since that
time, T. Rowe Price has become one of the largest and most
respected financial services firms in the country. The firm's
approach to managing investment risk and emphasis on the highest
standards of service are two of the numerous reasons that
millions of investors, and now the credit union movement, have
selected T. Rowe Price as their no-load mutual fund provider.
CAPITAL STOCK
The Charter of the CUNA Mutual Funds, Inc. (the
"Corporation") authorizes its Board of Directors to classify and
reclassify any and all shares which are then unissued, including
unissued shares of capital stock into any number of classes or
series, each class or series consisting of such number of shares
and having such designations, such powers, preferences, rights,
qualifications, limitations, and restrictions, as shall be
determined by the Board subject to the Investment Company Act and
other applicable law. Currently, the Corporation consists of
three series, CUNA Mutual Cornerstone Fund, CUNA Mutual Tax-Free
Intermediate-Term Fund, and CUNA U.S. Government Income Fund.
Each series represents a separate class of the Corporation's
PAGE 80
shares and has different objectives and investment policies. The
shares of any such additional classes or series might therefore
differ from the shares of the present class and series of capital
stock and from each other as to preferences, conversions or other
rights, voting powers, restrictions, limitations as to dividends,
qualifications or terms or conditions of redemption, subject to
applicable law, and might thus be superior or inferior to the
capital stock or to other classes or series in various
characteristics. The Corporation's Board of Directors may
increase or decrease the aggregate number of shares of stock or
the number of shares of stock of any class or series that the
Funds have authorized to issue without shareholder approval.
Except to the extent that the Corporation's Board of
Directors might provide by resolution that holders of shares of a
particular class are entitled to vote as a class on specified
matters presented for a vote of the holders of all shares
entitled to vote on such matters, there would be no right of
class vote unless and to the extent that such a right might be
construed to exist under Maryland law. The Charter contains no
provision entitling the holders of the present class of capital
stock to a vote as a class on any matter. Accordingly, the
preferences, rights, and other characteristics attaching to any
class of shares, including the present class of capital stock,
might be altered or eliminated, or the class might be combined
with another class or classes, by action approved by the vote of
the holders of a majority of all the shares of all classes
entitled to be voted on the proposal, without any additional
right to vote as a class by the holders of the capital stock or
of another affected class or classes.
Shareholders are entitled to one vote for each full share
held (and fractional votes for fractional shares held) and will
vote in the election of or removal of directors (to the extent
hereinafter provided) and on other matters submitted to the vote
of shareholders. There will normally be no meetings of
shareholders for the purpose of electing directors unless and
until such time as less than a majority of the directors holding
office have been elected by shareholders, at which time the
directors then in office will call a shareholders' meeting for
the election of directors. Except as set forth above, the
directors shall continue to hold office and may appoint successor
directors. Voting rights are not cumulative, so that the holders
of more than 50% of the shares voting in the election of
directors can, if they choose to do so, elect all the directors
of the Fund, in which event the holders of the remaining shares
PAGE 81
will be unable to elect any person as a director. As set forth
in the By-Laws of the Corporation, a special meeting of
shareholders of the Corporation shall be called by the Secretary
of the Corporation on the written request of shareholders
entitled to cast at least 10% of all the votes of the Corporation
entitled to be cast at such meeting. Shareholders requesting
such a meeting must pay to the Corporation the reasonably
estimated costs of preparing and mailing the notice of the
meeting. The Corporation, however, will otherwise assist the
shareholders seeking to hold the special meeting in communicating
to the other shareholders of the Corporation to the extent
required by Section 16(c) of the Investment Company Act of 1940.
FEDERAL AND STATE REGISTRATION OF SHARES
The Fund's shares are registered for sale under the
Securities Act of 1933, and the Fund or its shares are registered
under the laws of all states which require registration, as well
as the District of Columbia and Puerto Rico.
LEGAL COUNSEL
Shereff, Friedman, Hoffman, & Goodman, whose address is 919
Third Avenue, New York, New York 10022, is legal counsel to the
Fund.
INDEPENDENT ACCOUNTANTS
Price Waterhouse, 7 St. Paul Street, Suite 1700, Baltimore,
Maryland 21202, are independent accountants to the Fund. The
Statement of Assets and Liabilities of the Fund as of December
21, 1993, included in the Statement of Additional Information,
has been included in reliance on the report of Price Waterhouse,
given on the authority of said firm as experts in auditing and
accounting.
jmj/cnacornr.ptb
<PAGE>
PAGE 82
CUNA MUTUAL FUNDS, INC.
STATEMENT OF ASSETS AND LIABILITIES
December 21, 1993
CUNA
Mutual
Cornerstone
Fund
__________________
Assets
Cash. . . . . . . . . . . . . . . . . $40,000
____________
Total asset . . . . . . . . . . . . $40,000
Liabilities
Total liabilities . . . . . . . . . -0-
____________
Net Assets - offering and redemption price of
$10.00 per share; 1,000,000,000 shares of
$.0001 par value capital stock of the Corporation
authorized; 4,000 shares outstanding. . . $40,000
___________
___________
NOTE TO STATEMENT OF ASSETS AND LIABILITIES
CUNA Mutual Funds, Inc. (the "Corporation") was organized on
October 6, 1993, as a Maryland corporation and is registered
under the Investment Company Act of 1940. The Corporation is a
series fund, of which the CUNA Mutual Cornerstone Fund (the
"fund"), a diversified, open-end management investment company,
is one of the portfolios established under the Corporation. The
Corporation has had no operations other than those matters
related to organization and registration as an investment
company, the registration of shares for sale under the Securities
Act of 1933, and the sale of 4,000 shares of the Fund at $10.00
per share on December 20, 1993 to CMC-T. Rowe Price Management,
L.L.C. The Fund has entered into an investment management
agreement with CMC-T. Rowe Price Management, L.L.C.(the Manager)
which is described in the Statement of Additional Information
under the heading "Investment Management Services." The manager
has agreed to bear all organizational costs of the Fund.
<PAGE>
PAGE 83
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholder of
CUNA Mutual Cornerstone Fund
In our opinion, the accompanying statement of assets and
liabilities presents fairly, in all material respects, the
financial position of the CUNA Mutual Cornerstone Fund (the
"Fund"), a series of the CUNA Mutual Funds, Inc., at December 21,
1993, in conformity with generally accepted accounting
principles. This financial statement is the responsibility of
the Fund's management; our responsibility is to express an
opinion on this financial statement based on our audit. We
conducted our audit of this financial statement in accordance
with generally accepted auditing standards which require that we
plan and perform the audit to obtain reasonable assurance about
whether the financial statement is free of material misstatement.
An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statement, assessing
the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable
basis for the opinion expressed above.
PRICE WATERHOUSE
Baltimore, Maryland
December 21, 1993
<PAGE>
PAGE 84
STATEMENT OF ADDITIONAL INFORMATION
CUNA MUTUAL FUNDS, INC.
CUNA Mutual Tax-Free Intermediate-Term Fund
(the "Fund")
This Statement of Additional Information is not a
prospectus but should be read in conjunction with the Fund's
prospectus dated December 30, 1993, which may be obtained from
T. Rowe Price Investment Services, Inc., 100 East Pratt Street,
Baltimore, Maryland 21202.
The date of this Statement of Additional Information is
December 30, 1993.
<PAGE>
PAGE 85
TABLE OF CONTENTS
Page Page
Capital Stock. . . . . . . .39 Investment Restrictions . . . 19
Custodian. . . . . . . . . .30 Joint Venture . . . . . . . . 27
Development of the CUNA .Legal Counsel
. . . . . . . . . . . . . .41
Mutual Funds . . . . . . .39 Management of Fund. . . . . . 25
Dividends. . . . . . . . . .35 Municipal Securities. . . . . .5
Federal and State Registration Net Asset Value Per Share
. . . . . . . . . . . . . .34
of Shares. . . . . . . . .40 Options on Futures Contracts. 16
Forwards . . . . . . . . . .11 Portfolio Transactions. . . . 30
Fund Distribution. . . . . .28 Pricing of Securities . . . . 34
Fund Management and Administration . . . . . . . . . . . . . . 27
Principal Holders of Securities 27
Futures Contracts. . . . . .12 Ratings of Commerical Paper . 25
Independent Accountants. . .41 Ratings of Municipal Debt
Securities . . . . . . . . .23
Investment in Taxable Market Securities. . . . . . . . . . . . 11
Ratings of Municipal Notes and Variable
Investment Objective and Policies. . . . . . . . . . . . . . . .2
. . . . . . Rate Securities 24
(page 5 in Prospectus) Risk Factors
. . . . . . . . . . . . . . 3
Investment Objective and Program 2 .Tax-Exempt vs. Taxable Yields
. . . . . . . . . . . . . .36
(page 5 in Prospectus) Tax Status (page 8 in Prospectus)
. . . . . . . . . . . . . .35
Investment Performance . . .37 When-Issued Securities. . . . 10
Investment Program . . . . . 5 Yield Information . . . . . . 36
INVESTMENT OBJECTIVE AND POLICIES
The following information supplements the discussion of the
Fund's investment objective and policies discussed on pages 5 and
15 through 19 of the prospectus. The Fund will not make a
material change in its investment objective without obtaining
shareholder approval. Unless otherwise specified, the investment
programs and restrictions of the Fund are not fundamental
policies. The Fund's operating policies are subject to change by
its Board of Directors without shareholder approval. However,
shareholders will be notified of a material change in an
operating policy. The Fund's fundamental policies may not be
PAGE 86
changed without the approval of at least a majority of the
outstanding shares of the Fund or, if it is less, 67% of the
shares represented at a meeting of shareholders at which the
holders of 50% or more of the shares are represented.
INVESTMENT OBJECTIVE AND PROGRAM
The investment objective of the Fund is to provide the
highest level of tax-free income consistent with modest share
price fluctuation. The Fund will invest in investment-grade
municipal bonds rated AAA to BBB by nationally recognized rating
agencies or if unrated, of equivalent quality as determined by
the Fund's investment adviser.
The Fund is designed for credit union members seeking the
benefits of income exempt from federal taxes. The Fund is not
appropriate for qualified retirement plans where income is
already tax deferred.
The share price and yield of the Fund will fluctuate with
changing market conditions and interest rate levels, and your
investment may be worth more or less when redeemed than when
purchased. The Fund should not be relied upon as a complete
investment program, nor used for short-term trading purposes.
The Fund cannot guarantee it will achieve its investment
objective.
After purchase by the Fund, a security may cease to be rated
or its rating may be reduced below the minimum required for
purchase by the Fund. Neither event would require a sale of such
security by the Fund. However, T. Rowe Price Associates, Inc.
("T. Rowe Price") will consider such event in its determination
of whether the Fund should continue to hold the security. To the
extent that the ratings given by Moody's Investors Service, Inc.
("Moody's"), Standard & Poor's Corporation ("S&P"), or Fitch
Investors Service, Inc. ("Fitch") may change as a result of
changes in such organizations or their rating systems, the Fund
will attempt to use comparable ratings as standards for
investments in accordance with the investment policies contained
in the prospectus. When purchasing unrated securities, T. Rowe
Price, under the supervision of the Fund's Board of Directors,
determines whether the unrated security is of a quality
comparable to that which the Fund is allowed to purchase.
PAGE 87
RISK FACTORS
There can be no assurance that the Fund will achieve its
investment objective. Yields on municipal securities are
dependent on a variety of factors, including the general
conditions of the money market and the municipal bond market, the
size of a particular offering, the maturity of the obligation,
and the rating of the issue. Municipal securities with longer
maturities tend to produce higher yields and are generally
subject to potentially greater capital appreciation and
depreciation than obligations with shorter maturities and lower
yields. The market prices of municipal securities usually vary,
depending upon available yields. An increase in interest rates
will generally reduce the value of portfolio investments, and a
decline in interest rates will generally increase the value of
portfolio investments. The ability of the Fund to achieve its
investment objective is also dependent on the continuing ability
of the issuers of municipal securities in which the Fund invests
to meet their obligations for the payment of interest and
principal when due. The ratings of Moody's, S&P, and Fitch
represent their opinions as to the quality of municipal
securities which they undertake to rate. Ratings are not
absolute standards of quality; consequently, municipal securities
with the same maturity, coupon, and rating may have different
yields. There are variations in municipal securities, both
within a particular classification and between classifications,
depending on numerous factors. It should also be pointed out
that, unlike other types of investments, municipal securities
have traditionally not been subject to regulation by, or
registration with, the SEC, although there have been proposals
which would provide for regulation in the future.
The federal bankruptcy statutes relating to the debts of
political subdivisions and authorities of states of the United
States provide that, in certain circumstances, such subdivisions
or authorities may be authorized to initiate bankruptcy
proceedings without prior notice to or consent of creditors,
which proceedings could result in material and adverse changes in
the rights of holders of their obligations.
Proposals have been introduced in Congress to restrict or
eliminate the federal income tax exemption for interest on
municipal securities, and similar proposals may be introduced in
the future. Some of the past proposals would have applied to
interest on municipal securities issued before the date of
enactment, which would have adversely affected their value to a
PAGE 88
material degree. If such a proposal were enacted, the
availability of municipal securities for investment by the Fund
and the value of the Fund's portfolio would be affected and, in
such an event, the Fund would reevaluate its investment objective
and policies.
Although the banks and securities dealers with which the
Fund will transact business will be banks and securities dealers
that T. Rowe Price believes to be financially sound, there can be
no assurance that they will be able to honor their obligations to
the Fund with respect to such securities.
Because of its investment policy, the Fund may or may not be
suitable or appropriate for all investors. The Fund is designed
for investors who wish to invest long-term funds for income, and
who would benefit, because of their tax bracket, from receiving
income that is exempt from federal income taxes. The Fund's
investment program permits the purchase of investment grade
securities. Since investors generally perceive that there are
greater risks associated with investment in lower quality
securities, the yields from such securities normally exceed those
obtainable from higher quality securities. In addition, the
principal value of long term lower-rated securities generally
will fluctuate more widely than higher quality securities. Lower
quality investments entail a higher risk of default--that is, the
nonpayment of interest and principal by the issuer than higher
quality investments. The value of the portfolio securities of
the Intermediate Fund will fluctuate based upon market
conditions. Although the Fund seeks to reduce credit risk by
investing in a diversified portfolio, such diversification does
not eliminate all risk. The Fund is also not intended to provide
a vehicle for short-term trading purposes. Reference is also
made to the sections entitled "Types of Securities" and
"Portfolio Management Practices" for discussions of the risks
associated with the investments and practices described therein
as they apply to the Fund.
Municipal Bond Insurance. The Fund may purchase insured
bonds from time to time. Municipal bond insurance provides an
unconditional and irrevocable guarantee that the insured bond's
principal and interest will be paid when due. The guarantee is
purchased from a private, non-governmental insurance company.
There are two types of insured securities that may be
purchased by the Fund, bonds carrying either (1) new issue
insurance or (2) secondary insurance. New issue insurance is
PAGE 89
purchased by the issuer of a bond in order to improve the bond's
credit rating. By meeting the insurer's standards and paying an
insurance premium based on the bond's principal value, the issuer
is able to obtain a higher credit rating for the bond. Once
purchased, municipal bond insurance cannot be cancelled, and the
protection it affords continues as long as the bonds are
outstanding and the insurer remains solvent.
The Fund may also purchase bonds which carry secondary
insurance purchased by an investor after a bond's original
issuance. Such policies insure a security for the remainder of
its term. Generally, the Fund expects that portfolio bonds
carrying secondary insurance will have been insured by a prior
investor. However, the Fund may, on occasion, purchase secondary
insurance on their own behalf.
Each of the municipal bond insurance companies has
established reserves to cover estimated losses. Both the method
of establishing these reserves and the amount of the reserves
vary from company to company. The obligation of a municipal bond
insurance company may have to pay a claim extends over the life
of each insured bond. Municipal bond insurance companies are
obligated to pay a bond's interest and principal when due if the
issuing entity defaults on the insured bond. Although defaults
on insured municipal bonds have been low to date and municipal
insurers have met these claims. There is no assurance this low
rate will continue in the future. A higher than expected default
rate could deplete loss reserves and adversely affect the ability
of a municipal bond insurer to pay claims to holders of insured
bonds, such as the Fund.
Reference is also made to the sections entitled "Types of
Securities" and "Portfolio Management Practices" for discussions
of the risks associated with the investments and practices
described therein.
INVESTMENT PROGRAM
Types of Securities
Municipal Securities
Subject to the investment objective and program described in
the prospectus and the additional investment restrictions
described in this Statement of Additional Information, the Fund's
PAGE 90
portfolio may consist of any combination of the various types of
municipal securities described below or other types of municipal
securities that may be developed. The amount of the Fund's
assets invested in any particular type of municipal security can
be expected to vary.
The term "municipal securities" means obligations issued by
or on behalf of states, territories, and possessions of the
United States and the District of Columbia and their political
subdivisions, agencies and instrumentalities, as well as certain
other persons and entities, the interest from which is exempt
from federal income tax. In determining the tax-exempt status of
a municipal security, the Fund relies on the opinion of the
issuer's bond counsel at the time of the issuance of the
security. However, it is possible this opinion could be
overturned, and as a result, the interest received by the Fund
from such a security might not be exempt from federal income tax.
Municipal securities are classified by maturity as notes,
bonds, or adjustable rate securities.
Municipal Notes. Municipal notes generally are used to
provide for short-term operating or capital needs and generally
have maturities of one year or less. Municipal notes include:
Tax Anticipation Notes. Tax anticipation notes are issued
to finance working capital needs of municipalities.
Generally, they are issued in anticipation of various
seasonal tax revenue, such as income, property, use and
business taxes, and are payable from these specific future
taxes.
Revenue Anticipation Notes. Revenue anticipation notes are
issued in expectation of receipt of other types of revenue,
such as federal or state revenues available under the
revenue sharing or grant programs.
Bond Anticipation Notes. Bond anticipation notes are issued
to provide interim financing until long-term financing can
be arranged. In most cases, the long-term bonds then
provide the money for the repayment of the notes.
PAGE 91
Tax-Exempt Commercial Paper. Tax-exempt commercial paper is
a short-term obligation with a stated maturity of 270 days
or less. It is issued by state and local governments or
their agencies to finance seasonal working capital needs or
as short-term financing in anticipation of longer term
financing.
Municipal Bonds. Municipal bonds, which meet longer term
capital needs and generally have maturities of more than one year
when issued, have two principal classifications: general
obligation bonds and revenue bonds. Two additional categories of
potential purchases are lease revenue bonds and pre-
refunded/escrowed to maturity bonds. Another type of municipal
bond is referred to as an Industrial Development Bond.
General Obligation Bonds. Issuers of general obligation
bonds include states, counties, cities, towns, and special
districts. The proceeds of these obligations are used to
fund a wide range of public projects, including construction
or improvement of schools, public buildings, highways and
roads, and general projects not supported by user fees or
specifically identified revenues. The basic security behind
general obligation bonds is the issuer's pledge of its full
faith and credit and taxing power for the payment of
principal and interest. The taxes that can be levied for
the payment of debt service may be limited or unlimited as
to the rate or amount of special assessments. In many cases
voter approval is required before an issuer may sell this
type of bond.
Revenue Bonds. The principal security for a revenue bond is
generally the net revenues derived from a particular
facility, or enterprise, or in some cases, the proceeds of a
special charge or other pledged revenue source. Revenue
bonds are issued to finance a wide variety of capital
projects including: electric, gas, water and sewer systems;
highways, bridges, and tunnels; port and airport facilities;
colleges and universities; and hospitals. Revenue bonds are
sometimes used to finance various privately operated
facilities provided they meet certain tests established for
tax-exempt status.
PAGE 92
Although the principal security behind these bonds
may vary, many provide additional security in the form
of a mortgage or debt service reserve fund. Some
authorities provide further security in the form of the
state's ability (without obligation) to make up
deficiencies in the debt service reserve fund. Revenue
bonds usually do not require prior voter approval
before they may be issued.
Lease Revenue Bonds. Municipal borrowers may also
finance capital improvements or purchases with
tax-exempt leases. The security for a lease is
generally the borrower's pledge to make annual
appropriations for lease payments. The lease payment
is treated as an operating expense subject to
appropriation risk and not a full faith and credit
obligation of the issuer. Lease revenue bonds are
generally considered less secure than a general
obligation or revenue bond and often do not include a
debt service reserve fund. To the extent the Fund's
Board determines such securities are illiquid, they
will be subject to the Fund's limit on illiquid
securities. There have also been certain legal
challenges to the use of lease revenue bonds in various
states.
The liquidity of such securities will be determined
based on a variety of factors which may include, among
others: (1) the frequency of trades and quotes for the
obligation; (2) the number of dealers willing to
purchase or sell the security and the number of other
potential buyers; (3) the willingness of dealers to
undertake to make a market in the security; (4) the
nature of the marketplace trades, including, the time
needed to dispose of the security, the method of
soliciting offers, and the mechanics of transfer; and
(5) the rating assigned to the obligation by an
established rating agency or T. Rowe Price.
The Fund does not expect to invest more than 20% of its
total assets in these securities.
PAGE 93
Pre-refunded/Escrowed to Maturity Bonds. Certain
municipal bonds have been refunded with a later bond
issue from the same issuer. The proceeds from the
later issue are used to defease the original issue. In
many cases the original issue cannot be redeemed or
repaid until the first call date or original maturity
date. In these cases, the refunding bond proceeds
typically are used to buy U.S. Treasury securities that
are held in an escrow account until the original call
date or maturity date. The original bonds then become
"pre-refunded" or "escrowed to maturity" and are
considered as high quality investments. While still
tax-exempt, the security is the proceeds of the escrow
account. To the extent permitted by the Securities and
Exchange Commission and the Internal Revenue
Service, the Fund's investment in such securities
refunded with U.S. Treasury securities will, for
purposes of diversification rules applicable to the
Fund, be considered as an investment in the U.S.
Treasury securities.
Private Activity Bonds. Under current tax law all
municipal debt is divided broadly into two groups:
governmental purpose bonds and private activity bonds.
Governmental purpose bonds are issued to finance
traditional public purpose projects such as public
buildings and roads. Private activity bonds may be
issued by a state or local government or public
authority but principally benefit private users and are
considered taxable unless a specific exemption is
provided.
The tax code currently provides exemptions for
certain private activity bonds such as not-for-profit
hospital bonds, small-issue industrial development
revenue bonds and mortgage subsidy bonds, which may
still be issued as tax-exempt bonds. Some, but not
all, private activity bonds are subject to alternative
minimum tax.
PAGE 94
Industrial Development Bonds. Industrial development
bonds are considered Municipal Bonds if the interest
paid is exempt from federal income tax. They are
issued by or on behalf of public authorities to raise
money to finance various privately operated facilities
for business and manufacturing, housing, sports, and
pollution control. These bonds are also used to
finance public facilities such as airports, mass
transit systems, ports, and parking. The payment of the
principal and interest on such bonds is dependent
solely on the ability of the facility's user to meet
its financial obligations and the pledge, if any, of
real and personal property so financed as security for
such payment.
Adjustable Rate Securities. Municipal securities may
be issued with adjustable interest rates that are reset
periodically by pre-determined formulas or indexes in order to
minimize movements in the principal value of the investment.
Such securities may have long-term maturities, but may be treated
as a short-term investment under certain conditions. Generally,
as interest rates decrease or increase, the potential for capital
appreciation or depreciation on these securities is less than for
fixed-rate obligations. These securities may take the following
forms:
Variable Rate Securities. Variable rate
instruments are those whose terms provide for the
adjustment of their interest rates on set dates and
which, upon such adjustment, can reasonably be
expected to have a market value that approximates
its par value. A variable rate instrument, the
principal amount of which is scheduled to be paid
in 397 days or less, is deemed to have a maturity
equal to the period remaining until the next
readjustment of the interest. A variable rate
instrument which is subject to a demand feature
which entitles the purchaser to receive the
principal amount of the underlying security or
securities either (i) upon notice of usually 30
days, or (ii), at specified intervals not exceeding
397 days and upon no more than 30 days notice is
deemed to have a maturity equal to the longer of
the period remaining until the next readjustment of
the interest rate or the period remaining until the
principal amount can be recovered through demand.
PAGE 95
An instrument that is issued or guaranteed by the
U.S. government or any agency thereof which has a
variable rate of interest readjusted no less
frequently than every 762 days may be deemed to
have a maturity equal to the period remaining until
the next readjustment of the interest rate.
Floating Rate Securities. Floating rate
instruments are those whose terms provide for the
adjustment of their interest rates whenever a
specified interest rate changes and which, at any
time, can reasonably be expected to have a market
value that approximates its par value. The
maturity of a floating rate instrument is deemed to
be the period remaining until the date (noted on
the face of the instrument) on which the principal
amount must be paid, or in the case of an
instrument called for redemption, the date on which
the redemption payment must be made.
Floating rate instruments with demand features
are deemed to have a maturity equal to the period
remaining until the principal amount can be
recovered through demand.
Put Option Bonds. Long-term obligations with
maturities longer than one year may provide
purchasers an optional or mandatory tender of the
security at par value at predetermined intervals,
often ranging from one month to several years
(e.g., a 30-year bond with a five-year tender
period). These instruments are deemed to have a
maturity equal to the period remaining to the put
date.
Residual Interest Bonds. The Fund may purchase
municipal bond issues that are structured as two-
part, residual interest bond and variable rate
security offerings. The issuer is obligated only
to pay a fixed amount of tax-free income that is to
be divided among the holders of the two securities.
The interest rate for the holders of the variable
rate securities will be determined by an index or
auction process normally every seven to 35 days
while the bond holders will receive all interest
paid by the issuer minus the amount given to the
PAGE 96
variable rate security holders and a nominal
auction fee. Therefore, the coupon of the residual
interest bonds, and thus the income received, will
move inversely with respect to short-term, seven to
35 day tax-exempt interest rates. There is no
assurance that the auction will be successful and
that the variable rate security will provide short-
term liquidity. The issuer is not obligated to
provide such liquidity. In general, these
securities offer a significant yield advantage over
standard municipal securities, due to the
uncertainty of the shape of the yield curve (i.e.,
short term versus long term rates) and consequent
income flows.
Unlike many adjustable rate securities, residual
interest bonds are not necessarily expected to
trade at par and in fact present significant market
risks. In certain market environments, residual
interest bonds may carry substantial premiums or be
at deep discounts. This is a relatively new
product in the municipal market with limited
liquidity to date.
The Fund will not invest more than 5% of its total
assets in these instruments.
Participation Interests. The Fund may purchase
from third parties participation interests in all
or part of specific holdings of municipal
securities. The purchase may take different forms:
in the case of short-term securities, the
participation may be backed by a liquidity facility
that allows the interest to be sold back to the
third party (such as a trust, broker or bank) for a
predetermined price of par at stated intervals.
The seller may receive a fee from the Fund in
connection with the arrangement.
In the case of longer term bonds, the Fund may
purchase interests in a pool of municipal bonds or
a single municipal bond or lease without the right
to sell the interest back to the third party.
PAGE 97
The Fund will not purchase participation
interests unless a satisfactory opinion of counsel
or ruling of the Internal Revenue Service has been
issued that the interest earned from the municipal
securities on which the Fund holds participation
interests is exempt from federal income tax to the
Fund. However, there is no guarantee the IRS would
treat such interest income as tax-exempt.
The Fund will not invest more than 5% of its
total assets in these instruments.
Embedded Interest Rate Swaps and Caps. In a fixed-
rate, long-term municipal bond with an interest
rate swap attached to it, the bondholder usually
receives the bond's fixed-coupon payment as well as
a variable rate payment that represents the
difference between a fixed rate for the term of the
swap (which is typically shorter than the bond it
is attached to) and a variable rate short-term
municipal index. The bondholder receives excess
income when short-term rates remain below the fixed
interest rate swap rate. If short-term rates rise
above the fixed-income swap rate, the bondholder's
income is reduced. At the end of the interest rate
swap term, the bond reverts to a single fixed-
coupon payment. Embedded interest rate swaps
enhance yields, but also increase interest rate
risk.
An embedded interest rate cap allows the
bondholder to receive payments whenever short-term
rates rise above a level established at the time of
purchase. They normally are used to hedge against
rising short-term interest rates.
Both instruments may be volatile and of limited
liquidity and their use may adversely affect a
fund's total return.
The Fund will not invest more than 5% of its
total assets in these instruments.
The Fund may invest in other types of derivative
instruments as they become available
PAGE 98
There are, of course, other types of municipal securities
that are, or may become, available, and the Fund reserves the
right to invest in them.
For the purpose of the Fund's investment restrictions set
forth beginning on page 23, the identification of the "issuer" of
municipal securities which are not general obligation bonds is
made by the Fund's investment manager, T. Rowe Price, on the
basis of the characteristics of the obligation as described
above, the most significant of which is the source of funds for
the payment of principal and interest on such securities.
When-Issued Securities
The Fund may invest without limitation in when-issued
securities.
New issues of municipal securities are often offered on a
when-issued basis; that is, delivery and payment for the
securities normally takes place 15 to 45 days or more after the
date of the commitment to purchase. The payment obligation and
the interest rate that will be received on the securities are
each fixed at the time the buyer enters into the commitment. The
Fund will only make a commitment to purchase such securities with
the intention of actually acquiring the securities. However, the
Fund may sell these securities before the settlement date if it
is deemed advisable as a matter of investment strategy. The Fund
will maintain cash and/or high-grade marketable debt securities
with its custodian bank equal in value to commitments for
when-issued securities. Such securities either will mature or,
if necessary, be sold on or before the settlement date.
Securities purchased on a when-issued basis and the securities
held in a Fund's portfolio are subject to changes in market value
based upon the public perception of the creditworthiness of the
issuer and changes in the level of interest rates (which will
generally result in similar changes in value; i.e., both
experiencing appreciation when interest rates decline and
depreciation when interest rates rise). Therefore, to the extent
the Fund remains fully invested or almost fully invested at the
same time that it has purchased securities on a when-issued
basis, there will be greater fluctuations in its net asset value
than if it solely set aside cash to pay for when-issued
securities. In addition, there will be a greater potential for
the realization of capital gains, which are not exempt from
federal income tax. When the time comes to pay for when-issued
PAGE 99
securities, the Fund will meet its obligations from
then-available cash flow, sale of securities or, although it
would not normally expect to do so, from sale of the when-issued
securities themselves (which may have a value greater or less
than the payment obligation). The policies described in this
paragraph are not fundamental and may be changed by the Fund upon
notice to its shareholders.
Forwards
The Fund may purchase bonds on a when-issued basis with
longer than standard settlement dates, in some cases exceeding
one to two years. In such cases, the Fund must execute a receipt
evidencing the obligation to purchase the bond on the specified
issue date, and must segregate cash internally to meet that
forward commitment. Municipal "forwards" typically carry a
substantial yield premium to compensate the buyer for the risks
associated with a long when-issued period, including: shifts in
market interest rates that could materially impact the principal
value of the bond, deterioration in the credit quality of the
issuer, loss of alternative investment options during the when-
issued period, changes in tax law or issuer actions that would
affect the exempt interest status of the bonds and prevent
delivery, failure of the issuer to complete various steps
required to issue the bonds, and limited liquidity for the buyer
to sell the escrow receipts during the when-issued period.
Investment in Taxable Money Market Securities
The Fund will not invest more than 10% of its total assets
in these securities.
Although the Fund expects to be solely invested in municipal
securities, for temporary defensive purposes, it may elect to
invest in the taxable money market securities listed below
(without limitation) when such action is deemed to be in the best
interests of shareholders. The interest earned on these money
market securities is not exempt from federal income tax and may
be taxable to shareholders as ordinary income.
U.S. Government Obligations - direct obligations of the
government and its agencies and instrumentalities;
U.S. Government Agency Securities - obligations issued or
guaranteed by U.S. government sponsored enterprises, federal
agencies, and international institutions. Some of these
PAGE 100
securities are supported by the full faith and credit of the U.S.
Treasury; others are supported by the right of the issuer; and
the remainder are supported only by the credit of the
instrumentality;
Bank Obligations - certificates of deposit, bankers'
acceptances, and other short-term obligations of U.S. and
Canadian banks and their foreign branches with total assets of $1
billion or more;
Commercial Paper - paper rated A-2 or better by S&P, Prime-2
or better by Moody's, or F-2 or better by Fitch, or, if not
rated, is issued by a corporation having an outstanding debt
issue rated A or better by Moody's, S&P or Fitch; and
Short-Term Corporate Debt Securities - short-term corporate
debt securities rated at least AA by S&P, Moody's or Fitch.
Portfolio Management Practices
Futures Contracts
Transactions in Futures
The Fund may enter into interest rate futures contracts,
("futures" or "futures contracts"). Interest rate futures
contracts may be used as a hedge against changes in prevailing
levels of interest rates in order to establish more definitely
the effective return on securities held or intended to be
acquired by the Fund. The Fund could sell interest rate futures
as an offset against the effect of expected increases in interest
rates and purchase such futures as an offset against the effect
of expected declines in interest rates. Futures can also be used
as an efficient means of regulating a Fund's exposure to the
market.
The Fund will enter into futures contracts which are traded
on national futures exchanges and are standardized as to maturity
date and underlying financial instrument. A public market exists
in futures contracts covering various taxable fixed income
securities as well as municipal bonds. Futures exchanges and
trading in the United States are regulated under the Commodity
Exchange Act by the Commodity Futures Trading Commission
("CFTC"). Although techniques other than the sale and purchase
of futures contracts could be used for the above-referenced
PAGE 101
purposes, futures contracts offer an effective and relatively low
cost means of implementing the Fund's objectives in these areas.
Regulatory Limitations
The Fund will engage in futures contracts and options
thereon only for bona fide hedging, yield enhancement, and risk
management purposes, in each case in accordance with rules and
regulations of the CFTC, and not for speculation.
The Fund may not enter into futures contracts or options
thereon if, with respect to positions which do not qualify as
bona fide hedging under applicable CFTC rules, the sum of the
amounts of initial margin deposits on the Fund's existing futures
and premiums paid for options on futures would exceed 5% of the
net asset value of the Fund after taking into account unrealized
profits and unrealized losses on any such contracts it has
entered into; provided, however, that in the case of an option
that is in-the-money at the time of purchase, the in-the-money
amount may be excluded in calculating the 5% limitation.
The Fund's use of futures will not result in leverage.
Therefore, to the extent necessary, in instances involving the
purchase of futures contracts or call options thereon or the
writing of put options thereon by the Fund, an amount of cash,
U.S. government securities or other liquid, high-grade debt
obligations, equal to the market value of the futures contracts
and options thereon (less any related margin deposits), will be
identified in an account with the Fund's custodian to cover the
position, or alternative cover will be employed.
In addition, CFTC regulations may impose limitations on the
Fund's ability to engage in certain risk management strategies.
If the CFTC or other regulatory authorities adopt different
(including less stringent) or additional restrictions, the Fund
would comply with such new restrictions.
Trading in Futures Contracts
A futures contract provides for the future sale by one party
and purchase by another party of a specified amount of a specific
financial instrument (e.g., units of a debt security) for a
specified price, date, time and place designated at the time the
contract is made. Brokerage fees are incurred when a futures
contract is bought or sold and margin deposits must be
maintained. Entering into a contract to buy is commonly referred
PAGE 102
to as buying or purchasing a contract or holding a long position.
Entering into a contract to sell is commonly referred to as
selling a contract or holding a short position.
It is possible that the Fund's hedging activities will occur
primarily through the use of municipal bond index futures
contracts since the uniqueness of that index contract should
better correlate with the Fund's portfolio and thereby be more
effective. However, there may be times when it is deemed in the
best interest of shareholders to engage in the use of Treasury
bond futures, and the Fund reserves the right to use Treasury
bond futures at any time. Use of these futures could occur, as
an example, when both the Treasury bond contract and municipal
bond index futures contract are correlating well with municipal
bond prices, but the Treasury bond contract is trading at a more
advantageous price making the hedge less expensive with the
Treasury bond contract than would be obtained with the municipal
bond index futures contract. The Fund's activity in futures
contracts generally will be limited to municipal bond index
futures contracts and Treasury bond and not contracts.
Unlike when the Fund purchases or sells a security, no price
would be paid or received by the Fund upon the purchase or sale
of a futures contract. Upon entering into a futures contract,
and to maintain the Fund's open positions in futures contracts,
the Fund would be required to deposit with its custodian in a
segregated account in the name of the futures broker an amount of
cash, U.S. government securities, suitable money market
instruments, or liquid, high-grade debt securities, known as
"initial margin." The margin required for a particular futures
contract is set by the exchange on which the contract is traded,
and may be significantly modified from time to time by the
exchange during the term of the contract. Futures contracts are
customarily purchased and sold on margins that may range upward
from less than 5% of the value of the contract being traded.
If the price of an open futures contract changes (by
increase in the case of a sale or by decrease in the case of a
purchase) so that the loss on the futures contract reaches a
point at which the margin on deposit does not satisfy margin
requirements, the broker will require an increase in the margin.
However, if the value of a position increases because of
favorable price changes in the futures contract so that the
margin deposit exceeds the required margin, the broker will pay
the excess to the Fund.
PAGE 103
These subsequent payments, called "variation margin," to and
from the futures broker, are made on a daily basis as the price
of the underlying assets fluctuate making the long and short
positions in the futures contract more or less valuable, a
process known as "marking to the market." The Fund expects to
earn interest income on its margin deposits.
Although certain futures contracts, by their terms, require
actual future delivery of and payment for the underlying
instruments in practice most futures contracts are usually closed
out before the delivery date. Closing out an open futures
contract purchase or sale is effected by entering into an
offsetting futures contract purchase or sale, respectively, for
the same aggregate amount of the identical securities and the
same delivery date. If the offsetting purchase price is less
than the original sale price, the Fund realizes a gain; if it is
more, the Fund realizes a loss. Conversely, if the offsetting
sale price is more than the original purchase price, the Fund
realizes a gain; if it is less, the Fund realizes a loss. The
transaction costs must also be included in these calculations.
There can be no assurance, however, that the Fund will be able to
enter into an offsetting transaction with respect to a particular
futures contract at a particular time. If the Fund is not able
to enter into an offsetting transaction, the Fund will continue
to be required to maintain the margin deposits on the futures
contract.
As an example of an offsetting transaction in which the
underlying instrument is not delivered, the contractual
obligations arising from the sale of one contract of September
municipal bond index futures on an exchange may be fulfilled at
any time before delivery of the contract is required (i.e., on a
specified date in September, the "delivery month") by the
purchase of one contract of September municipal bond index
futures on the same exchange. In such instance, the difference
between the price at which the futures contract was sold and the
price paid for the offsetting purchase, after allowance for
transaction costs, represents the profit or loss to the Fund.
Special Risks of Transactions in Futures Contracts
Volatility and Leverage. The prices of futures contracts
are volatile and are influenced, among other things, by actual
and anticipated changes in the market and interest rates, which
in turn are affected by fiscal and monetary policies and national
PAGE 104
and international political and economic events.
Most United States futures exchanges limit the amount of
fluctuation permitted in futures contract prices during a single
trading day. The daily limit establishes the maximum amount that
the price of a futures contract may vary either up or down from
the previous day's settlement price at the end of a trading
session. Once the daily limit has been reached in a particular
type of futures contract, no trades may be made on that day at a
price beyond that limit. The daily limit governs only price
movement during a particular trading day and therefore does not
limit potential losses, because the limit may prevent the
liquidation of unfavorable positions. Futures contract prices
have occasionally moved to the daily limit for several
consecutive trading days with little or no trading, thereby
preventing prompt liquidation of futures positions and subjecting
some futures traders to substantial losses.
Because of the low margin deposits required, futures trading
involves an extremely high degree of leverage. As a result, a
relatively small price movement in a futures contract may result
in immediate and substantial loss, as well as gain, to the
investor. For example, if at the time of purchase, 10% of the
value of the futures contract is deposited as margin, a
subsequent 10% decrease in the value of the futures contract
would result in a total loss of the margin deposit, before any
deduction for the transaction costs, if the account were then
closed out. A 15% decrease would result in a loss equal to 150%
of the original margin deposit, if the contract were closed out.
Thus, a purchase or sale of a futures contract may result in
losses in excess of the amount invested in the futures contract.
However, the Fund would presumably have sustained comparable
losses if, instead of the futures contract, it had invested in
the underlying financial instrument and sold it after the
decline. Furthermore, in the case of a futures contract
purchase, in order to be certain that the Fund has sufficient
assets to satisfy its obligations under a futures contract, the
Fund earmarks to the futures contract money market instruments
equal in value to the current value of the underlying instrument
less the margin deposit.
Liquidity. The Fund may elect to close some or all of its
futures positions at any time prior to their expiration. The
Fund would do so to reduce exposure represented by long futures
positions or increase exposure represented by short futures
PAGE 105
positions. The Fund may close its positions by taking opposite
positions which would operate to terminate the Fund's position in
the futures contracts. Final determinations of variation margin
would then be made, additional cash would be required to be paid
by or released to the Fund, and the Fund would realize a loss or
a gain.
Futures contracts may be closed out only on the exchange or
board of trade where the contracts were initially traded.
Although the Fund intends to purchase or sell futures contracts
only on exchanges or boards of trade where there appears to be an
active market, there is no assurance that a liquid market on an
exchange or board of trade will exist for any particular contract
at any particular time. In such event, it might not be possible
to close a futures contract, and in the event of adverse price
movements, the Fund would continue to be required to make daily
cash payments of variation margin. However, in the event futures
contracts have been used to hedge the underlying instruments, the
Fund would continue to hold the underlying instruments subject to
the hedge until the futures contracts could be terminated. In
such circumstances, an increase in the price of underlying
instruments, if any, might partially or completely offset losses
on the futures contract. However, as described below, there is
no guarantee that the price of the underlying instruments will,
in fact, correlate with the price movements in the futures
contract and thus provide an offset to losses on a futures
contract.
Hedging Risk. A decision of whether, when, and how to hedge
involves skill and judgment, and even a well-conceived hedge may
be unsuccessful to some degree because of unexpected market
behavior, market or interest rate trends. There are several
risks in connection with the use by the Fund of futures contracts
as a hedging device. One risk arises because of the imperfect
correlation between movements in the prices of the futures
contracts and movements in the prices of the underlying
instruments which are the subject of the hedge. T. Rowe Price
will, however, attempt to reduce this risk by entering into
futures contracts whose movements, in its judgment, will have a
significant correlation with movements in the prices of the
Fund's underlying instruments sought to be hedged.
Successful use of futures contracts by the Fund for hedging
purposes is also subject to T. Rowe Price's ability to correctly
predict movements in the direction of the market. It is possible
that, when the Fund has sold futures to hedge its portfolio
PAGE 106
against a decline in the market, the index, indices, or
underlying instruments on which the futures are written might
advance and the value of the underlying instruments held in the
Fund's portfolio might decline. If this were to occur, the Fund
would lose money on the futures and also would experience a
decline in value in its underlying instruments. However, while
this might occur to a certain degree, T. Rowe Price believes that
over time the value of the Fund's portfolio will tend to move in
the same direction as the market indices which are intended to
correlate to the price movements of the underlying instruments
sought to be hedged. It is also possible that if the Fund were
to hedge against the possibility of a decline in the market
(adversely affecting the underlying instruments held in its
portfolio) and prices instead increased, the Fund would lose part
or all of the benefit of increased value of those underlying
instruments that it has hedged, because it would have offsetting
losses in its futures positions. In addition, in such
situations, if the Fund had insufficient cash, it might have to
sell underlying instruments to meet daily variation margin
requirements. Such sales of underlying instruments might be, but
would not necessarily be, at increased prices (which would
reflect the rising market). The Fund might have to sell
underlying instruments at a time when it would be disadvantageous
to do so.
In addition to the possibility that there might be an
imperfect correlation, or no correlation at all, between price
movements in the futures contracts and the portion of the
portfolio being hedged, the price movements of futures contracts
might not correlate perfectly with price movements in the
underlying instruments due to certain market distortions. First,
all participants in the futures market are subject to margin
deposit and maintenance requirements. Rather than meeting
additional margin deposit requirements, investors might close
futures contracts through offsetting transactions which could
distort the normal relationship between the underlying
instruments and futures markets. Second, the margin requirements
in the futures market are less onerous than margin requirements
in the securities markets, and as a result the futures market
might attract more speculators than the securities markets do.
Increased participation by speculators in the futures market
might also cause temporary price distortions. Due to the
possibility of price distortion in the futures market and also
because of the imperfect correlation between price movements in
the underlying instruments and movements in the prices of futures
contracts, even a correct forecast of general market trends by T.
PAGE 107
Rowe Price might not result in a successful hedging transaction
over a very short time period.
Options on Futures Contracts
The Fund might trade in municipal bond index option futures
or similar options on futures developed in the future. In
addition, the Fund may also trade in options on futures contracts
on U.S. government securities and any U.S. government securities
futures index contract which might be developed. In the opinion
of T. Rowe Price, there is a high degree of correlation in the
interest rate, and price movements of U.S. government securities
and municipal securities. However, the U.S. government
securities market and municipal securities markets are
independent and may not move in tandem at any point in time.
The Fund will purchase put options on futures contracts to
hedge its portfolio of municipal securities against the risk of
rising interest rates, and the consequent decline in the prices
of the municipal securities it owns. The Funds will also write
call options on futures contracts as a hedge against a modest
decline in prices of the municipal securities held in the Fund's
portfolio. If the futures price at expiration of a written call
option is below the exercise price, the Fund will retain the full
amount of the option premium, thereby partially hedging against
any decline that may have occurred in the Fund's holdings of debt
securities. If the futures price when the option is exercised is
above the exercise price, however, the Fund will incur a loss,
which may be wholly or partially offset by the increase of the
value of the securities in the Fund's portfolio which were being
hedged.
Writing a put option on a futures contract serves as a
partial hedge against an increase in the value of securities the
Fund intends to acquire. If the futures price at expiration of
the option is above the exercise price, the Fund will retain the
full amount of the option premium which provides a partial hedge
against any increase that may have occurred in the price of the
debt securities the Fund intends to acquire. If the futures
price when the option is exercised is below the exercise price,
however, the Fund will incur a loss, which may be wholly or
partially offset by the decrease in the price of the securities
the Fund intends to acquire.
PAGE 108
Options on futures are similar to options on underlying
instruments except that options on futures give the purchaser the
right, in return for the premium paid, to assume a position in a
futures contract (a long position if the option is a call and a
short position if the option is a put), rather than to purchase
or sell the futures contract, at a specified exercise price at
any time during the period of the option. Upon exercise of the
option, the delivery of the futures position by the writer of the
option to the holder of the option will be accompanied by
delivery of the accumulated balance in the writer's futures
margin account which represents the amount by which the market
price of the futures contract, at exercise, exceeds (in the case
of a call) or is less than (in the case of a put) the exercise
price of the option on the futures contract. Alternatively,
settlement may be made totally in cash. Purchasers of options
who fail to exercise their options prior to the exercise date
suffer a loss of the premium paid.
From time to time a single order to purchase or sell futures
contracts (or options thereon) may be made on behalf of the Fund
and other T. Rowe Price Funds. Such aggregated orders would be
allocated among the Fund and the other T. Rowe Price Funds in a
fair and non-discriminatory manner.
Special Risks of Transactions in Options on Futures Contracts
The Fund may seek to close out an option position by writing
or buying an offsetting option covering the same index,
underlying instrument or contract and having the same exercise
price and expiration date. The ability to establish and close
out positions on such options will be subject to the maintenance
of a liquid secondary market. Reasons for the absence of a
liquid secondary market on an exchange include the following: (i)
there may be insufficient trading interest in certain options;
(ii) restrictions may be imposed by an exchange on opening
transactions or closing transactions or both; (iii) trading
halts, suspensions or other restrictions may be imposed with
respect to particular classes or series of options, or underlying
instruments; (iv) unusual or unforeseen circumstances may
interrupt normal operations on an exchange; (v) the facilities of
an exchange or a clearing corporation may not at all times be
adequate to handle current trading volume; or (vi) one or more
exchanges could, for economic or other reasons, decide or be
compelled at some future date to discontinue the trading of
options (or a particular class or series of options), in which
PAGE 109
event the secondary market on that exchange (or in the class or
series of options) would cease to exist, although outstanding
options on the exchange that had been issued by a clearing
corporation as a result of trades on that exchange would continue
to be exercisable in accordance with their terms. There is no
assurance that higher than anticipated trading activity or other
unforeseen events might not, at times, render certain of the
facilities of any of the clearing corporations inadequate, and
thereby result in the institution by an exchange of special
procedures which may interfere with the timely execution of
customers' orders. In the event no such market exists for a
particular contract in which the Fund maintains a position, in
the case of a written option, the Fund would have to wait to sell
the underlying securities or futures positions until the option
expires or is exercised. The Fund would be required to maintain
margin deposits on payments until the contract is closed.
Options on futures are treated for accounting purposes in the
same way as the analogous option on securities are treated.
In addition, the correlation between movements in the price
of options on futures contracts and movements in the price of the
securities hedged can only be approximate. This risk is
significantly increased when an option on a U.S. government
securities future or an option on a municipal securities index
future is used to hedge a municipal bond portfolio. Another risk
is that the movements in the price of options on futures
contracts may not move inversely with changes in interest rates.
If the Fund has written a call option on a futures contract and
the value of the call increases by more than the increase in the
value of the securities held as cover, the Fund may realize a
loss on the call which is not completely offset by the
appreciation in the price of the securities held as cover and the
premium received for writing the call.
The successful use of options on futures contracts requires
special expertise and techniques different from those involved in
portfolio securities transactions. A decision of whether, when
and how to hedge involves skill and judgment, and even a well-
conceived hedge may be unsuccessful to some degree because of
unexpected market behavior or interest rate trends. During
periods when municipal securities market prices are appreciating,
the Fund may experience poorer overall performance than if it had
not entered into any options on futures contracts.
General Considerations
PAGE 110
Transactions by the Fund in options on futures will be
subject to limitations established by each of the exchanges,
boards of trade or other trading facilities governing the maximum
number of options in each class which may be written or purchased
by a single investor or group of investors acting in concert,
regardless of whether the options are written on the same or
different exchanges, boards of trade or other trading facilities
or are held or written in one or more accounts or through one or
more brokers. Thus, the number of contracts which the Fund may
write or purchase may be affected by contracts written or
purchased by other investment advisory clients of T. Rowe Price.
An exchange, board of trade or other trading facility may order
the liquidations of positions found to be in excess of these
limits, and it may impose certain other sanctions.
Additional Futures and Options Contracts
Although the Fund has no current intention of engaging in
futures or options on futures transactions other than those
described above, it reserves the right to do so. Such futures
and options trading might involve risks which differ from those
involved in the futures and options described above.
The Fund has no current intention of investing in options on
securities, although it reserves the right to do so. Appropriate
disclosure would be added to the Fund's prospectus and Statement
of Additional Information when and if the Fund decides to invest
in options.
Federal Tax Treatment of Futures Contracts
Although the Fund invests almost exclusively in securities
which generate income which is exempt from federal income taxes,
the instruments described above are not exempt from such taxes.
Therefore, use of the investment techniques described above could
result in taxable income to shareholders of the Fund.
Generally, the Fund is required, for federal income tax
purposes, to recognize as income for each taxable year its net
unrealized gains and losses on futures contracts as of the end of
the year as well as those actually realized during the year.
Gain or loss recognized with respect to a futures contract will
generally be 60% long-term capital gain or loss and 40% short-
term capital gain or loss, without regard to the holding period
of the contract.
PAGE 111
Futures contracts which are intended to hedge against a
change in the value of securities may be classified as "mixed
straddles," in which case the recognition of losses may be
deferred to a later year. In addition, sales of such futures
contracts on securities may affect the holding period of the
hedged security and, consequently, the nature of the gain or loss
on such security on disposition.
In order for the Fund to continue to qualify for federal
income tax treatment as a regulated investment company, at least
90% of its gross income for a taxable year must be derived from
qualifying income; i.e., dividends, interest, income derived from
loans of securities, and gains from the sale of securities.
Gains realized on the sale or other disposition of securities,
including futures contracts on securities, held for less than
three months, must be limited to less than 30% of the Fund's
annual gross income. In order to avoid realizing excessive gains
on securities held less than three months, the Fund may be
required to defer the closing out of futures contracts beyond the
time when it would otherwise be advantageous to do so. It is
anticipated that unrealized gains on futures contracts, which
have been open for less than three months as of the end of the
Fund's fiscal year and which are recognized for tax purposes,
will not be considered gains on securities or currencies held
less than three months for purposes of the 30% test.
The Fund will distribute to shareholders annually any net
gains which have been recognized for federal income tax purposes
from futures transactions (including unrealized gains at the end
of the Fund's fiscal year). Such distributions will be combined
with distributions of ordinary income or capital gains realized
on the Fund's other investments. Shareholders will be advised of
the nature of the payments. The Fund's ability to enter into
transactions in options on futures contracts may be limited by
the Internal Revenue Code's requirements for qualification as a
regulated investment company.
INVESTMENT RESTRICTIONS
Fundamental policies may not be changed without the approval
of the lesser of (1) 67% of the Fund's shares present at a
meeting of shareholders if the holders of more than 50% of the
outstanding shares are present in person or by proxy or (2) more
than 50% of the Fund's outstanding shares. Other restrictions in
the form of operating policies are subject to change by the
PAGE 112
Fund's Board of Directors without shareholder approval. Any
investment restriction which involves a maximum percentage of
securities or assets shall not be considered to be violated
unless an excess over the percentage occurs immediately after,
and is caused by, an acquisition of securities or assets of, or
borrowings by, the Fund.
Fundamental Policies
As a matter of fundamental policy, during periods of normal
market conditions, the Fund will not purchase any security if, as
a result, less than 80% of the Fund's income would be exempt from
federal income tax. The income derived from securities subject
to the alternative minimum tax does not count toward meeting this
80% test.
As a matter of fundamental policy, the Fund may not:
(1) Borrowing. Borrow money except that the Fund may
(i) borrow for non-leveraging, temporary or
emergency purposes and (ii) engage in reverse
repurchase agreements and make other investments
or engage in other transactions, which may involve
a borrowing, in a manner consistent with the
Fund's investment objective and program, provided
that the combination of (i) and (ii) shall not
exceed 33 1/3% of the value of the Fund's total
assets (including the amount borrowed) less
liabilities (other than borrowings) or such other
percentage permitted by law. Any borrowings which
come to exceed this amount will be reduced in
accordance with applicable law. The Fund may
borrow from banks, other Price Funds or other
persons to the extent permitted by applicable law;
(2) Commodities. Purchase or sell physical
commodities; except that it may enter into futures
contracts and options thereon;
(3) Equity Securities. Purchase equity securities, or
securities convertible into equity securities;
PAGE 113
(4) Industry Concentration. Purchase the securities
of any issuer if, as a result, more than 25% of
the value of the Fund's total assets would be
invested in the securities of issuers having their
principal business activities in the same
industry;
(5) Loans. Make loans, although the Fund may (i) lend
portfolio securities and participate in an
interfund lending program with other Price Funds
provided that no such loan may be made if, as a
result, the aggregate of such loans would exceed
33 1/3% of the value of the Fund's total assets;
(ii) purchase money market securities and enter
into repurchase agreements; and (iii) acquire
publicly-distributed or privately-placed debt
securities and purchase debt;
(6) Percent Limit on Assets Invested in Any One
Issuer. Purchase a security if, as a result, with
respect to 75% of the value of its total assets,
more than 5% of the value of the Fund's total
assets would be invested in the securities of a
single issuer, except securities issued or
guaranteed by the U.S. Government or any of its
agencies or instrumentalities;
(7) Percent Limit on Share Ownership of Any One
Issuer. Purchase a security if, as a result, with
respect to 75% of the value of the Fund's total
assets, more than 10% of the outstanding voting
securities of any issuer would be held by the Fund
(other than obligations issued or guaranteed by
the U.S. Government, its agencies or
instrumentalities);
(8) Real Estate. Purchase or sell real estate unless
acquired as a result of ownership of securities or
other instruments (but this shall not prevent the
Fund from investing in securities or other
instruments backed by real estate or securities of
companies engaged in the real estate business);
(9) Senior Securities. Issue senior securities except
in compliance with the Investment Company Act of
1940; or
PAGE 114
(10) Underwriting. Underwrite securities issued by
other persons, except to the extent that the Fund
may be deemed to be an underwriter within the
meaning of the Securities Act of 1933 in
connection with the purchase and sale of its
portfolio securities in the ordinary course of
pursuing its investment program.
With respect to investment restrictions (1) and (5), the
Fund will not borrow from or lend to any other Price
Fund (defined as any other mutual fund managed or for
which T. Rowe Price acts as adviser) unless they apply
for and receive an exemptive order from the SEC or the
SEC issues rules permitting such transactions. The Fund
has no current intention of engaging in any such
activity and there is no assurance the SEC would grant
any order requested by the Fund or promulgate any rules
allowing the transactions.
For purposes of investment restriction (4), U.S., state
or local governments, or related agencies or
instrumentalities, are not considered an industry.
For purposes of investment restriction (6), the Fund
will treat bonds which are refunded with escrowed U.S.
government securities as U.S. government securities.
Operating Policies
As a matter of operating policy, the Fund may not:
(1) Borrowing. The Fund will not purchase additional
securities when money borrowed exceeds 5% of its
total assets;
(2) Control of Portfolio Companies. Invest in
companies for the purpose of exercising management
or control;
(3) Futures Contracts. Purchase a futures contract or
an option thereon if, with respect to positions in
futures or options on futures which do not
represent bona fide hedging, the aggregate initial
margin and premiums on such positions would exceed
5% of the Fund's net asset value;
PAGE 115
(4) Illiquid Securities. Purchase illiquid securities
and securities of unseasoned issuers if, as a
result, more than 15% of its net assets would be
invested in such securities, provided that the
Fund will not invest more than 5% of its total
assets in restricted securities and not more than
5% in securities of unseasoned issuers.
Securities eligible for resale under Rule 144A of
the Securities Act of 1933 are not included in the
5% limitation but are subject to the 15%
limitation;
(5) Investment Companies. Purchase securities of
open-end or closed-end investment companies except
in compliance with the Investment Company Act of
1940 and applicable state law. Duplicate fees may
result from such purchases;
(6) Margin. Purchase securities on margin, except (i)
for use of short-term credit necessary for
clearance of purchases of portfolio securities and
(ii) it may make margin deposits in connection
with futures contracts or other permissible
investments;
(7) Mortgaging. Mortgage, pledge, hypothecate or, in
any manner, transfer any security owned by the
Fund as security for indebtedness except as may be
necessary in connection with permissible
borrowings or investments and then such
mortgaging, pledging or hypothecating may not
exceed 33 1/3% of the Fund's total assets at the
time of borrowing or investment;
(8) Oil and Gas Programs. Purchase participations or
other direct interests in or enter into leases
with respect to, oil, gas, or other mineral
exploration or development programs;
(9) Options, Etc. Invest in puts, calls, straddles,
spreads, or any combination thereof, except to the
extent permitted by the prospectus and Statement
of Additional Information;
PAGE 116
(10) Ownership of Portfolio Securities by Officers and
Directors. Purchase or retain the securities of
any issuer if, to the knowledge of the Fund's
management, those officers and directors of the
Fund, and of its investment manager, who each owns
beneficially more than .5% of the outstanding
securities of such issuer, together own
beneficially more than 5% of such securities;
(11) Short Sales. Effect short sales of securities;
(12) Unseasoned Issuers. Purchase a security (other
than obligations issued or guaranteed by the U.S.,
any foreign, state or local government, their
agencies or instrumentalities) if, as a result,
more than 5% of the value of the Fund's total
assets would be invested in the securities of
issuers which at the time of purchase had been in
operation for less than three years (for this
purpose, the period of operation of any issuer
shall include the period of operation of any
predecessor or unconditional guarantor of such
issuer). This restriction does not apply to
securities of pooled investment vehicles or
mortgage or asset-backed securities; or
(13) Warrants. Invest in warrants, if, as a result
thereof, more than 2% of the value of the total
assets of the Fund would be invested in warrants
which are not listed on the New York Stock
Exchange, the American Stock Exchange, or a
recognized foreign exchange, or more than 5% of
the value of the total assets of the Fund would be
invested in warrants whether or not so listed.
For purposes of these percentage limitations, the
warrants will be valued at the lower of cost or
market and warrants acquired by the Funds in units
or attached to securities may be deemed to be
without value.
With respect to investment restriction (5), the Fund has
no current intention of purchasing the securities of
other investment companies.
Notwithstanding anything in the above fundamental and
operating restrictions to the contrary, the Fund may invest all
PAGE 117
of its assets in a single investment company or a series thereof
in connection with a "master-feeder" arrangement. Such an
investment would be made where the Fund (a "Feeder"), and one or
more other Funds with the same investment objective and program
as the Fund, sought to accomplish its investment objective and
program by investing all of its assets in the shares of another
investment company (the "Master"). The Master would, in turn,
have the same investment objective and program as the Fund. The
Fund would invest in this manner in an effort to achieve the
economies of scale associated with having a Master fund make
investments in portfolio companies on behalf of a number of
Feeder funds. In the event that the Fund exercises its right to
convert to a Master Fund/Feeder Fund structure, it will do so in
compliance with the Guidelines for Registration of a Master
Fund/Feeder Fund as established by the North American Securities
Administrators Association, Inc. ("NASAA").
RATINGS OF MUNICIPAL DEBT SECURITIES
Moody's Investors Service, Inc.
Aaa - Bonds rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk.
Aa - Bonds rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are
generally known as high grade bonds.
A - Bonds rated A possess many favorable investment attributes
and are to be considered as upper medium grade obligations.
Baa - Bonds rated Baa are considered as medium-grade obligations,
i.e., they are neither highly protected nor poorly secured.
Interest payments and principal security appear adequate for the
present but certain protective elements may be lacking or may be
characteristically unreliable over any great length of time.
Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
<PAGE>
PAGE 118
Standard & Poor's Corporation
AAA - This is the highest rating assigned by Standard & Poor's to
a debt obligation and indicates an extremely strong capacity to
pay principal and interest.
AA - Debt rated AA has a very strong capacity to pay principal
and interest and differs from highest rated issues only in a
small degree.
A - Bonds rated A have a strong capacity to pay principal and
interest, although they are somewhat more susceptible to the
adverse effects of changes in circumstances and economic
conditions.
BBB - Bonds rated BBB are regarded as having an adequate capacity
to pay principal and interest. Whereas they normally exhibit
adequate protection parameters, adverse economic conditions or
changing circumstances are more likely to lead to a weakened
capacity to pay principal and interest for bonds in this category
than for bonds in the A category.
Fitch Investors Service, Inc.
AAA - Bonds rated AAA are 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 rated AA are considered to be investment grade and of
very high credit quality. The obligor's ability to pay interest
and repay principal is very strong, although not quite as strong
as bonds rated AAA. Because bonds rated in the AAA and AA
categories are not significantly vulnerable to foreseeable future
developments, short-term debt of these issuers is generally rate
F-1+.
A - Bonds rated A are 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 rated BBB are 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.
PAGE 119
RATINGS OF MUNICIPAL NOTES AND VARIABLE RATE SECURITIES
MOODY'S INVESTORS SERVICE, INC. VMIG1/MIG-1: the best
quality. VMIG2/MIG-2: high quality, with margins of protection
ample though not so large as in the preceding group. VMIG3/MIG-
3: favorable quality, with all security elements accounted for,
but lacking the undeniable strength of the preceding grades.
Market access for refinancing, in particular, is likely to be
less well established. VMIG4/MIG4: adequate quality but there is
specific risk.
STANDARD & POOR'S CORPORATION. Note rating symbols are as
follows: SP-1: very strong or strong capacity to pay principal
and interest. Those issues determined to possess overwhelming
safety characteristics will be given a plus (+) designation. SP-
2: satisfactory capacity to pay interest and principal. SP-3:
speculative capacity to pay principal and interest.
FITCH INVESTORS SERVICE. F-1+: exceptionally strong credit
quality, strongest degree of assurance for timely payment. F-1:
Very strong credit quality. F-2: Good credit quality, having a
satisfactory degree of assurance for timely payment. F-3: Fair
credit quality, assurance for timely payment is adequate but
adverse changes could cause the securities to be rated below
investment grade. F-5: Weak credit quality, having
characteristics suggesting a minimal degree of assurance for
timely payment.
RATINGS OF COMMERCIAL PAPER
MOODY'S INVESTORS SERVICES, INC. P-1: superior capacity
for repayment. P-2: strong capacity for repayment. P-3:
acceptable capacity for repayment of short-term promissory
obligations.
STANDARD & POOR'S CORPORATION. A-1: highest category,
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: satisfactory capacity to pay principal and interest. A-3:
adequate capacity for timely payment, but are vulnerable to
adverse effects of changes in circumstances than higher rated
issues. B and C: speculative capacity to pay principal and
interest.
PAGE 120
FITCH INVESTORS SERVICE. F-1+: exceptionally strong credit
quality, strongest degree of assurance for timely payment. F-1:
Very strong credit quality. F-2: Good credit quality, having a
satisfactory degree of assurance for timely payment. F-3: Fair
credit quality, assurance for timely payment is adequate but
adverse changes could cause the securities to be rated below
investment grade. F-5: Weak credit quality, having
characteristics suggesting a minimal degree of assurance for
timely payment.
MANAGEMENT OF FUND
The officers and directors of the Fund are listed below.
Unless otherwise noted, the address of each is 100 East Pratt
Street, Baltimore, Maryland 21202. Except as indicated, each has
been an employee of T. Rowe Price for more than five years. In
the list below, the Fund's directors who are considered
"interested persons" of T. Rowe Price as defined under
Section 2(a)(19) of the Investment Company Act of 1940 are noted
with an asterisk (*). These directors are referred to as inside
directors by virtue of their officership, directorship, and/or
employment with T. Rowe Price.
STEVEN S. CONNER, Director--Retired; formerly Executive Vice
President, Central Savings and Loan Association, San Diego,
California; Address: 910 Loma Court, El Cajon, California 92020
ROGER P. HAUCK, Director--President, Chief Executive Officer, and
Director, Marshall, Erdman & Associates, Inc., architect and
builder of ambulatory health care buildings, Director and member
of Executive Committee, University Health Care, Inc., and
Director, Madison-Kipp Corporation and Wisconsin Policy Research
Institute; Address: 3512 Blackhawk Drive, Shorewood Hills,
Wisconsin 53705
*RICHARD M. HEINS, PH.D., Director--President and Chief Executive
Officer, CUNA Mutual Insurance Group, Madison, Wisconsin;
Director, Chief Executive Officer and Vice Chairman, Century
Companies of America, Waverly, Iowa; Director, The CUMIS Group of
Companies (Canada); President, Filene Research Institute, Inc.;
Address: 5910 Mineral Point Road, P.O. Box 391, Madison,
Wisconsin 53701-0391
EMMETT J. RICE, Director--Retired; Director, The Ethyl
Corporation, Richmond, Virginia, Tredegar Industries, Inc.,
Richmond, Virginia, and Jardine Fleming China Region Fund, Inc.,
PAGE 121
Baltimore, Maryland; Address: 1673 Myrtle Street, N.S.,
Washington, D.C. 20012
*JAMES S. RIEPE, President and Director, Managing Director, T.
Rowe Price; Chairman of the Board, T. Rowe Price Services, Inc.,
T. Rowe Price Retirement Plan Services, Inc., and T. Rowe Price
Trust Company; President and Director, T. Rowe Price Investment
Services, Inc.; Member, Management Committee, CMC-T. Rowe Price
Management, LLC; Director, Rhone-Poulenc Rorer, Inc.
MARY J. MILLER, Executive Vice President--Managing Director, T.
Rowe Price
PETER VAN DYKE, Executive Vice President--Managing Director, T.
Rowe Price, Vice President, Rowe Price-Fleming International,
Inc. and T. Rowe Price Trust Company
DOROTHY L. BALLANTYNE, Vice President--Vice President, CUNA
Mutual Investment Corporation, LLC and Member, Management
Committee, CMC-T. Rowe Price Management, LLC
HENRY H. HOPKINS, Vice President--Managing Director, T. Rowe
Price; Vice President and Director, T. Rowe Price Investment
Services, Inc., T. Rowe Price Services, Inc., and T. Rowe Price
Trust Company; Vice President, Rowe Price-Fleming International,
Inc. and T. Rowe Price Retirement Plan Services, Inc.
BRADFORD L. MURPHY, Vice President--Executive Vice President,
CUNA Service Group, Inc. and Member, Management Committee, CMC-T.
Rowe Price Management, LLC
THOMAS O. OLSON, Vice President--Senior Vice President, CUNA
Mutual Investment Corporation, LLC and Member, Management
Committee, CMC-T. Rowe Price Management, LLC
CHARLES E. VIETH, Vice President--Managing Director, T. Rowe
Price; President and Director, T. Rowe Price Retirement Plan
Services, Inc.; Vice President and Director, T. Rowe Price
Services, Inc.; Member, Management Committee, CMC-T. Rowe Price
Management, LLC; Director, T. Rowe Price Investment Services,
Inc.
RICHARD T. WHITNEY, Vice President--Vice President, T. Rowe
Price; Chartered Financial Analyst
LENORA V. HORNUNG, Secretary--Vice President, T. Rowe Price
CARMEN F. DEYESU, Treasurer--Vice President, T. Rowe Price, T.
Rowe Price Services, Inc., and T. Rowe Price Trust Company
DAVID S. MIDDLETON, Controller--Vice President, T. Rowe Price, T.
Rowe Price Services, Inc., and T. Rowe Price Trust Company
ROGER L. FIERY, Assistant Vice President--Vice President, Rowe
Price-Fleming International, Inc.
EDWARD T. SCHNEIDER, Assistant Vice President--Vice President, T.
Rowe Price Services, Inc.
INGRID I. VORDEMBERGE, Assistant Vice President--Employee, T.
Rowe Price
PAGE 122
The Fund's Executive Committee, comprised of Messrs. Heins
and Riepe, has been authorized by its respective Board of
Directors to exercise all powers of the Board to manage the Fund
in the intervals between meetings of the Board, except the powers
prohibited by statute from being delegated.
PRINCIPAL HOLDERS OF SECURITIES
As of the date of the prospectus, the officers and directors
of the Fund, as a group, owned less than 1% of the outstanding
shares of the Fund.
JOINT VENTURE
T. Rowe Price Management, Inc. ("Price Management"), a
wholly-owned subsidiary of T. Rowe Price Associates, Inc. ("T.
Rowe Price"), and CUNA Mutual Funds Management Company L.L.C., a
Maryland limited liability company whose members are CUNA Mutual
Investment Corporation, a wholly-owned subsidiary of CUNA Mutual
Insurance Society ("CUNA Mutual"), and CUNA Service Group, Inc.,
an affiliate of Credit Union National Association, Inc. ("CUNA"),
have entered into an agreement (the "Joint Venture Agreement") to
form CMC-T. Rowe Price Management, L.L.C., a Maryland limited
liability company (the "Joint Venture"), in 1993 for the purpose
of establishing and operating a mutual fund program to be offered
to members of credit unions.
CUNA was founded in 1934 and is the national trade
association for credit unions. In addition, CUNA, together with
its affiliates, supplies products and services to credit unions
throughout the United States.
CUNA Mutual is a mutual insurance company established in
1935. CUNA Mutual and its affiliates serve the insurance,
financial and technology needs of credit unions and their members
in the United States and approximately 60 foreign countries.
T. Rowe Price is a registered investment adviser founded in
1937 by Thomas Rowe Price, Jr. T. Rowe Price serves as
investment manager to a variety of individuals and institutional
investors, including limited and real estate partnerships and
other mutual funds.
PAGE 123
Under the Joint Venture Agreement, the Joint Venture is
responsible for providing, either directly or through contracts
with others, investment management, fund accounting, transfer
agent and shareholder services, custodial and other services
necessary for the operation of the Fund. The Joint Venture has
entered into an Investment Management and Administration
Agreement with the Fund to perform or provide, or negotiate on
behalf of the Fund for third parties to perform or provide, these
services.
FUND MANAGEMENT AND ADMINISTRATION
The Joint Venture has entered into agreements with the Fund
and T. Rowe Price for the provision to the Fund of investment
advisory and fund accounting services; and the Fund and T. Rowe
Price Services, Inc. for fund transfer agent, dividend disbursing
and shareholder services. The Joint Venture has also entered
into an agreement with the Fund and State Street Bank and Trust
Company for fund custodial services.
The Fund pays the Joint Venture an annual all-inclusive fee
(the "Fee") of: 0.75%. The Fee is paid monthly to the Joint
Venture on the first business day of the next succeeding calendar
month and is the sum of the daily fee accruals for each month.
The daily fee accrual for any particular day is calculated by
multiplying the fraction of one (1) over the number of calendar
days in the year by the Fee and multiplying this product by the
net assets of the Fund for that day, as determined in accordance
with the Fund's prospectus as of the close of business on the
previous business day on which the Fund was open for business.
Under the all inclusive fee set forth in the Investment
Management and Administration Agreement, the Joint Venture bears
all expenses of the Fund's operations except: 12b-1 fees;
brokerage commissions and other costs incident to the purchase,
sale or lending of the Fund's portfolio securities; interest; all
taxes or governmental fees payable by or with respect to the
Fund, including stamp or other transfer taxes; and such
nonrecurring or extraordinary expenses that may arise, including
the costs of actions, suits or proceedings to which the Fund is a
party and the expenses the Fund might incur as a result of its
legal obligation to provide indemnification to its officers,
directors and agents.
Services Provided by T. Rowe Price
PAGE 124
Under a Sub-Advisory Agreement between the Fund, the Joint
Venture and T. Rowe Price, T. Rowe Price provides the Fund with
discretionary investment services. Specifically, T. Rowe Price
is responsible for supervising and directing the investments of
the Fund in accordance with its investment objective, programs,
and restrictions as provided in the prospectus and this Statement
of Additional Information. T. Rowe Price is also responsible for
effecting all security transactions on behalf of the Fund,
including the allocation of principal business and portfolio
brokerage and the negotiation of commissions. In addition to
these services, T. Rowe Price provides the Fund with certain
corporate administrative services, including: maintaining the
Fund's corporate existence, corporate records, and registering
and qualifying the Fund's shares under federal and state laws;
monitoring the financial, accounting, and administrative
functions of the Fund; maintaining liaison with the agents
employed by the Fund such as the Fund's custodian and transfer
agent; assisting the Fund in the coordination of such agents'
activities; and permitting T. Rowe Price's employees to serve as
officers, directors, and committee members of the Fund without
cost to the Fund.
The Sub-Advisory Agreement also provides that T. Rowe Price,
its directors, officers, employees, and certain other persons
performing specific functions for the Fund will only be liable to
the Fund for losses resulting from willful misfeasance, bad
faith, gross negligence, or reckless disregard of duty.
FUND DISTRIBUTION
T. Rowe Price Investment Services, Inc. ("Investment
Services"), a Maryland corporation formed in 1980 as a wholly-
owned subsidiary of T. Rowe Price, and CUNA Brokerage Services,
Inc. ("CUNA Brokerage"), a member of the CUNA Mutual Insurance
Group, under agreements with the Fund, serve as the distributors
of the Fund. Investment Services and CUNA Brokerage are
registered as broker-dealers under the Securities Exchange Act of
1934 and are members of the National Association of Securities
Dealers, Inc. The offering of the Fund's shares is continuous.
Investment Services is located at the same address as the
Fund and T. Rowe T. Rowe Price--100 East Pratt Street, Baltimore,
Maryland 21202. CUNA Brokerage is located at 5910 Mineral Point
Road, Madison, Wisconsin 53701-0391.
PAGE 125
Investment Services and CUNA serve as distributors to the
Fund pursuant to individual Underwriting Agreements
("Underwriting Agreements"), which provide that the Fund will pay
all fees and expenses in connection with: registering and
qualifying the Fund's shares under the various state "blue sky"
laws; preparing, setting in type, printing, and mailing its
prospectuses and reports to shareholders; and issuing its shares,
including expenses of confirming purchase orders. Investment
Services and CUNA Brokerage are responsible for all fees and
expenses in connection with the printing and distributing
prospectuses and reports for use in offering and selling shares
for the Fund; preparing, setting in type, printing, and mailing
all sales literature and advertising; Investment Services' and
CUNA Brokerage's federal and state registrations as a
broker-dealer; and offering and selling shares for the Fund,
except for those fees and expenses specifically assumed by the
Fund or paid for pursuant to the plan of distribution adopted by
the Fund. Investment Services' expenses are paid by T. Rowe
Price. CUNA Brokerage's expenses are paid by CMC. The Fund's
expenses are paid by the Joint Venture under the Investment
Management and Administration Agreement between the Fund and the
Joint Venture.
Investment Services and CUNA Brokerage act as the agents of
the Fund in connection with the sale of Fund shares in all states
in which the shares are qualified and in which Investment
Services and CUNA Brokerage are qualified as broker-dealers.
Under the Underwriting Agreements, orders for Fund shares are
accepted at net asset value. No sales charges are paid by
investors or the Fund.
Under a Distribution Plan (the "Plan") adopted by the Fund,
the Fund will transmit to the Joint Venture monthly, as paying
agent, an amount described in its prospectus for costs and
expenses of marketing the shares of the Fund. The Board of
Directors has concluded that there is a reasonable likelihood
that the Plan will benefit the Fund and its shareholders.
The Plan provides that it may not be amended to increase
materially the costs which the Fund may bear pursuant to the Plan
without shareholder approval and that other material amendments
of the Plan must be approved by the Board of Directors and the
Directors who are neither "interested persons" (as defined in the
1940 Act) of the Corporation ("Independent Directors"), nor have
any direct or indirect financial interest in the operation of the
PAGE 126
Plan or in any related agreement, Independent Directors by vote
cast in person at a meeting called for the purpose of considering
such amendments. The selection and nomination of the Independent
Directors of the Corporation have been committed to the
discretion of the Independent Directors. The Plan has been
approved and is subject to annual approval by the Board of
Directors and by the Independent Directors by vote cast in person
at a meeting called for the purpose of voting on the Plan. The
Board of Directors and the Independent Directors voted to approve
the Plan at a meeting held on December 21, 1993 and by a majority
of the outstanding shareholders of the Fund at a meeting held on
December 29, 1993. The Plan is terminable with respect to the
Fund at any time by a vote of a majority of the Independent
Directors or by vote of the holders of a majority of the shares
of the Fund.
Limitation on Fund Expenses
In compliance with certain state regulations, the Joint
Venture will reimburse the Fund for any expenses (excluding
interest, taxes, brokerage, other expenditures which are
capitalized in accordance with generally accepted accounting
principles, and extraordinary expenses) which in any year exceed
the limits prescribed by any state in which the Fund's shares are
qualified for sale. Presently, the most restrictive expense
ratio limitation imposed by any state is 2.5% of the first $30
million of the Fund's average daily net assets, 2% of the next
$70 million of such assets, and 1.5% of net assets in excess of
$100 million.
CUSTODIAN
State Street Bank and Trust Company is the custodian for the
Fund's securities and cash, but it does not participate in the
Fund's investment decisions. The Fund has authorized the Bank to
deposit certain portfolio securities in central depository
systems as allowed by federal law. In addition, the Fund is
authorized to maintain certain of its securities, for example,
variable rate demand notes, in uncertificated form in the
proprietary deposit systems of various dealers in municipal
securities. The Bank's main office is 225 Franklin Street,
Boston, Massachusetts 02107.
PAGE 127
PORTFOLIO TRANSACTIONS
Investment or Brokerage Discretion
Decisions with respect to the purchase and sale of portfolio
securities on behalf of the Fund are made by T. Rowe Price. T.
Rowe Price is also responsible for implementing these decisions,
including the negotiation of commissions and the allocation of
portfolio brokerage and principal business. The Fund's purchases
and sales of portfolio securities are normally done on a
principal basis and do not involve the payment of a commission
although they may involve the designation of selling concessions.
That part of the discussion below relating solely to brokerage
commissions would not normally apply to the Fund. However, it is
included because T. Rowe Price does manage a significant number
of common stock portfolios which do engage in agency transactions
and pay commissions and because some research and services
resulting from the payment of such commissions may benefit the
Fund.
How Brokers and Dealers are Selected
Fixed Income Securities
Fixed income securities are generally purchased from the
issuer or a primary market-maker acting as principal for the
securities on a net basis, with no brokerage commission being
paid by the client, although the price usually includes an
undisclosed compensation. Transactions placed through dealers
serving as primary market-makers reflect the spread between the
bid and asked prices. Securities may also be purchased from
underwriters at prices which include underwriting fees.
T. Rowe Price may effect principal transactions on behalf of
the Fund with a broker or dealer who furnishes brokerage and/or
research services, designate any such broker or dealer to receive
selling concessions, discounts or other allowances, or otherwise
deal with any such broker or dealer in connection with the
acquisition of securities in underwritings. The Fund may receive
brokerage and research services in connection with such
designations in fixed price underwritings.
In purchasing and selling the Fund's portfolio securities,
it is T. Rowe Price's policy to obtain quality execution at the
most favorable prices through responsible brokers and dealers
and, in the case of agency transactions (in which the Fund does
PAGE 128
not generally engage), at competitive commission rates. However,
under certain conditions, the Fund may pay higher brokerage
commissions in return for brokerage and research services. In
selecting broker-dealers to execute the Fund's portfolio
transactions, consideration is given to such factors as the price
of the security, the rate of the commission, the size and
difficulty of the order, the reliability, integrity, financial
condition, general execution and operational capabilities of
competing brokers and dealers, and brokerage and research
services provided by them. It is not the policy of T. Rowe Price
to seek the lowest available commission rate where it is believed
that a broker or dealer charging a higher commission rate would
offer greater reliability or provide better price or execution.
How Evaluations are Made of the Overall Reasonableness of
Brokerage Commissions Paid
On a continuing basis, T. Rowe Price seeks to determine what
levels of commission rates are reasonable in the marketplace for
transactions executed on behalf of the Fund. In evaluating the
reasonableness of commission rates, T. Rowe Price considers: (a)
historical commission rates, both before and since rates have
been fully negotiable; (b) rates which other institutional
investors are paying, based on available public information; (c)
rates quoted by brokers and dealers; (d) the size of a particular
transaction, in terms of the number of shares, dollar amount, and
number of clients involved; (e) the complexity of a particular
transaction in terms of both execution and settlement; (f) the
level and type of business done with a particular firm over a
period of time; and (g) the extent to which the broker or dealer
has capital at risk in the transaction.
Description of Research Services Received from Brokers and
Dealers
T. Rowe Price receives a wide range of research services
from brokers and dealers. These services include information on
the economy, industries, groups of securities, individual
companies, statistical information, accounting and tax law
interpretations, political developments, legal developments
affecting portfolio securities, technical market action, pricing
and appraisal services, credit analysis, risk measurement
analysis, performance analysis and analysis of corporate
responsibility issues. These services provide both domestic and
international perspective. Research services are received
primarily in the form of written reports, computer generated
PAGE 129
services, telephone contacts and personal meetings with security
analysts. In addition, such services may be provided in the form
of meetings arranged with corporate and industry spokespersons,
economists, academicians and government representatives. In some
cases, research services are generated by third parties but are
provided to T. Rowe Price by or through broker-dealers.
Research services received from brokers and dealers are
supplemental to T. Rowe Price's own research effort and, when
utilized, are subject to internal analysis before being
incorporated by T. Rowe Price into its investment process. As a
practical matter, it would not be possible for T. Rowe Price to
generate all of the information presently provided by brokers and
dealers. T. Rowe Price pays cash for certain research services
received from external sources. T. Rowe Price also allocates
brokerage for research services which are available for cash.
While receipt of research services from brokerage firms has not
reduced T. Rowe Price's normal research activities, the expenses
of T. Rowe Price could be materially increased if it attempted to
generate such additional information through its own staff. To
the extent that research services of value are provided by
brokers or dealers, T. Rowe Price may be relieved of expenses
which it might otherwise bear.
T. Rowe Price has a policy of not allocating brokerage
business in return for products or services other than brokerage
or research services. In accordance with the provisions of
Section 28(e) of the Securities Exchange Act of 1934, T. Rowe
Price may from time to time receive services and products which
serve both research and non-research functions. In such event,
T. Rowe Price makes a good faith determination of the anticipated
research and non-research use of the product or service and
allocates brokerage only with respect to the research component.
Brokerage and Execution Services Provided by Brokers and Dealers
who Furnish Research Services
Certain brokers who provide quality execution services also
furnish research services to T. Rowe Price. With regard to the
payment of brokerage commissions, T. Rowe Price has adopted a
brokerage allocation policy embodying the concepts of Section
28(e) of the Securities Exchange Act of 1934, which permits an
investment adviser to cause an account to pay commission rates in
excess of those another broker or dealer would have charged for
effecting the same transaction, if the adviser determines in good
faith that the commission paid is reasonable in relation to the
PAGE 130
value of the brokerage and research services provided. The
determination may be viewed in terms of either the particular
transaction involved or the overall responsibilities of the
adviser with respect to the accounts over which it exercises
investment discretion. Accordingly, while T. Rowe Price cannot
readily determine the extent to which commission rates charged by
broker-dealers reflect the value of their research services, T.
Rowe Price would expect to assess the reasonableness of
commissions in light of the total brokerage and research services
provided by each particular broker. T. Rowe Price may receive
research, as defined in Section 28(e), in connection with selling
concessions and designations in fixed price offerings.
Internal Allocation Procedures
T. Rowe Price has a policy of not precommitting a specific
amount of business to any broker or dealer over any specific time
period. Historically, the majority of brokerage placement has
been determined by the needs of a specific transaction such as
market-making, availability of a buyer or seller of a particular
security, or specialized execution skills. However, T. Rowe
Price does have an internal brokerage allocation procedure for
that portion of its discretionary client brokerage or selling
concession business where special needs do not exist, or where
the business may be allocated among several brokers or dealers
which are able to meet the needs of the transaction.
Each year, T. Rowe Price assesses the contribution of the
brokerage and research services provided by brokers and dealers,
and attempts to allocate a portion of its brokerage and selling
concession business in response to these assessments. Research
analysts, counselors, various investment committees, and the
Trading Department each seek to evaluate the brokerage and
research services they receive from brokers and make judgments as
to the level of business which would recognize such services. In
addition, brokers and dealers sometimes suggest a level of
business they would like to receive in return for the various
brokerage and research services they provide. Actual business
received by any firm may be less than the suggested allocations
but can, and often does, exceed the suggestions, because the
total business is allocated on the basis of all the
considerations described above. In no case is a broker or dealer
excluded from receiving business from T. Rowe Price because it
has not been identified as providing research services.
PAGE 131
Miscellaneous
T. Rowe Price's brokerage allocation policy is consistently
applied to all its fully discretionary accounts, which represent
a substantial majority of all assets under management. Research
services furnished by brokers and dealers through which T. Rowe
Price effects securities transactions may be used in servicing
all accounts (including non-Fund accounts) managed by T. Rowe
Price.
Conversely, research services received from brokers and
dealers which execute transactions for the Fund are not
necessarily used by T. Rowe Price exclusively in connection with
the management of the Fund.
From time to time, orders for clients may be placed through
a computerized transaction network.
The Fund does not allocate business to any broker-dealer on
the basis of its sales of the Fund's shares. However, this does
not mean that broker-dealers who purchase Fund shares for their
clients will not receive business from the Fund.
Some of T. Rowe Price's other clients have investment
objectives and programs similar to those of the Fund. T. Rowe
Price may occasionally make recommendations to other clients
which result in their purchasing or selling securities
simultaneously with the Fund. As a result, the demand for
securities being purchased or the supply of securities being sold
may increase, and this could have an adverse effect on the price
of those securities. It is T. Rowe Price's policy not to favor
one client over another in making recommendations or in placing
orders. T. Rowe Price frequently follows the practice of
grouping orders of various clients for execution which generally
results in lower commission rates being attained. In certain
cases, where the aggregate order is executed in a series of
transactions at various prices on a given day, each participating
client's proportionate share of such order reflects the average
price paid or received with respect to the total order. T. Rowe
Price has established a general investment policy that it will
ordinarily not make additional purchases of a common stock of a
company for its clients (including the CUNA Mutual Funds) if, as
a result of such purchases, 10% or more of the outstanding common
stock of such company would be held by its clients in the
aggregate.
PAGE 132
To the extent possible, T. Rowe Price intends to recapture
solicitation fees paid in connection with tender offers through
T. Rowe Price Investment Services, Inc., the Fund's distributor.
At the present time, T. Rowe Price does not recapture commissions
or underwriting discounts or selling group concessions in
connection with taxable securities acquired in underwritten
offerings. T. Rowe Price does, however, attempt to negotiate
elimination of all or a portion of the selling-group concession
or underwriting discount when purchasing tax-exempt municipal
securities on behalf of its clients in underwritten offerings.
PRICING OF SECURITIES
Fixed income securities are generally traded in the over-
the-counter market. Investments in securities with remaining
maturities of one year or more are stated at fair value using a
bid-side valuation as furnished by dealers who make markets in
such securities or by an independent pricing service, which
considers yield or price of bonds of comparable quality, coupon,
maturity, and type, as well as prices quoted by dealers who make
markets in such securities.
Securities with remaining maturities less than one year are
stated at fair value which is determined by using a matrix system
that establishes a value for each security based on bid-side
money market yields.
There are a number of pricing services available, and the
Board of Directors, on the basis of ongoing evaluation of these
services, may use or may discontinue the use of any pricing
service in whole or in part.
Securities or other assets for which the above valuation
procedures are deemed not to reflect fair value will be appraised
at prices deemed best to reflect their fair value. Such
determinations will be made in good faith by or under the
supervision of officers of the Fund as authorized by the Board of
Directors.
NET ASSET VALUE PER SHARE
The purchase and redemption price of the Fund's shares is
equal to the Fund's net asset value per share or share price.
The Fund determines its net asset value per share by subtracting
PAGE 133
the Fund's liabilities (including accrued expenses and dividends
payable) from its total assets (the market value of the
securities the Fund holds plus cash and other assets, including
income accrued but not yet received) and dividing the result by
the total number of shares outstanding. The net asset value per
share of the Fund is calculated as of the close of trading on the
New York Stock Exchange ("NYSE") every day the NYSE is open for
trading. The NYSE is closed on the following days: New Year's
Day, Washington's Birthday, Good Friday, Memorial Day,
Independence Day, Labor Day, Thanksgiving Day, and Christmas Day.
Determination of net asset value (and the offering, sale
redemption and repurchase of shares) for the Fund may be
suspended at times (a) during which the NYSE is closed, other
than customary weekend and holiday closings, (b) during which
trading on the NYSE is restricted, (c) during which an emergency
exists as a result of which disposal by the Fund of securities
owned by it is not reasonably practicable or it is not reasonably
practicable for the Fund fairly to determine the value of its net
assets, or (d) during which a governmental body having
jurisdiction over the Fund may by order permit such a suspension
for the protection of the Fund's shareholders; provided that
applicable rules and regulations of the Securities and Exchange
Commission (or any succeeding governmental authority) shall
govern as to whether the conditions prescribed in (b), (c), or
(d) exist.
DIVIDENDS
Unless you elect otherwise, the Fund's annual capital gain
distribution, if any, will be reinvested on the reinvestment date
using the NAV per share of that date. The reinvestment date
normally precedes the payment date by about 10 days although the
exact timing is subject to change.
TAX STATUS
The Fund intends to qualify as a "regulated investment
company" under Subchapter M of the Internal Revenue Code of 1986,
as amended ("Code").
Dividends and distributions paid by the Fund are not
eligible for the dividends-received deduction for corporate
shareholders. For tax purposes, it does not make any difference
whether dividends and capital gain distributions are paid in cash
PAGE 134
or in additional shares. The Fund must declare dividends equal
to at least 90% of net tax-exempt income (as of its year-end) to
permit pass-through of tax-exempt income to shareholders, and 98%
of capital gains (as of October 31) in order to avoid a federal
excise tax and 100% of capital gains (as of its tax year-end) to
avoid federal income tax.
At the time of your purchase, the Fund's net asset value may
reflect undistributed capital gains or net unrealized
appreciation of securities held by the Fund. A subsequent
distribution to you of such amounts, although constituting a
return of your investment, would be taxable as a capital gain
distribution. For federal income tax purposes, the Fund is
permitted to carry forward its net realized capital losses, if
any, for eight years and realize net capital gains up to the
amount of such losses without being required to pay taxes on, or
distribute such gains.
If, in any taxable year, the Fund should not qualify as a
regulated investment company under the Code: (i) the Fund would
be taxed at normal corporate rates on the entire amount of its
taxable income, if any, without deduction for dividends or other
distributions to shareholders; and (ii) the Fund's distributions
to the extent made out of the Fund's current or accumulated
earnings and profits would be taxable to shareholders as ordinary
dividends (regardless of whether they would otherwise have been
considered capital gain dividends).
The Fund anticipates acquiring bonds after initial issuance
at a price less than the principal amount of such bonds ("market
discount bonds"). Gain on the disposition of such bonds is
treated as taxable ordinary income to the extent of accrued
market discount. Such gains cannot be offset by losses on the
sale of other securities but must be distributed to shareholders
annually and taxed as ordinary income.
Each year, the Fund will mail you information on the tax
status of dividends and distributions. The Fund anticipates that
substantially all of the dividends to be paid by the Fund will be
exempt from federal income taxes. If any portion of the Fund's
dividends is not exempt from federal income taxes, you will
receive a Form 1099 stating the taxable portion. The Fund will
also advise you of the percentage of your dividends, if any,
which should be included in the computation of alternative
minimum tax. Social security recipients who receive interest
from tax-exempt securities may have to pay taxes on a portion of
PAGE 135
their social security benefit.
Because the interest on municipal securities is tax exempt,
any interest on money you borrow that is directly or indirectly
used to purchase Fund shares is not deductible. (See Section
265(2) of the Internal Revenue Code.) Further, entities or
persons who are "substantial users" (or persons related to
"substantial users") of facilities financed by industrial
development bonds should consult their tax advisers before
purchasing shares of the Fund. The income from such bonds may
not be tax exempt for such substantial users.
YIELD INFORMATION
From time to time, the Fund may advertise a yield figure
calculated in the following manner:
An income factor is calculated for each security in the
portfolio based upon the security's market value at the beginning
of the period and yield as determined in conformity with
regulations of the Securities and Exchange Commission. The
income factors are then totalled for all securities in the
portfolio. Next, expenses of the Fund for the period net of
expected reimbursements are deducted from the income to arrive at
net income, which is then converted to a per-share amount by
dividing net income by the average number of shares outstanding
during the period. The net income per share is divided by the
net asset value on the last day of the period to produce a
monthly yield which is then annualized. A taxable equivalent
yield is calculated by dividing this yield by one minus the
effective federal income tax rate. Quoted yield factors are for
comparison purposes only, and are not intended to indicate future
performance or forecast the dividend per share of the Fund.
<PAGE>
PAGE 136
From time to time, the Fund may also illustrate the effect
of tax equivalent yields using information such as that set forth
below:
TAX-EXEMPT VS. TAXABLE YIELDS
_________________________________________________________________
Your Taxable Income (1993)++
Joint Return Single Return Federal
Tax Rates
_________________________________________________________________
$36,901- $89,150 $22,101- $53,500 28.0
89,151- 140,000 53,501- 115,000 31.0
140,001- 250,000 115,001- 250,000 36.0
250,001 and above 250,001 and above 39.6
_________________________________________________________________
A Tax-Exempt Yield Of:
3% 4% 5% 6% 7% 8% 9% 10% 11%
Is Equivalent to a Taxable Yield of:
_________________________________________________________________
4.2 5.6 6.9 8.3 9.7 11.1 12.5 13.9 15.3
4.3 5.8 7.2 8.7 10.1 11.6 13.0 14.5 15.9
4.7 6.3 7.8 9.4 10.9 12.5 14.1 15.6 17.2
5.0 6.6 8.3 9.9 11.6 13.2 14.9 16.6 18.2
_________________________________________________________________
+Net amount subject to federal income tax after deductions and
exemptions.
++Federal rates may vary depending on family size and nature and
amount of itemized deductions.
<PAGE>
PAGE 137
INVESTMENT PERFORMANCE
Total Return Performance
The Fund's calculation of total return performance includes
the reinvestment of all capital gain distributions and income
dividends for the period or periods indicated, without regard to
tax consequences to a shareholder in the Fund. Total return is
calculated as the percentage change between the beginning value
of a static account in the Fund and the ending value of that
account measured by the then current net asset value, including
all shares acquired through reinvestment of income and capital
gains dividends. The results shown are historical and should not
be considered indicative of the future performance of the Fund.
Each average annual compound rate of return is derived from the
cumulative performance of the Fund over the time period
specified. The annual compound rate of return for the Fund over
any other period of time will vary from the average.
From time to time, in reports and promotional literature,
the Fund's performance will be compared to (1) indices of broad
groups of managed and unmanaged securities considered to be
representative of or similar to Fund portfolio holdings (2) other
mutual funds, or (3) other measures of performance set forth in
publications such as:
Bond Buyer 20 - an estimation of the yield which would be
offered on 20-year general obligation bonds with a composite
rating of approximately "A." Published weekly by The Bond
Buyer, a trade paper of the municipal securities industry;
Shearson Lehman/American Express Municipal Bond Index - a
composite measure of the total return performance of the
municipal bond market. Based upon approximately 1500 bonds;
Lipper General Purpose Municipal Bond Avg. - an average of
municipal mutual funds which invest 60% or more of their
assets in the top four tax-exempt credit ratings;
Lipper Analytical Services, Inc. - a widely used independent
research firm which ranks mutual funds by overall
performance, investment objectives, and assets;
Lipper Intermediate Municipal Avg. - an average of municipal
mutual funds which restrict their holdings to bonds with
maturities between 5 and 10 years;
PAGE 138
Lipper Insured Municipal Avg. - an average of municipal
mutual funds which utilize insured municipal securities for
65% of their portfolios.
Lipper High-Yield Municipal Bond Avg. - an average of
municipal mutual funds which may utilize lower rated bonds
for 50% of their portfolio;
Lipper Insured Municipal Avg. - an average of municipal
mutual funds which utilize insured municipal securities for
65% of their portfolios.
Donoghue's Tax-Exempt Money Fund Avg. - an average of
municipal money market funds as reported in Donoghue's Money
Fund Report, which tracks the performance of all money
market mutual funds;
Prime General Obligations - bonds with maturities from 1-30
years which are secured by the full faith and credit of
issuers with taxing power;
MIG 1 - Moody's Investment Grade 1 - a short-term note with
a top quality rating from Moody's Investors Service, Inc.;
and
Morningstar, Inc. - a widely used independent research firm
which rates mutual funds by overall performance, investment
objectives, and assets.
Indices prepared by the research departments of such
financial organizations as Merrill Lynch, Pierce, Fenner & Smith,
Inc., will be used, as well as information provided by the
Federal Reserve Board.
Information reported in the Bank Rate Monitor, an
independent publication which tracks the performance of certain
bank products, such as money market deposit accounts and
certificates of deposit, will also be used. Bank certificates of
deposit differ from mutual funds in several ways: the interest
rate established by the sponsoring bank is fixed for the term of
a CD; there are penalties for early withdrawal from CDs; and the
principal on a CD is insured.
Performance rankings and ratings reported periodically in
national financial publications such as MONEY, FORBES, BUSINESS
PAGE 139
WEEK, BARRON'S, etc. may also be used.
Other Features and Benefits
The Fund is a member of the CUNA Mutual Funds and may help
investors achieve various long-term investment goals, such as
saving for a down payment on a home or paying college costs. To
explain how the Fund could be used to assist investors in
planning for these goals and to illustrate basic principles of
investing, various worksheets and guides prepared by T. Rowe
Price, T. Rowe Price Investment Services, Inc. and/or CUNA
Brokerage Services, Inc. may be made available. These may
include: an Asset Mix Worksheet designed to show shareholders how
to reduce their investment risk by developing a diversified
investment plan and a College Planning Guide which discusses
various aspects of financial planning to meet college expenses
and assists parents in projecting the costs of a college
education for their children. From time to time, other
worksheets and guides may be made available as well. Of course,
an investment in the Fund cannot guarantee that such goals will
be met.
Redemptions in Kind
In the unlikely event a shareholder were to receive an in
kind redemption of portfolio securities of the Funds, brokerage
fees could be incurred by the shareholder in a subsequent sale of
such securities.
Issuance of Fund Shares for Securities
Transactions involving issuance of Fund shares for
securities or assets other than cash will be limited to (1) bona
fide reorganizations; (2) statutory mergers; or (3) other
acquisitions of portfolio securities that: (a) meet the
investment objectives and policies of the Funds; (b) are acquired
for investment and not for resale except in accordance with
applicable law; (c) have a value that is readily ascertainable
via listing on or trading in a recognized United States or
international exchange or market; and (d) are not illiquid.
DEVELOPMENT OF THE CUNA MUTUAL FUNDS
One and one-half trillion dollars has been deposited in
mutual funds since 1983, and mutual funds have been growing
PAGE 140
faster than any other form of investment. Investors in mutual
funds include a quarter of all credit union households. In 1992,
for example, substantial amounts of credit union member funds
were transferred into mutual funds. The CUNA Mutual Funds were
started in order to allow the credit union system to offer its
own exclusive group of mutual funds. The mutual funds will
strengthen credit unions' ability to serve as a member's primary
financial institution. The CUNA Mutual Funds will help credit
unions maintain relationships with investors currently within
their membership through direct communications on a wide variety
of subjects, including fund investment strategy, safety, and
other factors to consider when examining mutual funds.
T. Rowe Price, established by Thomas Rowe Price in 1937,
will be the sub-advisor to the CUNA Mutual Funds. Since that
time, T. Rowe Price has become one of the largest and most
respected financial services firms in the country. The firm's
approach to managing investment risk and emphasis on the highest
standards of service are two of the numerous reasons that
millions of investors, and now the credit union movement, have
selected T. Rowe Price as their no-load mutual fund provider.
CAPITAL STOCK
The Charter of the CUNA Mutual Funds, Inc. (the
"Corporation") authorizes its Board of Directors to classify and
reclassify any and all shares which are then unissued, including
unissued shares of capital stock into any number of classes or
series, each class or series consisting of such number of shares
and having such designations, such powers, preferences, rights,
qualifications, limitations, and restrictions, as shall be
determined by the Board subject to the Investment Company Act and
other applicable law. Currently, the Corporation consists of
three series, CUNA Mutual Cornerstone Fund, CUNA Mutual Tax-Free
Intermediate-Term Fund, and CUNA Mutual U.S. Government Income
Fund. Each series represents a separate class of the
Corporation's shares and has different objectives and investment
policies. The shares of any such additional classes or series
might therefore differ from the shares of the present class and
series of capital stock and from each other as to preferences,
conversions or other rights, voting powers, restrictions,
limitations as to dividends, qualifications or terms or
conditions of redemption, subject to applicable law, and might
thus be superior or inferior to the capital stock or to other
classes or series in various characteristics. The Corporation's
PAGE 141
Board of Directors may increase or decrease the aggregate number
of shares of stock or the number of shares of stock of any class
or series that the Funds have authorized to issue without
shareholder approval.
Except to the extent that the Corporation's Board of
Directors might provide by resolution that holders of shares of a
particular class are entitled to vote as a class on specified
matters presented for a vote of the holders of all shares
entitled to vote on such matters, there would be no right of
class vote unless and to the extent that such a right might be
construed to exist under Maryland law. The Charter contains no
provision entitling the holders of the present class of capital
stock to a vote as a class on any matter. Accordingly, the
preferences, rights, and other characteristics attaching to any
class of shares, including the present class of capital stock,
might be altered or eliminated, or the class might be combined
with another class or classes, by action approved by the vote of
the holders of a majority of all the shares of all classes
entitled to be voted on the proposal, without any additional
right to vote as a class by the holders of the capital stock or
of another affected class or classes.
Shareholders are entitled to one vote for each full share
held (and fractional votes for fractional shares held) and will
vote in the election of or removal of directors (to the extent
hereinafter provided) and on other matters submitted to the vote
of shareholders. There will normally be no meetings of
shareholders for the purpose of electing directors unless and
until such time as less than a majority of the directors holding
office have been elected by shareholders, at which time the
directors then in office will call a shareholders' meeting for
the election of directors. Except as set forth above, the
directors shall continue to hold office and may appoint successor
directors. Voting rights are not cumulative, so that the holders
of more than 50% of the shares voting in the election of
directors can, if they choose to do so, elect all the directors
of the Fund, in which event the holders of the remaining shares
will be unable to elect any person as a director. As set forth
in the By-Laws of the Corporation, a special meeting of
shareholders of the Corporation shall be called by the Secretary
of the Corporation on the written request of shareholders
entitled to cast at least 10% of all the votes of the Corporation
entitled to be cast at such meeting. Shareholders requesting
such a meeting must pay to the Corporation the reasonably
estimated costs of preparing and mailing the notice of the
PAGE 142
meeting. The Corporation, however, will otherwise assist the
shareholders seeking to hold the special meeting in communicating
to the other shareholders of the Corporation to the extent
required by Section 16(c) of the Investment Company Act of 1940.
FEDERAL AND STATE REGISTRATION OF SHARES
The Fund's shares are registered for sale under the
Securities Act of 1933, and the Fund or its shares are registered
under the laws of all states which require registration, as well
as the District of Columbia and Puerto Rico.
LEGAL COUNSEL
Shereff, Friedman, Hoffman, & Goodman, whose address is 919
Third Avenue, New York, New York 10022, is legal counsel to the
Fund.
INDEPENDENT ACCOUNTANTS
Price Waterhouse, 7 St. Paul Street, Suite 1700, Baltimore,
Maryland 21202, are independent accountants to the Fund. The
Statement of Assets and Liabilities of the Fund as of December
21, 1993, included in the Statement of Additional Information has
been so included in reliance on the report of Price Waterhouse,
given on the authority of said firm as experts in auditing and
accounting.
edg\cunatfit.ptb
<PAGE>
PAGE 143
CUNA MUTUAL FUNDS, INC.
STATEMENT OF ASSETS AND LIABILITIES
December 21, 1993
CUNA Mutual
Tax-Free
Intermediate-Term
Fund
Assets
Cash. . . . . . . . . . . . . . . . . $30,000
____________
Total asset . . . . . . . . . . . . $30,000
Liabilities
Total liabilities . . . . . . . . . -0-
____________
Net Assets - offering and redemption price of
$10.00 per share; 1,000,000,000 shares of
$.0001 par value capital stock of the Corporation
authorized; 3,000 shares outstanding. $30,000
___________
___________
NOTE TO STATEMENT OF ASSETS AND LIABILITIES
CUNA Mutual Funds, Inc. (the "Corporation") was organized on
October 6, 1993, as a Maryland corporation and is registered
under the Investment Company Act of 1940. The Corporation is a
series fund, of which the CUNA Mutual Tax-Free Intermediate-Term
Fund (the "fund"), a diversified, open-end management investment
company, is one of the portfolios established under the
Corporation. The Corporation has had no operations other than
those matters related to organization and registration as an
investment company, the registration of shares for sale under the
Securities Act of 1933, and the sale of 3,000 shares of the Fund
at $10.00 per share on December 20, 1993 to CMC-T. Rowe Price
Management, L.L.C. The Fund has entered into an investment
management agreement with CMC-T. Rowe Price Management,
L.L.C.(the Manager) which is described in the Statement of
Additional Information under the heading "Investment Management
Services." The manager has agreed to bear all organizational
costs of the Fund.
<PAGE>
PAGE 144
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholder of
CUNA Mutual Tax-Free Intermediate-Term Fund
In our opinion, the accompanying statement of assets and
liabilities presents fairly, in all material respects, the
financial position of the CUNA Mutual Tax-Free Intermediate-Term
Fund (the "Fund"), a series of the CUNA Mutual Funds, Inc., at
December 21, 1993, in conformity with generally accepted
accounting principles. This financial statement is the
responsibility of the Fund's management; our responsibility is to
express an opinion on this financial statement based on our
audit. We conducted our audit of this financial statement in
accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statement is free of
material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the
financial statement, assessing the accounting principles used and
significant estimates made by management, and evaluating the
overall financial statement presentation. We believe that our
audit provides a reasonable basis for the opinion expressed
above.
PRICE WATERHOUSE
Baltimore, Maryland
December 21, 1993
<PAGE>
PAGE 145
STATEMENT OF ADDITIONAL INFORMATION
CUNA MUTUAL FUNDS, INC.
CUNA Mutual U.S. Government Income Fund
(the "Fund")
This Statement of Additional Information is not a
prospectus but should be read in conjunction with the Fund's
prospectus dated December 30, 1993, which may be obtained from
T. Rowe Price Investment Services, Inc., 100 East Pratt Street,
Baltimore, Maryland 21202.
The date of this Statement of Additional Information is
December 30, 1993.
<PAGE>
PAGE 146
TABLE OF CONTENTS
Page Page
Capital Stock. . . . . . . .49 Investment Restrictions. . . . 29
Custodian. . . . . . . . . .38 Joint Venture. . . . . . . . . 34
Development of the CUNA . . .Legal Counsel
. . . . . . . . . . . . . .50
Mutual Funds . . . . . . .49 Lending of Portfolio
Dividends. . . . . . . . . .42 Securities . . . . . . . . . 16
Federal and State Management of Fund
. . . . . . . . . . . . . .33
Registration of Shares . .50 Mortgage-Related Securities. . .6
Fund Distribution. . . . . .36 Net Asset Value Per Share. . . 42
Fund Management and . . .Options
. . . . . . . . . . . . . .17
Administration . . . . . .35 Portfolio Transactions . . . . 38
Futures Contracts. . . . . .23 Pricing of Securities. . . . . 41
Independent Accountants. . .51 Principal Holders of
Investment Objective and Program . . Securities
. . . . . . . . . . . . . .34
(page 5 in Prospectus) . . 2 Ratings of Commercial Paper. . 51
Investment Objective and PoliciesRatings of Corporate Debt Securities
. . . . . . . . . . . . . .51
(page 5 in Prospectus) . . 2 Risk Factors . . . . . . . . . .3
Investment Performance . . .43 Tax Status (page 8 in
Prospectus). . . . . . . . .42
Investment Program When-Issued Securities and
(page 5 in Prospectus) . . 4 Forward Commitment Contracts .5
Yield Information
. . . . . . . . . . . . . .43
INVESTMENT OBJECTIVE AND POLICIES
The following information supplements the discussion of the
Fund's investment objective and policies discussed on pages 5 and
15 through 18 of the prospectus. The Fund will not make a
material change in its investment objective without obtaining
shareholder approval. Unless otherwise specified, the investment
programs and restrictions of the Fund are not fundamental
policies. The Fund's operating policies are subject to change by
its Board of Directors without shareholder approval. However,
shareholders will be notified of a material change in an
operating policy. The Fund's fundamental policies may not be
changed without the approval of at least a majority of the
PAGE 147
outstanding shares of the Fund or, if it is less, 67% of the
shares represented at a meeting of shareholders at which the
holders of 50% or more of the shares are represented.
INVESTMENT OBJECTIVE AND PROGRAM
The investment objective of the Fund is to seek the highest
level of current income consistent with moderate share price
fluctuation.
The Fund will invest primarily (at least 65% of total
assets) in securities issued by the U.S. Government and its
agencies. Such securities will carry the highest credit rating
as determined by nationally recognized rating agencies, or if
unrated, the equivalent as determined by the investment adviser.
These securities include U.S. Treasuries, mortgage-backed
certificates issued by the Government National Mortgage
Association (GNMA), and securities issued by other U.S.
Government-sponsored agencies (such as Fannie Mae, Freddie Mac,
and Sallie Mae, the Student Loan Marketing Association). Up to
35% of total assets can be invested in other types of high-
quality (AA-rated or higher) debt such as privately-issued
mortgage securities and corporate bonds.
The share price and yield of the Fund will fluctuate with
changing market conditions and interest rate levels, and your
investment may be worth more or less when redeemed than when
purchased. The Fund should not be relied upon as a complete
investment program, nor used for short-term trading purposes.
The Fund cannot guarantee it will achieve its investment
objective.
After purchase by the Fund, a security may cease to be rated
or its rating may be reduced below the minimum required for
purchase by the Fund. Neither event would require a sale of such
security by the Fund. However, T. Rowe Price Associates, Inc.
("T. Rowe Price") will consider such event in its determination
of whether the Fund should continue to hold the security. To the
extent that the ratings given by Moody's Investors Service, Inc.
("Moody's"), Standard & Poor's Corporation ("S&P"), or Fitch
Investors Service, Inc. ("Fitch") may change as a result of
changes in such organizations or their rating systems, the Fund
will attempt to use comparable ratings as standards for
investments in accordance with the investment policies contained
in the prospectus. When purchasing unrated securities, T. Rowe
PAGE 148
Price, under the supervision of the Fund's Board of Directors,
determines whether the unrated security is of a quality
comparable to that which the Fund is allowed to purchase.
RISK FACTORS
The Fund may or may not be suitable or appropriate for all
investors. The Fund is not a money market fund and is not an
appropriate investment for those whose primary objective is
principal stability. The Fund is designed for investors seeking
the highest current income and credit protection available from
investment primarily in high-quality securities, including those
issued or guaranteed by the U.S. government and its agencies and
instrumentalities. Consistent with a long-term investment
approach, investors in the Fund should not rely on the Fund for
their short-term financial needs. Reference is also made to the
sections entitled "Types of Securities" and "Portfolio Management
Practices" for discussions of the risks associated with the
investments and practices described therein.
Debt Obligations. Yields on short and intermediate-term
securities are dependent on a variety of factors, including the
general conditions of the money and bond markets, the size of a
particular offering, the maturity of the obligation, and the
credit quality and rating of the issue. Debt securities with
longer maturities tend to have higher yields and are generally
subject to potentially greater capital appreciation and
depreciation than obligations with shorter maturities and lower
yields. The market prices of debt securities usually vary,
depending upon available yields. An increase in interest rates
will generally reduce the value of portfolio investments, and a
decline in interest rates will generally increase the value of
portfolio investments. The ability of the Fund to achieve its
investment objective is also dependent on the continuing ability
of the issuers of the debt securities in which the Fund invests
to meet its obligations for the payment of interest and principal
when due. Although the Fund seeks to reduce risk by portfolio
diversification, credit analysis (considered by T. Rowe Price to
be among the most stringent in the investment management
industry), and attention to trends in the economy, industries and
financial markets, such efforts will not eliminate all risk.
There can, of course, be no assurance that the Fund will achieve
its investment objective.
The Fund may invest a substantial portion of its assets in
PAGE 149
mortgage-related securities. Because they consist of underlying
mortgages, many of these securities may not be an effective means
of "locking in" long-term interest rates due to the need for the
Fund to reinvest scheduled and unscheduled principal payments.
The incidence of unscheduled principal prepayments is also likely
to increase in mortgage pools owned by the Fund when prevailing
mortgage loan rates fall below the mortgage rates of the
securities underlying the individual pool. The effect of such
prepayments in a falling rate environment is to (1) cause the
Fund to reinvest principal payments at the then lower prevailing
interest rate, and (2) reduce the potential for capital
appreciation beyond the face amount of the security and adversely
affect the return to the Fund. Conversely, in a rising interest
rate environment such prepayments can be reinvested at higher
prevailing interest rates which will reduce the potential effect
of capital depreciation to which bonds are subject when interest
rates rise. In addition, prepayments of mortgage securities
purchased at a premium (or discount) will cause such securities
to be paid off at par, resulting in a loss (gain) to the Fund.
T. Rowe Price will actively manage the Fund's portfolio in an
attempt to reduce the risk associated with investment in
mortgage-backed securities.
INVESTMENT PROGRAM
In addition to the investments described in the Fund's
prospectus, the Fund may invest in the following:
Types of Securities
Adjustable Rate Securities
Generally, the maturity of a security is deemed to be the
period remaining until the date (noted on the face of the
instrument) on which the principal amount must be paid, or in the
case of an instrument called for redemption, the date on which
the redemption payment must be made. However, certain securities
may be issued with adjustable interest rates that are reset
periodically by pre-determined formulas or indexes in order to
minimize movements in the principal value of the investment.
Such securities may have long-term maturities, but may be treated
as a short-term investment under certain conditions. Generally,
as interest rates decrease or increase, the potential for capital
appreciation or depreciation on these securities is less than for
fixed-rate obligations. These securities may take the following
PAGE 150
forms:
Variable Rate Securities. Variable rate instruments may
take the form of domestic certificates of deposit which
provide for the adjustment of their interest rate on set
dates and which, upon adjustment, can reasonably be expected
to have a market value which approximates its par value. A
variable rate instrument, the principal amount of which is
scheduled to be paid in 397 calendar days or less, is deemed
to have a maturity equal to the period remaining until the
next readjustment of the interest rate. A variable rate
instrument which is subject to a demand feature which
entitles the purchaser to receive the principal amount of
the underlying security or securities, either (i) upon
notice of no more than 30 days, or (ii) at specified
intervals not exceeding 397 calendar days and upon no more
than 30 days' notice, is deemed to have a maturity equal to
the longer of the period remaining until the next
readjustment of the interest rate or the period remaining
until the principal amount can be recovered through demand.
Floating Rate Securities. Floating rate may take the form
of corporate or bank holding company notes or Eurodollar
certificates of deposit. These instruments provide for the
adjustment of their interest rates whenever a specified
interest rate changes and which, at any time, can reasonably
be expected to have a market value that approximates its par
value. Floating rate instruments with demand features are
deemed to have a maturity equal to the period remaining
until the principal amount can be recovered through demand.
An instrument that is issued or guaranteed by the U.S.
Government or any agency thereof which has a variable rate
of interest readjusted no less frequently than every 762
days may be deemed to have a maturity equal to the period
remaining until the next readjustment of the interest rate.
Put Option Bonds. Long-term obligations with maturities
longer than one year may provide purchasers an optional or
mandatory tender of the security at par value at
predetermined intervals, often ranging from one month to
several years (e.g., a 30-year bond with a five-year tender
period). These instruments are deemed to have a maturity
equal to the period remaining to the put date.
When-Issued Securities and Forward Commitment Contracts
PAGE 151
The Fund may purchase securities on a "when-issued" or
delayed delivery basis ("When-Issueds") and may purchase
securities on a forward commitment basis ("Forwards"). The Fund
may invest without limitation in When-Issueds and Forwards. The
price of such securities, which may be expressed in yield terms,
is fixed at the time the commitment to purchase is made, but
delivery and payment for take place at a later date. Normally,
the settlement date occurs within 90 days of the purchase for
When-Issueds, but may be substantially longer for Forwards.
During the period between purchase and settlement, no payment is
made by the Fund to the issuer and no interest accrues to the
Fund. The purchase of these securities will result in a loss if
their value declines prior to the settlement date. This could
occur, for example, if interest rates increase prior to
settlement. The longer the period between purchase and
settlement, the greater these risks are. At the time the Fund
makes the commitment to purchase these securities, it will record
the transaction and reflect the value of the security in
determining its net asset value. The Fund will cover the
securities by maintaining cash and/or liquid, high-grade debt
securities with its custodian bank equal in value to commitments
for them during the time between the purchase and the settlement.
Therefore, the longer this period, the longer the period during
which alternative investment options are not available to the
Fund (to the extent of the securities used for cover). Such
securities either will mature or, if necessary, be sold on or
before the settlement date.
To the extent the Fund remains fully or almost fully
invested (in securities with a remaining maturity of more than
one year) at the same time it purchases these securities, there
will be greater fluctuations in the Fund's net asset value than
if the Fund did not purchase them.
<PAGE>
PAGE 152
Money Market Securities
The money market securities that the Fund may invest in are
generally limited to those described below.
U.S. Government Obligations. Bills, notes, bonds, and other
debt securities issued by the U.S. Treasury. These are direct
obligations of the U.S. Government and differ mainly in the
length of their maturities.
U.S. Government Agency Securities. Issued or guaranteed by
U.S. Government sponsored enterprises and federal agencies.
These include securities issued by the Federal National Mortgage
Association, Government National Mortgage Association, Federal
Home Loan Bank, Federal Land Banks, Farmers Home Administration,
Banks for Cooperatives, Federal Intermediate Credit Banks,
Federal Financing Bank, Farm Credit Banks, the Small Business
Association, and the Tennessee Valley Authority. Some of these
securities are supported by the full faith and credit of the U.S.
Treasury; and the remainder are supported only by the credit of
the instrumentality, which may or may not include the right of
the issuer to borrow from the Treasury.
Bank Obligations. Certificates of deposit, bankers'
acceptances, and other short-term debt obligations. Certificates
of deposit are short-term obligations of commercial banks. A
bankers' acceptance is a time draft drawn on a commercial bank by
a borrower, usually in connection with international commercial
transactions. Certificates of deposit may have fixed or variable
rates. The Fund may invest in U.S. banks, foreign branches of
U.S. banks, U.S. branches of foreign banks and foreign branches
of foreign banks.
Short-term Corporate Debt Securities. Outstanding
nonconvertible corporate debt securities (e.g., bonds and
debentures) which have one year or less remaining to maturity.
Corporate notes may have fixed, variable, or floating rates.
Commercial Paper. Short-term promissory notes issued by
corporations primarily to finance short-term credit needs.
Certain notes may have floating or variable rates.
Savings and Loan Obligations. Negotiable certificates of
deposit and other short-term debt obligations of savings and loan
associations.
PAGE 153
Supranational Agencies. The Fund may also invest in the
securities of certain supranational entities, such as the
International Development Bank.
Mortgage-Related Securities
Investment in Mortgage-Backed Securities
Mortgage-Backed Securities. Mortgage-backed securities are
securities representing an interest in a pool of mortgages. The
mortgages may be of a variety of types, including adjustable
rate, conventional 30-year fixed rate, graduated payment, and 15-
year. Principal and interest payments made on the mortgages in
the underlying mortgage pool are passed through to the Fund.
This is in contrast to traditional bonds where principal is
normally paid back at maturity in a lump sum. Unscheduled
prepayments of principal shorten the securities' weighted average
life and may lower their total return. (When a mortgage in the
underlying mortgage pool is prepaid, an unscheduled principal
prepayment is passed through to the Fund. This principal is
returned to the Fund at par. As a result, if a mortgage security
were trading at a premium, its total return would be lowered by
prepayments, and if a mortgage security were trading at a
discount, its total return would be increased by prepayments.)
The value of these securities also may change because of changes
in the market's perception of the creditworthiness of the federal
agency that issued them. In addition, the mortgage securities
market in general may be adversely affected by changes in
governmental regulation or tax policies.
The Fund may invest without limitation in mortgage-backed
securities. These securities include, but are not limited to,
those described below.
U.S. Government Agency Mortgage-Backed Securities. These
are obligations issued or guaranteed by the United States
Government or one of its agencies or instrumentalities, such as
the Government National Mortgage Association ("Ginnie Mae" or
"GNMA"), the Federal National Mortgage Association ("Fannie Mae"
or "FNMA") and the Federal Home Loan Mortgage Corporation
("Freddie Mac" or "FHLMC"). FNMA and FHLMC obligations are not
backed by the full faith and credit of the U.S. Government as
GNMA certificates are, but FNMA and FHLMC securities are
supported by the instrumentality's right to borrow from the
United States Treasury. U.S. Government Agency Mortgage-Backed
Certificates provide for the pass-through to investors of their
PAGE 154
pro-rata share of monthly payments (including any prepayments)
made by the individual borrowers on the pooled mortgage loans,
net of any fees paid to the guarantor of such securities and the
servicer of the underlying mortgage loans. Each of GNMA, FNMA
and FHLMC guarantees timely distributions of interest to
certificate holders. GNMA and FNMA guarantee timely
distributions of scheduled principal. FHLMC has in the past
guaranteed only the ultimate collection of principal of the
underlying mortgage loan; however, FHLMC now issues
Mortgage-Backed Securities (FHLMC Gold PCs) which also guarantee
timely payment of monthly principal reductions.
Ginnie Mae Certificates. Ginnie Mae is a wholly-owned
corporate instrumentality of the United States within the
Department of Housing and Urban Development. The National
Housing Act of 1934, as amended (the "Housing Act"), authorizes
Ginnie Mae to guarantee the timely payment of the principal of
and interest on certificates that are based on and backed by a
pool of mortgage loans insured by the Federal Housing
Administration under the Housing Act, or Title V of the Housing
Act of 1949 ("FHA Loans"), or guaranteed by the Department of
Veterans Affairs under the Servicemen's Readjustment Act of 1944,
as amended ("VA Loans"), or by pools of other eligible mortgage
loans. The Housing Act provides that the full faith and credit
of the United States government is pledged to the payment of all
amounts that may be required to be paid under any guaranty. In
order to meet its obligations under such guaranty, Ginnie Mae is
authorized to borrow from the United States Treasury with no
limitations as to amount.
Fannie Mae Certificates. Fannie Mae is a federally
chartered and privately owned corporation organized and existing
under the Federal National Mortgage Association Charter Act of
1938. FNMA Certificates represent a pro-rata interest in a group
of mortgage loans purchased by Fannie Mae. FNMA guarantees the
timely payment of principal and interest on the securities it
issues. The obligations of FNMA are not backed by the full faith
and credit of the U.S. Government.
Freddie Mac Certificates. Freddie Mac is a corporate
instrumentality of the United States created pursuant to the
Emergency Home Finance Act of 1970, as amended (the "FHLMC Act").
Freddie Mac Certificates represent a pro-rata interest in a group
of mortgage loans (a "Freddie Mac Certificate group") purchased
by Freddie Mac. Freddie Mac guarantees timely payment of
interest and principal on certain securities it issues and timely
PAGE 155
payment of interest and eventual payment of principal on other
securities is issues. The obligations of Freddie Mac are
obligations solely of Freddie Mac and are not backed by the full
faith and credit of the U.S. Government.
When mortgages in the pool underlying a Mortgage-Backed
Security are prepaid by mortgagors or by result of foreclosure,
such principal payments are passed through to the certificate
holders. Accordingly, the life of the Mortgage-Backed Security
is likely to be substantially shorter than the stated maturity of
the mortgages in the underlying pool. Because of such variation
in prepayment rates, it is not possible to predict the life of a
particular Mortgage-Backed Security, but FHA statistics indicate
that 25- to 30-year single family dwelling mortgages have an
average life of approximately 12 years. The majority of Ginnie
Mae Certificates are backed by mortgages of this type, and,
accordingly, the generally accepted practice treats Ginnie Mae
Certificates as 30-year securities which prepay full in the 12th
year. FNMA and Freddie Mac Certificates may have differing
prepayment characteristics.
Fixed Rate Mortgage-Backed Securities bear a stated "coupon
rate" which represents the effective mortgage rate at the time of
issuance, less certain fees to GNMA, FNMA and FHLMC for providing
the guarantee, and the issuer for assembling the pool and for
passing through monthly payments of interest and principal.
Payments to holders of Mortgage-Backed Securities consist of
the monthly distributions of interest and principal less the
applicable fees. The actual yield to be earned by a holder of
Mortgage-Backed Securities is calculated by dividing interest
payments by the purchase price paid for the Mortgage-Backed
Securities (which may be at a premium or a discount from the face
value of the certificate).
Monthly distributions of interest, as contrasted to semi-
annual distributions which are common for other fixed interest
investments, have the effect of compounding and thereby raising
the effective annual yield earned on Mortgage-Backed Securities.
Because of the variation in the life of the pools of mortgages
which back various Mortgage-Backed Securities, and because it is
impossible to anticipate the rate of interest at which future
principal payments may be reinvested, the actual yield earned
from a portfolio of Mortgage-Backed Securities will differ
significantly from the yield estimated by using an assumption of
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a certain life for each Mortgage-Backed Security included in such
a portfolio as described above.
Stripped Agency Mortgage-Backed Securities. The Fund may
invest up to 10% of its total assets in stripped mortgage
securities.
Stripped Agency Mortgage-Backed securities representing
interests in a pool of mortgages, the cash flow of which has been
separated into its interest and principal components. "IOs"
(interest only securities) receive the interest portion of the
cash flow while "POs" (principal only securities) receive the
principal portion. Stripped Agency Mortgage-Backed Securities
may be issued by U.S. Government Agencies or by private issuers
similar to those described below with respect to CMOs and
privately-issued mortgage-backed certificates. As interest rates
rise and fall, the value of IOs tends to move in the same
direction as interest rates. The value of the other
mortgage-backed securities described herein, like other debt
instruments, will tend to move in the opposite direction compared
to interest rates. Under the Internal Revenue Code of 1986, as
amended (the "Code"), POs may generate taxable income from the
current accrual of original issue discount, without a
corresponding distribution of cash to the Fund.
The cash flows and yields on IO and PO classes are extremely
sensitive to the rate of principal payments (including
prepayments) on the related underlying mortgage assets. For
example, a rapid or slow rate of principal payments may have a
material adverse effect on the prices of IOs or POs,
respectively. If the underlying mortgage assets experience
greater than anticipated prepayments of principal, an investor
may fail to recoup fully its initial investment in an IO class of
a stripped mortgage-backed security, even if the IO class is
rated AAA or Aaa or is derived from a full faith and credit
obligation. Conversely, if the underlying mortgage assets
experience slower than anticipated prepayments of principal, the
price on a PO class will be affected more severely than would be
the case with a traditional mortgage-backed security.
The staff of the Securities and Exchange Commission has
advised the Fund that it believes the Fund should treat IOs and
POs, other than government-issued IOs or POs backed by fixed rate
mortgages, as illiquid securities and, accordingly, limit its
investments in such securities, together with all other illiquid
securities, to 15% of the Fund's net assets. Under the Staff's
PAGE 157
position, the determination of whether a particular
government-issued IO and PO backed by fixed rate mortgages may be
made on a case by case basis under guidelines and standards
established by the Fund's Board of Directors. The Fund's Board
of Directors has delegated to T. Rowe Price the authority to
determine the liquidity of these investments based on the
following guidelines: the type of issuer; type of collateral,
including age and prepayment characteristics; rate of interest on
coupon relative to current market rates and the effect of the
rate on the potential for prepayments; complexity of the issue's
structure, including the number of tranches; size of the issue
and the number of dealers who make a market in the IO or PO. The
Fund will treat non-government-issued IOs and POs not backed by
fixed or adjustable rate mortgages as illiquid unless and until
the Securities and Exchange Commission modifies its position.
Collateralized Mortgage Obligations (CMOs). The Fund may
invest up to 20% of its total assets in collateralized mortgage
obligations (CMOs).
CMOs are bonds that are collateralized by whole loan
mortgages or mortgage pass-through securities. The bonds issued
in a CMO deal are divided into groups, and each group of bonds is
referred to as a "tranche". Under the traditional CMO structure,
the cash flows generated by the mortgages or mortgage pass-
through securities in the collateral pool are used to first pay
interest and then pay principal to the CMO bondholders. The
bonds issued under a CMO structure are retired sequentially as
opposed to the pro rata return of principal found in traditional
pass-through obligations. Subject to the various provisions of
individual CMO issues, the cash flow generated by the underlying
collateral (to the extent it exceeds the amount required to pay
the stated interest) is used to retire the bonds. Under the CMO
structure, the repayment of principal among the different
tranches is prioritized in accordance with the terms of the
particular CMO issuance. The "fastest-pay" tranche of bonds, as
specified in the prospectus for the issuance, would initially
receive all principal payments. When that tranche of bonds is
retired, the next tranche, or tranches, in the sequence, as
specified in the prospectus, receive all of the principal
payments until they are retired. The sequential retirement of
bond groups continues until the last tranche, or group of bonds,
is retired. Accordingly, the CMO structure allows the issuer to
use cash flows of long maturity, monthly-pay collateral to
formulate securities with short, intermediate and long final
maturities and expected average lives.
PAGE 158
In recent years, new types of CMO structures have evolved.
These include floating rate CMOs, planned amortization classes,
accrual bonds and CMO residuals. These newer structures affect
the amount and timing of principal and interest received by each
tranche from the underlying collateral. Under certain of these
new structures, given classes of CMOs have priority over others
with respect to the receipt of prepayments on the mortgages.
Therefore, depending on the type of CMOs in which the Fund
invests, the investment may be subject to a greater or lesser
risk of prepayment than other types of mortgage-related
securities.
The primary risk of any mortgage security is the uncertainty
of the timing of cash flows. For CMOs, the primary risk results
from the rate of prepayments on the underlying mortgages serving
as collateral. An increase or decrease in prepayment rates
(resulting from a decrease or increase in mortgage interest
rates) will affect the yield, average life and price of CMOs.
The prices of certain CMOs, depending on their structure and the
rate of prepayments, can be volatile. Some CMOs may also not be
as liquid as other securities.
U.S. Government Agency Multiclass Pass-Through Securities.
Unlike CMOs, U.S. Government Agency Multiclass Pass-Through
Securities, which include FNMA Guaranteed REMIC Pass-Through
Certificates and FHLMC Multi-Class Mortgage Participation
Certificates, are ownership interests in a pool of Mortgage
Assets. Unless the context indicates otherwise, all references
herein to CMOs include multiclass pass-through securities.
Multi-Class Residential Mortgage Securities. Such
securities represent interests in pools of mortgage loans to
residential home buyers made by commercial banks, savings and
loan associations or other financial institutions. Unlike GNMA,
FNMA and FHLMC securities, the payment of principal and interest
on Multi-Class Residential Mortgage Securities is not guaranteed
by the U.S. Government or any of its agencies. Accordingly,
yields on Multi-Class Residential Mortgage Securities have been
historically higher than the yields on U.S. government mortgage
securities. However, the risk of loss due to default on such
instruments is higher since they are not guaranteed by the U.S.
Government or its agencies. Additionally, pools of such
securities may be divided into senior or subordinated segments.
Although subordinated mortgage securities may have a higher yield
than senior mortgage securities, the risk of loss of principal is
PAGE 159
greater because losses on the underlying mortgage loans must be
borne by persons holding subordinated securities before those
holding senior mortgage securities.
Privately-Issued Mortgage-Backed Certificates. The Fund may
also invest in pass-through certificates issued by non-
governmental issuers. Pools of conventional residential mortgage
loans created by such issuers generally offer a higher rate of
interest than government and government-related pools because
there are no direct or indirect government guarantees of payment.
Timely payment of interest and principal of these pools is,
however, generally supported by various forms of insurance or
guarantees, including individual loan, title, pool and hazard
insurance. The insurance and guarantees are issued by government
entities, private insurance or the mortgage poolers. Such
insurance and guarantees and the creditworthiness of the issuers
thereof will be considered in determining whether a mortgage-
related security meets the Fund's quality standards. The Fund
may buy mortgage-related securities without insurance or
guarantees if through an examination of the loan experience and
practices of the poolers, the investment manager determines that
the securities meet the Fund's quality standards.
The Fund expects that governmental, government-related or
private entities may create mortgage loan pools offering pass-
through investments in addition to those described above. The
mortgages underlying these securities may be alternative mortgage
instruments, that is, mortgage instruments whose principal or
interest payments may vary or whose terms to maturity may differ
from customary long-term fixed rate mortgages. As new types of
mortgage-related securities are developed and offered to
investors, the investment manager will, consistent with the
Fund's objective, policies and quality standards, consider making
investments in such new types of securities.
Adjustable Rate Mortgage Securities ("ARMs"). ARMs, like
fixed rate mortgages, have a specified maturity date, and the
principal amount of the mortgage is repaid over the life of the
mortgage. Unlike fixed rate mortgages, the interest rate on ARMs
is adjusted at regular intervals based on a specified, published
interest rate "index" such as a Treasury rate index. The new
rate is determined by adding a specific interest amount, the
"margin," to the interest rate of the index. Investment in ARM
securities allows the Fund to participate in changing interest
rate levels through regular adjustments in the coupons of the
PAGE 160
underlying mortgages, resulting in more variable current income
and lower price volatility than longer term fixed rate mortgage
securities. The ARM securities in which the Fund expects to
invest will generally adjust their interest rates at regular
intervals of one year or less. ARM securities are a less
effective means of locking in long-term rates than fixed rate
mortgages since the income from adjustable rate mortgages will
increase during periods of rising interest rates and decline
during periods of falling rates.
Characteristics of Adjustable Rate Mortgage Securities. The
interest rates paid on the mortgages underlying ARM securities
are reset at regular intervals by adding an interest rate margin
to a specified interest rate index. There are three main
categories of indices: those based on U.S. Treasury securities
such as the constant maturity treasury rate (CMT); those derived
from a calculated measure such as a cost of funds index (COFI) or
a moving average of mortgage rates; and those based on certain
actively traded or prominent short-term rates such as the LIBOR.
Some indices, such as the one-year constant maturity Treasury
rate, closely mirror changes in interest rate levels. Others,
such as COFI tend to lag behind changes in market rate levels but
reset monthly thus tending to be somewhat less volatile. Such a
delay in adjusting to changes in interest rates may cause
securities owned by the Fund to increase or decrease in value,
particularly during periods between interest adjustment dates.
ARMs will frequently have caps and floors which limit the
maximum amount by which the interest rate to the residential
borrower may move up or down, respectively, each adjustment
period and over the life of the loan. Interest rate caps on ARM
securities may cause them to decrease in value in an increasing
interest rate environment. Such caps may also prevent their
income from increasing to levels commensurate with prevailing
interest rates. Conversely, interest rate floors on ARM
securities may cause their income to remain higher than
prevailing interest rate levels and result in an increase in the
value of such securities. However, this increase may be tempered
by the acceleration of prepayments.
Mortgage securities generally have a maximum maturity of up
to 30 years. However, due to the adjustable rate feature of ARM
securities, their prices are considered to have volatility
characteristics which approximate the average period of time
until the next adjustment of the interest rate. As a result, the
PAGE 161
principal volatility of ARM securities may be more comparable to
short- and intermediate-term securities than to longer term fixed
rate mortgage securities. Prepayments however, will increase
their principal volatility. See also the discussion of Mortgage-
Backed Securities on page 4.
Asset-Backed Securities
The Fund may invest up to 35% of its total assets in debt
obligations known as asset-backed securities.
The credit quality of most asset-backed securities depends
primarily on the credit quality of the assets underlying such
securities, how well the entity issuing the security is insulated
from the credit risk of the originator or any other affiliated
entities and the amount and quality of any credit support
provided to the securities. The rate of principal payment on
asset-backed securities generally depends on the rate of
principal payments received on the underlying assets which in
turn may be affected by a variety of economic and other factors.
As a result, the yield on any asset-backed security is difficult
to predict with precision and actual yield to maturity may be
more or less than the anticipated yield to maturity. Asset-
backed securities may be classified either as pass-through
certificates or collateralized obligations.
Pass-through certificates are asset-backed securities which
represent an undivided fractional ownership interest in an
underlying pool of assets. Pass-through certificates usually
provide for payments of principal and interest received to be
passed through to their holders, usually after deduction for
certain costs and expenses incurred in administering the pool.
Because pass-through certificates represent an ownership interest
in the underlying assets, the holders thereof bear directly the
risk of any defaults by the obligors on the underlying assets not
covered by any credit support. See "Types of Credit Support".
Asset-backed securities issued in the form of debt
instruments, also known as collateralized obligations, are
generally issued as the debt of a special purpose entity
organized solely for the purpose of owning such assets and
issuing such debt. Such assets are most often trade, credit card
or automobile receivables. The assets collateralizing such
asset-backed securities are pledged to a trustee or custodian for
the benefit of the holders thereof. Such issuers generally hold
PAGE 162
no assets other than those underlying the asset-backed securities
and any credit support provided. As a result, although payments
on such asset-backed securities are obligations of the issuers,
in the event of defaults on the underlying assets not covered by
any credit support (see "Types of Credit Support"), the issuing
entities are unlikely to have sufficient assets to satisfy their
obligations on the related asset-backed securities.
Methods of Allocating Cash Flows. While many asset-backed
securities are issued with only one class of security, many
asset-backed securities are issued in more than one class, each
with different payment terms. Multiple class asset-backed
securities are issued for two main reasons. First, multiple
classes may be used as a method of providing credit support.
This is accomplished typically through creation of one or more
classes whose right to payments on the asset-backed security is
made subordinate to the right to such payments of the remaining
class or classes. See "Types of Credit Support". Second,
multiple classes may permit the issuance of securities with
payment terms, interest rates or other characteristics differing
both from those of each other and from those of the underlying
assets. Examples include so-called "strips" (asset-backed
securities entitling the holder to disproportionate interests
with respect to the allocation of interest and principal of the
assets backing the security), and securities with class or
classes having characteristics which mimic the characteristics of
non-asset-backed securities, such as floating interest rates
(i.e., interest rates which adjust as a specified benchmark
changes) or scheduled amortization of principal.
Asset-backed securities in which the payment streams on the
underlying assets are allocated in a manner different than those
described above may be issued in the future. The Fund may invest
in such asset-backed securities if such investment is otherwise
consistent with its investment objectives and policies and with
the investment restrictions of the Fund.
Types of Credit Support. Asset-backed securities are often
backed by a pool of assets representing the obligations of a
number of different parties. To lessen the effect of failures by
obligors on underlying assets to make payments, such securities
may contain elements of credit support. Such credit support
falls into two classes: liquidity protection and protection
against ultimate default by an obligor on the underlying assets.
Liquidity protection refers to the provision of advances,
generally by the entity administering the pool of assets, to
PAGE 163
ensure that scheduled payments on the underlying pool are made in
a timely fashion. Protection against ultimate default ensures
ultimate payment of the obligations on at least a portion of the
assets in the pool. Such protection may be provided through
guarantees, insurance policies or letters of credit obtained from
third parties, through various means of structuring the
transaction or through a combination of such approaches.
Examples of asset-backed securities with credit support arising
out of the structure of the transaction include "senior-
subordinated securities" (multiple class asset-backed securities
with certain classes subordinate to other classes as to the
payment of principal thereon, with the result that defaults on
the underlying assets are borne first by the holders of the
subordinated class) and asset-backed securities that have
"reserve funds" (where cash or investments, sometimes funded from
a portion of the initial payments on the underlying assets, are
held in reserve against future losses) or that have been
"overcollateralized" (where the scheduled payments on, or the
principal amount of, the underlying assets substantially exceeds
that required to make payment of the asset-backed securities and
pay any servicing or other fees). The degree of credit support
provided on each issue is based generally on historical
information respecting the level of credit risk associated with
such payments. Delinquency or loss in excess of that anticipated
could adversely affect the return on an investment in an asset-
backed security.
Automobile Receivable Securities. The Fund may invest in
Asset-Backed Securities which are backed by receivables from
motor vehicle installment sales contracts or installment loans
secured by motor vehicles ("Automobile Receivable Securities").
Since installment sales contracts for motor vehicles or
installment loans related thereto ("Automobile Contracts")
typically have shorter durations and lower incidences of
prepayment, Automobile Receivable Securities generally will
exhibit a shorter average life and are less susceptible to
prepayment risk.
Most entities that issue Automobile Receivable Securities
create an enforceable interest in their respective Automobile
Contracts only by filing a financing statement and by having the
servicer of the Automobile Contracts, which is usually the
originator of the Automobile Contracts, take custody thereof. In
such circumstances, if the servicer of the Automobile Contracts
were to sell the same Automobile Contracts to another party, in
violation of its obligation not to do so, there is a risk that
PAGE 164
such party could acquire an interest in the Automobile Contracts
superior to that of the holders of Automobile Receivable
Securities. Also although most Automobile Contracts grant a
security interest in the motor vehicle being financed, in most
states the security interest in a motor vehicle must be noted on
the certificate of title to create an enforceable security
interest against competing claims of other parties. Due to the
large number of vehicles involved, however, the certificate of
title to each vehicle financed, pursuant to the Automobile
Contracts underlying the Automobile Receivable Security, usually
is not amended to reflect the assignment of the seller's security
interest for the benefit of the holders of the Automobile
Receivable Securities. Therefore, there is the possibility that
recoveries on repossessed collateral may not, in some cases, be
available to support payments on the securities. In addition,
various state and federal securities laws give the motor vehicle
owner the right to assert against the holder of the owner's
Automobile Contract certain defenses such owner would have
against the seller of the motor vehicle. The assertion of such
defenses could reduce payments on the Automobile Receivable
Securities.
Credit Card Receivable Securities. The Fund may invest in
Asset Backed Securities backed by receivables from revolving
credit card agreements ("Credit Card Receivable Securities").
Credit balances on revolving credit card agreements ("Accounts")
are generally paid down more rapidly than are Automobile
Contracts. Most of the Credit Card Receivable Securities issued
publicly to date have been Pass-Through Certificates. In order
to lengthen the maturity of Credit Card Receivable Securities,
most such securities provide for a fixed period during which only
interest payments on the underlying Accounts are passed through
to the security holder and principal payments received on such
Accounts are used to fund the transfer to the pool of assets
supporting the related Credit Card Receivable Securities of
additional credit card charges made on an Account. The initial
fixed period usually may be shortened upon the occurrence of
specified events which signal a potential deterioration in the
quality of the assets backing the security, such as the
imposition of a cap on interest rates. The ability of the issuer
to extend the life of an issue of Credit Card Receivable
Securities thus depends upon the continued generation of
additional principal amounts in the underlying accounts during
the initial period and the non-occurrence of specified events.
An acceleration in cardholders' payment rates or any other event
which shortens the period during which additional credit card
PAGE 165
charges on an Account may be transferred to the pool of assets
supporting the related Credit Card Receivable Security could
shorten the weighted average life and yield of the Credit Card
Receivable Security.
Credit cardholders are entitled to the protection of a
number of state and federal consumer credit laws, many of which
give such holder the right to set off certain amounts against
balances owed on the credit card, thereby reducing amounts paid
on Accounts. In addition, unlike most other Asset Backed
Securities, Accounts are unsecured obligations of the cardholder.
Other Assets. T. Rowe Price anticipates that Asset Backed
Securities backed by assets other than those described above will
be issued in the future. The Fund may invest in such securities
in the future if such investment is otherwise consistent with its
investment objective and policies.
Hybrid Instruments
The Fund may invest up to 10% of its total assets in Hybrid
Instruments.
Hybrid Instruments have recently been developed and combine
the elements of futures contracts or options with those of debt,
preferred equity or a depository instrument (hereinafter "Hybrid
Instruments"). Often these Hybrid Instruments are indexed to the
price of a commodity, particular currency or a domestic or
foreign debt or equity securities index. Hybrid Instruments may
take a variety of forms, including, but not limited to, debt
instruments with interest or principal payments or redemption
terms determined by reference to the value of a currency or
commodity or securities index at a future point in time,
preferred stock with dividend rates determined by reference to
the value of a currency, or convertible securities with the
conversion terms related to a particular commodity.
The risks of investing in Hybrid Instruments reflect a
combination of the risks from investing in securities, options,
futures, and currencies, including volatility and lack of
liquidity. Reference is made to the discussion of futures,
options, and forward contracts herein for a discussion of these
risks. Further, the prices of the Hybrid Instrument and the
related commodity or currency may not move in the same direction
or at the same time. Hybrid Instruments may bear interest or pay
preferred dividends at below market (or even relatively nominal)
PAGE 166
rates. Alternatively, Hybrid Instruments may bear interest at
above market rates but bear an increased risk of principal loss
(or gain). In addition, because the purchase and sale of Hybrid
Instruments could take place in an over-the-counter market or in
a private transaction between each Fund and the seller of the
Hybrid Instrument, the creditworthiness of the contra party to
the transaction would be a risk factor which the Fund would have
to consider. Hybrid Instruments also may not be subject to
regulation of the Commodities Futures Trading Commission
("CFTC"), which generally regulates the trading of commodity
futures by U.S. persons, the SEC, which regulates the offer and
sale of securities, or any other governmental regulatory
authority.
Illiquid or Restricted Securities
Restricted securities may be sold only in privately
negotiated transactions or in a public offering with respect to
which a registration statement is in effect under the Securities
Act of 1933 (the "1933 Act"). Where registration is required,
the Fund may be obligated to pay all or part of the registration
expenses and a considerable period may elapse between the time of
the decision to sell and the time the Fund may be permitted to
sell a security under an effective registration statement. If,
during such a period, adverse market conditions were to develop,
the Fund might obtain a less favorable price than prevailed when
it decided to sell. Restricted securities will be priced at fair
value as determined in accordance with procedures prescribed by
the Fund's Board of Directors. If through the appreciation of
illiquid securities or the depreciation of liquid securities, the
Fund should be in a position where more than 15% of the value of
its net assets are invested in illiquid assets, including
restricted securities, the Fund will take appropriate steps to
protect liquidity.
Notwithstanding the above, the Fund may purchase securities
which, while privately placed, are eligible for purchase and sale
under Rule 144A under the 1933 Act. This rule permits certain
qualified institutional buyers, such as the Fund, to trade in
privately placed securities even though such securities are not
registered under the 1933 Act. T. Rowe Price under the
supervision of the Fund's Board of Directors, will consider
whether securities purchased under Rule 144A are illiquid and
thus subject to the Fund's restriction of investing no more than
15% of its assets in illiquid securities. A determination of
whether a Rule 144A security is liquid or not is a question of
PAGE 167
fact. In making this determination, T. Rowe Price will consider
the trading markets for the specific security taking into account
the unregistered nature of a Rule 144A security. In addition, T.
Rowe Price could consider the (1) frequency of trades and quotes,
(2) number of dealers and potential purchases, (3) dealer
undertakings to make a market, and (4) the nature of the security
and of marketplace trades (e.g., the time needed to dispose of
the security, the method of soliciting offers and the mechanics
of transfer). The liquidity of Rule 144A securities would be
monitored, and if as a result of changed conditions it is
determined that a Rule 144A security is no longer liquid, the
Fund's holdings of illiquid securities would be reviewed to
determine what, if any, steps are required to assure that the
Fund does not invest more than 15% of its assets in illiquid
securities. Investing in Rule 144A securities could have the
effect of increasing the amount of the Fund's assets invested in
illiquid securities if qualified institutional buyers are
unwilling to purchase such securities.
There are, of course, other types of securities that are, or
may become available, which are similar to the foregoing and the
Fund may invest in these securities.
Portfolio Management Policies
Lending of Portfolio Securities
For the purpose of realizing additional income, the Fund may
make secured loans of portfolio securities amounting to not more
than 33 1/3% of its total assets. This policy is a fundamental
policy. Securities loans are made to broker-dealers or
institutional investors or other persons, pursuant to agreements
requiring that the loans be continuously secured by collateral at
least equal at all times to the value of the securities lent
marked to market on a daily basis. The collateral received will
consist of cash, U.S. government securities, letters of credit or
such other collateral as may be permitted under its investment
program. While the securities are being lent, the Fund will
continue to receive the equivalent of the interest or dividends
paid by the issuer on the securities, as well as interest on the
investment of the collateral or a fee from the borrower. The
Fund has a right to call each loan and obtain the securities on
five business days' notice. The Fund will not have the right to
vote securities while they are being lent, but it will call a
loan in anticipation of any important vote. The risks in lending
portfolio securities, as with other extensions of secured credit,
PAGE 168
consist of possible delay in receiving additional collateral or
in the recovery of the securities or possible loss of rights in
the collateral should the borrower fail financially. Loans will
only be made to firms deemed by T. Rowe Price to be of good
standing and will not be made unless, in the judgment of T. Rowe
Price, the consideration to be earned from such loans would
justify the risk.
Other Lending/Borrowing
Subject to approval by the Securities and Exchange
Commission and certain state regulatory agencies, the Fund may
make loans to, or borrow funds from, other mutual funds sponsored
or advised by T. Rowe Price or Price-Fleming (collectively,
"Price Funds"). The Fund has no current intention of engaging in
these practices at this time.
Repurchase Agreements
The Fund may enter into a repurchase agreement through which
an investor (such as the Fund) purchases a security (known as the
"underlying security") from a well-established securities dealer
or a bank that is a member of the Federal Reserve System. Any
such dealer or bank will be on T. Rowe Price's approved list and
have a credit rating with respect to its short-term debt of at
least A1 by Standard & Poor's Corporation, P1 by Moody's
Investors Service, Inc., or the equivalent rating by T. Rowe
Price. At that time, the bank or securities dealer agrees to
repurchase the underlying security at the same price, plus
specified interest. Repurchase agreements are generally for a
short period of time, often less than a week. Repurchase
agreements which do not provide for payment within seven days
will be treated as illiquid securities. The Fund will only enter
into repurchase agreements where (i) the underlying securities
are of the type (excluding maturity limitations) which the Fund's
investment guidelines would allow it to purchase directly, (ii)
the market value of the underlying security, including interest
accrued, will be at all times equal to or exceed the value of the
repurchase agreement, and (iii) payment for the underlying
security is made only upon physical delivery or evidence of book-
entry transfer to the account of the custodian or a bank acting
as agent. In the event of a bankruptcy or other default of a
seller of a repurchase agreement, the Fund could experience both
delays in liquidating the underlying security and losses,
including: (a) possible decline in the value of the underlying
PAGE 169
security during the period while the Fund seeks to enforce its
rights thereto; (b) possible subnormal levels of income and lack
of access to income during this period; and (c) expenses of
enforcing its rights.
Options
Writing Covered Call Options
The Fund may write (sell) "covered" call options and
purchase options to close out options previously written by the
Fund. In writing covered call options, the Fund expects to
generate additional premium income which should serve to enhance
the Fund's total return and reduce the effect of any price
decline of the security involved in the option. Covered call
options will generally be written on securities which, in T. Rowe
Price's opinion, are not expected to have any major price
increases or moves in the near future but which, over the long
term, are deemed to be attractive investments for the Fund.
A call option gives the holder (buyer) the "right to
purchase" a security at a specified price (the exercise price) at
expiration of the option (European style) or at any time until a
certain date (the expiration date) (American style). So long as
the obligation of the writer of a call option continues, he may
be assigned an exercise notice by the broker-dealer through whom
such option was sold, requiring him to deliver the underlying
security against payment of the exercise price. This obligation
terminates upon the expiration of the call option, or such
earlier time at which the writer effects a closing purchase
transaction by repurchasing an option identical to that
previously sold. To secure his obligation to deliver the
underlying security in the case of a call option, a writer is
required to deposit in escrow the underlying security or other
assets in accordance with the rules of a clearing corporation.
The Fund will write only covered call options. This means that
the Fund will own the security subject to the option or an option
to purchase the same underlying security, having an exercise
price equal to or less than the exercise price of the "covered"
option, or will establish and maintain with its custodian for the
term of the option, an account consisting of cash, U.S.
government securities or other liquid high-grade debt obligations
having a value equal to the fluctuating market value of the
optioned securities. In order to comply with the requirements of
several states, the Fund will not write a covered call option if,
as a result, the aggregate market value of all portfolio
PAGE 170
securities covering call or put options exceeds 25% of the market
value of the Fund's net assets. Should these state laws change
or should the Fund obtain a waiver of its application, the Fund
reserves the right to increase this percentage. In calculating
the 25% limit, the Fund will offset, against the value of assets
covering written calls and puts, the value of purchased calls and
puts on identical securities with identical maturity dates.
Portfolio securities on which call options may be written
will be purchased solely on the basis of investment
considerations consistent with the Fund's investment objective.
The writing of covered call options is a conservative investment
technique believed to involve relatively little risk (in contrast
to the writing of naked or uncovered options, which the Fund will
not do), but capable of enhancing the Fund's total return. When
writing a covered call option, the Fund, in return for the
premium, gives up the opportunity for profit from a price
increase in the underlying security above the exercise price, but
conversely retains the risk of loss should the price of the
security decline. Unlike one who owns securities not subject to
an option, the Fund has no control over when it may be required
to sell the underlying securities, since it may be assigned an
exercise notice at any time prior to the expiration of its
obligation as a writer. If a call option which the Fund has
written expires, the Fund will realize a gain in the amount of
the premium; however, such gain may be offset by a decline in the
market value of the underlying security during the option period.
If the call option is exercised, the Fund will realize a gain or
loss from the sale of the underlying security. The Fund does not
consider a security covered by a call to be "pledged" as that
term is used in the Fund's policy which limits the pledging or
mortgaging of its assets.
The premium received is the market value of an option. The
premium the Fund will receive from writing a call option will
reflect, among other things, the current market price of the
underlying security, the relationship of the exercise price to
such market price, the historical price volatility of the
underlying security, and the length of the option period. Once
the decision to write a call option has been made, T. Rowe Price,
in determining whether a particular call option should be written
on a particular security, will consider the reasonableness of the
anticipated premium and the likelihood that a liquid secondary
market will exist for those options. The premium received by the
Fund for writing covered call options will be recorded as a
liability of the Fund. This liability will be adjusted daily to
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the option's current market value, which will be the latest sale
price at the time at which the net asset value per share of the
Fund is computed (close of the New York Stock Exchange), or, in
the absence of such sale, the latest asked price. The option
will be terminated upon expiration of the option, the purchase of
an identical option in a closing transaction, or delivery of the
underlying security upon the exercise of the option.
Closing transactions will be effected in order to realize a
profit on an outstanding call option, to prevent an underlying
security from being called, or, to permit the sale of the
underlying security. Furthermore, effecting a closing
transaction will permit the Fund to write another call option on
the underlying security with either a different exercise price or
expiration date or both. If the Fund desires to sell a
particular security from its portfolio on which it has written a
call option, or purchased a put option, it will seek to effect a
closing transaction prior to, or concurrently with, the sale of
the security. There is, of course, no assurance that the Fund
will be able to effect such closing transactions at favorable
prices. If the Fund cannot enter into such a transaction, it may
be required to hold a security that it might otherwise have sold.
When the Fund writes a covered call option, it runs the risk of
not being able to participate in the appreciation of the
underlying securities above the exercise price, as well as the
risk of being required to hold on to securities that are
depreciating in value. This could result in higher transaction
costs. The Fund will pay transaction costs in connection with
the writing of options to close out previously written options.
Such transaction costs are normally higher than those applicable
to purchases and sales of portfolio securities.
Call options written by the Fund will normally have
expiration dates of less than nine months from the date written.
The exercise price of the options may be below, equal to, or
above the current market values of the underlying securities at
the time the options are written. From time to time, the Fund
may purchase an underlying security for delivery in accordance
with an exercise notice of a call option assigned to it, rather
than delivering such security from its portfolio. In such cases,
additional costs may be incurred.
The Fund will realize a profit or loss from a closing
purchase transaction if the cost of the transaction is less or
more than the premium received from the writing of the option.
Because increases in the market price of a call option will
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generally reflect increases in the market price of the underlying
security, any loss resulting from the repurchase of a call option
is likely to be offset in whole or in part by appreciation of the
underlying security owned by the Fund.
Writing Covered Put Options
The Fund may write American or European style covered put
options and purchase options to close out options previously
written by the Fund. A put option gives the purchaser of the
option the right to sell, and the writer (seller) has the
obligation to buy, the underlying security at the exercise price
during the option period (American style) or at the expiration of
the option (European style). So long as the obligation of the
writer continues, he may be assigned an exercise notice by the
broker-dealer through whom such option was sold, requiring him to
make payment of the exercise price against delivery of the
underlying security. The operation of put options in other
respects, including their related risks and rewards, is
substantially identical to that of call options.
The Fund would write put options only on a covered basis,
which means that the Fund would maintain in a segregated account
cash, U.S. government securities or other liquid high-grade debt
obligations in an amount not less than the exercise price or the
Fund will own an option to sell the underlying security subject
to the option having an exercise price equal to or greater than
the exercise price of the "covered" option at all times while the
put option is outstanding. (The rules of a clearing corporation
currently require that such assets be deposited in escrow to
secure payment of the exercise price.) The Fund would generally
write covered put options in circumstances where T. Rowe Price
wishes to purchase the underlying security for the Fund's
portfolio at a price lower than the current market price of the
security or currency. In such event the Fund would write a put
option at an exercise price which, reduced by the premium
received on the option, reflects the lower price it is willing to
pay. Since the Fund would also receive interest on debt
securities maintained to cover the exercise price of the option,
this technique could be used to enhance current return during
periods of market uncertainty. The risk in such a transaction
would be that the market price of the underlying security would
decline below the exercise price less the premiums received.
Such a decline could be substantial and result in a significant
loss to the Fund. In addition, the Fund, because it does not own
the specific securities which it may be required to purchase in
PAGD 173
exercise of the put, cannot benefit from appreciation, if any,
with respect to such specific securities. In order to comply
with the requirements of several states, the Fund will not write
a covered put option if, as a result, the aggregate market value
of all portfolio securities covering put or call options exceeds
25% of the market value of the Fund's net assets. Should these
state laws change or should the Fund obtain a waiver of its
application, the Fund reserves the right to increase this
percentage. In calculating the 25% limit, the Fund will offset,
against the value of assets covering written puts and calls, the
value of purchased puts and calls on identical securities with
identical maturity dates.
Purchasing Put Options
The Fund may purchase American or European style put
options. As the holder of a put option, the Fund has the right
to sell the underlying security at the exercise price at any time
during the option period (American style) or at the expiration of
the option (European style). The Fund may enter into closing
sale transactions with respect to such options, exercise them or
permit them to expire. The Fund may purchase put options for
defensive purposes in order to protect against an anticipated
decline in the value of its securities. An example of such use
of put options is provided below.
The Fund may purchase a put option on an underlying security
(a "protective put") owned by the Fund as a defensive technique
in order to protect against an anticipated decline in the value
of the security. Such hedge protection is provided only during
the life of the put option when the Fund, as the holder of the
put option, is able to sell the underlying security at the put
exercise price regardless of any decline in the underlying
security's market price. For example, a put option may be
purchased in order to protect unrealized appreciation of a
security where T. Rowe Price deems it desirable to continue to
hold the security because of tax considerations. The premium
paid for the put option and any transaction costs would reduce
any capital gain otherwise available for distribution when the
security is eventually sold.
The Fund may also purchase put options at a time when the
Fund does not own the underlying security. By purchasing put
options on a security it does not own, the Fund seeks to benefit
from a decline in the market price of the underlying security.
If the put option is not sold when it has remaining value, and if
PAGE 174
the market price of the underlying security remains equal to or
greater than the exercise price during the life of the put
option, the Fund will lose its entire investment in the put
option. In order for the purchase of a put option to be
profitable, the market price of the underlying security must
decline sufficiently below the exercise price to cover the
premium and transaction costs, unless the put option is sold in a
closing sale transaction.
To the extent required by the laws of certain states, the
Fund may not be permitted to commit more than 5% of its assets to
premiums when purchasing put and call options. Should these
state laws change or should the Fund obtain a waiver of its
application, the Fund may commit more than 5% of its assets to
premiums when purchasing call and put options. The premium paid
by the Fund when purchasing a put option will be recorded as an
asset of the Fund. This asset will be adjusted daily to the
option's current market value, which will be the latest sale
price at the time at which the net asset value per share of the
Fund is computed (close of New York Stock Exchange), or, in the
absence of such sale, the latest bid price. This asset will be
terminated upon expiration of the option, the selling (writing)
of an identical option in a closing transaction, or the delivery
of the underlying security upon the exercise of the option.
Purchasing Call Options
The Fund may purchase American or European style call
options. As the holder of a call option, the Fund has the right
to purchase the underlying security at the exercise price at any
time during the option period (American style) or at the
expiration of the option (European style). The Fund may enter
into closing sale transactions with respect to such options,
exercise them or permit them to expire. The Fund may purchase
call options for the purpose of increasing its current return or
avoiding tax consequences which could reduce its current return.
The Fund may also purchase call options in order to acquire the
underlying securities. Examples of such uses of call options are
provided below.
Call options may be purchased by the Fund for the purpose of
acquiring the underlying securities for its portfolio. Utilized
in this fashion, the purchase of call options enables the Fund to
acquire the securities at the exercise price of the call option
plus the premium paid. At times the net cost of acquiring
PAGE 175
securities in this manner may be less than the cost of acquiring
the securities directly. This technique may also be useful to
the Fund in purchasing a large block of securities that would be
more difficult to acquire by direct market purchases. So long as
it holds such a call option rather than the underlying security
itself, the Fund is partially protected from any unexpected
decline in the market price of the underlying security and in
such event could allow the call option to expire, incurring a
loss only to the extent of the premium paid for the option.
To the extent required by the laws of certain states, the
Fund may not be permitted to commit more than 5% of its assets to
premiums when purchasing call and put options. Should these
state laws change or should the Fund obtain a waiver of its
application, the Fund may commit more than 5% of its assets to
premiums when purchasing call and put options. The Fund may also
purchase call options on underlying securities it owns in order
to protect unrealized gains on call options previously written by
it. A call option would be purchased for this purpose where tax
considerations make it inadvisable to realize such gains through
a closing purchase transaction. Call options may also be
purchased at times to avoid realizing losses.
Dealer (Over-the-Counter) Options
The Fund may engage in transactions involving dealer
options. Certain risks are specific to dealer options. While
the Fund would look to a clearing corporation to exercise
exchange-traded options, if the Fund were to purchase a dealer
option, it would rely on the dealer from whom it purchased the
option to perform if the option were exercised. Failure by the
dealer to do so would result in the loss of the premium paid by
the Fund as well as loss of the expected benefit of the
transaction.
Exchange-traded options generally have a continuous liquid
market while dealer options have none. Consequently, the Fund
will generally be able to realize the value of a dealer option it
has purchased only by exercising it or reselling it to the dealer
who issued it. Similarly, when the Fund writes a dealer option,
it generally will be able to close out the option prior to its
expiration only by entering into a closing purchase transaction
with the dealer to which the Fund originally wrote the option.
While the Fund will seek to enter into dealer options only with
dealers who will agree to and which are expected to be capable of
entering into closing transactions with the Fund, there can be no
PAGE 176
assurance that the Fund will be able to liquidate a dealer option
at a favorable price at any time prior to expiration. Until the
Fund, as a covered dealer call option writer, is able to effect a
closing purchase transaction, it will not be able to liquidate
securities (or other assets) used as cover until the option
expires or is exercised. In the event of insolvency of the
contra party, a Fund may be unable to liquidate a dealer option.
With respect to options written by the Fund, the inability to
enter into a closing transaction may result in material losses to
the Fund. For example, since the Fund must maintain a secured
position with respect to any call option on a security it writes,
the Fund may not sell the assets which it has segregated to
secure the position while it is obligated under the option. This
requirement may impair the Fund's ability to sell portfolio
securities at a time when such sale might be advantageous.
The Staff of the SEC has taken the position that purchased
dealer options and the assets used to secure the written dealer
options are illiquid securities. The Fund may treat the cover
used for written OTC options as liquid if the dealer agrees that
the Fund may repurchase the OTC option it has written for a
maximum price to be calculated by a predetermined formula. In
such cases, the OTC option would be considered illiquid only to
the extent the maximum repurchase price under the formula exceeds
the intrinsic value of the option. Accordingly, the Fund will
treat dealer options as subject to the Fund's limitation on
unmarketable securities. If the SEC changes its position on the
liquidity of dealer options, each Fund will change its treatment
of such instrument accordingly.
Interest Rate Transactions
The Fund may enter into various interest rate transactions
such as interest rate swaps and the purchase or sale of interest
rate caps and floors, to preserve a return or spread on a
particular investment or portion of its portfolio, to create
synthetic securities, or to structure transactions designed for
other non-speculative purposes.
Interest rate swaps involve the exchange by the Fund with
third parties of their respective commitments to pay or receive
interest, e.g., an exchange of floating rate payments for fixed
rate payments. The purchase of an interest rate cap entitles the
purchaser, to the extent that a specified index exceeds a
PAGE 177
predetermined interest rate, to receive payments of interest on a
contractually-based principal amount from the party selling the
interest rate cap. The purchase of an interest rate floor
entitles the purchaser, to the extent that a specified index
falls below a predetermined interest rate, to receive payments of
interest on a contractually-based principal amount from the party
selling the interest rate floor. In circumstances in which T.
Rowe Price anticipates that interest rates will decline, the Fund
might, for example, enter into an interest rate swap as the
floating rate payor. In the case where the Fund purchases such
an interest rate swap, if the floating rate payments fell below
the level of the fixed rate payment set in the swap agreement,
the Fund's counterparties would pay the Fund's amount equal to
interest computed at the difference between the fixed and
floating rates over the national principal amount. Such payments
would offset or partially offset the decrease in the payments the
Fund would receive in respect of floating rate assets being
hedged. In the case of purchasing an interest rate floor, if
interest rates declined below the floor rate, the Fund would
receive payments from the counterparties which would wholly or
partially offset the decrease in the payments they would receive
in respect of the financial instruments being hedged.
The Fund will usually enter into interest rate swaps on a
net basis, i.e., the two payment streams are netted out, with the
Fund receiving or paying, as the case may be, only the net amount
of the two payments. The net amount of the excess, if any, of
the Fund's obligations over its entitlements with respect to each
interest rate swap will be accrued on a daily basis and an amount
of cash or high-quality liquid securities having an aggregate net
asset value at least equal to the accrued excess will be
maintained in an account by the Fund's custodian. If the Fund
enters into an interest rate swap on other than a net basis, the
Fund would maintain an account in the full amount accrued on a
daily basis of the Fund's obligations with respect to the swap.
To the extent the Fund sells (i.e., writes) caps and floors, it
will maintain in an account cash or high-quality liquid debt
securities having an aggregate net asset value at least equal to
the full amount, accrued on a daily basis, of the Fund's
obligations with respect to any caps or floors. The Fund will
not enter into any interest rate swap, cap or floor transaction
unless the unsecured senior debt or the claims paying ability of
the counterparty thereto is rated at least A by S&P. T. Rowe
Price will monitor the creditworthiness of counterparties on an
ongoing basis. If there is a default by the other parties to
such a transaction, the Fund will have contractual remedies
PAGE 178
pursuant to the agreements related to the transaction.
The swap market has grown substantially in recent years with
a large number of banks and investment banking firms acting both
as principals and as agents utilizing standardized swap
documentation. T. Rowe Price has determined that, as a result,
the swap market has become relative liquid. The Fund may enter
into interest rate swaps only with respect to positions held in
its portfolio. Interest rate swaps do not involve the delivery
of securities or other underlying assets or principal.
Accordingly, the risk of loss with respect to interest rate swaps
is limited to the net amount of interest payments that the Funds
are contractually obligated to make. If the other parties to
interest rate swaps default, the Fund's risk of loss consists of
the net amount of interest payments that the Fund is
contractually entitled to receive. Since interest rate swaps are
individually negotiated, the Fund expects to achieve an
acceptable degree of correlation between their right to receive
interest on loan interests and their right and obligation to
receive and pay interest pursuant to interest rate swaps.
The aggregate purchase price of caps and floors held by the
Fund may not exceed 10% of the Fund's total assets. The Fund may
sell (i.e., write) caps and floors without limitation, subject to
the account coverage requirement described above.
Futures Contracts
Transactions in Futures
The Fund may enter into financial futures contracts,
including interest rate and currency futures) ("futures" or
"futures contracts"). Interest rate futures contracts may be
used as a hedge against changes in prevailing levels of interest
rates in order to establish more definitely the effective return
on securities held or intended to be acquired by the Fund. The
Fund could sell interest rate futures as an offset against the
effect of expected increases in interest rates and purchase such
futures as an offset against the effect of expected declines in
interest rates. Futures can also be used as an efficient means
of regulating a Fund's exposure to the market.
The Fund will enter into futures contracts which are traded
on national futures exchanges, and are standardized as to
maturity date and underlying financial instrument. The principal
futures exchanges in the United States are the Board of Trade of
PAGE 179
the City of Chicago, the Chicago Mercantile Exchange, the New
York Futures Exchange, and the Kansas City Board of Trade.
Futures exchanges and trading in the United States are regulated
under the Commodity Exchange Act by the Commodity Futures Trading
Commission ("CFTC"). Although techniques other than the sale and
purchase of futures contracts could be used for the above-
referenced purposes, futures contracts offer an effective and
relatively low cost means of implementing the Fund's objectives
in these areas.
Regulatory Limitations
The Fund will engage in futures contracts and options
thereon only for bona fide hedging, yield enhancement, and risk
management purposes, in each case in accordance with rules and
regulations of the CFTC, and not for speculation.
The Fund may not enter into futures contracts or options
thereon if, with respect to positions which do not qualify as
bona fide hedging under applicable CFTC rules, the sum of the
amounts of initial margin deposits on the Fund's existing futures
and premiums paid for options on futures would exceed 5% of the
net asset value of the Fund after taking into account unrealized
profits and unrealized losses on any such contracts it has
entered into; provided, however, that in the case of an option
that is in-the-money at the time of purchase, the in-the-money
amount may be excluded in calculating the 5% limitation.
The Fund's use of futures contracts will not result in
leverage. Therefore, to the extent necessary, in instances
involving the purchase of futures contracts or call options
thereon or the writing of put options thereon by the Fund, an
amount of cash, U.S. government securities or other liquid, high-
grade debt obligations, equal to the market value of the futures
contracts and options thereon (less any related margin deposits),
will be identified in an account with the Fund's custodian to
cover the position, or alternative cover will be employed.
In addition, CFTC regulations may impose limitations on the
Fund's ability to engage in certain risk management strategies.
If the CFTC or other regulatory authorities adopt different
(including less stringent) or additional restrictions, the Fund
would comply with such new restrictions.
Trading in Futures Contracts
PAGE 180
A futures contract provides for the future sale by one party
and purchase by another party of a specified amount of a specific
financial instrument (e.g., units of a debt security) for a
specified price, date, time and place designated at the time the
contract is made. Brokerage fees are incurred when a futures
contract is bought or sold and margin deposits must be
maintained. Entering into a contract to buy is commonly referred
to as buying or purchasing a contract or holding a long position.
Entering into a contract to sell is commonly referred to as
selling a contract or holding a short position.
Unlike when the Fund purchases or sells a security, no price
would be paid or received by the Fund upon the purchase or sale
of a futures contract. Upon entering into a futures contract,
and to maintain the Fund's open positions in futures contracts,
the Fund would be required to deposit with its custodian in a
segregated account in the name of the futures broker an amount of
cash, U.S. government securities, suitable money market
instruments, or liquid, high-grade debt securities, known as
"initial margin." The margin required for a particular futures
contract is set by the exchange on which the contract is traded,
and may be significantly modified from time to time by the
exchange during the term of the contract. Futures contracts are
customarily purchased and sold on margins that may range upward
from less than 5% of the value of the contract being traded.
If the price of an open futures contract changes (by
increase in the case of a sale or by decrease in the case of a
purchase) so that the loss on the futures contract reaches a
point at which the margin on deposit does not satisfy margin
requirements, the broker will require an increase in the margin.
However, if the value of a position increases because of
favorable price changes in the futures contract so that the
margin deposit exceeds the required margin, the broker will pay
the excess to the Fund.
These subsequent payments, called "variation margin," to and
from the futures broker, are made on a daily basis as the price
of the underlying assets fluctuate making the long and short
positions in the futures contract more or less valuable, a
process known as "marking to the market." The Fund expects to
earn interest income on its margin deposits.
Although certain futures contracts, by their terms, require
actual future delivery of and payment for the underlying
instruments in practice most futures contracts are usually closed
PAGE 181
out before the delivery date. Closing out an open futures
contract purchase or sale is effected by entering into an
offsetting futures contract purchase or sale, respectively, for
the same aggregate amount of the identical securities and the
same delivery date. If the offsetting purchase price is less
than the original sale price, the Fund realizes a gain; if it is
more, the Fund realizes a loss. Conversely, if the offsetting
sale price is more than the original purchase price, the Fund
realizes a gain; if it is less, the Fund realizes a loss. The
transaction costs must also be included in these calculations.
There can be no assurance, however, that the Fund will be able to
enter into an offsetting transaction with respect to a particular
futures contract at a particular time. If the Fund is not able
to enter into an offsetting transaction, the Fund will continue
to be required to maintain the margin deposits on the futures
contract.
As an example of an offsetting transaction in which the
underlying instrument is not delivered, the contractual
obligations arising from the sale of one contract of September
municipal bond index futures on an exchange may be fulfilled at
any time before delivery of the contract is required (i.e., on a
specified date in September, the "delivery month") by the
purchase of one contract of September municipal bond index
futures on the same exchange. In such instance, the difference
between the price at which the futures contract was sold and the
price paid for the offsetting purchase, after allowance for
transaction costs, represents the profit or loss to the Fund.
Special Risks of Transactions in Futures Contracts
Volatility and Leverage. The prices of futures contracts
are volatile and are influenced, among other things, by actual
and anticipated changes in the market and interest rates, which
in turn are affected by fiscal and monetary policies and national
and international political and economic events.
Most United States futures exchanges limit the amount of
fluctuation permitted in futures contract prices during a single
trading day. The daily limit establishes the maximum amount that
the price of a futures contract may vary either up or down from
the previous day's settlement price at the end of a trading
session. Once the daily limit has been reached in a particular
type of futures contract, no trades may be made on that day at a
price beyond that limit. The daily limit governs only price
PAGE 182
movement during a particular trading day and therefore does not
limit potential losses, because the limit may prevent the
liquidation of unfavorable positions. Futures contract prices
have occasionally moved to the daily limit for several
consecutive trading days with little or no trading, thereby
preventing prompt liquidation of futures positions and subjecting
some futures traders to substantial losses.
Because of the low margin deposits required, futures trading
involves an extremely high degree of leverage. As a result, a
relatively small price movement in a futures contract may result
in immediate and substantial loss, as well as gain, to the
investor. For example, if at the time of purchase, 10% of the
value of the futures contract is deposited as margin, a
subsequent 10% decrease in the value of the futures contract
would result in a total loss of the margin deposit, before any
deduction for the transaction costs, if the account were then
closed out. A 15% decrease would result in a loss equal to 150%
of the original margin deposit, if the contract were closed out.
Thus, a purchase or sale of a futures contract may result in
losses in excess of the amount invested in the futures contract.
However, the Fund would presumably have sustained comparable
losses if, instead of the futures contract, it had invested in
the underlying financial instrument and sold it after the
decline. Furthermore, in the case of a futures contract
purchase, in order to be certain that the Fund has sufficient
assets to satisfy its obligations under a futures contract, the
Fund earmarks to the futures contract money market instruments
equal in value to the current value of the underlying instrument
less the margin deposit.
Liquidity. The Fund may elect to close some or all of its
futures positions at any time prior to their expiration. The
Fund would do so to reduce exposure represented by long futures
positions or increase exposure represented by short futures
positions. The Fund may close its positions by taking opposite
positions which would operate to terminate the Fund's position in
the futures contracts. Final determinations of variation margin
would then be made, additional cash would be required to be paid
by or released to the Fund, and the Fund would realize a loss or
a gain.
Futures contracts may be closed out only on the exchange or
board of trade where the contracts were initially traded.
Although the Fund intends to purchase or sell futures contracts
only on exchanges or boards of trade where there appears to be an
PAGE 183
active market, there is no assurance that a liquid market on an
exchange or board of trade will exist for any particular contract
at any particular time. In such event, it might not be possible
to close a futures contract, and in the event of adverse price
movements, the Fund would continue to be required to make daily
cash payments of variation margin. However, in the event futures
contracts have been used to hedge the underlying instruments, the
Fund would continue to hold the underlying instruments subject to
the hedge until the futures contracts could be terminated. In
such circumstances, an increase in the price of underlying
instruments, if any, might partially or completely offset losses
on the futures contract. However, as described below, there is
no guarantee that the price of the underlying instruments will,
in fact, correlate with the price movements in the futures
contract and thus provide an offset to losses on a futures
contract.
Hedging Risk. A decision of whether, when, and how to hedge
involves skill and judgment, and even a well-conceived hedge may
be unsuccessful to some degree because of unexpected market
behavior, market or interest rate trends. There are several
risks in connection with the use by the Fund of futures contracts
as a hedging device. One risk arises because of the imperfect
correlation between movements in the prices of the futures
contracts and movements in the prices of the underlying
instruments which are the subject of the hedge. T. Rowe Price
will, however, attempt to reduce this risk by entering into
futures contracts whose movements, in its judgment, will have a
significant correlation with movements in the prices of the
Fund's underlying instruments sought to be hedged.
Successful use of futures contracts by the Fund for hedging
purposes is also subject to T. Rowe Price's ability to correctly
predict movements in the direction of the market. It is possible
that, when the Fund has sold futures to hedge its portfolio
against a decline in the market, the index, indices, or
underlying instruments on which the futures are written might
advance and the value of the underlying instruments held in the
Fund's portfolio might decline. If this were to occur, the Fund
would lose money on the futures and also would experience a
decline in value in its underlying instruments. However, while
this might occur to a certain degree, T. Rowe Price believes that
over time the value of the Fund's portfolio will tend to move in
the same direction as the market indices which are intended to
correlate to the price movements of the underlying instruments
PAGE 184
sought to be hedged. It is also possible that if the Fund were
to hedge against the possibility of a decline in the market
(adversely affecting the underlying instruments held in its
portfolio) and prices instead increased, the Fund would lose part
or all of the benefit of increased value of those underlying
instruments that it has hedged, because it would have offsetting
losses in its futures positions. In addition, in such
situations, if the Fund had insufficient cash, it might have to
sell underlying instruments to meet daily variation margin
requirements. Such sales of underlying instruments might be, but
would not necessarily be, at increased prices (which would
reflect the rising market). The Fund might have to sell
underlying instruments at a time when it would be disadvantageous
to do so.
In addition to the possibility that there might be an
imperfect correlation, or no correlation at all, between price
movements in the futures contracts and the portion of the
portfolio being hedged, the price movements of futures contracts
might not correlate perfectly with price movements in the
underlying instruments due to certain market distortions. First,
all participants in the futures market are subject to margin
deposit and maintenance requirements. Rather than meeting
additional margin deposit requirements, investors might close
futures contracts through offsetting transactions which could
distort the normal relationship between the underlying
instruments and futures markets. Second, the margin requirements
in the futures market are less onerous than margin requirements
in the securities markets, and as a result the futures market
might attract more speculators than the securities markets do.
Increased participation by speculators in the futures market
might also cause temporary price distortions. Due to the
possibility of price distortion in the futures market and also
because of the imperfect correlation between price movements in
the underlying instruments and movements in the prices of futures
contracts, even a correct forecast of general market trends by T.
Rowe Price might not result in a successful hedging transaction
over a very short time period.
Options on Futures Contracts
Options on futures are similar to options on underlying
instruments except that options on futures give the purchaser the
right, in return for the premium paid, to assume a position in a
futures contract (a long position if the option is a call and a
short position if the option is a put), rather than to purchase
PAGE 185
or sell the futures contract, at a specified exercise price at
any time during the period of the option. Upon exercise of the
option, the delivery of the futures position by the writer of the
option to the holder of the option will be accompanied by the
delivery of the accumulated balance in the writer's futures
margin account which represents the amount by which the market
price of the futures contract, at exercise, exceeds (in the case
of a call) or is less than (in the case of a put) the exercise
price of the option on the futures contract. Alternatively,
settlement may be made totally in cash. Purchasers of options
who fail to exercise their options prior to the exercise date
suffer a loss of the premium paid.
As an alternative to writing or purchasing call and put
options on interest rate futures, the Fund may write or purchase
call and put options on financial indices. Such options would be
used in a manner similar to the use of options on futures
contracts. From time to time, a single order to purchase or sell
futures contracts (or options thereon) may be made on behalf of
the Fund and other T. Rowe Price Funds. Such aggregated orders
would be allocated among the Fund and the other T. Rowe Price
Funds in a fair and non-discriminatory manner.
Special Risks of Transactions in Options on Futures Contracts
The Fund may seek to close out an option position by writing
or buying an offsetting option covering the same index,
underlying instrument or contract and having the same exercise
price and expiration date. The ability to establish and close
out positions on such options will be subject to the maintenance
of a liquid secondary market. Reasons for the absence of a
liquid secondary market on an exchange include the following: (i)
there may be insufficient trading interest in certain options;
(ii) restrictions may be imposed by an exchange on opening
transactions or closing transactions or both; (iii) trading
halts, suspensions or other restrictions may be imposed with
respect to particular classes or series of options, or underlying
instruments; (iv) unusual or unforeseen circumstances may
interrupt normal operations on an exchange; (v) the facilities of
an exchange or a clearing corporation may not at all times be
adequate to handle current trading volume; or (vi) one or more
exchanges could, for economic or other reasons, decide or be
compelled at some future date to discontinue the trading of
options (or a particular class or series of options), in which
event the secondary market on that exchange (or in the class or
series of options) would cease to exist, although outstanding
PAGE 186
options on the exchange that had been issued by a clearing
corporation as a result of trades on that exchange would continue
to be exercisable in accordance with their terms. There is no
assurance that higher than anticipated trading activity or other
unforeseen events might not, at times, render certain of the
facilities of any of the clearing corporations inadequate, and
thereby result in the institution by an exchange of special
procedures which may interfere with the timely execution of
customers' orders.
Additional Futures and Options Contracts
Although the Fund has no current intention of engaging in
financial futures or options transactions other than those
described above, it reserves the right to do so. Such futures
and options trading might involve risks which differ from those
involved in the futures and options described above.
Federal Tax Treatment of Options, Futures Contracts and Forward
Foreign Exchange Contracts
The discussion herein may refer to transactions in which the
Fund does not engage. The Fund's prospectus sets forth the types
of transactions permissible for the Fund.
The Fund may enter into certain option, futures, and forward
foreign exchange contracts, including options and futures on
currencies, which will be treated as Section 1256 contracts or
straddles.
Transactions which are considered Section 1256 contracts
will be considered to have been closed at the end of a Fund's
fiscal year and any gains or losses will be recognized for tax
purposes at that time. Such gains or losses from the normal
closing or settlement of such transactions will be characterized
as 60% long-term capital gain or loss and 40% short-term capital
gain or loss regardless of the holding period of the instrument.
A Fund will be required to distribute net gains on such
transactions to shareholders even though it may not have closed
the transaction and received cash to pay such distributions.
Options, futures and forward foreign exchange contracts,
including options and futures on currencies, which offset a
foreign dollar denominated bond or currency position may be
considered straddles for tax purposes in which case a loss on any
position in a straddle will be subject to deferral to the extent
PAGE 187
of unrealized gain in an offsetting position. The holding period
of the securities or currencies comprising the straddle will be
deemed not to begin until the straddle is terminated. For
securities offsetting a purchased put, this adjustment of the
holding period may increase the gain from sales of securities
held less than three months. The holding period of the security
offsetting an "in-the-money qualified covered call" option on an
equity security will not include the period of time the option is
outstanding.
Losses on written covered calls and purchased puts on
securities, excluding certain "qualified covered call" options on
equity securities, may be long-term capital loss, if the security
covering the option was held for more than twelve months prior to
the writing of the option.
In order for the Fund to continue to qualify for federal
income tax treatment as a regulated investment company, at least
90% of its gross income for a taxable year must be derived from
qualifying income; i.e., dividends, interest, income derived from
loans of securities, and gains from the sale of securities or
currencies. Pending tax regulations could limit the extent that
net gain realized from option, futures or foreign forward
exchange contracts on currencies is qualifying income for
purposes of the 90% requirement. In addition, gains realized on
the sale or other disposition of securities, including option,
futures or foreign forward exchange contracts on securities or
securities indexes and, in some cases, currencies, held for less
than three months, must be limited to less than 30% of a Fund's
annual gross income. In order to avoid realizing excessive gains
on securities or currencies held less than three months, the Fund
may be required to defer the closing out of option, futures or
foreign forward exchange contracts beyond the time when it would
otherwise be advantageous to do so. It is anticipated that
unrealized gains on Section 1256 option, futures and foreign
forward exchange contracts, which have been open for less than
three months as of the end of the Fund's fiscal year and which
are recognized for tax purposes, will not be considered gains on
securities or currencies held less than three months for purposes
of the 30% test.
INVESTMENT RESTRICTIONS
Fundamental policies may not be changed without the approval
of the lesser of (1) 67% of the Fund's shares present at a
PAGE 188
meeting of shareholders if the holders of more than 50% of the
outstanding shares are present in person or by proxy or (2) more
than 50% of the Fund's outstanding shares. Other restrictions in
the form of operating policies are subject to change by the
Fund's Board of Directors without shareholder approval. Any
investment restriction which involves a maximum percentage of
securities or assets shall not be considered to be violated
unless an excess over the percentage occurs immediately after,
and is caused by, an acquisition of securities or assets of, or
borrowings by, the Fund.
Fundamental Policies
As a matter of fundamental policy, the Fund may not:
(1) Borrowing. Borrow money except that the Fund may
(i) borrow for non-leveraging, temporary or
emergency purposes and (ii) engage in reverse
repurchase agreements and make other investments
or engage in other transactions, which may involve
a borrowing, in a manner consistent with the
Fund's investment objective and program, provided
that the combination of (i) and (ii) shall not
exceed 33 1/3% of the value of the Fund's total
assets (including the amount borrowed) less
liabilities (other than borrowings) or such other
percentage permitted by law. Any borrowings which
come to exceed this amount will be reduced in
accordance with applicable law. The Fund may
borrow from banks, other Price Funds or other
persons to the extent permitted by applicable law;
(2) Commodities. Purchase or sell physical
commodities; except that it may enter into futures
contracts and options thereon;
(3) Industry Concentration. Purchase the securities
of any issuer if, as a result, more than 25% of
the value of the Fund's total assets would be
invested in the securities of issuers having their
principal business activities in the same
industry;
PAGE 189
(4) Loans. Make loans, although the Fund may (i) lend
portfolio securities and participate in an
interfund lending program with other Price Funds
provided that no such loan may be made if, as a
result, the aggregate of such loans would exceed
33 1/3% of the value of the Fund's total assets;
(ii) purchase money market securities and enter
into repurchase agreements; and (iii) acquire
publicly-distributed or privately-placed debt
securities and purchase debt;
(5) Percent Limit on Assets Invested in Any One
Issuer. Purchase a security if, as a result, with
respect to 75% of the value of its total assets,
more than 5% of the value of the Fund's total
assets would be invested in the securities of a
single issuer, except securities issued or
guaranteed by the U.S. Government or any of its
agencies or instrumentalities;
(6) Percent Limit on Share Ownership of Any One
Issuer. Purchase a security if, as a result, with
respect to 75% of the value of the Fund's total
assets, more than 10% of the outstanding voting
securities of any issuer would be held by the Fund
(other than obligations issued or guaranteed by
the U.S. Government, its agencies or
instrumentalities);
(7) Real Estate. Purchase or sell real estate unless
acquired as a result of ownership of securities or
other instruments (but this shall not prevent the
Fund from investing in securities or other
instruments backed by real estate or securities of
companies engaged in the real estate business);
(8) Senior Securities. Issue senior securities except
in compliance with the Investment Company Act of
1940; or
PAGE 190
(9) Underwriting. Underwrite securities issued by
other persons, except to the extent that the Fund
may be deemed to be an underwriter within the
meaning of the Securities Act of 1933 in
connection with the purchase and sale of its
portfolio securities in the ordinary course of
pursuing its investment program.
With respect to investment restrictions (1) and (4), the
Fund will not borrow from or lend to any other Price
Fund (defined as any other mutual fund managed or for
which T. Rowe Price acts as adviser) unless they apply
for and receive an exemptive order from the SEC or the
SEC issues rules permitting such transactions. The Fund
has no current intention of engaging in any such
activity and there is no assurance the SEC would grant
any order requested by the Fund or promulgate any rules
allowing the transactions.
For purposes of investment restriction (3), U.S., state
or local governments, or related agencies or
instrumentalities, are not considered an industry.
Operating Policies
As a matter of operating policy, the Fund may not:
(1) Borrowing. The Fund will not purchase additional
securities when money borrowed exceeds 5% of its
total assets;
(2) Control of Portfolio Companies. Invest in
companies for the purpose of exercising management
or control;
(3) Futures Contracts. Purchase a futures contract or
an option thereon if, with respect to positions in
futures or options on futures which do not
represent bona fide hedging, the aggregate initial
margin and premiums on such positions would exceed
5% of the Fund's net asset value;
PAGE 191
(4) Illiquid Securities. Purchase illiquid securities
and securities of unseasoned issuers if, as a
result, more than 15% of its net assets would be
invested in such securities, provided that the
Fund will not invest more than 5% of its total
assets in restricted securities and not more than
5% in securities of unseasoned issuers.
Securities eligible for resale under Rule 144A of
the Securities Act of 1933 are not included in the
5% limitation but are subject to the 15%
limitation;
(5) Investment Companies. Purchase securities of
open-end or closed-end investment companies except
in compliance with the Investment Company Act of
1940 and applicable state law. Duplicate fees may
result from such purchases;
(6) Margin. Purchase securities on margin, except (i)
for use of short-term credit necessary for
clearance of purchases of portfolio securities and
(ii) it may make margin deposits in connection
with futures contracts or other permissible
investments;
(7) Mortgaging. Mortgage, pledge, hypothecate or, in
any manner, transfer any security owned by the
Fund as security for indebtedness except as may be
necessary in connection with permissible
borrowings or investments and then such
mortgaging, pledging or hypothecating may not
exceed 33 1/3% of the Fund's total assets at the
time of borrowing or investment;
(8) Oil and Gas Programs. Purchase participations or
other direct interests in or enter into leases
with respect to, oil, gas, or other mineral
exploration or development programs;
(9) Options, Etc. Invest in puts, calls, straddles,
spreads, or any combination thereof, except to the
extent permitted by the prospectus and Statement
of Additional Information;
PAGE 192
(10) Ownership of Portfolio Securities by Officers and
Directors. Purchase or retain the securities of
any issuer if, to the knowledge of the Fund's
management, those officers and directors of the
Fund, and of its investment manager, who each owns
beneficially more than .5% of the outstanding
securities of such issuer, together own
beneficially more than 5% of such securities;
(11) Short Sales. Effect short sales of securities;
(12) Unseasoned Issuers. Purchase a security (other
than obligations issued or guaranteed by the U.S.,
any foreign, state or local government, their
agencies or instrumentalities if, as a result,
more than 5% of the value of the Fund's total
assets would be invested in the securities of
issuers which at the time of purchase had been in
operation for less than three years (for this
purpose, the period of operation of any issuer
shall include the period of operation of any
predecessor or unconditional guarantor of such
issuer). This restriction does not apply to
securities of pooled investment vehicles or
mortgage or asset-backed securities; or
(13) Warrants. Invest in warrants if, as a result
thereof, more than 2% of the value of the total
assets of the Fund would be invested in warrants
which are not listed on the New York Stock
Exchange, the American Stock Exchange, or a
recognized foreign exchange, or more than 5% of
the value of the total assets of the Fund would be
invested in warrants whether or not so listed.
For purposes of these percentage limitations, the
warrants will be valued at the lower of cost or
market and warrants acquired by the Funds in units
or attached to securities may be deemed to be
without value.
With respect to investment restriction (5), the Fund has
no current intention of purchasing the securities of
other investment companies.
Notwithstanding anything in the above fundamental and
operating restrictions to the contrary, the Fund may invest all
of its assets in a single investment company or a series thereof
PAGE 193
in connection with a "master-feeder" arrangement. Such an
investment would be made where the Fund (a "Feeder"), and one or
more other Funds with the same investment objective and program
as the Fund, sought to accomplish its investment objective and
program by investing all of its assets in the shares of another
investment company (the "Master"). The Master would, in turn,
have the same investment objective and program as the Fund. The
Fund would invest in this manner in an effort to achieve the
economies of scale associated with having a Master fund make
investments in portfolio companies on behalf of a number of
Feeder funds. In the event that the Fund exercises its right to
convert to a Master Fund/Feeder Fund structure, it will do so in
compliance with the Guidelines for Registration of a Master
Fund/Feeder Fund as established by the North American Securities
Administrators Association, Inc. ("NASAA").
MANAGEMENT OF FUND
The officers and directors of the Fund are listed below.
Unless otherwise noted, the address of each is 100 East Pratt
Street, Baltimore, Maryland 21202. Except as indicated, each has
been an employee of T. Rowe Price for more than five years. In
the list below, the Fund's directors who are considered
"interested persons" of T. Rowe Price as defined under
Section 2(a)(19) of the Investment Company Act of 1940 are noted
with an asterisk (*). These directors are referred to as inside
directors by virtue of their officership, directorship, and/or
employment with T. Rowe Price.
STEVEN S. CONNER, Director--Retired; formerly Executive Vice
President, Central Savings and Loan Association, San Diego,
California; Address: 910 Loma Court, El Cajon, California 92020
ROGER P. HAUCK, Director--President, Chief Executive Officer, and
Director, Marshall, Erdman & Associates, Inc., architect and
builder of ambulatory health care buildings, Director and member
of Executive Committee, University Health Care, Inc., and
Director, Madison-Kipp Corporation and Wisconsin Policy Research
Institute; Address: 3512 Blackhawk Drive, Shorewood Hills,
Wisconsin 53705
*RICHARD M. HEINS, PH.D., Director--President and Chief Executive
Officer, CUNA Mutual Insurance Group, Madison, Wisconsin;
Director, Chief Executive Officer and Vice Chairman, Centure
Companies of America, Waverly, Iowa; Director, The CUMIS Group of
Companies (Canada); President, Filene Research Institute, Inc.;
Address: 5910 Mineral Point Road, P.O. Box 391, Madison,
PAGE 194
Wisconsin 53701-0391
EMMETT J. RICE, Director--Retired; Director, The Ethyl
Corporation, Richmond, Virginia, Tredegar Industries, Inc.,
Richmond, Virginia, and Jardine Fleming China Region Fund, Inc.,
Baltimore, Maryland; Address: 1673 Myrtle Street, N.W.,
Washington, D.C. 20012
*JAMES S. RIEPE, President and Director, Managing Director, T.
Rowe Price; Chairman of the Board, T. Rowe Price Services,
Inc., T. Rowe Price Retirement Plan Services, Inc., and T. Rowe
Price Trust Company; President and Director, T. Rowe Price
Investment Services, Inc.; Member, Management Committee, CMC-T.
Rowe Price Management, LLC; Director, Rhone-Poulenc Rorer, Inc.
MARY J. MILLER, Executive Vice President--Managing Director, T.
Rowe Price
PETER VAN DYKE, Executive Vice President--Managing Director, T.
Rowe Price, Vice President, Rowe Price-Fleming International,
Inc. and T. Rowe Price Trust Company
DOROTHY L. BALLANTYNE, Vice President--Vice President, CUNA
Mutual Investment Corporation, LLC and Member, Management
Committee, CMC-T. Rowe Price Management, LLC
HENRY H. HOPKINS, Vice President--Managing Director, T. Rowe
Price; Vice President and Director, T. Rowe Price Investment
Services, Inc., T. Rowe Price Services, Inc., and T. Rowe Price
Trust Company; Vice President, Rowe Price-Fleming International,
Inc. and T. Rowe Price Retirement Plan Services, Inc.
BRADFORD L. MURPHY, Vice President--Executive Vice President,
CUNA Service Group, Inc. and Member, Management Committee, CMC-T.
Rowe Price Management, LLC
THOMAS O. OLSON, Vice President--Senior Vice President, CUNA
Mutual Investment Corporation, LLC and Member, Management
Committee, CMC-T. Rowe Price Management, LLC
CHARLES E. VIETH, Vice President--Managing Director, T. Rowe
Price; President and Director, T. Rowe Price Retirement Plan
Services, Inc.; Vice President and Director, T. Rowe Price
Services, Inc.; Member, Management Committee, CMC-T. Rowe Price
Management, LLC; Director, T. Rowe Price Investment Services,
Inc.
RICHARD T. WHITNEY, Vice President--Vice President, T. Rowe
Price; Chartered Financial Analyst
LENORA V. HORNUNG, Secretary--Vice President, T. Rowe Price
CARMEN F. DEYESU, Treasurer--Vice President, T. Rowe Price, T.
Rowe Price Services, Inc., and T. Rowe Price Trust Company
DAVID S. MIDDLETON, Controller--Vice President, T. Rowe Price, T.
Rowe Price Services, Inc., and T. Rowe Price Trust Company
ROGER L. FIERY, Assistant Vice President--Vice President, Rowe
Price-Fleming International, Inc.
PAGE 195
EDWARD T. SCHNEIDER, Assistant Vice President--Vice President, T.
Rowe Price Services, Inc.
INGRID I. VORDEMBERGE, Assistant Vice President--Employee, T.
Rowe Price
The Fund's Executive Committee, comprised of Messrs. Heins
and Riepe, has been authorized by its respective Board of
Directors to exercise all powers of the Board to manage the Fund
in the intervals between meetings of the Board, except the powers
prohibited by statute from being delegated.
PRINCIPAL HOLDERS OF SECURITIES
As of the date of the prospectus, the officers and directors
of the Fund, as a group, owned less than 1% of the outstanding
shares of the Fund.
JOINT VENTURE
T. Rowe Price Management, Inc. ("Price Management"), a
wholly-owned subsidiary of T. Rowe Price Associates, Inc. ("T.
Rowe Price"), and CUNA Mutual Funds Management Company, L.L.C., a
Maryland limited liability company whose members are CUNA Mutual
Investment Corporation, a wholly-owned subsidiary of CUNA Mutual
Insurance Society ("CUNA Mutual"), and CUNA Service Group, Inc.,
an affiliate of Credit Union National Association, Inc. ("CUNA"),
have entered into an agreement (the "Joint Venture Agreement") to
form CMC-T. Rowe Price Management, LLC, a Maryland limited
liability company (the "Joint Venture"), in 1993 for the purpose
of establishing and operating a mutual fund program to be offered
to members of credit unions.
CUNA was founded in 1934 and is the national trade
association for credit unions. In addition, CUNA, together with
its affiliates, supplies products and services to credit unions
throughout the United States.
CUNA Mutual is a mutual insurance company established in
1935. CUNA Mutual and its affiliates serve the insurance,
financial and technology needs of credit unions and their members
in the United States and approximately 60 foreign countries.
T. Rowe Price is a registered investment adviser founded in
1937 by Thomas Rowe Price, Jr. T. Rowe Price serves as
PAGE 196
investment manager to a variety of individuals and institutional
investors, including limited and real estate partnerships and
other mutual funds.
Under the Joint Venture Agreement, the Joint Venture is
responsible for providing, either directly or through contracts
with others, investment management, fund accounting, transfer
agent and shareholder services, custodial and other services
necessary for the operation of the Fund. The Joint Venture has
entered into a Fund Management and Administration Agreement with
the Fund to perform or provide, or negotiate on behalf of the
Fund for third parties to perform or provide, these services.
FUND MANAGEMENT AND ADMINISTRATION
The Joint Venture has entered into agreements with the Fund
and T. Rowe Price for the provision to the Fund of investment
advisory and fund accounting services; and the Fund and T. Rowe
Price Services, Inc. for fund transfer agent, dividend disbursing
and shareholder services. The Joint Venture has also entered
into an agreement with the Fund and State Street Bank and Trust
Company for fund custodial services.
The Fund pays the Joint Venture an annual all-inclusive fee
(the "Fee") of: 1.00%. The Fee is paid monthly to the Joint
Venture on the first business day of the next succeeding calendar
month and is the sum of the daily fee accruals for each month.
The daily fee accrual for any particular day is calculated by
multiplying the fraction of one (1) over the number of calendar
days in the year by the Fee and multiplying this product by the
net assets of the Fund for that day, as determined in accordance
with the Fund's prospectus as of the close of business on the
previous business day on which the Fund was open for business.
Under the all inclusive fee set forth in the Investment
Management and Administration Agreement, the Joint Venture bears
all expenses of the Fund's operations except: 12b-1 fees;
brokerage commissions and other costs incident to the purchase,
sale or lending of the Fund's portfolio securities; interest; all
taxes or governmental fees payable by or with respect to the
Fund, including stamp or other transfer taxes; and such
nonrecurring or extraordinary expenses that may arise, including
the costs of actions, suits or proceedings to which the Fund is a
party and the expenses the Fund might incur as a result of its
legal obligation to provide indemnification to its officers,
PAGE 197
directors and agents.
Services Provided by T. Rowe Price
Under a Sub-Advisory Agreement between the Fund, the Joint
Venture and T. Rowe Price, T. Rowe Price provides the Fund with
discretionary investment services. Specifically, T. Rowe Price
is responsible for supervising and directing the investments of
the Fund in accordance with its investment objective, programs,
and restrictions as provided in the prospectus and this Statement
of Additional Information. T. Rowe Price is also responsible for
effecting all security transactions on behalf of the Fund,
including the allocation of principal business and portfolio
brokerage and the negotiation of commissions. In addition to
these services, T. Rowe Price provides the Fund with certain
corporate administrative services, including: maintaining the
Fund's corporate existence, corporate records, and registering
and qualifying the Fund's shares under federal and state laws;
monitoring the financial, accounting, and administrative
functions of the Fund; maintaining liaison with the agents
employed by the Fund such as the Fund's custodian and transfer
agent; assisting the Fund in the coordination of such agents'
activities; and permitting T. Rowe Price's employees to serve as
officers, directors, and committee members of the Fund without
cost to the Fund.
The Sub-Advisory Agreement also provides that T. Rowe Price,
its directors, officers, employees, and certain other persons
performing specific functions for the Fund will only be liable to
the Fund for losses resulting from willful misfeasance, bad
faith, gross negligence, or reckless disregard of duty.
FUND DISTRIBUTION
T. Rowe Price Investment Services, Inc. ("Investment
Services"), a Maryland corporation formed in 1980 as a wholly-
owned subsidiary of T. Rowe Price, and CUNA Brokerage Services,
Inc. ("CUNA Brokerage"), a member of the CUNA Mutual Insurance
Group, under agreements with the Fund, serve as the distributors
of the Fund. Investment Services and CUNA Brokerage are
registered as broker-dealers under the Securities Exchange Act of
1934 and are members of the National Association of Securities
Dealers, Inc. The offering of the Fund's shares is continuous.
Investment Services is located at the same address as the
PAGE 198
Fund and T. Rowe T. Rowe Price--100 East Pratt Street, Baltimore,
Maryland 21202. CUNA Brokerage is located at 5910 Mineral Point
Road, Madison, Wisconsin 53701-0391.
Investment Services and CUNA Brokerage serve as distributors
to the Fund pursuant to individual Underwriting Agreements
("Underwriting Agreements"), which provide that the Fund will pay
all fees and expenses in connection with: registering and
qualifying the Fund's shares under the various state "blue sky"
laws; preparing, setting in type, printing, and mailing its
prospectuses and reports to shareholders; and issuing its shares,
including expenses of confirming purchase orders. Investment
Services and CUNA Brokerage are responsible for all fees and
expenses in connection with the printing and distributing
prospectuses and reports for use in offering and selling shares
for the Fund; preparing, setting in type, printing, and mailing
all sales literature and advertising; Investment Services' and
CUNA Brokerage's federal and state registrations as a
broker-dealer; and offering and selling shares for the Fund,
except for those fees and expenses specifically assumed by the
Fund or paid for pursuant to the plan of distribution adopted by
the Fund. Investment Services' expenses are paid by T. Rowe
Price. CUNA Brokerage's expenses are paid by CMC. The Fund's
expenses are paid by the Joint Venture under the Investment
Management and Administration Agreement between the Fund and the
Joint Venture.
Investment Services and CUNA Brokerage act as the agents of
the Fund in connection with the sale of Fund shares in all states
in which the shares are qualified and in which Investment
Services and CUNA Brokerage are qualified as broker-dealers.
Under the Underwriting Agreements, orders for Fund shares are
accepted at net asset value. No sales charges are paid by
investors or the Fund.
Under a Distribution Plan (the "Plan") adopted by the Fund,
the Fund will transmit to the Joint Venture monthly, as paying
agent, an amount described in its prospectus for costs and
expenses of marketing the shares of the Fund. The Board of
Directors has concluded that there is a reasonable likelihood
that the Plan will benefit the Fund and its shareholders.
The Plan provides that it may not be amended to increase
materially the costs which the Fund may bear pursuant to the Plan
without shareholder approval and that other material amendments
of the Plan must be approved by the Board of Directors and the
PAGE 199
Directors who are neither "interested persons" (as defined in the
1940 Act) of the Corporation ("Independent Directors"), nor have
any direct or indirect financial interest in the operation of the
Plan or in any related agreement, Independent Directors by vote
cast in person at a meeting called for the purpose of considering
such amendments. The selection and nomination of the Independent
Directors of the Corporation have been committed to the
discretion of the Independent Directors. The Plan has been
approved and is subject to annual approval by the Board of
Directors and by the Independent Directors by vote cast in person
at a meeting called for the purpose of voting on the Plan. The
Board of Directors and the Independent Directors voted to approve
the Plan at a meeting held on December 21, 1993 and by a majority
of the outstanding shareholders of the Fund at a meeting held on
December 29, 1993. The Plan is terminable with respect to the
Fund at any time by a vote of a majority of the Independent
Directors or by vote of the holders of a majority of the shares
of the Fund.
Limitation on Fund Expenses
In compliance with certain state regulations, the Joint
Venture will reimburse the Fund for any expenses (excluding
interest, taxes, brokerage, other expenditures which are
capitalized in accordance with generally accepted accounting
principles, and extraordinary expenses) which in any year exceed
the limits prescribed by any state in which the Fund's shares are
qualified for sale. Presently, the most restrictive expense
ratio limitation imposed by any state is 2.5% of the first $30
million of the Fund's average daily net assets, 2% of the next
$70 million of such assets, and 1.5% of net assets in excess of
$100 million.
<PAGE>
PAGE 200
CUSTODIAN
State Street Bank and Trust Company is the custodian for the
Fund's securities and cash, but it does not participate in the
Fund's investment decisions. Portfolio securities purchased in
the U.S. are maintained in the custody of the Bank and may be
entered into the Federal Reserve Book Entry System, or the
security depository system of the Depository Trust Corporation.
The Bank's main office is 225 Franklin Street, Boston,
Massachusetts 02107.
PORTFOLIO TRANSACTIONS
Investment or Brokerage Discretion
Decisions with respect to the purchase and sale of portfolio
securities on behalf of the Fund are made by T. Rowe Price. T.
Rowe Price is also responsible for implementing these decisions,
including the negotiation of commissions and the allocation of
portfolio brokerage and principal business. The Fund's purchases
and sales of portfolio securities are normally done on a
principal basis and do not involve the payment of a commission
although they may involve the designation of selling concessions.
That part of the discussion below relating solely to brokerage
commissions would not normally apply to the Fund. However, it is
included because T. Rowe Price does manage a significant number
of common stock portfolios which do engage in agency transactions
and pay commissions and because some research and services
resulting from the payment of such commissions may benefit the
Fund.
How Brokers and Dealers are Selected
Fixed Income Securities
Fixed income securities are generally purchased from the
issuer or a primary market-maker acting as principal for the
securities on a net basis, with no brokerage commission being
paid by the client, although the price usually includes an
undisclosed compensation. Transactions placed through dealers
serving as primary market-makers reflect the spread between the
bid and asked prices. Securities may also be purchased from
underwriters at prices which include underwriting fees.
T. Rowe Price may effect principal transactions on behalf of
PAGE 201
the Fund with a broker or dealer who furnishes brokerage and/or
research services, designate any such broker or dealer to receive
selling concessions, discounts or other allowances, or otherwise
deal with any such broker or dealer in connection with the
acquisition of securities in underwritings. The Fund may receive
brokerage and research services in connection with such
designations in fixed price underwritings.
In purchasing and selling the Fund's portfolio securities,
it is T. Rowe Price's policy to obtain quality execution at the
most favorable prices through responsible brokers and dealers
and, in the case of agency transactions (in which the Fund does
not generally engage), at competitive commission rates. However,
under certain conditions, the Fund may pay higher brokerage
commissions in return for brokerage and research services. In
selecting broker-dealers to execute the Fund's portfolio
transactions, consideration is given to such factors as the price
of the security, the rate of the commission, the size and
difficulty of the order, the reliability, integrity, financial
condition, general execution and operational capabilities of
competing brokers and dealers, and brokerage and research
services provided by them. It is not the policy of T. Rowe Price
to seek the lowest available commission rate where it is believed
that a broker or dealer charging a higher commission rate would
offer greater reliability or provide better price or execution.
How Evaluations are Made of the Overall Reasonableness of
Brokerage Commissions Paid
On a continuing basis, T. Rowe Price seeks to determine what
levels of commission rates are reasonable in the marketplace for
transactions executed on behalf of the Fund. In evaluating the
reasonableness of commission rates, T. Rowe Price considers: (a)
historical commission rates, both before and since rates have
been fully negotiable; (b) rates which other institutional
investors are paying, based on available public information; (c)
rates quoted by brokers and dealers; (d) the size of a particular
transaction, in terms of the number of shares, dollar amount, and
number of clients involved; (e) the complexity of a particular
transaction in terms of both execution and settlement; (f) the
level and type of business done with a particular firm over a
period of time; and (g) the extent to which the broker or dealer
has capital at risk in the transaction.
Description of Research Services Received from Brokers and
Dealers
PAGE 202
T. Rowe Price receives a wide range of research services
from brokers and dealers. These services include information on
the economy, industries, groups of securities, individual
companies, statistical information, accounting and tax law
interpretations, political developments, legal developments
affecting portfolio securities, technical market action, pricing
and appraisal services, credit analysis, risk measurement
analysis, performance analysis and analysis of corporate
responsibility issues. These services provide both domestic and
international perspective. Research services are received
primarily in the form of written reports, computer generated
services, telephone contacts and personal meetings with security
analysts. In addition, such services may be provided in the form
of meetings arranged with corporate and industry spokespersons,
economists, academicians and government representatives. In some
cases, research services are generated by third parties but are
provided to T. Rowe Price by or through broker-dealers.
Research services received from brokers and dealers are
supplemental to T. Rowe Price's own research effort and, when
utilized, are subject to internal analysis before being
incorporated by T. Rowe Price into its investment process. As a
practical matter, it would not be possible for T. Rowe Price to
generate all of the information presently provided by brokers and
dealers. T. Rowe Price pays cash for certain research services
received from external sources. T. Rowe Price also allocates
brokerage for research services which are available for cash.
While receipt of research services from brokerage firms has not
reduced T. Rowe Price's normal research activities, the expenses
of T. Rowe Price could be materially increased if it attempted to
generate such additional information through its own staff. To
the extent that research services of value are provided by
brokers or dealers, T. Rowe Price may be relieved of expenses
which it might otherwise bear.
T. Rowe Price has a policy of not allocating brokerage
business in return for products or services other than brokerage
or research services. In accordance with the provisions of
Section 28(e) of the Securities Exchange Act of 1934, T. Rowe
Price may from time to time receive services and products which
serve both research and non-research functions. In such event,
T. Rowe Price makes a good faith determination of the anticipated
research and non-research use of the product or service and
allocates brokerage only with respect to the research component.
PAGE 203
Commissions to Brokers who Furnish Research Services
With regard to the payment of brokerage commissions, T. Rowe
Price has adopted a brokerage allocation policy embodying the
concepts of Section 28(e) of the Securities Exchange Act of 1934,
which permits an investment adviser to cause an account to pay
commission rates in excess of those another broker or dealer
would have charged for effecting the same transaction, if the
adviser determines in good faith that the commission paid is
reasonable in relation to the value of the brokerage and research
services provided. The determination may be viewed in terms of
either the particular transaction involved or the overall
responsibilities of the adviser with respect to the accounts over
which it exercises investment discretion. Accordingly, while T.
Rowe Price cannot readily determine the extent to which
commission rates charged by broker-dealers reflect the value of
their research services, T. Rowe Price would expect to assess the
reasonableness of commissions in light of the total brokerage and
research services provided by each particular broker.
Internal Allocation Procedures
T. Rowe Price has a policy of not precommitting a specific
amount of business to any broker or dealer over any specific time
period. Historically, the majority of brokerage placement has
been determined by the needs of a specific transaction such as
market-making, availability of a buyer or seller of a particular
security, or specialized execution skills. However, T. Rowe
Price does have an internal brokerage allocation procedure for
that portion of its discretionary client brokerage or selling
concession business where special needs do not exist, or where
the business may be allocated among several brokers or dealers
which are able to meet the needs of the transaction.
Each year, T. Rowe Price assesses the contribution of the
brokerage and research services provided by brokers and dealers,
and attempts to allocate a portion of its brokerage and selling
concession business in response to these assessments. Research
analysts, counselors, various investment committees, and the
Trading Department each seek to evaluate the brokerage and
research services they receive from brokers and make judgments as
to the level of business which would recognize such services. In
addition, brokers and dealers sometimes suggest a level of
business they would like to receive in return for the various
brokerage and research services they provide. Actual business
received by any firm may be less than the suggested allocations
PAGE 204
but can, and often does, exceed the suggestions, because the
total business is allocated on the basis of all the
considerations described above. In no case is a broker or dealer
excluded from receiving business from T. Rowe Price because it
has not been identified as providing research services.
Miscellaneous
T. Rowe Price's brokerage allocation policy is consistently
applied to all its fully discretionary accounts, which represent
a substantial majority of all assets under management. Research
services furnished by brokers and dealers through which T. Rowe
Price effects securities transactions may be used in servicing
all accounts (including non-Fund accounts) managed by T. Rowe
Price. Conversely, research services received from brokers and
dealers which execute transactions for the Fund are not
necessarily used by T. Rowe Price exclusively in connection with
the management of the Fund.
From time to time, orders for clients may be placed through
a computerized transaction network.
The Fund does not allocate business to any broker-dealer on
the basis of its sales of the Fund's shares. However, this does
not mean that broker-dealers who purchase Fund shares for their
clients will not receive business from the Fund.
Some of T. Rowe Price's other clients have investment
objectives and programs similar to those of the Fund. T. Rowe
Price may occasionally make recommendations to other clients
which result in their purchasing or selling securities
simultaneously with the Fund. As a result, the demand for
securities being purchased or the supply of securities being sold
may increase, and this could have an adverse effect on the price
of those securities. It is T. Rowe Price's policy not to favor
one client over another in making recommendations or in placing
orders. T. Rowe Price frequently follows the practice of
grouping orders of various clients for execution which generally
results in lower commission rates being attained. In certain
cases, where the aggregate order is executed in a series of
transactions at various prices on a given day, each participating
client's proportionate share of such order reflects the average
price paid or received with respect to the total order. T. Rowe
Price has established a general investment policy that it will
ordinarily not make additional purchases of a common stock of a
PAGE 205
company for its clients (including the CUNA Mutual Funds) if, as
a result of such purchases, 10% or more of the outstanding common
stock of such company would be held by its clients in the
aggregate.
To the extent possible, T. Rowe Price intends to recapture
solicitation fees paid in connection with tender offers through
T. Rowe Price Investment Services, Inc., the Fund's distributor.
At the present time, T. Rowe Price does not recapture commissions
or underwriting discounts or selling group concessions in
connection with taxable securities acquired in underwritten
offerings. T. Rowe Price does, however, attempt to negotiate
elimination of all or a portion of the selling-group concession
or underwriting discount when purchasing tax-exempt municipal
securities on behalf of its clients in underwritten offerings.
PRICING OF SECURITIES
Fixed income securities are generally traded in the over-
the-counter market. Investments in securities with remaining
maturities of one year or more are stated at fair value using
bid-side valuation as furnished by dealers who make markets in
such securities or by an independent pricing service, which
considers yield or price of bonds of comparable quality, coupon,
maturity, and type, as well as prices quoted by dealers who make
markets in such securities. Securities with remaining maturities
less than one year are stated at fair value which is determined
by using a matrix system that establishes a value for each
security based on bid-side money market yields.
There are a number of pricing services available, and the
Board of Directors, on the basis of an ongoing evaluation of
these services, may use or may discontinue the use of any pricing
service in whole or in part.
Assets and liabilities for which the above valuation
procedures are inappropriate or are deemed not to reflect fair
value are stated at fair value, as determined in good faith by or
under the supervision of officers of the Fund as authorized by
its Board of Directors.
NET ASSET VALUE PER SHARE
The purchase and redemption price of the Fund's shares is
PAGE 206
equal to the Fund's net asset value per share or share price.
The Fund determines its net asset value per share by subtracting
the Fund's liabilities (including accrued expenses and dividends
payable) from its total assets (the market value of the
securities the Fund holds plus cash and other assets, including
income accrued but not yet received) and dividing the result by
the total number of shares outstanding. The net asset value per
share of the Fund is calculated as of the close of trading on the
New York Stock Exchange ("NYSE") every day the NYSE is open for
trading. The NYSE is closed on the following days: New Year's
Day, Washington's Birthday, Good Friday, Memorial Day,
Independence Day, Labor Day, Thanksgiving Day, and Christmas Day.
Determination of net asset value (and the offering, sale
redemption and repurchase of shares) for the Fund may be
suspended at times (a) during which the NYSE is closed, other
than customary weekend and holiday closings, (b) during which
trading on the NYSE is restricted, (c) during which an emergency
exists as a result of which disposal by the Fund of securities
owned by it is not reasonably practicable or it is not reasonably
practicable for the Fund fairly to determine the value of its net
assets, or (d) during which a governmental body having
jurisdiction over the Fund may by order permit such a suspension
for the protection of the Fund's shareholders; provided that
applicable rules and regulations of the Securities and Exchange
Commission (or any succeeding governmental authority) shall
govern as to whether the conditions prescribed in (b), (c), or
(d) exist.
DIVIDENDS
Unless you elect otherwise, the Fund's annual capital gain
distribution, if any, will be reinvested on the reinvestment date
using the NAV per share of that date. The reinvestment date
normally precedes the payment date by about 10 days although the
exact timing is subject to change.
TAX STATUS
The Fund intends to qualify as a "regulated investment
company" under Subchapter M of the Internal Revenue Code of 1986,
as amended ("Code").
Dividends and distributions paid by the Fund are not
eligible for the dividends-received deduction for corporate
PAGE 207
shareholders. For tax purposes, it does not make any difference
whether dividends and capital gain distributions are paid in cash
or in additional shares. The Fund must declare dividends equal
to at least 98% of ordinary income (as of December 31) and
capital gains (as of October 31) in order to avoid a federal
excise tax and distribute 100% of ordinary income and capital
gains as of its tax year-end to avoid federal income tax.
At the time of your purchase, the Fund's net asset value may
reflect undistributed capital gains or net unrealized
appreciation of securities held by the Fund. A subsequent
distribution to you of such amounts, although constituting a
return of your investment, would be taxable as a capital gain
distribution. For federal income tax purposes, the Fund is
permitted to carry forward its net realized capital losses, if
any, for eight years and realize net capital gains up to the
amount of such losses without being required to pay taxes on, or
distribute such gains.
If, in any taxable year, the Fund should not qualify as a
regulated investment company under the Code: (i) the Fund would
be taxed at normal corporate rates on the entire amount of its
taxable income, if any, without deduction for dividends or other
distributions to shareholders; and (ii) the Fund's distributions
to the extent made out of the Fund's current or accumulated
earnings and profits would be taxable to shareholders as ordinary
dividends (regardless of whether they would otherwise have been
considered capital gain dividends).
YIELD INFORMATION
From time to time, the Fund may advertise a yield figure
calculated in the following manner:
In conformity with regulations of the Securities and
Exchange Commission, an income factor is calculated for each
security in the portfolio based upon the security's coupon rate.
The income factors are then adjusted for any gains or losses
which have resulted from prepayments of principal during the
period. The income factors are then totalled for all securities
in the portfolio. Next, expenses of the Fund for the period, net
of expected reimbursements, are deducted from the income to
arrive at net income, which is then converted to a per-share
amount by dividing net income by the average number of shares
outstanding during the period. The net income per share is
PAGE 208
divided by the net asset value on the last day of the period to
produce a monthly yield which is then annualized. Quoted yield
factors are for comparison purposes only, and are not intended to
indicate future performance or forecast the dividend per share of
the Fund.
INVESTMENT PERFORMANCE
Total Return Performance
The Fund's calculation of total return performance includes
the reinvestment of all capital gain distributions and income
dividends for the period or periods indicated, without regard to
tax consequences to a shareholder in the Fund. Total return is
calculated as the percentage change between the beginning value
of a static account in the Fund and the ending value of that
account measured by the then current net asset value, including
all shares acquired through reinvestment of income and capital
gains dividends. The results shown are historical and should not
be considered indicative of the future performance of the Fund.
Each average annual compound rate of return is derived from the
cumulative performance of the Fund over the time period
specified. The annual compound rate of return for the Fund over
any other period of time will vary from the average.
From time to time, in reports and promotional literature,
the Fund's performance may be compared to Overnight Government
Repurchase Agreements, Treasury bills, notes, and bonds,
certificates of deposit, and money market deposit accounts.
Performance may also be compared to (1) indices of broad groups
of managed and unmanaged securities considered to be
representative of or similar to Fund portfolio holdings; (2)
other mutual funds; or (3) other measures of performance set
forth in publications such as:
Advertising News Service, Inc., "Bank Rate Monitor+ - The
Weekly Financial Rate Reporter" is a weekly publication
which lists the yields on various money market instruments
offered to the public by 100 leading banks and thrift
institutions in the U.S., including loan rates offered by
these banks. Bank certificates of deposit differ from
mutual funds in several ways: the interest rate established
by the sponsoring bank is fixed for the term of a CD; there
are penalties for early withdrawal from CDs; and the
principal on a CD is insured.
PAGE 209
Donoghue Organization, Inc., "Donoghue's Money Fund Report"
is a weekly publication which tracks net assets, yield,
maturity and portfolio holdings on approximately 380 money
market mutual funds offered in the U.S. These funds are
broken down into various categories such as U.S. Treasury,
Domestic Prime and Euros, Domestic Prime and Euros and
Yankees, and Aggressive.
First Boston High Yield Index. It shows statistics on the
Composite Index and analytical data on new issues in the
marketplace and low-grade issuers.
Lipper Analytical Services, Inc., "Lipper-Fixed Income Fund
Performance Analysis" is a monthly publication which tracks
net assets, total return, principal return and yield on over
1900 fixed income mutual funds offered in the United States.
Merrill Lynch, Pierce, Fenner & Smith, Inc., "Taxable Bond
Indices" is a monthly publication which lists principal,
coupon and total return on over 100 different taxable bond
indices tracked by Merrill Lynch, together with the par
weighted characteristics of each Index. The index used as a
benchmark for the High Yield Fund is the High Yield Index.
The two indices used as benchmarks for the Short-Term Bond
Fund are the 91-Day Treasury Bill Index and the 1-2.99 Year
Treasury Note Index.
Morningstar, Inc. - is a widely used independent research
firm which rates mutual funds by overall performance,
investment objectives, and assets.
Salomon Brothers Inc., "Analytical Record of Yields and
Yield Spreads" is a publication which tracks historical
yields and yield spreads on short-term market rates, public
obligations of the U.S. Treasury and agencies of the U.S.
Government, public corporate debt obligations, municipal
debt obligations and preferred stocks.
Salomon Brothers Inc., "Bond Market Round-up" is a weekly
publication which tracks the yields and yield spreads on a
large, but select, group of money market instruments, public
corporate debt obligations, and public obligations of the
U.S. Treasury and agencies of the U.S. Government.
PAGE 210
Salomon Brothers Inc., "Market Performance" - a monthly
publication which tracks principal return, total return and
yield on the Salomon Brothers Broad investment - Grade Bond
Index and the components of the Index as well as some money
market instruments not included in the index.
Shearson Lehman Brothers, Inc., "The Bond Market Report" - a
monthly publication which tracks principal, coupon and total
return on the Shearson Lehman Govt./Corp. Index and Shearson
Lehman Aggregate Bond Index, as well as all the components
of these Indices.
Telerate Systems, Inc., a market data distribution network
computer system which tracks a broad range of financial
markets including, the daily rates on money market
instruments, public corporate debt obligations and public
obligations of the U.S. Treasury and agencies of the U.S.
Government.
Wall Street Journal, is a national daily financial news
publication which lists the yields and current market values
on money market instruments, public corporate debt
obligations, public obligations of the U.S. Treasury and
agencies of the U.S. Government as well as common stocks,
preferred stocks, convertible preferred stocks, options and
commodities; in addition to indices prepared by the research
departments of such financial organizations as Shearson
Lehman/American Express Inc., and Merrill Lynch, Pierce,
Fenner and Smith, Inc., including information provided by
the Federal Reserve Board.
Performance rankings and ratings reported periodically in
national financial publications such as MONEY, FORBES, BUSINESS
WEEK, BARRON'S, etc. will also be used.
Benefits of Investing in High-Quality Bond Funds
o Higher Income
PAGE 211
Bonds have generally provided a higher income than money
market securities because yield usually increased with
longer maturities. For instance, the yield on the 30-year
Treasury bond usually exceeds the yield on the 1-year
Treasury bill or 5-year Treasury note. However, securities
with longer maturities fluctuate more in price than those
with shorter maturities. Therefore, the investor must weigh
the advantages of higher yields against the possibility of
greater fluctuation in the principal value of your
investment.
o Income Compounding
Investing in bond mutual funds allows investors to benefit
from easy and convenient compounding because you can
automatically reinvest monthly dividends in additional fund
shares. Each month investors earn interest on a larger
number of shares. Also, reinvesting dividends removes the
temptation to spend the income.
o Broad Diversification
Each share of a mutual fund represents an interest in a
large pool of securities, so even a small investment is
broadly diversified by maturity. Since most bonds trade
efficiently only in very large blocks, mutual funds provide
a degree of diversification that may be difficult for
individual investors to achieve on their own.
o Lower Portfolio Volatility
Investing a portion of one's assets in longer term, high-
quality bonds can help smooth out the fluctuations in your
overall investment results, because bond prices do not
necessarily move with stock prices. Also, bonds usually
have higher income yields than stocks, thus increasing the
total income component of your portfolio. This strategy
should also add stability to overall results, as income is
always a positive component of total return.
o Liquidity
PAGE 212
A bond fund can supplement a money market fund or bank
account as a source of capital for unexpected contingencies.
T. Rowe Price fixed-income funds offer you easy access to
money through free checkwriting and convenient redemption
and exchange features. Of course, the value of a bond
fund's shares redeemed through checkwriting may be worth
more or less than their value at the time of their original
purchase.
Suitability
High-quality bond funds are most suitable for the following
objectives: obtaining a higher current income with minimal
credit risk; compounding of income over time; or
diversifying overall investments to reduce volatility.
IRAs
An IRA is a long-term investment whose objective is to
accumulate personal savings for retirement. Due to the long-term
nature of the investment, even slight differences in performance
will result in significantly different assets at retirement.
Mutual funds, with their diversity of choice, can be used for IRA
investments. Generally, individuals may need to adjust their
underlying IRA investments as their time to retirement and
tolerance for risk changes.
Other Features and Benefits
The Fund is a member of the CUNA Mutual Funds and may help
investors achieve various long-term investment goals, such as
investing money for retirement, saving for a down payment on a
home, or paying college costs. To explain how the Fund could be
used to assist investors in planning for these goals and to
illustrate basic principles of investing, various worksheets and
guides prepared by T. Rowe Price, T. Rowe Price Investment
Services, Inc., and/or CUNA Brokerage Services, Inc. may be made
available. These may include: an Asset Mix Worksheet designed to
show shareholders how to reduce their investment risk by
developing a diversified investment plan: a College Planning
Guide which discusses various aspects of financial planning to
meet college expenses and assists parents in projecting the costs
of a college education for their children; the Retirement
Planning Kit (also available in a PC version) which includes a
detailed workbook to determine how much money you may need for
PAGE 213
retirement and suggests how you might invest to reach your goal;
and the Retirees Financial Guide which includes a detailed
workbook to determine how much money you can afford to spend and
still preserve your purchasing power and suggest how you might
invest to reach your goal. From time to time, other worksheets
and guides may be made available as well. Of course, an
investment in the Fund cannot guarantee that such goals will be
met.
To assist investors in understanding the different returns
and risk characteristics of various investments, the
aforementioned guides will include presentation of historical
returns of various investments using published indices. An
example of this is shown on the next page.
Historical Returns for Different Investments
Annualized Returns for Periods Ended 12/31/92
50 Years 25 Years 10 Years 5 Years
Small company stocks 16.3% 12.4% 11.6% 13.6%
Large company stocks 12.6 10.6 16.2 15.9
Foreign stocks N/A N/A 17.1 1.6
Long-term corporate bonds5.4 8.8 13.1 12.5
Intermediate-Term U.S.
Gov't. bonds 5.6 9.0 11.0 10.3
Treasury bills 4.6 7.2 6.9 6.3
U.S. inflation 4.3 5.9 3.8 4.2
Source: Ibbotson Associates. Foreign stocks reflect performance
of The Morgan Stanley Capital International EAFE Index, which
includes some 1,000 companies representing the stock markets of
Europe, Australia, New Zealand, and the Far East. This chart is
for illustrative purposes only and should not be considered as
performance for any T. Rowe Price Fund. Past performance does
not guarantee future results.
<PAGE>
PAGE 214
Also included will be various portfolios demonstrating how these
historical indices would have performed in various combinations
over a specified time period in terms of return. An example of
this is shown below.
Performance of Retirement Portfolios*
Asset Mix Annualized Returns Number of Value of
20 Years Years with $10,000
Ending 12/31/92 Negative Invest-
Returns ment
After
Period
________________________________________________ ________
Best Worst
PortfolioGrowthIncomeSafety Average Year Year
I. Low
Risk 15% 35% 50% 9.0% 19.0%-0.2% 1 $ 56,451
II. Moderate
Risk 55% 30% 15% 10.4% 25.7%-7.5% 2 $ 72,918
III. High
Risk 85% 15% 0% 11.2% 34.5%-16.2% 5 $ 83,382
Source: T. Rowe Price Associates; data supplied by Ibbotson
Associates.
* Based on actual performance of stocks (Wilshire 5000),
Lehman Brothers Government/Corporate Bond Index, and
Treasury bills from January 1973 through December 1992.
Past performance does not guarantee future results. Figures
include changes in principal value and reinvested dividends.
This Exhibit is for illustrative purposes only and is not
representative of the performance of any T. Rowe Price Fund.
From time to time, publications of reports on specific
investment topics and strategies, may be included in the Fund's
fulfillment kit. Such reports may include information
concerning: calculating taxable gains and losses on mutual fund
transactions, coping with stock market volatility, benefiting
from dollar cost averaging, understanding international markets,
investing in high-yield "junk" bonds, growth stock investing,
conservative stock investing, value investing, investing in small
PAGE 215
companies, tax-free investing, fixed income investing, investing
in mortgage-backed securities, as well as other topics and
strategies.
Redemptions in Kind
In the unlikely event a shareholder were to receive an in
kind redemption of portfolio securities of the Fund, brokerage
fees could be incurred by the shareholder in subsequent sale of
such securities.
Issuance of Fund Shares for Securities
Transactions involving issuance of Fund shares for
securities or assets other than cash will be limited to (1) bona
fide reorganizations; (2) statutory mergers; or (3) other
acquisitions of portfolio securities that: (a) meet the
investment objective and policies of the Fund; (b) are acquired
for investment and not for resale except in accordance with
applicable law; (c) have a value that is readily ascertainable
via listing on or trading in a recognized United States or
international exchange or market; and (d) are not illiquid.
DEVELOPMENT OF THE CUNA MUTUAL FUNDS
One and one-half trillion dollars has been deposited in
mutual funds since 1983, and mutual funds have been growing
faster than any other form of investment. Investors in mutual
funds include a quarter of all credit union households. In 1992,
for example, substantial amounts of credit union member funds
were transferred into mutual funds. The CUNA Mutual Funds were
started in order to allow the credit union system to offer its
own exclusive group of mutual funds. The mutual funds will
strengthen credit unions' ability to serve as a member's primary
financial institution. The CUNA Mutual Funds will help credit
unions maintain relationships with investors currently within
their membership through direct communications on a wide variety
of subjects, including fund investment strategy, safety, and
other factors to consider when examining mutual funds.
T. Rowe Price, established by Thomas Rowe Price in 1937,
will be the sub-advisor to the CUNA Mutual Funds. Since that
time, T. Rowe Price has become one of the largest and most
respected financial services firms in the country. The firm's
approach to managing investment risk and emphasis on the highest
PAGE 216
standards of service are two of the numerous reasons that
millions of investors, and now the credit union movement, have
selected T. Rowe Price as their no-load mutual fund provider.
CAPITAL STOCK
The Charter of the CUNA Mutual Funds, Inc. (the
"Corporation") authorizes its Board of Directors to classify and
reclassify any and all shares which are then unissued, including
unissued shares of capital stock into any number of classes or
series, each class or series consisting of such number of shares
and having such designations, such powers, preferences, rights,
qualifications, limitations, and restrictions, as shall be
determined by the Board subject to the Investment Company Act and
other applicable law. Currently, the Corporation consists of
three series, CUNA Mutual Cornerstone Fund, CUNA Mutual Tax-Free
Intermediate-Term Fund, and CUNA Mutual U.S. Government Income
Fund. Each series represents a separate class of the
Corporation's shares and has different objectives and investment
policies. The shares of any such additional classes or series
might therefore differ from the shares of the present class and
series of capital stock and from each other as to preferences,
conversions or other rights, voting powers, restrictions,
limitations as to dividends, qualifications or terms or
conditions of redemption, subject to applicable law, and might
thus be superior or inferior to the capital stock or to other
classes or series in various characteristics. The Corporation's
Board of Directors may increase or decrease the aggregate number
of shares of stock or the number of shares of stock of any class
or series that the Funds have authorized to issue without
shareholder approval.
Except to the extent that the Corporation's Board of
Directors might provide by resolution that holders of shares of a
particular class are entitled to vote as a class on specified
matters presented for a vote of the holders of all shares
entitled to vote on such matters, there would be no right of
class vote unless and to the extent that such a right might be
construed to exist under Maryland law. The Charter contains no
provision entitling the holders of the present class of capital
stock to a vote as a class on any matter. Accordingly, the
preferences, rights, and other characteristics attaching to any
class of shares, including the present class of capital stock,
might be altered or eliminated, or the class might be combined
with another class or classes, by action approved by the vote of
PAGE 217
the holders of a majority of all the shares of all classes
entitled to be voted on the proposal, without any additional
right to vote as a class by the holders of the capital stock or
of another affected class or classes.
Shareholders are entitled to one vote for each full share
held (and fractional votes for fractional shares held) and will
vote in the election of or removal of directors (to the extent
hereinafter provided) and on other matters submitted to the vote
of shareholders. There will normally be no meetings of
shareholders for the purpose of electing directors unless and
until such time as less than a majority of the directors holding
office have been elected by shareholders, at which time the
directors then in office will call a shareholders' meeting for
the election of directors. Except as set forth above, the
directors shall continue to hold office and may appoint successor
directors. Voting rights are not cumulative, so that the holders
of more than 50% of the shares voting in the election of
directors can, if they choose to do so, elect all the directors
of the Fund, in which event the holders of the remaining shares
will be unable to elect any person as a director. As set forth
in the By-Laws of the Corporation, a special meeting of
shareholders of the Corporation shall be called by the Secretary
of the Corporation on the written request of shareholders
entitled to cast at least 10% of all the votes of the Corporation
entitled to be cast at such meeting. Shareholders requesting
such a meeting must pay to the Corporation the reasonably
estimated costs of preparing and mailing the notice of the
meeting. The Corporation, however, will otherwise assist the
shareholders seeking to hold the special meeting in communicating
to the other shareholders of the Corporation to the extent
required by Section 16(c) of the Investment Company Act of 1940.
FEDERAL AND STATE REGISTRATION OF SHARES
The Fund's shares are registered for sale under the
Securities Act of 1933, and the Fund or its shares are registered
under the laws of all states which require registration, as well
as the District of Columbia and Puerto Rico.
LEGAL COUNSEL
Shereff, Friedman, Hoffman, & Goodman, whose address is 919
Third Avenue, New York, New York 10022, is legal counsel to the
PAGE 218
Fund.
INDEPENDENT ACCOUNTANTS
Price Waterhouse, 7 St. Paul Street, Suite 1700, Baltimore,
Maryland 21202, are independent accountants to the Fund. The
Statement of Assets and Liabilities of the Fund as of December
21, 1993, included in the Statement of Additional Information has
been so included in reliance on the report of Price Waterhouse,
given on the authority of said firm as experts in auditing and
accounting.
RATINGS OF COMMERCIAL PAPER
Moody's Investors Service, Inc. The rating of Prime-1 is the
highest commercial paper rating assigned by Moody's. Among the
factors considered by Moody's in assigning ratings are the
following: valuation of the management of the issuer; economic
evaluation of the issuer's industry or industries and an
appraisal of speculative-type risks which may be inherent in
certain areas; evaluation of the issuer's products in relation to
competition and customer acceptance; liquidity; amount and
quality of long-term debt; trend of earnings over a period of 10
years; financial strength of the parent company and the
relationships which exist with the issuer; and recognition by the
management of obligations which may be present or may arise as a
result of public interest questions and preparations to meet such
obligations. These factors are all considered in determining
whether the commercial paper is rated P1, P2, or P3.
Standard & Poor's Corporation. Commercial paper rated A (highest
quality) by S&P has the following characteristics: liquidity
ratios are adequate to meet cash requirements; long-term senior
debt is rated "A" or better, although in some cases "BBB" credits
may be allowed. The issuer has access to at least two additional
channels of borrowing. Basic earnings and cash flow have an
upward trend with allowance made for unusual circumstances.
Typically, the issuer's industry is well established and the
issuer has a strong position within the industry. The
reliability and quality of management are unquestioned. The
relative strength or weakness of the above factors determines
whether the issuer's commercial paper is rated A1, A2, or A3.
Fitch Investors Service, Inc.: Fitch 1 - Highest grade.
PAGE 219
Commercial paper assigned this rating is regarded as having the
strongest degree of assurance for timely payment. Fitch 2 - Very
good grade. Issues assigned this rating reflect an assurance of
timely payment only slightly less in degree than the strongest
issues.
RATINGS OF CORPORATE DEBT SECURITIES
Moody's Investors Service, Inc.
Aaa - Bonds rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk.
Aa - Bonds rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are
generally known as high grade bonds.
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PAGE 220
Standard & Poor's Corporation
AAA - This is the highest rating assigned by Standard & Poor's to
a debt obligation and indicates an extremely strong capacity to
pay principal and interest.
AA - Bonds rated AA also qualify as high-quality debt
obligations. Capacity to pay principal and interest is very
strong.
Fitch Investors Service, Inc.: AAA - High grade, broadly
marketable, suitable for investment by trustees and fiduciary
institutions, and liable to but slight market fluctuation other
than through changes in the money rate. The prime feature of a
"AAA" bond is the showing of earnings several times or many times
interest requirements for such stability of applicable interest
that safety is beyond reasonable question whenever changes occur
in conditions. Other features may enter, such as a wide margin
of protection through collateral, security or direct lien on
specific property. Sinking funds or voluntary reduction of debt
by call or purchase are often factors, while guarantee or
assumption by parties other than the original debtor may
influence their rating. AA - Of safety virtually beyond question
and readily salable. Their merits are not greatly unlike those
of "AAA" class but a bond so rated may be junior though of strong
lien, or the margin of safety is less strikingly broad. The
issue may be the obligation of a small company, strongly secured,
but influenced as to rating by the lesser financial power of the
enterprise and more local type of market.
edg/cunagov.PtB
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PAGE 221
CUNA MUTUAL FUNDS, INC.
STATEMENT OF ASSETS AND LIABILITIES
December 21, 1993
CUNA Mutual
US Government
Income
Fund
________________
Assets
Cash. . . . . . . . . . . . . . . . . $30,000
____________
Total asset . . . . . . . . . . . . $30,000
Liabilities
Total liabilities . . . . . . . . . -0-
____________
Net Assets - offering and redemption price of
$10.00 per share; 1,000,000,000 shares of
$.0001 par value capital stock of the Corporation
authorized; 3,000 shares outstanding. . $30,000
___________
___________
NOTE TO STATEMENT OF ASSETS AND LIABILITIES
CUNA Mutual Funds, Inc. (the "Corporation") was organized on
October 6, 1993, as a Maryland corporation and is registered
under the Investment Company Act of 1940. The Corporation is a
series fund, of which the CUNA Mutual U.S. Government Income Fund
(the "fund"), a diversified, open-end management investment
company, is one of the portfolios established under the
Corporation. The Corporation has had no operations other than
those matters related to organization and registration as an
investment company, the registration of shares for sale under the
Securities Act of 1933, and the sale of 3,000 shares of the Fund
at $10.00 per share on December 20, 1993 to CMC-T. Rowe Price
Management, L.L.C. The Fund has entered into an investment
management agreement with CMC-T. Rowe Price Management,
L.L.C.(the Manager) which is described in the Statement of
Additional Information under the heading "Investment Management
Services." The manager has agreed to bear all organizational
costs of the Fund.
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PAGE 222
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholder of
CUNA Mutual U.S. Government Income Fund
In our opinion, the accompanying statement of assets and
liabilities presents fairly, in all material respects, the
financial position of the CUNA Mutual U.S. Government Income Fund
(the "Fund"), a series of the CUNA Mutual Funds, Inc., at
December 21, 1993, in conformity with generally accepted
accounting principles. This financial statement is the
responsibility of the Fund's management; our responsibility is to
express an opinion on this financial statement based on our
audit. We conducted our audit of this financial statement in
accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statement is free of
material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the
financial statement, assessing the accounting principles used and
significant estimates made by management, and evaluating the
overall financial statement presentation. We believe that our
audit provides a reasonable basis for the opinion expressed
above.
PRICE WATERHOUSE
Baltimore, Maryland
December 21, 1993
