<PAGE>
KEYSTONE AMERICA STATE TAX FREE FUND - SERIES II
PART A
PROSPECTUS
<PAGE>
KEYSTONE AMERICA STATE
TAX FREE FUND -- SERIES II
Keystone America California Insured
Tax Free Fund
Keystone America Missouri
Tax Free Fund
PROSPECTUS MARCH 31, 1995
Keystone America State Tax Free Fund -- Series II (the "FUND") is a mutual
fund that currently consists of two separate series of shares evidencing
interests in different portfolios of securities ("Funds"): the Keystone America
California Insured Tax Free Fund ("California Insured Fund") and the Keystone
America Missouri Tax Free Fund ("Missouri Tax Free Fund").
Each of the Funds seeks the highest possible current income exempt from
federal income taxes, while preserving capital. In addition, each Fund also
seeks to provide a maximum level of income to its shareholders that is exempt
from the personal income taxes of the shareholders' state of residence.
Each Fund invests principally in municipal obligations exempt from federal
income tax and municipal obligations issued by the state for which it is named
and its political subdivisions, agencies and instrumentalities. The Missouri Tax
Free Fund also seeks to hold securities exempt from Missouri personal property
taxes. At least 80% of the municipal securities in the California Insured Fund's
portfolio will be insured as to timely payment of both principal and interest.
All securities not insured by the issuer will be insured by a qualified
municipal bond insurer. Each Fund's net asset value per share will fluctuate in
response to changes in the market value of its portfolio securities.
KEYSTONE AMERICA STATE
TAX FREE FUND -- SERIES II
200 BERKELEY STREET, BOSTON, MA 02116-5034
CALL TOLL FREE 1-800-343-2898
Each Fund offers three classes of shares. Information on share classes and
their fee and sales charge structures may be found in each Fund's fee table,
"How to Buy Shares," Alternative Sales Options," "Contingent Deferred Sales
Charge and Waiver of Sales Charges," "Distribution Plans," and "FUND Shares."
This prospectus concisely states information about the FUND and its Funds
that you should know before investing. Please read it and retain it for future
reference.
Additional information about the FUND and its Funds is contained in a
statement of additional information dated March 31, 1995, which has been filed
with the Securities and Exchange Commission and is incorporated by reference
into this prospectus. For a free copy, or for other information about the FUND
and its Funds, write to the address or call the telephone number listed below.
SHARES OF THE FUNDS ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR
ENDORSED BY, ANY BANK, AND SHARES ARE NOT FEDERALLY INSURED BY THE FEDERAL
DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD, OR ANY OTHER AGENCY.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
<PAGE>
TABLE OF CONTENTS
Page
Fee Table ................................................................. 3
Financial Highlights ...................................................... 5
The FUND and Its Funds .................................................... 11
Investment Objectives and Policies ........................................ 11
Investment Restrictions ................................................... 14
Risk Factors .............................................................. 15
Pricing Shares ............................................................ 17
Dividends and Taxes ....................................................... 18
FUND Management and Expenses .............................................. 20
How to Buy Shares ......................................................... 22
Alternative Sales Options ................................................. 23
Contingent Deferred Sales Charge and Waiver of Sales Charges .............. 26
Distribution Plans ........................................................ 27
How to Redeem Shares ...................................................... 28
Shareholder Services ...................................................... 30
Performance Data .......................................................... 32
FUND Shares ............................................................... 32
Additional Information .................................................... 33
Additional Investment Information ......................................... (i)
Exhibit A ................................................................. A-1
Exhibit B ................................................................. B-1
<PAGE>
FEE TABLE
Keystone America California Insured Tax Free Fund
The purpose of this fee table is to assist investors in understanding the
costs and expenses that an investor in each class of the California Insured Fund
will bear directly or indirectly. For more complete descriptions of the various
cost and expenses, see the following sections of this prospectus: "FUND
Management and Expenses"; "How to Buy Shares"; "Alternative Sales Options";
"Contingent Deferred Sale Charge and Waiver of Sales Charges"; "Distribution
Plans"; and "Shareholder Services."
<TABLE>
<CAPTION>
CLASS A SHARES CLASS B SHARES CLASS C SHARES
FRONT END BACK END LEVEL LOAD
SHAREHOLDER TRANSACTION EXPENSES LOAD OPTION LOAD OPTION<F1> OPTION<F2>
-------------- -------------- --------------
<S> <C> <C> <C>
Sales Charge ........................ 4.75%<F3> None None
(as a percentage of offering price)
Contingent Deferred Sales Charge .... 0.00%<F4> 3.00% in the first 1.00% in the first
(as a percentage of the year declining year and 0.00%
lesser of cost or market to 1.00% in the thereafter
value of shares redeemed) fourth year and
0.00% thereafter
Exchange Fee (per exchange)<F5> ..... $10.00 $10.00 $10.00
ANNUAL FUND OPERATING EXPENSES<F6>
("After Expense Reimbursements")
(as a percentage of average net assets)
Management Fees ..................... 0.55% 0.55% 0.55%
12b-1 Fees .......................... 0.13% 0.88%<F7> 0.88 %<F7>
Other Expenses ...................... 0.00% 0.00% 0.00%
---- ---- ----
Total Fund Operating Expenses ....... 0.68% 1.43% 1.43%
==== ==== ====
<CAPTION>
EXAMPLES<F8> 1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
You would pay the following expenses on a $1,000
investment, assuming <F1> 5% annual return and <F2>
redemption at the end of each period:
Class A .......................................... $54 $68 $84 $128
Class B .......................................... $45 $65 $78 N/A
Class C .......................................... $25 $45 $78 $171
You would pay the following expenses on a $1,000
investment, assuming no redemption at the end of
each period:
Class A .......................................... $54 $68 $84 $128
Class B .......................................... $15 $45 $78 N/A
Class C .......................................... $15 $45 $78 $171
AMOUNTS SHOWN IN THE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST
OR FUTURE EXPENSES. ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN.
<FN>
- ---------
<F1> Class B Shares convert tax free to Class A shares after seven calendar
years.
<F2> Class C shares are available only through dealers who have entered into
special distribution agreements with Keystone Distributors, Inc. the Funds'
principal underwriter.
<F3> The sales charge applied to purchases of Class A shares declines as the
amount invested increases. See "Alternative Sales Options."
<F4> Purchases of Class A shares in the amount of $1,000,000 or more are not
subject to a sales charge, but may be subject to a contingent deferred
sales charge of 0.25%. See "Contingent Deferred Sales Charge and Waiver of
Sales Charges" for an explanation of the charge.
<F5> There is no fee for exchange orders received by the Funds directly from an
individual shareholder over the Keystone Automated Response Line ("KARL").
(For a description of KARL, see "Shareholder Services.")
<F6> Expense ratios are estimated for the fiscal year ending November 30, 1995
after giving effect to the reimbursement by Keystone Custodian Funds, Inc.
("Keystone") of expenses in accordance with certain voluntary expense
limitations. Currently, Keystone has voluntarily limited expenses of Class
A shares to 0.65% of average daily net assets of such class until May 15,
1995. Thereafter, Keystone has voluntarily limited Class A expenses to
0.75% until December 31, 1995. Similarly, Keystone currently has
voluntarily limited expenses of Class B and C shares to 1.40% of average
daily net assets of each such class until May 15, 1995. Thereafter,
Keystone has voluntarily limited expenses of each such class to 1.50% until
December 31, 1995. Keystone is under no obligation to maintain these
limits. Absent these voluntary expense limitations, expense ratios for the
California Insured Fund's fiscal year ending November 30, 1995 for Class A,
B and C shares are projected to be approximately 1.54%, 2.29% and 2.29%,
respectively.
<F7> The Class B and Class C Distribution Plans provide for payments at an
annual rate of up to 1.00% of the average daily net asset value of Class B
and Class C shares; however, such payments are currently limited to 0.90%.
Long term shareholders may pay more than the economic equivalent of the
maximum front end sales charges permitted by rules adopted by the National
Association of Securities Dealers, Inc.
<F8> The Securities and Exchange Commission requires use of a 5% annual return
figure for purposes of this example. Actual returns for the Funds may be
greater or less than 5%.
</TABLE>
<PAGE>
FEE TABLE
Keystone America Missouri Tax Free Fund
The purpose of this fee table is to assist investors in understanding the
costs and expenses that an investor in each class of the Missouri Tax Free Fund
will bear directly or indirectly. For more complete descriptions of the various
cost and expenses, see the following sections of this prospectus: "FUND
Management and Expenses"; "How to Buy Shares"; "Alternative Sales Options";
"Contingent Deferred Sale Charge and Waiver of Sales Charges"; "Distribution
Plans"; and "Shareholder Services."
<TABLE>
<CAPTION>
CLASS A SHARES CLASS B SHARES CLASS C SHARES
FRONT END BACK END LEVEL LOAD
SHAREHOLDER TRANSACTION EXPENSES LOAD OPTION LOAD OPTION<F1> OPTION<F2>
-------------- -------------- --------------
<S> <C> <C> <C>
Sales Charge .................................. 4.75%(3) None None
(as a percentage of offering price)
Contingent Deferred Sales Charge ............. 0.00%<F4> 3.00% in the first 1.00% in the first
(as a percentage of the lesser of cost year declining to 1.00% year and 0.00% thereafter
or market value of shares redeemed) in the fourth year
and 0.00% thereafter
Exchange Fee (per exchange)<F5> ............... $10.00 $10.00 $10.00
ANNUAL FUND OPERATING EXPENSES<F6>
("After Expense Reimbursements")
(as a percentage of average net assets)
Management Fees ............................... 0.55% 0.55% 0.55%
12b-1 Fees .................................... 0.13% 0.88%<F7> 0.88%<F7>
Other Expenses ................................ 0.00% 0.00% 0.00%
---- ---- ----
Total Fund Operating Expenses ................. 0.68% 1.43% 1.43%
==== ==== ====
<CAPTION>
EXAMPLES<F8> 1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
You would pay the following expenses on a
$1,000 investment, assuming (1) 5% annual
return and (2) redemption at the end of
each period:
Class A .................................. $54 $68 $84 $128
Class B .................................. $45 $65 $78 N/A
Class C .................................. $25 $45 $78 $171
You would pay the following expenses on a
$1,000 investment, assuming no redemption
at the end of each period:
Class A .................................. $54 $68 $84 $128
Class B .................................. $15 $45 $78 N/A
Class C .................................. $15 $45 $78 $171
AMOUNTS SHOWN IN THE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE EXPENSES. ACTUAL EXPENSES MAY BE GREATER
OR LESS THAN THOSE SHOWN.
<FN>
- ------------
<F1> Class B Shares convert tax free to Class A shares after seven calendar years.
<F2> Class C shares are available only through dealers who have entered into special distribution agreements with Keystone
Distributors, Inc., the Funds' principal underwriter.
<F3> The sales charge applied to purchases of Class A shares declines as the amount invested increases. See "Alternative Sales
Options."
<F4> Purchases of Class A shares in the amount of $1,000,000 or more are not subject to a sales charge, but may be subject to a
contingent deferred sales charge of 0.25%. See "Contingent Deferred Sales Charge and Waiver of Sales Charges" for an
explanation of the charge.
<F5> There is no fee for exchange orders received by the Funds directly from an individual shareholder over the Keystone Automated
Response Line ("KARL"). (For a description of KARL, see "Shareholder Services.")
<F6> Expense ratios are estimated for the fiscal year ending November 30, 1995 after giving effect to the reimbursement by
Keystone Custodian Funds, Inc. ("Keystone") of expenses in accordance with certain voluntary expense limitations. Currently,
Keystone has voluntarily limited expenses of Class A shares to 0.65% of average daily net assets of such class until May 15,
1995. Thereafter, Keystone has voluntarily limited Class A expenses to 0.75% until December 31, 1995. Similarly, Keystone
currently has voluntarily limited expenses of Class B and C shares to 1.40% of average daily net assets of each such class
until May 15, 1995. Thereafter, Keystone has voluntarily limited expenses of each such class to 1.50% until December 31,
1995. Keystone is under no obligation to maintain these limits. Absent these voluntary expense limitations, expense ratios
for the Missouri Tax Free Fund's fiscal year ending November 30, 1995 for Class A, B and C shares are projected to be
approximately 1.54%, 2.29% and 2.29%, respectively.
<F7> The Class B and Class C Distribution Plans provide for payments at an annual rate of up to 1.00% of the average daily net
asset value of Class B and Class C shares; however, such payments are currently limited to 0.90%. Long term shareholders may
pay more than the economic equivalent of the maximum front end sales charges permitted by rules adopted by the National
Association of Securities Dealers, Inc.
<F8> The Securities and Exchange Commission requires use of a 5% annual return figure for purposes of this example. Actual returns
for the Funds may be greater or less than 5%.
</TABLE>
<PAGE>
FINANCIAL HIGHLIGHTS
KEYSTONE AMERICA CALIFORNIA INSURED TAX FREE FUND
CLASS A SHARES
(For a share outstanding throughout the period)
The following table contains important financial information with respect to
the California Insured Tax Free Fund and has been audited by KPMG Peat Marwick
LLP, the FUND's independent auditors. The table appears in the FUND's Annual
Report and should be read in conjunction with the FUND's financial statements
and related notes, which also appear, together with the independent auditors'
report, in the FUND's Annual Report. The FUND's financial statements, related
notes, and independent auditors' report are included in the statement of
additional information. Additional information about the FUND's performance is
contained in its Annual Report, which will be made available upon request and
without charge.
FEBRUARY 1, 1994
(COMMENCEMENT OF
OPERATIONS) TO
NOVEMBER 30, 1994
-----------------
NET ASSET VALUE, BEGINNING OF PERIOD ............................ $10.000
-------
Income from investment operations
Investment income -- net ........................................ 0.439
Realized gains (losses) on investments -- net ................... (1.302)
-------
Total from investment operations ................................ (0.863)
-------
Less distributions
Dividends from investment income -- net ......................... (0.437)
-------
Total distributions ............................................. (0.437)
-------
NET ASSET VALUE, END OF PERIOD .................................. $ 8.700
=======
TOTAL RETURN .................................................... (8.78%)(b)
RATIOS/SUPPLEMENTAL DATA
Ratios to average net assets:
Operating and management expenses (a) ......................... 0.41%(c)
Investment income -- net ...................................... 5.53%(c)
Portfolio turnover rate ....................................... 104%
Net assets, end of period (thousands) ........................... $ 3,006
(a) Figures are net of the expense reimbursement by Keystone in connection with
the voluntary expense limitation in place during the fiscal period ended
November 30, 1994. Before expense reimbursement, the "Ratio of operating and
management expenses to average net assets" would have been 1.66%
(annualized) for the period February 1, 1994 (Commencement of Operations) to
November 30, 1994.
(b) Total return is calculated from February 1, 1994 (Commencement of
Operations) to November 30, 1994.
(c) Annualized.
<PAGE>
FINANCIAL HIGHLIGHTS
KEYSTONE AMERICA CALIFORNIA INSURED TAX FREE FUND
CLASS B SHARES
(For a share outstanding throughout the period)
The following table contains important financial information with respect to
the California Insured Tax Free Fund and has been audited by KPMG Peat Marwick
LLP, the FUND's independent auditors. The table appears in the FUND's Annual
Report and should be read in conjunction with the FUND's financial statements
and related notes, which also appear, together with the independent auditors'
report, in the FUND's Annual Report. The FUND's financial statements, related
notes, and independent auditors' report are included in the statement of
additional information. Additional information about the FUND's performance is
contained in its Annual Report, which will be made available upon request and
without charge.
FEBRUARY 1, 1994
(COMMENCEMENT OF
OPERATIONS) TO
NOVEMBER 30, 1994
-----------------
NET ASSET VALUE, BEGINNING OF PERIOD ............................. $10.000
-------
Income from investment operations
Investment income -- net ......................................... 0.401
Realized gains (losses) on investments -- net .................... (1.284)
-------
Total from investment operations ................................. (0.883)
-------
Less distributions
Dividends from investment income -- net .......................... (0.401)
Distributions in excess of investment income -- net .............. (0.036)
-------
Total distributions .............................................. (0.437)
-------
NET ASSET VALUE, END OF PERIOD ................................... $ 8.680
=======
TOTAL RETURN (a) ................................................. (9.00%)(c)
RATIOS/SUPPLEMENTAL DATA
Ratios to average net assets:
Operating and management expenses (b) .......................... 1.16%(d)
Investment income -- net ....................................... 4.83%(d)
Portfolio turnover rate ........................................ 104%
Net assets end of period (thousands) ............................. $11,415
(a) Without contingent deferred sales charge (CDSC).
(b) Figures are net of the expense reimbursement by Keystone in connection with
the voluntary expense limitation in place during the fiscal period ended
November 30, 1994. Before expense reimbursement, the "Ratio of operating and
management expenses to average net assets" would have been 2.36%
(annualized) for the period February 1, 1994 (Commencement of Operations) to
November 30, 1994.
(c) Total return is calculated from February 1, 1994 (Commencement of
Operations) to November 30, 1994.
(d) Annualized.
<PAGE>
FINANCIAL HIGHLIGHTS
KEYSTONE AMERICA CALIFORNIA INSURED TAX FREE FUND
CLASS C SHARES
(For a share outstanding throughout the period)
The following table contains important financial information with respect to
the California Insured Tax Free Fund and has been audited by KPMG Peat Marwick
LLP, the FUND's independent auditors. The table appears in the FUND's Annual
Report and should be read in conjunction with the FUND's financial statements
and related notes, which also appear, together with the independent auditors'
report, in the FUND's Annual Report. The FUND's financial statements, related
notes, and independent auditors' report are included in the statement of
additional information. Additional information about the FUND's performance is
contained in its Annual Report, which will be made available upon request and
without charge.
FEBRUARY 1, 1994
(COMMENCEMENT OF
OPERATIONS) TO
NOVEMBER 30, 1994
-----------------
NET ASSET VALUE, BEGINNING OF PERIOD ............................. $10.000
-------
Income from investment operations
Investment income -- net ......................................... 0.392
Realized gains (losses) on investments -- net .................... (1.292)
-------
Total from investment operations ................................. (0.900)
-------
Less distributions
Dividends from investment income -- net .......................... (0.392)
Distributions in excess of investment income -- net .............. (0.028)
-------
Total distributions .............................................. (0.420)
-------
NET ASSET VALUE, END OF PERIOD ................................... $ 8.680
=======
TOTAL RETURN (a) ................................................. (9.08%)(c)
RATIOS/SUPPLEMENTAL DATA
Ratios to average net assets:
Operating and management expenses (b) .......................... 1.16%(d)
Investment income -- net ....................................... 4.96%(d)
Portfolio turnover rate ........................................ 104%
Net assets end of period (thousands) ............................. $ 624
(a) Without contingent deferred sales charge (CDSC).
(b) Figures are net of the expense reimbursement by Keystone in connection with
the voluntary expense limitation in place during the fiscal period ended
November 30, 1994. Before expense reimbursement, the "Ratio of operating and
management expenses to average net assets" would have been 2.38%
(annualized) for the period February 1, 1994 (Commencement of Operations) to
November 30, 1994.
(c) Total return is calculated from February 1, 1994 (Commencement of
Operations) to November 30, 1994.
(d) Annualized.
<PAGE>
FINANCIAL HIGHLIGHTS
KEYSTONE AMERICA MISSOURI TAX FREE FUND
CLASS A SHARES
(For a share outstanding throughout the period)
The following table contains important financial information with respect to
the Missouri Tax Free Fund and has been audited by KPMG Peat Marwick LLP, the
FUND's independent auditors. The table appears in the FUND's Annual Report and
should be read in conjunction with the FUND's financial statements and related
notes, which also appear, together with the independent auditors' report, in the
FUND's Annual Report. The FUND's financial statements, related notes, and
independent auditors' report are included in the statement of additional
information. Additional information about the FUND's performance is contained in
its Annual Report, which will be made available upon request and without charge.
FEBRUARY 1, 1994
(COMMENCEMENT OF
OPERATIONS) TO
NOVEMBER 30, 1994
-----------------
NET ASSET VALUE, BEGINNING OF PERIOD ........................... $10.000
-------
Income from investment operations
Investment income -- net ....................................... 0.443
Realized gains (losses) on investments -- net .................. (1.279)
-------
Total from investment operations ............................... (0.836)
-------
Less distributions
Dividends from investment income -- net ........................ (0.443)
Distributions in excess of investment income -- net ............ (0.001)
-------
Total distributions ............................................ (0.444)
-------
NET ASSET VALUE, END OF PERIOD ................................. $ 8.720
=======
TOTAL RETURN ................................................... (8.55%)(b)
RATIOS/SUPPLEMENTAL DATA
Ratios to average net assets:
Operating and management expenses (a) ........................ 0.43%(c)
Investment income -- net ..................................... 5.38%(c)
Portfolio turnover rate ...................................... 25%
Net assets, end of period (thousands) .......................... $ 3,581
(a) Figures are net of the expense reimbursement by Keystone in connection with
the voluntary expense limitation in place during the fiscal period ended
November 30, 1994. Before expense reimbursement, the "Ratio of operating and
management expenses to average net assets" would have been 1.54%
(annualized) for the period February 1, 1994 (Commencement of Operations) to
November 30, 1994.
(b) Total return is calculated from February 1, 1994 (Commencement of
Operations) to November 30, 1994.
(c) Annualized.
<PAGE>
FINANCIAL HIGHLIGHTS
KEYSTONE AMERICA MISSOURI TAX FREE FUND
CLASS B SHARES
(For a share outstanding throughout the period)
The following table contains important financial information with respect to
the Missouri Tax Free Fund and has been audited by KPMG Peat Marwick LLP, the
FUND's independent auditors. The table appears in the FUND's Annual Report and
should be read in conjunction with the FUND's financial statements and related
notes, which also appear, together with the independent auditors' report, in the
FUND's Annual Report. The FUND's financial statements, related notes, and
independent auditors' report are included in the statement of additional
information. Additional information about the FUND's performance is contained in
its Annual Report, which will be made available upon request and without charge.
FEBRUARY 1, 1994
(COMMENCEMENT OF
OPERATIONS) TO
NOVEMBER 30, 1994
-----------------
NET ASSET VALUE, BEGINNING OF PERIOD ........................... $10.000
-------
Income from investment operations
Investment income -- net ....................................... 0.404
Realized gains (losses) on investments -- net .................. (1.290)
-------
Total from investment operations ............................... (0.886)
-------
Less distributions
Dividends from investment income -- net ........................ (0.404)
Distributions in excess of investment income -- net ............ (0.040)
-------
Total distributions ............................................ (0.444)
-------
NET ASSET VALUE, END OF PERIOD ................................. $ 8.670
=======
TOTAL RETURN (a) ............................................... (9.06%)(c)
RATIOS/SUPPLEMENTAL DATA
Ratios to average net assets:
Operating and management expenses (b) ........................ 1.16%(d)
Investment income -- net ..................................... 4.70%(d)
Portfolio turnover rate ...................................... 25%
Net assets, end of period (thousands) .......................... $12,906
(a) Without contingent deferred sales charge (CDSC).
(b) Figures are net of the expense reimbursement by Keystone in connection with
the voluntary expense limitation in place during the fiscal period ended
November 30, 1994. Before expense reimbursement, the "Ratio of operating and
management expenses to average net assets" would have been 2.49%
(annualized) for the period February 1, 1994 (Commencement of Operations) to
November 30, 1994.
(c) Total return is calculated from February 1, 1994 (Commencement of
Operations) to November 30, 1994.
(d) Annualized.
<PAGE>
FINANCIAL HIGHLIGHTS
KEYSTONE AMERICA MISSOURI TAX FREE FUND
CLASS C SHARES
(For a share outstanding throughout the period)
The following table contains important financial information with respect to
the Missouri Tax Free Fund and has been audited by KPMG Peat Marwick LLP, the
FUND's independent auditors. The table appears in the FUND's Annual Report and
should be read in conjunction with the FUND's financial statements and related
notes, which also appear, together with the independent auditors' report, in the
FUND's Annual Report. The FUND's financial statements, related notes, and
independent auditors' report are included in the statement of additional
information. Additional information about the FUND's performance is contained in
its Annual Report, which will be made available upon request and without charge.
FEBRUARY 1, 1994
(COMMENCEMENT OF
OPERATIONS) TO
NOVEMBER 30, 1994
-----------------
NET ASSET VALUE, BEGINNING OF PERIOD ........................... $10.000
-------
Income from investment operations
Investment income -- net ....................................... 0.388
Realized gains (losses) on investments -- net .................. (1.294)
-------
Total from investment operations ............................... (0.906)
-------
Less distributions
Dividends from investment income -- net ........................ (0.388)
Distributions in excess of investment income -- net ............ (0.046)
-------
Total distributions ............................................ (0.434)
-------
NET ASSET VALUE, END OF PERIOD ................................. $ 8.660
=======
TOTAL RETURN (a) ............................................... (9.25%)(c)
RATIOS/SUPPLEMENTAL DATA
Ratios to average net assets:
Operating and management expenses (b) ........................ 1.15%(d)
Investment income -- net ..................................... 4.72%(d)
Portfolio turnover rate ...................................... 25%
Net assets, end of period (thousands) .......................... $ 1,045
(a) Without contingent deferred sales charge (CDSC).
(b) Figures are net of the expense reimbursement by Keystone in connection with
the voluntary expense limitation in place during the fiscal period ended
November 30, 1994. Before expense reimbursement, the "Ratio of operating and
management expenses to average net assets" would have been 2.60%
(annualized) for the period February 1, 1994 (Commencement of Operations) to
November 30, 1994.
(c) Total return is calculated from February 1, 1994 (Commencement of
Operations) to November 30, 1994.
(d) Annualized.
<PAGE>
THE FUND AND ITS FUNDS
The FUND is a non-diversified, open-end management investment company
commonly known as a mutual fund. The FUND was formed as a Massachusetts business
trust on December 15, 1993. The FUND is one of twenty-nine funds managed or
advised by Keystone Custodian Funds, Inc. ("Keystone"), the FUND's investment
adviser. The FUND currently consists of two separate series evidencing interests
in different portfolios of securities: the California Insured Fund and Missouri
Tax Free Fund. The FUND may offer additional funds in the future.
INVESTMENT OBJECTIVES AND POLICIES
INVESTMENT OBJECTIVES
Each of the Funds seeks the highest possible current income exempt from
federal income taxes, while preserving capital.
FUNDS' PRINCIPAL INVESTMENTS
Generally, under ordinary circumstances, each Fund invests substantially all
and at least 80% of its assets in federally tax-exempt obligations, including
municipal bonds and notes and municipal tax-exempt commercial paper obligations,
which are obligations issued by or on behalf of states, territories and
possessions of the United States ("U.S."), the District of Columbia and their
political subdivisions, agencies and instrumentalities, the interest from which
is exempt from federal income taxes, including the alternative minimum tax. Thus
it is possible that up to 20% of a Fund's assets could be in securities subject
to the alternative minimum tax and/or in taxable obligations.
Municipal bonds include fixed, variable or floating rate general obligation
and revenue bonds (including municipal lease obligations, resource recovery
bonds and zero coupon bonds). Municipal notes include tax anticipation notes,
bond anticipation notes, revenue anticipation notes and project notes. Municipal
commercial paper obligations are unsecured promisory notes issued by
municipalities to meet short-term credit needs.
CALIFORNIA INSURED TAX FREE FUND
Under ordinary circumstances, the California Insured Fund invests at least 80%
of its assets in securities, the interest from which is exempt from federal
taxes and California state income taxes. The California Insured Fund invests in
debt obligations of the State of California and its political subdivisions,
agencies, authorities and instrumentalities and debt obligations of other
qualifying issuers, such as U.S. territories.
The California Insured Fund invests only in investment grade municipal
obligations -- bonds rated at the date of investment within the four highest
grades by Standard & Poor's Corporation ("S&P") (AAA, AA, A and BBB), by Moody's
Investors Service, Inc. ("Moody's") (Aaa, Aa, A and Baa), by Fitch Investors
Service, Inc. -- Municipal Division ("Fitch") (AAA, AA, A and BBB) or, if not
rated or rated under a different system, are of comparable quality to
obligations so rated as determined by Keystone. Securities that are in the
lowest investment grade (BBB or Baa) may have speculative characteristics.
As more fully discussed below in the section entitled "Insurance," at least
80% of the municipal securities in the investment portfolio of the California
Insured Fund will be insured as to timely payment of both principal and
interest. The purpose of insuring these investments is to minimize credit risks
associated with defaults in municipal securities owned by the Fund. Such
insurance, however, does not insure against market risk and therefore will not
guarantee the market value of the securities in the Fund's portfolio upon which
the net asset value of the Fund's shares is based.
For a further discussion of California tax treatment and the factors affecting
investment in California municipal obligations, see Exhibit A.
MISSOURI TAX FREE FUND
Under ordinary circumstances, the Missouri Tax Free Fund invests at least 80%
of its assets in securities, the interest from which is exempt from federal
taxes and Missouri state income taxes, as well as being exempt from Missouri
personal property taxes. The Missouri Tax Free Fund invests in debt obligations
of the State of Missouri and its political subdivisions, agencies, authorities
and instrumentalities and debt obligations of other qualifying issuers, such as
U.S. territories.
The Missouri Tax Free Fund invests at least 80% of its assets in investment
grade municipal obligations -- bonds rated at the date of investment within the
four highest grades by S&P (AAA, AA, A and BBB), by Moody's (Aaa, Aa, A and
Baa), by Fitch (AAA, AA, A and BBB) or, if not rated or rated under a different
system, are of comparable quality to obligations so rated as determined by
Keystone. The Fund may seek to maximize return with respect to a portion (not to
exceed 20%) of its assets. Such maximum return is ordinarily associated with
high yield, high risk municipal bonds in the lower rating categories of the
recognized rating agencies or that are unrated ("high yield bonds"). Such high
yield, high risk bonds generally involve greater volatility of price and risk of
principal and income than bonds in the higher rating categories and are, on
balance, considered predominantly speculative. High yield bonds are also
commonly known as "junk bonds."
For a further discussion of Missouri tax treatment and the factors affecting
investment in Missouri municipal obligations, see Exhibit A.
MUNICIPAL OBLIGATIONS
Municipal obligations include debt obligations issued by or on behalf of a
political subdivision of the U.S. or any agency or instrumentality thereof to
obtain funds for various public purposes. In addition, municipal obligations
include certain types of industrial development bonds that have been or may be
issued by or on behalf of public authorities to finance privately operated
facilities. General obligation bonds involve the credit of an issuer possessing
taxing power and are payable from the issuer's general unrestricted revenues.
Their payment may be dependent upon an appropriation by the issuer's legislative
body and may be subject to quantitative limitations on the issuer's taxing
power. Limited obligation or revenue bonds are payable only from the revenues of
a particular facility or class of facilities or, in some cases, from the
proceeds of a special excise or other specific revenue source, such as the user
of the facility. Since each Fund considers preservation of capital as well as
the level of tax-exempt income, each Fund may realize less income than a mutual
fund willing to expose shareholders' capital to greater risk.
The Tax Reform Act of 1986 made significant changes in the federal tax status
of certain obligations that were previously fully federally tax-exempt. As a
result, three categories of such obligations issued after August 7, 1986 now
exist: (1) "public purpose" bonds, the income from which remains fully exempt
from federal income tax; (2) qualified "private activity" industrial development
bonds, the income from which, while exempt from federal income tax under Section
103 of the Internal Revenue Code (the "Code"), is includable in the calculation
of the federal alternative minimum tax; and (3) "private activity" (private
purpose) bonds, the income from which is not exempt from federal income tax. A
Fund will not invest in private purpose bonds and, except as described under
"Other Eligible Investments," will not invest in qualified "private activity"
industrial development bonds whose distributions are subject to the alternative
minimum tax.
While a Fund may invest in securities of any maturity, it is currently
expected that a Fund will not invest in securities (other than certain money
market securities) with maturities of more than 30 years or less than 5 years.
OTHER ELIGIBLE INVESTMENTS
A Fund may invest up to 20% of its assets under ordinary circumstances and up
to 100% of its assets for temporary defensive purposes in the following types of
instruments: (1) commercial paper, including master demand notes, that at the
date of investment is rated A-1 (the highest grade by S&P), PRIME- 1 (the
highest grade by Moody's) or, if not rated by such services, is issued by a
company that at the date of investment has an outstanding issue rated A or
better by S&P or Moody's; (2) obligations, including certificates of deposit and
bankers' acceptances, of banks or savings and loan associations that have at
least $1 billion in assets as of the date of their most recently published
financial statements and are members of the Federal Deposit Insurance
Corporation, including U.S. branches of foreign banks and foreign branches of
U.S. banks; (3) corporate obligations (maturing in 13 months or less) that at
the date of investment are rated A or better by S&P or Moody's; (4) obligations
issued or guaranteed by the U.S. government or by any agency or instrumentality
of the U.S.; (5) qualified "private activity" industrial development bonds, the
income from which, while exempt from federal income tax under Section 103 of the
Code, is includable in the calculation of the federal alternative minimum tax;
and (6) municipal obligations, the income from which is exempt from federal
income tax, but not exempt from income tax in California or income or personal
property tax in Missouri. Each Fund may assume a temporary defensive position
upon Keystone's determination that market conditions so warrant. If a Fund is
investing defensively, it is not pursuing its investment objectives.
Each Fund may enter into repurchase and reverse repurchase agreements,
purchase and sell securities on a when issued and delayed delivery basis, write
covered call and put options and purchase call and put options, including
purchasing call and put options to close out existing positions, and may employ
new investment techniques with respect to such options. Each Fund may also
engage in financial futures contracts and related options transactions for
hedging purposes and not for speculation and may employ new investment
techniques with respect to such futures contracts and related options. In
addition, each Fund may invest in municipal obligations denominated in foreign
currencies and may use subsequently developed investment techniques that are
related to any of its investment policies. Neither Fund is expected to enter
into repurchase agreements in the ordinary course of its business.
In addition to the options and futures mentioned above, if consistent with its
investment objectives, the FUND may also invest in certain other types of
"derivative instruments," including structured securities.
For further information about the types of investments and investment
techniques available to the Funds, including the associated risks, see
"Additional Investment Information" located at the back of this prospectus and
the statement of additional information.
There can be no assurance that a Fund will achieve its investment objectives
since there is uncertainty in every investment.
INSURANCE
At least 80% of the municipal securities in the portfolio of the California
Insured Fund will consist of obligations that at all times are fully insured as
to the payment of all principal and interest when due ("Insured Securities").
Each Insured Security in the portfolio will be covered by either a "New Issue
Insurance Policy," a "Portfolio Insurance Policy" issued by a qualified
municipal bond insurer, or a "Secondary Insurance Policy." The insurance does
not insure against market risk and therefore does not guarantee the market value
of the securities in the California Insured Fund's portfolio. Similarly, because
the net asset value of the California Insured Fund's shares is based upon the
market value of the securities in the portfolio, such insurance does not cover
or guarantee the value of the California Insured Fund's shares.
NEW ISSUE INSURANCE POLICIES
New Issue Insurance Policies are obtained by the respective issuers of the
municipal securities and all premiums respecting such securities have been paid
in advance by such issuers. Such policies are noncancellable and will continue
in force so long as the municipal securities are outstanding and the respective
insurers remain in business. Since New Issue Insurance Policies remain in effect
as long as the securities are outstanding, the insurance may have an effect on
the resale value of the Insured Securities. Therefore, New Issue Insurance
Policies may be considered to represent an element of market value with regard
to the Insured Securities, but the exact effect, if any, of this insurance on
such market value cannot be estimated. The California Insured Fund will purchase
municipal securities subject to New Issue Insurance Policies only if the claims
paying ability of the insurer thereof is rated AAA by S&P or Aaa by Moody's.
PORTFOLIO INSURANCE POLICIES
Portfolio Insurance Policies are obtained by the California Insured Fund from
a qualified municipal bond insurer and are effective only so long as the Fund is
in existence, the insurer is still in business and meeting its obligations, and
the Insured Securities described in the policy are held by the California
Insured Fund. Premium rates for each issue of securities covered by the policy
are fixed for the life of the California Insured Fund and are periodically
adjusted to reflect purchases and sales of covered securities. The premium on
the Portfolio Insurance Policy is an item of expense and will be reflected in
the California Insured Fund's average annual expenses. Premiums are paid from
the California Insured Fund's assets and reduce the current yield on its
portfolio by the amount thereof. The insurer cannot cancel coverage already in
force with respect to Insured Securities owned by the California Insured Fund
and covered by the policy, except for nonpayment of premiums.
SECONDARY INSURANCE POLICIES
The California Insured Fund may at any time purchase Secondary Insurance on
any municipal security held by the Fund. Such insurance coverage will be
noncancellable and will ordinarily continue in force so long as the securities
so insured are outstanding. Secondary Insurance will likely be purchased by the
California Insured Fund if, in the opinion of Keystone, the market value or net
proceeds of the sale of a security by the Fund would exceed the current value of
such security (without insurance) plus the cost of such insurance. When the
California Insured Fund purchases Secondary Insurance, the single premium is
added to the cost basis of the security and is not considered an item of expense
of the Fund. One of the purposes of such insurance is to enable the securities
covered by such insurance to be sold as "AAA" or "Aaa" rated Insured Securities
at a market price higher than that which might otherwise be obtainable if the
securities were sold without the insurance coverage. Therefore, such insurance
may be considered to represent an element of market value of such Insured
Securities, although the exact effect, if any, on such market value cannot be
estimated. Any difference between the excess of such a security's market value
as an Aaa or AAA rated security over its market value without such rating,
including the single premium cost thereof, would inure to the California Insured
Fund in determining the net capital gain or loss realized by the Fund upon the
sale of such Insured Security.
FUNDAMENTAL NATURE OF INVESTMENT OBJECTIVES
The investment objectives of each Fund and the requirement that each Fund
invest, under ordinary circumstances, at least 80% of its assets in federally
tax-exempt municipal obligations that are also exempt from certain taxes in the
state for which it is named, as set forth above, are fundamental and may not be
changed without the vote of a majority, as defined in the Investment Company Act
of 1940 ("1940 Act"), of the affected Fund's outstanding shares (which means the
lesser of (1) 67% of the shares represented at a meeting at which more than 50%
of the outstanding shares are represented or (2) more than 50% of the
outstanding shares).
INVESTMENT RESTRICTIONS
Each Fund has adopted the fundamental restrictions summarized below, which may
not be changed without the vote of a majority of such Fund's outstanding shares.
These restrictions and certain other fundamental and non-fundamental
restrictions are contained in the statement of additional information. Unless
otherwise stated, all references to a Fund's assets are in terms of current
market value.
Generally, each Fund may not do the following:
(1) purchase any security of any issuer (other than issues of the U.S.
government, its agencies or instrumentalities) if as a result more than 25% of
its total assets would be invested in a single industry, including industrial
development bonds from the same facility or similar types of facilities;
governmental issuers of municipal bonds are not regarded as members of an
industry, and each Fund may invest more than 25% of its assets in industrial
development bonds; and
(2) borrow money or enter into reverse repurchase agreements, except that each
Fund may enter into reverse repurchase agreements or borrow money from banks for
temporary or emergency purposes in aggregate amounts up to one-third of the
value of the Fund's net assets; provided that while borrowings from banks (not
including reverse repurchase agreements) exceed 5% of the Fund's net assets, any
such borrowings will be repaid before additional investments are made.
The Funds are non-diversified under the federal securities laws. As
non-diversified funds, there is no restriction under the 1940 Act on the
percentage of assets that may be invested at any time in the securities of any
one issuer. The Funds intend to comply, however, with the Code's diversification
requirements and other requirements applicable to "regulated investment
companies" to ensure they will not be subject to U.S. federal income tax on
income and capital gain distributions to shareholders.
For this reason, each Fund has adopted the investment restriction set forth
below, which may not be changed without the approval of a majority of its
outstanding shares. Specifically, a Fund may not purchase a security if more
than 25% of the Fund's total assets would be invested in the securities of a
single issuer (other than the U.S. government, its agencies and
instrumentalities) or, with respect to 50% of the Fund's total assets, if more
than 5% of such assets would be invested in the securities of a single issuer
(other than the U.S. government, its agencies and instrumentalities).
As a matter of practice, a Fund treats reverse repurchase agreements as
borrowings for purposes of compliance with the limitations of the 1940 Act.
Reverse repurchase agreements will be taken into account along with borrowings
from banks for purposes of the 5% limit set forth in the fifth investment
restriction above.
The foregoing is only a summary of the Funds' investment restrictions and
policies. See the statement of additional information for details and the full
text of the Funds' investment restrictions and related policies.
RISK FACTORS
Investing in a Fund involves the risk common to investing in any security,
i.e., net asset value will fluctuate in response to changes in economic
conditions, interest rates and the market's perception of the underlying
portfolio securities of the Fund.
By itself, a Fund does not constitute a balanced investment program and is not
designed for investors seeking capital appreciation or maximum tax-exempt income
irrespective of fluctuations in principal or marketability. Shares of a Fund
would not be suitable for tax-exempt institutions and may not be suitable for
certain retirement plans that are unable to benefit from the Fund's federally
tax-exempt dividends. In addition, the Funds may not be appropriate investments
for entities that are "substantial users" of facilities financed by industrial
development bonds or related persons thereof.
To the extent the Funds are not fully diversified, they may be more
susceptible to adverse economic, political or regulatory developments affecting
a single issuer than would be the case if the Funds were more broadly
diversified.
In addition, the market value of the fixed income securities in which a Fund
may invest may vary inversely to changes in prevailing interest rates.
MUNICIPAL OBLIGATIONS
A Fund's ability to achieve its objectives depends partially on the prompt
payment by issuers of the interest on and principal of the municipal obligations
held by the Fund. A moratorium, default or other nonpayment of interest or
principal when due on any municipal obligation, in addition to affecting the
market value and liquidity of that particular security, could affect the market
value and liquidity of other municipal obligations held by a Fund. In addition,
the market for municipal obligations is often thin and can be temporarily
affected by large purchases and sales, including those by a Fund.
From time to time, proposals have been introduced before the U.S. Congress for
the purpose of restricting or eliminating the federal income tax exemption for
interest on municipal obligations, and similar proposals may well be introduced
in the future. If such a proposal were enacted, the availability of municipal
obligations for investment by each Fund and the value of the Fund's securities
could be materially affected. In such an event, the FUND would reevaluate its
Funds' investment objectives and policies and consider changes in the structure
of the Funds or dissolution.
If and when a Fund invests in municipal lease obligations, the possibility
exists that a municipality may not appropriate the funds for lease payments. The
FUND's Board of Trustees will be responsible for determining, on an ongoing
basis, the credit quality of such leases, including an assessment of the
likelihood of cancellation of any such lease.
NONINVESTMENT GRADE BONDS
The Missouri Tax Free Fund's investment policy allows the Fund to invest a
portion (not to exceed 20%) of its assets in high yield, high risk municipal
bonds, also commonly known as "junk bonds." The degree to which the Fund will
hold such securities will, among other things, depend upon Keystone's economic
forecast and its judgment as to the comparative values offered by high yield,
high risk bonds and higher quality bonds. The Missouri Tax Free Fund seeks to
invest up to 20% of its assets aggressively and to maximize return over time
from a combination of many factors, including high current income and capital
appreciation from high yield, high risk bonds. Although the total amount
invested in high yield, high risk bonds will not exceed 20% of the Missouri Tax
Free Fund, the Fund may (as a non-diversified fund) invest as much as the entire
20% in the securities of a single issuer. To that extent the Missouri Tax Free
Fund may be more susceptible to adverse economic, political or regulatory
developments affecting a single issuer than would be the case if the Fund were
more broadly diversified.
Such aggressive investing involves risks that are greater than the risks of
investing in higher quality debt securities. These risks are discussed in
greater detail below and include risks from (1) interest rate fluctuation; (2)
changes in credit status, including weaker overall credit condition of issuers
and risks of default; (3) industry, market and economic risk; (4) volatility of
price resulting from broad and rapid changes in the value of underlying
securities; and (5) greater price variability and credit risks of such high
yield, high risk securities as zero coupon bonds and PIK securities.
Specifically, investors should be aware of the following:
(1) securities rated BB or lower by S&P or Ba or lower by Moody's are
considered predominantly speculative with respect to the ability of the issuer
to meet principal and interest payments;
(2) the value of high yield, high risk securities may be more susceptible to
real or perceived adverse economic, company or industry conditions than is the
case for higher quality securities;
(3) adverse market, credit or economic conditions could make it difficult at
certain times to sell certain high yield, high risk securities held by the Fund;
(4) the secondary market for high yield, high risk securities may be less
liquid than the secondary market for higher quality securities, which may affect
the value of certain high yield, high risk securities held by the Fund at
certain times; and
(5) high yield, high risk zero coupon securities may be subject to greater
changes in value due to market conditions, the absence of a cash interest
payment and the tendency of issuers of such securities to have weaker overall
credit conditions than other high yield, high risk securities.
These characteristics of high yield, high risk securities make them generally
more appropriate for long term investment.
If and when a Fund invests in zero coupon bonds, the Fund does not expect to
have enough zero coupon bonds to have a material effect on dividends. The FUND
has undertaken to a state securities authority to disclose that zero coupon
securities pay no interest to holders prior to maturity, and that the interest
on these securities is reported as income to a Fund and distributed to its
shareholders. These distributions must be made from the Fund's cash assets or,
if necessary, from the proceeds of sales of portfolio securities. The Fund will
not be able to purchase additional income producing securities with cash used to
make such distributions, and its current income ultimately may be reduced as a
result.
These risks provide the opportunity for maximizing return over time on a
portion of the Missouri Tax Free Fund's assets, but may result in greater upward
and downward movement of the net asset value per share of the Fund. As a result,
they should be carefully considered by investors.
The maximum return sought by the Missouri Tax Free Fund with respect to up to
20% of its assets is ordinarily associated with securities in the lower rating
categories of the recognized rating agencies or with securities that are
unrated. Such high yield, high risk securities are generally rated BB or lower
by S&P or BA or lower by Moody's. The Fund may invest in securities that are
rated as low as D by S&P and C- by Moody's. These rating categories are
described in the section of this prospectus entitled "Additional Investment
Information." The Fund intends to invest in D rated debt only in cases where, in
Keystone's judgment, there is a distinct prospect of improvement in the issuer's
financial position as a result of the completion of reorganization or otherwise.
The Fund may also invest in unrated securities that, in Keystone's judgment,
offer comparable yields and risks to those of securities that are rated, as well
as non-investment quality zero coupon and PIK securities.
Since the Fund takes an aggressive approach to investing a portion of its
assets, Keystone tries to maximize the return by controlling the risk associated
with those investments through diversification, credit analyses, review of
sector and industry trends, interest rate forecasts and economic analysis.
Keystone's analysis of securities focuses on values based on factors such as
asset values, earnings prospects and the quality of management of the company.
In making investment recommendations, Keystone also considers current income,
potential for capital appreciation, maturity structure, quality guidelines,
coupon structure, average yield, percentage of zeros and PIKs, percentage of
non-accruing items and yield to maturity.
Keystone also considers the ratings of Moody's and S&P assigned to various
securities, but does not rely solely on ratings assigned by Moody's and S&P
because (1) Moody's and S&P assigned ratings are based largely on historical
financial data and may not accurately reflect the current financial outlook of
municipalities; and (2) there can be large differences among the current
financial conditions of issuers within the same rating category.
TAX CONSIDERATIONS
For a discussion of the tax considerations for each state and special
factors, including the risks associated with investing in the municipal
securities of a single state, see Exhibit A to this prospectus and Appendix A to
the statement of additional information.
PRICING SHARES
The net asset value of a Fund share is computed each day on which the New York
Stock Exchange (the "Exchange") is open as of the close of trading on the
Exchange (currently 4:00 p.m. eastern time for the purpose of pricing Fund
shares) except on days when changes in the value of a Fund's portfolio
securities do not affect the current net asset value of its shares. The Exchange
currently is closed on weekends, New Year's Day, Presidents' Day, Good Friday,
Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day.
The net asset value per share of each Fund is arrived at by determining the
value of the Fund's assets, subtracting its liabilities and dividing the result
by the number of its shares outstanding. Net asset value per share is calculated
to two decimal places for purposes of purchases and redemptions of a Fund's
shares.
The Funds value municipal obligations on the basis of valuations provided by a
pricing service, approved by the FUND's Board of Trustees, which uses
information with respect to transactions in bonds, quotations from bond dealers,
market transactions in comparable securities and various relationships between
securities in determining value.
Each Fund values its short-term instruments as follows: money market
instruments with maturities of sixty days or less are valued at amortized cost
(original purchase cost as adjusted for amortization of premium or accretion of
discount), which, when combined with accrued interest, approximates market;
short-term instruments having maturities of more than sixty days for which
market quotations are readily available are valued at current market value; and
short-term instruments maturing in more than sixty days when purchased that are
held on the sixtieth day prior to maturity are valued at amortized cost (market
value on the sixtieth day adjusted for amortization of premium or accretion of
discount), which, when combined with accrued interest, approximates market; and
which, in either case, reflects fair value as determined by the Board of
Trustees. All other investments are valued at market value or, where market
quotations are not readily available, at fair value as determined in good faith
according to procedures established by the Board of Trustees.
DIVIDENDS AND TAXES
Each Fund intends to declare dividends from net investment income daily and
distribute to its shareholders such dividends monthly and to declare and
distribute all net realized long-term capital gains annually. All dividends and
distributions will be payable in shares or, at the option of the shareholder, in
cash. Shareholders of a Fund who have not opted to receive cash prior to the
payable date for any dividend from net investment income or the record date for
any capital gains distribution will have the number of such shares determined on
the basis of the Fund's net asset value per share computed at the end of that
day after adjustment for the distribution. Net asset value is used in computing
the number of shares in both capital gains and income distribution
reinvestments. There is a possibility that shareholders may lose the tax-exempt
status on accrued income on municipal bonds if shares of the Funds are redeemed
before a dividend has been declared.
Currently, commissions paid by the Funds on new sales of shares under the
Funds' Distribution Plans (see "Distribution Plans") and deferred sales charge
receipts are treated as capital charges and capital credits, respectively, in
determining net investment income for tax purposes. For financial statement
purposes, however, these expenses and receipts are treated as operating expenses
and expense offsets. As a result, the amount of dividend distributions required
to satisfy the requirements of the Code might exceed net investment income for
financial statement purposes, resulting in a portion of such dividends being a
distribution in excess of net investment income for financial statement
purposes. Total investment return is equally affected by both treatments.
Recently, the Internal Revenue Service ("IRS") issued a ruling that will
require the FUND, effective April 1, 1995, to treat its 12b-1 fees as operating
expenses, instead of as capital charges. The Funds intend to comply with the IRS
ruling by that date. As a result, after April 1, 1995, dividend distributions
are no longer expected to exceed net investment income for financial statement
purposes. Total investment return will not be affected.
Differences in the operation of the Distribution Plan adopted by the Class A
shares of each Fund from that of the Class B and Class C Distribution Plans will
cause a variation in the net asset values of the respective classes of shares.
Account statements and/or checks as appropriate will be mailed within seven
days after the Fund pays the distribution. Unless the FUND receives instructions
to the contrary before the record or payable date, as the case may be, it will
assume that a shareholder wishes to receive that distribution and future capital
gains and income distributions in shares. Instructions continue in effect until
changed in writing.
Each of the Funds intends to qualify in the future as a regulated investment
company under the Code. Each Fund is a separate taxable entity for purposes of
Code provisions applicable to regulated investment companies. Each of the Funds
qualifies if, among other things, it distributes to its shareholders at least
90% of its net investment income for its fiscal year. Each Fund also intends to
make timely distributions, if necessary, sufficient in amount to avoid the
nondeductible 4% excise tax imposed on a regulated investment company to the
extent that it fails to distribute, with respect to each calendar year, at least
98% of its ordinary income for such calendar year and 98% of its net capital
gains for the one-year period ending on October 31 of such calendar year. Any
taxable distribution (1) would be declared in October, November or December to
shareholders of record in such a month, (2) would be paid by the following
January 31, and (3) would be includable in the taxable income of shareholders
for the year in which such distributions were declared. If a Fund qualifies and
if it distributes substantially all of its net investment income and net capital
gains, if any, to shareholders, it will be relieved of any federal income tax
liability.
Each Fund expects that substantially all of its dividends will be "exempt
interest dividends," which should be treated as excludable from federal gross
income. In order to pay exempt interest dividends, at least 50% of the value of
the Fund's assets must consist of federally tax-exempt obligations at the close
of each quarter. An exempt interest dividend is any dividend or part thereof
(other than a capital gain dividend) paid by the Fund with respect to its net
federally excludable municipal obligation interest and designated as an exempt
interest dividend in a written notice mailed to each shareholder not later than
60 days after the close of its taxable year. The percentage of the total
dividends paid by a Fund with respect to any taxable year that qualifies as
exempt interest dividends will be the same for all shareholders of the Fund
receiving dividends with respect to such year. If a shareholder receives an
exempt interest dividend with respect to any share and such share has been held
for six months or less, any loss on the sale or exchange of such share will be
disallowed to the extent of the exempt interest dividend amount.
Any shareholder of a Fund who may be a"substantial user" of a facility
financed with an issue of tax-exempt obligations or a "related person" to such a
user should consult his tax adviser concerning his qualification to receive
exempt interest dividends should the Fund hold obligations financing such
facility.
Interest on certain "private activity bonds" issued after August 7, 1986,
although otherwise tax exempt, is treated as a tax preference item for
alternative minimum tax purposes. Under regulations to be promulgated, a Fund's
exempt interest dividends will be treated the same way to the extent
attributable to interest paid on such private activity bonds. Corporate
shareholders should also be aware that the receipt of exempt interest dividends
could subject them to alternative minimum tax under the provisions of Section
56(g) of the Code (relating to "adjusted current earnings").
Since none of a Fund's income will consist of corporate dividends, no
distributions will qualify for the corporate dividends received deduction.
Each Fund intends to distribute its net capital gains as capital gain
dividends; shareholders should treat such dividends as long-term capital gains.
Such distributions will be designated as capital gain dividends by a written
notice mailed to each shareholder no later than 60 days after the close of the
Fund's fiscal taxable year. If a shareholder receives a capital gain dividend
and holds his shares for six months or less, then any allowable loss on
disposition of such shares will be treated as a long-term capital loss to the
extent of such capital gain dividend.
Interest on indebtedness incurred or continued by shareholders to purchase or
carry shares of a Fund will not be deductible for federal income tax purposes to
the extent of the portion of the interest expense relating to exempt interest
dividends; that portion is determined by multiplying the total amount of
interest paid or accrued on the indebtedness by a fraction, the numerator of
which is the exempt interest dividends received by a shareholder in his taxable
year and the denominator of which is the sum of the exempt interest dividends
and the taxable distributions out of the Fund's investment income and long-term
capital gains received by the shareholder.
The Funds may acquire options to "put" specified securities to municipal bond
dealers or issuers from whom the securities are purchased. It is expected that
each Fund will be treated for federal income tax purposes as the owner of the
municipal bonds acquired subject to the put. The interest on the municipal bonds
will be tax-exempt to the Funds, and the purchase prices must be allocated
between such securities and the put based upon their respective fair market
values. The IRS has not issued a published ruling on this matter and could reach
a different conclusion.
STATE INCOME TAXES
The exemption of interest on municipal bonds for federal income tax purposes
does not necessarily result in exemption under the income, corporate or personal
property tax laws of any state or city. Generally, individual shareholders of
the Funds receive tax-exempt treatment at the state level for distributions
derived from municipal securities of their state of residency. Each Fund will
report to shareholders on a state by state basis the sources of its exempt
interest dividends. For a further discussion of state tax treatment relating to
each Fund see Exhibit A to this prospectus.
The foregoing is only a summary of some of the important tax considerations
generally affecting the FUND, its Funds and their shareholders. No attempt is
made to present a detailed explanation of the federal or state income or other
tax treatment of the FUND, its Funds or their shareholders, and this discussion
is not intended as a substitute for careful tax planning. Accordingly,
shareholders are urged to consult their tax advisers with specific reference to
their tax situations.
As mentioned above, at the end of each quarter, at least 50% of the value of a
Fund's assets must be invested in municipal obligations in order for
distributions to qualify as exempt interest dividends. Under particularly
unusual circumstances, such as when a Fund is in a prolonged defensive
investment position, it is possible that no portion of a Fund's distributions of
income to its shareholders for a fiscal year would be exempt from federal income
tax. The FUND does not presently anticipate, however, that such unusual
circumstances will occur.
FUND MANAGEMENT AND EXPENSES
BOARD OF TRUSTEES
Under Massachusetts law, the FUND's Board of Trustees has absolute and
exclusive control over the management and disposition of all assets of the FUND
and its Funds. Subject to the authority of the Board of Trustees, Keystone
serves as investment adviser to the FUND and its Funds and is responsible for
the overall management of the FUND's business and affairs.
INVESTMENT ADVISER
Keystone, the FUND's investment adviser, located at 200 Berkeley Street,
Boston, Massachusetts 02116-5034, has provided investment advisory and
management services to investment companies and private accounts since it was
organized in 1932. Keystone is a wholly-owned subsidiary of Keystone Group, Inc.
("Keystone Group"), 200 Berkeley Street, Boston, Massachusetts 02116-5034.
Keystone Group is a corporation predominantly owned by current and former
members of management of Keystone and its affiliates. The shares of Keystone
Group common stock beneficially owned by management are held in a number of
voting trusts, the trustees of which are George S. Bissell, Albert H. Elfner,
III, Edward F. Godfrey and Ralph J. Spuehler, Jr. Keystone Group provides
accounting, bookkeeping, legal, personnel and general corporate services to
Keystone, its affiliates and the Keystone Group of Mutual Funds.
Pursuant to its Investment Advisory and Management Agreement with the FUND
(the "Advisory Agreement"), Keystone provides investment advisory and management
services to the FUND and each Fund.
Each Fund currently offered pays Keystone a fee for its services at the annual
rate set forth below:
Aggregate
Net Asset Value
Management of the Shares
Fee of the Fund
- --------------------------------------------------------------------------------
0.55% of the first $ 50,000,000, plus
0.50% of the next $ 50,000,000, plus
0.45% of the next $100,000,000, plus
0.40% of the next $100,000,000, plus
0.35% of the next $100,000,000, plus
0.30% of the next $100,000,000, plus
0.25% of amounts over $500,000,000
computed as of the close of business each business day and paid daily.
The Advisory Agreement continues in effect from year to year only so long as
such continuance is specifically approved at least annually by the Board of
Trustees or by vote of a majority of the outstanding shares of each Fund. In
either case, the terms of the Advisory Agreement and continuance thereof must be
approved by the vote of a majority of Independent Trustees in person at a
meeting called for the purpose of voting on such approval. The Advisory
Agreement may be terminated as to any Fund, without penalty, on 60 days' written
notice by the FUND or Keystone, or may be terminated as to a Fund by the vote of
a majority of the shares of such Fund. The Advisory Agreement will terminate
automatically upon its assignment.
Keystone and the FUND have each adopted a Code of Ethics incorporating
policies on personal securities trading as recommended by the Investment Company
Institute.
FUND EXPENSES
Each Fund will pay all of its expenses. In addition to the investment advisory
and management fees discussed above, the principal expenses that each Fund is
expected to pay include, but are not limited to, transfer, dividend disbursing
and shareholder servicing agent costs and expenses; custodian costs and
expenses; its pro rata portion of certain Trustees' fees, fees of its
independent auditors, fees of the FUND's legal counsel and legal counsel to the
FUND's Board of Trustees; fees payable to government agencies, including
registration and qualification fees of the FUND, the Funds and their shares
under federal and state securities laws; and certain extraordinary expenses. In
addition, each class of shares of a Fund will pay all of the expenses
attributable to it. Such expenses are currently limited to Distribution Plan
expenses. Each Fund also pays its brokerage commissions, interest charges and
taxes and certain extraordinary expenses.
During the period February 1, 1994 (Commencement of Operations) to November
30, 1994, the California Insured Fund and the Missouri Tax Free Fund paid or
accrued to Keystone investment management and administrative services fees of
$49,627 and $47,930, respectively.
During the period February 1, 1994 (Commencement of Operations) to November
30, 1994, the California Insured Fund and the Missouri Tax Free Fund paid or
accrued to Keystone Investor Resource Center, Inc. ("KIRC"), the FUND's transfer
and dividend disbursing agent, $16,901, and $25,820, respectively, for
shareholder services. During the period February 1, 1994 (Commencement of
Operations) to November 30, 1994, the California Insured Fund and the Missouri
Tax Free Fund paid or accrued to KGI $11,753, and $10,954, respectively, as
reimbursement for certain accounting services.
Currently, Keystone has voluntarily limited the expenses of Class A shares of
each Fund to 0.65% of the average daily net assets of such class until May 15,
1995. Thereafter, Keystone has currently voluntarily limited Class A expenses to
0.75% until December 31, 1995. Keystone has currently voluntarily limited
expenses of Class B and C shares to 1.40% of the average daily net assets of
each such class until May 15, 1995. Thereafter, Keystone has currently
voluntarily limited the expenses of such classes to 1.50% until December 31,
1995. Thereafter, a redetermination of whether to continue these expense
limitations and, if so, at what rate, will be made. Keystone will not be
required to make such reimbursement to the extent it would result in a Fund's
inability to qualify as a regulated investment company under the provisions of
the Code. In accordance with expense limitations in effect for the fiscal period
ended November 30, 1994, Keystone reimbursed the California Insured Fund and the
Missouri Tax Free Fund (1) $23,507 and $12,109, respectively, with respect to
each Fund's Class A shares; (2) $81,857 and $91,759, respectively, with respect
to each Fund's Class B shares; and (3) $4,427 and $10,208, respectively, with
respect to each Fund's Class C shares.
PORTFOLIO MANAGER
Betsy Blacher, a Keystone Vice President and Senior Portfolio Manager, has
been the FUND's portfolio manager since the FUND's inception and is responsible
for the day-to-day management of the California Insured Fund. Ms. Blacher has
more than 15 years of investment experience.
Daniel A Rabasco, a Keystone Vice President and Portfolio Manager, is
responsible for the day-to-day management of the Missouri Tax Free Fund. Mr.
Rabasco has more than 8 years of investment experience.
SECURITIES TRANSACTIONS
Under policies established by the Board ofTrustees, Keystone selects
broker-dealers to execute transactions subject to the receipt of best execution.
When selecting broker-dealers to execute portfolio transactions for a Fund,
Keystone may follow a policy of considering as a factor the number of shares of
the Fund sold by such broker-dealer. In addition, broker-dealers executing
portfolio transactions from time to time may be affiliated with the FUND,
Keystone, the FUND's Principal Underwriter or their affiliates.
A Fund may pay higher commissions to broker-dealers that provide research
services. Keystone may use these services in advising a Fund as well as in
advising its other clients.
PORTFOLIO TURNOVER
For the fiscal period ended November 30, 1994, the portfolio turnover rate for
the California Insured Fund was 104%. For the same period the turnover rate for
the Missouri Tax Free Fund was 25%. High portfolio turnover may involve
correspondingly greater brokerage commissions and other transaction costs, which
would be borne directly by a Fund, as well as additional gains and/or losses to
shareholders. For additional information about brokerage and distributions, see
the statement of additional information to this prospectus.
HOW TO BUY SHARES
Shares of each Fund may be purchased from any broker-dealer that has a selling
agreement with Keystone Distributors, Inc. ("KDI"), the FUND's principal
underwriter. KDI, a wholly-owned subsidiary of Keystone, is located at 200
Berkeley Street, Boston, Massachusetts 02116-5034.
In addition, you may open an account for the purchase of shares of a Fund by
mailing to the FUND, c/o KIRC, P.O. Box 2121, Boston, Massachusetts 02106- 2121,
a completed account application and a check payable to the FUND. Or you may
telephone 1-800-343-2898 to obtain the number of an account to which you can
wire or electronically transfer funds and then send in a completed account
application. Subsequent investments in a Fund's shares in any amount may be made
by check, by wiring federal funds or by an electronic funds transfer ("EFT").
Orders for the purchase of shares of a Fund will be confirmed at an offering
price equal to the net asset value per share next determined after receipt of
the order in proper form by KDI (generally as of the close of the Exchange on
that day) plus, in the case of Class A shares, the applicable sales charge.
Orders received by dealers or other firms prior to the close of the Exchange and
received by KDI prior to the close of its business day will be confirmed at the
offering price effective as of the close of the Exchange on that day. The FUND
reserves the right to determine the net asset value more frequently than once a
day if deemed desirable. Dealers and other financial services firms are
obligated to transmit orders promptly.
Orders for shares of a Fund received other than as stated above will receive
the offering price equal to the net asset value per share next determined
(generally the next business day's offering price) plus, in the case of Class A
shares, the applicable sales charge.
Your initial purchase must be at least $1,000. There is no minimum amount for
subsequent purchases.
Shares become entitled to income distributions declared on the first business
day following receipt by KIRC of payment for the shares. It is the investor's
responsibility to see that his dealer promptly forwards payment to KDI for
shares being purchased through the dealer.
The FUND reserves the right to withdraw all or any part of the offering made
by this prospectus and to reject purchase orders.
Shareholder inquiries should be directed to KIRC by calling toll free
1-800- 343-2898 or writing to KIRC or to the firm from which you received this
prospectus.
ALTERNATIVE SALES OPTIONS
Each Fund offers three classes of shares:
CLASS A SHARES -- FRONT END LOAD OPTION
Class A shares are sold with a sales charge at the time of purchase. Class A
shares are not subject to a sales charge when they are redeemed (except that
shares sold in a single purchase in excess of $1,000,000 without a front end
sales charge will be subject to a contingent deferred sales charge for one
year).
CLASS B SHARES -- BACK END LOAD OPTION
Class B shares are sold without a sales charge at the time of purchase, but
are subject to a deferred sales charge if they are redeemed during the calendar
year of purchase or within three calendar years after the calendar year of
purchase. Class B shares will automatically convert to Class A shares at the end
of seven calendar years after purchase.
CLASS C SHARES -- LEVEL LOAD OPTION
Class C shares are sold without a sales charge at the time of purchase, but
are subject to a deferred sales charge if they are redeemed within one year
after the date of purchase. Class C shares are available only through dealers
who have entered into special distribution agreements with KDI.
Class A and B shares, pursuant to their Distribution Plans, currently pay an
annual service fee of 0.15% of the Fund's average daily net assets attributable
to their respective classes. Class C shares pay an annual service fee of 0.25%
of the Fund's average daily net assets attributable to Class C. In addition to
the service fee, the Class B and Class C Distribution Plans provide for the
payment of an annual distribution fee of up to 0.75% of the average daily net
assets attributable to their respective classes.
Investors who would rather pay the entire cost of distribution at the time of
investment, rather than spreading the cost over time, might consider Class A
shares. Other investors might consider Class B or Class C shares, in which case
100% of the purchase price is invested immediately, depending on the amount of
the purchase and the length of investment. The Funds will not normally accept
any purchase of Class B shares in the amount of $250,000 or more and will not
normally accept any purchase of Class C shares in the amount of $1,000,000 or
more.
-----------------------------------------
CLASS A SHARES
Class A shares are offered at net asset value plus an initial sales charge as
follows:
AS A % OF CONCESSION TO
AS A % OF NET AMOUNT DEALERS AS A % OF
AMOUNT OF PURCHASE OFFERING PRICE INVESTED* OFFERING PRICE
- --------------------------------------------------------------------------------
Less than $100,000 .................. 4.75% 4.99% 4.25%
$100,000 but less than $250,000 ..... 3.75% 3.90% 3.25%
$250,000 but less than $500,000 ..... 2.50% 2.56% 2.25%
$500,000 but less than $1,000,000 ... 1.50% 1.52% 1.50%
$1,000,000 and over** ............... 0% 0% 0.25%
*Rounded to the nearest one-hundredth percent.
**Purchases of $1,000,000 or more may be subject to a contingent deferred sales
charge of 0.25%. See "Contingent Deferred Sales Charge and Waiver of Sales
Charges."
-------------------------------------------
The sales charge is paid to KDI, which in turn normally reallows a portion to
your broker-dealer. In addition, your broker-dealer currently will be paid
periodic service fees at an annual rate of up to 0.15% of the average daily net
asset value of outstanding shares of Class A maintained outstanding on the books
of the FUND for specified period.
Upon written notice to dealers with whom it has dealer agreements, KDI may
reallow up to the full applicable sales charge.
Initial sales charges may be reduced or eliminated for persons or
organizations purchasing Class A shares of a Fund alone or in combination with
Class A shares of other Keystone America Funds. See Exhibit B to this
prospectus. Initial sales charges may also be eliminated for persons purchasing
Class A shares to be included in a managed fee based program ("wrap account")
through broker dealers who have entered into special agreements with KDI.
Beginning January 1, 1995 through June 30, 1995 ("offering period") and upon
prior notification to KDI, Class A shares may be purchased at net asset value by
clients of registered representatives within six months after the redemption of
shares of any registered open-end investment company not distributed or managed
by KDI or its affiliates, where the amount invested represents redemption
proceeds from such unrelated, registered open-end investment company, and the
shareholder either (1) paid a front end sales charge, or (2) was at some time
subject to, but did not actually pay, a contingent deferred sales charge with
respect to the redemption proceeds.
In addition, upon prior notification to KDI, Class A shares may be purchased
at net asset value by clients of registerd representatives within six months
after a change in the registered representative's employment, where the amount
invested represents redemption proceeds from a registered open-end management
investment company not distributed or managed by KDI or its affiliates; and the
shareholder either (1) paid a front end sales charge, or (2) was at some time
subject to, but did not actually pay, a contingent deferred sales charge with
respect to the redemption proceeds.
With certain exceptions, purchases of Class A shares in the amount of
$1,000,000 or more on which no sales charge has been paid will be subject to a
contingent deferred sales charge of 0.25% upon redemption during the one year
period commencing on the date the shares were originally purchased. The
contingent deferred sales charge is retained by KDI. See "Contingent Deferred
Sales Charges and Waiver of Sales Charges" below.
CLASS A DISTRIBUTION PLAN
Each Fund has adopted a Distribution Plan with respect to its Class A shares
(the "Class A Distribution Plan"), which provides for payments (currently
limited to 0.15% annually of the average daily net asset value of Class A
shares) to pay expenses associated with the distribution of Class A shares.
Amounts paid by each Fund to KDI under the Class A Distribution Plan are
currently used to pay others, such as dealers, service fees at an annual rate of
up to 0.15% of the average daily net asset value of Class A shares maintained by
such others outstanding on the books of a Fund for specified periods.
CLASS B SHARES
Class B shares are offered at net asset value, without an initial sales
charge. With certain exceptions, a Fund may impose a deferred sales charge of
3.00% on shares redeemed during the calendar year of purchase and the first
calendar year after the year of purchase; 2.00% on shares redeemed during the
second calendar year after the year of purchase; and 1.00% on shares redeemed
during the third calendar year after the year of purchase. No deferred sales
charge is imposed on amounts redeemed thereafter. If imposed, the deferred sales
charge is deducted from the redemption proceeds otherwise payable to the
shareholder. The deferred sales charge is retained by KDI. Amounts received by
KDI under the Class B Distribution Plan are reduced by deferred sales charges
retained by KDI. See "Contingent Deferred Sales Charges and Waiver of Sales
Charges" below.
Class B shares that have been outstanding during seven calendar years will
automatically convert to Class A shares, which are subject to a lower
Distribution Plan charge, without imposition of a front end sales charge or
exchange fee. (Conversion of Class B shares represented by stock certificates
will require the return of the stock certificates to KIRC.) The Class B shares
so converted will no longer be subject to the higher expenses borne by Class B
shares. Because the net asset value per share of the Class A shares may vary
from that of the Class B shares at the time of conversion, although the dollar
value will be the same, a shareholder may receive more or fewer Class A shares
than the number of Class B shares converted. Under current law, it is the FUND's
opinion that such a conversion will not constitute a taxable event under federal
income tax law. In the event that this ceases to be the case, the Board of
Trustees will consider what action, if any, is appropriate and in the best
interests of the Class B shareholders.
CLASS B DISTRIBUTION PLAN
Each Fund has adopted a Distribution Plan with respect to its Class B shares
(the "Class B Distribution Plan") that provides for expenditures at an annual
rate of up to 1.00% of the average daily net asset value of Class B shares
(currently limited to 0.90%) to pay expenses of the distribution of Class B
shares. Payments under the Class B Distribution Plan are currently made to KDI
(which may reallow all or part to others, such as dealers) (1) as commissions
for Class B shares sold and (2) as shareholder service fees. Amounts paid or
accrued to KDI under (1) and (2) in the aggregate may not exceed the annual
limitation referred to above. KDI generally reallows to brokers or others a
commission equal to 3% of the price paid for each Class B share sold and the
shareholder service fee, which is paid at the rate of 0.15% per annum of the net
asset value of Class B shares maintained by the recipients outstanding on the
books of the Fund for specified periods. See "Distribution Plans" below.
CLASS C SHARES
Class C shares are offered only through dealers who have special distribution
agreements with KDI. Class C shares are offered at net asset value, without an
initial sales charge. With certain exceptions, each Fund may impose a deferred
sales charge of 1.00% on shares redeemed within one year after the date of
purchase. No deferred sales charge is imposed on amounts redeemed thereafter. If
imposed, the deferred sales charge is deducted from the redemption proceeds
otherwise payable to you. The deferred sales charge is retained by KDI. See
"Contingent Deferred Sales Charges and Waiver of Sales Charges" below.
CLASS C DISTRIBUTION PLAN
Each Fund has adopted a Distribution Plan with respect to its Class C shares
(the "Class C Distribution Plan") that provides for expenditures at an annual
rate of up to 1.00% of the average daily net asset value of Class C shares
(currently limited to 0.90%) to pay expenses of the distribution of Class C
shares. Payments under the Class C Distribution Plan are currently made to KDI
(which may reallow all or part to others, such as dealers) (1) as commissions
for Class C shares sold and (2) as shareholder service fees. Amounts paid or
accrued to KDI under (1) and (2) in the aggregate may not exceed the annual
limitation referred to above. KDI generally reallows to brokers or others a
commission in the amount of 0.75% of the price paid for each Class C share sold,
plus the first year's service fee in advance in the amount of 0.25% of the price
paid for each Class C share sold, and, beginning approximately fifteen months
after purchase, a commission at an annual rate of 0.75% (subject to the NASD
rule -- see "Distribution Plans") plus service fees which are paid at the annual
rate of 0.25%, respectively, of the average daily net asset value of each Class
C share maintained by the recipients outstanding on the books of the Fund for
specified periods. See "Distribution Plans" below.
CONTINGENT DEFERRED SALES CHARGE AND WAIVER OF SALES CHARGES
Any contingent deferred sales charge imposed upon the redemption of Class A,
Class B or Class C shares is a percentage of the lesser of (1) the net asset
value of the shares redeemed or (2) the net cost of such shares. No contingent
deferred sales charge is imposed when amounts redeemed are derived from (1)
increases in the value of an account above the net cost of such shares due to
increases in the net asset value per share of a Fund; (2) certain shares with
respect to which a Fund did not pay a commission on issuance, including shares
acquired through reinvestment of dividend income and capital gains
distributions; (3) Class C shares and certain Class A shares held for more than
one year from the date of purchase; or (4) Class B shares held during more than
four consecutive calendar years. Upon request for redemption, shares not subject
to the contingent deferred sales charge will be redeemed first. Thereafter,
shares held the longest will be the first to be redeemed.
Each Fund may also sell Class A, Class B or Class C shares at net asset value
without any initial sales charge or a contingent deferred sales charge to
certain Directors, Trustees, officers and employees of the Fund and Keystone and
certain of their affiliates; to registered representatives of firms with dealer
agreements with KDI; and to a bank or trust company acting as a trustee for a
single account.
In addition, no contingent deferred sales charge is imposed on a redemption of
shares of a Fund in the event of (1) death or disability of the shareholder; (2)
a lump-sum distribution from a 401(k) plan or other benefit plan qualified under
the Employee Retirement Income Security Act of 1974 ("ERISA"); (3) automatic
withdrawals from ERISA plans if the shareholder is at least 5912 years old; (4)
involuntary redemptions of accounts having an aggregate net asset value of less
than $1,000; or (5) automatic withdrawals under an automatic withdrawal plan of
up to 112% per month of the shareholder's initial account balance.
ARRANGEMENTS WITH BROKER-DEALERS AND OTHERS
From time to time, KDI may provide promotional incentives, including
reallowance of up to the entire sales charge, to certain dealers whose
representatives have sold or are expected to sell significant amounts of a Fund.
In addition, from time to time, dealers may receive additional cash payments.
KDI may provide written information to dealers with whom it has dealer
agreements that relates to sales incentive campaigns conducted by such dealers
for their representatives as well as financial assistance in connection with
pre-approved seminars, conferences and advertising. No such programs or
additional compensation will be offered to the extent they are prohibited by the
laws of any state or any self-regulatory agency such as the National Association
of Securities Dealers, Inc. ("NASD"). Dealers to whom substantially the entire
sales charge on Class A shares is reallowed may be deemed to be underwriters as
that term is defined under the Securities Act of 1933.
KDI may, at its own expense, pay concessions in addition to those described
above to dealers that satisfy certain criteria established from time to time by
KDI. These conditions relate to increasing sales of shares of the Keystone funds
over specified periods and certain other factors. Such payments may, depending
on the dealer's satisfaction of the required conditions, be up to 0.25% of the
value of shares sold by such dealer.
KDI may also pay a transaction fee (up to the level of payments allowed to
dealers for the sale of shares, as described above) to banks and other financial
services firms that facilitate transactions in shares of a Fund for their
clients. The Glass-Steagall Act currently limits the ability of a depository
institution (such as a commercial bank or a savings and loan association) to
become an underwriter or distributor of securities. In the event the
Glass-Steagall Act is deemed to prohibit depository institutions from accepting
payments under the arrangement described above, or should Congress relax current
restrictions on depository institutions, the Board of Trustees will consider
what action, if any, is appropriate.
In addition, state securities laws on this issue may differ from the
interpretations of federal law expressed herein, and banks and financial
institutions may be required to register as dealers pursuant to state law.
DISTRIBUTION PLANS
Each Fund bears some of the costs of selling its shares under Distribution
Plans adopted with respect to its Class A, Class B and Class C shares pursuant
to Rule 12b-1 under the 1940 Act. Payments under the Class A Distribution Plans
are currently limited to up to 0.15% annually of the average daily net asset
value of Class A shares. The Class B Distribution Plans and the Class C
Distribution Plans provide for the payment at an annual rate of up to 1.00% of
the average daily net asset value of Class B shares and Class C shares,
respectively, although payments under the Class B and Class C Distribution Plans
are currently limited to 0.90%.
The NASD currently limits the amount that a Fund may pay annually in
distribution costs for the sale of its shares and shareholder service fees. The
rule limits annual expenditures to 1% of the aggregate average daily net asset
value of its shares, of which 0.75% may be used to pay such distribution costs
and 0.25% may be used to pay shareholder service fees. The NASD also limits the
aggregate amount that a Fund may pay for such distribution costs to 6.25% of
gross share sales since the inception of a 12b-1 Distribution Plan, plus
interest at the prime rate plus 1% on such amounts (less any contingent deferred
sales charges paid by shareholders to KDI).
KDI intends, but is not obligated, to continue to pay or accrue distribution
charges incurred in connection with the Class B Distribution Plans that exceed
current annual payments permitted to be received by KDI from a Fund. KDI intends
to seek full payment of such charges from a Fund (together with annual interest
thereon at the prime rate plus one percent) at such time in the future as, and
to the extent that, payment thereof by a Fund would be within the permitted
limits.
If the FUND's Independent Trustees authorize such payments, the effect would
be to extend the period of time during which the FUND incurs the maximum amount
of costs allowed by a Distribution Plan. If a Distribution Plan is terminated,
KDI will ask the Independent Trustees to take whatever action they deem
appropriate under the circumstances with respect to payment of such amounts.
Each of the Distribution Plans may be terminated at any time by vote of the
Independent Trustees or by vote of a majority of the outstanding voting shares
of the respective class.
Unreimbursed distribution expenses at November 30, 1994 for Class B shares
were $784,751 (6.87% of Class B net assets at November 30, 1994) and $862,192
(6.88% of Class B net assets at November 30, 1994) for the California Insured
Fund and the Missouri Tax Free Fund, respectively.
Dealers or others may receive different levels of compensation depending on
which class of shares they sell. Payments pursuant to a Distribution Plan are
included in the operating expenses of the class.
HOW TO REDEEM SHARES
Your shares of a Fund may be redeemed for cash at their net asset value upon
written order by you to the FUND, c/o KIRC, and presentation to the FUND of a
properly endorsed share certificate if certificates have been issued. Your
signature(s) on the written order and certificates must be guaranteed as
described below. The redemption value of a Fund's share is its net asset value
per share adjusted for fractions of a cent and may be more or less than your
cost depending upon changes in the value of a Fund's portfolio securities
between purchase and redemption. In order to redeem by telephone you must have
completed the authorization in your account application.
At various times the FUND may be requested to redeem a Fund's shares for which
it has not yet received good payment. In such a case, the FUND will mail, wire
or send by EFT the redemption proceeds upon clearance of the purchase check,
which may take up to 15 days or more. Any delay may be avoided by purchasing
shares either with a certified check or bank wire of funds or EFT. Although the
mailing of a redemption check or wiring or sending by EFT of redemption proceeds
may be delayed, the redemption value will be determined and the redemption
processed in the ordinary course of business upon receipt of proper
documentation. In such a case, after the redemption and prior to the release of
the proceeds, no appreciation or depreciation will occur in the value of the
redeemed shares and no interest will be paid on the redemption proceeds. If the
payment of a redemption has been delayed, the check will be mailed or the
proceeds wired or sent EFT promptly after good payment has been collected.
The FUND computes the amount due you at the close of the Exchange at the end
of the day on which it has received all proper documentation from you. Payment
of the amount due on redemption will be made within seven days thereafter except
as discussed herein.
You may also redeem your shares through broker-dealers. KDI, acting as agent
for the FUND, stands ready to repurchase a Fund's shares upon orders from
dealers at the redemption value described above computed on the day KDI receives
the order. If KDI has received proper documentation, it will pay the redemption
proceeds to the broker-dealer placing the order within seven days thereafter.
KDI charges no fees for this service. However, your broker-dealer may do so.
For your protection, SIGNATURES ON CERTIFICATES, STOCK POWERS AND ALL WRITTEN
ORDERS OR AUTHORIZATIONS MUST BE GUARANTEED BY A U.S. STOCK EXCHANGE MEMBER, A
BANK OR OTHER PERSONS ELIGIBLE TO GUARANTEE SIGNATURES UNDER THE SECURITIES ACT
OF 1934 AND KIRC'S POLICIES. The FUND and KIRC may waive this requirement, but
may also require additional documents in certain cases. Currently, the
requirement for a signature guarantee has been waived on redemptions of $50,000
or less where the account address of record has been the same for a minimum
period of 30 days. The FUND and KIRC reserve the right to withdraw this waiver
at any time.
If the FUND receives a redemption order, but you have not clearly indicated
the amount of money or number of shares of the Fund involved, the FUND cannot
execute the order. In such cases, the FUND will request the missing information
from you and process the order on the day such information is received.
TELEPHONE
Under ordinary circumstances, you may redeem up to $50,000 from your account
by telephone by calling toll free 1-800-343-2898. However, you must complete the
Telephone Redemption section of the application to enjoy the telephone
redemption privileges.
In order to insure that instructions received by KIRC are genuine when you
initiate a telephone transaction, you will be asked to verify certain criteria
specific to your account. At the conclusion of the transaction, you will be
given a transaction number confirming your request, and written confirmation of
your transaction will be mailed the next business day. Your telephone
instructions will be recorded. Redemptions by telephone are allowed only if the
address and bank account of record have been the same for a minimum period of 30
days.
If the redemption proceeds are less than $2,500, they will be mailed by check.
If they are $2,500 or more, they will be mailed, wired or sent by EFT to your
previously designated bank account as you direct. If you do not specify how you
wish your redemption proceeds to be sent, they will be mailed by check.
If you cannot reach the FUND by telephone, you should follow the procedures
for redeeming by mail or through a broker as set forth above.
SMALL ACCOUNTS
Because of the high cost of maintaining small accounts, the FUND reserves the
right to redeem your account if its value has fallen below $1,000, the current
minimum investment level, as a result of your redemptions (but not as a result
of market action). You will be notified in writing and allowed 60 days to
increase the value of your account to the minimum investment level.
REDEMPTIONS IN KIND
If conditions arise that would make it undesirable for the FUND to pay for all
redemptions in cash, the FUND may authorize payment to be made in portfolio
securities or other property. The FUND has obligated itself, however, under the
1940 Act to redeem for cash all shares of a Fund presented for redemption by any
one shareholder in any 90-day period up to the lesser of $250,000 or 1% of the
Fund's net assets. Securities delivered in payment of redemptions would be
valued at the same value assigned to them in computing the net asset value per
share and, to the extent permitted by law, would be readily marketable.
Shareholders receiving such securities would incur brokerage costs when these
securities are sold.
REDEMPTION OF CERTAIN CLASS A SHARES
Certain purchases of Class A Shares in the amount of $1,000,000 or more, on
which no initial sales charge has been paid, are subject to a contingent
deferred sales charge of 0.25%. See the section entitled "Class A Shares."
GENERAL
The FUND reserves the right at any time to terminate, suspend or change the
terms of any redemption method described in this prospectus, except redemption
by mail, and to impose or change fees including fees for services in connection
with exchanges.
Except as otherwise noted, neither the FUND, KIRC nor KDI assumes
responsibility for the authenticity of any instructions received by any of them
from a shareholder in writing, over the Keystone Automated Response Line
("KARL") or by telephone. KIRC will employ reasonable procedures to confirm that
instructions received over KARL or by telephone are genuine. Neither the FUND,
KIRC nor KDI will be liable when following instructions received over KARL or by
telephone that KIRC reasonably believes to be genuine.
The FUND may temporarily suspend the right to redeem its shares when (1) the
Exchange is closed, other than customary weekend and holiday closings; (2)
trading on the Exchange is restricted; (3) an emergency exists and the FUND
cannot dispose of its investments or fairly determine their value; or (4) the
Securities and Exchange Commission so orders.
SHAREHOLDER SERVICES
Details on all shareholder services may be obtained from KIRC by writing or by
calling toll free 1-800-343-2898.
KEYSTONE AUTOMATED RESPONSE LINE
KARL offers you specific fund account information and price, total return and
yield quotations as well as the ability to do account transactions, including
investments, exchanges and redemptions. You may access KARL by dialing toll free
1-800-346-3858 on any touch-tone telephone, 24 hours a day, seven days a week.
EXCHANGES
If you have obtained the appropriate prospectus, you may exchange shares of a
Fund for shares of certain other Keystone America Funds and Keystone Liquid
Trust ("KLT") as follows:
Class A shares may be exchanged for Class A shares of other Keystone
America Funds and Class A shares of KLT;
Class B shares may be exchanged for Class B shares of other Keystone
America Funds and Class B shares of KLT; and
Class C shares may be exchanged for Class C shares of other Keystone
America Funds and Class C shares of KLT.
The exchange of Class B shares and Class C shares will not be subject to a
contingent deferred sales charge. However, if the shares being tendered for
exchange are
(1) Class A shares where the original purchase was for $1,000,000 or more and
no sales charge was paid,
(2) Class B shares that have been held for less than four years, or
(3) Class C shares that have been held for less than one year, and are still
subject to a deferred sales charge, such charge will carry over to the shares
being acquired in the exchange transaction.
You may exchange shares by calling toll free 1-800-343-2898, by writing KIRC
or by calling KARL. However, you must complete the Telephone Exchanges section
of the application to enjoy the telephone exchange privileges. Shares purchased
by check are eligible for exchange after 15 days. There is a $10.00 fee for each
exchange; however, there is no exchange fee for exchange orders received by the
FUND directly from an individual shareholder over KARL. The FUND reserves the
right, after providing shareholders with any required notice, to change the
terms of or to terminate this exchange offer, including the right to change the
service charge for any exchange.
Orders to exchange shares of a Fund for shares of KLT will be executed by
redeeming the shares of the Fund and purchasing shares of KLT at the net asset
value of KLT shares next determined after the proceeds from such redemption
become available, which may be up to seven days after such redemption. In all
other cases, orders for exchanges received by the FUND prior to 4:00 p.m.
eastern time on any day the FUND is open for business will be executed at the
respective net asset values determined as of the close of business that day.
Orders for exchanges received after 4:00 p.m. eastern time on any business day
will be executed at the respective net asset values determined at the close of
the next business day.
An excessive number of exchanges may be disadvantageous to the FUND.
Therefore, the FUND, in addition to its right to reject any exchange, reserves
the right to terminate the exchange privilege of any shareholder who makes more
than five exchanges of shares of the Funds in a year or three in a calendar
quarter.
An exchange order must comply with the requirements for a redemption or
repurchase order and must specify the dollar value or number of shares to be
exchanged. Exchanges are subject to the minimum initial purchase requirements of
the fund being acquired. An exchange constitutes a sale for federal income tax
purposes.
The exchange privilege is available only in states where shares of the fund
being acquired may legally be sold.
KEYSTONE AMERICA MONEY LINE
Keystone America Money Line eliminates the delay of mailing a check or the
expense of wiring funds. You must request the service on your application.
Keystone America Money Line allows you to authorize electronic transfers of
money to purchase a Fund's shares in any amount and to redeem up to $50,000
worth of a Fund's shares. You can use Keystone America Money Line like an
"electronic check" to move money between your bank account and your account in
the FUND with one telephone call. You must allow two business days after the
call for the transfer to take place. For money recently invested, you must allow
normal check clearing time before redemption proceeds are sent to your bank.
You may also arrange for systematic monthly or quarterly investments in your
Keystone America account. Once proper authorization is given, your bank account
will be debited to purchase shares in the Fund specified in your account
application. You will receive confirmation from KDI for every transaction.
To change the amount of or terminate a Keystone America Money Line service
(which could take up to 30 days), you must write to KIRC, P.O. Box 2121, Boston,
Massachusetts 02106-2121, and include your account number.
AUTOMATIC WITHDRAWAL PLAN
Under an Automatic Withdrawal Plan, if your account for a Fund's shares has a
value of at least $10,000, you may arrange for regular monthly or quarterly
fixed withdrawal payments. Each payment must be at least $100 and may be as much
as 1.5% per month or 4.5% per quarter of the total net asset value of the Fund
shares in your account when the Automatic Withdrawal Plan is opened. Excessive
withdrawals may decrease or deplete the value of your account. Because of the
effect of the applicable sales charge, a Class A investor should not make
continuous purchases of a Fund's shares while participating in an Automatic
Withdrawal Program.
DOLLAR COST AVERAGING
Through dollar cost averaging you can invest a fixed dollar amount each month
or each quarter in any Keystone America Fund. This results in more shares being
purchased when the selected fund's net asset value is relatively low and fewer
shares being purchased when the fund's net asset value is relatively high, which
may cause a lower average cost per share than a less systematic investment
approach.
Prior to participating in dollar cost averaging, you must have established an
account in a Keystone America Fund or a money market fund managed or advised by
Keystone. You should designate on the application the dollar amount of each
monthly or quarterly investment (minimum $100) you wish to make and the fund in
which the investment is to be made. Thereafter, on the first day of the
designated month an amount equal to the specified monthly or quarterly
investment will automatically be redeemed from your initial account and invested
in shares of the designated fund. If you are a Class A investor and paid a sales
charge on your initial purchase, the shares purchased will be eligible for
Rights of Accumulation and the sales charge applicable to the purchase will be
determined accordingly. In addition, the value of shares purchased will be
included in the total amount required to fulfill a Letter of Intent. If a sales
charge was not paid on the initial purchase, a sales charge will be imposed at
the time of subsequent purchases and the value of shares purchased will become
eligible for Rights of Accumulation and Letters of Intent.
TWO DIMENSIONAL INVESTING
You may elect to have income and capital gains distributions from any of your
Keystone America Funds automatically invested to purchase Class A shares of any
other Keystone America Fund. You may select this service on the application and
indicate the Keystone America Fund(s) into which distributions are to be
invested. The value of shares purchased will be ineligible for Rights of
Accumulation and Letters of Intent.
OTHER SERVICES
Under certain circumstances you may, within 30 days after a redemption,
reinstate your account at current net asset value.
PERFORMANCE DATA
From time to time a Fund may advertise "total return," "current yield" and a
"tax equivalent yield." ALL FIGURES ARE BASED ON HISTORICAL EARNINGS AND ARE NOT
INTENDED TO INDICATE FUTURE PERFORMANCE. Total return and total yield are
computed separately for each class of shares of a Fund. Total return refers to a
Fund's average annual compounded rates of return over specified periods
determined by comparing the initial amount invested in a particular class to the
ending redeemable value of that amount. The resulting equation assumes
reinvestment of all dividends and distributions and deduction of the maximum
sales charge and all recurring charges, if any, applicable to all shareholder
accounts. The exchange fee is not included in the calculation.
Current yield quotations represent the yield on an investment for a stated
30-day period computed by dividing net investment income earned per share during
the base period by the maximum offering price per share on the last day of the
base period. Such yield will include income from sources other than municipal
obligations, if any.
Tax equivalent yield is, in general, the current yield divided by a factor
equal to one minus a stated income tax rate and reflects the yield a taxable
investment would have to achieve in order to equal on an after-tax basis a
tax-exempt yield.
Any given yield or total return quotation should not be considered
representative of a Fund's yield or total return for any future period.
The FUND may also include comparative performance information for each class
of shares when advertising or marketing the FUND's shares, such as data from
Lipper Analytical Services, Inc., Morningstar, Inc., CDS-Weisenberger and Value
Line or other industry publications.
FUND SHARES
The FUND currently issues shares of two separate series evidencing interests
in different portfolio securities. Each Fund issues three classes of shares. The
FUND is authorized to issue additional series or classes of shares. Shares of a
Fund participate in dividends and distributions and have equal voting,
liquidation and other rights with other shares of the Fund except that (1)
expenses related to the distribution of each class of shares, or other expenses
that the Board of Trustees may designate as class expenses, from time to time,
are borne solely by each class; (2) each class of shares has exclusive voting
rights with respect to its Distribution Plan; (3) each class has different
exchange privileges; and (4) each class has a different designation. When issued
and paid for, the shares of each Fund will be fully paid and nonassessable by
the FUND. Shares of each Fund may be exchanged as explained under "Shareholder
Services," but will have no other preference, conversion, exchange or preemptive
rights. Shares are redeemable, transferable and freely assignable as collateral.
There are no sinking fund provisions.
Shareholders of a Fund are entitled to one vote for each full share owned and
fractional votes for fractional shares on all matters subject to Fund vote.
Shares of a Fund vote together except when required by law to vote separately by
class. The FUND does not have annual meetings. The FUND will have special
meetings, from time to time, as required under its Declaration of Trust and
under the 1940 Act. As provided in the FUND's Declaration of Trust, shareholders
have the right to remove Trustees by an affirmative vote of two-thirds of the
outstanding shares. A special meeting of the shareholders will be held when 10%
of the outstanding shares request a meeting for the purpose of removing a
Trustee. As prescribed by Section 16(c) of the 1940 Act, shareholders may be
eligible for shareholder communication assistance in connection with the special
meeting.
Under Massachusetts law, it is possible that a FUND shareholder may be held
personally liable for the FUND's obligations. The FUND's Declaration of Trust
provides, however, that shareholders shall not be subject to any personal
liability forthe FUND's obligations and provides indemnification from FUND
assets for any shareholder held personally liable for the FUND's obligations.
ADDITIONAL INFORMATION
KIRC, located at 101 Main Street, Cambridge, Massachusetts 02142-1519, is a
wholly-owned subsidiary of Keystone. As previously mentioned, KIRC serves as the
FUND's transfer agent and dividend disbursing agent.
When the FUND determines from its records that more than one account in the
FUND is registered in the name of a shareholder or shareholders having the same
address, upon notice to those shareholders, the FUND intends, when an annual
report or a semi-annual report of the FUND is required to be furnished, to mail
one copy of such report to that address.
Except as otherwise stated in this prospectus or required by law, the FUND
reserves the right to change the terms of the offer stated in this prospectus
without shareholder approval, including the right to impose or change fees for
services provided.
<PAGE>
- ------------------------------------------------------------------------------
ADDITIONAL INVESTMENT INFORMATION
- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------
CORPORATE AND MUNICIPAL BOND RATINGS
- ------------------------------------------------------------------------------
S&P CORPORATE AND MUNICIPAL BOND RATINGS
A. MUNICIPAL NOTES
An S&P note rating reflects the liquidity concerns and market access risks
unique to notes. Notes due in three years or less will likely receive a note
rating. Notes maturing beyond three years will most likely receive a long-term
debt rating. The following criteria are used in making that assessment:
1. amortization schedule (the larger the final maturity relative to other
maturities the more likely it will be treated as a note); and
2. source of payment (the more dependent the issue is on the market for its
refinancing, the more likely it will be treated as a note).
Note ratings are as follows:
1. SP-1 -- Strong capacity to pay principal and interest. Those issues
determined to possess a very strong capacity to pay debt service is given
a plus (+) designation.
2. SP-2 -- Satisfactory capacity to pay principal and interest, with some
vulnerability to adverse financial and economic changes over the terms of
the notes.
3. SP-3 -- Speculative capacity to pay principal and interest.
B. TAX EXEMPT DEMAND BONDS
S&P assigns "dual" ratings to all long-term debt issues that have as part of
their provisions a demand or double feature.
The first rating addresses the likelihood of repayment of principal and interest
as due, and the second rating addresses only the demand feature. The long-term
debt rating symbols are used for bonds to denote the long-term maturity and the
commercial paper rating symbols are used to denote the put option (for example,
"AAA/A-1+"). For the newer "demand notes," S&P note rating symbols, combined
with the commercial paper symbols, are used (for example, "SP -- 1+/A-1+" ).
C. CORPORATE AND MUNICIPAL BOND RATINGS
An S&P corporate or municipal bond rating is a current assessment of the
creditworthiness of an obligor, including obligors outside the U.S., with
respect to a specific obligation. This assessment may take into consideration
obligors such as guarantors, insurers or lessees. Ratings of foreign obligors do
not take into account currency exchange and related uncertainties. The ratings
are based on current information furnished by the issuer or obtained by S&P from
other sources it considers reliable.
The ratings are based, in varying degrees, on the following considerations:
1. likelihood of default capacity and willingness of the obligor as to the
timely payment of interest and repayment of principal in accordance with the
terms of the obligation;
2. nature of and provisions of the obligation; and
3. protection afforded by and relative position of the obligation in the
event of bankruptcy reorganization or other arrangement under the laws of
bankruptcy and other laws affecting creditors' rights.
PLUS (+) OR MINUS (-): To provide more detailed indications of credit quality,
ratings from "AA" to "BBB" may be modified by the addition of a plus or minus
sign to show relative standing within the major rating categories.
A provisional rating is sometimes used by S&P. It assumes the successful
completion of the project being financed by the debt being rated and indicates
that payment of debt service requirements is largely or entirely dependent upon
the successful and timely completion of the project. This rating, however, while
addressing credit quality subsequent to completion of the project, makes no
comment on the likelihood of, or the risk of default upon failure of, such
completion.
D. BOND RATINGS ARE AS FOLLOWS:
1. AAA -- Debt rated AAA has the highest rating assigned by S&P. Capacity to
pay interest and repay principal is extremely strong.
2. AA -- Debt rated AA has a very strong capacity to pay interest and repay
principal and differs from the higher rated issues only in small degree.
3. A -- Debt rated A has a strong capacity to pay interest and repay principal
although it is somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in higher rated categories.
4. BBB -- Debt rated BBB is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher rated categories.
MOODY'S CORPORATE AND MUNICIPAL BOND RATINGS
A. MUNICIPAL NOTES
A Moody's rating for municipal short-term obligations will be designated Moody's
Investment Grade or (MIG). These ratings recognize the difference between
short-term credit risk and long-term risk. Factors affecting the liquidity of
the borrower and the short-term cyclical elements are critical in short-term
ratings.
A short-term rating may also be assigned on issues with a demand feature --
variable rate demand obligation (VRDO). Such ratings will be designated as VMIG.
Short-term ratings on issues with demand features are differentiated by the use
of the VMIG symbol to reflect such characteristics as payment upon periodic
demand rather than fixed maturity dates and payment relying on the external
liquidity.
The note ratings are as follows:
1. MIG1/VMIG1 This designation denotes the best quality. There is present strong
protection by established cash flows, superior liquidity support or demonstrated
broadbased access to the market for refinancing.
2. MIG2/VMIG2 This designation denotes high quality. Margins of protection are
ample although not so large as in the preceding group.
3. MIG3/VMIG3 This designation denotes favorable quality. All security elements
are accounted for but there is lacking the undeniable strength of the preceding
grades. Liquidity and cash flow protection may be narrow and market access for
refinancing is likely to be less well established.
4. MIG4/VMIG4 This designation denotes adequate quality. Protection commonly
regarded as required of an investment security is present and although not
distinctly or predominantly speculative, there is specific risk.
B. CORPORATE AND MUNICIPAL BOND RATINGS
1. Aaa -- Bonds rated Aaa are judged to be of the best quality. They carry the
smallest degree of investment risk and are generally referred to as "gilt-
edge." 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.
2. Aa -- Bonds rated Aa are judged to be of high quality by all standards.
Together with the Aaa group, they comprise what are generally known as high
grade bonds. 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 that
make the long term risks appear somewhat larger than in Aaa securities.
3. A -- Bonds 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 that
suggest a susceptibility to impairment sometime in the future.
4. Baa -- Bonds rated Baa are considered to be 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.
Moody's applies numerical modifiers, 1, 2 and 3 in each generic rating
classification from Aa through Baa in its corporate bond rating system. The
modifier 1 indicates that the security ranks in the higher end of its generic
rating category; the modifier 2 indicates a mid-range ranking; and the modifier
3 indicates that the issue ranks in the lower end of its generic rating
category.
CON. (--) -- Municipal bonds for which the security depends upon the completion
of some act or the fulfillment of some condition are rated conditionally. These
are bonds secured by (1) earnings of projects under construction, (2) earnings
of projects unseasoned in operation experience, (3) rentals that begin when
facilities are completed, or (4) payments to which some other limiting condition
attaches. Parenthetical rating denotes probable credit stature upon completion
of construction or elimination of basis of condition.
Those municipal bonds in the Aa, A, and Baa groups that Moody's believes possess
the strongest investment attributes are designated by the symbols Aa 1, A 1, and
Baa 1.
FITCH CORPORATE AND MUNICIPAL RATINGS
A. MUNICIPAL NOTES
Fitch's short-term ratings apply to debt obligations that are payable on
demand or have original maturities of generally three years or less. These
include commercial paper, certificates of deposit, medium-term notes, and
municipal and investment notes. The short-term rating places greater emphasis on
the existence of liquidity necessary to meet the issuer's obligations in a
timely manner.
The note ratings are as follows:
1. F-1+ Exceptionally Strong Credit Quality. Issues assigned this rating are
regarded as having the strongest degree of assurance for timely payment.
2. F-1 Very Strong Credit Quality. Issues assigned this rating reflect an
assurance of timely payment only slightly less in degree than issues rated
F-1+.
3. F-2 Good Credit Quality. Issues assigned this rating have a satisfactory
degree of assurance for timely payment, but the margin of safety is not as great
as for issues assigned the two higher ratings.
4. F-3 Fair Credit Quality. Issues assigned this rating have characteristics
suggesting that the degree of assurance for timely payment is adequate, however,
near-term adverse changes could cause these securities to be rated below
investment grade.
B. CORPORATE AND MUNICIPAL BOND RATINGS
AAA -- Bonds considered to be investment grade and of the highest credit
quality. The obligor has an exceptionally strong ability to pay interest and
repay principal, which is unlikely to be affected by reasonably foreseeable
events.
AA -- Bonds considered to be investment grade and of very high credit quality.
The obligor's ability to pay interest and repay principal is very strong,
although not quite as strong as bonds rated AAA.
A -- Bonds considered to be investment grade and of high credit quality. The
obligor's ability to pay interest and repay principal is considered to be
strong, but may be more vulnerable to adverse changes in economic conditions and
circumstances than bonds with higher ratings.
BBB -- Bonds considered to be investment grade and of satisfactory credit
quality. The obligor's ability to pay interest and repay principal is considered
to be adequate. Adverse changes in economic conditions and circumstances,
however, are more likely to have adverse impact on these bonds, and therefore
impair timely payment. The likelihood that the ratings of these bonds will fall
below investment grade is higher than for bonds with higher ratings.
PLUS (+) OR MINUS (-) signs are used with a rating symbol to indicate the
relative position of a credit within the rating category. Plus and minus signs,
however, are not used in the AAA category. A CONDITIONAL rating is premised on
the successful completion of a project or the occurrence of a specific event.
Debt rated BB, B, CCC, CC and C by S&P is regarded, on balance, as predominantly
speculative with respect to 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 debt will likely
have some quality and protective characteristics, these are outweighed by large
uncertainties or major risk exposures to adverse conditions. Debt rated C1 by
S&P is debt (income bonds) on which no interest is being paid. Debt rated D by
S&P is in default and payment of interest and/ or repayment of principal is in
arrears. The Funds intend to invest in D-rated debt only in cases where in
Keystone's judgment there is a distinct prospect of improvement in the issuer's
financial position as a result of the completion of reorganization or otherwise.
Bonds that are rated Caa by Moody's are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal or
interest. Bonds that are rated Ca by Moody's represent obligations that are
speculative in a high degree. Such issues are often in default or have other
market shortcomings. Bonds that are rated C by Moody's are the lowest rated
bonds, and issues so rated can be regarded as having extremely poor prospects of
ever attaining any real investment standing. Debt rated BB, B, CCC, CC, and C by
Fitch is regarded as speculative with respect to capacity to pay interest and
repay principal in accordance with the terms of the obligation. BB indicates the
lowest degree of speculation and C represents the highest degree of speculation.
Debt rated DDD, DD, and D are in default on interest and/or principal payments.
DESCRIPTIONS OF CERTAIN TYPES OF INVESTMENTS AND INVESTMENT TECHNIQUES AVAILABLE
TO THE FUNDS
OBLIGATIONS OF FOREIGN BRANCHES OF UNITED STATES BANKS
The obligations of foreign branches of U.S. banks may be general obligations
of the parent bank in addition to the issuing branch, or may be limited by the
terms of a specific obligation and by government regulation. Payment of interest
and principal upon these obligations may also be affected by governmental action
in the country of domicile of the branch (generally referred to as sovereign
risk). In addition, evidences of ownership of such securities may be held
outside the U.S. and a Fund may be subject to the risks associated with the
holding of such property overseas. Examples of governmental actions would be the
imposition of currency controls, interest limitations, withholding taxes,
seizure of assets or the declaration of a moratorium. Various provisions of
federal law governing domestic branches do not apply to foreign branches of
domestic banks.
OBLIGATIONS OF UNITED STATES BRANCHES OF FOREIGN BANKS
Obligations of U.S. branches of foreign banks may be general obligations of the
parent bank in addition to the issuing branch, or may be limited by the terms of
a specific obligation and by federal and state regulation as well as by
governmental action in the country in which the foreign bank has its head
office. In addition, there may be less publicly available information about a
U.S. branch of a foreign bank than about a domestic bank.
MASTER DEMAND NOTES
Master demand notes are unsecured obligations that permit the investment of
fluctuating amounts by a Fund at varying rates of interest pursuant to direct
arrangements between the Fund, as lender, and the issuer as borrower. Master
demand notes may permit daily fluctuations in the interest rate and daily
changes in the amounts borrowed. A Fund has the right to increase the amount
under the note at any time up to the full amount provided by the note agreement,
or to decrease the amount. The borrower may repay up to the full amount of the
note without penalty. Notes acquired by a Fund permit the Fund to demand payment
of principal and accrued interest at any time (on not more than seven days'
notice). Notes acquired by a Fund may have maturities of more than one year,
provided that (1) the Fund is entitled to payment of principal and accrued
interest upon not more than seven days notice, and (2) the rate of interest on
such notes is adjusted automatically at periodic intervals which normally will
not exceed 31 days, but may extend up to one year. The notes will be deemed to
have a maturity equal to the longer of the period remaining to the next interest
rate adjustment or the demand notice period. Because these types of notes are
direct lending arrangements between the lender and borrower, such instruments
are not normally traded and there is no secondary market for these notes,
although they are redeemable and thus repayable by the borrower at face value
plus accrued interest at any time. Accordingly, a Fund's right to redeem is
dependent on the ability of the borrower to pay principal and interest on
demand. In connection with master demand note arrangements, Keystone considers,
under standards established by the Board of Trustees, earning power, cash flow
and other liquidity ratios of the borrower and will monitor the ability of the
borrower to pay principal and interest on demand. These notes are not typically
rated by credit rating agencies. Unless rated, a Fund may invest in them only if
at the time of an investment the issuer meets the criteria established for
commercial paper discussed in the statement of additional information.
REPURCHASE AGREEMENTS
A Fund may enter into repurchase agreements with member banks of the Federal
Reserve System having at least $1 billion in assets, primary dealers in U.S.
government securities or other financial institutions believed by Keystone to be
creditworthy. Such persons must be registered as U.S. government securities
dealers with appropriate regulatory organizations. Under such agreements, the
bank, primary dealer or other financial institution agrees upon entering into
the contract to repurchase the security at a mutually agreed upon date and
price, thereby determining the yield during the term of the agreement. This
results in a fixed rate of return insulated from market fluctuations during such
period. Under a repurchase agreement, the seller must maintain the value of the
securities subject to the agreement at not less than the repurchase price, such
value being determined on a daily basis by marking the underlying securities to
their market value. Although the securities subject to the repurchase agreement
might bear maturities exceeding a year, the Funds only intend to enter into
repurchase agreements that provide for settlement within a year and usually
within seven days. Securities subject to repurchase agreements will be held by
the FUND's custodian or in the Federal Reserve book entry system. The Funds do
not bear the risk of a decline in the value of the underlying security unless
the seller defaults under its repurchase obligation. In the event of a
bankruptcy or other default of a seller of a repurchase agreement, a Fund could
experience both delays in liquidating the underlying securities and losses,
including (1) possible declines in the value of the underlying securities during
the period while the Fund seeks to enforce its rights thereto; (2) possible
subnormal levels of income and lack of access to income during this period; and
(3) expenses of enforcing its rights. The Board of Trustees has established
procedures to evaluate the creditworthiness of each party with whom each Fund
enters into repurchase agreements by setting guidelines and standards of review
for Keystone and monitoring Keystone's actions with regard to repurchase
agreements.
REVERSE REPURCHASE AGREEMENTS
Under a reverse repurchase agreement, a Fund would sell securities and agree
to repurchase them at a mutually agreed upon date and price. Each Fund intends
to enter into reverse repurchase agreements to avoid otherwise having to sell
securities during unfavorable market conditions in order to meet redemptions. At
the time a Fund enters into a reverse repurchase agreement, it will establish a
segregated account with the FUND's custodian containing liquid assets such as
U.S. government securities or other high grade debt securities having a value
not less than the repurchase price (including accrued interest) and will
subsequently monitor the account to ensure such value is maintained. Reverse
repurchase agreements involve the risk that the market value of the securities
that a Fund is obligated to repurchase may decline below the repurchase price.
Borrowing and reverse repurchase agreements magnify the potential for gain or
loss on the portfolio securities of a Fund and, therefore, increase the
possibility of fluctuation in the Fund's net asset value. Such practices may
constitute leveraging. In the event the buyer of securities under a reverse
repurchase agreement files for bankruptcy or becomes insolvent, such buyer or
its trustee or receiver may receive an extension of time to determine whether to
enforce a Fund's obligation to repurchase the securities and the Fund's use of
the proceeds of the reverse repurchase agreement may effectively be restricted
pending such determination. The staff of the Securities and Exchange Commission
("SEC") has taken the position that the 1940 Act treats reverse repurchase
agreements as being included in the percentage limit on borrowings imposed on a
Fund.
"WHEN ISSUED" SECURITIES
Each Fund may also purchase and sell securities and currencies on a when
issued and delayed delivery basis. When issued or delayed delivery transactions
arise when securities or currencies are purchased or sold by a Fund with payment
and delivery taking place in the future in order to secure what is considered to
be an advantageous price and yield to the Fund at the time of entering into the
transaction. When a Fund engages in when issued and delayed delivery
transactions, the Fund relies on the buyer or seller, as the case may be, to
consummate the sale. Failure to do so may result in a Fund missing the
opportunity to obtain a price or yield considered to be advantageous. When
issued and delayed delivery transactions may be expected to occur a month or
more before delivery is due. However, no payment or delivery is made by a Fund
until it receives payment or delivery from the other party to the transaction. A
separate account of liquid assets equal to the value of such purchase
commitments will be maintained until payment is made. When issued and delayed
delivery agreements are subject to risks from changes in value based upon
changes in the level of interest rates, currency rates and other market factors,
both before and after delivery. A Fund does not accrue any income on such
securities or currencies prior to their delivery. To the extent each Fund
engages in when issued and delayed delivery transactions, it will do so
consistent with its investment objective and policies and not for the purpose of
investment leverage.
LOANS OF SECURITIES TO BROKER-DEALERS
Each Fund may lend securities to brokers and dealers pursuant to agreements
requiring that the loans be continuously secured by cash or securities of the
U.S. government, its agencies or instrumentalities, or any combination of cash
and such securities, as collateral equal at all times in value to at least the
market value of the securities loaned. Such securities loans will not be made
with respect to a Fund if as a result the aggregate of all outstanding
securities loans exceeds 15% of the value of the Fund's total assets taken at
their current value. A Fund continues to receive interest or dividends on the
securities loaned and simultaneously earns interest on the investment of the
cash loan collateral in U.S. Treasury notes, certificates of deposit, other
high-grade, short-term obligations or interest bearing cash equivalents.
Although voting rights attendant to securities loaned pass to the borrower, such
loans may be called at any time and will be called so that the securities may be
voted by a Fund if, in the opinion of the Fund, a material event affecting the
investment is to occur. There may be risks of delay in receiving additional
collateral or in recovering the securities loaned or even loss of rights in the
collateral should the borrower of the securities fail financially. Loans may
only be made to borrowers deemed to be of good standing, under standards
approved by the Board of Trustees, when the income to be earned from the loan
justifies the attendant risks.
DERIVATIVES
Each Fund may use derivatives in furtherance of its investment objective.
Derivatives are financial contracts whose value depends on, or is derived from,
the value of an underlying asset, reference rate or index. These assets, rates,
and indices may include bonds, stocks, mortgages, commodities, interest rates,
currency exchange rates, bond indices and stock indices. Derivatives can be used
to earn income or protect against risk, or both. For example, one party with
unwanted risk may agree to pass that risk to another party who is willing to
accept the risk, the second party being motivated, for example, by the desire
either to earn income in the form of a fee or premium from the first party, or
to reduce its own unwanted risk by attempting to pass all or part of that risk
to the first party.
Derivatives can be used by investors such as the Funds to earn income and
enhance returns, to hedge or adjust the risk profile of the portfolio, and
either in place of more traditional direct investments or to obtain exposure to
otherwise inaccessible markets. Each Fund is permitted to use derivatives for
one or more of these purposes. Each of these uses entails greater risk than if
derivatives were used solely for hedging purposes. The Funds use futures
contracts and related options for hedging purposes. Derivatives are a valuable
tool which, when used properly, can provide significant benefit to a Fund's
shareholders. Keystone is not an aggressive user of derivatives with respect to
the Funds. However, a Fund may take positions in those derivatives that are
within its investment policies if, in Keystone's judgement, this represents an
effective response to current or anticipated market conditions. Keystone's use
of derivatives is subject to continuous risk assessment and control from the
standpoint of a Fund's investment objectives and policies.
Derivatives may be (1) standardized, exchange-traded contracts or (2)
customized, privately negotiated contracts. Exchange-traded derivatives tend to
be more liquid and subject to less credit risk than those that are privately
negotiated.
There are four principal types of derivative instruments -- options, futures,
forwards and swaps -- from which virtually any type of derivative transaction
can be created. Further information regarding options and futures, is provided
later in this section and is provided in the FUND's statement of additional
information.
Debt instruments that incorporate one or more of these building blocks for the
purpose of determining the principal amount of and/or rate of interest payable
on the debt instruments are often referred to as "structured securities." An
example of this type of structured security is indexed commercial paper. The
term is also used to describe certain securities issued in connection with the
restructuring of certain foreign obligations. See "Structured Securities" below.
The term "derivative" is also sometimes used to describe securities involving
rights to a portion of the cash flows from an underlying pool of mortgages or
other assets from which payments are passed through to the owner of, or that
collateralize, the securities.
While the judicious use of derivatives by experienced investment managers such
as Keystone can be beneficial, derivatives also involve risks different from,
and, in certain cases, greater than, the risks presented by more traditional
investments. Following is a general discussion of important risk factors and
issues concerning the use of derivatives that investors should understand before
investing in a Fund.
* Market Risk -- This is the general risk attendant to all investments that the
value of a particular investment will decline or otherwise change in a way
detrimental to a Fund's interest.
* Management Risk -- Derivative products are highly specialized instruments that
require investment techniques and risk analyses different from those
associated with stocks and bonds. The use of a derivative requires an
understanding not only of the underlying instrument, but also of the
derivative itself, without the benefit of observing the performance of the
derivative under all possible market conditions. In particular, the use and
complexity of derivatives require the maintenance of adequate controls to
monitor the transactions entered into, the ability to assess the risk that a
derivative adds to a Fund's portfolio and the ability to forecast price,
interest rate or currency exchange rate movements correctly.
* Credit Risk -- This is the risk that a loss may be sustained by a Fund as a
result of the failure of a another party to a derivative (usually referred to
as a "counterparty") to comply with the terms of the derivative contract. The
credit risk for exchange traded derivatives is generally less than for
privately negotiated derivatives, since the clearing house, which is the
issuer or counterparty to each exchange-traded derivative, provides a
guarantee of performance. This guarantee is supported by a daily payment
system (i.e., margin requirements) operated by the clearing house in order to
reduce overall credit risk. For privately negotiated derivatives, there is no
similar clearing agency guarantee. Therefore, a Fund considers the
creditworthiness of each counterparty to a privately negotiated derivative in
evaluating potential credit risk.
* Liquidity Risk -- Liquidity risk exists when a particular instrument is
difficult to purchase or sell. If a derivative transaction is particularly
large or if the relevant market is illiquid (as is the case with many
privately negotiated derivatives), it may not be possible to initiate a
transaction or liquidate a position at an advantageous price.
* Leverage Risk -- Since many derivatives have a leverage component, adverse
changes in the value or level of the underlying asset, rate or index can
result in a loss substantially greater than the amount invested in the
derivative itself. In the case of swaps, the risk of loss generally is related
to a notional principal amount, even if the parties have not made any initial
investment. Certain derivatives have the potential for unlimited loss,
regardless of the size of the initial investment.
* Other Risks -- Other risks in using derivatives include the risk of mispricing
or improper valuation and the inability of derivatives to correlate perfectly
with underlying assets, rates and indices. Many derivatives, in particular
privately negotiated derivatives, are complex and often valued subjectively.
Improper valuations can result in increased cash payment requirements to
counterparties or a loss of value to a Fund. Derivatives do not always
perfectly or even highly correlate or track the value of the assets, rates or
indices they are designed to closely track. Consequently, a Fund's use of
derivatives may not always be an effective means of, and sometimes could be
counterproductive to, furthering the Fund's investment objective.
OPTIONS TRANSACTIONS
WRITING COVERED OPTIONS. Each Fund may write (i.e., sell) covered call and put
options. By writing a call option, the Fund becomes obligated during the term of
the option to deliver the securities underlying the option upon payment of the
exercise price. By writing a put option, a Fund becomes obligated during the
term of the option to purchase the securities underlying the option at the
exercise price if the option is exercised. Each Fund also may write straddles
(combinations of covered puts and calls on the same underlying security).
Each Fund may only write "covered" options. This means that so long as a Fund
is obligated as the writer of a call option, it will own the underlying
securities subject to the option or, in the case of call options on U.S.
Treasury bills, the Fund might own substantially similar U.S. Treasury bills. If
a Fund has written options against all of its securities which are available for
writing options, the Fund may be unable to write additional options unless it
sells a portion of its portfolio holdings to obtain new securities against which
it can write options. If this were to occur, higher portfolio turnover and
correspondingly greater brokerage commissions and other transaction costs may
result. However, the Funds do not expect that this will occur.
Each Fund will be considered "covered" with respect to a put option it writes
if, so long as it is obligated as the writer of the put option, it deposits and
maintains with its custodian in a segregated account liquid assets having a
value equal to or greater than the exercise price of the option.
The principal reason for writing call or put options is to obtain, through a
receipt of premiums, a greater current return than would be realized on the
underlying securities alone. A Fund receives a premium from writing a call or
put option, which it retains whether or not the option is exercised. By writing
a call option, a Fund might lose the potential for gain on the underlying
security while the option is open, and by writing a put option the Fund might
become obligated to purchase the underlying security for more than its current
market price upon exercise.
PURCHASING OPTIONS. Each Fund may purchase put or call options, including
purchasing put or call options for the purpose of offsetting previously written
put or call options of the same series.
If a Fund is unable to effect a closing purchase transaction with respect to
covered options it has written, the Fund will not be able to sell the underlying
security or dispose of assets held in a segregated account until the options
expire or are exercised.
An option position may be closed out only in a secondary market for an option
of the same series. Although a Fund generally will write only those options for
which there appears to be an active secondary market, there is no assurance that
a liquid secondary market will exist for any particular option at any particular
time, and for some options no secondary market may exist. In such event, it
might not be possible to effect a closing transaction in a particular option.
Options on some securities are relatively new, and it is impossible to predict
the amount of trading interest that will exist in such options. There can be no
assurance that viable markets will develop or continue. The failure of such
markets to develop or continue could significantly impair a Fund's ability to
use such options to achieve its investment objective.
OPTIONS TRADING MARKETS. Options in which the Fund will trade generally are
listed on national securities exchanges. Exchanges on which such options
currently are traded include the Chicago Board Options Exchange and the New
York, American, Pacific and Philadelphia Stock Exchanges. Options on some
securities may not be listed on any Exchange, but traded in the over-the-counter
market. Options traded in the over-the-counter market involve the additional
risk that securities dealers participating in such transactions could fail to
meet their obligations to a Fund. The use of options traded in the
over-the-counter market may be subject to limitations imposed by certain state
securities authorities. In addition to the limits on its use of options
discussed herein, each Fund is subject to the investment restrictions described
in this prospectus and in the statement of additional information.
The staff of the SEC is of the view that the premiums that a Fund pays for the
purchase of unlisted options, and the value of securities used to cover unlisted
options written by a Fund, are considered to be invested in illiquid securities
or assets for the purpose of calculating whether the Fund is in compliance with
its investment restriction relating to illiquid investments.
FUTURES TRANSACTIONS
Each Fund may enter into currency and other financial futures contracts and
write options on such contracts. Each Fund intends to enter into such contracts
and related options for hedging purposes. Each Fund will enter into futures on
securities or currencies or index-based futures contracts in order to hedge
against changes in interest or exchange rates or securities prices. A futures
contract on securities or currencies is an agreement to buy or sell securities
or currencies at a specified price during a designated month. A futures contract
on a securities index does not involve the actual delivery of securities, but
merely requires the payment of a cash settlement based on changes in the
securities index. A Fund does not make payment or deliver securities upon
entering into a futures contract. Instead, it puts down a margin deposit, which
is adjusted to reflect changes in the value of the contract and which continues
until the contract is terminated.
Each Fund may sell or purchase futures contracts. When a futures contract is
sold by the Fund, the value of a Fund's contract will tend to rise when the
value of the underlying securities or currencies declines and to fall when the
value of such securities or currencies increases. Thus, each Fund sells futures
contracts in order to offset a possible decline in the value of its securities
or currencies. If a futures contract is purchased by a Fund, the value of the
contract will tend to rise when the value of the underlying securities or
currencies increases and to fall when the value of such securities or currencies
declines. Each Fund intends to purchase futures contracts in order to establish
what is believed by Keystone to be a favorable price and rate of return for
securities or favorable exchange rate for currencies the Fund intends to
purchase.
Each Fund also intends to purchase put and call options on futures contracts
for hedging purposes. A put option purchased by a Fund would give it the right
to assume a position as the seller of a futures contract. A call option
purchased by a Fund would give it the right to assume a position as the
purchaser of a futures contract. The purchase of an option on a futures contract
requires a Fund to pay a premium. In exchange for the premium, a Fund becomes
entitled to exercise the benefits, if any, provided by the futures contract, but
is not required to take any action under the contract. If the option cannot be
exercised profitably before it expires, a Fund's loss will be limited to the
amount of the premium and any transaction costs.
Each Fund may enter into closing purchase and sale transactions in order to
terminate a futures contract and may sell put and call options for the purpose
of closing out its options positions. A Fund's ability to enter into closing
transactions depends on the development and maintenance of a liquid secondary
market. There is no assurance that a liquid secondary market will exist for any
particular contract or at any particular time. As a result, there can be no
assurance that a Fund will be able to enter into an offsetting transaction with
respect to a particular contract at a particular time. If a Fund is not able to
enter into an offsetting transaction, the Fund will continue to be required to
maintain the margin deposits on the contract and to complete the contract
according to its terms, in which case it would continue to bear market risk on
the transaction.
Although futures and options transactions are intended to enable a Fund to
manage market, interest rate or exchange rate risk, unanticipated changes in
interest rates, exchange rates or market prices could result in poorer
performance than if it had not entered into these transactions. Even if Keystone
correctly predicts interest or exchange rate movements, a hedge could be
unsuccessful if changes in the value of a Fund's futures position did not
correspond to changes in the value of its investments. This lack of correlation
between a Fund's futures and securities or currencies positions may be caused by
differences between the futures and securities or currencies markets or by
differences between the securities or currencies underlying a Fund's futures
position and the securities or currencies held by or to be purchased for a Fund.
Keystone will attempt to minimize these risks through careful selection and
monitoring of the Fund's futures and options positions.
The Funds do not intend to use futures transactions for speculation or
leverage. Each Fund has the ability to write options on futures, but intends to
write such options only to close out options purchased by a Fund. The Funds will
not change these policies without supplementing the information in the FUND's
prospectus and statement of additional information.
FOREIGN CURRENCY TRANSACTIONS
As discussed above, each Fund may invest in securities of foreign issuers.
When a Fund invests in foreign securities they usually will be denominated in
foreign currencies, and the Fund temporarily may hold funds in foreign
currencies. Thus, the value of Fund shares will be affected by changes in
exchange rates.
As one way of managing exchange rate risk, in addition to entering into
currency futures contracts, a Fund may enter into forward currency exchange
contracts (agreements to purchase or sell currencies at a specified price and
date). The exchange rate for the transaction (the amount of currency a Fund will
deliver or receive when the contract is completed) is fixed when a Fund enters
into the contract. A Fund usually will enter into these contracts to stabilize
the U.S. dollar value of a security it has agreed to buy or sell. Each Fund
intends to use these contracts to hedge the U.S. dollar value of a security it
already owns, particularly if a Fund expects a decrease in the value of the
currency in which the foreign security is denominated. Although a Fund will
attempt to benefit from using forward contracts, the success of its hedging
strategy will depend on Keystone's ability to predict accurately the future
exchange rates between foreign currencies and the U.S. dollar. The value of a
Fund's investments denominated in foreign currencies will depend on the relative
strength of those currencies and the U.S. dollar, and a Fund may be affected
favorably or unfavorably by changes in the exchange rates or exchange control
regulations between foreign currencies and the dollar. Changes in foreign
currency exchange rates also may affect the value of dividends and interest
earned, gains and losses realized on the sale of securities and net investment
income and gains, if any, to be distributed to shareholders by a Fund. Each Fund
may also purchase and sell options related to foreign currencies in connection
with hedging strategies.
INVERSE FLOATING RATE SECURITIES. If permitted by its investment policies, a
Fund may also invest in securities with rates that move inversely to market
rates ("inverse floaters"). An inverse floater bears an interest rate that
resets in the opposite direction of the change in a specified interest rate
index. As market interest rates rise, the interest rate on the inverse floater
goes down, and vice versa. Inverse floaters tend to exhibit greater price
volatility than fixed-rate bonds of similar maturity and credit quality. The
interest rates on inverse floaters may be significantly reduced, even to zero,
if interest rates rise. Moreover, the secondary market for inverse floaters may
be limited in rising interest rate environments.
VARIABLE, FLOATING AND LEVERAGED INVERSE FLOATING RATE INSTRUMENTS. Fixed-income
securities may have fixed, variable or floating rates of interest. Variable and
floating rate securities pay interest at rates that are adjusted periodically,
according to a specified formula. A "variable" interest rate adjusts at
predetermined intervals (e.g., daily, weekly or monthly), while a "floating"
interest rate adjusts whenever a specified benchmark rate (such as the bank
prime lending rate) changes.
The Fund may invest in fixed-income securities that pay interest at a coupon
rate equal to a base rate, plus additional interest for a certain period of time
if short-term interest rates rise above a predetermined level or "cap." The
amount of such an additional interest payment typically is calculated under a
formula based on a short-term interest rate index multiplied by a designated
factor.
An inverse floater may be considered to be leveraged to the extent that its
interest rate varies by a magnitude that exceeds the magnitude of the change in
the index rate of interest. The higher degree of leverage inherent in inverse
floaters is associated with greater volatility in market value.
STRUCTURED SECURITIES. Structured securities generally represent interests in
entities organized and operated solely for the purpose of restructuring the
investment characteristics of debt obligations. This type of restructuring
involves the deposit with or purchase by an entity, such as a corporation or
trust, of specified instruments (such as commercial bank loans) and the issuance
by that entity of one or more classes of structured securities backed by, or
representing interests in, the underlying instruments. The cash flow on the
underlying instruments may be apportioned among the newly issued structured
securities to create securities with different investment characteristics such
as varying maturities, payment priorities and interest rate provisions, and the
extent of the payments made with respect to structured securities is dependent
on the extent of the cash flow on the underlying instruments. Because structured
securities typically involve no credit enhancement, their credit risk generally
will be equivalent to that of the underlying instruments. Structured securities
of a given class may be either subordinated or unsubordinated to the right of
payment of another class. Subordinated structured securities typically have
higher yields and present greater risks than unsubordinated structured
securities.
<PAGE>
EXHIBIT A
KEYSTONE AMERICA CALIFORNIA INSURED TAX FREE FUND
DESCRIPTION OF STATE AND LOCAL TAX TREATMENT
In the opinion of Messrs. Orrick, Herrington & Sutcliffe, California tax
counsel to the California Insured Fund, dividends paid by the California Insured
Fund that are derived from interest on debt obligations that is exempt from
regular federal and California personal income tax will not be subject to either
federal or California personal income tax when received by the California Fund's
shareholders. The pass through of exempt- interest dividends is allowed only if
the California Insured Fund meets its federal and California requirements that
at least 50% of its total assets are invested in such exempt obligations at the
end of each quarter of its fiscal year. Distributions to individual shareholders
derived from interest on state or municipal obligations issued by governmental
authorities in states other than California, short term capital gains and other
taxable income will be taxed as dividends for purposes of California personal
income taxation. The Fund's long term capital gains distributed to shareholders
will be taxed as long term capital gains to individual shareholders of the
California Insured Fund for purposes of California personal income taxation.
Present California law taxes both long term and short term capital gains at the
rates applicable to ordinary income. Generally, for corporate taxpayers subject
to the California franchise tax, all distributions will be fully taxable.
SPECIAL FACTORS AFFECTING CALIFORNIA
Through popular initiative and legislative activity, the ability of the State
and its local governments to raise money through property taxes and to increase
spending has been the subject of considerable debate and change in recent years.
Various State Constitutional amendments, for example, have been adopted that
have the effect of limiting property tax and spending increases, while
legislation has sometimes added to these limitations and has at other times
sought to reduce their impact. It can be expected that similar types of State
legislation or Constitutional proposals will continue to be introduced. To date,
these developments do not appear to have severely decreased the ability of the
State and local governments to pay principal and interest on their obligations.
Because of the uncertain impact of the aforementioned efforts and legislation,
the possible inconsistencies in the terms of existing statutes, and the
impossibility of predicting the level of future appropriations and applicability
of related statutes to such questions, it is not currently possible to predict
the results of such legislation and policies on the long term ability of State
and municipal issuers to pay principal and interest on their obligations.
California's economy is large and diverse, accounting for about 13% of
national personal income. Growth was rapid in the 1980s and is expected to
continue, although more moderately. California's economy is the eighth largest
in the world and the State ranks number one among the fifty states in
manufacturing, foreign trade, agriculture, construction and tourism. Through the
1980s, the rate of state population growth was more than twice that for the
nation.
Currently, California is experiencing the effects of the recession more
severely than the nation. Personal income growth has been below national rates
for the past two years and in first quarter 1993. Deep defense budget cuts,
overbuilt commercial real estate, consolidation and decline in the State's
financial services industry and high business and living costs, especially
compared to neighboring Western states, are expected to produce slower growth
for several years.
An expanded discussion is contained in the Statement of Additional
Information.
<PAGE>
KEYSTONE AMERICA MISSOURI TAX FREE FUND
DESCRIPTION OF STATE AND LOCAL TAX TREATMENT
In the opinion of Messrs. Bryan Cave, Missouri tax counsel to the Missouri Tax
Free Fund, dividends paid by the Missouri Tax Free Fund that qualify as tax
exempt dividends under Section 852(b)(5) of the Code will be exempt from
Missouri income tax to the extent that such dividends are derived from interest
on obligations issued by the State of Missouri or any of its political
subdivisions, or interest on obligations of the U.S. and its territories and
possessions to the extent exempt from Missouri income taxes under the laws of
the U.S.
Dividends paid by the Missouri Tax Free Fund, if any, that do not qualify as
tax exempt dividends under Section 852(b)(5) of the Code, will be exempt from
Missouri income tax only to the extent that such dividends are derived from
interest on certain U.S. obligations that the State of Missouri is expressly
prohibited from taxing under the laws of the U.S. The portion of such dividends
that is not subject to taxation by the State of Missouri may be reduced by
interest, or other expenses, in excess of $500 paid or incurred by a shareholder
in any taxable year to purchase or carry shares of the Missouri Tax Free Fund or
other investments producing income that is includable in federal gross income,
but exempt from Missouri income tax.
Dividends and distributions derived from the Missouri Tax Free Fund's other
investment income and its capital gains, to the extent includable in Federal
adjusted gross income, will be subject to Missouri income tax. Dividends and
distributions paid by the Missouri Tax Free Fund, including dividends that are
exempt from Missouri income tax as described above, may be subject to state
taxes in states other than Missouri or to local taxes. Shares in the Missouri
Fund are not subject to Missouri personal property taxes.
SPECIAL FACTORS AFFECTING MISSOURI
Missouri's economic base is diversified and includes agriculture, commerce,
manufacturing, services, trade and mining. The State's proximity to the
geographical and population centers of the nation makes the State an attractive
location for business and industry. The State has experienced a significant
increase in tourism.
In recent years, Missouri's wealth indicators have grown at a rate below the
1980s. The State's per capita personal income has been growing at a somewhat
slower rate than the nation as a whole. Missouri's unemployment levels have
equaled or exceeded the national average in recent years. Defense contracts are
important to the State's economy and adverse changes in military appropriations
could contribute to the continuation of this pattern.
The State operates from a General Revenue Fund. The General Fund includes
funds received from tax revenues and federal grants. The Missouri Constitution
imposes a limit on the amount of taxes that may be imposed by the General
Assembly during any fiscal year. No assurances can be given that the amount of
revenue derived from taxes will remain at its current level or that the amount
of federal grants previously provided to the State will continue.
An expanded discussion is contained in the Statement of Additional
Information.
<PAGE>
EXHIBIT B
REDUCED SALES CHARGES
Initial sales charges may be reduced or eliminated for persons or
organizations purchasing Class A shares of either Fund alone or in combination
with Class A shares of other Keystone America Funds.
For purposes of qualifying for reduced sales charges on purchases made
pursuant to Rights of Accumulation or Letters of Intent, the term "Purchaser"
includes the following persons: an individual; an individual, his or her spouse
and children under the age of 21; a trustee or other fiduciary of a single trust
estate or single fiduciary account established for their benefit; an
organization exempt from federal income tax under Section 501 (c)(3) or (13) of
the Internal Revenue Code; a pension, profit-sharing or other employee benefit
plan whether or not qualified under Section 401 of the Internal Revenue Code; or
other organized groups of persons, whether incorporated or not, provided the
organization has been in existence for at least six months and has some purpose
other than the purchase of redeemable securities of a registered investment
company at a discount. In order to qualify for a lower sales charge, all orders
from an organized group will have to be placed through a single investment
dealer or other firm and identified as originating from a qualifying purchaser.
CONCURRENT PURCHASES
For purposes of qualifying for a reduced sales charge, a Purchaser may combine
concurrent direct purchases of Class A shares of two or more of the "Eligible
Funds," as defined under "Rights of Accumulation." For example, if a Purchaser
concurrently invested $75,000 in one of the other "Eligible Funds" and $75,000
in a Fund, the sales charge would be that applicable to a $150,000 purchase,
i.e., 3.75% of the offering price, as indicated in the sales charge schedule in
the prospectus.
RIGHT OF ACCUMULATION
In calculating the sales charge applicable to current purchases of a Fund's
Class A shares, a Purchaser is entitled to accumulate current purchases with the
current value of previously purchased Class A shares of the Fund and Class A
shares of certain other eligible funds that are still held in (or exchanged for
shares of and are still held in) the same or another eligible fund ("Eligible
Fund(s)") irrespective of class. The Eligible Funds are the Keystone America
Funds and Keystone Liquid Trust.
For example, if a Purchaser held shares valued at $99,999 and purchased an
additional $5,000, the sales charge for the $5,000 purchase would be at the next
lower sales charge of 3.75% of the offering price as indicated in the Class A
sales charge schedule. KIRC must be notified at the time of purchase that the
Purchaser is entitled to a reduced sales charge, which reduction will be granted
subject to confirmation of the Purchaser's holdings. The Right of Accumulation
may be modified or discontinued at any time.
LETTER OF INTENT
A Purchaser may qualify for a reduced sales charge on a purchase of Class A
shares of a Fund alone or in combination with purchases of Class A shares of any
of the other Eligible Funds by completing the Letter of Intent section of the
application. By so doing, the Purchaser agrees to invest within a thirteen-month
period a specified amount that, if invested at one time, would qualify for a
reduced sales charge. Each purchase will be made at a public offering price
applicable to a single transaction of the dollar amount specified on the
application, as described in this prospectus. The Letter of Intent does not
obligate the Purchaser to purchase, nor the Fund to sell, the amount indicated.
After the Letter of Intent is received by KIRC, each investment made will be
entitled to the sales charge applicable to the level of investment indicated on
the application. The Letter of Intent may be back-dated up to ninety days so
that any investments made in any of the Eligible Funds during the preceding
ninety-day period, valued at the Purchaser's cost, can be applied toward
fulfillment of the Letter of Intent. However, there will be no refund of sales
charges already paid during the ninety-day period. No retroactive adjustment
will be made if purchases exceed the amount specified in the Letter of Intent.
Income and capital gains distributions taken in additional shares will not apply
toward completion of the Letter of Intent.
If total purchases made pursuant to the Letter of Intent are less than the
amount specified, the Purchaser will be required to remit an amount equal to the
difference between the sales charge paid and the sales charge applicable to
purchases actually made. Out of the initial purchase (or subsequent purchases,
if necessary) 5% of the dollar amount specified on the application will be held
in escrow by KIRC in the form of shares registered in the Purchaser's name. The
escrowed shares will not be available for redemption, transfer or encumbrance by
the Purchaser until the Letter of Intent is completed or the higher sales charge
paid. All income and capital gains distributions on escrowed shares will be paid
to the Purchaser or his order.
When the minimum investment specified in the Letter of Intent is completed
(either prior to or by the end of the thirteen-month period), the Purchaser will
be notified and the escrowed shares will be released. If the intended investment
is not completed, the Purchaser will be asked to remit to KDI any difference
between the sales charge on the amount specified and on the amount actually
attained. If the Purchaser does not within 20 days after written request by KDI
or his dealer pay such difference in sales charge, KIRC will redeem an
appropriate number of the escrowed shares in order to realize such difference.
Shares remaining after any such redemption will be released by KIRC. Any
redemptions made by the Purchaser during the thirteen-month period will be
subtracted from the amount of the purchases for purposes of determining whether
the Letter of Intent has been completed. In the event of a total redemption of
the account prior to completion of the Letter of Intent, the additional sales
charge due will be deducted from the proceeds of the redemption and the balance
will be forwarded to the Purchaser.
By signing the application, the Purchaser irrevocably constitutes and appoints
KIRC his attorney to surrender for redemption any or all escrowed shares with
full power of substitution.
The Purchaser or his dealer must inform KDI or KIRC that a Letter of Intent is
in effect each time a purchase is made.
<PAGE>
KEYSTONE AMERICA
FAMILY OF FUNDS
Capital Preservation and Income Fund
Government Securities Fund
Intermediate Term Bond Fund
Strategic Income Fund
World Bond Fund
Tax Free Income Fund
California Insured Tax Free Fund
Florida Tax Free Fund
Massachusetts Tax Free Fund
Missouri Tax Free Fund
New York Insured Tax Free Fund
Pennsylvania Tax Free Fund
Texas Tax Free Fund
Fund for Total Return
Global Opportunities Fund
Hartwell Emerging Growth Fund, Inc.
Hartwell Growth Fund, Inc.
Omega Fund, Inc.
Fund of the Americas
Strategic Development Fund
[Logo] KEYSTONE
Distributors, Inc.
200 Berkeley Street
Boston, Massachusetts 02116-5034
KEYSTONE
AMERICA
Photo: Golden Gate Bridge with City in background
CALIFORNIA INSURED
TAX FREE FUND
[Logo]
PROSPECTUS AND
APPLICATION
KACA-P 3/95
2.5M
<PAGE>
KEYSTONE AMERICA
FAMILY OF FUNDS
Capital Preservation and Income Fund
Government Securities Fund
Intermediate Term Bond Fund
Strategic Income Fund
World Bond Fund
Tax Free Income Fund
California Insured Tax Free Fund
Florida Tax Free Fund
Massachusetts Tax Free Fund
Missouri Tax Free Fund
New York Insured Tax Free Fund
Pennsylvania Tax Free Fund
Texas Tax Free Fund
Fund for Total Return
Global Opportunities Fund
Hartwell Emerging Growth Fund, Inc.
Hartwell Growth Fund, Inc.
Omega Fund, Inc.
Fund of the Americas
Strategic Development Fund
[Logo] KEYSTONE
Distributors, Inc.
200 Berkeley Street
Boston, Massachusetts 02116-5034
KEYSTONE
AMERICA
Photo: Gateway Arch, St. Louis
MISSOURI
TAX FREE FUND
[Logo]
PROSPECTUS AND
APPLICATION
KAMO-P 3/95
4M
<PAGE>
KEYSTONE AMERICA STATE TAX FREE FUND - SERIES II
PART B
STATEMENT OF ADDITIONAL INFORMATION
KEYSTONE AMERICA STATE TAX FREE FUND - SERIES II
STATEMENT OF ADDITIONAL INFORMATION
MARCH 31, 1995
This statement of additional information is not a prospectus, but relates
to, and should be read in conjunction with, the prospectus of Keystone America
State Tax Free Fund - Series II (the "FUND") dated March 31, 1995. A copy of the
prospectus may be obtained from Keystone Distributors, Inc. ("KDI"), the FUND's
principal underwriter ("Principal Underwriter"), 200 Berkeley Street, Boston,
Massachusetts 02116-5034.
- --------------------------------------------------------------------------------
TABLE OF CONTENTS
- --------------------------------------------------------------------------------
Page
The FUND 2
Investment Policies 2
Investment Restrictions 5
Valuation and Redemption of Securities 9
Shareholder Services 10
Sales Charges 11
Distribution Plans 13
Investment Adviser 16
Trustees and Officers 19
Principal Underwriter 23
Brokerage 24
Declaration of Trust 26
Standardized Total Return and Yield Quotations 28
Additional Information 29
Appendix A A-1
Appendix B B-1
Financial Statements F-1
Independent Auditors' Report F-21
<PAGE>
- --------------------------------------------------------------------------------
THE FUND
- --------------------------------------------------------------------------------
The FUND is a non-diversified, open-end management investment company
commonly known as a mutual fund. The FUND was formed as a Massachusetts business
trust on December 15, 1993. The FUND is one of the twenty-nine funds managed or
advised by Keystone Custodian Funds, Inc. ("Keystone"), the FUND's investment
adviser. The FUND currently consists of the following two separate series
evidencing interests in different portfolios of securities: Keystone America
California Insured Tax Free Fund ("California Insured Fund") and Keystone
America Missouri Tax Free Fund ("Missouri Tax Free Fund") (each a "Fund" and
collectively, the "Funds").
The essential information about the FUND and its Funds is contained in its
prospectus. This statement of additional information provides additional
information about the FUND and its Funds that may be of interest to some
investors.
For special factors affecting each Fund, see Appendix A to this statement
of additional information.
- --------------------------------------------------------------------------------
INVESTMENT POLICIES
- --------------------------------------------------------------------------------
Each Fund invests primarily in municipal obligations that are exempt from
federal income tax and also exempt from certain specified taxes in the state for
which it is named. In addition, the Funds invest in certain other securities as
described below.
MUNICIPAL OBLIGATIONS
Municipal obligations include debt obligations issued by or on behalf of a
state, a territory or a possession of the United States ("U.S."), the District
of Columbia or any political subdivision, agency or instrumentality thereof (for
example, counties, cities, towns, villages, districts, authorities) to obtain
funds for various public purposes, including the construction of a wide range of
public facilities such as airports, bridges, highways, housing, hospitals, mass
transportation, schools, streets and water and sewer works. Other public
purposes for which municipal obligations may be issued include the refunding of
outstanding obligations, obtaining funds for general operating expenses and
obtaining funds to lend to public or private institutions for the construction
of facilities, such as educational, hospital and housing facilities. In
addition, certain types of industrial development bonds have been or may be
issued by or on behalf of public authorities to finance certain
privately-operated facilities, and certain local facilities for water supply,
gas, electricity or sewage or solid waste disposal. Such obligations are
included within the term municipal obligations if the interest paid thereon
qualifies as fully exempt from federal income tax. The income of certain types
of industrial development bonds used to finance certain privately operated
facilities (qualified private activity bonds) issued after August 7, 1986, while
exempt from federal income tax, is includable for the purposes of the
calculation of the alternative minimum tax. Other types of industrial
development bonds, the proceeds from which are used for the construction,
equipment, repair or improvement of privately operated industrial or commercial
facilities, may constitute municipal obligations, although the current federal
tax laws place substantial limitations on the size of such issues.
The two principal classifications of municipal obligations are "general
obligation" and limited obligation or "revenue" bonds. General obligation bonds
are obligations involving the credit of an issuer possessing taxing power and
are payable from the issuer's general unrestricted revenues and not from any
particular fund or revenue source. Their payment may be dependent upon an
appropriation by the issuer's legislative body and may be subject to
quantitative limitations on the issuer's taxing power. The characteristics and
methods of enforcement of general obligation bonds vary according to the law
applicable to the particular issuer. Limited obligation or revenue bonds are
payable only from the revenues derived from a particular facility or class of
facilities or, in some cases, from the proceeds of a special excise or other
specific revenue source, such as the user of the facility. Industrial
development bonds that are municipal obligations are, in most cases, revenue
bonds and generally are not payable from the unrestricted revenues of the
issuer. The credit quality of industrial development revenue bonds is usually
directly related to the credit standing of the owner or user of the facilities.
There are, of course, variations in the security of municipal obligations, both
within a particular classification and between classifications, depending on
numerous factors.
The yields on municipal obligations are dependent on a variety of factors,
including general money market conditions, the financial condition of the
issuer, general conditions of the municipal obligations market, the size of a
particular offering, and the maturity of the obligation and rating of the issue.
The ratings of Moody's Investors Service, Inc. ("Moody's"), Standard & Poor's
Corporation ("S&P") and Fitch Investor Services, Inc. -- Municipal Division
("Fitch"), as described herein and in the prospectus, represent their opinions
as to the quality of the municipal obligations that they undertake to rate. It
should be emphasized, however, that ratings are general and not absolute
standards of quality. Consequently, municipal obligations with the same
maturity, interest rate and rating may have different yields while municipal
obligations of the same maturity and interest rate with different ratings may
have the same yield. It should also be noted that the standards of disclosure
applicable to and the amount of information relating to the financial condition
of issuers of municipal obligations are not generally as extensive as those
generally relating to corporations.
Subsequent to its purchase by a Fund, an issue of municipal obligations or
other investment may cease to be rated or its rating may be reduced below the
minimum rating required for purchase by the Fund. Neither event requires the
elimination of such obligation from the Fund's portfolio, but Keystone will
consider such an event in its determination of whether the Fund should continue
to hold such obligation in its portfolio.
The ability of each Fund to achieve its investment objectives is dependent
upon the continuing ability of issuers of municipal obligations to meet their
obligations to pay interest and principal when due. Obligations of issuers of
municipal obligations are subject to the provisions of bankruptcy, insolvency
and other laws affecting the rights and remedies of creditors, such as the
federal Bankruptcy Act, and laws, if any, that may be enacted by Congress or
state legislatures extending the time for payment of principal or interest, or
both, or imposing other constraints upon enforcement of such obligations. There
is also the possibility that as a result of litigation or other conditions, the
power or ability of any one or more issuers to pay, when due, principal of and
interest on its or their municipal obligations may be materially affected. In
addition, the market for municipal obligations is often thin and can be
temporarily affected by large purchases and sales, including those by a Fund.
From time to time, proposals have been introduced before Congress for the
purpose of restricting or eliminating the federal income tax exemption for
interest on municipal obligations, and similar proposals may well be introduced
in the future. If such a proposal were enacted, the availability of municipal
obligations for investment by the Funds and the value of the Funds' portfolios
could be materially affected, in which event the FUND would reevaluate the
investment objectives and policies of its Funds and consider changes in the
structure of the Funds or dissolution.
The Tax Reform Act of 1986 made significant changes in the federal tax
status of certain obligations that were previously fully federally tax-exempt.
As a result, three categories of such obligations issued after August 7, 1986
now exist: (1) "public purpose" bonds, the income from which remains fully
exempt from federal income tax; (2) qualified "private activity" industrial
development bonds, the income from which, while exempt from federal income tax
under Section 103 of the Internal Revenue Code of 1986, as amended (the "Code")
is includable in the calculation of the federal alternative minimum tax; and (3)
"private activity" (private purpose) bonds, the income from which is not exempt
from federal income tax. A Fund will not invest in private purpose bonds and,
except as described under "Other Eligible Investments," will not invest in
qualified "private activity" industrial development bonds whose distributions
are subject to the alternative minimum tax.
OTHER ELIGIBLE INVESTMENTS
A Fund may invest up to 20% of its assets under ordinary circumstances and
up to 100% of its assets for temporary defensive purposes in the following types
of instruments: (1) commercial paper, including master demand notes, that at the
date of investment is rated A-1 (the highest grade by S&P), Prime-1 (the highest
grade by Moody's) or, if not rated by such services, is issued by a company that
at the date of investment has an outstanding issue rated A or better by S&P or
Moody's; (2) obligations, including certificates of deposit and bankers'
acceptances, of banks, or savings and loan associations that have at least $1
billion in assets as of the date of their most recently published financial
statements that are members of the Federal Deposit Insurance Corporation,
including U.S. branches of foreign banks and foreign branches of U.S. banks; (3)
corporate obligations (maturing in 13 months or less) that at the date of
investment are rated A or better by S&P or Moody's; (4) obligations issued or
guaranteed by the U.S. government or by any agency or instrumentality of the
U.S.; (5) qualified "private activity" industrial development bonds, the income
from which, while exempt from federal income tax under Section 103 of the Code,
is includable in the calculation of the federal alternative minimum tax; and (6)
municipal obligations, the income of which is exempt from federal income tax.
Each Fund will assume a temporary defensive position when, for example, Keystone
determines that market conditions so warrant. If a Fund is investing
defensively, it is not pursuing its objectives.
FUNDAMENTAL NATURE OF INVESTMENT OBJECTIVES
The investment objectives of each Fund are fundamental and may not be
changed without approval of the holders of a majority (as defined in the
Investment Company Act of 1940 ("1940 Act")) of such Fund's outstanding voting
shares (which means the lesser of (1) 67% of the shares represented at a meeting
at which more than 50% of the outstanding shares are represented or (2) more
than 50% of the outstanding shares).
- --------------------------------------------------------------------------------
INVESTMENT RESTRICTIONS
- --------------------------------------------------------------------------------
The investment restrictions set forth below are fundamental for each Fund
and may not be changed without the vote of a 1940 Act majority of such Fund's
outstanding voting shares. Unless otherwise stated, all references to the assets
of a Fund are in terms of current market value. Each Fund may not do the
following:
(1) purchase any security of any issuer (other than issues of the U.S.
government, its agencies or instrumentalities) if as a result more than 25% of
its total assets would be invested in a single industry, including in industrial
development bonds from the same facility or similar types of facilities;
governmental issuers of municipal bonds are not regarded as members of an
industry and a Fund may invest more than 25% of its assets in industrial
development bonds;
(2) invest more than 15% of its assets in securities which may not be sold
or disposed of in the ordinary course of business within seven days at
approximately the value at which a Fund has valued such securities on its books;
(3) invest more than 5% of its total assets in securities of any
company having a record, together with its predecessors, of less than three
years of continuous operation;
(4) pledge more than 15% of its net assets to secure indebtedness; the
purchase or sale of securities on a "when issued" basis, or collateral
arrangement with respect to the writing of options on securities, are not deemed
to be a pledge of assets;
(5) issue senior securities; the purchase or sale of securities on a "when
issued" basis or collateral arrangement with respect to the writing of options
on securities, are not deemed to be the issuance of a senior security;
(6) borrow money or enter into reverse repurchase agreements, except that a
Fund may enter into reverse repurchase agreements or borrow money from banks for
temporary or emergency purposes in aggregate amounts up to one-third of the
value of the Fund's net assets; provided that while borrowings from banks (not
including reverse repurchase agreements) exceed 5% of the Fund's net assets, any
such borrowings will be repaid before additional investments are made;
(7) purchase securities on margin except that it may obtain such short-term
credit as may be necessary for the clearance of purchases and sales of
securities;
(8) make short sales of securities or maintain a short position, unless at
all times when a short position is open it owns an equal amount of such
securities or of securities which, without payment of any further consideration,
are convertible into or exchangeable for securities of the same issue as, and
equal in amount to, the securities sold short;
(9) make loans, except that a Fund may purchase or hold debt securities
consistent with its investment objectives, lend portfolio securities valued at
not more than 15% of its total assets to broker-dealers and enter into
repurchase agreements;
(10) purchase securities of other investment companies, except as part of a
merger, consolidation, purchase of assets or similar transaction;
(11) purchase or sell commodities or commodity contracts or real estate,
except that it may purchase and sell securities secured by real estate and
securities of companies which invest in real estate, and may engage in currency
or other financial futures contracts and related options transactions;
(12) underwrite securities of other issuers, except that the Fund may
purchase securities from the issuer or others and dispose of such securities in
a manner consistent with its investment objective; or
(13) participate on a joint, or a joint and several, basis in any trading
account in securities; the "bunching" of orders for the sale or purchase of
portfolio securities with other funds advised by Keystone or its affiliates to
reduce brokerage commissions or otherwise to achieve best overall execution is
not considered participation in a trading account in securities.
The Funds are non-diversified under the federal securities laws. As
non-diversified Funds, there is no restriction under the 1940 Act on the
percentage of assets that may be invested at any time in the securities of any
one issuer. The Funds intend to comply, however, with the Code's diversification
requirements and other requirements applicable to "regulated investment
companies" so that they will not be subject to U.S. federal income tax on income
and capital gain distributions to shareholders. For this reason, each Fund has
adopted the additional investment restriction set forth below, which may not be
changed without the approval of shareholders. Specifically, a Fund may not
purchase a security if more than 25% of the Fund's total assets would be
invested in the securities of a single issuer (other than the U.S. government,
its agencies and instrumentalities) or, with respect to 50% of the Fund's total
assets, if more than 5% of such assets would be invested in the securities of a
single issuer (other than the U.S. government, its agencies and
instrumentalities).
As a matter of practice, each Fund treats reverse repurchase agreements as
borrowings for purposes of compliance with the limitations of the 1940 Act.
Reverse repurchase agreements will be taken into account along with borrowings
from banks for purposes of the 5% limit set forth in the sixth fundamental
investment restriction above.
To the extent the Funds are not fully diversified, they may be more
susceptible to adverse economic, political or regulatory developments affecting
a single issuer than would be the case if the Funds were more broadly
diversified.
Additional restrictions adopted for each Fund, which may be changed by the
Board of Trustees, provide that a Fund may not purchase or retain securities of
an issuer if, to the knowledge of the FUND, officers, Trustees or Directors of
the FUND or Keystone each owning beneficially more than 1/2 of 1% of the
securities of such issuer own in the aggregate more than 5% of the securities of
such issuer, or such persons or management personnel of the FUND or Keystone
have a substantial beneficial interest in the securities of such issuer.
Portfolio securities of a Fund may not be purchased from or sold or loaned to
Keystone or any affiliate thereof or any of their Directors, officers or
employees.
None of the Funds presently intends to invest more than 25% of its total
assets in municipal obligations the payment of which depends on revenues derived
from a single facility or similar types of facilities. Since certain municipal
obligations may be related in such a way that an economic, business or political
development or change affecting one such security could likewise affect the
other securities, a change in this policy could result in increased investment
risk, but no change is presently contemplated.
For the purposes of the first, third, and twelfth fundamental investment
restrictions set forth above, each Fund will treat (1) each state, territory and
possession of the U.S., the District of Columbia and, if its assets and revenues
are separate from those of the entity or entities creating it, each political
subdivision, agency and instrumentality of any one (or more, as in the case of a
multistate authority or agency) of the foregoing as an issuer of all securities
that are backed primarily by its assets or revenues; (2) each company as an
issuer of all securities that are backed primarily by its assets or revenues;
and (3) each of the foregoing entities as an issuer of all securities that it
guarantees; provided, however, that for the purpose of the first fundamental
investment restriction no entity shall be deemed to be an issuer of a security
that it guarantees so long as no more than 10% of a Fund's total assets (taken
at current value) are invested in securities guaranteed by the entity and
securities of which it is otherwise deemed to be an issuer.
The FUND has undertaken to a state securities authority that, so long as
the state authority requires and shares of the FUND are registered for sale in
that state, the FUND will (1) not invest in real estate limited partnerships and
(2) not invest in oil, gas or other mineral leases.
Further, the FUND has undertaken to a state securities authority that, so
long as the state authority requires and shares of the FUND are registered for
sale in that state, all loans of portfolio securities will be made in accordance
with fair, just and equitable practice and the collateral values of portfolio
securities loaned will be maintained at no less than 100% by "marking to market"
daily.
In order to permit the sale of a Fund's shares in certain states, the FUND
may make commitments more restrictive than the investment restrictions described
above. Should the FUND determine that any such commitment is no longer in the
best interests of the affected Fund, it will revoke the commitment by
terminating sales of its shares in the state involved.
If a percentage limit is satisfied at the time of investment or borrowing,
a later increase or decrease resulting from a change in asset value is not a
violation of the limit.
- --------------------------------------------------------------------------------
VALUATION AND REDEMPTION OF SECURITIES
- --------------------------------------------------------------------------------
Current values for each Fund's portfolio securities may be determined in
the following manner:
1. securities for which market quotations are readily available are valued
at the mean of the bid and asked prices at the time of valuation;
2. (a) instruments having maturities of sixty days or less when purchased
are valued at amortized cost (original purchase cost as adjusted for
amortization of premium or accretion of discount), which, when combined with
accrued interest, approximates market;
(b) investments maturing in more than sixty days when purchased that are
held on the sixtieth day prior to maturity are valued at amortized cost (market
value on the sixtieth day adjusted for amortization of premium or accretion of
discount), which, when combined with accrued interest, approximates market; and
which, in either case, reflects fair value as determined by the FUND's Board of
Trustees;
3. short-term instruments having maturities of more than sixty days for
which market quotations are readily available are valued at current market
value; and
4. the following securities are valued at prices deemed in good faith to be
fair under procedures established by the Board of Trustees: (a) securities,
including restricted securities, for which market quotations are not readily
available; and (b) other assets.
The FUND believes that reliable market quotations are generally not readily
available for purposes of valuing municipal obligations. As a result, depending
on the particular municipal obligations owned by a Fund, it is likely that most
of the valuations for such obligations will be based upon their fair value
determined under procedures approved by the Board of Trustees. The Board of
Trustees has authorized the use of a pricing service to determine the fair value
of each Fund's municipal obligations and certain other securities. Non
tax-exempt securities for which market quotations are readily available are
valued on a consistent basis at that price quoted that, in the opinion of the
Board of Trustees or the person designated by the Board of Trustees to make the
determination, most nearly represents the market value of the particular
security. Any securities for which market quotations are not readily available
or other assets are valued on a consistent basis at fair value as determined in
good faith using methods prescribed by the FUND's Board of Trustees.
The FUND has obligated itself under the 1940 Act to redeem for cash all
shares presented for redemption by any one shareholder in any 90 day period up
to the lesser of $250,000 or 1% of a Fund's assets.
- --------------------------------------------------------------------------------
SHAREHOLDER SERVICES
- --------------------------------------------------------------------------------
REINVESTMENT PRIVILEGE
A shareholder may elect to make a reinvestment purchase with any part of
the proceeds of a total or partial redemption of Fund shares. Upon making such
an election, the FUND will waive the applicable sales charge. Such an election
must be made within 30 days of the date of such redemption and the purchase must
be of shares of the same Fund. The number of shares credited upon reinvesting
will be based on the net asset value of the Fund's shares next computed
following receipt of the proceeds and request for reinvestment. If a shareholder
exercises this reinvestment privilege, any tax loss realized upon the original
sale of Fund shares will not be recognized for federal income tax purposes. Any
capital gains, however, would be recognized for federal income tax purposes.
This reinvestment privilege may be used only once with respect to any
shareholder. For tax reporting purposes, the FUND will treat a redemption and
subsequent reinvestment purchase as separate transactions.
OTHER SERVICES
Please refer to the prospectus for more information on shareholder
services.
- --------------------------------------------------------------------------------
SALES CHARGES
- --------------------------------------------------------------------------------
GENERAL
Each Fund offers three classes of shares. Class A shares are offered with a
maximum sales charge of 4.75% payable at the time of purchase of Fund shares
("Front End Load Option"). Class B shares are sold subject to a contingent
deferred sales charge payable upon redemption during the calendar year of
purchase and the three calendar years following calendar year of purchase.
("Back End Load Option"). Class B shares that have been outstanding during seven
calendar years will automatically convert to Class A shares, without imposition
of a front end sales charge. (Conversion of Class B shares represented by stock
certificates will require the return of the stock certificates to Keystone
Investor Resource Center, Inc. ("KIRC"), the FUND's transfer and dividend
disbursing agent.) Class C shares are sold subject to a contingent deferred
sales charge payable upon redemption within one year after purchase ("Level Load
Option"). Class C shares are available only through dealers who have entered
into special distribution agreements with KDI, the FUND's Principal Underwriter.
The FUND's prospectus contains a general description of how investors may buy
shares of the FUND, as well as a table of applicable sales charges for Class A
shares, a discussion of reduced sales charges applicable to subsequent purchases
and a description of applicable contingent deferred sales charges.
CONTINGENT DEFERRED SALES CHARGES
In order to reimburse a Fund for certain expenses relating to the sale of
its shares (see "Distribution Plan"), a contingent deferred sales charge may be
imposed at the time of redemption of certain Fund shares as follows:
CLASS A SHARES
With certain exceptions, purchases of Class A shares in the amount of
$1,000,000 on which no sales charge has been paid will be subject to a
contingent deferred sales charge of 0.25% upon redemption during the one year
period commencing on the date the shares were originally purchased. The
contingent deferred sales charge will be retained by KDI. See "Calculation of
Contingent Deferred Sales Charge" below.
CLASS B SHARES
With certain exceptions, a Fund may impose a deferred sales charge of 3.00%
on shares redeemed during the calendar year of purchase and during the first
calendar year after purchase; 2.00% on shares redeemed during the second
calendar year after purchase; and 1.00% on shares redeemed during the third
calendar year after the year of purchase. No deferred sales charge is imposed on
amounts redeemed thereafter. If imposed, the deferred sales charge is deducted
from the redemption proceeds otherwise payable to you. The deferred sales charge
is retained by KDI. See "Calculation of Contingent Deferred Sales Charge" below.
CLASS C SHARES
With certain exceptions, a Fund may impose a deferred sales charge of 1% on
shares redeemed within one year after the date of purchase. No deferred sales
charge is imposed on amounts redeemed thereafter. If imposed, the deferred sales
charge is deducted from the redemption proceeds otherwise payable to you. The
deferred sales charge is retained by KDI. See "Calculation of Contingent
Deferred Sales Charge" below.
CALCULATION OF CONTINGENT DEFERRED SALES CHARGE
Any contingent deferred sales charge imposed upon the redemption of Class
A, Class B or Class C shares is a percentage of the lesser of (1) the net asset
value of the shares redeemed or (2) the net cost of such shares. No contingent
deferred sales charge is imposed when you redeem amounts derived from (1)
increases in the value of your account above the net cost of such shares due to
increases in the net asset value per share of a Fund; (2) certain shares with
respect to which a Fund did not pay a commission on issuance, including shares
acquired through reinvestment of dividend income and capital gains
distributions; (3) Class C shares and certain Class A shares held during more
than one year; or (4) Class B shares held during more than four consecutive
calendar years. Upon request for redemption, shares not subject to the
contingent deferred sales charge will be redeemed first. Thereafter, shares held
the longest will be the first to be redeemed. There is no contingent deferred
sales charge when the shares of a class are exchanged for the shares of the same
class of another Keystone America Fund. Moreover, when shares of one such class
of a fund have been exchanged for shares of another such class of a fund, the
calendar year of the exchange is assumed to be the year shares tendered for
exchange were originally purchased.
WAIVER OF SALES CHARGES
Shares also may be sold, to the extent permitted by applicable law,
regulations, interpretations or exemptions, at net asset value without the
imposition of an initial sales charge to (1) certain officers, Directors,
Trustees, full-time employees and sales representatives of the FUND, Keystone
Management, Inc. ("Keystone Management"), Keystone, Keystone Group, Inc.
("Keystone Group"), Harbor Capital Management Company, Inc., any one of their
subsidiaries or KDI, who have been such for not less than ninety days; (2) a
pension and profit-sharing plan established by such companies, their
subsidiaries and affiliates, for the benefit of their officers, Directors,
Trustees, full-time employees and sales representatives; or (3) a registered
representative of a firm with a dealer agreement with KDI, provided all such
sales are made upon the written assurance that the purchase is made for
investment purposes and that the securities will not be resold except through
redemption by the FUND.
No initial sales charge is charged on a purchase of shares of a Fund by a
bank or trust company in a single account in the name of such bank or trust
company as trustee if the initial investment in shares of one of the Funds or
any Keystone mutual fund is at least $500,000.
In addition, no contingent deferred sales charge is imposed on a redemption
of shares of a Fund in the event of (1) death or disability of the shareholder;
(2) a lump-sum distribution from a benefit plan qualified under the Employee
Retirement Income Security Act of 1974 ("ERISA"); (3) automatic withdrawals from
ERISA plans if the shareholder is at least 59 1/2 years old; (4) involuntary
redemptions of an account having an aggregate net asset value of less than
$1,000; or (5) automatic withdrawals under an automatic withdrawal plan of up to
1 1/2% per month of the shareholder's initial account balance.
DISTRIBUTION PLANS
Rule 12b-1 under the 1940 Act permits investment companies, such as the
FUND, to use their assets to bear expenses of distributing their shares if they
comply with various conditions, including adoption of a distribution plan
containing certain provisions set forth in Rule 12b-1. On December 15, 1993,
each Fund's Class A, B and C Distribution Plans were approved by the FUND's
Board of Trustees, including a majority of the Trustees who are not interested
persons of the FUND, as defined in the 1940 Act ("Independent Trustees"), and
the Trustees who have no direct or indirect financial interest in the
Distribution Plan or any agreement related thereto (the "Rule 12b-1 Trustees,"
who are the same as the Independent Trustees).
The National Association of Securities Dealers, Inc. ("NASD") currently
limits the amount that a Fund may pay annually in distribution costs for sale of
its shares and shareholder service fees. The NASD limits annual expenditures to
1% of the aggregate average daily net asset value of its shares, of which 0.75%
may be used to pay such distribution costs and 0.25% may be used to pay
shareholder service fees. The NASD also limits the aggregate amount that a Fund
may pay for such distribution costs to 6.25% of gross share sales since the
inception of a 12b-1 Plan, plus interest at the prime rate plus 1% on such
amounts (less any contingent deferred sales charges paid by shareholders to
KDI).
CLASS A DISTRIBUTION PLAN
The Class A Distribution Plan provides that a Fund may expend daily amounts
at an annual rate currently limited to 0.15% of the Fund's average daily net
asset value attributable to Class A shares to finance any activity that is
primarily intended to result in the sale of Class A shares, including, without
limitation, expenditures consisting of payments to a Principal Underwriter of a
Fund (currently KDI) to enable the Principal Underwriter to pay or to have paid
to others who sell Class A shares a service or other fee, at such intervals as
the Principal Underwriter may determine, in respect of Class A shares maintained
by such recipients outstanding on the books of the FUND for specified periods.
Amounts paid by a Fund under its Class A Distribution Plan are currently
used to pay others, such as dealers, service fees at an annual rate of up to
0.15% of the average net asset value of Class A shares maintained by such
recipients outstanding on the books of the FUND for specified periods.
CLASS B DISTRIBUTION PLAN
The Class B Distribution Plan provides that the Fund may expend daily
amounts at an annual rate of up to 1.00% of the Fund's average daily net asset
value attributable to Class B shares (currently limited to 0.90%) to finance any
activity that is primarily intended to result in the sale of Class B shares.
Payments under the Class B Distribution Plan are currently made to KDI (which
may reallow all or part to others, such as dealers) (1) as commissions in
respect of Class B shares sold and (2) as shareholder service fees. Amounts paid
or accrued to KDI under (1) and (2) in the aggregate may not exceed the annual
limitation referred to above. KDI generally reallows to brokers a commission
equal to 3.00% of the price paid for each Class B share sold as well as a
service fee at the rate of 0.15% of the average net asset value of Class B
shares maintained by such recipients outstanding on the books of the Fund for
specified periods.
KDI intends, but is not obligated, to continue to pay or accrue
distribution charges incurred in connection with the Class B Distribution Plan
that exceed current annual payments permitted to be received by KDI from the
Fund. KDI intends to seek full payment of such charges from a Fund (together
with annual interest thereon at the prime rate plus one percent) at such time in
the future as, and to the extent that, payment thereof by the Fund would be
within the permitted limits.
CLASS C DISTRIBUTION PLAN
The Class C Distribution Plan provides that the Fund may expend daily
amounts at an annual rate of up to 1.00% of the Fund's average daily net asset
value attributable to Class C shares (currently limited to 0.90%) to finance any
activity that is primarily intended to result in the sale of Class C shares.
Payments under the Class C Distribution Plan are currently made to KDI (which
may reallow all or part to others, such as dealers) (1) as commissions for Class
C shares sold and (2) as shareholder service fees. Amounts paid or accrued to
KDI under (1) and (2) in the aggregate may not exceed the annual limitation
referred to above. KDI generally reallows to brokers or others (1) a commission
in the amount of 0.75% of the price paid for each Class C share sold, plus the
first year's service fees in advance in the amount of 0.25% of the price paid
for each Class C share sold and (2) beginning approximately fifteen months after
purchase, a commission at an annual rate of 0.75% (subject to NASD rules) plus
service fees at an annual rate of 0.25%, respectively, of the average daily net
asset value of each Class C share maintained by such recipients outstanding on
the books of the Fund for specified periods.
DISTRIBUTION PLANS IN GENERAL
Each of the Distribution Plans may be terminated as to a Fund at any time
by vote of the Rule 12b-1 Trustees or by a vote of a majority of the appropriate
outstanding voting shares of the Fund.
Unreimbursed distribution expenses at November 30, 1994 for Class B shares
were $784,751 (6.87% of Class B net assets at November 30, 1994) and $862,192
(6.88% of Class B net assets at November 30, 1994) for the California Insured
Fund and the Missouri Tax Free Fund, respectively.
Any change in a Distribution Plan that would materially increase the
distribution expenses of the affected Fund provided for in a Distribution Plan
requires shareholder approval. Otherwise, the Distribution Plans may be amended
by the Trustees, including the Rule 12b-1 Trustees.
While the Distribution Plans are in effect, the FUND will be required to
commit the selection and nomination of candidates for Independent Trustees to
the discretion of the Independent Trustees.
The total amounts paid by a Fund under the foregoing arrangements may not
exceed the maximum Distribution Plan limits specified above, and the amounts and
purposes of expenditures under a Distribution Plan must be reported to the Rule
12b-1 Trustees quarterly. The Rule 12b-1 Trustees may require or approve changes
in the implementation or operation of a Distribution Plan and may also require
that total expenditures by a Fund under a Distribution Plan be kept within
limits lower than the maximum amount permitted by a Distribution Plan as stated
above.
The Independent Trustees of the FUND have determined that the sales of each
Fund's shares resulting from payments under the Distribution Plans are expected
to benefit such Fund.
During the period February 1, 1994 (Commencement of Operations) to November
30, 1994, the California Insured Fund and the Missouri Tax Free Fund paid KDI
(i) $2,813, and $1,634, respectively, pursuant to each Fund's Class A
Distribution Plan; (ii) $60,793, and $61,502, respectively, pursuant to each
Fund's Class B Distribution Plan; and (iii) $3,259, and $6,508, respectively,
pursuant to each Fund's Class C Distribution Plan.
Presently, a Fund's class-specific expenses are limited to Distribution
Plan expenses incurred by a class of shares pursuant to its respective
Distribution Plan.
INVESTMENT ADVISER
Subject to the general supervision of the FUND's Board of Trustees,
Keystone serves as investment adviser to the FUND and is responsible for the
overall management of the FUND's business and affairs.
Keystone, located at 200 Berkeley Street, Boston, Massachusetts 02116-5034,
has provided investment advisory and management services to investment companies
and private accounts since it was organized in 1932. Keystone is a wholly-owned
subsidiary of Keystone Group, 200 Berkeley Street, Boston, Massachusetts
02116-5034. Keystone Group, a corporation predominantly owned by former and
current members of management of Keystone and its affiliates, provides
accounting, bookkeeping, legal, personnel and general corporate services to
Keystone, its affiliates and the Keystone Group of Mutual Funds. The shares of
Keystone Group common stock beneficially owned by management are held in a
number of voting trusts, the trustees of which are George Bissel, Albert H.
Elfner, III, Edward F. Godfrey and Ralph J. Spuehler, Jr.
Pursuant to its Investment Advisory and Management Agreement with the FUND
(the "Advisory Agreement") and subject to the supervision of the FUND's Board of
Trustees, Keystone manages and administers the operation of the FUND and its
Funds, and manages the investment and reinvestment of each Fund's assets in
conformity with such Fund's investment objectives and restrictions. The Advisory
Agreement stipulates that Keystone shall provide office space, all necessary
office facilities, equipment and personnel in connection with its services as
well as pay or reimburse the FUND for the compensation of FUND officers and
Trustees who are affiliated with the investment adviser. The Advisory Agreement
requires Keystone to pay all of its expenses incurred in connection with its
services. All charges and expenses other than those specifically referred to as
being borne by Keystone will be paid by the FUND, including, but not limited to,
custodian charges and expenses; bookkeeping and auditors' charges and expenses;
transfer agent charges and expenses; fees of Independent Trustees; brokerage
commissions, brokers' fees and expenses; issue and transfer taxes; costs and
expenses under the Distribution Plans; taxes and trust fees payable to
governmental agencies; the costs of share certificates; fees and expenses of the
registration and qualification of the FUND and its shares with the Securities
and Exchange Commission (sometimes referred to herein as the "SEC" or the
"Commission") or under state or other securities laws; expenses of preparing,
printing and mailing prospectuses, statements of additional information,
notices, reports and proxy materials to shareholders of the FUND; expenses of
shareholders' and Trustees' meetings; charges and expenses of legal counsel for
the FUND and for the Trustees of the FUND on matters relating to the FUND;
charges and expenses of filing annual and other reports with the SEC and other
authorities; and all extraordinary charges and expenses of the FUND.
Each Fund pays Keystone a fee for its services to the Fund at the annual
rate set forth below:
Management Aggregate Net Asset Value
Fee of the shares of the Fund
0.55% of the first $ 50,000,000, plus
0.50% of the next $ 50,000,000, plus
0.45% of the next $ 100,000,000, plus
0.40% of the next $ 100,000,000, plus
0.35% of the next $ 100,000,000, plus
0.30% of the next $ 100,000,000, plus
0.25% of amounts over $ 500,000,000
computed as of the close of business each business day and paid daily.
During the period February 1, 1994 (commencement of operations) to November
30, 1994, the California Insured Fund and the Missouri Tax Free Fund paid or
accrued to Keystone investment management and administative services fees of
$49,627 and $47,930, respectively.
The Advisory Agreement continues in effect from year to year only if
approved at least annually by the FUND's Board of Trustees or by a vote of a
majority of the outstanding shares of each Fund, and such renewal has been
approved by the vote of a majority of the Independent Trustees cast in person at
a meeting called for the purpose of voting on such approval. The Advisory
Agreement may be terminated, without penalty, on 60 days' written notice by the
FUND's Board of Trustees or by a vote of a majority of outstanding shares of
each Fund. The Advisory Agreement will terminate automatically upon its
"assignment" as that term is defined in the 1940 Act.
Previously,Keystone had voluntarily limited the expenses of Class A shares
of each Fund to 0.35% of the average daily net assets of such class until August
15, 1994; after which the expense limitation was increased to 0.45% until
November 15, 1994; 0.55% until February 15, 1995. Currently Keystone has
voluntarily limited expenses of Class A shares to 0.65% of average daily net
assets until May 15, 1995. Thereafter, Keystone has voluntarily limited expenses
of Class A shares to 0.75% until December 31, 1995. Previously, expenses for
Class B and C shares were limited to 1.10% of the average daily net assets of
such Class for each Fund until August 15, 1994; after which such expense
limitations were increased to 1.20% until November 15, 1994; and 1.30% until
February 15, 1995. Currently, Keystone has voluntarily limited the expenses of
the Class B and C shares to 1.40% of each Class's average daily net assets until
May 15, 1995. Thereafter, Keystone has voluntarily limited expenses of Class B
and Class C shares to 1.50% until December 15, 1995. Thereafter, a
redetermination of whether to continue these expense limitations and, if so, at
what rate, will be made. Keystone will not be required to make such
reimbursement to the extent it would result in a Fund's inability to qualify as
a regulated investment company under the provisions of the Code. In accordance
with these expense limitations, Keystone reimbursed the California Insured Fund
and the Missouri Tax Free Fund (i) $23,507 and $12,109, respectively, with
respect to each Fund's Class A shares; (ii) $81,857 and $91,759, respectively,
with respect to each Fund's Class B shares; and (iii) $4,427 and $10,208,
respectively, with respect to each Fund's Class C shares.
Each Fund is subject to certain annual state expense limitations, the most
restrictive of which is as follows:
2.5% of the first $30 million of Fund average net assets; 2.0% of the next
$70 million of Fund average net assets; and 1.5% of Fund average net assets
over $100 million.
TRUSTEES AND OFFICERS
Trustees and officers of the FUND, their principal occupations and some of
their affiliations over the last five years are as follows:
*ALBERT H. ELFNER, III: President, Trustee and Chief Executive Officer of the
FUND; Chairman of the Board, President, Director and Chief Executive
Officer of Keystone Group; President and Trustee or Director of
Keystone America Capital Preservation and Income Fund, Keystone America
Intermediate Term Bond Fund, Keystone America Strategic Income Fund,
Keystone America World Bond Fund, Keystone Tax Free Income Fund,
Keystone America State Tax Free Fund, Keystone America Fund for Total
Return, Keystone America Global Opportunities Fund, Keystone America
Hartwell Emerging Growth Fund, Inc., Keystone America Hartwell Growth
Fund, Inc., Keystone America Omega Fund, Inc., Keystone Fund of the
Americas-Luxembourg and Keystone Fund of the Americas - U.S., Keystone
Strategic Development Fund (collectively, together with the FUND,
"Keystone America Funds"); Keystone Custodian Funds, Series B- 1, B-2,
B-4, K-1, K-2, S-1, S-3, and S-4; Keystone International Fund, Keystone
Precious Metals Holdings, Inc., Keystone Tax Free Fund, Keystone Tax
Exempt Trust, Keystone Liquid Trust (collectively, "Keystone Custodian
Funds"); Keystone Institutional Adjustable Rate Fund and Master
Reserves Trust (all such funds, collectively, "Keystone Group Funds");
Director and Chairman of the Board, Chief Executive Officer and Vice
Chairman of Keystone; Chairman of the Board and Director of Keystone
Investment Management Corporation ("KIMCO") and Keystone Fixed Income
Advisors ("KFIA"); Director, Chairman of the Board, Chief Executive
Officer and President of Keystone Management, Keystone Software Inc.
("Keystone Software"); Director and President of Hartwell Keystone
Advisers, Inc. ("Hartwell Keystone"), Keystone Asset Corporation,
Keystone Capital Corporation, and Keystone Trust Company; Director of
KDI, KIRC, and Fiduciary Investment Company, Inc. ("FICO"); Director
and Vice President of Robert Van Partners, Inc.; Director of Boston
Children's Services Association; Trustee of Anatolia College, Middlesex
School, and Middlebury College; Member, Board of Governors, New England
Medical Center and former Trustee of Neworld Bank.
FREDERICK AMLING: Trustee of the FUND; Trustee or Director of all other Keystone
Group Funds; Professor, Finance Department, George Washington
University; President, Amling & Company (investment advice); Member,
Board of Advisers, Credito Emilano (banking); and former Economics and
Financial Consultant, Riggs National Bank.
CHARLES A. AUSTIN III: Trustee of the FUND; Trustee or Director of all other
Keystone Group Funds; Investment Counselor to Appleton Partners, Inc.;
former Managing Director, Seaward Management Corporation (investment
advice) and former Director, Executive Vice President and Treasurer,
State Street Research & Management Company (investment advice).
*GEORGE S. BISSELL: Chairman of the Board and Trustee of the FUND; Chairman of
the Board and Trustee or Director of all other Keystone Group Funds,;
Director of Keystone Group; Director and Chairman of the Board of
Hartwell Keystone; Chairman of the Board and Trustee of Anatolia
College; Trustee of University Hospital (and Chairman of its Investment
Committee); former Chairman of the Board and Chief Executive Officer of
Keystone Group; and former Chief Executive Officer of the Fund.
EDWIN D. CAMPBELL: Trustee of the FUND; Trustee or Director of all other
Keystone Group Funds; Executive Director, Coalition of Essential
Schools, Brown University; Director and former Executive Vice
President, National Alliance of Business; former Vice President,
Educational Testing Services; and former Dean, School of Business,
Adelphi University.
CHARLES F. CHAPIN: Trustee of the FUND; Trustee or Director of all other
Keystone Group Funds; former Group Vice President, Textron Corp.; and
former Director, Peoples Bank (Charlotte, N.C).
LEROY KEITH, JR.: Trustee of the FUND; Trustee or Director of all other
Keystone Group Funds; Director of Phoenix Total Return Fund and
Equifax, Inc.; Trustee of Phoenix Series Fund, Phoenix Multi-Portfolio
Fund and The Phoenix Big Edge Series Fund; and former President,
Morehouse College.
K. DUN GIFFORD: Trustee of the FUND; Trustee or Director of all other
Keystone Group Funds; Chairman of the Board, Director and Executive
Vice President, The London Harness Company; Managing Partner, Roscommon
Capital Corp.; Trustee, Cambridge College; Chairman Emeritus and
Director, American Institute of Food and Wine; Chief Executive Officer,
Gifford Gifts of Fine Foods; Chairman, Gifford, Drescher & Associates
(environmental consulting); President, Oldways Preservation and
Exchange Trust (education); and former Director, Keystone Group and
Keystone.
F. RAY KEYSER, JR.: Trustee of the FUND; Trustee or Director of all other
Keystone Group Funds; Of Counsel, Keyser, Crowley & Meub, P.C.; Member,
Governor's (VT) Council of Economic Advisers; Chairman of the Board and
Director, Central Vermont Public Service Corporation and Hitchcock
Clinic; Director, Vermont Yankee Nuclear Power Corporation, Vermont
Electric Power Company, Inc., Grand Trunk Corporation, Central Vermont
Railway, Inc., S.K.I. Ltd., Sherburne Corporation, Union Mutual Fire
Insurance Company, New England Guaranty Insurance Company, Inc. and the
Investment Company Institute; former Governor of Vermont; former
Director and President, Associated Industries of Vermont; former
Chairman and President, Vermont Marble Company; former Director of
Keystone; and former Director and Chairman of the Board, Green Mountain
Bank.
DAVID M. RICHARDSON: Trustee of the FUND; Trustee or Director of all other
Keystone Group Funds; Executive Vice President, DHR International, Inc.
(executive recruitment); former Senior Vice President, Boyden
International Inc. (executive recruit- ment); and Director, Commerce
and Industry Association of New Jersey, 411 International, Inc. and J &
M Cumming Paper Co.
RICHARD J. SHIMA: Trustee of the FUND; Trustee or Director of all other
Keystone Group Funds; Chairman, Environmental Warranty, Inc., and
Consultant, Drake Beam Morin, Inc. (executive outplacement); Director
of Connecticut Natural Gas Corporation, Trust Company of Connecticut,
Hartford Hospital, Old State House Association and Enhanced Financial
Services, Inc.; Member, Georgetown College Board of Advisors; Chairman,
Board of Trustees, Hartford Graduate Center; Trustee, Kingswood- Oxford
School and Greater Hartford YMCA; former Director, Executive Vice
President and Vice Chairman of The Travelers Corporation; and former
Managing Director of Russell Miller, Inc.
ANDREW J. SIMONS: Trustee of the FUND; Trustee or Director of all other
Keystone Group Funds; Partner, Farrell, Fritz, Caemmerer, Cleary,
Barnosky & Armentano, P.C.; President, Nassau County Bar Association;
former Associate Dean and Professor of Law, St. John's University
School of Law.
EDWARD F. GODFREY: Senior Vice President of the FUND; Senior Vice President of
all other Keystone Group Funds; Director, Senior Vice President, Chief
Financial Officer and Treasurer of Keystone Group, KDI, Keystone Asset
Corporation, Keystone Capital Corporation, Keystone Trust Company;
Treasurer of KIMCO, Robert Van Partners, Inc., and FICO; Treasurer and
Director of Keystone Management, Keystone Software, Inc., and Hartwell
Keystone; Vice President and Treasurer of KFIA; and Director of KIRC.
JAMES R. McCALL: Senior Vice President of the FUND; Senior Vice President of
all other Keystone Group Funds; and President of Keystone.
KEVIN J. MORRISSEY: Treasurer of the FUND; Treasurer of all other Keystone
Group Funds; Vice President of Keystone Group; Assistant Treasurer of
FICO and Keystone; and former Vice President and Treasurer of KIRC.
BETSY BLACHER: Vice President of the FUND; Vice President of certain other
Keystone Group Funds; and Vice President of Keystone.
CHRISTOPHER P. CONKEY: Vice President of the FUND; Vice President of certain
other Keystone Group Funds; and Vice President of Keystone.
ROSEMARY D. VAN ANTWERP: Senior Vice President and Secretary of the FUND; Senior
Vice President and Secretary of all other Keystone Group Funds; Senior
Vice President, General Counsel and Secretary of Keystone; Senior Vice
President, General Counsel, Secretary and Director of KDI, Keystone
Management and Keystone Software; Senior Vice President and General
Counsel of KIMCO; Senior Vice President, General Counsel and Director
of FICO and KIRC; Senior Vice President and Secretary of Hartwell
Keystone and Robert Van Partners, Inc.; Vice President and Secretary of
KFIA; Senior Vice President, General Counsel and Secretary of Keystone
Group, Keystone Asset Corporation, Keystone Capital Corporation and
Keystone Trust Company.
* This Trustee may be considered an "interested person" within the meaning of
the 1940 Act.
Mr. Elfner and Mr. Bissell are "interested persons" by virtue of their
positions as officers and/or Directors of Keystone Group and several of its
affiliates including Hartwell Keystone, KDI and KIRC. Mr. Elfner and Mr. Bissell
own shares of Keystone Group. Mr. Elfner is President, Chairman of the Board,
Chief Executive Officer and a Director of Keystone Group. Mr. Bissell is a
Director of Keystone Group.
During the fiscal period ended November 30, 1994, no Trustee affiliated
with Keystone nor any officer received any direct remuneration from the FUND.
During that same period, the nonaffiliated Trustees and officers of the FUND did
not receive any retainers or fees. For the twelve month period ending November
30, 1994, fees paid to Independent Trustees on a fund complex wide basis were
approximately $585,975. On February 28, 1995, the FUND's Trustees and officers
did not beneficially own any of the FUND's then outstanding shares.
The address of all Trustees and officers of the FUND and the address of the
FUND is 200 Berkeley Street, Boston, Massachusetts 02116-5034.
- --------------------------------------------------------------------------------
PRINCIPAL UNDERWRITER
- --------------------------------------------------------------------------------
The FUND has entered into a Principal Underwriting Agreement (the
"Underwriting Agreement"), with KDI, a wholly-owned subsidiary of Keystone. KDI,
as agent, has agreed to use its best efforts to find purchasers for the shares.
KDI may retain and employ representatives to promote distribution of the shares
and may obtain orders from brokers, dealers and others, acting as principals,
for sales of shares to them. The Underwriting Agreement provides that KDI will
bear the expense of preparing, printing and distributing advertising and sales
literature and prospectuses used by it. In its capacity as principal
underwriter, KDI may receive payments from each Fund pursuant to such Fund's
Distribution Plans.
All subscriptions and sales of shares by KDI are at the offering price of
the shares in accordance with the provisions of the FUND's Declaration of Trust,
By-Laws, the current prospectus and statement of additional information. All
orders are subject to acceptance by the FUND and the FUND reserves the right in
its sole discretion to reject any order received. Under the Underwriting
Agreement, the FUND is not liable to anyone for failure to accept any order.
The FUND has agreed under the Underwriting Agreement to pay all expenses in
connection with registration of the shares of its Funds with the Commission as
well as auditing and filing fees in connection with registration of such shares
under the various state "blue-sky" laws, and KDI assumes the cost of sales
literature and preparation of prospectuses used by it and certain other
expenses.
From time to time, if in KDI's judgment it could benefit the sales of a
Fund's shares, KDI may use its discretion in providing to selected dealers
promotional materials and selling aids, including, but not limited to, personal
computers, related software and FUND data files.
KDI has agreed that it will in all respects duly conform with all state and
federal laws applicable to the sale of the shares and will indemnify and hold
harmless the FUND, and each person who has been, is or may be a Trustee or
officer of the FUND, against expenses reasonably incurred by any of them in
connection with any claim or in connection with any action, suit or proceeding
to which any of them may be a party, that arises out of or is alleged to arise
out of any misrepresentation or omission to state a material fact on the part of
KDI or any other person for whose acts KDI is responsible or is alleged to be
responsible, unless such misrepresentation or omission was made in reliance upon
written information furnished by the FUND.
The Underwriting Agreement provides that it will remain in effect as long
as its terms and continuance are approved by a majority of the Trustees of the
FUND and a majority of the FUND's Rule 12b-1 Trustees at least annually in
accordance with the 1940 Act and rules and regulations thereunder.
The Underwriting Agreement may be terminated, without penalty, on 60 days'
written notice by a majority of the FUND's Rule 12b-1 Trustees or KDI or
terminated as to any Fund by a vote of a majority of outstanding shares of such
Fund. The Underwriting Agreement will terminate automatically upon its
"assignment" as that term is defined in the 1940 Act.
- --------------------------------------------------------------------------------
BROKERAGE
- --------------------------------------------------------------------------------
It is the policy of the FUND, in effecting transactions in portfolio
securities, to seek best execution of orders at the most favorable prices. The
determination of what may constitute best execution and price in the execution
of a securities transaction by a broker involves a number of considerations,
including, without limitation, the overall direct net economic result to a Fund,
involving both price paid or received and any commissions and other costs paid,
the efficiency with which the transaction is effected, the ability to effect the
transaction at all where a large block is involved, the availability of the
broker to stand ready to execute potentially difficult transactions in the
future and the financial strength and stability of the broker. Management weighs
such considerations in determining the overall reasonableness of brokerage
commissions paid.
Subject to the foregoing, a factor in the selection of brokers is the
receipt of research services, such as analyses and reports concerning issuers,
industries, securities, economic factors and trends and other statistical and
factual information. Any such research and other statistical and factual
information provided by brokers to a Fund is considered to be in addition to and
not in lieu of services required to be performed by Keystone under the Advisory
Agreement. The cost, value and specific application of such information are
indeterminable and cannot be practically allocated among the Funds and other
clients of Keystone who may indirectly benefit from the availability of such
information. Similarly, a Fund may indirectly benefit from information made
available as a result of transactions effected for such other clients. Under the
Advisory Agreement, Keystone is permitted to pay higher brokerage commissions
for brokerage and research services in accordance with Section 28(e) of the
Securities Exchange Act of 1934. In the event Keystone does follow such a
practice, it will do so on a basis that is fair and equitable to the Funds.
The FUND expects that purchases and sales of municipal obligations and
temporary instruments usually will be principal transactions. Municipal
obligations and temporary instruments are normally purchased directly from the
issuer or from an underwriter or market maker for the securities. There usually
will be no brokerage commissions paid by a Fund for such purchases. Purchases
from underwriters will include the underwriting commission or concession, and
purchases from dealers serving as market makers will include a dealer's mark up
or reflect a dealer's mark down. Where transactions are made in the
over-the-counter market, each Fund will deal with primary market makers unless
more favorable prices are otherwise obtainable.
Each Fund may participate, if and when practicable, in group bidding for
the purchase directly from an issuer of certain securities for the Fund's
portfolio in order to take advantage of the lower purchase price available to
members of such a group.
Neither Keystone nor the Funds intend to place securities transactions with
any particular broker-dealer or group thereof. The FUND's Board of Trustees has
determined, however, that the Funds may follow a policy of considering sales of
shares as a factor in the selection of broker-dealers to execute portfolio
transactions, subject to the requirements of best execution, including best
price, described above.
The policy of the FUND with respect to brokerage is and will be reviewed by
the FUND's Board of Trustees from time to time. Because of the possibility of
further regulatory developments affecting the securities exchanges and brokerage
practices generally, the foregoing practices may be changed, modified or
eliminated.
Investment decisions for the Funds are made independently by Keystone from
those of the other funds and investment accounts managed by Keystone. It may
frequently develop that the same investment decision is made for more than one
fund. Simultaneous transactions are inevitable when the same security is
suitable for the investment objective of more than one account. When two or more
funds or accounts are engaged in the purchase or sale of the same security, the
transactions are allocated as to amount in accordance with a formula that is
equitable to each fund or account. It is recognized that in some cases this
system could have a detrimental effect on the price or volume of the security as
far as the Funds are concerned. In other cases, however, it is believed that the
ability of a Fund to participate in volume transactions will produce better
executions for the Fund.
In no instance are portfolio securities purchased from or sold to Keystone,
KDI or any of their affiliated persons, as defined in the 1940 Act and rules and
regulations issued thereunder.
During the fiscal period ended November 30, 1994, the FUND did not pay any
brokerage commissions.
- --------------------------------------------------------------------------------
DECLARATION OF TRUST
- --------------------------------------------------------------------------------
MASSACHUSETTS BUSINESS TRUST
The FUND is a Massachusetts business trust established under a Declaration
of Trust dated September 13, 1990 ("Declaration of Trust"). The FUND is similar
in most respects to a business corporation. The principal distinction between
the FUND and a corporation relates to the shareholder liability described below.
A copy of the Declaration of Trust was filed as an exhibit to the FUND's
Registration Statement. This summary is qualified in its entirety by reference
to the Declaration of Trust.
DESCRIPTION OF SHARES
The Declaration of Trust authorizes the issuance of an unlimited number of
shares of beneficial interest of classes of shares. Each share of a Fund
represents an equal proportionate interest in such Fund with each other share of
the Fund. Each Fund currently issues three classes of shares, but may issue
additional classes or series of shares. Upon liquidation, Fund shares are
entitled to a pro rata share of the Fund based on the relative net assets of
each class. Shareholders have no preemptive or conversion rights. Shares are
transferable, redeemable and fully assignable as collateral. There are no
sinking fund provisions.
SHAREHOLDER LIABILITY
Pursuant to certain decisions of the Supreme Judicial Court of
Massachusetts, shareholders of a Massachusetts business trust may, under certain
circumstances, be held personally liable as partners for the obligations of the
trust. If the FUND were held to be a partnership, the possibility of the
shareholders incurring financial loss for that reason appears remote because the
FUND's Declaration of Trust (1) contains an express disclaimer of shareholder
liability for obligations of the FUND; and (2) requires that notice of such
disclaimer be given in each agreement, obligation or instrument entered into or
executed by the FUND or the Trustees; and (3) provides for indemnification out
of FUND property for any shareholder held personally liable for the obligations
of the FUND.
VOTING RIGHTS
Under the Declaration of Trust the FUND does not hold annual meetings.
Shares of a Fund are entitled to one vote per share. Shares generally vote
together as one class on all matters, except that each Fund has exclusive voting
rights with respect to matters that affect only that Fund. Classes of shares of
a Fund have equal voting rights except that each class of shares has exclusive
voting rights with respect to its respective Distribution Plan. No amendment may
be made to the Declaration of Trust adversely that affects any class of shares
without the approval of a majority of the shares of that class. Shares have
non-cumulative voting rights, which means that the holders of more than 50% of
the shares voting for the election of Trustees can elect 100% of the Trustees to
be elected at a meeting and, in such event, the holders of the remaining 50% or
less of the shares voting will not be able to elect any Trustees.
After the initial meeting to elect Trustees no further meetings of
shareholders for the purpose of electing Trustees will be held, unless required
by law, unless and until such time as less than a majority of the Trustees
holding office have been elected by shareholders, at which time the Trustees
then in office will call a shareholders' meeting for election of Trustees.
Except as set forth above, the Trustees shall continue to hold office
indefinitely, unless otherwise required by law, and may appoint successor
Trustees. A Trustee may be removed from or cease to hold office (as the case may
be) (1) at any time by two-thirds vote of the remaining Trustees; (2) when such
Trustee becomes mentally or physically incapacitated; or (3) at a special
meeting of shareholders by a two-thirds vote of the outstanding shares. Any
Trustee may voluntarily resign from office.
LIMITATION OF TRUSTEES' LIABILITY
The Declaration of Trust provides that a Trustee shall be liable only
for his own willful defaults and, if reasonable care has been exercised in the
selection of officers, agents, employees or investment advisers, shall not be
liable for any neglect or wrongdoing of any such person; provided, however, that
nothing in the Declaration of Trust shall protect a Trustee against any
liability for his willful misfeasance, bad faith, gross negligence or reckless
disregard of his duties.
The Trustees have absolute and exclusive control over the management
and disposition of all assets of the Funds and may perform such acts as in their
sole judgment and discretion are necessary and proper for conducting the
business and affairs of the FUND or promoting the interests of the FUND and its
Funds and the shareholders.
- --------------------------------------------------------------------------------
STANDARDIZED TOTAL RETURN AND YIELD QUOTATIONS
- --------------------------------------------------------------------------------
Total return quotations for a class of shares of a Fund as they may appear
from time to time in advertisements are calculated by finding the average annual
compounded rates of return over one, five and ten year periods, or the time
periods for which such class of shares has been effective, whichever is
relevant, on a hypothetical $1,000 investment that would equate the initial
amount invested in the class to the ending redeemable value. To the initial
investment all dividends and distributions are added, and all recurring fees
charged to all shareholder accounts are deducted. The ending redeemable value
assumes a complete redemption at the end of the relevant periods.
The total returns for the Class A shares of the California Insured Fund and
the Missouri Tax Free Fund for the period February 1, 1994 (commencement of
operations) to November 30, 1994 were (13.12)% and (12.89)%, respectively. The
total returns for the Class B shares of the California Insured Fund and the
Missouri Tax Free Fund for the period February 1, 1994 (commencement of
operations) to November 30, 1994 were (11.60)% and (11.66)%, respectively. The
total returns for the Class C shares of the California Insured Fund and the
Missouri Tax Free Fund for the period February 1, 1994 (commencement of
operations) to November 30, 1994 were (9.95)% and (10.11)%, respectively.
Current yield quotations as they may appear from time to time in
advertisements will consist of a quotation based on a 30-day period ended on the
date of the most recent balance sheet of a Fund, computed by dividing the net
investment income per share earned during the period by the maximum offering
price per share on the last day of the base period. Such yield will include
income from sources other than municipal obligations, if any.
The current yields for the Class A shares of the California Insured Fund
and the Missouri Tax Free Fund for the 30-day period ended November 30, 1994
were 6.19% and 6.12%, respectively. The current yields for the Class B shares of
the California Insured Fund and the Missouri Tax Free Fund for the 30-day period
ended November 30, 1994 were 5.73% and 5.62%, respectively. The current yields
for the Class C shares of the California Insured Fund and the Missouri Tax Free
Fund for the 30-day period ended November 30, 1994 were 5.73% and 5.64%,
respectively.
Tax equivalent yield is, in general, the current yield divided by a factor
equal to one minus a stated income tax rate and reflects the yield a taxable
investment would have to achieve in order to equal on an after-tax basis a
tax-exempt yield.
The tax equivalent yields for the Class A shares of the California Insured
Fund and the Missouri Tax Free Fund for an investor in the 31% federal tax
bracket for the 30-day period ended November 30, 1994 were 8.97% and 8.87%,
respectively. The tax equivalent yields for the Class B shares of the California
Insured Fund and the Missouri Tax Free Fund for an investor in the 31% federal
tax bracket for the 30-day period ended November 30, 1994 were 8.30% and 8.14%,
respectively. The tax equivalent yields for the Class C shares of the California
Insured Fund and the Missouri Tax Free Fund for an investor in the 31% federal
tax bracket for the 30-day period ended November 30, 1994 were 8.30% and 8.17%,
respectively.
Any given yield or total return quotation should not be considered
representative of the Fund's yield or total return for any future period.
ADDITIONAL INFORMATION
As of February 28, 1995, the following shareholders of record owned 5% or
more of the California Insured Fund's outstanding Class A shares:
SHAREHOLDER OF RECORD % OF CLASS
Merrill Lynch Pierce Fenner & Pierce 13.53%
Attn: Book Entry
4800 Deer Lake Drive East, 3rd Floor
Jacksonville, FL 32246-6484
Wydea Haddad TTEE 6.73%
The Haddad Family Trust "B"
UA DTD 01-18-78
4514 Noeline Way
Encino, CA 91436-2108
As of February 28, 1995, the following shareholders of record owned 5% or
more of the California Insured Fund's outstanding Class B shares:
SHAREHOLDER OF RECORD % OF CLASS
Merrill Lynch Pierce Fenner & Pierce 27.41%
Attn: Book Entry
4800 Deer Lake Drive East, 3rd Floor
Jacksonville, FL 32246-6484
John O. Fleming 5.54%
Agnes Mae Fleming TTEES
UTA DTD 10/21/91
FBO Fleming Family Rev Trust
8339 G Avenue
Coronado, CA 82118-2519
As of February 28, 1995, the following shareholders of record owned 5% or
more of the California Insured Fund's outstanding Class C shares:
SHAREHOLDER OF RECORD % OF CLASS
Victor E. Rylander 27.94%
Lucille Rylander JT WROS
4102 Caflur Avenue
San Diego, California 92117-4436
Richard B. Smith 12.88%
Doris M. Smith TTEE
U/A DTD 04-08-93
Smith Trust
4853 Mt. Royal Court
San Diego, CA 92117-2917
William L. O'Daly 7.98%
Madeline M. O'Daly TTEES
U/A DTD 09-05-89
O'Daly Family Trust
19601 Vintage Street
Northridge, CA 91324-1045
Alfred Bodek 7.81%
26012 Eshelman Avenue
Lomita, CA 90717-3225
Keystone Distributors Inc. 6.86%
Attn: Treasury Dept., 21st Floor
Attn: Kevin Stoddard
200 Berkeley Street
Boston, MA 02116-5022
Robert Lee Davis 5.13%
13566 Avenida Del Charro
El Cajon, CA 992021-2119
As of February 28, 1995, the following shareholders of record owned 5% or
more of the Missouri Tax Free Fund's outstanding Class A shares:
SHAREHOLDER OF RECORD % OF CLASS
Shoji Entertainment Inc. 45.63%
2709 State Highway 248
Branson, MO 65616-9226
Merrill Lynch Pierce Fenner & Pierce 7.60%
Attn: Book Entry
4800 Deer Lake Drive East, 3rd Floor
Jacksonville, FL 32246-6484
As of February 28, 1995, the following shareholder of record owned 5% or
more of the Missouri Tax Free Fund's outstanding Class B shares:
SHAREHOLDER OF RECORD % OF CLASS
Merrill Lynch Pierce Fenner & Pierce 21.98%
Attn: Book Entry
4800 Deer Lake Drive East, 3rd Floor
Jacksonville, FL 32246-6484
As of February 28, 1995, the following shareholders of record owned 5% or
more of the Missouri Tax Free Fund's outstanding Class C shares:
SHAREHOLDER OF RECORD % OF CLASS
Painewebber FBO 10.08%
Jeannette M. Holz Trust
Jeannette M. Holz TTEE
U/A DTD 10/15/83
Box 698
Lake Ozark, MO 65049-0698
Kathy D. Reise 7.16%
6926 Broken Oak Drive
Saint Louis, MO 63129
Painewebber FBO 7.12%
Anne B. Moore & Allen
Moore III TTEES
The Anne B. Moore Trust
U/A DTD 7/27/87
1024 West Desert Hills Drive
Green Valley, AZ 85614
Dorothy Keay 7.03%
84 So. Beach Street, Apt. 204
Ormond Beach, FL 32174
Painewebber FBO 7.01%
Iman Karmadi
4618 Warwick Boulevard, Apt. 6A
Kansas City, MO 64112-1780
Painewebber FBO 6.82%
Lorraine Wilder TTEE
Lorraine Wilder Rev Tr
U/A DTD 7-26-88
444 1/2 Jackson
Chillicothe, MO 64601
Painewebber FBO 5.37%
Allen Moore III & Anne B. Moore
Trustees of Allen Moore III Trust
UAD 7/27/87
1024 West Desert Hills Drive
Green Valley, AZ 85614
Shoji Babuchi 5.25%
Dorothy Babuchi JT TEN
2709 State Highway 2248
Branson, MO 65616-9226
State Street Bank and Trust Company, 225 Franklin Street, Boston,
Massachusetts 02110, is the custodian of all securities and cash of the FUND
("Custodian"). The Custodian performs no investment management functions for the
FUND, but, in addition to its custodial services, is responsible for accounting
and related recordkeeping on behalf of the FUND.
KPMG Peat Marwick LLP, One Boston Place, Boston, Massachusetts 02108,
Certified Public Accountants, are the independent auditors for the FUND.
KIRC, located at 101 Main Street, Cambridge, Massachusetts 02142-1519, is a
wholly-owned subsidiary of Keystone and acts as transfer agent and dividend
disbursing agent for the FUND.
Except as otherwise stated in its prospectus or required by law, the FUND
reserves the right to change the terms of the offer stated in its prospectus
without shareholder approval, including the right to impose or change fees for
services provided.
No dealer, salesman or other person is authorized to give any information
or to make any representation not contained in the FUND's prospectus, statement
of additional information or in supplemental sales literature issued by the FUND
or KDI, and no person is entitled to rely on any information or representation
not contained therein.
The FUND's prospectus and statement of additional information omit certain
information contained in the registration statement filed with the Commission, a
copy of which may be obtained from the Commission's principal office in
Washington, D.C. upon payment of the fee prescribed by the rules and regulations
promulgated by the Commission.
The FUND is one of 15 different investment companies in the Keystone
America family, which offers a range of choices to serve shareholder needs. In
addition to the FUND, the Keystone America family includes the following funds
having the various investment objectives described below:
KEYSTONE AMERICA CAPITAL PRESERVATION AND INCOME FUND - Seeks high level of
current income, consistent with low volatility of principal, by investing under
ordinary circumstances at least 65% in adjustable rate securities issued by the
U.S. government, its agencies or instrumentalities.
KEYSTONE AMERICA FUND FOR TOTAL RETURN - Seeks total return from a combination
of capital growth and income from dividend paying quality common stocks,
preferred stocks, convertible bonds, other fixed-income securities and foreign
securities (up to 25%).
KEYSTONE AMERICA GLOBAL OPPORTUNITIES FUND - Seeks long-term capital growth from
foreign and domestic securities.
KEYSTONE AMERICA GOVERNMENT SECURITIES FUND - Seeks income and capital
preservation from U.S. government securities.
KEYSTONE AMERICA HARTWELL EMERGING GROWTH FUND, INC. - Seeks capital
appreciation by investment primarily in small and medium-sized companies in a
relatively early stage of development that are principally traded in the
over-the-counter market.
KEYSTONE AMERICA HARTWELL GROWTH FUND, INC. - Seeks capital appreciation by
investment in securities selected for their long- term growth prospects.
KEYSTONE AMERICA INTERMEDIATE TERM BOND FUND - Seeks income, capital
preservation and price appreciation potential from investment grade corporate
bonds.
KEYSTONE AMERICA OMEGA FUND, INC. - Seeks maximum capital growth from common
stocks and securities convertible into common stocks.
KEYSTONE AMERICA STATE TAX FREE FUND - A mutual fund consisting of five separate
series of shares investing in different portfolio securities which seeks the
highest possible current income, exempt from federal income taxes and applicable
state taxes.
KEYSTONE AMERICA STATE TAX FREE FUND - SERIES II - A mutual fund consisting of
two separate series of shares investing in different portfolio securities which
seeks the highest possible current income, exempt from federal income taxes and
applicable state taxes.
KEYSTONE AMERICA STRATEGIC INCOME FUND - Seeks high yield and capital
appreciation potential from corporate bonds, discount bonds, convertible bonds,
preferred stock and foreign bonds (up to 25%).
KEYSTONE AMERICA TAX FREE INCOME FUND - Seeks income exempt from federal income
taxes and capital preservation from the four highest grades of municipal bonds.
KEYSTONE AMERICA WORLD BOND FUND - Seeks total return from interest income,
capital gains and losses and currency exchange gains and losses from investment
in debt securities denominated in U.S. and foreign currencies.
KEYSTONE FUND OF THE AMERICAS - Seeks growth and income from a diversified
portfolio of established North American stocks, Latin American stocks and Latin
American bonds.
KEYSTONE STRATEGIC DEVELOPMENT FUND - Seeks long term capital growth by
investing primarily in equity securities.
<PAGE>
- --------------------------------------------------------------------------------
APPENDIX A
- --------------------------------------------------------------------------------
KEYSTONE AMERICA CALIFORNIA INSURED TAX FREE FUND
GENERAL
California's economy is the largest among the 50 states and one of the
largest in the world. The State's population of almost 32 million represents
12.3% of the total U.S. population and grew by 27% in the 1980's. Total personal
income in the State, at an estimated $683 billion in 1993, accounts for almost
13% of all personal income in the nation. Total employment is almost 14 million,
the majority of which is in the service, trade and manufacturing sectors.
From mid-1990 to late 1993, the State suffered a recession with the
worst economic, fiscal and budget conditions since the 1930's. Construction,
manufacturing (especially aerospace), and financial services, among others, were
all severely affected, particularly in Southern California. Job losses were the
worst of any post-war recession. Employment levels stabilized by late 1993 and
steady growth occurred in 1994 and is expected in 1995, but pre-recession job
levels are not expected to be reached for several more years. Unemployment,
while higher than the national average, has come down about 3% in 1994. Economic
indicators show a steady recovery underway in California since the start of
1994.
CONSTITUTIONAL LIMITATIONS ON TAXES AND APPROPRIATIONS
LIMITATION ON TAXES. Certain California municipal obligations may be
obligations of issuers that rely in whole or in part, directly or indirectly, on
ad valorem property taxes as a source of revenue. The taxing powers of
California local governments and districts are limited by Article XIIIA of the
California Constitution, enacted by the voters in 1978 and commonly known as
"Proposition 13." Briefly, Article XIIIA limits to 1% of full cash value the
rate of ad valorem property taxes on real property and generally restricts the
reassessment of property to 2% per year, except upon new construction or change
of ownership (subject to a number of exemptions). Taxing entities may, however,
raise ad valorem taxes above the 1% limit to pay debt service on voter-approved
bonded indebtedness.
Under Article XIIIA, the basic 1% ad valorem tax levy is applied
against the assessed value of property as of the owner's date of acquisition (or
as of March 1, 1975, if acquired earlier), subject to certain adjustments. This
system has resulted in widely varying amounts of tax on similarly situated
properties. Several lawsuits have been filed challenging the acquisition-based
assessment system of Proposition 13, and on June 18, 1992 the U.S. Supreme Court
announced a decision upholding Proposition 13.
Article XIIIA prohibits local governments from raising revenues through
ad valorem property taxes above the 1% limit; it also requires voters of any
governmental unit to give two-thirds approval to levy any "special tax." Court
decisions, however, allowed non-voter approved levy of "general taxes" that
were not dedicated to a specific use. In response to these decisions, the voters
of the State in 1986 adopted an initiative statute that imposed significant new
limits on the ability of local entities to raise or levy general taxes, except
by receiving majority local voter approval. Significant elements of this
initiative, "Proposition 62," have been overturned in recent court cases. An
initiative proposed to re-enact the provisions of Proposition 62 as a
constitutional amendment was defeated by the voters in November 1990, but such a
proposal may be renewed in the future.
APPROPRIATION LIMITS. The State and its local governments are subject
to an annual "appropriations limit" imposed by Article XIIIB of the California
Constitution, enacted by the voters in 1979 and significantly amended by
Propositions 98 and 111 in 1988 and 1990, respectively. Article XIIIB prohibits
the State or any covered local government from spending "appropriations subject
to limitation" in excess of the appropriations limit imposed. "Appropriations
subject to limitation" are authorizations to spend "proceeds of taxes," which
consist of tax revenues and certain other funds, including proceeds from
regulatory licenses, user charges or other fees, to the extent that such
proceeds exceed the cost of providing the product or service, but "proceeds of
taxes" excludes most State subventions to local governments. No limit is imposed
on appropriations of funds that are not "proceeds of taxes," such as reasonable
user charges or fees, and certain other non-tax funds, including bond proceeds.
Among the expenditures not included in the Article XIIIB appropriations
limit are (1) the debt service cost of bonds issued or authorized prior to
January 1, 1979, or subsequently authorized by the voters, (2) appropriations
arising from certain emergencies declared by the Governor, (3) appropriations
for certain capital outlay projects, (4) appropriations by the State of post
1989 increases in gasoline taxes and vehicle weight fees, and (5) appropriations
made in certain cases of emergency.
The appropriations limit for each year is adjusted annually to reflect
changes in cost of living and population and any transfers of service
responsibilities between governmental units. The definitions for such
adjustments were liberalized in 1990 to follow more closely growth in the
State's economy.
"Excess" revenues are measured over a two year cycle. Local governments
must return any excess to taxpayers by rate reductions. The State must refund
50% paid to schools and community colleges. With more liberal annual adjustment
factors since 1988, and depressed revenues since 1990 because of the recession,
few governments, including the State, are currently operating near their
spending limits, but this condition may change over time. Local governments may
by voter approval exceed their spending limits for up to four years.
Because of the complex nature of Articles XIIIA and XIIIB of the
California Constitution, the ambiguities and possible inconsistencies of their
terms, and the impossibility of predicting future appropriations or changes in
population and cost of living, and the probability of continuing legal
challenges, it is not currently possible to determine fully the impact of
Article XIIIA or Article XIIIB on California municipal obligations. It is not
presently possible to predict the outcome of any pending litigation with respect
to the ultimate scope, impact or constitutionality of either Article XIIIA or
Article XIIIB, or the impact of any such determinations upon State agencies or
local governments, or upon their ability to pay debt service on their
obligations. Future initiatives or legislative changes in laws or the California
Constitution may also affect the ability of the State or local issuers to repay
their obligations.
OBLIGATIONS OF THE STATE OF CALIFORNIA
As of March 1, 1995, the State had approximately $18.9 billion of
general obligation bonds outstanding, and $3.7 billion remained authorized but
unissued. In addition, at June 30, 1994, the State had lease-purchase
obligations, payable from the State's General Fund, of approximately $5.1
billion. In fiscal year 1993-1994, debt service on general obligation bonds and
lease-purchase debt was approximately 5.2% of General Fund revenues. The State
has paid the principal of and interest on its general obligation bonds,
lease-purchase debt and short-term obligations when due.
RECENT FINANCIAL RESULTS
The principal sources of General Fund revenues in 1993-1994 were the
California personal income tax (44% of total revenues), the sales tax (35%),
bank and corporation taxes (12%), and the gross premium tax on insurance (3%).
The State maintains a Special Fund for Economic Uncertainties," derived from
General Fund revenues, as a reserve to meet cash needs of the General Fund.
GENERAL. Throughout the 1980's, State spending increased rapidly as the
State population and economy also grew rapidly, including increased spending for
many assistance programs to local governments, which were constrained by
Proposition 13 and other laws. The largest State program is assistance to local
public school districts. In 1988, an initiative (Proposition 98) was enacted
which (subject to suspension by a two-thirds vote of the Legislature and the
Governor) guarantees local school districts and community college districts a
minimum share of State General Fund revenues (currently 35%).
Since the start of 1990-91 Fiscal Year, the State has faced adverse
economic, fiscal, and budget conditions. The economic recession seriously
affected State tax revenues. It also caused increased expenditures for health
and welfare programs. The State is also facing a structural imbalance in its
budget with the largest programs supported by the General Fund (education,
health, welfare and corrections) growing at rates higher than the growth rates
for the principal revenue sources of the General Fund. As a result, the State
entered a period of budget imbalance, with expenditures exceeding revenues for
four of the five fiscal years ending in 1991-92; revenues and expenditures were
about equal in 1992-93. The General Fund had an operating surplus in 1993-94. By
June 30, 1994, the State's General Fund had an accumulated deficit, on a budget
basis, of approximately $1.8 billion.
CASH FLOW REQUIREMENTS. Because of the budget deficit accumulated over
the past several years, the payment of certain unbudgeted expenditures to
schools to maintain constant per-pupil aid levels, and a reduction of the level
of available internal borrowing, the State's cash resources have been
significantly depleted. This has required the State to rely on a series of
external borrowings for the past several years to pay its normal expenses,
including repayment of previous cash flow borrowings. Since June 1992, some of
these borrowings have gone past the end of the fiscal year. In February, 1994,
the State borrowed $3.2 billion, maturing by December, 1994. In July, 1994, the
State borrowed a total of $7.0 billion to meet its cash flow requirements for
the 1994-95 fiscal year, and to fund a part of its deficit into the 1995-96
fiscal year. A total of $4.0 billion of this borrowing matures in April, 1996.
The State will continue to have to rely on external borrowing to meet its cash
needs for the foreseeable future.
RECENT BUDGETS. The State failed to enact its 1992-93 budget by July 1,
1992. Although the State had no legal authority to pay many of its vendors,
certain obligations (such as debt service, school apportionments, welfare
payments, and employee salaries) were payable because of continuing or special
appropriations, or court orders. However, the State Controller did not have
enough cash to pay, as they came due, all of these ongoing obligations, as well
as valid obligations incurred in the prior fiscal year.
Starting on July 1, 1992, the Controller was required to issue
"registered warrants" in lieu of normal warrants backed by cash to pay many
State obligations. Available cash was used to pay constitutionally mandated and
priority obligations. Between July 1 and September 3, 1992, the Controller
issued an aggregate of approximately $3.8 billion of registered warrants all of
which were called for redemption by September 4, 1992 following enactment of the
1992-93 Budget Act and issuance by the State of short-term notes.
The 1992-93 Budget Act, when finally adopted, was projected to
eliminate the State's accumulated deficit, with additional expenditure cuts and
a $1.3 billion transfer of State education funding costs to local governments by
shifting local property taxes to school districts. However, as the recession
continued longer and deeper than expected, revenues once again were far below
projections, and only reached a level just equal to the amount of expenditures.
Thus, the State continued to carry its $2.8 billion budget deficit at June 30,
1993.
The 1993-94 Budget Act represented a third consecutive year of
difficult budget choices. As in the prior year, the budget cccontained no
general state tax increases, and relied principally on expenditure cuts,
particularly for health and welfare and higher education, a two-year suspension
of the renters' tax credit, some one-time and accounting adjustments, and -- the
largest component -- an additional $2.6 billion transfer of property taxes from
local government, particularly counties, to school districts to reduce State
education funding requirements. A temporary state sales tax scheduled to expire
on June 30, 1993 was extended for six months, and dedicated to support local
government safety costs.
A major feature of the budget was a two-year plan to eliminate the
accumulated deficit by borrowing into the 1994-95 fiscal year. With the
recession still continuing longer than expected, the General Fund had $800
million less revenue and $800 million higher expenditures than budgeted. As a
result, revenues only exceeded expenditures by about $500 million. However, this
was the first operating surplus in four years and reduced the accumulated
deficit to $2.0 billion at June 30, 1994 (after taking account of certain other
accounting reserves).
CURRENT BUDGET. The 1994-95 Budget Act was passed on July 8, 1994, and
provides for an estimated $41.9 billion of General Fund revenues, and $40.9
billion of expenditures. The budget assumed receipt of about $750 million of new
federal assistance for the costs of incarceration, education, health and welfare
related to undocumented immigrants. Other major components of the budget include
further reductions in health and welfare costs and miscellaneous government
costs, some additional transfers of funds from local government, and a plan to
defer retirement of $1 billion of the accumulated budget deficit to the 1995-96
fiscal year. The federal government has apparently budgeted only $33 million of
the expected immigration aid. However, this shortfall is expected to be almost
fully offset by higher than projected revenues, and lower than projected
caseload growth, as the economy improves.
As noted above under "Cash Flow Requirements," the State issued $7.0
billion of short-term debt in July, 1994 to meet its cash flow needs and to
finance the deferral of part of the accumulated budget deficit to the 1995-96
fiscal year. In order to assure repayment of the $4 billion, 22-month part of
this borrowing, the State enacted legislation (the "Trigger Law") which can lead
to automatic, across-the-board cuts in General Fund expenditures in either the
1994-95 or 1995-96 fiscal years if cash flow projections made at certain times
during those years show deterioration from the projections made in July 1994
when the borrowings were made. On November 15, 1994, the State Controller, as
part of the Trigger Law, reported that the cash position of the General Fund on
June 30, 1995 would be about $580 million better than earlier projected, so no
automatic budget adjustments were required in 1994-95. The Controller's report
showed that loss of federal funds was offset by higher revenues, lower
expenditures, and certain other increases in cash resources.
The proposed Governor's Budget for the 1995-96 fiscal year projects
General Fund revenues of $42.5 billion and expenditures of $41.7 billion. The
Governor's Budget projects that all the accumulated budget deficits will be
repaid by June 30, 1996, with a small balance ($92 million) in the Special Fund
for Economic Uncertainties, the budget reserve. The proposed budget assumes
receipt of about $830 million of new federal aid for undocumented aliens' costs,
and also assumes success in certain ongoing litigation concerning previous
budget actions. The Governor has proposed a 15% cut in personal income and
corporate taxes, to be phased in over three years starting in 1996.
The State's financial difficulties for the current and upcoming years
will result in continued pressure upon almost all local governments,
particularly school districts and counties which depend on State aid. Despite
efforts in recent years to increase taxes and reduce governmental expenditures,
there can be no assurance that the State will not face budget gaps in the
future.
ORANGE COUNTY. On December 6, 1994, Orange County, California (the
"County"), together with its pooled investment funds (the "Pools") filed for
protection under Chapter 9 of the federal Bankruptcy Code, after reports that
the Pools had suffered significant market losses in their investments causing a
liquidity crisis for the Pools and the County. More than 180 other public
entities, most but not all located in the County, were also depositors in the
Pools. As of mid-January, 1995, the County estimated the Pools' loss at about
$1.7 billion, or 22% of its initial deposits of around $7.5 billion. Many of the
entities that kept moneys in the Pools, including the County, are facing cash
flow difficulties because of the bankruptcy filing and may be required to reduce
programs or capital projects. The County and some of these entities have, and
others may in the future, default in payment of their obligations. Moody's and
Standard & Poor's have suspended, reduced to below investment grade levels, or
placed on "Credit Watch" various securities of the County and the entities
participating in the Pool.
The State of California has no existing obligation with respect to any
obligations or securities of the County or any of the other participating
entities. However, the State may be obligated to intervene to ensure that school
districts have sufficient funds to operate, or to maintain certain
countyadministered state programs.
BOND RATINGS
State general obligation bonds are currently rated "A1" by Moody's and
"A" by S&P. Both of these ratings were reduced from "AAA" levels which the State
held until late 1991. There can be no assurance that such ratings will be
maintained in the future. It should be noted that the creditworthiness of
obligations issued by local California issuers may be unrelated to the
creditworthiness of obligations issued by the State of California, and that
there is no obligation on the part of the State to make payment on such
obligations in the event of default.
LEGAL PROCEEDING.
The State is involved in certain legal proceedings (described in the
State's recent financial statements) that, if decided against the State, may
require the State to make significant future expenditures or may substantially
impair revenues.
OBLIGATIONS OF OTHER ISSUERS
OTHER ISSUERS OF CALIFORNIA MUNICIPAL OBLIGATIONS. There are a number
of state agencies, instrumentalities and political subdivisions of the State
that issue Municipal Obligations, some of which may be conduit revenue
obligations payable from payments from private borrowers. These entities are
subject to various economic risks and uncertainties, and the credit quality of
the securities issued by them may vary considerably from the credit quality of
obligations backed by the full faith and credit of the State.
STATE ASSISTANCE. Property tax revenues received by local governments
declined more than 50% following passage of Proposition 13. Subsequently, the
California Legislature enacted measures to provide for the redistribution of the
State's General Fund surplus to local agencies, the reallocation of certain
State revenues to local agencies and the assumption of certain governmental
functions by the State to assist municipal issuers to raise revenues. Through
1990-91, local assistance (including public schools) accounted for around 75% of
General Fund spending. To reduce State General Fund support for school
districts, the 1992-93 and 1993-94 Budget Acts caused local governments to
transfer a total of $3.9 billion of property tax revenues to school districts,
representing loss of all the post-Proposition 13 "bailout" aid. The largest
share of these transfers came from counties, and the balance from cities,
special districts and redevelopment agencies. In order to make up part of this
shortfall, the Legislature proposed, and voters approved, dedicating 0.5% of the
sales tax to counties and cities for public safety purposes. In addition, the
Legislature has changed laws to relieve local governments of certain mandates,
allowing them to reduce costs.
To the extent the State should be constrained by its Article XIIIB
appropriations limit, or its obligation to conform to Proposition 98, or other
fiscal considerations, the absolute level, or the rate of growth, of State
assistance to local governments may continue to be reduced. Any such reductions
in State aid could compound the serious fiscal constraints already experienced
by many local governments, particularly counties. At least one rural county
(Butte) publicly announced that it might enter bankruptcy proceedings in August
1990, although such plans were put off after the Governor approved legislation
to provide additional funds for the county. Other counties have also indicated
that their budgetary condition is extremely grave. The Richmond Unified School
District (Contra Cost County) entered bankruptcy proceedings in May 1991, but
the proceedings have been dismissed.
ASSESSMENT BONDS. California municipal obligations that are assessment
bonds may be adversely affected by a general decline in real estate values or a
slowdown in real estate sales activity. In many cases, such bonds are secured by
land that is undeveloped at the time of issuance, but anticipated to be
developed within a few years after issuance. In the event of such reduction or
slowdown, such development may not occur or may be delayed, thereby increasing
the risk of a default on the bonds. Because the special assessments or taxes
securing these bonds are not the personal liability of the owners of the
property assessed, the lien on the property is the only security for the bonds.
Moreover, in most cases the issuer of these bonds is not required to make
payments on the bonds in the event of delinquency in the payment of assessments
or taxes, except from amounts, if any, in a reserve fund established for the
bonds.
CALIFORNIA LONG-TERM LEASE OBLIGATIONS. Certain California long-term
lease obligations, though typically payable from the general fund of the
municipality, are subject to "abatement" in the event the facility being leased
use and occupancy by the municipality during the term of the lease. Abatement is
not a default, and there may be no remedies available to the holders of the
certificates evidencing the lease obligation in the event abatement occurs. The
most common cases of abatement are failure to complete construction of the
facility before the end of the period during which lease payments have been
capitalized and uninsured casualty losses to the facility (e.g. due to
earthquake). In the event abatement occurs with respect to a lease obligation,
lease payments may be interrupted (if all available insurance proceeds and
reserves are exhausted) and the certificates may not be paid when due.
Several years ago the Richmond Unified School District (the "District")
entered into a lease transaction in which certain existing properties of the
District were sold and leased back in order to obtain funds to cover operating
deficits. Following a fiscal crisis in which the District's finances were taken
over by a State receiver (including a brief period under bankruptcy court
protection), the District failed to make rental payments on this lease,
resulting in a lawsuit by the Trustee for the Certificate of Participation
holders, in which the State was a named defendant (on the grounds that it
controlled the District's finances). One of the defenses raised in answer to
this lawsuit was the invalidity of the District's lease. The trial court upheld
the validity of the lease, and the case has subsequently been settled. Any
judgment in a similar case against the position taken by the Trustee may have
adverse implications for lease transactions of a similar nature by other
California entities.
OTHER CONSIDERATIONS
The repayment of industrial development securities secured by real
property may be affected by California laws limiting foreclosure rights of
creditors. Securities backed by health care and hospital revenues may be
affected by changes in State regulations governing cost reimbursements to health
care providers under Medi-Cal (the State's Medicaid program), including risks
related to the policy of awarding exclusive contracts to certain hospitals.
Limitations on ad valorem property taxes may particularly affect "tax
allocation" bonds issued by California redevelopment agencies. Such bonds are
secured solely by the increase in assessed valuation of a redevelopment project
area after the start of redevelopment activity. In the event that assessed
values in the redevelopment project decline (e.g. because of major natural
disaster such as an earthquake), the tax increment revenue may be insufficient
to make principal and interest payments on these bonds. Both Moody's and S&P
suspended ratings on California tax allocation bonds after the enactment of
Articles XIIIA and XIIIB, and only resumed such ratings on a selective basis.
Proposition 87, approved by California voters in 1988, requires that
all revenues produced by a tax rate increase go directly to the taxing entity
that increased such tax rate to repay that entity's general obligation
indebtedness. As a result, redevelopment agencies (which typically are the
issuers of tax allocation securities) no longer receive an increase in tax
increment when taxes on property in the project area are increased to repay
voter-approved bonded indebtedness.
The effect of these various constitutional and statutory changes upon
the ability of California municipal securities issuers to pay interest and
principal on their obligations remains unclear. Furthermore, other measures
affecting the taxing or spending authority of California or its political
subdivisions may be approved or enacted in the future. Legislation has been or
may be introduced that would modify existing taxes or other revenue raising
measures or that either would further limit or, alternatively, would increase
the abilities of state and local governments to impose new taxes or increase
existing taxes. It is not presently possible to predict the extent to which any
such legislation will be enacted. Nor is it presently possible to determine the
impact of any such legislation on California Municipal Obligations in which the
Fund may invest, future allocations of state revenues to local governments or
the abilities of state or local governments to pay the interest on, or repay the
principal of, such California municipal obligations.
Substantially all of California is within an active geologic region
subject to major seismic activity. Northern California in 1989 and Southern
California in 1994 experienced major earthquakes causing billions of dollars in
damages. The federal government provided more than $13 billion in aid for both
earthquakes, and neither event is expected to have any long-term negative
economic impact. Any security in the California Insured Fund could be affected
by an interruption of revenues because of damaged facilities, or, consequently,
income tax deductions for casualty losses or property tax assessment reductions.
Compensatory financial assistance could be constrained by the inability of (i)
an issuer to have obtained earthquake insurance coverage at reasonable rates;
(ii) an insurer to perform on its contracts of insurance in the event of
widespread losses; or (iii) the federal or State governments to appropriate
sufficient funds within their respective budget limitations.
KEYSTONE AMERICA MISSOURI TAX FREE FUND
GENERAL
Missouri's economy includes manufacturing, commerce, trade, services,
agriculture, tourism and mining. The State's economy is diversified and closely
resembles that of the nation's although growth prospects are less favorable than
in the past. It is the nation's fifteenth largest state. The State employment
sectors, services, trade and manufacturing, also account for the primary sources
of national employment. Recent growth in the manufacturing sector has outpaced
the nation as a whole. Labor force growth has remained steady, totaling 2.65
million in 1993, up from 2.3 million in 1980. Through the 1980's and early
1990's the State's unemployment rate essentially mirrored that of the nation;
however, adverse changes in military appropriations, which play an important
role in the State's economy, could contribute to a significant increase in
unemployment. In 1991, according to the Bureau of Labor Statistics, the State
ranked fifteenth among the states in unadjusted nonagricultural employment and
estimated the November 1992 adjusted unemployment rate to be 4.9%, below the
national rate of 7.2%. In December 1994, the State's unemployment rate was
estimated to be 4.3% as against the national rate of 5.1%. In recent years,
Missouri's wealth indicators have grown at a slower rate than national levels
and in 1993 the State's per capita personal income was approximately 94.1% of
the average for the nation as a whole.
Missouri displayed strong fiscal performance during most of the 1980's.
However, Missouri has recently experienced difficulties in balancing its budget
as a result of increased expenses and declining sources of revenues. Other
factors contributing to Missouri's weak fiscal position relate to the reduction
of large manufacturing companies, including those in aerospace and the auto
industry. The Missouri portions of the St. Louis and Kansas City metropolitan
areas together contain over 50% of Missouri's population. Economic reversals in
either of these two areas would have a major impact on the overall economic
condition of the State of Missouri. Additionally, the State of Missouri has a
significant agricultural sector, which may experience problems comparable to
those which are occurring in other states. To the extent that any such problems
intensify, there could possibly be an adverse impact on the overall economic
condition of the State.
Currently, general obligations of Missouri are rated "AAA," "Aaa" and
"AAA," by S&P, Moody's and Fitch, respectively. There can be no assurance that
the economic conditions on which these ratings are based will continue or that
particular bond issues may not be adversely affected by changes in economic,
political or other conditions.
REVENUES AND LIMITATIONS THEREON
Approximately 55% of total state revenues are derived from state taxes.
The major components are the sales and use tax, individual income tax and
corporate income tax. For the fiscal year ended June 30, 1994, revenue
collections were $4,963.6 million, representing an increase of approximately
10.1% percent over revenue collections from the previous fiscal year.
Article X, Sections 16-24 of the Constitution of Missouri (often
referred to as the "Hancock Amendment") imposes limitations on the amount of
State taxes that may be collected by the State of Missouri as well as on the
amount of local taxes, licenses and fees (including taxes, licenses and fees
used to meet debt service commitments on debt obligations) that may be imposed
by local governmental units (such as cities, counties, school districts, fire
protection districts and other similar bodies) in the State of Missouri in any
fiscal year. The limit is tied to total State revenues for the fiscal year ended
June 30, 1981, as defined in the Hancock Amendment, adjusted annually, in
accordance with the formula set forth in the Amendment, which adjusts the limit
based on increases in the average personal income of Missouri for designated
periods. The details of the Amendment are too complex and clarification from
subsequent legislation and further judicial decisions may be necessary. If total
State revenues exceed the State revenue limit by more than one percent, the
State is required to refund the excess. The revenue limit can only be exceeded
if the General Assembly approves, by a two-thirds vote of each House, an
emergency declared by the Governor. The revenue limit can also be exceeded by a
constitutional amendment authorizing new or increased taxes or revenues adopted
by the voters of the State of Missouri. The revenue limit has not been exceeded
in any past year and current projections indicate the revenue limit will not be
exceeded in fiscal year 1995.
The Hancock Amendment further provides that the State financed
proportion of the costs of any existing activity or service required of counties
and other political subdivisions cannot be reduced. In addition, State
government expenses cannot exceed the sum of a State's revenues (limited as
described above) plus Federal funds and any surplus from a previous year.
The Missouri Constitution also limits new taxes, licenses and fees and
increases in taxes, licenses and fees by local governmental units in Missouri.
It prohibits counties and other political subdivisions (essentially all local
governmental units) from levying new taxes, licenses and fees or increasing the
current levy of an existing tax, license or fee "without the approval of the
required majority of the qualified voters of that county or other political
subdivision voting thereon." The Missouri Supreme Court has ruled that the voter
approval requirement on new or increased taxes, licenses and fees does not apply
to traditional user fees such as those charged to customers of municipally owned
utilities.
If the required majority of qualified electors voting on the issuance
of debt obligations approves the issuance of the debt obligations and the levy
of taxes or imposition of licenses or fees necessary to meet the payments of
principal and interest on such debt obligations, taxes, licenses or fees may be
imposed or existing taxes, licenses or fees may be increased to cover the
principal and interest on such debt obligations without violating the Hancock
Amendment. Missouri constitutional or statutory provisions other than the
Hancock Amendment may require greater than majority voter approval for valid
issuance of certain debt obligations.
Taxes may also be increased by counties and other political
subdivisions (but not by the State), without regard to the limitations of the
Hancock Amendment, for the purpose of paying principal and interest on such
bonds, other evidences of indebtedness, and obligations issued in anticipation
of the issuance of bonds, if such bonds and other obligations were authorized to
be issued prior to the adoption of the Hancock Amendment.
When a local government unit's tax base with respect to certain fees or
taxes is broadened, the Hancock Amendment requires the tax levy or fee to be
reduced "to yield the same estimated gross revenue as on the prior base." It
also effectively limits any percentage increase in property tax revenues to the
percentage increase in the general price level (plus the value of new
construction and improvements), even if the assessed valuation of property in
the local governmental unit, excluding the value of new construction and
improvements, increases at a rate exceeding the increase in the general price
level.
To the extent that the payment of general obligation bonds issued by
the State of Missouri or a unit of local government in the Missouri State Tax
Free Fund's portfolio is dependent on revenues from the levy of taxes and such
obligations have been issued subsequent to the date of the Hancock Amendment's
adoption (November 4, 1980), the ability of the State or the appropriate local
unit to levy sufficient taxes to pay the debt service on such bonds may be
affected, unless there has been specific voter approval of the issuance of such
bonds and the levy of such taxes as are necessary to pay the principal and
interest on such bonds and obligations.
Debt obligations issued by certain state issuers are payable either
solely or primarily from the rentals, incomes and revenues of specific projects
financed with the proceeds of the debt obligations and are not supported by the
taxing powers of the State or of the issuer of the bonds. The Hancock Amendment
may most strongly affect such State revenue bonds, since they are dependent in
whole or in part on appropriations of the General Assembly to provide sufficient
revenues to pay principal and interest. Unless such bonds are approved by the
voters of Missouri, under the Hancock Amendment, taxes cannot be raised to cover
the State appropriations necessary to provide revenues to pay principal and
interest on the bonds. Consequently, payment of principal and interest on such
state revenue bonds or other obligations, relating to specific projects and not
supported by the taxing power of the State of Missouri, may not be made or may
not be made in a timely fashion because of (i) the inability of the General
Assembly to appropriate sufficient funds for the payment of such debt
obligations (or to make up shortfalls therein) due to the limitations on State
taxes and expenditures imposed by the Hancock Amendment; (ii) the inability of
the issuer to generate sufficient income or revenue from the project to make
such payment; or (iii) a combination of the above.
As described above, general obligations bonds and revenue bonds of
local governmental units, including counties, cities and similar municipalities,
sewer districts, school districts and other similar issuers, may also be
affected by the tax, license and fee limitations of the Hancock Amendment.
Unless the required voter approval of such debt obligations and the imposition
of taxes to pay them is obtained prior to their issuance, the Hancock Amendment
imposes limitations on the imposition of new taxes and the increase of existing
taxes which may be necessary to pay principal and interest on general obligation
bonds of local issuers. The limitations contained in the Hancock Amendment may
also affect the payment of principal and interest on bonds and other obligations
issued by local governmental units and supported by the revenues generated from
user fees, licenses or other fees and charges, unless the requisite voter
approval of the issuance of such bonds or other obligations, and the approval of
the assessment of such fees or other charges as may be necessary to pay the
principal and interest on such bonds or other obligations, has been obtained
prior to their issuance.
Debt obligations of certain other state and local agencies and
authorities are not, by the terms of their respective authorizing statutes,
obligations of the State or any political subdivision, public instrumentality or
authority, county, municipality or other state or local unit of government.
Illustrative of such issuers are the Missouri Housing Development Commission,
the State Environmental Improvement and Energy Resources Authority, the Health
and Educational Facilities Authority of the State of Missouri, the Missouri
Higher Education Loan Authority, the Industrial Development Board of the State
of Missouri, the Missouri Agricultural and Small Business Development Authority
and other similar bodies organized on a local level under similar state
authorizing statutes such as the various local industrial development
authorities, planned industrial expansion authorities and land clearance for
redevelopment authorities. The debt obligations of such issuers are payable only
from the revenues generated by the project or program financed from the proceeds
of the debt obligations they issue, and the Hancock Amendment has no
application.
INDUSTRY AND EMPLOYMENT
While Missouri has a diverse economy with a distribution of earnings
and employment among manufacturing, trade and service sectors closely
approximating the average national distribution, the national economic recession
of the early 1980's had a disproportionately adverse impact on the economy of
Missouri. During the 1970's, Missouri characteristically had a pattern of
unemployment levels well below the national averages. However, since the 1980 to
1983 recession periods Missouri unemployment levels generally approximated or
slightly exceeded the national average. A return to a pattern of high
unemployment could adversely affect the Missouri debt obligations acquired by
the Missouri Fund and, consequently, the value of the shares of the Fund.
The Missouri portions of the St. Louis and Kansas City metropolitan
areas contain approximately 1,939,500 and 975,241 residents, respectively,
constituting over fifty percent of Missouri's 1994 population census of
approximately 5,278,000. St. Louis is an important site for banking and
manufacturing activity, as well as a distribution and transportation center,
with eight Fortune 500 industrial companies (as well as other major educational,
financial, insurance, retail, wholesale and transportation companies and
institutions) headquartered there. Kansas City is a major agribusiness center
and an important center for finance and industry. Economic reversals in either
of these two areas would have a major impact on the overall economic condition
of the State of Missouri. Additionally, the State of Missouri has a significant
agricultural sector which is experiencing farm-related problems comparable to
those which are occurring in other states. To the extent that these problems
were to intensify, there could possibly be an adverse impact on the overall
economic condition of the State of Missouri.
Defense related business plays an important role in Missouri's economy.
In addition to the large number of civilians employed at the various military
installations and training bases in the State, aircraft and related businesses
in Missouri are the recipients of substantial annual dollar volumes of defense
contract awards. McDonnell Douglas Corporation is the State's largest employer,
currently employing approximately 24,000 employees in Missouri. In the past,
Missouri has ranked in the top six states in total military contract awards,
however due to recent large cuts in the defense budget, Missouri dropped to
tenth in 1992 in the dollar volume of defense contracts. This compares to its
population ranking as the nation's fifteenth largest state. Recent changes in
the levels of military appropriations and the cancellation of the A-12 program
has affected McDonnell Douglas Corporation in Missouri and over the last three
years it has reduced its Missouri work force by approximately 30%. There can be
no assurances that there will be further changes in the levels of military
appropriations, and, to the extent that further changes in military
appropriations are enacted by the United States Congress, Missouri could be
disproportionately affected.
OTHER FACTORS
Desegregation lawsuits in St. Louis and Kansas City, and a U.S. Supreme
Court decision continue to require significant levels of state funding and are
sources of uncertainty. Litigation continues on many issues, court orders are
unpredictable, and school district spending patterns have proven difficult to
predict. The State paid $277.5 million for desegregation costs in fiscal 1994
and the budget for fiscal 1995 provides $358.9 million. This expense accounts
for close to 7% of total state General Revenue Fund spending.
<PAGE>
APPENDIX B
CORPORATE AND MUNICIPAL BOND RATINGS
S&P CORPORATE AND MUNICIPAL BOND RATINGS
A. MUNICIPAL NOTES
An S&P note rating reflects the liquidity concerns and market access
risks unique to notes. Notes due in three years or less will likely receive a
note rating. Notes maturing beyond three years will most likely receive a
long-term debt rating. The following criteria are used in making that
assessment:
a. Amortization schedule (the larger the final maturity relative to
other maturities the more likely it will be treated as a note), and
b. Source of payment (the more dependent the issue is on the market for
its refinancing, the more likely it will be treated as a note).
Note ratings are as follows:
1. SP-1 - Very strong or strong capacity to pay principal and
interest. Those issues determined to possess overwhelming safety
characteristics will be given a plus (+) designation.
2. SP-2 - Satisfactory capacity to pay principal and interest.
3. SP-3 - Speculative capacity to pay principal and interest.
B. TAX EXEMPT DEMAND BONDS
S&P assigns "dual" ratings to all long-term debt issues that have as
part of their provisions a demand or double feature.
The first rating addresses the likelihood of repayment of principal and
interest as due, and the second rating addresses only the demand feature. The
long-term debt rating symbols are used for bonds to denote the long-term
maturity and the commercial paper rating symbols are used to denote the put
option (for example, "AAA/A-1+"). For the newer "demand notes," S&P note rating
symbols, combined with the commercial paper symbols, are used (for example,
"SP-1+/A-1+" ).
C. CORPORATE AND MUNICIPAL BOND RATINGS
An S&P corporate or municipal bond rating is a current assessment of
the creditworthiness of an obligor, including obligors outside the U.S., with
respect to a specific obligation. This assessment may take into consideration
obligors such as guarantors, insurers or lessees. Ratings of foreign obligors do
not take into account currency exchange and related uncertainties. The ratings
are based on current information furnished by the issuer or obtained by S&P from
other sources it considers reliable.
The ratings are based, in varying degrees, on the following
considerations:
a. Likelihood of default and capacity and willingness of the obligor as
to the timely payment of interest and repayment of principal in accordance with
the terms of the obligation;
b. Nature of and provisions of the obligation; and
c. Protection afforded by and relative position of the obligation in
the event of bankruptcy reorganization or other arrangement under the laws of
bankruptcy and other laws affecting creditors' rights.
PLUS (+) OR MINUS (-): To provide more detailed indications of credit
quality, ratings from "AA" to "BBB" may be modified by the addition of a plus or
minus sign to show relative standing within the major rating categories.
A provisional rating is sometimes used by S&P. It assumes the
successful completion of the project being financed by the debt being rated and
indicates that payment of debt service requirements is largely or entirely
dependent upon the successful and timely completion of the project. This rating,
however, while addressing credit quality subsequent to completion of the
project, makes no comment on the likelihood of, or the risk of default upon
failure of, such completion.
C. BOND RATINGS ARE AS FOLLOWS:
a. AAA - Debt rated AAA has the highest rating assigned by S&P.
Capacity to pay interest and repay principal is extremely strong.
b. AA - Debt rated AA has a very strong capacity to pay interest and
repay principal and differs from the higher rated issues only in small degree.
3. A - Debt rated A has a strong capacity to pay interest and repay
principal although it is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher rated
categories.
4. BBB - Debt rated BBB is regarded as having an adequate capacity to
pay interest and repay principal. Whereas it normally exhibits adequate
protection parameters, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity to pay interest and repay principal
for debt in this category than in higher rated categories.
5. BB, B, CCC, CC AND C - Debt rated BB, B, CCC, CC AND C is regarded,
on balance, as predominantly speculative with respect to 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 debt will likely have some quality and protective
characteristics, these are outweighed by large uncertainties or major risk
exposures to adverse conditions.
D. MOODY'S CORPORATE AND MUNICIPAL BOND RATINGS
Moody's ratings are as follows:
1. Aaa - Bonds that are rated Aaa are judged to be of the best quality.
They carry the smallest degree of investment risk and are generally referred to
as "gilt-edge." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized are
most unlikely to impair the fundamentally strong position of such issues.
2. Aa - Bonds that 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.
3. A - Bonds that 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 that suggest a susceptibility to impairment sometime in the
future.
4. Baa - Bonds that 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.
5. Ba - Bonds that 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.
6. B - Bonds that 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.
Moody's applies numerical modifiers, 1, 2 and 3 in each generic rating
classification from Aa through Baa in its corporate bond rating system. The
modifier 1 indicates that the security ranks in the higher end of its generic
rating category; the modifier 2 indicates a mid-range ranking; and the modifier
3 indicates that the issue ranks in the lower end of its generic rating
category.
CON. (---) - Municipal bonds for which the security depends upon the
completion of some act or the fulfillment of some condition are rated
conditionally. These are bonds secured by (a) earnings of projects under
construction, (b) earnings of projects unseasoned in operation experience, (c)
rentals that begin when facilities are completed, or (d) payments to which some
other limiting condition attaches. Parenthetical rating denotes probable credit
stature upon completion of construction or elimination of basis of condition.
Those municipal bonds in the Aa, A, and Baa groups which Moody's
believes possess the strongest investment attributes are designated by the
symbols Aa 1, A 1, and Baa 1.
MONEY MARKET INSTRUMENTS
Money market securities are instruments with remaining maturities of
one year or less such as bank certificates of deposit, bankers' acceptances,
commercial paper (including variable rate master demand notes), and obligations
issued or guaranteed by the U.S. government, its agencies or instrumentalities,
some of which may be subject to repurchase agreements.
COMMERCIAL PAPER
Commercial paper will consist of issues rated at the time of purchase
A-1, by Standard & Poor's Corporation (S&P), or PRIME-1 by Moody's Investors
Service, Inc., (Moody's) or F-1 by Fitch Investors Services, Inc. (Fitch's); or,
if not rated, will be issued by companies that have an outstanding debt issue
rated at the time of purchase Aaa, Aa or A by Moody's, or AAA, AA or A by S&P,
or will be determined by Keystone to be of comparable quality.
A. S&P RATINGS
An S&P 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. Ratings are graded into four categories, ranging from "A" for the
highest quality obligations to "D" for the lowest. The top category is as
follows:
1. A: Issues assigned this highest rating are regarded as having the
greatest capacity for timely payment. Issues in this category are delineated
with the numbers 1, 2 and 3 to indicate the relative degree of safety.
2. A-1: This designation indicates that the degree of safety regarding
timely payment is either overwhelming or very strong. Those issues determined to
possess overwhelming safety characteristics are denoted with a plus (+) sign
designation.
B. MOODY'S RATINGS
The term "commercial paper" as used by Moody's means promissory
obligations not having an original maturity in excess of nine months. 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 designation, judged to be investment
grade, to indicate the relative repayment capacity of rated issuers.
1. The rating PRIME-1 is the highest commercial paper rating assigned
by Moody's. Issuers rated PRIME-1 (or related supporting institutions) are
deemed to have a superior capacity for repayment of short term promissory
obligations. Repayment capacity of PRIME-1 issuers is normally evidenced by the
following characteristics:
1) leading market positions in well-established industries;
2) high rates of return on funds employed;
3) conservative capitalization structures with moderate
reliance on debt and ample asset protection;
4) broad margins in earnings coverage of fixed financial
charges and high internal cash generation; and
5) well established access to a range of financial markets and
assured sources of alternate liquidity.
In assigning ratings to issuers whose commercial paper obligations are
supported by the credit of another entity or entities, Moody's evaluates the
financial strength of the affiliated corporations, commercial banks, insurance
companies, foreign governments or other entities, but only as one factor in the
total rating assessment.
CERTIFICATES OF DEPOSIT
Certificates of deposit are receipts issued by a bank in exchange for
the deposit of funds. The issuer agrees to pay the amount deposited plus
interest to the bearer of the receipt on the date specified on the certificate.
The certificate usually can be traded in the secondary market prior to maturity.
Certificates of deposit will be limited to U.S. dollar-denominated
certificates of U.S. banks or of savings and loan associations, including their
branches abroad, and of U.S. branches of foreign banks, which are members of the
Federal Reserve System or the Federal Deposit Insurance Corporation, and have at
least $1 billion in deposits as of the date of their most recently published
financial statements.
The Funds will not acquire time deposits or obligations issued by the
International Bank for Reconstruction and Development, the "World Bank", the
Asian Development Bank or the Inter-American Development Bank. Additionally, the
Funds do not currently intend to purchase foreign securities (except to the
extent that certificates of deposit of foreign branches of U.S. banks may be
deemed foreign securities) or purchase certificates of deposit, bankers'
acceptances or other similar obligations issued by foreign banks.
BANKERS' ACCEPTANCES
Bankers' acceptances typically arise from short-term credit
arrangements designed to enable businesses to obtain funds to finance commercial
transactions. Generally, an acceptance is a time draft drawn on a bank by an
exporter or an importer to obtain a stated amount of funds to pay for specific
merchandise. The draft is then "accepted" by the bank that, in effect,
unconditionally guarantees to pay the face value of the instrument on its
maturity date. The acceptance may then be held by the accepting bank as an
earning asset or it may be sold in the secondary market at the going rate of
discount for a specific maturity. Although maturities for acceptances can be as
long as 270 days, most acceptances have maturities of six months or less.
Bankers' acceptances acquired by a Fund must have been accepted by U.S.
commercial banks, including foreign branches of U.S. commercial banks, having
total deposits at the time of purchase in excess of $1 billion and must be
payable in U.S. dollars.
U.S. GOVERNMENT SECURITIES
Securities issued or guaranteed by the U.S. government include a
variety of Treasury securities that differ only in their interest rates,
maturities and dates of issuance and securities issued by the Government
National Mortgage Association ("GNMA"). Treasury bills have maturities of one
year or less. Treasury notes have maturities of one to ten years and Treasury
bonds generally have maturities of greater than ten years at the date of
issuance. GNMA securities include GNMA mortgage pass-through certificates. Such
securities are supported by the full faith and credit of the U.S.
Securities issued or guaranteed by U.S. government agencies or
instrumentalities include securities issued or guaranteed by the Federal Housing
Administration, Farmers Home Administration, Export-Import Bank of the U.S.,
Small Business Administration, General Services Administration, Central Bank for
Cooperatives, Federal Home Loan Banks, Federal Loan Mortgage Corporation,
Federal Intermediate Credit Banks, Federal Land Banks, Maritime Administration,
The Tennessee Valley Authority, District of Columbia Armory Board and Federal
National Mortgage Association.
Some obligations of U.S. government agencies and instrumentalities,
such as securities of Federal Home Loan Banks, are supported by the right of the
issuer to borrow from the Treasury. Others, such as bonds issued by the Federal
National Mortgage Association, a private corporation, are supported only by the
credit of the instrumentality. Because the U.S. government is not obligated by
law to provide support to an instrumentality it sponsors, a Fund will invest in
the securities issued by such an instrumentality only when Keystone determines
under standards established by the Board of Trustees that the credit risk with
respect to the instrumentality does not make its securities unsuitable
investments. U.S. government securities do not include international agencies or
instrumentalities in which the U.S. government, its agencies or
instrumentalities participate, such as the World Bank, Asian Development Bank or
the Inter-American Development Bank, or issues insured by the Federal Deposit
Insurance Corporation.
MUNICIPAL LEASE OBLIGATIONS
Municipal lease obligations purchased primarily through Certificates of
Participation ("CPOs") are used by state and local governments to finance the
purchase of property, and function much like installment purchase obligations.
The payments made by the municipality under the lease are used to repay interest
and principal on the bonds issued to purchase the property. Once these lease
payments are completed, the municipality gains ownership of the property for a
nominal sum. The lessor is, in effect, a lender secured by the property being
leased. A feature that distinguishes CPOs from municipal debt is that the lease
that is the subject of the transaction must contain a "nonappropriation" or
"abatement" clause. A nonappropriation clause provides that provides that, while
the municipality will use its best efforts to make lease payments, the
municipality may terminate the lease without penalty if the municipality's
appropriating body does not allocate the necessary funds. Local administrations,
being faced with increasingly tight budgets, therefore have more discretion to
curtail payments under COPs than they do to curtail payments on traditionally
funded debt obligations. If the government lessee does not appropriate
sufficient monies to make lease payments, the lessor or its agent is typically
entitled to repossess the property. In most cases, however, the private sector
value of the property will be less than the amount the government lessee was
paying.
Criteria considered by the rating agencies and Keystone in assessing
the risk of appropriation include the issuing municipality's credit rating,
evaluation of how essential the leased property is to the municipality and term
of the lease compared to the useful life of the leased property. The Board of
Trustees reviews the COPs held in each Fund's portfolio to assure that they
constitute liquid investments based on various factors reviewed by Keystone and
monitored by the Board. Such factors include (a) the credit quality of such
securities and the extent to which they are rated or, if unrated, comply with
existing criteria and procedures followed to ensure that they are of quality
comparable to the ratings required for each Fund's investment, including an
assessment of the likelihood that the leases will not be cancelled; (b) the size
of the municipal securities market, both in general and with respect to COPs;
and (c) the extent to which the type of COPs held by each Fund trade on the same
basis and with the same degree of dealer participation as other municipal bonds
of comparable credit rating or quality.
FUTURES CONTRACTS AND RELATED OPTIONS TRANSACTIONS
The Funds intend to enter into financial futures contracts as a hedge
against changes in prevailing levels of interest rates to seek relative
stability of principal and to establish more definitely the effective return on
securities held or intended to be acquired by a Fund or as a hedge against
changes in the prices of securities held by a Fund or to be acquired by a Fund.
A Fund's hedging may include sales of futures as an offset against the effect of
expected increases in interest rates or securities prices and purchases of
futures as an offset against the effect of expected declines in interest rates.
For example, when a Fund anticipates a significant market or market
sector advance, it will purchase a stock index futures contract as a hedge
against not participating in such advance at a time when a Fund is not fully
invested. The purchase of a futures contract serves as a temporary substitute
for the purchase of individual securities which may then be purchased in an
orderly fashion. As such purchases are made, an equivalent amount of index based
futures contracts would be terminated by offsetting sales. In contrast, a Fund
would sell stock index futures contracts in anticipation of or in a general
market or market sector decline that may adversely affect the market value of
the Fund's portfolio. To the extent that the Fund's portfolio changes in value
in correlation with a given index, the sale of futures contracts on that index
would substantially reduce the risk to the portfolio of a market decline or
change in interest rates, and, by doing so, provide an alternative to the
liquidation of the Fund's securities positions and the resulting transaction
costs.
The Funds intend to engage in options transactions that are related to
financial futures contracts for hedging purposes and in connection with the
hedging strategies described above.
Although techniques other than sales and purchases of futures contracts
and related options transactions could be used to reduce the Funds' exposure to
interest rate and/or market fluctuations, the Funds may be able to hedge their
exposure more effectively and perhaps at a lower cost through using futures
contracts and related options transactions. While the Funds do not intend to
take delivery of the instruments underlying futures contracts they hold, the
Funds do not intend to engage in such futures contracts for speculation.
FUTURES CONTRACTS
Futures contracts are transactions in the commodities markets rather
than in the securities markets. A futures contract creates an obligation by the
seller to deliver to the buyer the commodity specified in the contract at a
specified future time for a specified price. The futures contract creates an
obligation by the buyer to accept delivery from the seller of the commodity
specified at the specified future time for the specified price. In contrast, a
spot transaction creates an immediate obligation for the seller to deliver and
the buyer to accept delivery of and pay for an identified commodity. In general,
futures contracts involve transactions in fungible goods such as wheat, coffee
and soybeans. However, in the last decade an increasing number of futures
contracts have been developed which specify financial instruments or financially
based indexes as the underlying commodity.
U.S. futures contracts are traded only on national futures exchanges
and are standardized as to maturity date and underlying financial instrument.
The principal financial futures exchanges in the United States are The Board of
Trade of the City of Chicago, the Chicago Mercantile Exchange, the International
Monetary Market (a division of the Chicago Mercantile Exchange), the New York
Futures Exchange and the Kansas City Board of Trade. Each exchange guarantees
performance under contract provisions through a clearing corporation, a
nonprofit organization managed by the exchange membership, which is also
responsible for handling daily accounting of deposits or withdrawals of margin.
A futures commission merchant ("Broker") effects each transaction in connection
with futures contracts for a commission. Futures exchanges and trading are
regulated under the Commodity Exchange Act by the Commodity Futures Trading
Commission ("CFTC") and National Futures Association ("NFA").
INTEREST RATE FUTURES CONTRACTS
The sale of an interest rate futures contract creates an obligation by
a Fund, as seller, to deliver the type of financial instrument specified in the
contract at a specified future time for a specified price. The purchase of an
interest rate futures contract creates an obligation by a Fund, as purchaser, to
accept delivery of the type of financial instrument specified at a specified
future time for a specified price. The specific securities delivered or
accepted, respectively, at settlement date, are not determined until at or near
that date. The determination is in accordance with the rules of the exchange on
which the futures contract sale or purchase was made.
Currently, interest rate futures contracts can be purchased or sold on
90-day U.S. Treasury bills, U.S. Treasury bonds, U.S. Treasury notes with
maturities between 6 1/2 and 10 years, GNMA certificates, 90-day domestic bank
certificates of deposit, 90-day commercial paper, and 90-day Eurodollar
certificates of deposit. It is expected that futures contracts trading in
additional financial instruments will be authorized. The standard contract size
is $100,000 for futures contracts in U.S. Treasury bonds, U.S. Treasury notes
and GNMA certificates, and $1,000,000 for the other designated contracts. While
U.S. Treasury bonds, U.S. Treasury bills and U.S. Treasury notes are backed by
the full faith and credit of the U.S. government and GNMA certificates are
guaranteed by a U.S. government agency, the futures contracts in U.S. government
securities are not obligations of the U.S. Treasury.
INDEX BASED FUTURES CONTRACTS, OTHER THAN STOCK INDEX BASED
It is expected that bond index and other financially based index
futures contracts will be developed in the future. It is anticipated that such
index based futures contracts will be structured in the same way as stock index
futures contracts but will be measured by changes in interest rates, related
indexes or other measures, such as the consumer price index. In the event that
such futures contracts are developed, the Funds will sell interest rate index
and other index based futures contracts to hedge against changes which are
expected to affect the Funds' portfolios.
The purchase or sale of a futures contract differs from the purchase or
sale of a security, in that no price or premium is paid or received. Instead, to
initiate trading an amount of cash, cash equivalents, money market instruments,
or U.S. Treasury bills equal to approximately 1 1/2% (up to 5%) of the contract
amount must be deposited by a Fund with the Broker. This amount is known as
initial margin. The nature of initial margin in futures transactions is
different from that of margin in security transactions. Futures contract margin
does not involve the borrowing of funds by the customer to finance the
transactions. Rather, the initial margin is in the nature of a performance bond
or good faith deposit on the contract which is returned to a Fund upon
termination of the futures contract assuming all contractual obligations have
been satisfied. The margin required for a particular futures contract is set by
the exchange on which the contract is traded and may be significantly modified
from time to time by the exchange during the term of the contract.
Subsequent payments, called variation margin, to the Broker and from
the Broker, are made on a daily basis as the value of the underlying instrument
or index fluctuates making the long and short positions in the futures contract
more or less valuable, a process known as mark-to-market. For example, when a
Fund has purchased a futures contract and the price of the underlying financial
instrument or index has risen, that position will have increased in value, and
the Fund will receive from the Broker a variation margin payment equal to that
increase in value. Conversely, where a Fund has purchased a futures contract and
the price of the underlying financial instrument or index has declined, the
position would be less valuable and the Fund would be required to make a
variation margin payment to the Broker. At any time prior to expiration of the
futures contract, a Fund may elect to close the position. A final determination
of variation margin is then made, additional cash is required to be paid to or
released by the Broker, and the Fund realizes a loss or gain.
The FUND intends to enter into arrangements with its custodian and with
Brokers to enable the initial margin of a Fund and any variation margin to be
held in a segregated account by its custodian on behalf of the Broker.
Although interest rate futures contracts by their terms call for actual
delivery or acceptance of financial instruments, and index based futures
contracts call for the delivery of cash equal to the difference between the
closing value of the index on the expiration date of the contract and the price
at which the futures contract is originally made, in most cases such futures
contracts are closed out before the settlement date without the making or taking
of delivery. Closing out a futures contract sale is effected by an offsetting
transaction in which a Fund enters into a futures contract purchase for the same
aggregate amount of the specific type of financial instrument or index and same
delivery date. If the price in the sale exceeds the price in the offsetting
purchase, the Fund is paid the difference and thus realizes a gain. If the
offsetting purchase price exceeds the sale price, the Fund pays the difference
and realizes a loss. Similarly, the closing out of a futures contract purchase
is effected by an offsetting transaction in which a Fund enters into a futures
contract sale. If the offsetting sale price exceeds the purchase price, the Fund
realizes a gain. If the purchase price exceeds the offsetting sale price the
Fund realizes a loss. The amount of the Fund's gain or loss on any transaction
is reduced or increased, respectively, by the amount of any transaction costs
incurred by the Fund.
As an example of an offsetting transaction, the contractual obligations
arising from the sale of one contract of September U.S. Treasury bills on an
exchange may be fulfilled at any time before delivery of the contract is
required (i.e. on a specified date in September, the "delivery month") by the
purchase of one contract of September U.S. Treasury bills on the same exchange.
In such instance the difference between the price at which the futures contract
was sold and the price paid for the offsetting purchase, after allowance for
transaction costs, represents the profit or loss to a Fund.
There can be no assurance, however, that a Fund will be able to enter
into an offsetting transaction with respect to a particular contract at a
particular time. If a Fund is not able to enter into an offsetting transaction,
the Fund will continue to be required to maintain the margin deposits on the
contract and to complete the contract according to its terms.
OPTIONS ON FINANCIAL FUTURES
The Funds intend to purchase call and put options on financial futures
contracts and sell such options to terminate an existing position. Options on
futures are similar to options on stocks except that an option on a futures
contract gives the purchaser the right, in return for the premium paid, to
assume a position in a futures contract (a long position if the option is a call
and a short position if the option is a put) rather than to purchase or sell
stock at a specified exercise price at any time during the period of the option.
Upon exercise of the option, the delivery of the futures position by the writer
of the option to the holder of the option will be accompanied by delivery of the
accumulated balance in the writer's futures margin account. This amount
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. If an option is
exercised the last trading day prior to the expiration date of the option, the
settlement will be made entirely in cash equal to the difference between the
exercise price of the option and value of the futures contract.
The Funds intend to use options on financial futures contracts in
connection with hedging strategies. In the future the Funds may use such options
for other purposes.
PURCHASE OF PUT OPTIONS ON FUTURES CONTRACTS
The purchase of protective put options on financial futures contracts
is analogous to the purchase of protective puts on individual stocks, where an
absolute level of protection is sought below which no additional economic loss
would be incurred by a Fund. Put options may be purchased to hedge a portfolio
of stocks or debt instruments or a position in the futures contract upon which
the put option is based.
PURCHASE OF CALL OPTIONS ON FUTURES CONTRACTS
The purchase of call options on financial futures contracts represents
a means of obtaining temporary exposure to market appreciation at limited risk.
It is analogous to the purchase of a call option on an individual stock, which
can be used as a substitute for a position in the stock itself. Depending on the
pricing of the option compared to either the futures contract upon which it is
based, or upon the price of the underlying financial instrument or index itself,
purchase of a call option may be less risky than the ownership of the interest
rate or index based futures contract or the underlying securities. Call options
on commodity futures contracts may be purchased to hedge against an interest
rate increase or a market advance when a Fund is not fully invested.
USE OF NEW INVESTMENT TECHNIQUES INVOLVING FINANCIAL FUTURES CON-
TRACTS OR RELATED OPTIONS
The Funds may employ new investment techniques involving financial
futures contracts and related options. The Funds intend to take advantage of new
techniques in these areas which may be developed from time to time and which are
consistent with the Fund's investment objective. The FUND believes that no
additional techniques have been identified for employment by the Funds in the
foreseeable future other than those described above.
LIMITATIONS ON PURCHASE AND SALE OF FUTURES CONTRACTS AND RELATED
OPTIONS ON SUCH FUTURES CONTRACTS
A Fund will not enter into a futures contract if, as a result thereof,
more than 5% of the Fund's total assets (taken at market value at the time of
entering into the contract) would be committed to margin deposits on such
futures contracts.
Each Fund intends that its futures contracts and related options
transactions will be entered into for traditional hedging purposes. That is,
futures contracts will be sold to protect against a decline in the price of
securities that a Fund owns, or futures contracts will be purchased to protect a
Fund against an increase in the price of securities it intends to purchase. The
Funds do not intend to enter into futures contracts for speculation.
In instances involving the purchase of futures contracts by a Fund, an
amount of cash and cash equivalents equal to the market value of the futures
contracts will be deposited in a segregated account with the FUND's custodian
and/or in a margin account with a Broker to collateralize the position and
thereby insure that the use of such futures is unleveraged.
FEDERAL INCOME TAX TREATMENT
For federal income tax purposes, a Fund is required to recognize as
income for each taxable year its net unrealized gains and losses on futures
contracts as of the end of the year as well as those actually realized during
the year. Any gain or loss recognized with respect to a futures contract is
considered to be 60% long term and 40% short term, without regard to the holding
period of the contract. In the case of a futures transaction classified as a
"mixed straddle," the recognition of losses may be deferred to a later taxable
year. The federal income tax treatment of gains or losses from transactions in
options on futures is unclear.
In order for a Fund to continue to qualify for federal income tax
treatment as a regulated investment company, at least 90% of its gross income
for a taxable year must be derived from qualifying income. Any net gain realized
from the closing out of futures contracts, for purposes of the 90% requirement,
will be qualifying income. In addition, gains realized on the sale or other
disposition of securities held for less than three months must be limited to
less than 30% of a Fund's annual gross income. The 1986 Tax Act added a
provision which effectively treats both positions in certain hedging
transactions as a single transaction for the purpose of the 30% requirement. The
provision provides that, in the case of any "designated hedge," increases and
decreases in the value of positions of the hedge are to be netted for the
purposes of the 30% requirement. However, in certain situations, in order to
avoid realizing a gain within a three month period, a Fund may be required to
defer the closing out of a contract beyond the time when it would otherwise be
advantageous to do so.
RISKS OF FUTURES CONTRACTS
Financial futures contracts prices are volatile and are influenced,
among other things, by changes in stock prices, market conditions, prevailing
interest rates and anticipation of future stock prices, market movements or
interest rate changes, all of which in turn are affected by economic conditions,
such as government fiscal and monetary policies and actions, and national and
international political and economic events.
At best, the correlation between changes in prices of futures contracts
and of the securities being hedged can be only approximate. The degree of
imperfection of correlation depends upon circumstances, such as variations in
speculative market demand for futures contracts and for securities, including
technical influences in futures contracts trading; differences between the
securities being hedged and the financial instruments and indexes underlying the
standard futures contracts available for trading, in such respects as interest
rate levels, maturities and creditworthiness of issuers, or identities of
securities comprising the index and those in a Fund's portfolio. In addition,
futures contract transactions involve the remote risk that a party be unable to
fulfill its obligations and that the amount of the obligation will be beyond the
ability of the clearing broker to satisfy. A decision of whether, when and how
to hedge involves the exercise of skill and judgment, and even a well conceived
hedge may be unsuccessful to some degree because of market behavior or
unexpected interest rate trends.
Because of the low margin deposits required, futures trading involves
an extremely high degree of leverage. As a result, a relatively small price
movement in a futures contract may result in immediate and substantial loss, as
well as gain, to the investor. For example, if at the time of purchase, 10% of
the value of the futures contract is deposited as margin, a 10% decrease in the
value of the futures contract would result in a total loss of the margin
deposit, before any deduction for the transaction costs, if the account were
then closed out, and a 15% decrease would result in a loss equal to 150% of the
original margin deposit. Thus, a purchase or sale of a futures contract may
result in losses in excess of the amount invested in the futures contract.
However, a Fund would presumably have sustained comparable losses if, instead of
entering into the futures contract, it had invested in the underlying financial
instrument. Furthermore, in order to be certain that a Fund has sufficient
assets to satisfy its obligations under a futures contract, the Fund will
establish a segregated account in connection with its futures contracts which
will hold cash or cash equivalents equal in value to the current value of the
underlying instruments or indices less the margins on deposit.
Most U.S. futures exchanges limit the amount of fluctuation permitted
in futures contract prices during a single trading day. The daily limit
establishes the maximum amount that the price of a futures contract may vary
either up or down from the previous day's settlement price at the end of a
trading session. Once the daily limit has been reached in a particular type of
contract, no trades may be made on that day at a price beyond that limit. The
daily limit governs only price movement during a particular trading day and
therefore does not limit potential losses because the limit may prevent the
liquidation of unfavorable positions. Futures contract prices have occasionally
moved to the daily limit for several consecutive trading days with little or no
trading, thereby preventing prompt liquidation of futures positions and
subjecting some futures traders to substantial losses.
RISKS OF OPTIONS ON FUTURES CONTRACTS
In addition to the risks described above for financial futures
contracts, there are several special risks relating to options on futures
contracts. The ability to establish and close out positions on such options will
be subject to the development and maintenance of a liquid secondary market.
There is no assurance that a liquid secondary market will exist for any
particular contract or at any particular time. A Fund will not purchase options
on any futures contract unless and until it believes that the market for such
options has developed sufficiently that the risks in connection with such
options are not greater than the risks in connection with the futures contracts.
Compared to the use of futures contracts, the purchase of options on such
futures involves less potential risk to a Fund because the maximum amount at
risk is the premium paid for the options (plus transaction costs). However,
there may be circumstances when the use of an option on a futures contract would
result in a loss to a Fund, even though the use of a futures contract would not,
such as when there is no movement in the level of the futures contract.
Keystone America California Insured Tax Free Fund
<PAGE>
SCHEDULE OF INVESTMENTS--November 30, 1994
Coupon Maturity Principal Market
Rate Date Amount Value
MUNICIPAL BONDS (95.7%)
Alameda County, California,
Certificates of
Participation, Santa Rita
Jail Project (MBIA) 5.700% 12/01/2014 $1,000,000 $ 865,760
California Educational
Facilities Authority,
Stanford University Project,
Series H 5.000 01/01/2015 250,000 195,215
California State Public Works
Board (AMBAC) 5.250 12/01/2013 150,000 121,926
California Statewide
Communities Certificates
(AMBAC) 5.500 10/01/2014 650,000 542,412
China Basin, California,
Regional Financing Authority,
Municipal Water District
Sewer (AMBAC) 6.000 08/01/2016 500,000 447,570
Corona, California,
Redevelopment Agency, Tax
Allocation, Refunding
Redevelopment Project, Area
A, Series A (FGIC) 6.250 09/01/2016 500,000 458,265
Los Angeles County,
California, Transportation
Commission, Series A (MBIA) 6.250 07/01/2013 1,300,000 1,204,177
Los Angeles, California,
Community Redevelopment
Agency, Series H (FSA) 6.500 12/01/2016 340,000 319,185
Los Angeles, California,
Convention and Exhibition
Center Authority, Lease
Refunding, Series A (MBIA) 5.375 08/15/2018 240,000 194,167
Los Angeles, California,
Wastewater Systems, Series D
(FGIC) 6.000 11/01/2014 1,400,000 1,258,684
MSR Public Power Agency,
California, San Juan Project,
Series B (MBIA) 6.750 07/01/2011 400,000 398,684
Oakland, California,
Pensions, Series A (FGIC) (c) 7.600 08/01/2021 1,000,000 1,045,150
Pleasant Hill, California,
Joint Powers Financing,
Capital Improvement Project,
Series A (MBIA) 5.250 12/01/2016 400,000 318,500
Rio Linda, California, Union
School District, Series A
(AMBAC) 7.400 08/01/2010 725,000 754,935
Sacramento, California,
Municipal Utility District,
Series D (FGIC) 5.250 11/15/2012 650,000 537,999
San Francisco, California,
City and County Sewer
Refunding (AMBAC) 5.500 10/01/2015 900,000 747,675
San Joaquin Hills,
California, Transportation
Corridor Agency, Toll Road 6.750 01/01/2032 3,000,000 2,654,100
San Jose, California, Airport
Refunding (MBIA) 5.750 03/01/2016 1,295,000 1,111,796
San Jose, California,
Redevelopment Tax Allocation
(MBIA) 6.000 08/01/2015 610,000 550,446
Santa Ana, California,
Financing Authority (MBIA) 6.250 07/01/2015 300,000 278,967
University of California,
Multiple Purpose Project,
Series C (AMBAC) 5.125 09/01/2013 300,000 240,312
University of California,
Multiple Purpose Project,
Series C (AMBAC) 5.000 09/01/2013 200,000 157,628
TOTAL MUNICIPAL BONDS
(Cost--$14,837,308) 14,403,553
TEMPORARY TAX-EXEMPT
INVESTMENTS (1.2%)
San Diego County, California,
Regional Transportation
Commission,
Series A (FGIC) (a) (Cost
$180,000) 3.500 04/01/2008 180,000 180,000
TOTAL INVESTMENTS
(Cost--$15,017,308) (b) 14,583,553
OTHER ASSETS AND LIABILITIES--NET (3.1%) 460,709
NET ASSETS (100.0%) $15,044,262
See Notes to Schedule of Investments. (continued on next page)
<PAGE>
Keystone America California Insured Tax Free Fund
NOTES TO SCHEDULE OF INVESTMENTS:
(a) Variable or floating rate instrument with periodic demand features. The
Fund is entitled to full payment of principal and accrued interest upon
surrendering the security to the issuing agent according to the terms of the
demand features.
(b) The cost of investments for federal income tax purposes amounted to
$15,020,693. Gross unrealized appreciation and depreciation of investments,
based on identified tax cost, at November 30, 1994 are as follows:
Gross unrealized appreciation $ 97,520
Gross unrealized depreciation (534,660)
Net unrealized depreciation ($ 437,140)
(c) At November 30, 1994, Oakland, California, Pensions, Series A (FGIC),
7.60%, 08/01/21, par value $100,000 was pledged to cover margin requirements
for open futures contracts (See Note 1 of Notes to Financial Statements). At
November 30, 1994, the bond pledged had a market value of $104,515.
Information concerning open futures contracts to sell at November 30, 1994 is
shown below:
Aggregate Expiration
Number of Face Value Date of Unrealized
Contracts of Contracts Contracts Appreciation
U.S. Treasury Bond
Futures 16 $1,600,000 December 1994 $16,563
Municipal Bond
Futures 19 1,900,000 December 1994 71,312
35 $3,500,000 $87,875
<PAGE>
Keystone America California Insured Tax Free Fund
FINANCIAL HIGHLIGHTS--CLASS A SHARES
(For a share outstanding throughout the period)
February 1, 1994
(Commencement of
Operations) to
November 30, 1994
Net asset value: Beginning of period $10.000
Income from investment operations
Investment income--net 0.439
Realized gains (losses) on investments--net (1.302)
Total from investment operations (0.863)
Less distributions
Dividends from investment income--net (0.437)
Total distributions (0.437)
Net asset value: End of period $ 8.700
Total return (8.78%)(b)
Ratios/supplemental data
Ratios to average net assets:
Operating and management expenses (a) 0.41%(c)
Investment income--net 5.53%(c)
Portfolio turnover rate 104%
Net assets, end of period (thousands) $ 3,006
(a) Figures are net of the expense reimbursement by Keystone in connection
with the voluntary expense limitation. Before expense reimbursement, the
"Ratio of operating and management expenses to average net assets" would have
been 1.66% (annualized) for the period February 1, 1994 (Commencement of
Operations) to November 30, 1994.
(b) Total return is calculated from February 1, 1994 (Commencement of
Operations) to November 30, 1994.
(c) Annualized.
<PAGE>
Keystone America California Insured Tax Free Fund
FINANCIAL HIGHLIGHTS--CLASS B SHARES
(For a share outstanding throughout the period)
February 1, 1994
(Commencement of
Operations) to
November 30, 1994
Net asset value: Beginning of period $10.000
Income from investment operations
Investment income--net 0.401
Realized gains (losses) on
investments--net (1.284)
Total from investment operations (0.883)
Less distributions
Dividends from investment
income--net (0.401)
Distributions in excess of
investment income--net (0.036)
Total distributions (0.437)
Net asset value: End of period $ 8.680
Total return (a) (9.00%)(c)
Ratios/supplemental data
Ratios to average net assets:
Operating and management expenses (b) 1.16%(d)
Investment income--net 4.83%(d)
Portfolio turnover rate 104%
Net assets, end of period (thousands) $11,415
(a) Without contingent deferred sales charge (CDSC).
(b) Figures are net of the expense reimbursement by Keystone in connection
with the voluntary expense limitation. Before expense reimbursement, the
"Ratio of operating and management expenses to average net assets" would have
been 2.36% (annualized) for the period February 1, 1994 (Commencement of
Operations) to November 30, 1994.
(c) Total return is calculated from February 1, 1994 (Commencement of
Operations) to November 30, 1994.
(d) Annualized.
<PAGE>
Keystone America California Insured Tax Free Fund
FINANCIAL HIGHLIGHTS--CLASS C SHARES
(For a share outstanding throughout the period)
February 1, 1994
(Commencement of
Operations) to
November 30, 1994
Net asset value: Beginning of period $10.000
Income from investment operations
Investment income--net 0.392
Realized gains (losses) on
investments--net (1.292)
Total from investment operations (0.900)
Less distributions
Dividends from investment
income--net (0.392)
Distributions in excess of
investment income--net (0.028)
Total distributions (0.420)
Net asset value: End of period $ 8.680
Total return (a) (9.08%)(c)
Ratios/supplemental data
Ratios to average net assets:
Operating and management expenses
(b) 1.16%(d)
Investment income--net 4.96%(d)
Portfolio turnover rate 104%
Net assets, end of period (thousands) $ 624
(a) Without contingent deferred sales charge (CDSC).
(b) Figures are net of the expense reimbursement by Keystone in connection
with the voluntary expense limitation. Before expense reimbursement, the
"Ratio of operating and management expenses to average net assets" would have
been 2.38% (annualized) for the period February 1, 1994 (Commencement of
Operations) to November 30, 1994.
(c) Total return is calculated from February 1, 1994 (Commencement of
Operations) to November 30, 1994.
(d) Annualized.
<PAGE>
Keystone America California Insured Tax Free Fund
STATEMENT OF ASSETS AND LIABILITIES
November 30, 1994
Assets:
Investments at market value (identified
cost--$15,017,308) (Note 1) $14,583,553
Cash 595
Receivable for:
Investments sold 114,433
Fund shares sold 91,880
Interest 327,980
Due from Investment Adviser (Note 4) 52,422
Deferred organization expense (Note 1) 2,739
Total assets 15,173,602
Liabilities:
Payable for:
Income distribution 73,515
Daily variation on open futures contracts (Note 1) 35,437
Accrued reimbursable expenses (Note 4) 1,103
Other accrued expenses 19,285
Total liabilities 129,340
Net assets $15,044,262
Net assets represented by (Note 1):
Paid-in capital $16,432,969
Undistributed investment income--net 4,468
Accumulated realized gains (losses) on investments
and closed futures contracts--net (1,047,295)
Net unrealized depreciation on investments (433,755)
Net unrealized appreciation of open futures contracts 87,875
Total net assets $15,044,262
Net asset value and redemption price per share (Note 2):
Class A Shares ($8.70 on 345,654 shares
outstanding) $ 3,005,802
Class B Shares ($8.68 on 1,314,391 shares outstanding) 11,414,842
Class C Shares ($8.68 on 71,884 shares
outstanding) 623,618
$15,044,262
Offering price per share:
Class A Shares (including sales charge of 4.75%) $9.13
Class B Shares $8.68
Class C Shares $8.68
STATEMENT OF OPERATIONS
February 1, 1994 (Commencement of
Operations) to November 30, 1994
Investment Income (Note 1):
Interest $ 536,920
Amortization 3,152
540,072
Expenses (Notes 1, 2 and 4):
Management fee $ 49,627
Shareholder services 16,901
Custodian fees 18,355
Accounting 11,753
Auditing 10,766
Legal 10,375
Printing 9,018
Registration fees 2,115
Organization expenses 3,844
Distribution Plan expenses 66,865
Miscellaneous expenses 435
Total expenses 200,054
Less: Reimbursement from Investment
Adviser (Note 4) (109,791)
Net expenses 90,263
Investment income--net 449,809
Realized and unrealized gain (loss) on
investments and futures contracts--net
(Notes 1 and 3):
Realized gain (loss) on:
Investments sold (1,073,341)
Closed futures contracts 26,046
Realized loss on investments and
closed futures contracts--net (1,047,295)
Net change in unrealized appreciation
(depreciation) on:
Investments (433,755)
Open futures contracts 87,875
Net change in unrealized appreciation
or depreciation (345,880)
Net loss on investments and futures
contracts (1,393,175)
Net decrease in net assets resulting
from operations ($ 943,366)
<PAGE>
Keystone America California Insured Tax Free Fund
STATEMENT OF CHANGES IN NET ASSETS
February 1, 1994
(Commencement of
Operations) to
November 30, 1994
Operations:
Investment income--net $ 449,809
Realized loss on investments and
closed futures contracts--net (1,047,295)
Net change in unrealized appreciation
or depreciation (345,880)
Net decrease in net assets
resulting from operations (943,366)
Distributions to shareholders from
(Notes 1 and 5):
Investment income--net--Class A
Shares (103,422)
Investment income--net--Class B
Shares (327,857)
In excess of investment
income--net--Class B Shares (47,642)
Investment income--net--Class C
Shares (17,973)
In excess of investment
income--net--Class C Shares (2,036)
Total distributions to shareholders (498,930)
Capital share transactions (Note 2):
Proceeds from shares sold--Class A
Shares 3,653,153
Proceeds from shares sold--Class B
Shares 13,549,247
Proceeds from shares sold--Class C
Shares 942,116
Payment for shares redeemed--Class A
Shares (364,506)
Payment for shares redeemed--Class B
Shares (1,189,908)
Payment for shares redeemed--Class C
Shares (265,039)
Net asset value of shares issued in
reinvestment of distributions from:
Investment income--net--Class A
Shares 19,906
Investment income--net and in excess
of investment income--net--
Class B Shares 132,637
Investment income--net and in excess
of investment income--net--
Class C Shares 8,952
Net increase in net assets resulting
from capital share transactions 16,486,558
Total increase in net assets 15,044,262
Net assets:
Beginning of period 0
End of period (Including
undistributed investment income--net
as follows: 1994--$4,468) $15,044,262
See Notes to Financial Statements.
<PAGE>
Keystone America Missouri Tax Free Fund
SCHEDULE OF INVESTMENTS--November 30, 1994
Coupon Maturity Principal Market
Rate Date Amount Value
MUNICIPAL BONDS (104.0%)
Clay County, Missouri, Public
Building Authority 7.000% 05/15/2014 $1,000,000 $1,004,850
Columbia, Missouri, School
District, Unlimited Tax,
General Obligation 5.000 03/01/2013 465,000 377,906
Franklin County, Missouri,
Reorganized School District R
Xi (FGIC) 5.750 03/01/2013 150,000 133,719
Greene County, Missouri, Single
Family Mortgage (effective
yield 6.530%)(a) 0.000 03/01/2016 1,000,000 220,430
Guam Airport Authority, Series
B 6.400 10/01/2005 300,000 284,565
Missouri Higher Education, Loan
Authority, Student Loan, Series
D 6.750 02/15/2009 500,000 465,850
Missouri Higher Education,
Student Loan, Series A 5.450 02/15/2009 600,000 486,690
Missouri State Environmental
Improvement and Energy
Resources Authority, Water Poll
Control, State Revolving Fund
Project, Series A 6.050 07/01/2015 250,000 226,193
Missouri State Environmental
Improvement and Energy
Resources Authority 5.450 10/01/2028 500,000 385,215
Missouri State Health and
Educational Facilities
Authority 6.000 02/01/2024 750,000 578,212
Missouri State Health and
Educational Facilities
Authority, Lester Cox Hospital 5.350 06/01/2010 710,000 609,031
Missouri State Health and
Educational Facilities
Authority, Health Facilities
Midwest, Series B (MBIA) (d) 6.100 06/01/2011 500,000 465,455
Missouri State Health and
Educational Facilities
Authority, Barnes
Jewish Inc. 5.250 05/15/2012 300,000 242,673
Missouri State Health and
Educational Facilities
Authority, Health
Facility Refunding, Series Aa
(MBIA) 6.250 06/01/2016 2,000,000 1,844,520
Missouri State Health and
Educational Facilities
Authority, St. Luke's Hospital
(MBIA) 5.125 11/15/2019 400,000 311,992
Missouri State Health and
Educational Facilities
Authority, Health Systems,
Series A 6.500 02/15/2020 500,000 455,445
Missouri State Health and
Educational Facilities
Authority, Children's Mercy
Hospital Project 6.000 08/15/2023 1,200,000 926,256
Missouri State Health and
Educational Facilities,
Bethesda Health
Group, Project A 7.500 08/15/2012 1,000,000 939,290
Missouri State Housing
Development Commission, Single
Family,
GNMA, Series A 7.125 12/01/2014 500,000 500,935
Missouri State Regional
Convention and Sports Project 5.500 08/15/2013 950,000 784,709
Missouri State Water Pollution
Control, Series A 7.200 07/01/2016 600,000 605,964
Puerto Rico Aqueduct and Sewer
Authority, Series A 7.875 07/01/2017 230,000 240,957
Puerto Rico Commonwealth,
General Obligation 7.000 07/01/2010 20,000 19,625
Puerto Rico Commonwealth,
Highway and Transportation
Authority, Series X 5.500 07/01/2019 450,000 361,850
Puerto Rico Commonwealth,
Highway and Transportation
Authority, Series W 5.250 07/01/2020 605,000 464,325
Puerto Rico Commonwealth,
Telephone Authority 5.400 01/01/2008 700,000 610,939
Puerto Rico Electric Power
Authority, Power Revenue 6.000 07/01/2014 320,000 284,205
Puerto Rico Industrial,
Tourist, Educational, Medical
and Environmental Control
Facilities Authority 5.700 08/01/2013 300,000 247,281
Puerto Rico Public Buildings
Authority, Guaranteed Public
Education
and Health Facilities, Series M 5.700 07/01/2009 300,000 267,747
Shrewsbury, Missouri, General
Obligation, Unlimited Tax
(FGIC) 6.200 02/01/2012 100,000 93,910
<PAGE>
Keystone America Missouri Tax Free Fund
SCHEDULE OF INVESTMENTS--November 30, 1994
Coupon Maturity Principal Market
Rate Date Amount Value
MUNICIPAL BONDS (continued)
St. Charles, Missouri, Public
Facilities Authority 5.650% 02/01/2008 $ 95,000 $ 86,785
St. Louis County, Missouri,
Regional Convention and Sports
Project 5.375 08/15/2006 150,000 129,611
St. Louis County, Missouri,
Public Facilities, Series A (d) 6.000 02/15/2013 50,000 46,037
St. Louis County, Missouri,
Regional Convention and Sports
Facility, Convention and Sports
Project 5.750 08/15/2021 1,375,000 1,098,171
St. Louis County, Missouri,
Series D 5.650 02/01/2015 250,000 211,120
St. Louis, Missouri, Airport,
Lambert St. Louis International
(FGIC) 6.125 07/01/2012 300,000 276,144
St. Louis, Missouri, Municipal
Finance Corp., Series A 5.850 07/15/2009 500,000 438,945
University Development
Foundation, Missouri, Power
Plant Equipment 5.750 05/01/2013 200,000 175,528
University of Missouri,
Refunding Improvement Systems
Facilities 5.500 11/01/2023 25,000 20,712
University of Missouri,
Refunding Improvement Systems
Facilities 5.200 11/01/2008 500,000 431,155
Webster Groves, Missouri,
General Obligation 5.500 02/01/2011 1,000,000 881,880
TOTAL MUNICIPAL BONDS
(Cost--$19,574,721) 18,236,827
TEMPORARY TAX-EXEMPT
INVESTMENTS (3.5%)
Missouri State Health and
Educational Facilities
Authority (b) (Cost $615,000) 3.750 06/01/2014 615,000 615,000
TOTAL INVESTMENTS
(Cost--$20,189,721) (c) 18,851,827
OTHER ASSETS AND
LIABILITIES--NET (-7.5%) (1,319,441)
NET ASSETS (100.0%) $17,532,386
NOTES TO SCHEDULE OF INVESTMENTS:
(a) Effective yield (calculated at the date of purchase) is the annual yield
at which the bond accretes until its maturity date.
(b) Variable or floating rate instrument with periodic demand features. The
Fund is entitled to full payment of principal and accrued interest upon
surrendering the security to the issuing agent according to the terms of the
demand features.
(c) The cost of investments for federal income tax purposes amounted to
$20,197,065. Gross unrealized appreciation and depreciation of investments,
based on identified tax cost, at November 30, 1994 are as follows:
Gross unrealized appreciation $ 34,298
Gross unrealized depreciation (1,379,536)
Net unrealized depreciation ($ 1,345,238)
(d) At November 30, 1994, Missouri State Health and Educational Facilities
Authority, Health Facilities Midwest, Series B (MBIA), 6.100%, 06/01/11, par
value $120,000 and St. Louis County, Missouri, Public Facilities, Series A,
6.000%, 02/15/13, par value $30,000 were pledged to cover margin requirements
for open futures contracts (See Note 1 of Notes to Financial Statements). At
November 30, 1994, the bonds pledged had market values of $111,709 and
$27,622, respectively. Information concerning open futures contracts to sell
at November 30, 1994 is shown below:
Aggregate Expiration
Number of Face Value Date of Unrealized
Contracts of Contracts Contracts Appreciation
U.S. Treasury
Bond Futures 19 $1,900,000 December 1994 $13,656
Municipal
Bond Futures 23 2,300,000 December 1994 80,500
42 $4,200,000 $94,156
<PAGE>
Keystone America Missouri Tax Free Fund
FINANCIAL HIGHLIGHTS--CLASS A SHARES
(For a share outstanding throughout the period)
February 1, 1994
(Commencement of
Operations) to
November 30,
1994
Net asset value: Beginning of period $10.000
Income from investment operations
Investment income--net 0.443
Realized gains (losses) on investments--net (1.279)
Total from investment operations (0.836)
Less distributions
Dividends from investment income--net (0.443)
Distributions in excess of investment income--net (0.001)
Total distributions (0.444)
Net asset value: End of period $ 8.720
Total return (8.55%)(b)
Ratios/supplemental data
Ratios to average net assets:
Operating and management expenses (a) 0.43%(c)
Investment income--net 5.38%(c)
Portfolio turnover rate 25%
Net assets, end of period (thousands) $ 3,581
(a) Figures are net of the expense reimbursement by Keystone in connection
with the voluntary expense limitation. Before expense reimbursement, the
"Ratio of operating and management expenses to average net assets" would have
been 1.54% (annualized) for the period February 1, 1994 (Commencement of
Operations) to November 30, 1994.
(b) Total return is calculated from February 1, 1994 (Commencement of
Operations) to November 30, 1994.
(c) Annualized.
<PAGE>
Keystone America Missouri Tax Free Fund
FINANCIAL HIGHLIGHTS--CLASS B SHARES
(For a share outstanding throughout the period)
February 1, 1994
(Commencement of
Operations) to
November 30, 1994
Net asset value: Beginning of period $10.000
Income from investment operations
Investment income--net 0.404
Realized gains (losses) on investments--net (1.290)
Total from investment operations (0.886)
Less distributions
Dividends from investment income--net (0.404)
Distributions in excess of investment income--net (0.040)
Total distributions (0.444)
Net asset value: End of period $ 8.670
Total return (a) (9.06%)(c)
Ratios/supplemental data
Ratios to average net assets:
Operating and management expenses (b) 1.16%(d)
Investment income--net 4.70%(d)
Portfolio turnover rate 25%
Net assets, end of period (thousands) $12,906
(a) Without contingent deferred sales charge (CDSC).
(b) Figures are net of the expense reimbursement by Keystone in connection
with the voluntary expense limitation. Before expense reimbursement, the
"Ratio of operating and management expenses to average net assets" would have
been 2.49% (annualized) for the period February 1, 1994 (Commencement of
Operations) to November 30, 1994.
(c) Total return is calculated from February 1, 1994 (Commencement of
Operations) to November 30, 1994.
(d) Annualized.
<PAGE>
Keystone America Missouri Tax Free Fund
FINANCIAL HIGHLIGHTS--CLASS C SHARES
(For a share outstanding throughout the period)
February 1, 1994
(Commencement of
Operations) to
November 30, 1994
Net asset value: Beginning of period $10.000
Income from investment operations
Investment income--net 0.388
Realized gains (losses) on investments--net (1.294)
Total from investment operations (0.906)
Less distributions
Dividends from investment income--net (0.388)
Distributions in excess of investment income--net (0.046)
Total distributions (0.434)
Net asset value: End of period $ 8.660
Total return (a) (9.25%)(c)
Ratios/supplemental data
Ratios to average net assets:
Operating and management expenses (b) 1.15%(d)
Investment income--net 4.72%(d)
Portfolio turnover rate 25%
Net assets, end of period (thousands) $ 1,045
(a) Without contingent deferred sales charge (CDSC).
(b) Figures are net of the expense reimbursement by Keystone in connection
with the voluntary expense limitation. Before expense reimbursement, the
"Ratio of operating and management expenses to average net assets" would have
been 2.60% (annualized) for the period February 1, 1994 (Commencement of
Operations) to November 30, 1994.
(c) Total return is calculated from February 1, 1994 (Commencement of
Operations) to November 30, 1994.
(d) Annualized.
<PAGE>
Keystone America Missouri Tax Free Fund
STATEMENT OF ASSETS AND LIABILITIES
November 30, 1994
Assets:
Investments at market value (identified
cost--$20,189,721) (Note 1) $18,851,827
Cash 3,631
Receivable for:
Investments sold 464,693
Fund shares sold 526,130
Interest 357,058
Due from Investment Adviser (Note 4) 47,512
Deferred organization expense (Note 1) 231
Total assets 20,251,082
Liabilities:
Payable for:
Investments purchased 2,568,444
Fund shares redeemed 5,020
Income distribution 80,746
Daily variation on open futures contracts (Note 1) 42,656
Accrued reimbursable expenses (Note 4) 303
Other accrued expenses 21,527
Total liabilities 2,718,696
Net assets $17,532,386
Net assets represented by (Note 1):
Paid-in capital $19,037,245
Accumulated distributions in excess of investment
income--net (7,792)
Accumulated realized gains (losses) on investments
and closed futures contracts--net (253,329)
Net unrealized depreciation on investments (1,337,894)
Net unrealized appreciation of open futures contracts 94,156
Total net assets $17,532,386
Net asset value and redemption price per share (Note
2):
Class A Shares ($8.72 on 410,528 shares
outstanding) $ 3,580,960
Class B Shares ($8.67 on 1,489,246 shares
outstanding) 12,905,977
Class C Shares ($8.66 on 120,781 shares
outstanding) 1,045,449
$17,532,386
Offering price per share:
Class A Shares (including sales charge of 4.75%) $9.15
Class B Shares $8.67
Class C Shares $8.66
STATEMENT OF OPERATIONS
February 1, 1994 (Commencement of
Operations) to November 30, 1994
Investment Income (Note 1):
Interest $501,935
Amortization 7,904
509,839
Expenses (Notes 1, 2 and 4):
Management fee $ 47,930
Shareholder services 25,820
Custodian fees 18,627
Accounting 10,954
Auditing 10,766
Legal 7,691
Printing 9,118
Registration fees 2,115
Organization expenses 3,853
Distribution Plan expenses 69,644
Miscellaneous expenses 448
Total expenses 206,966
Less: Reimbursement from Investment Adviser
(Note 4) (114,076)
Net expenses 92,890
Investment income--net 416,949
Realized and unrealized gain (loss) on
investments and futures contracts--net (Notes 1
and 3):
Realized gain (loss) on:
Investments sold (298,920)
Closed futures contracts 45,591
Realized loss on investments and closed futures
contracts--net (253,329)
Net change in unrealized appreciation
(depreciation) on:
Investments (1,337,894)
Open futures contracts 94,156
Net change in unrealized appreciation or
depreciation (1,243,738)
Net loss on investments and closed futures
contracts (1,497,067)
Net decrease in net assets resulting from
operations ($1,080,118)
See Notes to Financial Statements.
<PAGE>
Keystone America Missouri Tax Free Fund
STATEMENT OF CHANGES IN NET ASSETS
February 1, 1994
(Commencement of
Operations) to
November 30, 1994
Operations:
Investment income--net $ 416,949
Realized loss on investments and closed futures
contracts--net (253,329)
Net change in unrealized appreciation or depreciation (1,243,738)
Net decrease in net assets resulting from operations (1,080,118)
Distributions to shareholders from (Notes 1 and 5):
Investment income--net--Class A Shares (58,702)
In excess of investment income--net--Class A Shares (466)
Investment income--net--Class B Shares (324,108)
In excess of investment income--net--Class B Shares (58,892)
Investment income--net--Class C Shares (34,139)
In excess of investment income--net--Class C Shares (5,609)
Total distributions to shareholders (481,916)
Capital share transactions (Note 2):
Proceeds from shares sold--Class A Shares 4,347,894
Proceeds from shares sold--Class B Shares 14,457,771
Proceeds from shares sold--Class C Shares 1,600,310
Payment for shares redeemed--Class A Shares (570,413)
Payment for shares redeemed--Class B Shares (479,634)
Payment for shares redeemed--Class C Shares (448,097)
Net asset value of shares issued in reinvestment of
distributions from:
Investment income--net and in excess of investment
income--net--
Class A Shares 29,808
Investment income--net and in excess of investment
income--net--
Class B Shares 144,139
Investment income--net and in excess of investment
income--net--
Class C Shares 12,642
Net increase in net assets resulting from capital share
transactions 19,094,420
Total increase in net assets 17,532,386
Net assets:
Beginning of period 0
End of period [Including accumulated distributions in
excess of investment income--net as follows:
1994--($7,792)] $17,532,386
See Notes to Financial Statements.
<PAGE>
Keystone America State Tax Free Fund-Series II
NOTES TO FINANCIAL STATEMENTS
(1.) Significant Accounting Policies
Keystone America State Tax Free Fund-Series II ("FUND") was formed as a
Massachusetts business trust on December 15, 1993 and is registered under the
Investment Company Act of 1940 (the Act) as an open-end management investment
company. Keystone Custodian Funds, Inc. ("Keystone") is the Investment
Adviser. The FUND currently offers shares of two separate series evidencing
interests in different portfolios of securities ("Fund(s)"), the Keystone
America California Insured Tax Free Fund ("California Fund") and the Keystone
America Missouri Tax Free Fund ("Missouri Fund") which had no operations
prior to February 1, 1994. The Funds are registered under the Act as
non-diversified open-end investment companies.
Each Fund currently issues three classes of shares. Class A shares are
charged a sales charge of 4.75% payable at the time of purchase. Class B
shares are sold subject to a contingent deferred sales charge payable upon
redemption within three calendar years after the year of purchase. Class C
shares are sold subject to a contingent deferred sales charge payable upon
redemption within one year of purchase. Class C shares are available only
through dealers who have entered into special distribution agreements with
Keystone Distributors, Inc. ("KDI"), the FUND's principal underwriter.
Keystone is a wholly-owned subsidiary of Keystone Group, Inc. ("KGI"), a
Delaware corporation. KGI is privately owned by an investor group consisting
of members of current and former management. Keystone Investor Resource
Center, Inc. ("KIRC") a wholly-owned subsidiary of Keystone, is the FUND's
transfer agent.
The following is a summary of significant accounting policies consistently
followed by the Funds in the preparation of their financial statements. The
policies are in conformity with generally accepted accounting principles.
A. Tax-exempt bonds are valued on the basis of valuations provided by a
pricing service, approved by the Board of Trustees, that uses information
with respect to transactions in bonds, quotations from bond dealers, market
transactions in comparable securities and various relationships between
securities in determining value. Non-tax-exempt securities for which market
quotations are readily available are valued at the price quoted which, in the
opinion of the Board of Trustees or their representative, most nearly
represents their market value. Short-term investments which are purchased
with maturities of sixty days or less are valued at amortized cost (original
purchase cost as adjusted for amortization of premium or accretion of
discount) which when combined with accrued interest approximates market.
Short-term investments maturing in more than sixty days for which market
quotations are readily available are valued at current market value.
Short-term investments maturing in more than sixty days when purchased which
are held on the sixtieth day prior to maturity are valued at amortized cost
(market value on the sixtieth day adjusted for amortization of premium or
accretion of discount) which when combined with accrued interest approximates
market. All other securities and other assets are valued at fair value as
determined in good faith using methods prescribed by the Board of Trustees.
A futures contract is an agreement between two parties to buy and sell a
specific amount of a commodity, security, financial instrument, or, in the
case of a stock index, cash at a set price on a future date. Upon entering
into a futures contract, each Fund is required to deposit with a broker an
amount ("initial margin") equal to a certain percentage of the purchase price
indicated in the futures contract. Subsequent payments ("variation margin")
are made or received by a Fund each day, as the value of the underlying
instrument or index fluctuates, and are recorded for book purposes as
unrealized gains or losses by a Fund. For federal tax purposes, any futures
contracts which remain open at fiscal year-end are marked-to-market and the
resultant net gain or loss is included in the Fund's federal taxable income.
<PAGE>
B. When issued or delayed delivery transactions arise when securities or
currencies are purchased or sold by a Fund with payment and delivery taking
place in the future in order to secure what is considered to be an
advantageous price and yield to the Fund at the time of entering into the
transaction. A separate account of liquid assets equal to the value of such
purchase commitments will be maintained until payment is made. When issued
and delayed agreements are subject to risks from changes in the value based
upon changes in the level of interest rates and other market factors, both
before and after delivery.
C. Securities transactions are accounted for on the trade date. Interest
income is recorded on the accrual basis. All premiums and original issue
discounts are amortized/accreted for both financial reporting and federal
income tax purposes. Realized gains and losses are recorded on the identified
cost basis.
D. Each Fund has qualified and intends to qualify in the future as a
regulated investment company under the Internal Revenue Code of 1986, as
amended ("Internal Revenue Code"). Thus, each Fund is relieved of any federal
income tax liability by distributing all of its net taxable investment income
and net taxable capital gains, if any, to its shareholders. The tax-exempt
interest portion of each dividend is declared uniformly based on the ratio of
each Fund's tax-exempt and taxable income for the entire year. Each Fund
intends to avoid excise tax liability by making the required distributions
under the Internal Revenue Code.
E. When a Fund enters into a repurchase agreement (a purchase of securities
whereby the seller agrees to repurchase the securities at a mutually agreed
upon date and price) the repurchase price of the securities will generally
equal the amount paid by the Fund plus a negotiated interest amount. The
seller under the repurchase agreement will be required to provide securities
("collateral") to the Fund whose value will be maintained at an amount not
less than the repurchase price and which generally will be maintained at 101%
of the repurchase price. A Fund monitors the value of the collateral on a
daily basis, and if the value of the collateral falls below required levels,
the Fund intends to seek additional collateral from the seller or terminate
the repurchase agreement. If the seller defaults, a Fund would suffer a loss
to the extent that the proceeds from the sale of the underlying securities
were less than the repurchase price. Any such loss would be increased by any
cost incurred on disposing of such securities. If bankruptcy proceedings are
commenced against the seller under the repurchase agreement, the realization
on the collateral may be delayed or limited. Repurchase agreements entered
into by a Fund will be limited to transactions with dealers or domestic banks
believed to present minimal credit risks, and the Fund will take constructive
receipt of all securities underlying repurchase agreements until such
agreements expire.
F. Organization expenses are being amortized to operations over a five-year
period on a straight-line basis. In the event any of the initial shares are
redeemed by any holder thereof during the five-year amortization period,
redemption proceeds will be reduced by any unamortized organization expenses
in the same proportion as the number of initial shares being redeemed bears
to the number of initial shares outstanding at the time of redemption.
Keystone America State Tax Free Fund--Series II
<PAGE>
G. Distributions from net investment income are based on tax basis net
income. From time to time, the Fund may distribute dividends which exceed
book basis net income. Differences between book basis investment income--net
available for distribution and tax basis investment income--net available for
distribution are primarily attributable to differences in the treatment of
12b-1 Distribution Plan charges and tax basis returns of capital.
(2.) Capital Share Transactions
The Declaration of Trust authorizes the issuance of an unlimited number of
shares of beneficial interest without par value. Transactions in shares of
the FUND were as follows:
California Fund
Class A Shares
February 1, 1994
(Commencement of
Operations)
to November 30, 1994
Shares sold 382,583
Shares redeemed (39,080)
Shares issued in reinvestment of distributions
from:
Investment income--net and in excess of
investment income--net 2,151
Net increase 345,654
Class B Shares
February 1, 1994
(Commencement of
Operations)
to November 30, 1994
Shares sold 1,429,334
Shares redeemed (129,251)
Shares issued in reinvestment of distributions
from:
Investment income--net and in excess of
investment income--net 14,308
Net increase 1,314,391
Class C Shares
February 1, 1994
(Commencement of
Operations)
to November 30, 1994
Shares sold 99,167
Shares redeemed (28,249)
Shares issued in reinvestment of distributions
from:
Investment income--net and in excess of
investment income--net 966
Net increase 71,884
Missouri Fund
Class A Shares
February 1, 1994
(Commencement of
Operations)
to November 30, 1994
Shares sold 467,351
Shares redeemed (60,027)
Shares issued in reinvestment of distributions
from:
Investment income--net and in excess of
investment income--net 3,204
Net increase 410,528
<PAGE>
Class B Shares
February 1, 1994
(Commencement of
Operations)
to November 30, 1994
Shares sold 1,523,789
Shares redeemed (50,032)
Shares issued in reinvestment of distributions
from:
Investment income--net and in excess of
investment income--net 15,489
Net increase 1,489,246
Class C Shares
February 1, 1994
(Commencement of
Operations)
to November 30, 1994
Shares sold 167,136
Shares redeemed (47,712)
Shares issued in reinvestment of distributions
from:
Investment income--net and in excess of
investment income--net 1,357
Net increase 120,781
Each Fund bears some of the cost of selling its shares under a Distribution
Plan adopted with respect to its Class A, Class B and Class C shares.
The Class A Distribution Plan provides for payments which are currently
limited to 0.15% annually of the average daily net asset value of Class A
shares to pay expenses of the distribution of Class A shares. Amounts paid by
each Fund to KDI under the Class A Distribution Plan are currently used to
pay others, such as dealers, service fees at an annual rate of up to 0.15% of
the average daily net asset value of shares sold by such others and remaining
outstanding on the books of the Fund for specified periods.
The Class B Distribution Plan provides for payments at an annual rate of up
to 1.00% (currently limited to 0.90%) of the average daily net asset value of
Class B shares to pay expenses of the distribution of Class B shares. Amounts
paid by each Fund under the Class B Distribution Plan are currently used to
pay others (dealers) (i) a commission at the time of purchase normally equal
to 3.00% of the value of each share sold; and/or (ii) service fees currently
at an annual rate of 0.15% of the average net asset value of share sold by
such others and remaining outstanding on the books of the Fund for specified
periods.
The Class C Distribution Plan provides for payments at an annual rate of up
to 1.00% (currently limited to 0.90%) of the average daily net asset value of
Class C shares to pay expenses of the distribution of Class C shares. Amounts
paid by each Fund under the Class C Distribution Plan are currently used to
pay others (dealers) (i) a payment at the time of purchase of 1.00% of the
value of each share sold, such payment to consist of a commission in the
amount of 0.75% and the first year's service fee in advance in the amount of
up to 0.25% (currently limited to 0.15%); (ii) beginning approximately 15
months after purchase, a commission at an annual rate of 0.75% (subject to
applicable limitations imposed by the rules of the National Association of
Security Dealers, Inc.) and service fees at an annual rate of up to 0.25% of
the average net asset value of shares sold by such others and remaining
outstanding on the books of the Fund for specified periods.
Each of the Distribution Plans may be terminated at any time by vote of the
Independent Trustees or by majority of the outstanding voting shares of the
respective class. However, after the termination of the Class B Distribution
Plan, payments to KDI will continue at the annual rate of 1.00% of the
average daily
<PAGE>
Keystone America State Tax Free Fund--Series II
net asset value of Class B shares, as compensation for its services which had
been earned while the Class B Distribution Plan was in effect. Such
unreimbursed distribution expenses at November 30, 1994 for Class B shares
were $368,064, and $412,838 for the California Fund, and the Missouri Fund,
respectively.
During the period February 1, 1994 (Commencement of Operations) to November
30, 1994, the California Fund and the Missouri Fund paid KDI (i) $2,813, and
$1,634, respectively, pursuant to each Fund's Class A Distribution Plan; (ii)
$60,793, and $61,502, respectively, pursuant to each Fund's Class B
Distribution Plan; and (iii) $3,259, and $6,508, respectively, pursuant to
each Fund's Class C Distribution Plan.
Presently, the Fund's class-specific expenses are limited to Distribution
Plan expenses incurred by a class of shares pursuant to its respective
Distribution Plan.
(3.) Securities Transactions
As of November 30, 1994, the California Fund and the Missouri Fund had
capital loss carryovers for federal income tax purposes of approximately
$920,597 and $109,170, respectively, which expire in the year 2002.
Realized gains and losses are recorded on the identified cost basis. Purchases
and sales of investment securities (including proceeds received at maturity),
during the period February 1, 1994 (Commencement of Operations) to November 30,
1994, for each Fund were as follows:
California Fund
Cost of Proceeds
Purchases From Sales
Tax-exempt investments
and futures contracts $26,991,347 $11,106,744
Short-term commercial and
tax-exempt notes 12,970,000 12,790,000
$39,961,347 $23,896,744
Missouri Fund
Cost of Proceeds
Purchases From Sales
Tax-exempt investments
and futures contracts $22,531,472 $ 2,703,422
Short-term commercial and
tax-exempt notes 13,040,000 12,425,000
$35,571,472 $15,128,422
(4.) Investment Management and Transactions with Affiliates
Under the terms of the Investment Advisory and Management Agreement between
Keystone and the FUND, dated December 15, 1993, Keystone provided investment
advisory and management services to the FUND and its Funds.
In return, Keystone was paid an amount computed and paid daily by applying
percentage rates, which start at 0.55% and decline, as net assets increase,
to 0.25%, to the average annual net asset value of each Fund.
During the period February 1, 1994 (Commencement of Operations) to November
30, 1994, the California Fund and the Missouri Fund paid or accrued to
Keystone investment management and administrative services fees of $49,627,
and $47,930, respectively.
During the period February 1, 1994 (Commencement of Operations) to November
30, 1994, the California Fund and the Missouri Fund paid or accrued to KIRC
$16,901, and $25,820, respectively, for shareholder services. During the
period February 1, 1994 (Commencement of Operations) to November 30, 1994,
the California Fund and the Missouri Fund paid or accrued to KGI $11,753, and
$10,954, respectively, as reimbursement for certain accounting services.
<PAGE>
Keystone had voluntarily limited the expenses of Class A Shares of each Fund
to 0.35% for six months, after which the expense limitation was increased by
0.10% per month until November 1, 1994 when expenses were limited to 0.75%;
expenses for Class B and C shares were limited to 1.10% for the Fund's first
six months, after which the expense limitations were similarly increased
until November 1, 1994 when expenses were limited to 1.50%. These expense
limitations will continue until December 31, 1995. Keystone will not be
required to make such reimbursement to the extent it would result in a Fund's
inability to qualify as a regulated investment company under the provisions
of the Internal Revenue Code. In accordance with these expense limitations,
Keystone reimbursed the California Fund and the Missouri Fund (i) $23,507 and
$12,109, respectively, with respect to each Fund's Class A Shares; (ii)
$81,857 and $91,759, respectively, with respect to each Fund's Class B
Shares; and (iii) $4,427 and $10,208, respectively, with respect to each
Fund's Class C Shares. Keystone does not intend to seek repayment for these
amount.
Certain officers and/or Directors of Keystone are also officers and/or
Trustees of the FUND. Officers of Keystone and affiliated Trustees receive no
compensation directly from the Fund. Currently, the Independent Trustees of
the FUND receive no compensation for their services.
(5.) Distributions to Shareholders
Each Fund intends to declare dividends from net investment income daily and
distribute to its shareholders such dividends monthly and to declare and
distribute all net realized long-term capital gains, if any, at least
annually.
<PAGE>
Keystone America State Tax Free Fund-Series II
INDEPENDENT AUDITORS' REPORT
The Trustees and Shareholders
Keystone America State Tax Free Fund--Series II
We have audited the financial statements of Keystone America California
Insured Tax Free Fund and Keystone America Missouri Tax Free Fund, portfolios
of Keystone America State Tax Free Fund--Series II ("FUND"), including the
schedules of investments as of November 30, 1994, and the related statements
of operations, statements of changes in net assets and the financial
highlights for the period from February 1, 1994 (Commencement of Operations)
to November 30, 1994. These financial statements and financial highlights are
the responsibility of the FUND's management. Our responsibility is to express
an opinion on these financial statements and financial highlights based on
our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements and
financial highlights are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures
in the financial statements. Our procedures included confirmation of
securities owned as of November 30, 1994 by correspondence with the custodian
and brokers. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audit provides
a reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of
Keystone America California Insured Tax Free Fund and Keystone America
Missouri Tax Free Fund as of November 30, 1994, and the results of their
operations, the changes in their net assets and the financial highlights for
the period from February 1, 1994 to November 30, 1994 in conformity with
generally accepted accounting principles.
KPMG PEAT MARWICK LLP
Boston, Massachusetts
January 6, 1995
