<PAGE>
Preface/Directory
Preface to the Multi Fund(R) Prospectuses
Pages 21 and 22 are part of the Prospectus for each of the following funds:
Lincoln National Aggressive Growth Fund, Inc. (AG)
Lincoln National Bond Fund, Inc. (B)
Lincoln National Capital Appreciation Fund, Inc. (CA)
Lincoln National Equity-Income Fund, Inc. (E-I)
Lincoln National Global Asset Allocation Fund, Inc. (GAA)
Lincoln National Growth and Income Fund, Inc. (GI)
Lincoln National International Fund, Inc. (I)
Lincoln National Managed Fund, Inc. (M)
Lincoln National Money Market Fund, Inc. (MM)
Lincoln National Social Awareness Fund, Inc. (SA)
Lincoln National Special Opportunities Fund, Inc. (SO)
Shares of all the funds are sold to Lincoln National Life Insurance Co. (Lincoln
Life) for allocation to our Variable Annuity Account C (the variable annuity
account [VAA]) to fund variable annuity contracts and for allocation to our
Variable Life Account K to fund Variable Life Insurance Contracts.
To fund its variable life contracts, Variable Life Account D buys shares of the
Bond, Growth and Income, Managed, Money Market and Special Opportunities Funds.
To fund its variable life contracts, Variable Life Account G buys shares of the
Growth and Income and Special Opportunities Funds.
Each of these Variable Life and Annuity Accounts may be referred to as a
variable account. For each fund listed above, see Description of the fund in its
Prospectus, for a statement of that fund's investment objective. We refer to
each of these funds individually as a fund; collectively, the funds.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION (SEC) NOR HAS THE COMMISSION PASSED UPON THE ACCURACY OR
ADEQUACY OF THESE PROSPECTUSES. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
These Prospectuses set forth concisely the information about each fund that you
ought to know before investing. Please read and keep this Prospectus booklet for
future reference.
A separate Statement of Additional Information (SAI) for each fund has been
filed with the SEC. By this reference, each SAI, dated May 1, 1996, is
incorporated into the Prospectus of the fund with which it is registered. A free
copy will be provided upon request. Either write Kim Oakman, Lincoln National
Life Insurance Co., P.O. Box 2340, Fort Wayne, Indiana 46801 or call 1-800-348-
1212, Ext. 4912.
The Financial Highlights table of each fund contains per-share data calculated
on the basis of a share outstanding throughout the period, together with
financial ratios and other supplemental data. The Financial Highlights table is
incorporated by reference to the fund's 1995 Annual Report (see pages 47-49 of
the Annual Report). A copy of the Annual Report will be provided on request and
without charge. Please write or call Eric Jones, Lincoln National Life Insurance
Co., P.O. Box 2340, Fort Wayne, Indiana 46801; telephone: 1-800-348-1212, Ext.
6536.
NO DEALER, SALESPERSON, OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THESE
PROSPECTUSES, IN CONNECTION WITH THE OFFERS CONTAINED IN THEM. IF ANY ARE GIVEN
OR MADE, THE INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING
BEEN AUTHORIZED BY THE FUND(S) IN QUESTION. THESE PROSPECTUSES DO NOT CONSTITUTE
OFFERS BY THE FUNDS TO SELL, OR SOLICITATIONS OF ANY OFFERS TO BUY, ANY OF THE
SECURITIES OFFERED BY THEM IN ANY JURISDICTION TO ANY PERSON TO WHOM IT IS
UNLAWFUL FOR THE FUNDS TO MAKE THOSE OFFERS.
Prospectuses dated May 1, 1996
21
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Directory for the fund prospectuses
Subject Page
- --------------------------------------------------------
Preface 21
Description of the fund
Aggressive Growth Fund 23
Bond Fund 29
Capital Appreciation Fund 33
Equity-Income Fund 37
Global Asset Allocation Fund 41
Growth and Income Fund 47
International Fund 49
Managed Fund 53
Money Market Fund 57
Social Awareness Fund 59
Special Opportunities Fund 61
- --------------------------------------------------------
Investment policies and techniques
Aggressive Growth Fund 23
Bond Fund 29
Capital Appreciation Fund 33
Equity-Income Fund 37
Global Asset Allocation Fund 41
Growth and Income Fund 47
International Fund 49
Managed Fund 53
Money Market Fund 57
Social Awareness Fund 59
Special Opportunities Fund 61
- --------------------------------------------------------
Investment restrictions
Aggressive Growth Fund 26
Bond Fund 30
Capital Appreciation Fund 35
Equity-Income Fund 39
Global Asset Allocation Fund 44
Growth and Income Fund 47
International Fund 51
Managed Fund 54
Money Market Fund 58
Social Awareness Fund 60
Special Opportunities Fund 62
- --------------------------------------------------------
Strategic portfolio transactions
Aggressive Growth Fund 26
Bond Fund 31
Capital Appreciation Fund 36
Equity-Income Fund 39
Global Asset Allocation Fund 45
Growth and Income Fund 48
International Fund 51
Managed Fund 55
Money Market Fund 58
Social Awareness Fund 60
Special Opportunities Fund 63
- --------------------------------------------------------
Appendix - contains important
information for all funds
Net asset value 65
Management of the funds 65
Purchase of securities being offered 67
Sale and redemption of shares 68
Distributions and federal income tax considerations 68
Management discussion of fund performance 68
Description of shares 68
Strategic portfolio transactions-
additional information 69
Foreign investments 71
General information 72
Statement of Additional Information
table of contents - 11 underlying funds 73
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Lincoln National Capital Appreciation Fund, Inc.
Description of the fund
The Capital Appreciation Fund (fund) was incorporated in Maryland in 1993 as an
open-end diversified management investment company whose investment objective is
long-term growth of capital in a manner consistent with the preservation of
capital. The fund pursues its objective through a strategic policy of investing
in a diversified portfolio of common stock (and securities convertible into
common stock) of issuers of all sizes, with particular emphasis on issuers with
earnings growth potential that may not be recognized in the market.
The fund's objective, strategic policy and some restrictions are fundamental,
and cannot be changed without the affirmative vote of a majority of the fund's
outstanding shares. All other investment policies, practices and restrictions of
the fund are not fundamental, so they may be changed by a majority vote of the
Board of Directors. See General information in the Appendix. There is no
assurance that the objective of the fund will be achieved. Realization of income
is not a significant investment consideration, and any income realized on the
fund's investments will be incidental to its primary objective.
The fund is not designed as a short-term trading vehicle, and should not be
relied upon for short-term financial needs. The principal risks of this fund are
those normally associated with investing in the common stock of a broad range of
companies, and the potential for shares to fluctuate in value with the common
stock market. Additional risks are discussed under Special risk factors.
Because the strategic policy of this fund is to emphasize investment in a broad
range of companies, it is expected that at times the volatility level may depart
somewhat from broad stock market indices such as the Dow Jones Industrial
Average and the Standard & Poor's 500 Index (S&P 500). See Investment policies
and techniques.
Fund management expects securities selection for the fund to closely parallel
that of the Janus Fund, a publicly available mutual fund which is part of the
Janus Group of Funds. However, there is no precise correlation between the two.
Selection criteria for the securities and the relative weightings of the
selections can differ based on asset size, timing, cash flow, expenses and other
factors.
Portfolio manager
The portfolio manager for the fund is James P. Craig, Vice-President of Janus
Capital Corp., sub-advisor to the fund. Craig has been active in investment
management since 1983, with Janus since 1985. He holds a Master's Degree in
finance from the Wharton School, University of Pennsylvania.
Investment policies and techniques
Common stocks selected for the fund will generally be from those industries and
companies both in the United States and overseas, which are experiencing a high
demand for their products and services and for which both the competitive
environment and the regulatory climate are favorable. Within this framework the
fund intends to buy stocks with earnings growth potential that may not be
recognized in the market. Capital growth potential is the sole criterion.
Realization of interest income is incidental. The fund intends to purchase
stocks of a large number of issuers of all sizes, from large, well-established
companies to smaller, emerging growth companies. Under normal conditions a
minimum of 65% of the fund's total assets will be invested in common stocks at
any one time.
Up to 35% of the fund's total assets may be invested in debt securities, cash,
and/or cash equivalents, in any combination, either because the fund anticipates
an opportunity for capital growth from those securities, or because it seeks a
return on idle cash. Debt securities include, but are not limited to, preferred
stocks, warrants, stock rights, corporate bonds and debentures and longer-term
government securities. Cash equivalents include, but are not limited to, short-
term government securities (i.e., with remaining maturities of less than one
year), high-grade commercial paper, certificates of deposit, banker's
acceptances and time deposits.
The fund intends to limit its investments in debt securities and cash
equivalents to those issued by: U.S. companies; the U.S. Government, its
agencies and instrumentalities; foreign governments, their agencies and
instrumentalities; and supranational organizations such as (but not limited to)
the European Economic Community and the World Bank. When the fund invests in
debt securities and cash equivalents, the investment income of the fund will
increase; however, the fund will not be participating in market advances and
declines to the extent it would if it were fully invested in common stocks.
Special situations
At times, the fund may invest in certain securities under special situations. A
special situation arises when, in the sub-advisor's opinion, the securities of a
particular
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company will be recognized and appreciate in value due to a specific
development at that company. Developments creating a special situation might
include a new product or process, a management change or a technological
breakthrough. Investment in special situations may carry an additional risk of
loss in the event that the anticipated development does not occur or does not
attract the expected attention. The impact of the strategy on the fund will
depend on the fund's size and the extent of the holdings of the special
situation company relative to its total assets.
Foreign investments; American Depositary Receipts (ADRs)
The fund may invest up to 25% of its assets in foreign securities, defined as
those which are denominated in a foreign currency and not publicly traded in the
United States. Foreign investing involves risks that differ from investing in
U.S. markets. For a discussion of those risks see Foreign investments in the
Appendix. A detailed discussion of how the fund intends to handle these risks
appears in the SAI.
In connection with its foreign investments and as a non-fundamental policy, the
fund will not commit more than 10% of its assets to the currency cross-hedge
contracts and will maintain high-grade, liquid assets to cover those contracts.
See Foreign investments in the Appendix for an explanation of these
transactions.
In addition, the fund may purchase dollar-denominated ADRs, which do not involve
the same direct currency and liquidity risks as securities denominated in
foreign currency, because they are issued by domestic banks and publicly traded
in the U.S. ADRs are U.S. securities which indirectly replace foreign securities
and will not be subject to the 25% limit.
High-yield/high-risk bonds
The fund has no pre-established minimum quality standards and may invest in debt
securities of any quality, including lower-rated bonds (including junk bonds)
that may offer higher yields because of the greater risk involved in those
investments. See Special risk factors. It may invest up to 35% of its assets in
those securities. Debt securities rated below investment grade by the primary
rating agencies (bonds rated Ba or lower by Moody's Investors Service and BB or
lower by Standard & Poor's Corp.) constitute lower-rated securities that are
subject to the above limit. Unrated bonds or bonds with split ratings are
included in this limit if the portfolio manager determines that these securities
have the same characteristics as non-investment-grade bonds. Even though the
fund may at times invest in non-investment-grade securities, it invests
primarily in medium-grade obligations. See Special risk factors.
Mortgage-backed and asset-backedsecurities
The fund may invest in mortgage- and asset-backed securities. These securities
are subject to prepayment risk, meaning there is the possibility that
prepayments on the underlying mortgages or other loans will cause the principal
and interest on the mortgage- and asset-backed securities to be paid before
their stated maturities. Unscheduled prepayments are more likely to speed up
during periods of declining long-term interest rates. In the event of a
prepayment during a period of declining interest rates, the fund may be required
to invest the unanticipated proceeds at a lower interest rate. Prepayments
during those periods will also limit the fund's ability to participate in as
large a market gain as may be experienced with a comparable security not subject
to prepayment.
When-issued securities
The fund may purchase new issues of U.S. Government securities on a when-issued
basis. However, it does not intend to invest more than 20% of its assets in
when-issued securities. Because actual payment for and delivery of when-issued
securities generally take place 15 to 45 days after the purchase date, a fund
that purchases when-issued securities bears the risk that interest rates on debt
securities at the time of delivery may be higher or lower than those contracted
for on the when-issued security.
Illiquid securities
The fund may invest up to 15% of its net assets in loans to other persons and/or
securities that are considered illiquid because of the absence of a readily
available market or due to legal or contractual restrictions. Certain restricted
securities that are not registered for sale to the general public but can be
resold to institutional investors may not be considered illiquid, provided that
a dealer or institutional trading market exists. The institutional trading
market is relatively new and liquidity of the fund's investments could be
impaired if trading fails to further develop, or if it declines.
Borrowing
The fund may borrow money from banks for temporary or emergency purposes in an
amount not to exceed 25% of its total assets. Certain state insurance
regulations may impose additional restrictions on the fund's ability to borrow
money. See the SAI.
Diversification
The fund qualifies as a diversified investment company under the Investment
Company Act of 1940 (1940 Act). As a fundamental policy, a diversified fund may
not purchase a security of any issuer (except cash items and U.S. Government
securities) if: a) it would cause the fund to own more than 10% of the
outstanding voting securities of that issuer; or b) it would cause the fund's
holdings of that issuer to amount to more than 5% of
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the fund's total assets (as applied to 75% of the fund's total assets). It may
invest up to 25% of its total assets in the securities of one issuer. See Item
1. under Investment restrictions.
The fund does not anticipate concentrating its holdings in so few issuers unless
the sub-advisor believes a security has the potential for substantial capital
appreciation consistent with the fund's investment policies and goals. However,
the fund does intend to take advantage of the ability to invest more than 5% of
its total assets in the securities of one issuer. To the extent that the fund
invests more than 5% of its assets in a particular issuer, its exposure to
credit risk and/or market risks associated with that issuer increases. As an
additional fundamental policy, the fund will not invest more than 25% of its
total assets in any particular industry.
Special risk factors
Lower-rated bonds involve a higher degree of credit risk--that is, the risk that
the issuer will not make interest or principal payments when due. In the event
of an unanticipated default, the fund would experience a reduction in its
income, and could expect a decline in the market value of the securities
affected. More careful analysis of the financial condition of each issuer of
lower grade securities is necessary. During an economic downturn or substantial
period of rising interest rates, highly leveraged issuers may experience
financial stress which would adversely affect their ability to honor their
principal and interest payment obligations, to meet projected business goals,
and obtain additional financing.
The market prices of lower-grade securities are generally less sensitive to
interest rate changes than higher-rated investments, but more sensitive to
adverse economic or political changes, or in the case of corporate issuers, to
individual corporate developments. Periods of economic or political uncertainty
and change can be expected to result in volatility of prices of these
securities. Since the last major economic recession, there has been a
substantial increase in the use of high-yield debt securities to fund highly
leveraged corporate acquisitions and restructurings, so past experience with
high-yield securities in a prolonged economic downturn may not provide an
accurate indication of future performance during such periods. Lower-rated
securities also may have less liquid markets than higher-rated securities, and
their liquidity as well as their value may be negatively affected by adverse
economic conditions. Adverse publicity and investor perceptions as well as new
or proposed laws may also have a negative impact on the market for high-
yield/high-risk bonds.
The fund may also invest in unrated debt securities of foreign and domestic
issuers. Unrated debt, while not necessarily of lower quality than rated
securities, may not have as broad a market. Sovereign debt of foreign
governments is generally rated by country. Because these ratings do not take
into account individual factors relevant to each issue and may not be updated
regularly, the sub-advisor may treat these securities as unrated debt. Unrated
debt securities will be included in the 35% limit of the fund, unless the sub-
advisor deems these securities to be the equivalent of investment grade
securities. See the Appendix to the SAI for a description of bond credit rating
categories.
Portfolio turnover
Although it is the policy of the fund to purchase and hold securities for
appreciation of capital, changes in the securities held by the fund generally
will be made whenever the fund believes changes are advisable. Investment
changes may result from liquidity needs, securities having reached a price or
yield objective, anticipated changes in interest rates or the credit standing of
an issuer, or by reason of economic or other developments in the United States
and abroad not foreseen at the time of the investment decision. Because
investment changes usually will be made without reference to the length of time
a security has been held, a significant number of short-term transactions may
result. It is expected that the fund's portfolio turnover rate will not exceed
200% under normal market conditions. (For example, a rate of portfolio turnover
of 100% would occur if all of the fund's portfolio were replaced in a period of
one year.)
To a limited extent the fund may also purchase individual securities in
anticipation of relatively short-term price gains, and the rate of portfolio
turnover will not be a determining factor in the sale of such securities.
Certain tax rules may restrict the fund's ability to sell securities in some
circumstances when the security has been held for less than three months.
Increased portfolio turnover results in higher brokerage costs for the fund.
During 1995 the fund's portfolio turnover was 195.63% and in 1994 it was
185.28%.
Investment restrictions
The following investment restrictions have been adopted by the fund as
fundamental policies. See General information in the Appendix. For purposes of
the following restrictions: (1) all percentage limitations apply immediately
after the making of an investment; and (2) any subsequent change in any
applicable percentage resulting from market fluctuations does not require
elimination of any security from the portfolio.
The fund may not:
1. Invest in the securities of a single issuer, unless the following conditions
are met: At least 75% of the value of the fund's total assets must be
represented by: (a) U.S. Government obligations, cash and cash items; (b)
securities of other investment companies; and (c) securities of issuers as to
each of which, at the time the investment was made, the fund's investment in
the issuer did not exceed 5% of the fund's total assets. The fund does not
anticipate that any more than 15% of the fund's total assets would be
invested in the
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securities of a single issuer at any time, other than those of the U.S.
Government, its agencies and instrumentalities;
2. Acquire more than 10% of the voting securities of any issuer;
3. Invest more than 5% of its net assets in securities restricted as to resale;
and/or
4. Invest more than 25% of its assets in any one industry.
A complete listing of the fund's fundamental and non-fundamental investment
restrictions can be found in the SAI.
Fixed income investing
The performance of the debt component of the fund depends primarily on interest
rate changes, the average weighted maturity of the fund and the quality of the
securities held. The debt component of the fund will tend to decrease in value
when interest rates rise and increase when interest rates fall. Subject to
applicable maturity restrictions, the fund will vary its average maturities
based on the sub-advisor's analysis of interest rate trends and other factors.
Generally, shorter-term securities are less sensitive to interest rate changes,
but offer lower yields; conversely, longer-term securities are more sensitive to
interest rate changes, but offer higher yields. The fund's share price and yield
also depend, in part, on the quality of its investments. U.S. Government
securities generally are of high quality. U.S. Government securities that are
not backed by the full faith and credit of the United States (including those of
foreign governments), as well as other debt securities, may be affected by
changes in the creditworthiness of the issuer of the security. The extent that
these changes are reflected in the fund's share price will depend upon the
extent of the fund's investment in such securities.
Strategic portfolio transactions
The portfolio manager for the fund has considerable discretion in the selection
of appropriate fund investments. In the exercise of that discretion, the
portfolio manager may, at any given time, invest a portion of the fund's assets
in one or more strategic portfolio transactions which we define as derivative
transactions and cash enhancement transactions.
For your convenience, in the Appendix, we have included a basic discussion of
these special financial arrangement transactions and some of the risks
associated with them. Note also that the SAI booklet for the 11 funds contains
definitions of the more commonly used derivative transactions, technical
explanations of how these transactions will be used and the limits on their use.
You should consult your financial counselor if you have specific questions.
The Capital Appreciation Fund is authorized:
a) for derivative transactions, to: buy and sell options on securities
(including index options) and options on foreign currencies; buy and sell
futures contracts for instruments based on financial indices, including interest
rates or an index of U.S. Government or foreign government securities or equity
or fixed-income securities, futures contracts on foreign currencies and on
fixed-income securities; buy and sell options on futures contracts; engage in
forward contracts, interest rate swaps and swap-related products.
b) for cash enhancement transactions, to lend portfolio securities; engage in
repurchase and reverse repurchase transactions. Collateral will be continually
maintained at no less than 102% of the value of the loaned securities or of the
repurchase price, as applicable. As a matter of fundamental policy, the fund
will not lend securities if, as a result, more than 25% of its total assets
would be lent to other parties.
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APPENDIX
- --------------------------------------------------------------------------------
APPENDIX - CONTAINS IMPORTANT INFORMATION FOR ALL FUNDS
This Appendix constitutes part of the Prospectuses of Lincoln National
Aggressive Growth Fund, Inc. (Aggressive Growth Fund), Lincoln National Bond
Fund, Inc. (Bond Fund), Lincoln National Capital Appreciation Fund, Inc.
(Capital Appreciation Fund), Lincoln National Equity-Income Fund, Inc. (Equity-
Income Fund), Lincoln National Global Asset Allocation Fund, Inc. (Global Asset
Allocation Fund), Lincoln National Growth and Income Fund, Inc. (Growth and
Income Fund), Lincoln National International Fund, Inc. (International Fund),
Lincoln National Managed Fund, Inc. (Managed Fund), Lincoln National Money
Market Fund, Inc. (Money Market Fund), Lincoln National Social Awareness Fund,
Inc. (Social Awareness Fund), and Lincoln National Special Opportunities Fund,
Inc. (Special Opportunities Fund). Unless otherwise indicated, the following
information applies to each fund.
NET ASSET VALUE
Each fund's net asset value per share is determined as of close of business
(currently 4:00 p.m., New York Time) on the New York Stock Exchange (NYSE) on
each day it is open for trading. The net asset value per share for all funds
except the Money Market Fund is determined by adding the values of all
securities and other assets, subtracting liabilities (including dividends
payable) and dividing by the number of shares outstanding. Debt securities and
other assets of the fund, other than equity securities, for which market
quotations are readily available, are valued at their bid quotations.
When market quotations are not readily available, debt securities and other
assets are valued at their fair value as determined in good faith. This
valuation is made by or under the authority of the fund's Board of Directors and
it may include the use of valuations furnished by outside sources, including
pricing services which utilize electronic data processing techniques for valuing
normal institutional-size trading units of debt securities. The value of equity
securities is based on the last sale prices of those securities on national
securities exchanges or, in the absence of recorded sales, at the average of
readily available closing bid and asked prices on exchanges or over-the-counter.
In the absence of readily available closing bid and asked prices, equity
securities will be valued at fair value.
SHORT-TERM INVESTMENTS. For funds (other than the Money Market Fund) that trade
in short-term investments which mature in less than 60 days, these instruments
are valued at amortized cost; if these securities are acquired with a remaining
maturity of 61 days or more, the cost for purposes of valuation is deemed to be
the value on the sixty-first day prior to maturity.
OPTIONS TRADING. For those funds engaging in options trading, fund investments
underlying call options will be valued as described previously. Options are
valued at the last sale price or, if there has been no sale that day, at the
mean of the last bid and asked price on the principal exchange where the option
is traded, as of the close of trading on the NYSE. The fund's net asset value
will be increased or decreased by the difference between the premiums received
on writing options and the cost of liquidating those positions measured by the
closing price of those options on the exchange where traded.
FOREIGN SECURITIES. For funds investing in foreign securities, the value of a
foreign portfolio security held by a fund is determined based upon its closing
price or upon the mean of the closing bid and asked prices on the foreign
exchange or market on which it is traded and in the currency of that market, as
of the close of the appropriate exchange. As of the close of business on the
NYSE, that fund's portfolio securities which are quoted in foreign currencies
are converted into their U.S. dollar equivalents at the prevailing market rates,
as computed by the custodian of the fund's assets.
However, trading on foreign exchanges may take place on dates or at times of day
when the NYSE is not open; conversely, overseas trading may not take place on
dates or at times of day when the NYSE is open. Any of these circumstances could
affect the net asset value of fund shares on days when the investor has no
access to the fund. There are more detailed explanations of these circumstances
in the SAI for the various funds. See the Preface to this Prospectus booklet for
information about how to obtain a copy of the SAI booklet.
MONEY MARKET FUND. The net asset value per share of the Money Market Fund is
determined by the amortized cost method of valuation, under Rule 2a-7, as
amended (the Rule) of the Investment Company Act of 1940 (1940 Act). Under the
Rule, the fund's net asset value using the amortized cost method must fairly
reflect market value. The Board of Directors of the fund has established
procedures to assist fund management and the investment advisor in complying
with the requirements of the Rule, which imposes specific standards for the
maturity, quality and diversification of portfolio securities. The Rule also
assigns certain specific duties to fund management and the Board.
MANAGEMENT OF THE FUNDS
The business and affairs of each fund are managed under the direction of its
Board of Directors. The Board has the power to amend the bylaws of each fund, to
declare and pay dividends and to exercise all the powers of the fund except
those granted to the shareholder. Lincoln Life is the sole shareholder of each
fund.
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APPENDIX
- --------------------------------------------------------------------------------
INVESTMENT ADVISOR. Lincoln Investment is the investment advisor to the funds
and is headquartered at 200 East Berry Street, Fort Wayne, Indiana 46802.
Lincoln Investment (the advisor) is registered with the Securities and Exchange
Commission (the Commission) [SEC] as an investment advisor and has acted as an
investment advisor to mutual funds for over 40 years. The advisor also acts as
investment advisor to Lincoln National Convertible Securities Fund, Inc., and
Lincoln National Income Fund, Inc., closed-end investment companies as well as
Lincoln Advisor Funds, Inc., an open-end series.
The advisor is a wholly-owned subsidiary of Lincoln National Corp. (LNC), a
publicly-held insurance holding company organized under Indiana law. Through its
subsidiaries, LNC provides life insurance and annuities, property-casualty
insurance, reinsurance and financial services.
Under advisory agreements described in the Prospectus for the variable account,
the advisor provides portfolio management and investment advice to the funds and
administers their other affairs, subject to the supervision of each fund's Board
of Directors.
As compensation for its services to each fund, the advisor is paid an investment
advisory fee at an annual rate based on the average daily net asset value of
each fund, as shown in the following chart:
<TABLE>
<CAPTION>
First Next In excess of
Fund $200 million $200 million $400 million
...Of average daily net asset value
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Aggressive Growth .75 of 1% .70 of 1% .65 of 1%
Capital Appreciation .80 of 1 .80 of 1 .80 of 1
Equity-Income .95 of 1 .95 of 1 .95 of 1
Global Asset Allocation .75 of 1 .70 of 1 .68 of 1
International .90 of 1 .75 of 1 .60 of 1
All other funds .48 of 1 .40 of 1 .30 of 1
</TABLE>
The advisory fees for the Capital Appreciation, Equity-Income, and International
funds reflect the more extensive services and increased expense associated with
portfolios of securities issued outside the United States.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------
FUND EXPENSES (see accompanying text below)
1995 ratio of the advisor's 1995 ratio of total expenses
compensation to average to average net assets
Fund net assets operational fund
- ---------------------------------------------------------------------------------------------
<S> <C> <C>
Aggressive Growth .75% .94%
Bond .47 .49
Capital Appreciation .80 1.07
Equity-Income .95 1.15
Global Asset Allocation .70 .92
Growth and Income .34 .35
International .84 1.27
Managed .41 .43
Money Market .48 .52
Social Awareness .47 .50
Special Opportunities .43 .45
</TABLE>
Expenses specifically assumed by each fund include: compensation and expenses of
Directors of the fund who are not interested persons of the fund as defined in
the 1940 Act; registration, filing, and other fees in connection with filings
with regulatory authorities, including the costs of printing and mailing
registration statements and updated Prospectuses provided to current contract
owners; fees and expenses of independent auditors; the expenses of printing and
mailing proxy statements and shareholder reports; custodian and transfer agent
charges; brokerage commissions and securities and options transaction costs
incurred by the fund; taxes and corporate fees; legal fees incurred in
connection with the affairs of the fund (other than legal services provided by
personnel of the advisor or its affiliated companies); the fees of any trade
association of which the fund is a member; and expenses of shareholder and
Director meetings.
66
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APPENDIX
- --------------------------------------------------------------------------------
SUB-ADVISORS. As advisor, Lincoln Investment is primarily responsible for
investment decisions affecting each of the funds. However, Lincoln Investment
has entered into sub-advisory agreements with several professional investment
management firms. These firms provide some or substantially all of the
investment advisory services required by a number of the funds, including day-
to-day investment management of those funds' portfolios. Each sub-advisor makes
investment decisions for its respective fund in accordance with that fund's
investment objectives and places orders on behalf of that fund to effect those
decisions. See the following tables for more information about the sub-advisors
and their fees:
<TABLE>
<CAPTION>
Date of
Fund Sub-advisor agreement Annual fee rate based on average daily net asset value
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Aggressive .50 of 1% of the first $150 million
Growth Lynch & Mayer 12/20/93 .35 of 1% of the excess over $150 million
Capital
Appreciation Janus 1/1/94 .60 of 1% of the first $100 million
.55 of 1% of the excess over $100 million
Equity-Income Fidelity 12/20/93 .75 of 1%
Global Asset the greater of (a) $40,000; or (b) .47 of 1% of the
Allocation Putnam 6/8/87 first $200 million; .42 of 1% of the next $200 million;
and .40 of 1% of any excess over $400 million
International Clay Finlay 11/19/90 .665 of 1% of the first $50 million; .475 of 1% of the
next $50 million; and .250 of 1% of any excess over $100
million
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Annual fee rate based on market value of securities held
in the portfolio of each respective client fund at the
Date of close of business on the last trading day of each
Fund Sub-advisor agreement calendar quarter
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Growth and
Income Vantage 8/21/85 .20 of 1%
Managed Vantage 8/21/85 .20 of 1%
(stock portfolio only)
Social
Awareness Vantage 4/30/88 .20 of 1%
Special
Opportunities Vantage 8/21/85 .20 of 1%
</TABLE>
No additional compensation from the assets of the funds will be assessed as a
result of the sub-advisory agreements; the sub-advisors are paid by Lincoln
Investment. (There is no sub-advisor for the Bond and Money Market Funds.)
SERVICE MARKS. The service mark for the funds and the name Lincoln National have
been adopted by the funds with the permission of LNC, and their continued use is
subject to the right of LNC to withdraw this permission in the event the advisor
should not be the investment advisor of the funds.
In the Prospectus and sales literature, the name Fidelity Investments will be
used with the Equity-Income Fund, Janus with the Capital Appreciation Fund and
Putnam with the Global Asset Allocation Fund. The continued use of these names
is subject to the right of the respective sub-advisor to withdraw its permission
in the event it ceases to be the sub-advisor to the particular fund it advises.
PURCHASE OF SECURITIES BEING OFFERED
Shares of the funds' common stock ($0.01 par value) will be sold to Lincoln Life
for allocation to the variable annuity account (VAA), which has been established
for the purpose of funding variable annuity contracts; shares in the funds will
also be sold to Lincoln Life for allocation to one or more of the variable life
accounts, which have been established for the purpose of funding variable life
insurance contracts. Shares of each fund are sold and redeemed at their net
asset value determined daily. See Sale and redemption of shares. Also see Net
asset value. The funds' shares are sold to Lincoln Life for the variable
accounts on a no-load basis-that is; without the imposition of a sales charge.
67
<PAGE>
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APPENDIX
- --------------------------------------------------------------------------------
SALE AND REDEMPTION OF SHARES
The shares of each fund are sold and redeemed by the fund at their net asset
value next determined after receipt of a purchase or redemption order in
acceptable form. The value of shares redeemed may be more or less than original
cost, depending upon the market value of the portfolio securities at the time of
redemption. Payment for shares redeemed will be made within seven days after the
redemption request is received in proper form by the funds. However, the right
to redeem fund shares may be suspended or payment postponed for any period
during which (1) trading on the NYSE is restricted as determined by the
Commission, or the NYSE is closed for other than weekends and holidays; (2) an
emergency exists, as determined by the Commission, as a result of which (a)
disposal by each fund of securities owned by it is not reasonably practicable,
or (b) it is not reasonably practicable for each fund to determine fairly the
value of its net assets; or (3) the Commission by order so permits for the
protection of shareholders of the funds.
DISTRIBUTION AND FEDERAL INCOME TAX CONSIDERATIONS
Each fund's policy is to distribute, at least once a year, substantially all of
its net investment income. Net realized capital gains may only be distributed
annually. These distributions, when paid to Lincoln Life for the variable
accounts, will be reinvested automatically in additional shares of that fund, at
its net asset value.
Each fund intends to qualify and has elected to be taxed as a regulated
investment company under the provisions of Subchapter M of the Internal Revenue
Code of 1986, as amended (the code). If a fund qualifies as a regulated
investment company and complies with the provisions of the code relieving
regulated investment companies which distribute substantially all of their net
income (both ordinary income and capital gain) from Federal income tax and the
4% nondeductible Federal excise tax, the funds will be relieved of those taxes
on the amounts distributed. See the SAI for a more complete discussion.
Since the sole shareholder of the funds is Lincoln Life, there is no discussion
here about the Federal income tax consequences at the shareholder level. For
information concerning the Federal income tax consequences to holders of annuity
or life insurance contracts, see the Prospectus for the variable account at the
front of this booklet.
MANAGEMENT DISCUSSION OF FUND PERFORMANCE
In the Annual Report for the funds, the portfolio manager for each fund
discusses that fund's performance for the previous fiscal year and the factors
which affected that performance. We will send you a copy of the Annual Report
free upon request.
DESCRIPTION OF SHARES
The authorized capital stock of each fund consists of 50 million shares of
common stock (100 million for the Growth and Income Fund), $0.01 par value. As
of April 1, 1996, each fund had the following number of shares issued and
outstanding:
Aggressive Growth 12,933,481
Bond 22,622,136
Capital Appreciation 12,115,745
Equity-Income 21,459,285
Global Asset Allocation 20,930,014
Growth and Income 69,131,710
International 28,134,844
Managed 41,694,836
Money Market 8,326,457
Social Awareness 15,887,303
Special Opportunities 20,963,247
Fund shares will be owned by Lincoln Life and will be held by it in the variable
accounts. As stated in the Prospectuses for the variable accounts, Lincoln Life
provides to contract owners of the variable accounts the right to direct the
voting of fund shares at shareholder meetings, to the extent provided by law.
However, if the 1940 Act or any regulation under it should change, and as a
result Lincoln Life determines it is permitted to vote fund shares in its own
right, it may elect to do so.
All the shares of each fund are of the same class with equal rights and
privileges. Each full share is entitled to one vote and each fractional share is
entitled to a proportionate fractional vote, on all matters subjected to a vote
of the shareholder. All shares, full and fractional, participate proportionately
in any dividends and capital gains distributions and, in the event of
liquidation, in that fund's net assets remaining after satisfaction of
outstanding liabilities.
When issued, each share is fully-paid and non-assessable and the shareholder has
no preemptive or conversion rights. Fund shares have non-cumulative voting
rights, which means that holders of more than 50% of the shares voting for the
election of directors can elect 100% of the directors if they choose to do so.
In that event the
68
<PAGE>
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APPENDIX
- --------------------------------------------------------------------------------
holders of the remaining shares so voting will not be able to elect any
directors. Shares may be redeemed as set forth under Sale and redemption of
shares.
The Bylaws of the funds allow them, in proper cases, to dispense with their
annual meetings of the shareholder. Generally, this may be done as long as: (1)
a majority of the Directors then in office have at some point been elected by
the shareholder and, if any vacancy is filled by vote of the Board of Directors,
then immediately after filling the vacancy at least two thirds of the Directors
shall have been elected by the shareholder; (2) there is no change in the
independent auditor of the funds; (3) there is no material change to the
investment advisory and/or sub-advisory agreements; and (4) a shareholder vote
is not required with respect to a distribution agreement. In adopting this
procedure for dispensing with annual meetings that are a formality, the
Directors of the funds have undertaken to comply with the requirements of
Section 16(c) of the 1940 Act. That Section protects contract owners by
providing a procedure by which they may require management to convene a meeting
of the shareholder to vote on removal of one or more Directors. The Directors
also have agreed to facilitate communication among contract owners for the
purpose of calling those meetings. Further information about these procedures is
available from fund management.
STRATEGIC PORTFOLIO TRANSACTIONS-ADDITIONAL INFORMATION
Because of their different investment objectives and portfolio management
philosophies many of the funds engage to varying degrees in strategic portfolio
transactions, in order to preserve or enhance the value of their assets. These
can be generally identified as either derivative transactions or cash
enhancement transactions. Derivative transactions are recognized by the
investment community as an acceptable way to increase the fund's overall value
(or, depending on the condition of the securities markets, at least to slow its
decrease). Cash enhancement transactions are designed to make some extra money
for the fund when it has excess cash, or to help the fund obtain some cash for
temporary purposes when needed. SEE THE PROSPECTUS FOR EACH FUND FOR A LISTING
OF THE KINDS OF TRANSACTIONS IN WHICH EACH FUND MAY ENGAGE.
1. DERIVATIVE TRANSACTIONS
A. Introduction
A derivative transaction is a financial agreement the value of which is
dependent upon the values of one or more underlying assets or upon the
values of one or more indices of asset values. The following types are
currently in fairly common use in the investment community, although not
every fund will use all of them:
1. Equity contracts: stock options and indexed options; equity swaps;
stock index futures and options on futures; swaptions;
2. Interest rate contracts: interest rate futures and options on them;
forward rate agreements (FRAs); interest rate swaps and their related
transactions (e.g., caps, floors, collars and corridors); and/or
3. Currency derivative contracts: currency forward contracts; currency
options; currency futures; currency swaps; cross-currency interest rate
swaps.
SIMPLIFIED DEFINITIONS FOR THESE TRANSACTIONS ARE PROVIDED IN THE SAI APPENDIX.
Although they may be structured in complex combinations, derivative transactions
in which the funds engage generally fall into two broad categories: options
contracts or forward contracts. The combined forms are constantly evolving. In
fact, variations on the types listed previously may come into use after the date
of these Prospectuses. Therefore, where the Prospectus for a particular fund
discloses the intent of that fund to engage in any of the types listed, that
fund hereby reserves the right to engage in related variations on those
transactions.
The funds intend to engage in derivative transactions only defensively. Examples
of this defensive use might be: to hedge against a perceived decrease in a
fund's asset value; to control transaction costs associated with market timing
(e.g., by using futures on an unleveraged basis); and to lock in returns,
spreads, or currency exchange rates in anticipation of future cash market
transactions.
There is no discussion here of asset-backed or mortgage-backed securities (such
as collateralized mortgage obligations, structured notes, inverse floaters,
principal-only or interest-only securities, etc.). See the Prospectus and SAI
for the Capital Appreciation and Equity-Income funds, which are authorized to
engage in this kind of trading.
B. Risk factors commonly associated with derivative transactions.
There are certain risks associated with derivatives, and some derivatives
involve more of these risks than others. We briefly describe the most
common ones here; however, this is not an exhaustive list. Consult your
financial counselor if you have additional questions.
69
<PAGE>
- --------------------------------------------------------------------------------
APPENDIX
- --------------------------------------------------------------------------------
CREDIT RISK is the possibility that a counterparty to a transaction will
fail to perform according to the terms and conditions of the transaction,
causing the holder of the claim to suffer a loss.
CROSS-CURRENCY SETTLEMENT RISK (or Herstatt risk) is related to the
settlement of foreign exchange contracts. It arises when one of the
counterparties to a contract pays out one currency prior to receiving
payment of the other. Herstatt risk arises because the hours of operation
of domestic interbank fund transfer systems often do not overlap due to
time zone differences. In the interval between the time one counterparty
has received payment in one indicated currency and the time the other
counterparty(ies) receive payment in the others, those awaiting payment
are exposed to credit risk and market risk.
LEGAL RISK is the chance that a derivative transaction, which involves
highly complex financial arrangements, will be unenforceable in particular
jurisdictions or against a financially troubled entity; or will be subject
to regulation from unanticipated sources.
MARKET LIQUIDITY RISK is the risk that a fund will be unable to control
its losses if a liquid secondary market for a financial instrument does
not exist. It is often considered as the risk that a (negotiable or
assignable) financial instrument cannot be sold quickly and at a price
close to its fundamental value.
MARKET RISK is the risk of a change in the price of a financial
instrument, which may depend on the price of an underlying asset.
OPERATING RISK is the potential of unexpected loss from inadequate
internal controls or procedures; human error; system (including data
processing system) failure; or employee dishonesty.
SETTLEMENT RISK between two counterparties is the possibility that a
counterparty to whom a firm has made a delivery of assets or money
defaults before the amounts due or assets have been received; or the risk
that technical difficulties interrupt delivery or settlement even if the
counterparties are able to perform. In the latter case, payment is likely
to be delayed but recoverable.
SYSTEMIC RISK is the uncertainty that a disruption (at a firm, in a market
segment, to a settlement system, etc.) might cause widespread difficulties
at other firms, in other market segments, or in the financial system as a
whole.
SPECIAL NOTE FOR OPTIONS AND FUTURES TRANSACTIONS: Gains and losses on
options and futures transactions depend on the portfolio manager's ability
to correctly predict the direction of stock prices and interest rates, and
other economic factors. Options and futures trading may fail as hedging
techniques in cases where the price movements of the securities underlying
the options and futures do not follow the price movements of the portfolio
securities subject to the hedge. The loss from investing in futures
transactions is potentially unlimited.
SOME OF THESE RISKS MAY BE PRESENT IN EACH TYPE OF TRANSACTION, WHILE
OTHERS MAY PERTAIN ONLY TO CERTAIN ONES. These risks are discussed here
only briefly. Before you invest in a particular fund, please consult your
financial counselor if you have questions about the risks associated with
that fund's use of derivatives.
C. Varying usage of derivative transactions
Subject to the terms of the Prospectus and SAI for each fund, that fund's
portfolio manager decides which types of derivative transactions to
employ, at which times and under what circumstances. For a description of
the limits, risk factors and circumstances under which derivative
transactions will be used by each fund, refer to the SAI booklet.
D. Increased government scrutiny
Derivative transactions are coming under increased scrutiny by Congress
and industry regulators (such as the SEC and the Office of the Comptroller
of the Currency), and by self-regulatory agencies (such as the NASD).
Should legislation or regulatory initiatives be enacted resulting in
additional restrictive requirements for derivative transactions, we
reserve the right to make all necessary changes in the contracts and/or
the Registration Statements for the funds to comply with those
requirements.
2. CASH ENHANCEMENT TRANSACTIONS
Cash enhancement transactions also involve certain risks to the fund. They
are discussed more fully inthe SAI.
A. Lending of portfolio securities
Any fund authorized to do so may make secured loans of its portfolio
securities, in order to realize additional income. The loans are limited
to a maximum of a stipulated amount of the fund's total assets. As a
matter of policy, securities loans are made to broker/dealers under
agreements requiring that the loans be continuously secured by collateral
in cash or short-term debt obligations at least equal at all times to 102%
of the value of the securities lent.
The borrower pays the fund an amount equal to any dividends or interest
received on securities lent. The fund retains all or a portion of the
interest received on securities lent. The fund also retains all or a
portion of the interest received on investment of the cash collateral, or
receives a fee from the borrower.
70
<PAGE>
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APPENDIX
- --------------------------------------------------------------------------------
With respect to the loaned securities, voting rights or rights to consent
pass to the borrower. However, the fund retains the right to call in the
loans and have the loaned securities returned at any time with reasonable
notice. This is important when issuers of the securities ask holders of
those securities-including the fund-to vote or consent on matters which
could materially affect the holders' investment. The fund may also call in
the loaned securities in order to sell them. None of the funds' portfolio
securities will be loaned to Lincoln Investment, to any sub-advisor, or to
any of their respective affiliates. The fund may pay reasonable finder's
fees to persons unaffiliated with it in connection with the arrangement of
the loans.
B. Repurchase (Repo) and reverse repurchase (Reverse Repo) transactions
1. Repos. From time to time, the funds may enter into Repo transactions.
In a typical Repo transaction, the fund involved buys U.S. Government
or other money market securities from a financial institution (such as
a bank, broker, or savings and loan association). At the same time, as
part of the arrangement, the fund obtains an agreement from the seller
to repurchase those same securities from the fund at a specified price
on a fixed future date.
The repurchase date is normally not more than seven days from the date
of purchase. Keeping the term under seven days is significant, because
the SEC considers Repo Agreements with maturities of more than seven
days to be illiquid assets of the fund, and the funds have strict
limitations on the percentage of their respective assets which may be
illiquid.
2. Reverse repos. A fund may also be authorized to enter into Reverse Repo
transactions. This simply means the fund is on the reverse side of a
Repo transaction. That is, the fund is the Seller of some of its
portfolio securities, subject to buying them back at a set price and
date.
Authorized funds will engage in Reverse Repos for temporary purposes,
such as for obtaining cash to fund redemptions; or for the purpose of
increasing the income of the fund by investing the cash proceeds at a
higher rate than the cost of the agreement. Entering into a reverse
repo transaction is considered to be the borrowing of money by the
fund. Funds authorized to engage in Repos as buyers are not necessarily
authorized to do Reverse Repos.
FOREIGN INVESTMENTS
There are certain risks involved in investing in foreign securities, including
those resulting from fluctuations in currency exchange rates; devaluation of
currencies; political or economic developments including the possible imposition
of currency exchange blockages or other foreign governmental laws or
restrictions; reduced availability of public information concerning issuers; and
the fact that foreign companies are not generally subject to uniform accounting,
auditing, and financial reporting standards or to other regulatory practices and
requirements comparable to those applicable to domestic companies. With respect
to certain foreign countries, there is also the possibility of expropriation,
nationalization, confiscatory taxation, and limitations on the use or removal of
cash or other assets of a fund, including the withholding of interest payments
or dividends. These risks may be particularly great in so-called developing or
undeveloped countries, sometimes referred to as Emerging Markets.
In addition, while the volume of transactions effected on foreign stock
exchanges has increased in recent years, in most cases it remains appreciably
below that of the NYSE. Accordingly, a fund's foreign investments may be less
liquid and their prices may be more volatile than comparable investments in
securities of U.S. companies. Moreover, the settlement periods for foreign
securities, which are often longer than those for securities of U.S. issuers,
may affect portfolio liquidity. The funds will incur costs in converting foreign
currencies into U.S. dollars. Custody charges are generally higher for foreign
securities. In buying and selling securities on foreign exchanges, a fund
normally pays fixed commissions that are generally higher than the negotiated
commissions charged in the United States. In addition, there is generally less
governmental supervision and regulation of securities exchanges, brokers and
issuers in foreign countries that in the United States. There may be difficulty
in enforcing legal rights outside the United States. For example, in the event
of default on any foreign debt obligations, it may be more difficult or
impossible for the fund to obtain or to enforce a judgment against the issuers
of these securities. The advisor or sub-advisor will take all these factors into
consideration in managing a fund's foreign investments.
Certain state insurance regulations impose additional restrictions on the extent
to which a fund may invest in foreign securities. See the SAI.
The share price of a fund that invests in foreign securities will reflect the
movements of both the prices of the portfolio securities and the currencies in
which those securities are denominated. Depending on the extent of a fund's
investments abroad, changes in a fund's share price may have a low correlation
with movements in the U.S. markets. Because most of the foreign securities in
which the fund invests will be denominated in foreign currencies, or otherwise
will have values that depend on the performance of foreign currencies relative
to the U.S. dollar, the relative strength of the U.S. dollar may be an important
factor in the performance of the fund.
71
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APPENDIX
- --------------------------------------------------------------------------------
FOREIGN CURRENCIES
When an advisor or sub-advisor believes that a currency in which a portfolio
security or securities is denominated may suffer a decline against the U. S.
dollar, it may hedge that risk by entering into a forward contract to sell an
amount of foreign currency approximating the value of some or all of the
portfolio securities denominated in that foreign currency.
Because foreign securities generally are denominated and pay dividends or
interest in foreign currencies, and a fund may hold various foreign currencies,
the value of the net assets of that fund as measured in U. S. dollars will be
affected favorably or unfavorably by changes in exchange rates. Generally,
currency exchange transactions will be conducted on a spot (i.e., cash) basis at
the spot rate prevailing in the currency exchange market. The cost of currency
exchange transactions will generally be the difference between the bid and offer
spot rate of the currency being purchased or sold. Some foreign currency values
may be volatile, and there is the possibility of government controls on currency
exchange or governmental intervention in currency markets which could adversely
affect the fund.
Investors should be aware that exchange rate movements can be significant and
can endure for long periods of time. In order to protect against uncertainty in
the level of future foreign currency exchange rates, a fund's advisor or sub-
advisor may attempt to manage exchange rate risk through active currency
management, including the use of certain foreign currency hedging transactions.
For example, it may hedge some or all of its investments denominated in a
foreign currency against a decline in the value of that currency relative to the
U.S. dollar by entering into contracts to exchange that currency for U.S.
dollars (not exceeding the value of the fund's assets denominated in that
currency), or by participating in options or futures contracts with respect to
that currency. If the advisor or sub-advisor believes that a particular currency
may decline relative to the U.S. dollar, the fund may also enter into contracts
to sell that currency (up to the value of the fund's assets denominated in that
currency) in exchange for another currency that the advisor or sub-advisor
expects to remain stable or to appreciate relative to the U.S. dollar. This
technique is known as currency cross-hedging. Refer to the Prospectus for each
fund to determine which funds may engage in these transactions.
These strategies minimize the effect of currency appreciation as well as
depreciation, but do not protect against a decline in the underlying value of
the hedged security. In addition, these strategies may reduce or eliminate the
opportunity to profit from increases in the value of the original currency and
may adversely impact the fund's performance if the advisor or sub-advisor's
projection of future exchange rates is inaccurate. See Strategic portfolio
transactions.
GENERAL INFORMATION
Your inquiries should be directed to Lincoln National Life Insurance Co., at
P.O. Box 2340, Fort Wayne, Indiana 46801; or, you may call 1-800-348-1212.
The funds will issue unaudited semiannual reports showing current investments in
each fund and other information; and annual financial statements audited by
their independent auditors.
Under the 1940 Act a fundamental policy of a fund may not be changed without the
affirmative vote of a majority of the fund's outstanding shares.
As used in this Prospectus, the term majority of the fund's outstanding shares
means the vote of: (1) 67% or more of each fund's shares present at a meeting,
if the holders of more than 50% of the outstanding shares of each fund are
present or represented by proxy, or (2) more than 50% of each fund's outstanding
shares, whichever is less.
These Prospectuses do not contain all the information included in their
Registration Statements filed with the Commission. The Registration Statements,
including the exhibits filed with them, may be examined at the office of the
Commission in Washington, D.C. Statements contained in the Prospectuses about
the contents of any contract or other document referred to in them are not
necessarily complete. In each instance, reference is made to the copy of that
contract or other document filed as an exhibit to the Registration Statement of
which the particular Prospectus forms a part, and each statement is qualified in
all respects by that reference.
The use of funds by both variable annuity and variable life insurance separate
accounts is known as mixed funding. Due to differences in redemption rates, tax
treatment, or other considerations, the interests of contract owners under the
variable life accounts may conflict with those of contract owners under the
variable annuity account, in those cases where mixed funding occurs. The Board
of Directors of each fund will monitor for any material conflicts and determine
what action, if any, should be taken.
Should any conflict arise which requires that a substantial amount of assets be
withdrawn from any of the funds, orderly portfolio management could be
disrupted, to the detriment of those contract owners still investing in that
fund. Also, if that fund believes that any portfolio has become so large as to
materially impair investment performance, then the fund will examine other
investment options.
Lincoln Life performs the dividend and transfer functions for the funds.
72
<PAGE>
LINCOLN NATIONAL CAPITAL APPRECIATION FUND, INC.
Statement of Additional Information (SAI)
This SAI should be read in conjunction with the Prospectus of Lincoln National
Capital Appreciation Fund, Inc. (fund) dated May 1, 1996. You may obtain a
copy of the fund's Prospectus on request and without charge. Please write Kim
Oakman, Lincoln National Life Insurance Co., P.O. Box 2340, Fort Wayne, Indiana
46801 or call 1-800-348-1212, Ext. 4912.
<TABLE>
<CAPTION>
TABLE OF CONTENTS
Page
- ---------------------------------------------------------
<S> <C>
Investment objective and policies CA-2
- ---------------------------------------------------------
Investment restrictions CA-3
- ---------------------------------------------------------
Portfolio transactions and brokerage CA-4
- ---------------------------------------------------------
Determination of net asset value CA-5
- ---------------------------------------------------------
Investment techniques CA-5
- ---------------------------------------------------------
Appendix
Investment advisor and sub-advisor A-1
- ---------------------------------------------------------
Directors and officers A-3
- ---------------------------------------------------------
Investment policies and techniques (continued):
options, futures, securities lending, repurchase
and reverse repurchase agreements A-4
- ---------------------------------------------------------
Custodian A- 9
- ---------------------------------------------------------
Independent auditors A-10
- ---------------------------------------------------------
Financial statements A-10
- ---------------------------------------------------------
Bond ratings A-10
- ---------------------------------------------------------
Commercial paper ratings A-11
- ---------------------------------------------------------
U.S. Government obligations A-11
- ---------------------------------------------------------
Taxes A-11
- ---------------------------------------------------------
State requirements A-12
- ---------------------------------------------------------
Derivative transactions-definitions A-12
- ---------------------------------------------------------
</TABLE>
This SAI is not a Prospectus.
The date of this SAI is May 1, 1996
CA-1
<PAGE>
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the fund is long-term growth of capital in a
manner consistent with the preservation of capital. The fund's investment
objective and policies are fundamental and cannot be changed without the
affirmative vote of a majority of the outstanding voting securities of the
fund. See General information in the Prospectus. There can be no assurance that
the objective of the fund will be achieved.
This fund invests in investment-grade common stocks of established companies
with the objective of maximizing longer-term total return. The primary risk is
that associated with common stock investing and the shares will fluctuate in
value with the common stock market. Because the policy of this fund is to
emphasize investment in established companies, it is expected that the
volatility will be in line with the broad stock market indices such as the Dow
Jones Industrial Average and the Standard & Poor's 500 Index (S&P 500).
In addition the fund may write (sell) and purchase options; invest in futures
contracts and options thereon; and engage in other derivative transactions such
as (but not limited to) swaps, forward arrangements, and currency options; and
employ other techniques to enhance the portfolio, such as lending its portfolio
securities and engaging in repurchase and reverse repurchase agreements. These
transactions and techniques are subject to limits set out elsewhere in the
Prospectus and in this SAI.
Repurchase and Reverse Repurchase Agreements
The fund may make short-term investments in repurchase and reverse repurchase
agreements. A repurchase agreement typically involves the purchase by the fund
of securities (U.S. Government or other money market securities) from a
financial institution such as a bank, broker or savings and loan association,
coupled with an agreement by the seller to repurchase the same securities from
the fund at the specified price and at a fixed time in the future, usually not
more than seven days from the date of purchase. The difference between the
purchase price to the fund and the resale price to the seller represents the
interest earned by the fund which is unrelated to the coupon rate or maturity of
the purchased security. If the seller defaults, the fund may incur a loss if the
value of the collateral securing the repurchase agreement declines, or the fund
may incur disposition costs in connection with liquidating the collateral. If
bankruptcy proceedings are commenced with respect to the seller, realization
upon the collateral by the fund may be delayed or limited and a loss may be
incurred if the collateral securing the repurchase agreement declines in value
during the bankruptcy proceedings. However, repurchase agreements will be made
only with brokers, dealers and institutions deemed by the Board of Directors, or
its delegate, to be creditworthy; they will be fully collateralized; and the
collateral for each transaction will be in the actual or constructive possession
of the fund during the term of the transaction, as provided in the agreement.
Repurchase agreements with a duration of more than seven days are considered
illiquid securities and are subject to the limit stated below.
When the fund invests in a reverse repurchase agreement it sells a security
to another party, such as a bank or broker-dealer, in return for cash, and
agrees to buy the security back at a future date and price. Reverse repurchase
agreements may be used to provide cash to satisfy unusually heavy redemption
requests of for other temporary or emergency purposes without the necessity of
selling portfolio securities or to earn additional income on portfolio
securities, such as treasury bills and notes. Reverse repurchase agreements may
expose the fund to greater fluctuation in the value of its assets.
Futures, Options and Other Derivative Instruments
Subject to certain limits described in the SAI, the fund may purchase and
write options on securities (including index options) and options on foreign
currencies, and may invest in futures contracts for the purchase or sale of
instruments based on financial indices, including interest rates or an index of
U.S. Government or foreign government securities or equity or fixed income
securities, futures contracts on foreign currencies and fixed income securities
(futures contract), options on futures contracts, forward contracts, interest
rate swaps and swap-related products.
These instruments will be used primarily to hedge the fund's securities
positions, i.e., to attempt to reduce the overall level of investment risk that
normally would be expected to be associates with the fund's securities and to
attempt to protect the fund against market movements that might adversely
affect the value of its securities or the price of secu-
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rities that it is considering purchasing. The use of these instruments by the
fund involves certain risks.
The use of futures, options, forward contracts and swaps exposes the fund to
additional investment risks and transaction costs. If the sub-advisor seeks to
protect the fund against potential adverse movements in the securities, foreign
currency or interest rate markets using these instrument, and such markets do
not move in a direction adverse to the fund, that fund could be left in a less
favorable position than if such strategies had not been used. Risks inherent in
the use of futures, options, forward contracts and swaps include (1) the risk
that interest rates, securities prices and currency markets will not move in the
directions anticipated; (2) imperfect correlation between the price of futures,
options and forward contracts and movements in the prices of securities or
currencies being hedged; (3) the fact that skills needed to use these strategies
are different from those needed to select portfolio securities; (4) the possible
absence of a liquid secondary market for any particular instrument at any time;
and (5) the possible need to defer closing out certain hedged positions to avoid
adverse tax consequences.
INVESTMENT RESTRICTIONS
As indicated in the Prospectus, the fund is subject to certain fundamental
policies and restrictions that may not be changed without the approval of the
shareholders of a majority of the outstanding voting shares of the fund. This
term is defined under General information, in the Appendix.
As fundamental policies, the fund may not:
1. Own more than 10% of the outstanding voting securities of any one issuer and,
as to 75% of the value of the total assets of the fund, purchase the
securities of anyone issuer [except cash item and government securities as
defined under the Investment Company Act of 1940 (1940 Act)], if immediately
after and as a result of such purchase the value of the holdings of the fund
in the securities of such issuer exceeds 5% of the value of the fund's total
assets.
2. Invest more than 25% of the value of its assets in any particular industry.
3. Invest directly in real estate or interests in real estate; however, the fund
may own debt or equity securities issued by companies engaged in those
businesses.
4. Purchase or sell physical commodities other than foreign currencies unless
acquired as a result of ownership of securities (but this limitation shall
not prevent the fund from purchasing or selling options, futures, swaps and
forward contracts or from investing in securities or other instruments backed
by physical commodities).
5. Lend any security or make any other loan if, as a result, more than 25% of
the fund's total assets would be lent to other parties (but this limitation
does not apply to purchases of commercial paper, debt securities or
repurchase agreements).
6. Act as an underwriter of securities issued by others, except to the extent
that the fund may be deemed an underwriter in connection with the disposition
of its portfolio securities.
7. Invest in the securities of other investment companies, except as they may be
acquired as part of a merger, consolidation or acquisition of assets.
The Directors have adopted additional investment restrictions for the fund.
These restrictions are non-fundamental operating policies of the fund and, as
such, may be changed by the Directors without shareholder approval. The
additional investment restrictions adopted by the Directors to date include the
following:
a. The fund's investments in warrants, valued at the lower of cost or market,
may not exceed 5% of the value of its net assets. Included within that
amount, but not to exceed 2% of the value of the fund's net assets, may be
warrants that are not listed on the New York or American Stock Exchange.
Warrants acquired by the fund in units or attached to securities shall be
deemed to be without value.
b. The fund will not (1) enter into any futures contracts and related options
for purposes other than bona fide hedging transactions within the meaning of
Commodity Futures Trading Commission (CFTC) Regulations if the aggregate
initial margin and premiums required to establish positions in futures
contracts and related options that do not fall within the definition of bona
fide hedging transactions will exceed 5% of the fair market value of the
fund's net assets, after taking into account unrealized profits and
unrealized losses on any such contracts it has entered into; or (2) enter
into any futures contracts if the aggregate amount of the fund's commitments
under its outstanding futures contracts positions would exceed the market
value of its total assets.
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c. The fund does not currently intend to sell securities short, unless it owns
or has the right to obtain securities equivalent in kind and amount to the
securities sold short without the payment of any additional consideration
therefor, and provided that transactions in options, futures, swaps and
forward contracts are not deemed to constitute selling securities short.
d. The fund does not currently intend to purchase securities on margin, except
that the fund may obtain such short-term credits as are necessary for the
clearance of transactions, and provided that margin payments and other
deposits in connection with transactions in options, futures, swaps and
forward contracts shall not be deemed to constitute purchasing securities on
margin.
e. The fund may not mortgage or pledge any securities owned or held by it in
amounts that exceed, in the aggregate, 15% of its net asset value, provided
that this limitation does not apply to reverse repurchase agreements, assets
deposited to margin, guarantee positions in futures, options, swaps or
forward contracts or the segregation of assets in connection with such
contracts.
f. The fund does not intend to purchase securities of any issuer (other than
U.S. Government agencies and instrumentalities or instruments guaranteed by
an entity with a record of more than three years' continuous operation,
including that of predecessors) with a record of less than three years'
continuous operation (including that of predecessors) if such purchase would
cause the cost of the fund's investments in all such issuers to exceed 5% of
the fund's total assets taken at market value at the time of such purchase.
g. The fund does not currently intend to invest directly in oil, gas or other
mineral development or exploration programs or leases; however, the fund
may own debt or equity securities of companies engaged in those businesses.
h. The fund may borrow money for temporary or emergency purposes (not for
leveraging or investment) in an amount not exceeding 25% of the value of its
total assets (including the amount borrowed) less liabilities (other than
borrowings). If borrowings exceed 25% of the value of the fund's total assets
by reason of a decline in net assets, it will reduce its borrowings within
three business days to the extent necessary to comply with the 25%
limitation. This policy shall not prohibit reverse repurchase agreements,
deposits of assets to margin or guarantee positions in futures, options,
swaps or forward contracts or the segregation of assets in connection with
such contracts.
i. The fund does not currently intend to purchase any security or enter into a
repurchase agreement, if as a result, more than 15% of its net assets would
be invested in repurchase agreements not entitling the holder to payment of
principal and interest within seven days, and in securities that are illiquid
by virtue of legal or contractual restrictions on resale or the absence of a
readily available market. The Directors, or (if such authority is expressly
delegated to them, the advisor & sub-advisor) the fund's investment advisor
acting pursuant to authority delegated by the Directors, may determine that a
readily available market exists for securities eligible for resale pursuant
to Rule 144A under the Securities Act of 1933, or any successor to such rule,
and therefore that such securities are not subject to the foregoing
limitation.
j. The fund may not invest in companies for the purpose of exercising control or
management.
PORTFOLIO TRANSACTIONS AND BROKERAGE
The advisor is responsible for decisions to buy and sell securities for the
fund, the selection of brokers and dealers to effect the transactions and the
negotiation of brokerage commissions, if any. Purchases and sales of securities
on a stock exchange are effected through brokers who charge a commission for
their services. In the over-the-counter market, securities are generally traded
on a net basis with dealers acting as principal for their own accounts without a
stated commission, although the price of the security usually includes a profit
to the dealer. In underwritten offerings, securities are purchased at a fixed
price which includes an amount of compensation to the underwriter, generally
referred to as the underwriter's concession or discount. On occasion, certain
money market instruments may be purchased directly from an issuer, in which case
no commissions or discounts are paid.
The advisor currently provides investment advice to a number of other clients.
See Investment advisor and sub-advisor in the Appendix. It will be the practice
of the advisor to allocate purchase and sale transactions among the fund and
others whose assets it manages in such manner as it deems equitable. In making
such allocations, major factors to be considered are investment objectives, the
relative size of portfolio holdings of the same or compa-
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rable securities, the availability of cash for investment, the size of
investment commitments generally held and the opinions of the persons
responsible for managing the portfolios of the fund and other client accounts.
Fund securities are not purchased from or sold to the advisor or any affiliated
person [as defined in the 1940 Act] of the advisor.
In connection with effecting portfolio transactions, primary consideration will
be given to securing most favorable price and efficient execution. Within the
framework of this policy, the reasonableness of commission or other transaction
costs is a major factor in the selection of brokers and is considered together
with other relevant factors, including financial responsibility, research and
investment information and other services provided by such brokers. It is
expected that, as a result of such factors, transaction costs charged by some
brokers may be greater than the amounts other brokers might charge. The advisor
may determine in good faith that the amount of such higher transaction costs is
reasonable in relation to the value of the brokerage and research services
provided. The Board of Directors of the fund will review regularly the
reasonableness of commission and other transaction costs incurred by the fund in
the light of facts and circumstances deemed relevant from time to time, and, in
that connection, will receive reports from the advisor and published data
concerning transaction costs incurred by institutional investors generally. The
nature of the research services provided to the advisor by brokerage firms
varies, but generally includes current and historical financial data concerning
particular companies and their securities; information and analysis concerning
securities markets and economic and industry matters; and technical and
statistical studies and data dealing with various investment opportunities,
risks and trends, all of which the advisor regards as a useful supplement to its
own internal research capabilities. The advisor may direct trades to brokers
which have provided specific brokerage or research services for the benefit of
the advisor's clients; in addition the advisor may allocate trades among brokers
that generally provide superior brokerage and research services. Research
services furnished by brokers are used for the benefit of all of the advisor's
clients and not solely or necessarily for the benefit of the fund. The advisor
believes that the value of research services received is not determinable and
does not significantly reduce its expenses. The fund does not reduce its fee to
the advisor by any amount that might be attributable to the value of such
services.
If the fund effects a closing purchase transaction with respect to an option
written by it, normally such transaction will be executed by the same broker-
dealer who executed the sale of the option. If a call written by the fund is
exercised, normally the sale of the underlying securities will be executed by
the same broker-dealer who executed the sale of the call.
The writing of options by the fund will be subject to limitations established by
each of the exchanges governing the maximum number of options in each class
which may be written by a single investor or group of investors acting in
concert, regardless of whether the options are written on the same or different
exchanges or are held or written in one or more accounts or through one or more
brokers. Thus, the number of options which the fund may write may be affected by
options written by other investment advisory clients of its advisor. An exchange
may order the liquidations of positions found to be in excess of these limits,
and it may impose certain other sanctions. As of the date of this Prospectus,
these limits (which are subject to change) are 2,000 options (200,000 shares) in
each class of puts or calls.
DETERMINATION OF NET ASSET VALUE
A description of the days on which the fund's net asset value per share will be
determined is given in the Prospectus. The New York Stock Exchange's most recent
announcement (which is subject to change) states that in 1996 it will be closed
on New Year's Day, January 1; President's Day, February 19; Good Friday, April
5; Memorial Day, May 27; Independence Day, July 4; Labor Day, September 2;
Thanksgiving Day, November 28; and Christmas Day, December 25. It may also be
closed on other days.
INVESTMENT TECHNIQUES
Repurchase and Reverse Repurchase Agreements
In a repurchase agreement, the fund purchases a security and simultaneously
commits to resell that security to the seller at an agreed upon price on an
agreed upon date within a number of days (usually not more than seven) from the
date of purchase. The resale price reflects the purchase price plus an agreed
upon incremental amount that is unrelated
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to the coupon rate or maturity of the purchased security. A repurchase agreement
involves the obligation of the seller to pay the agreed upon price, which
obligation is in effect secured by the value (at least equal to the amount of
the agreed upon resale price and marked-to-market daily) of the underlying
security. The fund may engage in a repurchase agreement with respect to any
security in which it is authorized to invest. While it does not presently appear
possible to eliminate all risks from these transactions (particularly the
possibility of a decline in the market value of the underlying securities, as
well as delays and costs to the fund in the event of bankruptcy of the seller),
it is the policy of the fund to limit repurchase agreements to those parties
whose creditworthiness has been reviewed and found satisfactory by the advisor
or sub-advisor. In addition, the fund currently intends to invest only in
repurchase agreements collateralized by U.S. Government securities.
Reverse repurchase agreements may be used to provide cash to satisfy unusually
heavy redemption requests or for other temporary or emergency purposes without
the necessity of selling portfolio securities, or to earn additional income on
portfolio securities, such as Treasury bills and notes. In a reverse repurchase
agreement, the fund sells a portfolio security to another party, such as a bank
or broker-dealer, in return for cash and agrees to repurchase the instrument at
a particular price and time. While a reverse repurchase agreement is
outstanding, the fund will maintain cash and appropriate liquid assets in a
segregated custodial account to cover its obligation under the agreement. The
fund will enter into reverse repurchase agreements only with parties that the
advisor or sub-advisor deems creditworthy.
Mortgage- and asset-backed securities
The fund may invest in mortgage- and asset-backed securities. Government
National Mortgage Association (GNMA) Certificates are mortgage-backed securities
that evidence an undivided interest in a pool of mortgage loans. GNMA
Certificates differ from bonds in that principal is paid back monthly by the
borrowers over the term of the loan rather than returned in a lump sum at
maturity. GNMA Certificates that the fund may purchase are the modified pass-
through type. Modified pass-through GNMA Certificates entitle the holder to
receive a share of all interest and principal payments paid and owned on the
mortgage pool, net of fees paid to the issuer and GNMA, regardless of whether or
not the mortgagor actually makes the payment. GNMA Certificates are backed as to
the timely payment of principal and interest by the full faith and credit of the
U.S. Government.
The Federal Home Loan Mortgage Corp. (FHLMC) issues two types of mortgage pass-
through securities: mortgage participation certificates (PCs) and guaranteed
mortgage certificates (GMCs). PCs resemble GNMA Certificates in that each PC
represents a pro rata share of all interest and principal payments made and
owned on the underlying pool. FHLMC guarantees timely payments of interest on
PCs and the full return of principal. GMCs also represent a pro rata interest in
a pool of mortgages. However, these instruments pay interest semiannually and
return principal once a year in guaranteed minimum payments. This type of
security is guaranteed by FHLMC as to timely payment of principal and interest
but it is not guaranteed by the full faith and credit of the U.S. Government.
The Federal National Mortgage Association (FNMA) issues guaranteed mortgage
pass-through certificates (FNMA Certificates). FNMA Certificates resemble GNMA
Certificates in that each FNMA Certificate represents a pro rata share of all
interest and principal payments made and owned on the underlying pool. The
principal and the timely payment of interest on FNMA Certificates are guaranteed
only by FNMA itself, not by the full faith and credit of the U.S. Government.
Each of the mortgage-backed securities described above is characterized by
monthly payments to the holder, reflecting the monthly payments made by the
borrowers who received the underlying mortgage loans. The payments to the
security holders (such as the fund), like the payments on the underlying loans,
represent both principal and interest. Although the underlying mortgage loans
are for specified periods of time, such as 20 or 30 years, the borrowers can,
and typically do, pay them off sooner. Thus, the security holders frequently
receive prepayments of principal in addition to the principal that is part of
the regular monthly payments. A borrower is more likely to prepay a mortgage
that bears a relatively high rate of interest. This means that in times of
declining interest rates, some of the fund's higher yielding mortgage-backed
securities might be converted to cash and the fund will be forced to accept
lower interest rates when that cash is used to purchase additional securities
in the mortgage-backed securities sector or in the other investment sectors.
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<PAGE>
Futures, options and other derivative instruments
FUTURES CONTRACTS. The fund may enter into contracts for the purchase or sale
for future delivery of fixed income securities, foreign currencies or contracts
based on financial indices including interest rates or an index of U.S.
Government securities, foreign government securities, equity securities or fixed
income securities. U.S. futures contracts are traded on exchanges which have
been designated contract markets by the CFTC and must be executed through a
futures commission merchant (an FCM), or brokerage firm, which is a member of
the relevant contract market. Through their clearing corporations, the exchanges
guarantee performance of the contracts as between the clearing members of the
exchange.
The buyer or seller of a futures contract is not required to deliver or pay for
the underlying instrument unless the contract is held until the delivery date.
However, both the buyer and seller are required to deposit initial margin for
the benefit of an FCM when the contract is entered into. Initial margin deposits
are equal to a percentage of the contract's value, as set by the exchange on
which the contract is traded, and may be maintained in cash or certain high-
grade liquid assets. If the value of either party's position declines, that
party will be required to make additional variation margin payments with an FCM
to settle the change in value on a daily basis. The party that has a gain may be
entitled to receive all or a portion of this amount. Initial and variation
margin payments are similar to good faith deposits or performance bonds, unlike
margin extended by a securities broker, and initial and variation margin
payments do not constitute purchasing securities on margin for purposes of the
fund's investment limitations. In the event of the bankruptcy of an FCM that
holds margin on behalf of the fund, may be entitled to return of margin owed to
it only in proportion to the amount received by FCM's other customers. The sub-
advisor will attempt to minimize the risk by careful monitoring of the
creditworthiness of the FCMs with which the fund does business and by depositing
margin payments in a segregated account with the custodian when practical or
otherwise required by law.
The fund intends to comply with guidelines of eligibility for exclusion from the
definition of the term commodity pool operator with the CFTC and the National
Futures Association, which regulate trading in the futures markets. The fund
will use futures contracts and related options solely for bona fide hedging
purposes within the meaning of CFTC regulations; except that, in addition, the
fund may hold positions in futures contracts and related options that do not
fall within the definition of bona fide hedging transactions, provided that the
aggregate initial margin and premiums required to establish such positions will
not exceed 5% of the fair market value of the fund's net assets, after taking
into account unrealized profits and unrealized losses on any such contracts it
has entered into.
Although the fund would hold cash and liquid assets in a segregated account with
a value sufficient to cover its open futures obligations, the segregated assets
would be available to the fund immediately upon closing out the futures
position, while settlement of securities transactions could take several days.
However, because the fund's cash that may otherwise be invested would be held
uninvested or invested in high-grade liquid assets so long as the futures
position remains open, the fund's return could be diminished due to the
opportunity losses of foregoing other potential investments.
The acquisition or sale of a futures contract may occur, for example, when the
fund holds or is considering purchasing equity securities and seeks to protect
itself from fluctuations in prices without buying or selling those securities.
For example, if prices were expected to decrease, the fund might sell equity
index futures contracts, thereby hoping to offset a potential decline in the
value of equity securities in the portfolio by a corresponding increase in the
value of the futures contract position held by the fund and thereby preventing
the fund's net asset value from declining as much as it otherwise would have.
The fund also could protect against potential price declines by selling
portfolio securities and investing in money market instruments. However, since
the futures market is more liquid than the cash market, the use of futures
contracts as an investment technique allows the fund to maintain a defensive
position without having to sell portfolio securities.
Similarly, when prices of equity securities are expected to increase, futures
contracts may be bought to attempt to hedge against the possibility of having to
buy equity securities at higher prices. This technique is sometimes known as an
anticipatory hedge. Since the fluctuations in the value of futures contracts
should be similar to those of equity securities, the fund could take advantage
of the potential rise in the value of equity securities without buying them
until the market has stabilized. At that time, the futures contracts could be
liquidated and the fund could buy equity securities on the cash market. To the
extent the fund enters into futures
CA-7
<PAGE>
contracts for this purpose, the assets in the segregated asset account
maintained to cover the fund's obligations with respect to the futures contracts
will consist of high-grade liquid assets from its portfolio in an amount equal
to the difference between the contract price and the aggregate value of the
initial and variation margin payments made by the fund with respect to the
futures contracts.
The ordinary spreads between prices in the cash and futures markets, due to
differences in the nature of those markets, are subject to distortions. First,
all participants in the futures market are subject to initial margin and
variation margin requirements. Rather than meeting additional variation margin
requirements, investors may close out futures contracts through offsetting
transactions which could distort the normal price relationship between the cash
and futures markets. Second, the liquidity of the futures market depends on
participants entering into offsetting transactions rather than making or taking
delivery. To the extent participants decide to make or take delivery, liquidity
in the futures market could be reduced and prices in the futures market
distorted. Third, from the point of view of speculators, the margin deposit
requirements in the futures market are less onerous than margin requirements in
the securities market. Therefore, increased participation by speculators in the
futures market may cause temporary price distortions. Due to the possibility of
the foregoing distortions, a correct forecast of general price trends by the
sub-advisor still may not result in a successful use of futures.
Futures contracts entail risk. Although the fund believes that use of such
contracts will benefit the fund, the fund's overall performance could be worse
than if the fund had not entered into futures contracts if the sub-advisor's
investment judgement proves incorrect. For example, if the fund has hedged
against the effects of a possible decrease in prices of securities held in its
portfolio and prices increase instead, the fund will lose part or all of the
benefit of the increased value of these securities because of offsetting losses
in its futures positions. In addition, if the fund has insufficient cash, it may
have to sell securities from its portfolio to meet daily variation margin
requirements. Those sales may be, but not necessarily be, at increased prices
which reflect the rising market and may occur at a time when the sales are
disadvantageous to the fund.
The prices of futures contracts depend primarily on the value of their
underlying instruments. Because there are a limited number of types of futures
contracts, it is possible that the standardized futures contracts available to
the fund will not match exactly the fund's current or potential investments. The
fund may buy and sell futures contracts based on underlying instruments with
different characteristics from the securities in which it typically invests --
for example, by hedging investments in portfolio securities with a futures
contract based on a broad index of securities -- which involves a risk that the
futures position will not correlate precisely with the performance of the fund's
investments.
Futures prices can also diverge from the prices of their underlying instruments,
even if the underlying instruments closely correlate with the fund's
investments. Futures prices are affected by factors such as current and
anticipated short-term interest rates, changes in volatility of the underlying
instruments and the time remaining until expiration of the contract. Those
factors may affect securities prices differently from futures prices. Imperfect
correlations between the fund's investments and its futures positions also may
result from differing levels of demand in the futures markets and the securities
markets, from structural differences in how futures and securities are traded,
and from imposition of daily price fluctuation limits for futures contracts. The
fund may buy or sell futures contracts with a greater or lesser value than the
securities it wishes to hedge or is considering purchasing in order to attempt
to compensate for differences in historical volatility between the futures
contract and the securities, although this may not be successful in all cases.
If price changes in the fund's futures positions are poorly correlated with its
other investments, its futures position may fail to produce desired gains or
result in losses that are not offset by the gains in the fund's other
investments.
Because futures contracts are generally settled within a day from the date they
are closed out, compared with a settlement period of seven days for some types
of securities, the futures markets can provide superior liquidity to the
securities markets. Nevertheless, there is no assurance that a liquid secondary
market will exist for any particular futures contract at any particular time. In
addition, futures exchanges may establish daily price fluctuation limits for
futures contracts and may halt trading if a contract's price moves upward or
downward more than the limit in a given day. On volatile trading days when the
price fluctuation limit is reached, it may be impossible for the fund to enter
into new positions or close out existing positions. If the secondary market for
a futures contract is not liquid because of price fluctuation limits or
otherwise, the fund may not be able to promptly liquidate unfa-
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vorable futures positions and potentially could be required to continue to hold
a futures position until the delivery date, regardless of changes in its value.
As a result, the fund's access to other assets held to cover its futures
positions also could be impaired.
OPTIONS ON FUTURES CONTRACTS. The fund may buy and write put and call options on
futures contracts for hedging purposes. An option on a future gives the fund the
right (but not the obligation) to buy or sell a futures contract as a specified
price on or before a specified date. The purchase of a call option on a futures
contract is similar in some respects to the purchase of a call option on an
individual security. Depending on the pricing of the option compared to either
the price of the futures contract upon which it is based or the price of the
underlying instrument, ownership of the option may or may not be less risky than
ownership of the futures contract or the underlying instrument. As with the
purchase of futures contracts, when the fund is not fully invested it may buy a
call option on a futures contract to hedge against a market advance.
The writing of a call option on a futures contract constitutes a partial hedge
against declining prices of the security or foreign currency which is
deliverable under, or of the index comprising, the futures contract. If the
futures price at the expiration of the option is below the exercise price, the
fund will retain the full amount of the option premium which provides a partial
hedge against any decline that may have occurred in the fund's portfolio
holdings. The writing of a put option on a futures contract constitutes a
partial hedge against increasing prices of the security or foreign currency
which is deliverable under, or of the index comprising, the futures contract. If
the futures price at expiration of the option is higher than the exercise price,
the fund will retain the full amount of the option premium which provides a
partial hedge against any increase in the price of securities which the fund is
considering buying. If a call or put option the fund has written is exercised,
the fund will incur a loss which will be reduced by the amount of the premium it
received. Depending on the degree of correlation between change in the value of
its portfolio securities and changes in the value of the futures positions, the
fund's losses from existing options on futures may to some extent be reduced or
increased by changes in the value of portfolio securities.
The purchase of a put option on a futures contract is similar in some respects
to the purchase of protective put options on portfolio securities. For example,
the fund may buy a put option on a futures contract to hedge its portfolio
against the risk of falling prices.
The amount of risk the fund assumes when it buys an option on a futures contract
is the premium paid for the option plus related transaction costs. In addition
to the correlation risks discussed previously, the purchase of an option also
entails the risk that changes in the value of the underlying futures contract
will not be fully reflected in the value of the options bought.
FORWARD CONTRACTS. The fund may enter into forward foreign currency exchange
contracts (forward currency contracts) with stated contract values of up to the
value of the fund's assets. A forward currency contract is on obligation to buy
or sell an amount of a specified currency for an agreed price (which may be in
U.S. dollars or a foreign currency). The fund will exchange foreign currencies
for U.S. dollars and for other foreign currencies in the normal course of
business and may buy and sell currencies through forward currency contracts in
order to fix a price for securities it has agreed to buy or sell (transaction
hedge). The fund also may hedge some or all of its investments denominated in
foreign currency against a decline in the value of that currency relative to the
U.S. dollar by entering into forward currency contracts to sell an amount of
that currency (or a proxy currency whose performance is expected to replicate
the performance of that currency) approximating the value of some or all of its
portfolio securities denominated in that currency (position hedge) or by
participating in options or futures contracts with respect to the currency. The
fund also may enter into a forward currency contract with respect to a currency
where the fund is considering the purchase of investments denominated in that
currency but has not yet done so (anticipatory hedge).
In any of these circumstances the fund may, alternatively, enter into a forward
currency contract with respect to a different foreign currency when the fund
believes that the U.S. dollar value of that currency will correlate with the
U.S. dollar value of the currency in which portfolio securities of, or being
considered for purchase by, the fund is denominated (cross-hedge).
These types of hedging minimize the effect of currency appreciation as well as
depreciation, but do not protect against a decline in the security's value
relative to other securities denominated in the foreign currency. Shifting the
fund's currency exposure from one foreign currency to another removes the fund's
opportunity to profit from increases in the
CA-9
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value of the original currency and involves a risk of increased losses to the
fund if the sub-advisor's projection of future exchange rates is inaccurate.
The fund will cover outstanding forward positions by maintaining liquid
portfolio securities denominated in the currency underlying the forward contract
or, in the case of a cross-hedge, in the currency being hedged. To the extent
that the fund is not able to cover its forward currency positions with
underlying portfolio securities, the fund's custodian will segregate cash or
high-grade liquid assets having a value equal to the aggregate amount of the
fund's commitments under forward contracts entered into with respect to position
hedges, cross-hedges and anticipatory hedges. If the value of the securities
used to cover a position or the value of segregated assets declines, the fund
will find alternative cover or segregate additional cash or high-grade liquid
assets on a daily basis so that the value of the covered and segregated assets
will be equal to the amount of the fund's commitments with respect to such
contracts. As an alternative to segregating assets, the fund may buy call
options permitting the fund to buy the amount of foreign currency being hedged
by a forward sale contract or the fund may buy put options permitting it to sell
the amount of foreign currency subject to a forward buy contract.
While forward contracts are not currently regulated by the CFTC, the CFTC may in
the future assert authority to regulate forward contacts. In such event, the
fund's ability to utilize forward contracts may be restricted. Forward contracts
will reduce the potential gain from a positive change in the relationship
between the U.S. dollar and foreign currencies. Unforeseen changes in currency
prices may result in poorer overall performance for the fund than if it had not
entered into such contracts. The use of foreign currency forward contracts will
not eliminate fluctuations in the underlying U.S. dollar equivalent value of the
proceeds of or rates of return on the fund's foreign currency denominated
portfolio securities.
The matching of the increase in value of a forward contract and the decline in
the U.S. dollar equivalent value of the foreign currency denominated asset that
is the subject of the hedge generally will not be precise. In addition, the fund
may not always be able to enter into forward contracts at attractive prices and
may be limited in its ability to use these contracts to hedge fund assets.
Also, with regard to the fund's use of cross-hedges, there can be no assurance
that historical correlations between the movement of certain foreign currencies
relative to the U.S. dollar will continue. Poor correlation may exist between
movements in the exchange rates of the foreign currencies underlying the fund's
cross-hedges and the movements in the exchange rates of the foreign currencies
in which its assets that are the subject of such cross-hedges are denominated.
OPTIONS ON FOREIGN CURRENCIES. The fund may buy and write options on foreign
currencies for hedging purposes in a manner similar to that in which futures or
forward contracts on foreign currencies will be utilized. For example, a decline
in the U.S. dollar value of a foreign currency in which portfolio securities are
denominated will reduce the U.S. dollar value of such securities, even if their
value in the foreign currency remains constant. In order to protect against such
decreases in the value of portfolio securities, the fund may buy put options on
the foreign currency. If the value of the currency declines, the fund will have
the right to sell such currency for a fixed amount in U.S. dollars and will
offset, in whole or in part, the adverse effect on its portfolio.
Conversely, when a rise in the U.S. dollar value of a currency in which
securities to be acquired are denominated is projected, thereby increasing the
cost of such securities, the fund may buy call options thereon. The purchase of
such options could offset, at least partially, the effects of the adverse
movements in exchange rates. As in the case of other types of options, however,
the benefit to the fund from purchases of foreign currency options will be
reduced by the amount of the premium and related transaction costs. In addition,
if currency exchange rates do not move in the direction or to the extent
desired, the fund could sustain losses on transactions in foreign currency
options that would require the fund to forego a portion or all of the benefits
of advantageous changes in those rates.
The fund may write options on foreign currencies for hedging purposes. For
example, to hedge against a potential decline in the U.S. dollar value of
foreign currency denominated securities due to adverse fluctuations in exchange
rates, the fund could, instead of purchasing a put option, write a call option
on the relevant currency. If the expected decline occurs, the option will most
likely not be exercised and the decrease in value of portfolio securities will
be offset by the amount of the premium received.
Similarly, instead of purchasing a call option to hedge against a potential
increase in the U.S. dollar cost of securities to be acquired, the fund could
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write a put option on the relevant currency which, if rates move in the manner
projected, will expire unexercised and allow the fund to hedge the increased
cost up to the amount of the premium. As in the case of other types of options,
however, the writing of a foreign currency option will constitute only a partial
hedge up to the amount of the premium. If exchange rates do not move in the
expected direction, the option may be exercised and the fund would be required
to buy or sell the underlying currency at a loss which may not be offset by the
amount of the premium. Through the writing of options on foreign currencies, the
fund also may lose all or a portion of the benefits which might otherwise have
been obtained from favorable movements in exchange rates.
The fund may write covered call options on foreign currencies. A call option
written on a foreign currency by the fund is covered if the fund owns the
underlying foreign currency covered by the call or has an absolute and immediate
right to acquire that foreign currency without additional cash consideration (or
for additional cash consideration held in a segregated account by its custodian)
upon conversion or exchange of other foreign currency held in its portfolio. A
call option is also covered if the fund has a call on the same foreign currency
and in the same principal amount as the call written if the exercise price of
the call held (1) is equal to or less than the exercise price of the call
written or (2) is greater than the exercise price of the call written, if the
difference is maintained by the fund in cash or high-grade liquid assets in a
segregated account with the fund's custodian.
The fund also may write call options on foreign currencies for cross-hedging
purposes that would not be deemed to be covered. A call option on a foreign
currency is for cross-hedging purposes if it is not covered but is designed to
provide a hedge against a decline due to an adverse change in the exchange rate
in the U.S. dollar value of a security which the fund owns or has the right to
acquire and which is denominated in the currency underlying the option. In such
circumstances, the fund collateralizes the option by maintaining, in a
segregated account with the fund's custodian, cash or high-grade liquid assets
in an amount not less than the value of the underlying foreign currency in U.S.
dollars marked-to-market daily.
OPTIONS ON SECURITIES. In an effort to reduce fluctuations in net asset value
and preserve the fund's assets, the fund may write covered put and call options
and buy covered put and call options on securities that are traded on United
States and foreign securities exchanges and over-the-counter. The fund may write
and buy options on the same types of securities that the fund may purchase
directly.
A put option written by the fund is covered if the fund (1) maintains cash not
available for investment or high-grade liquid assets with a value equal to the
exercise price in a segregated account with its custodian or (2) holds a put on
the same security and in the same principal amount as the put written and the
exercise price of the put held is equal to or greater than the exercise price of
the put written. The premium paid by the buyer of an option will reflect, among
other things, the relationship of the exercise price to the market price and the
volatility of the underlying security, the remaining term of the option, supply
and demand and interest rates.
A call option written by the fund is covered if the fund owns the underlying
security covered by the call or has an absolute and immediate right to acquire
that security without additional cash consideration (or for additional cash
consideration held in a segregated account by its custodian) upon conversion or
exchange of other securities held in its portfolio. A call option is also deemed
to be covered if the fund holds a call on the same security and in the same
principal amount as the call written and the exercise price of the call held (1)
is equal to or less than the exercise price of the call written or (2) is
greater than the exercise price of the call written if the difference is
maintained by the fund in cash and high-grade liquid assets in a segregated
account with its custodian.
The fund also may write call options that are not covered for cross-hedging
purposes. The fund collateralizes its obligation under a written call option for
cross-hedging purposes by maintaining cash or high-grade liquid assets in a
segregated account with its custodian in an amount not less than the market
value of the underlying security, marked to market daily. The fund would write a
call option for cross-hedging purposes, instead of writing a covered call
option, when the premium to be received from the cross-hedge transaction would
exceed that which would be received from writing a covered call option and the
sub-advisor believes that writing the option would achieve the desired hedge.
The writer of an option may have no control when the underlying securities must
be sold, in the case of a call option, or bought, in the case of a put option,
since with regard to certain options, the writer may be assigned an exercise
notice at any time before the termination of the obligation. Whether or not an
option expires unexercised, the
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writer retains the amount of the premium. This amount, of course, may, in the
case of a covered call option, be offset by a decline in the market value of the
underlying security during the option period. If a call option is exercised, the
writer must fulfill the obligation to buy the underlying security at the
exercise price, which will usually exceed the then market value of the
underlying security.
The writer of an option that wishes to terminate its obligation may effect a
closing purchase transaction. This is accomplished by buying an option of the
same series as the option previously written. The effect of the purchase is that
the writer's position will be canceled by the clearing corporation. However, a
writer may not effect a closing purchase transaction after being notified of the
exercise of an option. Likewise, an investor who is the holder of an option may
liquidate its position by effecting a closing sale transaction. This is
accomplished by selling an option of the same series as the option previously
bought. There is no guarantee that either a closing purchase or a closing sale
transaction can be effected.
In the case of a written call option, 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. In the case of a
written put option, such transaction will permit the fund to write another put
option to the extent that the exercise price thereof is secured by deposited
high-grade liquid assets. Effecting a closing transaction also will permit the
fund to use the cash or proceeds from the concurrent sale of any securities
subject to the option for other investments. If the fund desires to sell a
particular security from its portfolio on which it has written a call option,
the fund will effect a closing transaction before or concurrent with the sale of
the security.
The fund will realize a profit from a closing transaction if the price of the
purchase transaction is less than the premium received from writing the option
or the price received from a sale transaction is more than the premium paid to
buy the option. The fund will realize a loss from a closing transaction if the
price of the purchase transaction is more than the premium received from writing
the option or the price received from a sale transaction is less than the
premium paid to buy the option. Because increases in the market of a call option
generally will 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.
An option position may be closed out only where a secondary market for an option
of the same series exists. If a secondary market does not exist, the fund may
not be able to effect closing transactions in particular options and the fund
would have to exercise the options in order to realize any profit. If the fund
is unable to effect a closing purchase transaction in a secondary market, it
will not be able to sell the underlying security until the option expires or the
fund delivers the underlying security upon exercise. The absence of a liquid
secondary market may be due to the following: (1) insufficient trading interest
in certain options, (2) restrictions imposed by a national securities exchange
on which the option is traded (Exchange) on opening or closing transactions or
both, (3) trading halts, suspensions or other restrictions imposed with respect
to particular classes or series of options or underlying securities, (4) unusual
or unforeseen circumstances that interrupt normal operations on an Exchange, (5)
the facilities of an Exchange or of the Options Clearing Corp. (OCC) may not at
all times be adequate to handle current trading volume, or (6) 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
that class or series of options), in which event the secondary market on that
Exchange (or in that class or series of options) would cease to exist, although
outstanding options on that Exchange that had been issued by the OCC as a result
of trades on that Exchange would continue to be exercisable in accordance with
their terms.
The fund may write options in connection with buy-and-write transactions. In
other words the fund may buy a security and then write a call option against
that security. The exercise price of such call will depend upon the expected
price movement of the underlying security. The exercise price of a call option
may be below (in-the-money), equal to (at-the-money) or above (out-of-the-money)
the current value of the underlying security at the time the option is written.
Buy-and-write transactions using in-the-money call options may be used when it
is expected that the price of the underlying security will remain flat or
decline moderately during the option period. Buy-and-write transactions using
at-the-money call options may be used when it is expected that the price of the
underlying security will remain fixed or advance moderately during the option
period. Buy-and-write transactions using out-of-the-money call options may be
used when it
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is expected that the premiums received from writing the call option plus the
appreciation in the market price of the underlying security up to the exercise
price will be greater than the appreciation in the price of the underlying
security alone. If the call options are exercised in such transactions, the
fund's maximum gain will be the premium received by it for writing the option,
adjusted upwards or downwards by the difference between the fund's purchase
price of the security and the exercise price. If the options are not exercised
and the price of the underlying security declines, the amount of such decline
will be offset by the amount of premium received.
The writing of covered put options is similar in terms of risk and return
characteristics to buy-and-write transactions. If the market price of the
underlying security rises or otherwise is above the exercise price, the put
option will expire worthless and the fund's gain will be limited to the premium
received. If the market price of the underlying security declines or otherwise
is below the exercise price, the fund may elect to close the position or take
delivery of the security at the exercise price and the fund's return will be the
premium received from the put options minus the amount by which the market price
of the security is below the exercise price.
The fund may buy put options to hedge against a decline in the value of its
portfolio. By using put options in this way, the fund will reduce any profit it
might otherwise have realized in the underlying security by the amount of the
premium paid for the put option and by transaction costs.
The fund may buy call options to hedge against an increase in the price of
securities that it may buy in the future. The premium paid for the call option
plus any transaction costs will reduce the benefit, if any, realized by the fund
upon exercise of the option, and, unless the price of the underlying security
rises sufficiently, the option may expire worthless to the fund.
SWAPS AND SWAP-RELATED PRODUCTS. The fund may enter into interest rate swaps,
caps and floors on either an asset-based or liability-based basis, depending
upon whether it is hedging its assets or its liabilities, and 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 entitlement with respect to each interest rate swap will be
calculated on a daily basis and an amount of cash or high-grade liquid assets
having an aggregate net asset value at least equal to the accrued excess will be
maintained in a segregated account by the fund's custodian. If the fund enters
into an interest rate swap on other than a net basis, it would maintain a
segregated account in the full amount accrued on a daily basis of its
obligations with respect to the swap. 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 other party thereto is rated in one of the three
highest credit rating categories of at least one nationally recognized
statistical rating organization at the time of entering into such transaction.
The sub-advisor will monitor the creditworthiness of all counterparties on an
ongoing basis. If there is a default by the other party to such a transaction,
the fund will have contractual remedies pursuant to the agreements related to
the transaction.
The swap market has grown substantially in recent years with a large number of
banks and investment banking firms acting both as principals and as agents
utilizing standardized swap documentation. The sub-advisor has determined that,
as a result, the swap market has become relatively liquid. Caps and floors are
more recent innovations for which standardized documentation has not yet been
developed and, accordingly, they are less liquid than swaps. To the extent the
fund sells (i.e., writes) caps and floors, it will maintain cash or high-grade
liquid assets having an aggregate net asset value at least equal to the full
amount, accrued on a daily basis, of its obligations with respect to any caps or
floors in a segregated account.
There is no limit on the amount of interest rate swap transactions that may be
entered into by the fund. These transactions may in some instances involve the
delivery of securities or other underlying assets by the fund or its
counterparty to collateralize obligations under the swap. Under the
documentation currently used in those markets, the risk of loss with respect to
interest rate swaps is limited to the net amount of the payments that the fund
is contractually obligated to make. If the other party to an interest rate swap
that is not collateralized defaults, the fund would risk the loss of the net
amount of the payments that it contractually is entitled to receive. The fund
may buy and sell (i.e., write) caps and floors without limitation, subject to
the segregated account requirement described previously.
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ADDITIONAL RISKS OF OPTIONS ON FOREIGN CURRENCIES, FORWARD CONTRACTS AND FOREIGN
INSTRUMENTS. Unlike transactions entered into by the fund in futures contracts,
options on foreign currencies and forward contracts are not traded on contract
markets regulated by the CFTC or (with the exception of certain foreign currency
options) by the Securities and Exchange Commission (SEC). To the contrary, such
instruments are traded through financial institutions acting as market-makers,
although foreign currency options are also traded on certain national securities
exchanges, such as the Philadelphia Stock Exchange and the Chicago Board Options
Exchange, subject to SEC regulation. Similarly, options on currencies may be
traded over-the-counter. In an over-the-counter trading environment, many of the
protections afforded to exchange participants will not be available. For
example, there are no daily price fluctuation limits, and adverse market
movements could therefore continue to an unlimited extent over a period of time.
Although the buyer of an option cannot lose more than the amount of the premium
plus related transaction costs, this entire amount could be lost. Moreover, an
option writer and a buyer or seller of futures or forward contracts could lose
amounts substantially in excess of any premium received or initial margin or
collateral posted due to the potential additional margin and collateral
requirements associated with such positions.
Options on foreign currencies traded on national securities exchanges are within
the jurisdiction of the SEC, as are other securities traded on such exchanges.
As a result, many of the protections provided to traders on organized exchanges
will be available with respect to such transactions. In particular, all foreign
currency option positions entered into on a national securities exchange are
cleared and guaranteed by the OCC, thereby reducing the risk of counterparty
default. Further, a liquid secondary market in options traded on a national
securities exchange may be more readily available than in the over-the-counter
market, potentially permitting the fund to liquidate open positions at a profit
before exercise or expiration, or to limit losses in the event of adverse market
movements.
The purchase and sale of exchange-traded foreign currency options, however, is
subject to the risks of the availability of a liquid secondary market described
previously, as well as the risks regarding adverse market movements, margining
of options written, the nature of the foreign currency market, possible
intervention by governmental authorities and the effects of other political and
economic events. In addition, exchange-traded options on foreign currencies
involve certain risks not presented by the over-the-counter market. For example,
exercise and settlement of such options must be made exclusively through the
OCC, which has established banking relationships in applicable foreign countries
for this purpose. As a result, the OCC may, if it determines that foreign
governmental restrictions or taxes would prevent the orderly settlement of
foreign currency option exercises, or would result in undue burdens on the OCC
or its clearing member, impose special procedures on exercise and settlement,
such as technical changes in the mechanics of delivery of currency, the fixing
of dollar settlement prices or prohibitions on exercise.
In addition, options on U.S. Government securities, futures contracts, options
on futures contracts, forward contracts and options on foreign currencies may be
traded on foreign exchanges and over-the-counter in foreign countries. Such
transactions are subject to the risk of governmental actions affecting trading
in or the prices of foreign currencies or securities. The value of such
positions also could be adversely affected by (1) other complex foreign
political and economic factors, (2) lesser availability than in the United
States of data on which to make trading decisions, (3) delays in the fund's
ability to act upon economic events occurring in foreign markets during non-
business hours in the United States, (4) the imposition of different exercise
and settlement terms and procedures and margin requirements than in the United
States, and (5) low trading volume.
Lending of portfolio securities
The fund may from time to time lend securities from its portfolio to brokers,
dealers and financial institutions and receive collateral from the borrower, in
the form of cash (which may be invested in short-term securities), U.S.
Government obligations or certificates of deposit. Such collateral will be
maintained at all times in an amount equal to at least 102% of the current
market value of the loaned securities, and will be in the actual or constructive
possession of the fund during the term of the loan. The fund will retain the
incidents of ownership of the loaned securities and will be entitled to the
interest or dividends payable on the loaned securities. In addition, the fund
will receive interest on the amount of the loan. The loans will be terminable by
the fund at any time and will not be made to any affiliates of the fund or the
advisor. The
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fund may pay reasonable finder's fees to persons unaffiliated with it in
connection with the arrangement of the loans.
As with any extensions of credit, there are risks of delay in recovery and, in
some cases, even loss of rights in the collateral or the loaned securities
should the borrower of securities fail financially. However, loans of portfolio
securities will be made only to firms deemed by the advisor or sub-advisor to be
creditworthy. As a fundamental policy the fund will not lend securities if, as a
result, more than 25% of its total assets would be lent to other parties.
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APPENDIX
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STATEMENT OF ADDITIONAL INFORMATION TABLE OFCONTENTS-11 UNDERLYING FUNDS*
Item
- --------------------------------------------------------------------------------
General Information and History
Investment objective
Investment policies and techniques
Investment restrictions
Portfolio transactions and brokerage
Determination of net asset value
Item
- --------------------------------------------------------------------------------
Appendix
Investment advisor and sub-advisor
Directors and officers
Investment policies and techniques (continued): options, futures, securities
lending, repurchase and reverse repurchase agreements
Custodian
Independent auditors
Financial statements
Bond ratings
Commercial paper ratings
U.S. Government obligations
Taxes
State requirements
Derivative transactions - definitions
*Note: This is a generic table. There are variations in the contents of the SAI
from fund to fund.
- --------------------------------------------------------------------------------
Please send me a free copy of the current Statement of Additional Information
for Lincoln National Life Insurance Co. Variable Annuity Account C:
(Please Print)
Name:___________________________________________________________________________
Address:________________________________________________________________________
City ___________________________________State ____________________Zip __________
Mail to Kim Oakman, Lincoln National Life Insurance Co., P.O. Box 2340, Fort
Wayne, Indiana 46801
73
<PAGE>
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74
<PAGE>
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APPENDIX
- --------------------------------------------------------------------------------
APPENDIX
(Note: This is uniform information for the 11 Funds. See each Fund's SAI for
information specific to that Fund.)
THIS APPENDIX CONSTITUTES PART OF THE SAIS OF LINCOLN NATIONAL AGGRESSIVE GROWTH
FUND, INC. (AGGRESSIVE GROWTH FUND), LINCOLN NATIONAL BOND FUND, INC. (BOND
FUND), LINCOLN NATIONAL CAPITAL APPRECIATION FUND, INC. (CAPITAL APPRECIATION
FUND), LINCOLN NATIONAL EQUITY-INCOME FUND, INC. (EQUITY-INCOME FUND), LINCOLN
NATIONAL GLOBAL ASSET ALLOCATION FUND, INC. (GLOBAL ASSET ALLOCATION FUND),
LINCOLN NATIONAL GROWTH AND INCOME FUND, INC. (GROWTH AND INCOME FUND), LINCOLN
NATIONAL INTERNATIONAL FUND, INC. (INTERNATIONAL FUND), LINCOLN NATIONAL MANAGED
FUND, INC. (MANAGED FUND), LINCOLN NATIONAL MONEY MARKET FUND, INC. (MONEY
MARKET FUND), LINCOLN NATIONAL SOCIAL AWARENESS FUND, INC. (SOCIAL AWARENESS
FUND), AND LINCOLN NATIONAL SPECIAL OPPORTUNITIES FUND, INC. (SPECIAL
OPPORTUNITIES FUND). UNLESS OTHERWISE INDICATED, THE FOLLOWING INFORMATION
APPLIES TO EACH FUND.
INVESTMENT ADVISOR AND SUB-ADVISOR
Lincoln Investment Management, Inc. (Lincoln Investment) is the investment
advisor to the funds and is headquartered at 200 E. Berry Street, Fort Wayne,
Indiana 46802. Lincoln Investment (the advisor) is a subsidiary of Lincoln
National Corp. (LNC), a publicly-held insurance holding company organized under
Indiana law. Through its subsidiaries, LNC provides, on a national basis,
insurance and financial services. Lincoln Investment is registered with the
Securities and Exchange Commission (SEC) as an investment advisor and has acted
as an investment advisor to mutual funds for over 40 years. The advisor also
acts as investment advisor to Lincoln National Income Fund, Inc. (a closed-end
investment company whose investment objective is to provide a high level of
current income from interest on fixed-income securities) and Lincoln National
Convertible Securities Fund, Inc. (a closed-end investment company whose
investment objective is a high level of total return on its assets through a
combination of capital appreciation and current income), Lincoln Advisor Funds,
Inc. (a retail mutual fund complex) and to other clients.
Under Advisory Agreements with the funds, the advisor provides portfolio
management and investment advice to the funds and administers its other affairs,
subject to the supervision of the funds' Board of Directors. The advisor, at its
expense, will provide office space to the funds and all necessary office
facilities, equipment and personnel and will make its officers and employees
available to the funds as appropriate. In addition, the advisor will pay all
expenses incurred by it or by the funds in connection with the management of
each fund's assets or the administration of its affairs, other than those
assumed by the funds, as described later. Lincoln Life has paid the
organizational expenses of all the funds. The rates of compensation to the
advisor and the sub-advisor are set forth in the Appendix to the Prospectus.
During the last three years, the advisor received the following amounts for
investment advisory services:
<TABLE>
<CAPTION>
1995 1994 1993
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Aggressive Growth Fund $ 725,544 $ 232,000 N/A
Bond Fund 1,061,701 999,397 $ 978,266
Capital Appreciation Fund 726,011 211,773 N/A
Equity-Income Fund 1,457,623 348,255 N/A
Global Asset Allocation Fund 1,570,876 1,381,059 901,004
Growth and Income Fund 5,077,981 3,896,902 3,293,315
International Fund 2,770,197 2,262,664 759,801
Managed Fund 2,120,656 1,919,150 1,756,544
Money Market Fund 385,019 404,441 449,374
Social Awareness Fund 1,048,366 736,602 542,142
Special Opportunities Fund 1,809,514 1,351,374 1,052,967
</TABLE>
A-1
<PAGE>
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APPENDIX
- --------------------------------------------------------------------------------
Expenses specifically assumed by the funds include: compensation and expenses of
directors of the funds who are not interested persons of the funds as defined in
the Investment Company Act of 1940 (1940 Act); registration, filing and other
fees in connection with filings with regulatory authorities, including the costs
of printing and mailing registration statements and updated prospectuses
provided to current shareholders; fees and expenses of independent auditors; the
expenses of printing and mailing proxy statement and shareholder reports;
custodian charges; brokerage commissions and securities transaction costs
incurred by the funds; taxes and corporate fees; legal fees incurred in
connection with the affairs of the funds (other than legal services provided by
personnel of the advisor or its affiliated companies); the fees of any trade
association of which the funds are members; and expenses of shareholder and
director meetings.
If total expenses of the funds (excluding taxes, interest, portfolio brokerage
commissions and fees, and expenses of an extraordinary and non-recurring nature,
but including the investment advisory fee) exceed 1 1/2% per annum of the
average daily net assets of each fund (2% for the International Fund), the
advisor will pay such excess by offsetting it against the advisory fee. If such
offset is insufficient to cover the excess, any balance remaining will be paid
directly by the advisor to each fund.
The current advisory agreements between the advisor and the funds will remain in
effect from year to year if approved annually by: (1) the Board of Directors of
each fund or by the vote of a majority of the outstanding voting securities of
each fund, and (2) a vote of a majority of the directors who are not interested
persons of the funds or the advisor, cast in person at a meeting called for the
purpose of voting on such approval. The advisory agreement may be terminated
without penalty at any time, on 60 days' written notice by: (1) the Board of
Directors of each fund, (2) vote of a majority of the outstanding voting
securities of each fund or (3) the advisor. The advisory agreement terminates
automatically in the event of assignment.
In like manner, the current sub-advisory agreement will remain in effect from
year to year if approved annually by the Board of Directors of the applicable
funds or by the vote of a majority of the outstanding voting securities of those
funds. The sub-advisory agreements may be terminated without penalty at any
time, on 60 days' written notice, by: (1) the Board of Directors of the
applicable fund, (2) vote of the majority of the outstanding voting securities
of the applicable fund, (3) the sub-advisor, or (4) the advisor. The sub-
advisory agreements terminate automatically in the event of assignment.
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APPENDIX
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DIRECTORS AND OFFICERS
The directors and executive officers of each fund, their business
addresses, positions with fund and their principal occupations during the past
five years areas follows:
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* KELLY D. CLEVENGER Vice President, Lincoln National Life Insurance Co.
Chairman of the Board,
President and Director
1300 S. Clinton Street
Fort Wayne, IN 46802
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JOHN B. BORSCH, JR. Retired, formerly Associate Vice President-
Director Investments,Northwestern University
1776 Sherwood Road Northwestern University
Des Planes, IL 60016
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NANCY L. FRISBY, CPA Regional Vice President/Chief Financial Officer
Director (formerly Vice President -- Finance; Regional
700 Broadway Controller of Finance), St. Joseph Medical Center,
Fort Wayne, IN 46802 Fort Wayne, Indiana
- --------------------------------------------------------------------------------
* BARBARA S. KOWALCZYK Executive Vice President, Lincoln Investment
Director Management, Inc. (formerly Senior Vice President);
1300 S. Clinton St. Vice President, Lincoln National Life Insurance Co.
Fort Wayne, IN 46802
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STANLEY R. NELSON Executive in Residence Program in Health Services
Director Administration, University of Minnesota,
420 Delaware St., S.E. Minneapolis, Minnesota, (formerly President, Henry
Minneapolis, MN 55455 Ford Health Care Corp., Detroit, Michigan)
- --------------------------------------------------------------------------------
* JANET C. WHITNEY Vice President and Treasurer, Lincoln National
200 East Berry Street Corp. (formerly Vice President and General Auditor)
Fort Wayne, IN 46802
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* CYNTHIA A. ROSE Assistant Secretary, Lincoln National Life
200 East Berry Street Insurance Co.
Fort Wayne, IN 46802
- --------------------------------------------------------------------------------
* Interested persons of the funds, as defined in the 1940 Act. Directors' fees
of $250 per meeting are paid by each fund to each director who is not an
interested person of the fund.
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APPENDIX
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INVESTMENT POLICIES AND TECHNIQUES (CONTINUED) OPTIONS AND FINANCIAL FUTURES
TRADING
This discussion relates to the Bond, Growth and Income, Managed, Social
Awareness and Special Opportunities Funds. Neither the International Fund nor
the Money Market Fund has sought the authority to engage either in options or in
futures trading. (NOTE: The Aggressive Growth, Capital Appreciation, Equity-
Income and Global Asset Allocation Funds have their own respective discussions
of the strategic portfolio transactions in which they may engage).
OPTIONS TRADING
The fund may purchase or write (sell) options on financial instruments as a
means of achieving additional return or hedging the value of the fund's
portfolio. The fund may not write put or covered call options in an amount
exceeding 30% of the value of its total assets. The fund would invest in options
in standard contracts which may be quoted on NASDAQ, or on national securities
exchanges. Currently options are traded on numerous securities and indices
including, without limitation, the Standard and Poor's 100 Index (S&P 100), the
Standard and Poor's 500 Index (S&P 500), and the NYSE Beta Index.
A) In General. Put and call options are generally short-term contracts with
durations of nine months or less. The investment advisor will generally write
covered call options when it anticipates declines in the market value of the
portfolio securities and the premiums received may offset to some extent the
decline in the fund's net asset value. On the other hand, writing put options
is a useful portfolio investment strategy when the fund has cash or other
reserves and it intends to purchase securities but expects prices to decline.
Generally, the risk to the fund in writing options is that the investment
advisor's assumption about the price trend of the underlying security may prove
inaccurate. If, as a result, the fund wrote a put, expecting the price of a
security to increase, and it decreases, or if the fund wrote a call, expecting
the price to decrease but it increased, the fund could suffer a loss if the
premium received in each case did not equal the difference between the exercise
price and the market price.
B) Call Options. The fund may write only call options which are covered, meaning
that the fund either owns the underlying security or has an absolute and
immediate right to acquire that security, without additional cash
consideration, upon conversion or exchange of other securities currently held
in its portfolio. In addition, the fund will not, before the expiration of a
call option, permit the call to become uncovered. If the fund writes a call
option, the purchaser of the option has the right to buy (and the fund has
the obligation to sell) the underlying security at the exercise price
throughout the term of the option. The amount paid to the fund by the
purchaser of the option is the premium. The fund's obligation to deliver the
underlying security against payment of the exercise price would terminate
either upon expiration of the option or earlier if the fund were to effect a
closing purchase transaction through the purchase of an equivalent option on
an exchange. The fund would not be able to effect a closing purchase
transaction after it had received notice of exercise.
In order to write a call option, the fund is required to deposit in escrow the
underlying security or other assets in accordance with the rules of The Options
Clearing Corp. (OCC) and the various exchanges. The fund may not purchase call
options except in connection with a closing purchase transaction. It is possible
that the cost of effecting a closing purchase transaction may be greater than
the premium received by the fund for writing the option.
Generally, the investment advisor (the advisor) intends to write listed covered
calls during periods when it anticipates declines in the market values of
portfolio securities and the premiums received (net of transaction costs) may
offset to some extent the decline in the fund's net asset value occasioned by
such declines in market value. The advisor will generally not write listed
covered call options when it anticipates that the market value of the fund's
portfolio securities will increase.
If the advisor decides that at a price higher than the current value a portfolio
security would be overvalued and should be sold, the fund may write an option on
the security at that price. Should the security subsequently reach that price
and the option be exercised, the fund would, in effect, have increased the
selling price of that security, which it would have sold at that price in any
event, by the amount of the premium. In the event the market price of the
security declined and the option were not exercised, the premium would offset
all or some portion of that decline. It is possible, of
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APPENDIX
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course, that the price of the security could increase beyond the exercise price;
in that event, the fund would forego the opportunity to sell the security at
that higher price.
In addition, call options may be used as part of a different strategy in
connection with sales of portfolio securities. If, in the judgment of the
advisor, the market price of a security is overvalued and it should be sold, the
fund may elect to write a call with an exercise price substantially below the
current market price. So long as the value of the underlying security remains
above the exercise price during the term of the option, the option will be
exercised, and the fund will be required to sell the security at the exercise
price. If the sum of the premium and the exercise price exceeds the market price
of the security at the time the call is written, the fund would, in effect, have
increased the selling price of the security. The fund would not write a call
under these circumstances if the sum of the premium and the exercise price were
less than the current market price of the security.
In summary, a principal reason for writing calls on a securities portfolio is to
attempt to realize, through the receipt of premium income, a greater return than
would be earned on the securities alone. A covered call writer, such as the
fund, which owns the underlying security has, in return for the premium, given
up the opportunity for profit from a price increase in the underlying security
above the exercise price, but has retained the risk of loss should the price of
the security decline. Unlike one who owns securities not subject to a call, the
fund as a call writer may be required to hold such securities until the
expiration of the call option or until the fund engages in a closing purchase
transaction at a price that may be below the prevailing market.
C) Put Options. The fund may also write put options. If the fund writes a put
option, it is obligated to purchase a given security at a specified price at
any time during the term of the option. The rules regarding the writing of
put options are generally comparable to those described above with respect to
call options.
Writing put options is a useful portfolio investment strategy when the fund has
cash or other reserves available for investment as a result of sales of fund
shares or because the advisor believes a more defensive and less fully invested
position is desirable in light of market conditions. If the fund wishes to
invest its cash or reserves in a particular security at a price lower than
current market value, it may write a put option on that security at an exercise
price which reflects the lower price it is willing to pay. The buyer of the put
option generally will not exercise the option unless the market price of the
underlying security declines to a price near or below the exercise price. If the
fund writes a put option, the price of the underlying security declines and the
option is exercised, the premium, net of transaction charges, will reduce the
purchase price paid by the fund for the security. Of course, the price of the
security may continue to decline after exercise of the put options, in which
event the fund would have foregone an opportunity to purchase the security at a
lower price, or the option might never be exercised.
If, before the exercise of a put, the advisor determines that it no longer
wishes to invest in the security on which the put has been written, the fund may
be able to effect a closing purchase transaction on an exchange by purchasing a
put of the same series as the one which it has previously written. The cost of
effecting a closing purchase transaction may be greater than the premium
received on writing the put option, and there is no guarantee that a closing
purchase transaction can be effected. The fund may purchase put options only in
connection with a closing transaction.
As with the writer of a call, a put writer generally hopes to realize premium
income. The risk position of the fund as a put writer is similar to that of a
covered call writer which owns the underlying securities. Like the covered call
writer (who must bear the risk of the position in the underlying security), the
fund as a put writer stands to incur a loss if and to the extent the price of
the underlying security falls below the exercise price plus premium.
At the time a put option is written, the fund will be required to establish, and
will maintain until the put is exercised or has expired, a segregated account
with its custodian consisting of cash or short-term U.S. Government securities
equal in value to the amount which the fund will be obligated to pay upon
exercise of the put. Principal factors affecting the market value of a put or
call option include supply and demand, interest rates, the current market price
and price volatility of the underlying security and the time remaining until the
expiration date. In addition, there is no assurance that the fund will be able
to effect a closing transaction at a favorable price. If the fund cannot enter
into such a transaction, it may be required to hold a security that it might
otherwise have sold, in which case it would continue to be at market risk on the
security. If a substantial number of covered options
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APPENDIX
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written by the fund are exercised, the fund's rate of portfolio turnover could
exceed historic levels. This could result in higher transaction costs, including
brokerage commissions. The fund will pay brokerage commissions in connection
with the writing and purchasing of options to close out previously written
options. Such brokerage commissions are normally higher than those applicable to
purchases and sales of portfolio securities.
FUTURES CONTRACTS AND OPTIONS THEREON
A. Generally, the fund may buy and sell financial futures contracts (futures
contracts) and related options thereon solely for hedging purposes. The fund
may sell a futures contract or purchase a put option on that futures contract
to protect the value of the fund's portfolio in the event the investment
advisor anticipates declining security prices. Similarly, if security prices
are expected to rise, the fund may purchase a futures contract or a call
option thereon. (For certain limited purposes, as explained later, the fund
is also authorized to buy futures contracts on an unleveraged basis and not
as an anticipatory hedge.)
The fund will not invest in futures contracts and options thereon if immediately
thereafter the amount committed to margins plus the amount paid or option
premiums exceeds 5% of the fund's total assets. In addition the fund will not
hedge more than 1/3 of its net assets.
B. Futures contracts. The fund may purchase and sell financial futures contracts
(futures contracts) as a hedge against fluctuations in the value of
securities which are held in the fund's portfolio or which the fund intends
to purchase. The fund will engage in such transactions consistent with the
fund's investment objective. Currently, futures contracts are available on
Treasury bills, notes, and bonds.
There are a number of reasons why entering into futures contracts for hedging
purposes can be beneficial to the fund. First, futures markets may be more
liquid than the corresponding cash markets on the underlying securities. Such
enhanced liquidity results from the standardization of the futures contracts and
the large transaction volumes. Greater liquidity permits a portfolio manager to
effect a desired hedge both more quickly and in greater volume than would be
possible in the cash market. Second, a desired sale and subsequent purchase can
generally be accomplished in the futures market for a fraction of the
transaction costs that might be incurred in the cash market.
The purpose of selling a futures contract is to protect the fund's portfolio
from fluctuation in asset value resulting from stock price changes. Selling a
futures contract has an effect similar to selling a portion of the fund's
portfolio securities. If stock prices were to decline, the value of the fund's
futures contracts would increase, thereby keeping the net asset value of the
fund from declining as much as it otherwise might have. In this way, selling
futures contracts acts as a hedge against the effects of declining stock prices.
However, an increase in the value of portfolio securities tends to be offset by
a decrease in the value of corresponding futures contracts.
Similarly, when stock prices are expected to rise, futures contracts may be
purchased to hedge against anticipated subsequent purchases of portfolio
securities at higher prices. By buying futures, the fund could effectively hedge
against an increase in the price of the securities it intends to purchase at a
later date in order to permit the purchase to be effected in an orderly manner.
At that time, the futures contracts could be liquidated at a profit if stock
prices had increased as expected, and the fund's cash position could be used to
purchase securities.
When a purchase or sale of a futures contract occurs, a deposit of high-quality,
liquid securities called initial margin is made by both buyer and seller with a
custodian for the benefit of the broker. Unlike other types of margin, a futures
margin account does not involve any loan or borrowing but is merely a good faith
deposit that must be maintained in a minimum amount of cash or U.S. Treasury
bills. All futures positions, both long and short, are marked-to-market daily,
with cash payments called variation margin being made by buyers and sellers to
the custodian, and passed through to the sellers and buyers, to reflect daily
changes in the contract values.
Most futures contracts are typically canceled or closed out before the scheduled
settlement date. The closing is accomplished by purchasing (or selling) an
identical futures contract to offset a short (or long) position. Such an
offsetting transaction cancels the contractual obligations established by the
original futures transaction. Other financial futures contracts call for cash
settlements rather than delivery of securities.
If the price of an offsetting futures transaction varies from the price of the
original futures transaction, the hedger will realize a gain or loss
corresponding to the difference. That gain or loss will tend to offset the
unrealized loss or gain on the
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APPENDIX
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hedged securities position, but may not always or completely do so.
The fund will not enter into any futures contract if, immediately thereafter,
the aggregate initial margin for all existing futures contracts and options
thereon and for premiums paid for related options would exceed 5% of the fund's
total assets. The fund will not purchase or sell futures contracts or related
options if immediately thereafter more than 1/3 of its net assets would be
hedged.
C. Risks and limitations involved in futures hedging. There are a number of
risks associated with futures hedging. Changes in the price of a futures
contract generally parallel but do not necessarily equal changes in the
prices of the securities being hedged. The risk of imperfect correlation
increases as the composition of the fund's securities portfolio diverges from
the securities that are the subject of the futures contract. Because the
change in the price of the futures contract may be more or less than the
change in the prices of the underlying securities, even a correct forecast of
stock price changes may not result in a successful hedging transaction.
Another risk is that the investment advisor could be incorrect in its
expectation as to the direction or extent of various market trends or the
time period within which the trends are to take place.
The fund intends to purchase and sell futures contracts only on exchanges where
there appears to be a market in such futures sufficiently active to accommodate
the volume of its trading activity. There can be no assurance that a liquid
market will always exist for any particular contract at any particular time.
Accordingly, there can be no assurance that it will always be possible to close
a futures position when such closing is desired 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
sold to hedge portfolio securities, such securities will not be sold until the
offsetting futures contracts can be executed. Similarly, in the event futures
have been bought to hedge anticipated securities purchases, such purchases will
not be executed until the offsetting futures contracts can be sold.
Successful use of futures contracts by the fund is also subject to the ability
of the investment advisor to predict correctly movements in the direction of
interest rates and other factors affecting markets for securities. For example,
if the fund has hedged against the possibility of an increase in interest rates
that would adversely affect the price of securities in its portfolio and prices
of such securities increase instead, the fund will lose part or all of the
benefit of the increased value of its securities because it will have offsetting
losses in its futures positions. In addition, in such situations, if the fund
has insufficient cash to meet daily variation margin requirements, it may have
to sell securities to meet such requirements. Such sale of securities may be,
but will not necessarily be, at increased prices that reflect the rising market.
The fund may have to sell securities at a time when it is disadvantageous to do
so. Where futures are purchased to hedge against a possible increase in the
price of securities before the fund is able to invest its cash in an orderly
fashion, it is possible that the market may decline instead; if the fund then
concludes not to invest in securities at that time because of concern as to
possible further market decline or for other reasons, the fund will realize a
loss on the futures contract that is not offset by a reduction in the price of
the securities purchased.
The selling of futures contracts by the fund and use of related transactions in
options on futures contracts (discussed later) are subject to position limits,
which are affected by the activities of the investment advisor.
The hours of trading of futures contracts may not conform to the hours during
which the fund may trade equity securities. To the extent that the futures
markets close before the equity securities markets, significant price and rate
movements can take place in the equity securities markets that cannot be
reflected in the futures markets.
Pursuant to Rule 4.5 under the Commodity Exchange Act, investment companies
registered under the 1940 Act are exempted from the definition of commodity pool
operator in the Commodity Exchange Act, subject to compliance with certain
conditions. The exemption is conditioned upon a requirement that all of the
investment company's commodity futures transactions constitute bona fide hedging
transactions (except on an unleveraged basis, as described in E.). With respect
to long positions assumed by the fund, the fund will segregate with its
custodian, an amount of cash and other assets permitted by Commodity Futures
Trading Commission (CFTC) regulations equal to the market value of the futures
contracts and thereby insure that the use of futures contracts is unleveraged.
The fund will use futures in a manner consistent with these requirements.
A-7
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D. Options on futures contracts. The fund only intends to engage in options on
futures contracts for bona fide hedging purposes in compliance with CFTC
regulations. An option on a futures contract gives the purchaser the right,
but not the obligation, to assume a position in a futures contract (which
position may be a long or short position) at a specified exercise price at
any time during the option exercise period. The writer of the option is
required upon exercise to assume an offsetting futures position (which
position may be a long or short position). Upon exercise of the option, the
assumption of offsetting futures positions by the writer and holder of the
option will be accompanied by delivery of the accumulated balance in the
writer's futures margin account that 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.
The holder or writer of an option may terminate its position by selling or
purchasing an option of the same series. There is no guarantee that such closing
transactions can be effected.
The fund will be required to deposit initial and variation margin with respect
to put and call options on futures contracts written by it pursuant to the
fund's futures commissions merchants' requirements similar to those applicable
to the futures contracts themselves, described previously.
E. Risks of futures transactions. The fund's successful use of futures contracts
and options thereon depends upon the ability of its investment advisor to
predict movements in the stock market and other factors affecting markets for
securities and upon the degree of correlation between the prices of the
futures contracts and the prices of the securities being hedged. As a result,
even a correct forecast of stock price changes may not result in a successful
hedging transaction. Although futures contracts and options thereon may limit
the fund's exposure to loss, they may also limit the fund's potential for
capital gains. For example, if the fund has hedged against the possibility of
decrease in stock prices which would adversely affect the price of securities
in its portfolio and prices of such securities increase instead, the fund
will lose part or all of the benefit of the increased value of its securities
because it will have offsetting losses in its futures positions. Although the
fund will enter into futures contracts only where there appears to be a
liquid market, there can be no assurance that such liquidity will always
exist.
F. The fund also is authorized, subject to the limitations set out in the
Prospectus, to purchase futures contracts on an unleveraged basis, when not
intended as an anticipatory hedge. When a contract is purchased on this basis
the investment company establishes a segregated account, composed of cash
and/or cash equivalents, equal to the total value of the contract (less
margin on deposit). As with other futures trading, these purchases must not
be for speculative purposes.
The ability to engage in these purchases on an unleveraged basis can
significantly decrease transaction costs to the funds in certain instances. For
example, if an inordinately large deposit should occur on a single day, the
sheer volume of securities purchases required for that day may place the fund at
a market disadvantage by requiring it to purchase particular securities in such
volume that its own buying activity could cause prices to increase. In addition,
if this deposit had involved `market-timing' and as a result there subsequently
were an oversized withdrawal, the fund could again suffer market disadvantage,
this time because the volume of sales could, for the same reason, force prices
of particular securities to decrease. The fund, by buying a futures contract
(followed by the appropriate closing transaction) instead of purchasing
securities could achieve considerable savings in transaction costs without
departing from fund objectives. Furthermore, as stated in (B.), price changes in
a futures contract generally parallel price changes in the securities that the
fund might otherwise have purchased. Thus, purchase of a futures contract on an
unleveraged basis allows the fund to comply with its objective while at the same
time achieving these lower transaction costs.
LENDING OF PORTFOLIO SECURITIES
As described in the Prospectus, the funds may from time to time lend securities
from their portfolios to brokers, dealers and financial institutions and receive
collateral from the borrower, in the form of cash (which may be invested in
short-term securities), U.S. Government obligations or certificates of deposit.
Such collateral will be maintained at all times in an amount equal to at least
100% of the current market value of the loaned securities, and will be in the
actual or constructive possession of the particular fund during the term of the
loan. The
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APPENDIX
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fund will maintain the incidents of ownership of the loaned securities and will
continue to be entitled to the interest or dividends payable on the loaned
securities. In addition, the fund will receive interest on the amount of the
loan. The loans will be terminable by the fund at any time and will not be made
to any affiliates of the fund or the advisor. The fund may pay reasonable
finder's fees to persons unaffiliated with it in connection with the arrangement
of the loans.
As with any extensions of credit, there are risks of delay in recovery and, in
some cases, even loss of rights in the collateral or the loaned securities
should the borrower of securities fail financially. However, loans of portfolio
securities will be made to firms deemed by the advisor to be creditworthy.
REPURCHASE AND REVERSE REPURCHASE AGREEMENTS
The funds may make short-term investments in repurchase agreements. A repurchase
agreement typically involves the purchase by the fund of securities (U.S.
Government or other money market securities) from a financial institution such
as a bank, broker or savings and loan association, coupled with an agreement by
the seller to repurchase the same securities from the fund at the specified
price and at a fixed time in the future, usually not more than seven days from
the date of purchase. The difference between the purchase price to the fund and
the resale price to the seller represents the interest earned by the fund which
is unrelated to the coupon rate or maturity of the purchased security. If the
seller defaults, the fund may incur a loss if the value of the collateral
securing the repurchase agreement declines, or the fund may incur disposition
costs in connection with liquidating the collateral. If bankruptcy proceedings
are commenced with respect to the seller, realization upon the collateral by the
fund may be delayed or limited and a loss may be incurred if the collateral
securing the repurchase agreement declines in value during the bankruptcy
proceedings. The Board of Directors of the fund will evaluate the
creditworthiness of all entities, including banks and broker-dealers, with which
they propose to enter into repurchase agreements. These transactions will be
fully collateralized; and the collateral for each transaction will be in the
actual or constructive possession of the particular fund during the terms of the
transaction, as provided in the agreement.
In a reverse repurchase agreement, the fund involved sells a portfolio security
to another party, such as a bank or broker-dealer, in return for cash and agrees
to repurchase the instrument at a particular price and time. While a reverse
repurchase agreement is outstanding, the fund will maintain cash and appropriate
liquid assets in a segregated custodial account to cover its obligation under
the agreement. The fund will enter into reverse repurchase agreements only with
parties that the advisor or sub-advisor deems creditworthy. Reverse repurchase
agreements and considered to be borrowing transactions, and thus are subject to
the fund's limitation on borrowing. Not every fund is authorized to enter into
reverse repurchase agreements.
CUSTODIAN
All securities, cash and other similar assets of the Bond, Growth and Income,
Managed, Money Market, Social Awareness and Special Opportunities Funds are
currently held in custody by Bankers Trust Co., 14 Wall Street, 4th Floor, New
York, New York 10005. Bankers Trust agreed to act as custodian for each fund
pursuant to a Custodian Agreement dated June 17, 1985 (March 10, 1986 for the
Social Awareness Fund).
All securities, cash and other similar assets of the Aggressive Growth, Capital
Appreciation, Equity-Income, Global Asset Allocation and International Funds are
held in custody by State Street Bank and Trust Co., 225 Franklin Street, Boston,
Massachusetts 02110. State Street agreed to act as custodian for these funds
pursuant to Custodian Contracts effective July 21, 1987 for the Global Asset
Allocation Fund, April 29, 1991 for the International Fund, and December 6, 1993
for the other three funds.
Under these Agreements, the respective custodians shall (1) receive and disburse
money; (2) receive and hold securities; (3) transfer, exchange, or deliver
securities; (4) present for payment coupons and other income items, collect
interest and cash dividends received, hold stock dividends, etc.; (5) cause
escrow and deposit receipts to be executed; (6) register securities; and (7)
deliver to the funds proxies, proxy statements, etc.
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APPENDIX
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INDEPENDENT AUDITORS
Each fund's Board of Directors has engaged Ernst & Young LLP, 2300 Fort Wayne
National Bank Building, Fort Wayne, Indiana 46802, to be the independent
auditors for the fund. In addition to the audit of the 1995 financial statements
of the funds, other services provided include review and consultation connected
with filings of annual reports and registration statements with the Securities
and Exchange Commission (SEC); consultation on financial accounting and
reporting matters; and meetings with the Audit Committee.
FINANCIAL STATEMENTS
The financial statements for the funds are incorporated by reference to the
funds' 1995 Annual Report (see Pages 36-49 for all funds; and Pages 10-11,
Aggressive Growth; and Pages 11-13, Bond Fund; Pages 13-14, Capital Appreciation
Fund; Page 14-18, Equity-Income Fund; Pages 18-24, Global Asset Allocation Fund;
Pages 24-25, Growth and Income Fund; Pages 26-27, International Fund; Pages 27-
31, Managed Fund; Pages 31-32, Money Market Fund; Pages 32-33, Social Awareness
Fund; and Pages 33-35, Special Opportunities Fund). We will provide a copy of
the Annual Report on request and without charge. Please write or call Eric
Jones, Lincoln National Life Insurance Co., P.O. Box 2340, Fort Wayne, Indiana
46801; telephone: 1-800-348-1212, Ext. 6536.
BOND RATINGS
MOODY'S INVESTORS SERVICE, INC.
Aaa -- Bonds which are rated Aaa are judged to be of the best quality and carry
the smallest degree of investment risk. Interest payments are protected by a
large or by an exceptionally stable margin, and principal is secure. While the
various protective elements are likely to change, such changes as can be
visualized are most unlikely to impair the fundamentally strong position of such
issues.
Aa -- Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known as
high grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude or there may be other elements present
which make the long-term risks appear somewhat larger than in Aaa securities.
A -- Bonds which are rated A possess many favorable investment attributes and
are to be considered as upper medium grade obligations. Factors giving security
to principal and interest are considered adequate but elements may be present
which suggest a susceptibility to impairment some time in the future.
Baa -- Bonds which are rated Baa are considered as medium grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba -- Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well assured. Often the protection of interest
and principal payments may be very moderate and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
B -- Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
Caa -- Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal or
interest.
Ca -- Bonds which are rated Ca represent obligations which are speculative in a
high degree. Such issues are often in default or have other marked shortcomings.
STANDARD & POOR'S CORP.
AAA -- This is the highest rating assigned by Standard & Poor's Corp. to a debt
obligation and indicates an extremely strong capacity to pay principal and
interest.
AA -- Bonds rated AA also qualify as high-quality debt obligations. Capacity to
pay principal and interest is very strong, and in the majority of instances they
differ from AAA issues only in small degree.
A -- Bonds rated A have a strong capacity to pay principal and interest,
although they are somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions.
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BBB -- Bonds rated BBB are regarded as having an adequate capacity to pay
principal and interest. Whereas these bonds 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 than for
bonds in the A category and higher.
BB-B-CCC-CC -- Bonds rated BB, B, CCC and CC are regarded, on balance, as
predominantly speculative with respect to the issuer's capacity to pay interest
and repay principal in accordance with the terms of the obligation. BB indicates
the lowest degree of speculation and C 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.
COMMERCIAL PAPER RATINGS
MOODY'S INVESTORS SERVICE, INC.
Moody's Commercial Paper ratings are opinions of the ability of issuers to repay
punctually promissory obligations not having an original maturity in excess of
nine months. Moody's employs the following three designations, all judged to be
investment grade, to indicate the relative repayment capacity of rated issuers:
Prime 1 -- Highest Quality;
Prime 2 -- Higher Quality;
Prime 3 -- High Quality.
(The fund will not invest in commercial paper rated Prime 3).
STANDARD & POOR'S CORP.
A Standard & Poor's Corp. commercial paper rating is a current assessment of the
likelihood of timely payment of debt having an original maturity of no more than
365 days. The fund will invest in commercial paper rated in the A Categories, as
follows:
A Issues assigned this highest rating are regarded as having the greatest
capacity for timely payment. Issues in this category are further refined
with the designation 1, 2, and 3 to indicate the relative degree of
safety. (The fund will not invest in commercial paper rated A-3).
A - 1 This designation indicates that the degree of safety regarding timely
payment is very strong.
A - 2 Capacity for timely payment on issues with this designation is strong.
However, the relative degree of safety is not overwhelming as for
issues designated A-1.
U.S. GOVERNMENT OBLIGATIONS
Securities issued or guaranteed as to principal and interest by the U.S.
Government include a variety of Treasury securities, which differ only in their
interest rates, maturities and times of issuance. Treasury bills have a maturity
of one year or less. Treasury notes have maturities of one to seven years and
Treasury bonds generally have a maturity of greater than five years.
Various agencies of the U.S. Government issue obligations. Some of these
securities are supported by the full faith and credit of the U.S. Treasury (for
example those issued by Export-Import Bank of the United States, Farmers Home
Administration, Federal Housing Administration, Government National Mortgage
Association, Maritime Administration, Small Business Administration and The
Tennessee Valley Authority). Obligations of instrumentalities of the U.S.
Government are supported by the right of the issuer to borrow from the Treasury
(for example, those issued by Federal Farm Credit Banks, Federal Home Loan Bank,
Federal Home Loan Mortgage Corp., Federal Intermediate Credit Banks, Federal
Land Bank and the U.S. Postal Service). Obligations supported by the credit of
the instrumentality include securities issued by government sponsored
corporations whose stock is publicly held (for example, the Federal National
Mortgage Association, and the Student Loan Marketing Association).
TAXES
Each fund intends to qualify and has elected to be taxed as a regulated
investment company under certain provisions of the Internal Revenue Code of
1986, as amended (the code). If a fund qualifies as a regulated investment
company and complies with the provisions of the code relieving regulated
investment companies which distribute substantially all of their net income
(both net ordinary income and net capital gain) from Federal income tax, it will
be relieved from such tax on the part of its net ordinary income and net
realized capital gain which it distributes to its shareholders. To qualify for
treatment as a regulated investment company, each fund must, among other things,
derive in each taxable year at least 90% of its gross income from dividends,
interest, payments with respect to securities loans and gains from the sale or
other disposition of stock or securities or foreign currencies (subject to the
authority of the Secretary
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of the Treasury to exclude foreign currency gains which are not directly related
to the fund's principal business of investing in stock or securities or options
and futures with respect to such stock or securities), or other income
(including but not limited to gains from options, futures, or forward contracts)
derived with respect to its investing in such stocks, securities, or currencies.
In addition, to qualify as a regulated investment company each fund must derive
less than 30% of its gross income from the sale or other disposition of
securities held for less than three months. In order to meet these requirements,
a fund may be required to defer disposing of certain futures contracts and
underlying securities beyond the time when it might otherwise be advantageous to
do so. Specifically, these requirements may limit a fund's ability to (a) sell
securities held for less than three months; (b) effect closing transactions on
futures contracts entered into less than three months previously; (c) enter into
futures contracts for a period of less than three months; and (d) enter into
futures contracts on securities held for less than the long-term capital gains
holding period. Further, for purposes of the 30% test, increases (and decreases)
in the value of positions that are part of a designated hedge (as defined in the
code) are netted.
The Federal tax laws impose a 4% nondeductible excise tax on each regulated
investment company with respect to an amount, if any, by which such company does
not meet distribution requirements specified in such tax laws, unless certain
exceptions apply. Each fund intends to comply with such distribution
requirements or qualify under one or more exceptions, and thus does not expect
to incur the 4% nondeductible excise tax.
Since the sole shareholder of each fund will be Lincoln Life, no discussion is
stated herein as to the Federal income tax consequences at the shareholder
level.
The discussion of Federal income tax considerations in the Prospectus, in
conjunction with the foregoing, is a general and abbreviated summary of the
applicable provisions of the code and Treasury Regulations currently in effect
as interpreted by the Courts and the Internal Revenue Service (IRS). These
interpretations can be changed at any time. The above discussion covers only
Federal tax considerations with respect to the fund. State and local taxes vary.
STATE REQUIREMENTS
The California Department of Insurance has established the following guidelines
for an underlying portfolio of a Separate Account. The funds intend to comply
with these guidelines:
BORROWING
The borrowing limits for any variable contract separate account portfolio are
(1) 10% of net asset value when borrowing for any general purpose and (2) 25% of
net asset value when borrowing as a temporary measure to facilitate redemptions.
Net asset value of a portfolio is the market value of all investments or assets
owned less outstanding liabilities of the portfolio at the time that any new or
additional borrowing is undertaken.
FOREIGN INVESTMENTS -- DIVERSIFICATION
The foreign country diversification guidelines to be followed by the funds are
as follows:
1. A portfolio will be invested in a minimum of five different foreign countries
at all times. However, this minimum is reduced to four when foreign country
investments comprise less than 80% of the portfolio's net asset value; to
three when less than 60% of such value; to two when less than 40%; and to one
when less than 20%.
2. Except as set forth in items 3 and 4, a portfolio will have no more than 20%
of its net asset value invested in securities of issuers located in any one
country.
3. A portfolio may have an additional 15% of its value invested in securities of
issuers located in any one of the following countries: Australia, Canada,
France, Japan, the United Kingdom or West Germany.
4. A portfolio's investments in United States issuers are not subject to the
foreign country diversification guidelines.
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DERIVATIVE TRANSACTIONS-DEFINITIONS
The Prospectus for each fund and the uniform Appendix for the Prospectus booklet
discuss the type of derivative transactions in which the funds may engage and
the risks typically associated with many derivative transactions. Here are some
definitions for the derivatives listed in the Appendix:
Option. A contract which gives the fund the right, but not the obligation, to
buy or sell specified securities at a fixed price before or at a designated
future date. If the contract allows the fund to buy securities, it is a call
option; if to sell, it is a put option. It is common practice in options trading
to terminate an outstanding option contract by entering into an offsetting
transaction known as a closing transaction; as a result of which the fund would
either pay out or receive a cash settlement. This is discussed below.
CURRENCY OPTION. Discussed later.
FIXED INCOME OPTION. One based on a fixed-income security, such as a corporate
or government bond.
INDEXED OPTION. One based on the value of an index which measures the
fluctuating value of a basket of pre-selected securities.
STOCK (EQUITY) OPTION. One based on the shares of stock of a particular company.
OPTION ON A FUTURES CONTRACT. Discussed later.
SWAP. A financial transaction in which the fund and another party agree to
exchange streams of payments at periodic intervals under a predetermined set of
occurrences related to the price, level, performance or value of one or more
underlying securities, and pegged to a reference amount known as the notional
amount. A swap is normally used to change the market risk associated with a loan
or bond borrowing from one interest rate base (fixed term or floating rate) or
currency of one denomination to another.
EQUITY SWAP. One which allows the fund to exchange the rate of return (or some
portion of the rate) on its portfolio stocks (an individual share, a basket or
index) for the rate of return on another equity or non-equity investment.
INTEREST RATE SWAP. One in which the fund and another party exchange different
types of interest payment streams, pegged to an underlying notional principal
amount. The three main types of interest rate swaps are coupon swaps (fixed rate
to floating rate in the same currency); basis swaps (one floating rate index to
another floating rate index in the same currency); and cross-currency interest
rate swaps (fixed rate in one currency to floating rate in another).
Related transactions to interest rate swaps:
a. Cap. A contract for which the buyer pays a fee, or premium, to obtain
protection against a rise in a particular interest rate above a certain
level. For example, an interest rate cap may cover a specified principal
amount of a loan over a designated time period, such as a calendar quarter.
If the covered interest rate rises above the rate ceiling, the seller of the
rate cap pays the purchaser an amount of money equal to the average rate
differential times the principal amount times one-quarter.
b. Floor. A contract in which the seller agrees to pay to the purchaser, in
return for the payment of a premium, the difference between current interest
rates and an agreed (strike) rate times the notional amount, should interest
rates fall below the agreed level (the floor). A floor contract has the
effect of a string of interest rate guarantees.
c. Collar. An arrangement to simultaneously purchase a cap and sell a floor, in
order to maintain interest rates within a defined range. The premium income
from the sale of the floor reduces or offsets the cost of buying the cap.
d. Corridor. An agreement to buy a cap at one interest rate and sell a cap at a
higher rate.
SWAPTION. An option to enter into, extend, or cancel a swap.
FUTURES CONTRACT. A contract which commits the fund to buy or sell a specified
amount of a financial instrument at a fixed price on a fixed date in the future.
Futures contracts are normally traded on an exchange and their terms are
standardized, which makes it easier to buy and sell them.
INTEREST RATE FUTURES (AND OPTIONS ON THEM). Futures contracts pegged to U.S.
and foreign fixed-income securities, debt indices and reference rates.
STOCK INDEX FUTURES. Futures contracts based on an index of pre-selected stocks,
with prices based on a composite of the changes to the prices of the individual
securities in the index (e.g., S&P 500).
OPTION ON A FUTURES CONTRACT. An option taken on a futures position.
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FORWARD CONTRACT. An over-the-counter, individually-tailored futures contract.
FORWARD RATE AGREEMENT (FRA). A contract in which the fund and another party
agree on the interest rate to be paid on a notional deposit of specified
maturity at a specific future time. Normally, no exchange of principal is
involved; the difference between the contracted rate and the prevailing rate is
settled in cash.
CURRENCY CONTRACT. A contract entered into for the purpose of reducing or
eliminating an anticipated rise or drop in currency exchange rates over time.
CURRENCY FUTURES. Futures contracts on foreign currencies. Used to hedge the
purchase or sale of foreign securities.
CURRENCY OPTION. An option taken on foreign currency.
CURRENCY SWAP. A swap involving the exchange of cash flows and principal in one
currency for those in another, with an agreement to reverse the principal swap
at a future date.
CROSS-CURRENCY INTEREST RATE SWAP. A swap involving the exchange of streams of
interest rate payments (but not necessarily principal payments) in different
currencies and often on different interest bases (e.g., fixed Deutsche Mark
against floating dollar, but also fixed Deutsche Mark against fixed dollar).
FORWARD CURRENCY CONTRACT. A contract to lock in a currency exchange rate at a
future date, to eliminate risk of currency fluctuation when the time comes to
convert from one currency to another.
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