<PAGE>
KEYSTONE STATE TAX FREE FUND -- SERIES II
Keystone California Tax Free Fund
Keystone Missouri Tax Free Fund
PROSPECTUS MARCH 31, 1996
AS SUPPLEMENTED JANUARY 1, 1997
Keystone State Tax Free Fund -- Series II (formerly named Keystone America
State Tax Free Fund -- Series II) (the "FUND") is a mutual fund that currently
consists of two separate non-diversified series of shares evidencing interests
in different portfolios of securities ("Funds"): the Keystone California Tax
Free Fund ("California Fund") and the Keystone 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 state for which the Fund is named.
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 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.
The Fund currently offers Class A, B and C shares. Information on share
classes and their fee and sales charge structures may be found in the "Expense
Information," "How to Buy Shares," "Alternative Sales Options," "Contingent
Deferred Sales Charge and Waiver of Sales Charges," "Distribution Plans and
Agreements" 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.
KEYSTONE STATE TAX FREE FUND -- SERIES II
200 BERKELEY STREET
BOSTON, MASSACHUSETTS 02116-5034
CALL TOLL FREE 1-800-343-2898
Additional information about the FUND and its Funds is contained in a
statement of additional information dated March 31, 1996, as supplemented, 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 FUND ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR
ENDORSED BY, ANY BANK, AND SHARES ARE NOT INSURED OR OTHERWISE PROTECTED BY THE
U.S. GOVERNMENT, THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE
BOARD OR ANY OTHER GOVERNMENT AGENCY AND INVOLVE RISK, INCLUDING THE POSSIBLE
LOSS OF PRINCIPAL.
TABLE OF CONTENTS Page
Expense Information 2
Financial Highlights 4
The FUND and Its Funds 10
Investment Objectives and Policies 10
Investment Restrictions 13
Risk Factors 14
Pricing Shares 17
Dividends and Taxes 17
FUND Management and Expenses 19
Distribution Plans and Agreements 22
How to Buy Shares 25
Alternative Sales Options 26
Contingent Deferred Sales Charge and
Waiver of Sales Charges 29
How to Redeem Shares 30
Shareholder Services 31
Performance Data 33
FUND Shares 34
Additional Information 35
Additional Investment Information (i)
Exhibit A A-1
Exhibit B B-1
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>
EXPENSE INFORMATION
KEYSTONE CALIFORNIA 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 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 Sales Charge and Waiver of Sales Charges"; "Distribution Plans and
Agreements"; and "Shareholder Services."
<TABLE>
<CAPTION>
CLASS A SHARES CLASS B SHARES CLASS C SHARES
FRONT-END LOAD BACK-END LEVEL LOAD
SHAREHOLDER TRANSACTION EXPENSES OPTION LOAD OPTION(1) OPTION(2)
--------- --------- ---------
<S> <C> <C> <C>
Maximum Sales Load Imposed on Purchases ........... 4.75%(3) None None
(as a percentage of offering price)
Deferred Sales Load ............................... 0.00%(4) 5.00% in the first year 1.00% in the first
(as a percentage of original purchase price or declining to 1.00% in the year and 0.00%
redemption proceeds, as applicable) sixth year and 0.00% thereafter
thereafter
Exchange Fee ...................................... None None None
ANNUAL FUND OPERATING EXPENSES(5)
(after expense reimbursements)
(as a percentage of average net assets)
Management Fees ................................... 0.55% 0.55% 0.55%
12b-1 Fees ........................................ 0.15% 0.90%(6) 0.90%(6)
Other Expenses .................................... 0.02% 0.03% 0.04%
---- ---- ----
Total Fund Operating Expenses ..................... 0.72% 1.48% 1.49%
==== ==== ====
<CAPTION>
EXAMPLES(7) 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 .................................................................. $55 $69 $ 86 $133
Class B .................................................................. $65 $77 $101 $147
Class C .................................................................. $25 $47 $ 81 $178
You would pay the following expenses on the same investment, assuming no
redemption at the end of each period:
Class A .................................................................. $55 $69 $ 86 $133
Class B .................................................................. $15 $47 $ 81 $147
Class C .................................................................. $15 $47 $ 81 $178
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.
- ----------
(1) Class B shares purchased after January 1, 1997, convert tax free to Class A shares after seven years. See "Class B Shares" for
more information.
(2) Class C shares are available only through broker-dealers who have entered into special distribution agreements with Evergreen
Keystone Distributor, Inc., the Funds' principal underwriter.
(3) The sales charge applied to purchases of Class A shares declines as the amount invested increases. See "Alternative Sales
Options."
(4) Purchases of Class A shares made after January 1, 1997, in the amount of $1,000,000 or more are not subject to a sales charge
at the time of purchase, but may be subject to a contingent deferred sales charge. See the "Class A Shares" and "Contingent
Deferred Sales Charge and Waiver of Sales Charges" sections of this prospectus for an explanation of the charge.
(5) Expense ratios are for the fiscal year ended November 30, 1995 after giving effect to the reimbursement by Keystone Investment
Management Company ("Keystone") of expenses in accordance with certain voluntary expense limitations. Currently, Keystone
has voluntarily limited annual expenses of the Fund's Class A, B and C shares to 0.75%, 1.50% and 1.50% of average net
class assets, respectively. Keystone intends to continue the foregoing expense limitations on a calendar month-by-month basis.
Keystone is under no obligation to maintain these limits. Absent voluntary expense limitations, expense ratios for the
California Fund's fiscal year ended November 30, 1995 for Class A, B and C shares would have been 1.31%, 2.07% and 2.07%,
respectively. Total Fund Operating Expenses for the fiscal year ended November 30, 1995 include indirectly paid expenses.
(6) 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, in connection with certain voluntary expense limitations, are
currently limited to 0.90% of the average daily net asset value of each respective class. 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.
(7) The Securities and Exchange Commission requires use of a 5% annual return figure for purposes of this example. Actual returns
for the Fund may be greater or less than 5%.
</TABLE>
<PAGE>
EXPENSE INFORMATION
KEYSTONE 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 Sales Charge and Waiver of Sales Charges"; "Distribution
Plans and Agreements"; 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(1) OPTION(2)
--------- --------- ---------
<S> <C> <C> <C>
Maximum Sales Load Imposed on Purchases ........... 4.75%(3) None None
(as a percentage of offering price)
Deferred Sales Load ............................... 0.00%(4) 5.00% in the first year 1.00% in the first
(as a percentage of original purchase price or declining to 1.00% in the year and 0.00%
redemption proceeds, as applicable) sixth year and 0.00% thereafter
thereafter
Exchange Fee ...................................... None None None
ANNUAL FUND OPERATING EXPENSES(5)
(after expense reimbursements)
(as a percentage of average net assets)
Management Fees ................................... 0.55% 0.55% 0.55%
12b-1 Fees ........................................ 0.15% 0.90%(6) 0.90%(6)
Other Expenses .................................... 0.02% 0.02% 0.01%
---- ---- ----
Total Fund Operating Expenses ..................... 0.72% 1.47% 1.46%
==== ==== ====
EXAMPLES(7) 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 .................................................................. $55 $69 $ 86 $133
Class B .................................................................. $65 $76 $100 $146
Class C .................................................................. $25 $46 $ 80 $175
You would pay the following expenses on the same investment, assuming no
redemption at the end of each period:
Class A .................................................................. $55 $69 $ 86 $133
Class B .................................................................. $15 $46 $ 80 $146
Class C .................................................................. $15 $46 $ 80 $175
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.
- ----------
(1) Class B shares purchased after January 1, 1997, convert tax free to Class A shares after seven years. See "Class B Shares" for
more information.
(2) Class C shares are available only through broker-dealers who have entered into special distribution agreements with Evergreen
Keystone Distributor, Inc., the Funds' principal underwriter.
(3) The sales charge applied to purchases of Class A shares declines as the amount invested increases. See "Alternative Sales
Options."
(4) Purchases of Class A shares made after January 1, 1997, in the amount of $1,000,000 or more are not subject to a sales charge
at the time of purchase, but may be subject to a contingent deferred sales charge. See the "Class A Shares" and "Contingent
Deferred Sales Charge and Waiver of Sales Charges" sections of the prospectus for an explanation of the charge.
(5) Expense ratios are for the fiscal year ended November 30, 1995 after giving effect to the reimbursement by Keystone Investment
Management Company ("Keystone") of expenses in accordance with certain voluntary expense limitations. Currently, Keystone has
voluntarily limited annual expenses of the Fund's Class A, B and C shares to 0.75%, 1.50% and 1.50% of average net class
assets, respectively. Keystone intends to continue the foregoing expense limitations on a calendar month-by-month basis.
Keystone is under no obligation to maintain these limits. Absent voluntary expense limitations, expense ratios for the
Missouri Tax Free Fund's fiscal year ended November 30, 1995 for Class A, B and C shares would have been 1.32%, 2.08% and
2.07%, respectively. Total Fund Operating Expenses for the fiscal year ended November 30, 1995 included indirectly paid
expenses.
(6) 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, in connection with certain voluntary expense limitations,
are currently limited to 0.90% of the average daily net asset value of each respective class. 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.
(7) The Securities and Exchange Commission requires use of a 5% annual return figure for purposes of this example. Actual returns
for the Fund may be greater or less than 5%.
</TABLE>
<PAGE>
FINANCIAL HIGHLIGHTS
KEYSTONE CALIFORNIA TAX FREE FUND
CLASS A SHARES
(For a share outstanding throughout the period)
The following table contains important financial information relating to the
California 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
YEAR ENDED OPERATIONS) TO
NOVEMBER 30, 1995 NOVEMBER 30, 1994
------------------ -----------------
NET ASSET VALUE, BEGINNING OF PERIOD $ 8.70 $10.00
Income from investment operations:
Net investment income ............... 0.49 0.44
Net realized and unrealized gain 1.17 (1.30)
(loss) on investments and
futures contracts .................
------ ------
Total from investment operations .... 1.66 (0.86)
------ ------
Less distributions from:
Net investment income ............... (0.47) (0.44)
In excess of net investment income .. (0.03) (0.00)
------ ------
Total distributions ................. (0.50) (0.44)
------ ------
NET ASSET VALUE, END OF PERIOD ...... $ 9.86 $ 8.70
====== ======
TOTAL RETURN (a) .................... 19.63% (8.78%)(c)
RATIOS/SUPPLEMENTAL DATA Ratios to average net assets:
Total expenses (b) ................ 0.72%(e) 0.41%(d)
Net investment income ............. 5.37% 5.53%(d)
Portfolio turnover rate ............. 119% 104%
------ ------
NET ASSETS, END OF PERIOD (THOUSANDS) $4,555 $3,006
====== ======
(a) Excluding applicable sales charges.
(b) Figures are net of the expense reimbursement by Keystone in connection with
the voluntary expense limitation. Before the expense reimbursement, the
"Ratio of total expenses to average net assets" would have been 1.31% and
1.66% (annualized) for the fiscal year ended November 30, 1995 and the
period February 1, 1994 (Commencement of Operations) to November 30, 1994,
respectively.
(c) Total return is calculated from February 1, 1994 (Commencement of
Operations) to November 30, 1994.
(d) Annualized.
(e) "Ratio of total expenses to average net assets" for the year ended November
30, 1995 includes indirectly paid expenses. Excluding indirectly paid
expenses, the expense ratio would have been 0.69%.
<PAGE>
FINANCIAL HIGHLIGHTS
KEYSTONE CALIFORNIA TAX FREE FUND
CLASS B SHARES
(For a share outstanding throughout the period)
The following table contains important financial information relating to the
California 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
YEAR ENDED OPERATIONS) TO
NOVEMBER 30, 1995 NOVEMBER 30, 1994
------------------ -----------------
NET ASSET VALUE, BEGINNING OF PERIOD .. $ 8.68 $ 10.00
------- -------
Income from investment operations:
Net investment income ................. 0.44 0.40
Net realized and unrealized gain (loss)
on investments and
futures contracts ................... 1.17 (1.28)
------- -------
Total from investment operations ...... 1.61 (0.88)
------- -------
Less distributions from:
Net investment income ................. (0.44) (0.40)
In excess of net investment income .... (0.03) (0.04)
------- -------
Total distributions ................... (0.47) (0.44)
------- -------
NET ASSET VALUE, END OF PERIOD ........ $ 9.82 $ 8.68
======= =======
TOTAL RETURN (a) ...................... 18.95% (9.00%)(c)
RATIOS/SUPPLEMENTAL DATA Ratios to average net assets:
Total expenses (b) .................. 1.48%(e) 1.16%(d)
Net Investment income ............... 4.57% 4.83%(d)
Portfolio turnover rate ............... 119% 104%
------- -------
NET ASSETS, END OF PERIOD (THOUSANDS) . $22,743 $11,415
======= =======
(a) Excluding applicable sales charges.
(b) Figures are net of the expense reimbursement by Keystone in connection with
the voluntary expense limitation. Before the expense reimbursement, the
"Ratio of total expenses to average net assets" would have been 2.07% and
2.36% (annualized) for the fiscal year ended November 30, 1995 and for the
period February 1, 1994 (Commencement of Operations) to November 30, 1994,
respectively.
(c) Total return is calculated from February 1, 1994 (Commencement of
Operations) to November 30, 1994.
(d) Annualized.
(e) "Ratio of total expenses to average net assets" for the year ended November
30, 1995 includes indirectly paid expenses. Excluding indirectly paid
expenses, the expense ratio would have been 1.45%.
<PAGE>
FINANCIAL HIGHLIGHTS
KEYSTONE CALIFORNIA TAX FREE FUND
CLASS C SHARES
(For a share outstanding throughout the period)
The following table contains important financial information relating to the
California 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
YEAR ENDED OPERATIONS) TO
NOVEMBER 30, 1995 NOVEMBER 30, 1994
------------------ -----------------
NET ASSET VALUE, BEGINNING OF PERIOD .. $ 8.68 $ 10.00
------- -------
Income from investment operations:
Net investment income ................. 0.43 0.39
Net realized and unrealized gain (loss)
on investments and
futures contracts ................... 1.15 (1.29)
------- -------
Total from investment operations ...... 1.58 (0.90)
------- -------
Less distributions from:
Net investment income ................. (0.43) (0.39)
In excess of net investment income .... (0.03) (0.03)
------- -------
Total distributions ................... (0.46) (0.42)
------- -------
NET ASSET VALUE, END OF PERIOD ........ $ 9.80 $ 8.68
======= =======
TOTAL RETURN (a) ...................... 18.69% (9.08%)(c)
RATIOS/SUPPLEMENTAL DATA Ratios to average net assets:
Total expenses (b) .................. 1.49%(e) 1.16%(d)
Net investment income ............... 4.51% 4.96%(d)
Portfolio turnover rate ............... 119% 104%
------- -------
NET ASSETS, END OF PERIOD (THOUSANDS) . $ 1,535 $ 624
======= =======
(a) Excluding applicable sales charges.
(b) Figures are net of the expense reimbursement by Keystone in connection with
the voluntary expense limitation. Before the expense reimbursement, the
"Ratio of total expenses to average net assets" would have been 2.07% and
2.38% (annualized) for the fiscal year ended November 30, 1995 and for the
period February 1, 1994 (Commencement of Operations) to November 30, 1994,
respectively.
(c) Total return is calculated from February 1, 1994 (Commencement of
Operations) to November 30, 1994.
(d) Annualized.
(e) "Ratio of total expenses to average net assets" for the year ended November
30, 1995 includes indirectly paid expenses. Excluding indirectly paid
expenses, the expense ratio would have been 1.46%.
<PAGE>
FINANCIAL HIGHLIGHTS
KEYSTONE MISSOURI TAX FREE FUND
CLASS A SHARES
(For a share outstanding throughout the period)
The following table contains important financial information relating 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
YEAR ENDED OPERATIONS) TO
NOVEMBER 30, 1995 NOVEMBER 30, 1994
------------------ -----------------
NET ASSET VALUE, BEGINNING OF PERIOD .. $ 8.72 $10.00
------ ------
Income from investment operations:
Net investment income ................. 0.50 0.44
Net realized and unrealized gain (loss)
on investments and
futures contracts ................... 1.19 (1.28)
------ ------
Total from investment operations ...... 1.69 (0.84)
------ ------
Less distributions from:
Net investment income ................. (0.47) (0.44)
In excess of net investment income .... (0.03) 0.00(e)
------ ------
Total distributions ................... (0.50) (0.44)
------ ------
NET ASSET VALUE, END OF PERIOD ........ $ 9.91 $ 8.72
====== ======
TOTAL RETURN (a) ...................... 19.86% (8.55%)(c)
RATIOS/SUPPLEMENTAL DATA Ratios to average net assets:
Total expenses (b) .................. 0.72%(f) 0.43%(d)
Net investment income ............... 5.26% 5.38%(d)
Portfolio turnover rate ............... 74% 25%
------ ------
NET ASSETS, END OF PERIOD (THOUSANDS) . $4,848 $3,581
====== ======
(a) Excluding applicable sales charges.
(b) Figures are net of the expense reimbursement by Keystone in connection with
the voluntary expense limitation. Before the expense reimbursement, the
"Ratio of total expenses to average net assets" would have been 1.32% and
1.54% (annualized) for the fiscal year ended November 30, 1995 and for the
period February 1, 1994 (Commencement of Operations) to November 30, 1994,
respectively.
(c) Total return is calculated from February 1, 1994 (Commencement of
Operations) to November 30, 1994.
(d) Annualized.
(e) Amount represents less than $0.01 per share.
(f) "Ratio of total expenses to average net assets" for the year ended November
30, 1995 includes indirectly paid expenses. Excluding indirectly paid
expenses, the expense ratio would have been 0.69%.
<PAGE>
FINANCIAL HIGHLIGHTS
KEYSTONE MISSOURI TAX FREE FUND
CLASS B SHARES
(For a share outstanding throughout the period)
The following table contains important financial information relating 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
YEAR ENDED OPERATIONS) TO
NOVEMBER 30, 1995 NOVEMBER 30, 1994
------------------ -----------------
NET ASSET VALUE, BEGINNING OF PERIOD .. $ 8.67 $ 10.00
------- -------
Income from investment operations:
Net investment income ................. 0.44 0.40
Net realized and unrealized gain (loss)
on investments and
futures contracts ................... 1.15 (1.29)
------- -------
Total from investment operations ...... 1.59 (0.89)
------- -------
Less distributions from:
Net investment income ................. (0.43) (0.40)
In excess of net investment income .... (0.03) (0.04)
------- -------
Total distributions ................... (0.46) (0.44)
------- -------
NET ASSET VALUE, END OF PERIOD ........ $ 9.80 $ 8.67
======= ======
TOTAL RETURN (a) ...................... 18.79% (9.06%)(c)
RATIOS/SUPPLEMENTAL DATA Ratios to average net assets:
Total expenses (b) .................. 1.47%(e) 1.16%(d)
Net investment income ............... 4.56% 4.70%(d)
Portfolio turnover rate ............... 74% 25%
------- -------
NET ASSETS, END OF PERIOD (THOUSANDS) . $21,231 $12,906
======= =======
(a) Excluding applicable sales charges.
(b) Figures are net of the expense reimbursement by Keystone in connection with
the voluntary expense limitation. Before the expense reimbursement, the
"Ratio of total expenses to average net assets" would have been 2.08% and
2.49% (annualized) for the fiscal year ended November 30, 1995 and for the
period February 1, 1994 (Commencement of Operations) to November 30, 1994,
respectively.
(c) Total return is calculated from February 1, 1994 (Commencement of
Operations) to November 30, 1994.
(d) Annualized.
(e) "Ratio of total expenses to average net assets" for the year ended November
30, 1995 includes indirectly paid expenses. Excluding indirectly paid
expenses, the expense ratio would have been 1.44%.
<PAGE>
FINANCIAL HIGHLIGHTS
KEYSTONE MISSOURI TAX FREE FUND
CLASS C SHARES
(For a share outstanding throughout the period)
The following table contains important financial information relating 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
YEAR ENDED OPERATIONS) TO
NOVEMBER 30, 1995 NOVEMBER 30, 1994
------------------ -----------------
NET ASSET VALUE, BEGINNING OF PERIOD .. $ 8.66 $10.00
------ ------
Income from investment operations:
Net investment income ................. 0.43 0.39
Net realized and unrealized gain (loss)
on investments and
futures contracts ................... 1.16 (1.29)
------ ------
Total from investment operations ...... 1.59 (0.90)
------ ------
Less distributions from:
Net investment income ................. (0.43) (0.39)
In excess of net investment income .... (0.03) (0.05)
------ ------
Total distributions ................... (0.46) (0.44)
------ ------
NET ASSET VALUE, END OF PERIOD ........ $ 9.79 $ 8.66
====== ======
TOTAL RETURN (a) ...................... 18.78% (9.25%)(c)
RATIOS/SUPPLEMENTAL DATA Ratios to average net assets:
Total expenses (b) .................. 1.46%(e) 1.15%(d)
Net investment income ............... 4.56% 4.72%(d)
Portfolio turnover rate ............... 74% 25%
------ ------
NET ASSETS, END OF PERIOD (THOUSANDS) . $1,788 $1,045
====== ======
(a) Excluding applicable sales charges.
(b) Figures are net of the expense reimbursement by Keystone in connection with
the voluntary expense limitation. Before the expense reimbursement, the
"Ratio of total expenses to average net assets" would have been 2.07% and
2.60% (annualized) for the fiscal year ended November 30, 1995 and the
period February 1, 1994 (Commencement of Operations) to November 30, 1994,
respectively.
(c) Total return is calculated from February 1, 1994 (Commencement of
Operations) to November 30, 1994.
(d) Annualized.
(e) "Ratio of total expenses to average net assets" for the year ended November
30, 1995 includes indirectly paid expenses. Excluding indirectly paid
expenses, the expense ratio would have been 1.44%.
<PAGE>
THE FUND AND ITS FUNDS
The FUND is an 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 more than thirty funds advised and managed by
Keystone Investment Management Company ("Keystone"), the FUND's investment
adviser. The FUND currently consists of two separate non-diversified series
evidencing interests in different portfolios of securities: the California Fund
and Missouri Tax Free Fund. The FUND may offer additional series 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.
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 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 of the affected Fund's outstanding
shares, as defined in the Investment Company Act of 1940 ("1940 Act"), 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 (a "1940 Act Majority").
There can be no assurance that a Fund will achieve its investment objectives
since there is uncertainty in every investment.
FUNDS' PRINCIPAL INVESTMENTS
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, that 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 invested 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 TAX FREE FUND
Under ordinary circumstances, the California 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 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 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
("Moody's") (Aaa, Aa, A and Baa), or 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
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, Missouri state income taxes and 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), or 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.
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 with maturities of more than
30 years or less than 5 years (other than certain money market securities).
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 objective.
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, each 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.
INSURANCE
At least 80% of the municipal securities in the portfolio of the California
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 Fund's portfolio. Similarly, because the net
asset value of the California 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 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 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 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 Fund.
Premium rates for each issue of securities covered by the policy are fixed for
the life of the California 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
Fund's average annual expenses. Premiums are paid from the California 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 Fund and covered by the policy, except for
nonpayment of premiums.
SECONDARY INSURANCE POLICIES
The California 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 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 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 Fund in
determining the net capital gain or loss realized by the Fund upon the sale of
such Insured Security.
INVESTMENT RESTRICTIONS
Each Fund has adopted the fundamental restrictions summarized below, which may
not be changed without the vote of a 1940 Act 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:
(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 1940 Act. 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).
RISK FACTORS
GENERAL
Like any investment, your investment in a Fund involves an element of risk.
Before you invest in a Fund, you should carefully evaluate your ability to
assume the risks your investment in the Fund poses.
Certain risks related to the Funds are discussed below. To the extent not
discussed in this section, specific risks attendant to individual securities or
investment practices are discussed in "Additional Investment Information."
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.
Should the FUND need to raise cash to meet a large number of redemptions it
might have to sell portfolio securities at a time when it would be
disadvantageous to do so.
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 Fund computes its net asset value as of the close of trading (currently
4:00 p.m. eastern time) on each day that the New York Stock Exchange (the
"Exchange") is open. However, the Fund does not compute its net asset value 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.
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. Shareholders
receive Fund distributions in the form of additional shares of that class of
shares upon which the distribution is based or, at the shareholder's option, 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.
As of April 1, 1995, in compliance with a recent ruling issued by the Internal
Revenue Service, the Fund treats its 12b-1 fees for tax purposes as operating
expenses rather than as capital charges.
Because Class A shares bear most of the costs of distribution of such shares
through payment of a front-end sales charge while Class B and Class C
shares bear such expenses through a higher annual distribution fee, expenses
attributable to Class B shares and Class C shares will generally be higher, and
income distributions paid by a Fund with respect to Class A shares will
generally be greater than those paid with respect to Class B and Class C 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 has qualified and intends to continue to qualify as a
regulated investment company (a "RIC") under the Code. Each Fund is a separate
taxable entity for purposes of Code provisions applicable to RICs. 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 RIC 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.
If a Fund qualifies as a RIC 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.
Any taxable distribution declared in October, November or December to
shareholders of record in such a month and paid by the following January 31 will
be includable in the taxable income of the shareholder as if paid on December 31
of the year in which the dividend was declared.
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."
At least 50% of the value of a Fund's assets must be invested in tax-exempt
obligations in order for distributions to qualify as exempt interest dividends
at the end of each quarter. 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.
Since none of a Fund's income will consist of corporate dividends, no
distributions will qualify for the 70% 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 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 Internal Revenue Service 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.
FUND MANAGEMENT AND EXPENSES
FUND MANAGEMENT
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
provides investment advice, management and administrative services to the FUND.
INVESTMENT ADVISER
Keystone has provided investment advisory and management services to
investment companies and private accounts since 1932. Keystone is a wholly-owned
subsidiary of Keystone Investments, Inc. ("Keystone Investments"). Keystone
Investments provides accounting, bookkeeping, legal, personnel and general
corporate services to Keystone, its affiliates, and the Keystone Investments
Families of Funds. Both Keystone and Keystone Investments are located at 200
Berkeley Street, Boston, Massachusetts 02116-5034.
On December 11, 1996, Keystone Investments succeeded to the business of a
corporation with the same name, but under different ownership. Keystone
Investments is a wholly-owned subsidiary of First Union National Bank of North
Carolina ("FUNB"). FUNB is a subsidiary of First Union Corporation ("First
Union"), the sixth largest bank holding company in the U.S. based on total
assets as of September 30, 1996.
First Union is headquartered in Charlotte, North Carolina, and had $133.9
billion in consolidated assets as of September 30, 1996. First Union and its
subsidiaries provide a broad range of financial services to individuals and
businesses throughout the U.S. The Capital Management Group of FUNB ("CMG"),
together with Lieber & Company and Evergreen Asset Management Corp. ("Evergreen
Asset"), wholly-owned subsidiaries of FUNB, manage or otherwise oversee the
investment of over $50 billion in assets belonging to a wide range of clients,
including the Evergreen Family of Funds.
Pursuant to its Investment Advisory and Management Agreement with the FUND
(the "Advisory Agreement"), Keystone manages the investment and reinvestment of
each Fund's assets, supervises the operation of the FUND and each Fund and
provides all necessary office space, facilities and equipment.
Each Fund 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
Keystone's fee is computed as of the close of business each business day and
payable daily.
The Advisory Agreement continues in effect for two years from its effective
date and, thereafter, 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
shareholders 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 (Trustees who are not "interested persons" of the FUND, as
defined in the 1940 Act, and who have no direct or indirect financial interest
in either Fund's Distribution Plans or any agreement related thereto) cast 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 shareholders of such Fund. The Advisory Agreement will terminate
automatically upon its assignment.
PRINCIPAL UNDERWRITER
Evergreen Keystone Distributor, Inc. (formerly Evergreen Funds Distributor,
Inc.) ("EKD"), a wholly-owned subsidiary of Furman Selz LLC ("Furman Selz"),
which is not affiliated with First Union, is now the Fund's principal
underwriter (the "Principal Underwriter"). EKD replaces Evergreen Keystone
Investment Services, Inc. (formerly Keystone Investment Distributors Company)
("EKIS") as the FUND's principal underwriter. EKIS may no longer act as
principal underwriter of the FUND due to regulatory restrictions imposed by the
Glass-Steagall Act upon national banks such as FUNB and their affiliates, that
prohibit such entities from acting as the underwriters or distributors of mutual
fund shares. While EKIS may no longer act as principal underwriter of the FUND
as discussed above, EKIS may continue to receive compensation from the FUND or
the Principal Underwriter in respect of underwriting and distribution services
performed prior to the termination of EKIS as principal underwriter. In
addition, EKIS may also be compensated by the Principal Underwriter for the
provision of certain marketing support services to the Principal Underwriter at
an annual rate of up to .75% of the average daily net assets of each Fund,
subject to certain restrictions. Both EKD and Furman Selz are located at 230
Park Avenue, New York, New York 10169.
SUB-ADMINISTRATOR
Furman Selz provides officers and certain administrative services to each Fund
pursuant to a sub-administration agreement. For its services under that
agreement, Furman Selz receives a fee from Keystone at the maximum annual rate
of .01% of the average daily net assets of each Fund.
It is expected that on or about January 2, 1997, Furman Selz will transfer
EKD, and its related mutual fund distribution and administration business, to
BISYS Group, Inc. ("BISYS"). At that time, BISYS will succeed as
sub-administrator for each Fund. It is not expected that the acquisition of the
mutual fund distribution and administration business by BISYS will affect the
services currently provided by EKD or Furman Selz.
PORTFOLIO MANAGERS
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 9 years of investment experience.
George J. Kimball, a Keystone Vice President and Portfolio Manager, is
responsible for the day-to-day management of the California Fund. Mr. Kimball
has more than 10 years of investment experience.
FUND EXPENSES
Each Fund pays 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 Independent 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. Total expenses for each Fund include
indirectly paid expenses.
For the fiscal year ended November 30, 1995, the California Fund and the
Missouri Tax Free Fund paid or accrued to Keystone investment management and
administrative services fees of $113,353 and $120,166, respectively, which
represented 0.55% and 0.55% of the respective Fund's average net assets for the
fiscal year ended November 30, 1995.
For the fiscal year ended November 30, 1995, the California Fund and the
Missouri Tax Free Fund paid or accrued $24,058 and $33,338, respectively, to
Evergreen Keystone Service Company (formerly Keystone Investor Resource Center,
Inc.) ,9999 and ("EKSC") for services rendered as the FUND's transfer and
dividend dispersing agent. For the fiscal year ended November 30, 1995, the
California Fund and the Missouri Tax Free Fund paid or accrued $19,921, and
$20,721, respectively, to Keystone Investments aKe371$Ie 9,,eNt,998tKee,,127 and
for certain accounting services. EKSC, located at 200 Berkeley Street, Boston,
Massachusetts 02116-5034, is a wholly-owned subsidiary of Keystone.
Keystone has currently voluntarily limited the expenses of Class A shares of
each Fund to 0.75% of the average daily net assets of such class and has
currently voluntarily limited expenses of Class B and C shares of each Fund to
1.50% of the average daily net assets of each such class. Keystone currently
intends to continue the foregoing expense limitations on a calendar month-by-
month basis. Keystone will periodically evaluate the foregoing expense
limitations and may modify or terminate them in the future. 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 year
ended November 30, 1995, Keystone reimbursed the California Fund and the
Missouri Tax Free Fund (i) $21,353 and $18,923, respectively, with respect to
each Fund's Class A shares; (ii) $94,978 and $104,097, respectively, with
respect to each Fund's Class B shares; and (iii) $5,946 and $9,601,
respectively, with respect to each Fund's Class C shares.
SECURITIES TRANSACTIONS
Under policies established by the Board of Trustees, 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 consider the number of shares of the Fund sold by the
broker-dealer. In addition, broker-dealers executing portfolio transactions may,
from time to time, 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, and the fiscal year ended
November 30, 1995, the portfolio turnover rates for the California Fund were
104% and 119%, respectively. For the same periods the turnover rates for the
Missouri Tax Free Fund were 25% and 74%, respectively. 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.
CODE OF ETHICS
The FUND has adopted a Code of Ethics incorporating policies on personal
securities trading as recommended by the Investment Company Institute.
DISTRIBUTION PLANS AND AGREEMENTS
CLASS A DISTRIBUTION PLAN
Each Fund has adopted a Distribution Plan with respect to its Class A shares
(the "Class A Distribution Plan") that provides for expenditures by the Fund,
currently limited to 0.15% annually of the average daily net asset value of
Class A shares, in connection with the distribution of Class A shares. Payments
under the Class A Distribution Plan are currently made to the Principal
Underwriter (which may reallow all or part to others, such as broker-dealers),
as service fees at an annual rate of up to 0.15% of the average daily net asset
value of Class A shares maintained by the recipient and outstanding on the books
of such Fund for specified periods.
CLASS B DISTRIBUTION PLANS
Each Fund has adopted Distribution Plans with respect to its Class B shares
(the "Class B Distribution Plans") that provide for expenditures by each Fund 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. Payments under the Class B Distribution Plans are currently made to the
Principal Underwriter (which may reallow all or part to others, such as
broker-dealers) and to EKIS, the predecessor to the Fund's Principal
Underwriter, (1) as commissions for Class B shares sold, (2) as shareholder
service fees and (3) as interest. Amounts paid or accrued to the Principal
Underwriter or EKIS in the aggregate may not exceed the annual limitation
referred to above.
The Principal Underwriter generally reallows to broker-dealers or others a
commission equal to 4.00% of the price paid for each Class B share sold. The
broker-dealer or other party will also receive service fees at an annual rate of
0.15% of the value of Class B shares maintained by the recipient and outstanding
on the books of such Fund for specified periods. See "Distribution Plans
Generally" 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 by the Fund 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. Payments under the Class C Distribution Plan are currently made to the
Principal Underwriter (which may reallow all or part to others, such as
broker-dealers) and to EKIS, the predecessor to the Fund's Principal
Underwriter, (1) as commissions for Class C shares sold, (2) as shareholder
service fees, and (3) as interest. Amounts paid or accrued to the Principal
Underwriter or EKIS in the aggregate may not exceed the annual limitation
referred to above.
The Principal Underwriter generally reallows to broker-dealers 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 NASD rules
- -- see "Distribution Plans Generally") plus service fees which are paid at the
annual rate of 0.25%, respectively, of the value of Class C shares maintained by
the recipient and outstanding on the books of a Fund for specified periods. See
"Distribution Plans Generally" below.
DISTRIBUTION PLANS GENERALLY
As discussed above, 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.
The NASD limits the amount that a Fund may pay annually in distribution costs
for the 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 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 the 12b-1 Distribution Plan, plus interest at the prime rate plus
1% on such amounts (less any contingent deferred sales charges ("CDSCs") paid by
shareholders to the Principal Underwriter) remaining unpaid from time to time.
In connection with financing its distribution costs, including commission
advances to broker-dealers and others, EKIS, the predecessor to the Principal
Underwriter, sold to a financial institution substantially all of its 12b-1 fee
collection rights and CDSC collection rights in respect of Class B shares sold
during the period beginning approximately June 1, 1995 through November 30,
1996. Each Fund has agreed not to reduce the rate of payment of 12b-1 fees in
respect of such Class B shares, unless it terminates such shares' Distribution
Plan completely. If it terminates such Distribution Plan, each Fund may be
subject to adverse distribution consequences.
The financing of payments made by the Principal Underwriter to compensate
broker-dealers or other persons for distributing shares of each Fund will be
provided by FUNB or its affiliates.
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. If a Distribution Plan is terminated, the Principal
Underwriter and EKIS will ask the Independent Trustees to take whatever action
they deem appropriate under the circumstances with respect to payment of
Advances (as defined below).
For the California and Missouri Funds, unreimbursed Class B Distribution Plan
expenses at November 30, 1995 for Class B shares sold prior to June 1, 1995 were
$881,590 (6.22% of such Class B net assets) and $1,004,012 (5.74% of such Class
B net assets), respectively. For the California and Missouri Funds, unreimbursed
Class B Distribution Plan expenses at November 30, 1995 for Class B shares sold
on or after June 1, 1995 were $503,630 (5.88% of such Class B net assets) and
$226,290 (6.04% of such Class B net assets), respectively.
For the California and Missouri Funds, unreimbursed Class C Distribution Plan
expenses at November 30, 1995 were $94,402 (0.42% of Class C net assets) and
$123,873 (0.58% of Class C net assets), respectively.
Broker-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.
DISTRIBUTION AGREEMENTS
The FUND has entered into principal underwriting agreements with the Principal
Underwriter (each a "Distribution Agreement") with respect to each class.
Pursuant to its Distribution Agreements, the FUND will compensate the Principal
Underwriter for its services as distributor at an annual rate that may not
exceed .25 of 1% of each Fund's average daily net assets attributable to Class A
shares, .75 of 1% of each Fund's average daily net assets attributable to the
Class B shares, subject to certain restrictions, and .75 of 1% of each Fund's
average daily net assets attributable to the Class C shares.
Each Fund may also make payments under its Distribution Plans, in amounts of
up to .25 of 1% of its average daily net assets on an annual basis, attributable
to Class A, B and C shares, respectively, to compensate organizations, which may
include, among others, the Principal Underwriter and Keystone or their
respective affiliates, for services rendered to shareholders and/or the
maintenance of shareholder accounts.
A Fund may not pay any distribution or servicing fees during any fiscal period
in excess of NASD limits. Since the Principal Underwriter's compensation under
the Distribution Agreements is not directly tied to the expenses incurred by the
Principal Underwriter, the amount of compensation received by it under the
Distribution Agreements during any year may, subject to certain conditions, be
more than its actual expenses and may result in a profit to the Principal
Underwriter. Distribution expenses incurred by the Principal Underwriter in one
fiscal year that exceed the level of compensation paid to the Principal
Underwriter for that year may be paid from distribution fees received from a
Fund in subsequent fiscal years.
The Principal Underwriter 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 the
Principal Underwriter from a Fund ("Advances"). The Principal Underwriter
intends to seek full reimbursement for such Advances from such Fund (together
with annual interest thereon at the prime rate plus 1%) at such time in the
future as, and to the extent that, payment thereof by the 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 a Fund
incurs the maximum amount of costs allowed by a Distribution Plan.
In states where the Principal Underwriter is not registered as a
broker-dealer, shares of a Fund will only be sold through other broker-dealers
or other financial institutions that are registered.
ARRANGEMENTS WITH BROKER-DEALERS AND OTHERS
The Principal Underwriter may, from time to time, provide promotional
incentives, including reallowance of up to the entire sales charge, to certain
broker-dealers whose representatives have sold or are expected to sell
significant amounts of a Fund's shares. In addition, broker-dealers may, from
time to time, receive additional cash payments. The Principal Underwriter may
also provide written information to those broker-dealers with whom it has dealer
agreements that relates to sales incentive campaigns conducted by such
broker-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
NASD. Broker-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 1933 Act.
The Principal Underwriter may, at its own expense, pay concessions in addition
to those described above to broker-dealers including, from time to time, to
First Union Brokerage Services, Inc., an affiliate of Keystone, that satisfy
certain criteria established from time to time by the Principal Underwriter.
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
broker-dealer's satisfaction of the required conditions, be periodic and may be
up to 1.00% of the value of shares sold by such broker-dealer.
The Principal Underwriter may also pay a transaction fee (up to the level of
payments allowed to broker-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.
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 broker-dealers pursuant to state laws.
EFFECTS OF BANKING LAWS
The Glass-Steagall Act currently limits the ability of depository institutions
(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.
The Glass-Steagall Act and other banking laws and regulations also presently
prohibit member banks of the Federal Reserve System ("Member Banks") or their
non-bank affiliates from sponsoring, organizing, controlling, or distributing
the shares of registered open-end investment companies such as the FUND. Such
laws and regulations also prohibit banks from issuing, underwriting or
distributing securities in general. However, under the Glass-Steagall Act and
such other laws and regulations, a Member Bank or an affiliate thereof may act
as investment adviser transfer agent or custodian to a registered open-end
investment company and may also act as agent in connection with the purchase of
shares of such an investment company upon the order of its customer. Keystone
and its affiliates, since they are direct or indirect subsidiaries of FUNB, are
subject to and in compliance with the aforementioned laws and regulations.
Changes to applicable laws and regulations or future judicial or
administrative decisions could prevent Keystone Investments or its affiliates
from performing the services required under the investment advisory contract or
from acting as agent in connection with the purchase of shares of a fund by its
customers. In such event, it is expected that the Trustees would identify, and
call upon each Fund's shareholders to approve, a new investment adviser. If this
were to occur, it is not anticipated that the shareholders of any Fund would
suffer any adverse financial consequences.
HOW TO BUY SHARES
You may purchase shares of each Fund from any broker-dealer that has a selling
agreement with the Principal Underwriter. In addition, you may purchase shares
of a Fund by mailing to the FUND, c/o Evergreen Keystone Service Company, P.O.
Box 2121, Boston, Massachusetts 02106-2121, a completed account application and
a check payable to the FUND. You may also 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 any
amount may be made by check, by wiring Federal funds, by direct deposit or by an
electronic funds transfer ("EFT").
Orders for the purchase of shares of a Fund will be confirmed at the public
offering price, which is equal to the net asset value per share next determined
after receipt of the order in proper form by the Principal Underwriter
(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 broker-dealers
or other firms prior to the close of the Exchange and received by the Principal
Underwriter 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.
Broker-dealers and other financial services firms are obligated to transmit
orders promptly.
Orders for shares received other than as stated above will receive the public
offering price, which is 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.
The FUND reserves the right to determine the net asset value more frequently
than once a day if deemed desirable.
The initial purchase must be at least $1,000. There is no minimum amount for
subsequent purchases.
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 EKSC by calling toll free
1-800-343-2898 or writing to EKSC or to the firm from which you received this
prospectus.
ALTERNATIVE SALES OPTIONS
This prospectus provides information regarding the Class A, B, and C shares
offered by each Fund:
CLASS A SHARES -- FRONT-END LOAD OPTION
With certain exceptions, Class A shares are sold with a sales charge at the
time of purchase. Class A shares are not subject to a CDSC when they are
redeemed except as follows: Class A shares purchased after January 1, 1997, in
an amount equal to or exceeding $1 million, without a front-end sales charge,
will be subject to a CDSC during the month of purchase and the 12-month period
following the month of purchase.
CLASS B SHARES -- BACK-END LOAD OPTION
Class B shares purchased after January 1, 1997, are sold without a sales
charge at the time of purchase, but are, with certain exceptions, subject to a
CDSC if redeemed during the month of purchase and the 72-month period following
the month of purchase. Class B shares purchased after January 1, 1997, that have
been outstanding for seven years after the month of purchase, will automatically
convert to Class A shares without the imposition of a front-end sales charge or
exchange fee.
CLASS C SHARES -- LEVEL LOAD OPTION
Class C shares purchased after January 1, 1997, are sold without a sales
charge at the time of purchase, but are subject to a CDSC if they are redeemed
during the month of purchase and the 12-month period following the month of
purchase. Class C shares are available only through broker-dealers who have
entered into special distribution agreements with the Principal Underwriter.
Class A and B shares, pursuant to their Distribution Plans, currently pay an
annual service fee of 0.15% of each Fund's average daily net assets attributable
to their respective classes. Class C shares, pursuant to its Distribution Plan,
pays an annual service fee of 0.25% of each Fund's average daily net assets
attributable to that class. In addition to the service fee, the Class B and 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. As a result, income distributions paid by a Fund with respect to Class
B and Class C shares will generally be less than those paid with respect to
Class A shares.
Investors who would rather pay the entire cost of distribution at the time of
investment, rather than spreading such 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 intended 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 $500,000 or more.
----------------------------------------------
CLASS A SHARES
Class A shares are currently offered at the public offering price, which is
equal to net asset value plus an initial sales charge as follows:
<TABLE>
<CAPTION>
AS A % OF CONCESSION TO
AS A % OF NET AMOUNT DEALERS AS A % OF
AMOUNT OF PURCHASE OFFERING PRICE INVESTED* OFFERING PRICE
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Less than $50,000 ............................... 4.75% 4.99% 4.25%
$50,000 but less than $100,000 .................. 4.50% 4.71% 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% 2.00%
$500,000 but less than $1,000,000 ............... 2.00% 2.04% 1.75%
- ----------
*Rounded to the nearest one-hundredth percent.
----------------------------------------------
</TABLE>
Purchases of a Fund's Class A shares made after January 1, 1997, (i) in the
amount of $1 million or more; (ii) by a corporate or certain other qualified
retirement plan or a non-qualified deferred compensation plan or a Title I tax
sheltered annuity or TSA plan sponsored by an organization having 100 or more
eligible employees (a "Qualifying Plan"), or a TSA plan sponsored by a public
educational entity having 5,000 or more eligible employees (an "Educational TSA
Plan"); or (iii) by (a) institutional investors, which may include bank trust
departments and registered investment advisers; (b) investment advisers,
consultants or financial planners who place trades for their own accounts or the
accounts of their clients and who charge such clients a management, consulting,
advisory or other fee; (c) clients of investment advisers or financial planners
who place trades for their own accounts if the accounts are linked to the master
account of such investment advisers or financial planners on the books of the
broker-dealer through whom shares are purchased; (d) institutional clients of
broker-dealers, including retirement and deferred compensation plans and the
trusts used to fund these plans, which place trades through an omnibus account
maintained with the Fund by the broker-dealer; and (e) employees of FUNB and its
affiliates, EKD and any broker-dealer with whom EKD has entered into an
agreement to sell shares of the Fund, and members of the immediate families of
such employees, will each be at net asset value without the imposition of a
front-end sales charge. Certain broker-dealers or other financial institutions
may impose a fee on transactions in shares of the Funds.
With respect to purchases of the Funds' Class A shares made after January 1,
1997, in the amount of $1 million or more, the Principal Underwriter will pay
broker-dealers or others concessions at the following rate: 1.00% of the
investment amount up to $2,999,999; plus 0.50% of the investment amount between
$3,000,000 and $4,999,999; plus 0.25% of the investment amount over $4,999,999.
With respect to purchases of the Funds' Class A shares made after January 1,
1997, by Qualifying Plans and Educational TSA Plans, the Principal Underwriter
will pay broker-dealers and others concessions at the rate of 0.50% of the net
asset value of the shares purchased. These payments are subject to reclaim in
the event the shares are redeemed within twelve months after purchase.
Purchases of the Fund's Class A shares made after January 1, 1997, in the
amount of $1 million or more, are subject to a CDSC of 1.00% upon redemption
during the month of purchase and the 12-month period following the month of
purchase.
The sales charge is paid to the Principal Underwriter, 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 value of Class A shares maintained by such recipient and outstanding on the
books of the Fund for specified periods.
Upon written notice to broker-dealers with whom it has dealer agreements, the
Principal Underwriter may reallow up to the full applicable sales charge.
Initial sales charges may be eliminated for persons purchasing Class A shares
that are offered in connection with certain fee based programs, such as wrap
accounts sponsored or managed by broker-dealers, investment advisers, or others
who have entered into special agreements with the Principal Underwriter. 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 A to this prospectus.
Upon prior notification to the Principal Underwriter, Class A shares may be
purchased at net asset value by clients of registered representatives within 30
days after a change in the registered representative's employment when the
amount invested represents redemption proceeds from a registered open-end
management investment company not distributed or managed by Keystone 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 CDSC with respect to
the redemption proceeds.
Upon prior notification to the Principal Underwriter, Class A shares may be
purchased at net asset value by clients of registered representatives within 30
days after the redemption of shares of any registered open-end investment
company not distributed or managed by Keystone or its affiliates when 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 CDSC
with respect to the redemption proceeds. This special net asset value purchase
is currently being offered on a calendar month-by-month basis and may be
modified or terminated in the future.
CLASS B SHARES
Class B shares are offered at net asset value, without an initial sales
charge. With respect to shares purchased after January 1, 1997, each Fund, with
certain exceptions, imposes a CDSC on Class B shares redeemed as follows:
CDSC
REDEMPTION TIMING IMPOSED
Month of purchase and first twelve-month
period following the month of purchase ..... 5.00%
Second twelve-month period following the month
of purchase ................................ 4.00%
Third twelve-month period following the month
of purchase ................................ 3.00%
Fourth twelve-month period following the month
of purchase ................................ 3.00%
Fifth twelve-month period following the month
of purchase ................................ 2.00%
Sixth twelve-month period following the month
of purchase ................................ 1.00%
No CDSC is imposed on amounts redeemed thereafter.
When imposed, the CDSC is deducted from the redemption proceeds otherwise
payable to you. The CDSC is retained by the Principal Underwriter or its
predecessor. Amounts received by the Principal Underwriter or its predecessor
under the Class B Distribution Plans are reduced by CDSCs retained by the
Principal Underwriter or its predecessor. See "Contingent Deferred Sales Charge
and Waiver of Sales Charges" below.
Class B shares purchased after January 1, 1997, that have been outstanding for
seven years after the month of purchase, 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 EKSC.) The Class B shares so converted will no longer be subject
to the higher distribution expenses and other expenses, if any, borne by Class B
shares. Because the net asset value per share of Class A shares may be higher or
lower than 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
interest of such Class B shareholders.
CLASS C SHARES
Class C shares are offered only through broker-dealers who have special
distribution agreements with the Principal Underwriter. Class C shares are
offered at net asset value, without an initial sales charge. With certain
exceptions, each Fund imposes a CDSC of 1.00% on shares redeemed during the
month of purchase and the 12-month period following the month of purchase. No
CDSC is imposed on amounts redeemed thereafter. If imposed, the CDSC is deducted
from the redemption proceeds otherwise payable to you. The CDSC is retained by
the Principal Underwriter or its predecessor. See "Contingent Deferred Sales
Charge and Waiver of Sales Charges" below.
CONTINGENT DEFERRED SALES CHARGE AND WAIVER OF SALES CHARGES
Any CDSC 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 asset value at the time of purchase of such shares.
With respect to shares purchased after January 1, 1997, no CDSC is imposed
when you redeem amounts derived from (1) increases in the value of shares
redeemed above the net cost of such shares; (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)
certain Class A shares held for more than 12 months after the month of purchase;
(4) Class B shares held for more than 72 months after the month of purchase; or
(5) Class C shares held for more than one year after the month of purchase. Upon
request for redemption, shares not subject to the CDSC will be redeemed first.
Thereafter, shares held the longest will be the first to be redeemed.
With respect to Class C shares purchased by a Qualifying Plan, no CDSC will be
imposed on any redemptions made specifically by an individual participant in the
Qualifying Plan. This waiver is not available in the event a Qualifying Plan (as
a whole) redeems substantially all of its assets.
In addition, no CDSC 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 59 1/2 years old; (4) involuntary
redemptions of accounts having an aggregate net asset value of less than $1,000;
(5) automatic withdrawals under the Systematic Income Plan of up to 1.0% per
month of the shareholder's initial account balance; (6) withdrawals consisting
of loan proceeds to a retirement plan participant; (7) financial hardship
withdrawals made by a retirement plan participant; or (8) withdrawals consisting
of returns of excess contributions or excess deferral amounts made to a
retirement plan participant.
Each Fund may also sell Class A, Class B or Class C shares at net asset value
without any initial sales charge or a CDSC to certain Directors, Trustees,
officers and employees of the Fund, Keystone, the Principal Underwriter and
certain of their affiliates, and to members of the immediate families of such
persons; to registered representatives of firms with dealer agreements with the
Principal Underwriter; and to a bank or trust company acting as a trustee for a
single account. See the statement of additional information.
HOW TO REDEEM SHARES
You may redeem Fund shares for cash at their net redemption value by writing
to the FUND, c/o EKSC, and presenting a properly endorsed share certificate (if
certificates have been issued) to the FUND. Your signature(s) on the written
order and certificates must be guaranteed as described below. In order to redeem
by telephone or to engage in telephone transactions generally, you must complete
the authorization in your account application. Proceeds for shares redeemed on
telephone order will be deposited by wire or EFT only to the bank account
designated in your account application.
You may also redeem your shares through your broker-dealer. The Principal
Underwriter, acting as agent for the FUND, stands ready to repurchase Fund
shares upon orders from broker-dealers and will calculate the net asset value on
the same terms as those orders for the purchase of shares received from
broker-dealers and described under "How to Buy Shares." If the Principal
Underwriter has received proper documentation, it will pay the redemption
proceeds, less any applicable CDSC, to the broker-dealer placing the order
within seven days thereafter. The Principal Underwriter charges no fee for this
service. Your broker-dealer, however, may charge a service fee.
The redemption value equals the 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. A CDSC may be imposed by a Fund at the time of redemption of certain
shares as explained in "How to Buy Shares." If imposed, the CDSC is deducted
from the redemption proceeds otherwise payable to you.
REDEMPTION OF SHARES IN GENERAL
At various times, the FUND may be requested to redeem shares for which it has
not yet received good payment. In such a case, the FUND will mail the redemption
proceeds upon clearance of the purchase check, which may take 15 days or more.
Any delay may be avoided by purchasing shares either with a certified check, by
Federal Reserve or bank wire of funds, by direct deposit or by EFT. Although the
mailing of a redemption check or the wiring or 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, less any applicable CDSC (as described above),
will be made within seven days thereafter except as discussed herein.
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
EXCHANGE ACT OF 1934 AND EKSC'S POLICIES. The FUND or EKSC may waive this
requirement or may require additional documents in certain cases. Currently, the
requirement for a signature guarantee has been waived on redemptions of $50,000
or less when the account address of record has been the same for a minimum
period of 30 days. The FUND and EKSC 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 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 REDEMPTIONS
Under ordinary circumstances, you may redeem up to $50,000 from your account
by telephone by calling toll free 1-800-343-2898. As mentioned above, to engage
in telephone transactions generally, you must complete the appropriate sections
of the Fund's application.
In order to insure that instructions received by EKSC 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 you cannot reach the FUND by telephone, you should follow the procedures
for redeeming by mail or through a broker-dealer as set forth herein.
SMALL ACCOUNTS
Due to 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. No CDSCs are
applied to such redemptions.
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 fees.
Except as otherwise noted, neither the FUND, EKSC, nor the Principal
Underwriter 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. EKSC will employ reasonable
procedures to confirm that instructions received over KARL or by telephone are
genuine. Neither the FUND, EKSC, nor the Principal Underwriter will be liable
when following instructions received over KARL or by telephone that EKSC
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 EKSC by writing or by
calling toll free 1-800-343-2898.
KEYSTONE AUTOMATED RESPONSE LINE
KARL offers you specific fund account information and price 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 the same type of Class B shares of other
Keystone America Funds and the same type of 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
CDSC. However, if the shares being tendered for exchange are
(1) Class A shares acquired without a front-end sales charge,
(2) Class B shares that have been held for less than 72 months, or
(3) Class C shares that have been held for less than one year,
and are still subject to a CDSC, such charge will carry over to the shares being
acquired in the exchange transaction.
You may exchange shares for another Keystone fund by calling or writing to
EKSC or by using KARL. As noted above, if the shares being tendered for exchange
are still subject to a CDSC, such charge will carry over to the shares being
acquired in the exchange transaction. The FUND reserves the right to terminate
this exchange offer or to change its terms, including the right to charge for
exchanges.
Orders to exchange a certain class of shares of the Fund for the corresponding
class of shares of KLT will be executed by redeeming the shares of the Fund and
purchasing the corresponding class of shares of KLT at the net asset value of
such 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. 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.
AUTOMATIC INVESTMENT PLAN
With a Keystone Automatic Investment Plan, you can automatically transfer as
little as $25 per month or $75 per quarter from your bank account or KLT to the
Keystone fund of your choice. Your bank account will be debited for each
transfer. You will receive confirmation with your next account statement.
To establish or terminate an Automatic Investment Plan or to change the amount
or schedule of your automatic investments, you may write to or call EKSC. Please
include your account numbers. Termination may take up to 30 days.
RETIREMENT PLANS
The FUND has various retirement plans available to you, including Individual
Retirement Accounts (IRAs); Rollover IRAs; Simplified Employee Pension Plans
(SEPs); Salary Reduction Plans (SARSEPs); Tax Sheltered Annuity Plans; 403(b)
(7) Plans; 401(k) Plans; Keogh Plans; Corporate Profit-Sharing Plans; and Money
Purchase Plans. For details, including fees and application forms, call toll
free 1-800-247-4075 or write to EKSC.
SYSTEMATIC INCOME PLAN
Under a Systematic Income Plan, if your account 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 $75 and may be as much as 1.0% per month
or 3.0% per quarter of the total net asset value of the Fund shares in your
account when the Systematic Income Plan was opened. Fixed withdrawal payments
are not subject to a CDSC. Excessive withdrawals may decrease or deplete the
value of your account. Moreover, because of the effect of the applicable sales
charge, a Class A investor should not make continuous purchases of the Fund's
shares while participating in a Systematic Income Plan.
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 and
may result in a lower average cost per share than a less systematic investment
approach.
Prior to participating in dollar cost averaging, you must establish an account
in a Keystone America Fund or a money market fund managed or advised by
Keystone. You should designate on the application (1) the dollar amount of each
monthly or quarterly investment you wish to make and (2) 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. See Exhibit A -- "Reduced Sales Charges" at
the back of the prospectus.
TWO DIMENSIONAL INVESTING
You may elect to have income and capital gains distributions from any class of
Keystone America Fund shares you may own automatically invested to purchase the
same class of shares of any other Keystone America Fund. You may select this
service on your 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. See Exhibit A --
"Reduced Sales Charges" at the back of the prospectus.
OTHER SERVICES
Under certain circumstances, you may, within 30 days after a redemption,
reinstate your account in the same class of shares that you redeemed at current
net asset value.
PERFORMANCE DATA
From time to time a Fund may advertise "total return" and "current yield." ALL
DATA IS BASED ON HISTORICAL RESULTS. PAST PERFORMANCE SHOULD NOT BE CONSIDERED
REPRESENTATIVE OF RESULTS FOR ANY FUTURE PERIOD OF TIME. Total return and
current 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 or applicable contingent deferred 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 Class A, B and C 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 except that (1) expenses related to the
distribution of each series or 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 series or class; (2) each series or class of shares has exclusive voting
rights with respect to its Distribution Plan; (3) each series or class has
different exchange privileges; and (4) each series or class generally 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
holders of 10% of the outstanding shares request a meeting for the purpose of
removing a Trustee. The Fund is prepared to assist shareholders in
communications with one another for the purpose of convening such a meeting as
prescribed by Section 16(c) of the 1940 Act.
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 for the FUND's obligations and provides indemnification from FUND
assets for any shareholder held personally liable for the FUND's obligations.
ADDITIONAL INFORMATION
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
Each Fund may engage in the following investment practices to the extent
described in the prospectus and statement of additional information.
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 a 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 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 each 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 a Fund, the value of the 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 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 Fund, dividends paid by the California 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 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 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 12% of
national personal income. Growth was rapid in the 1980s and is expected to
continue, although more moderately. California's economy is one of the 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, but it has slowed since 1990.
California suffered a severe economic recession between 1990-1993, largely as
a result of deep federal defense budget cuts, which resulted in broad-based
revenue shortfalls for the State and many local governments. Southern California
was particularly hard-hit. California's fiscal condition has improved as its
economy has been in a sustained recovery since 1994, which is expected to
continue. During the recession, the State substantially reduced local
assistance, and further reductions could adversely affect the financial
condition of cities, counties and other government agencies facing constraints
in their own revenue collections.
An expanded discussion is contained in the Statement of Additional
Information.
<PAGE>
KEYSTONE MISSOURI TAX FREE FUND
DESCRIPTION OF STATE AND LOCAL TAX TREATMENT
In the opinion of Messrs. Bryan Cave LLP, 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 the Fund alone or in combination with Class A
shares of other Keystone America Funds. Only Class A shares subject to an
initial or deferred sales charge are eligible for inclusion in reduced sales
charge programs.
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 below. For example, if a Purchaser concurrently invested
$75,000 in one of the other "Eligible Funds" and $75,000 in the 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 the 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)"). 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 Sales
Charge schedule. EKSC 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 the 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 which, 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 EKSC, 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 EKSC 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 the Principal
Underwriter 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 the Principal Underwriter or his dealer pay such difference
in sales charge, EKSC 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 EKSC. 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 irre-
vocably constitutes and appoints EKSC his attorney to surrender for redemption
any or all escrowed shares with full power of substitution.
The Purchaser or his dealer must inform the Principal Underwriter or EKSC that
a Letter of Intent is in effect each time a purchase is made.
<PAGE>
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KEYSTONE AMERICA
FUND FAMILY
()
Balanced Fund II
Capital Preservation and Income Fund
Government Securities Fund
Intermediate Term Bond Fund
Strategic Income Fund
World Bond Fund
Tax Free Income Fund
California Tax Free Fund
Florida Tax Free Fund
Massachusetts Tax Free Fund
Missouri Tax Free Fund
New York Tax Free Fund
Pennsylvania Tax Free Fund
Fund for Total Return
Global Opportunities Fund
Hartwell Emerging Growth Fund, Inc.
Omega Fund
Fund of the Americas
Global Resoures and Development Fund
Small Company Growth Fund II
- -------------------------------------------------------------------------------
- ---------------------
Evergreen Keystone
- ---------------------
[logo] FUNDS [logo]
- ---------------------
Evergreen Keystone Distributor, Inc.
230 Park Avenue
New York, New York 10169
CATFF-P Sup. 1/97
3.5M
540096 [recycle symbol]
- -------------------------------------------------------------------------------
KEYSTONE
[graphic omitted]
CALIFORNIA
TAX FREE FUND
- -------------------------------------------------------------------------------
---------------------
Evergreen Keystone
---------------------
[logo] FUNDS [logo]
---------------------
PROSPECTUS AND
APPLICATION
<PAGE>
- -------------------------------------------------------------------------------
KEYSTONE AMERICA
FUND FAMILY
()
Balanced Fund II
Capital Preservation and Income Fund
Government Securities Fund
Intermediate Term Bond Fund
Strategic Income Fund
World Bond Fund
Tax Free Income Fund
California Tax Free Fund
Florida Tax Free Fund
Massachusetts Tax Free Fund
Missouri Tax Free Fund
New York Tax Free Fund
Pennsylvania Tax Free Fund
Fund for Total Return
Global Opportunities Fund
Hartwell Emerging Growth Fund, Inc.
Omega Fund
Fund of the Americas
Global Resoures and Development Fund
Small Company Growth Fund II
- -------------------------------------------------------------------------------
- ---------------------
Evergreen Keystone
- ---------------------
[logo] FUNDS [logo]
- ---------------------
Evergreen Keystone Distributor, Inc.
230 Park Avenue
New York, New York 10169
MOTFF-P Sup. 1/97
3M
540099 [recycle symbol]
- -------------------------------------------------------------------------------
KEYSTONE
[graphic omitted]
MISSOURI
TAX FREE FUND
- -------------------------------------------------------------------------------
---------------------
Evergreen Keystone
---------------------
[logo] FUNDS [logo]
---------------------
PROSPECTUS AND
APPLICATION
<PAGE>
KEYSTONE STATE TAX FREE FUND - SERIES II
STATEMENT OF ADDITIONAL INFORMATION
MARCH 31, 1996
AS SUPPLEMENTED JANUARY 1, 1997
This statement of additional information is not a prospectus, but
relates to, and should be read in conjunction with, the prospectus of Keystone
State Tax Free Fund - Series II (the "FUND") dated March 31, 1996, as
supplemented. You may obtain a copy of the prospectus from the Fund's principal
underwriter, Evergreen Keystone Distributor, Inc., or your broker-dealer.
Evergreen Keystone Distributor, Inc. is located at 230 Park Avenue, New York,
New York 10169.
- --------------------------------------------------------------------------------
TABLE OF CONTENTS
- --------------------------------------------------------------------------------
Page
The Fund .......................................................... 2
Investment Policies ............................................... 2
Investment Restrictions ........................................... 4
Valuation and Redemption of Securities ............................ 7
Shareholder Services .............................................. 8
Sales Charges ..................................................... 8
Distribution Plans ................................................ 11
Investment Adviser ................................................ 13
Trustees and Officers ............................................. 15
Principal Underwriter ............................................. 19
Sub-administrator ................................................. 20
Brokerage ......................................................... 20
Declaration of Trust .............................................. 22
Standardized Total Return and Yield Quotations .................... 24
Additional Information ............................................ 25
Appendix A ........................................................ A-1
Appendix B ........................................................ B-1
Financial Statements .............................................. F-1
<PAGE>
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THE FUND
- --------------------------------------------------------------------------------
The FUND is an 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 currently consists of the following two non-diversified
separate series evidencing interests in different portfolios of securities:
Keystone California Tax Free Fund ("California Fund") and Keystone Missouri Tax
Free Fund ("Missouri Tax Free Fund") (each a "Fund" and collectively, the
"Funds.") On or around May 1, 1995, the FUND changed its name from Keystone
America State Tax Free Fund - Series II to its present name.
Keystone Investment Management Company ("Keystone") is each Fund's
investment adviser. Evergreen Keystone Distributor, Inc. (formerly Evergreen
Funds Distributor, Inc.) ("EKD" or the "Principal Underwriter") is the FUND's
principal underwriter. Evergreen Keystone Investment Services, Inc. (formerly
Keystone Investment Distributors Company) ("EKIS") is the predecessor to the
Principal Underwriter. See "Investment Adviser" and "Principal Underwriter"
below.
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.
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INVESTMENT POLICIES
- --------------------------------------------------------------------------------
Each Fund invests primarily in municipal obligations that are exempt
from federal income tax and are 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 Standard & Poor's Corporation ("S&P"), Moody's Investors
Service ("Moody's"), 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 objective 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. The enactment of such a proposal could materially affect the
availability of municipal obligations for investment by the Funds and the value
of the Funds' portfolios. 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 objective.
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INVESTMENT RESTRICTIONS
- --------------------------------------------------------------------------------
The investment restrictions set forth below are fundamental for each
Fund and may not be changed without the vote of a majority of such Fund's
outstanding shares (as defined in the Investment Company Act of 1940, as amended
(the "1940 Act")). 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; and
(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 intend to invest more than 25% of 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.
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.
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VALUATION AND REDEMPTION OF SECURITIES
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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.
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SHAREHOLDER SERVICES
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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.
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SALES CHARGES
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Each Fund offers three classes of shares that differ primarily with
respect to sales charges and distribution fees. As described below, depending
upon the class of shares that you purchase, a Fund will impose a sales charge
when you purchase Fund shares, a contingent deferred sales charge (a "CDSC")
when you redeem Fund shares or no sales charges at all. A Fund charges a CDSC as
reimbursement for certain expenses, such as commissions or shareholder servicing
fees, that it has incurred in connection with the sale of its shares (see
"Distribution Plans"). If imposed, a Fund deducts CDSCs from the redemption
proceeds you would otherwise receive. CDSCs attributable to your shares are, to
the extent permitted by the National Association of Securities Dealers, Inc.
("NASD"), paid to the Principal Underwriter or its predecessor. See the
prospectus for additional information on a particular class.
CLASS DISTINCTIONS
Class A Shares
With certain exceptions, when you purchase Class A shares after January
1, 1997, you will pay a maximum sales charge of 4.75%, payable at the time of
purchase. (The prospectus contains a complete table of applicable sales charges
and a discussion of sales charge reductions or waivers that may apply to
purchases.) If you purchase Class A shares in the amount of $1 million or more,
without an initial sales charge, the Fund will charge a CDSC of 1.00% if you
redeem during the month of your purchase and the 12-month period following the
month of your purchase. See "Calculation of Contingent Deferred Sales Charge"
below.
Class B Shares
Each Fund offers Class B shares at net asset value (without an initial
sales charge). With respect to Class B shares purchased after January 1, 1997,
each Fund charges a CDSC on shares redeemed as follows:
Redemption Timing CDSC Rate
----------------- ---------
Month of purchase and the first twelve-month
period following the month of purchase ............... 5.00%
Second twelve-month
period following the month of purchase ............... 4.00%
Third twelve-month
period following the month of purchase ............... 3.00%
Fourth twelve-month
period following the month of purchase ............... 3.00%
Fifth twelve-month
period following the month of purchase ............... 2.00%
Sixth twelve-month
period following the month of purchase ............... 1.00%
Thereafter ................................................ 0.00%
Class B shares purchased after January 1, 1997, that have been
outstanding for seven years after the month of purchase, will automatically
convert to Class A shares 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 certificate to Evergreen Keystone Service
Company (formerly Keystone Investor Resource Center, Inc.) ("EKSC") the FUND's
transfer and dividend disbursing agent.)
Class C Shares
Class C shares are available only through broker-dealers who have
entered into special distribution agreements with the Underwriter. Each Fund
offers Class C shares at net asset value (without an initial sales charge). With
certain exceptions, however, a Fund will charge a CDSC of 1.00%, if you redeem
shares purchased after January 1, 1997, during the month of your purchase and
the 12-month period following the month of your purchase. See "Calculation of
Contingent Deferred Sales Charge" below.
CALCULATION OF CONTINGENT DEFERRED SALES CHARGE
Any CDSC 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. Upon request for redemption, a Fund
will redeem shares not subject to the CDSC first. Thereafter, a Fund will redeem
shares held the longest first.
SHARES THAT ARE NOT SUBJECT TO A SALES CHARGE OR CDSC
Exchanges
A Fund does not charge a CDSC when you exchange your shares for the
shares of the same class of another Keystone America Fund. However, if you are
exchanging shares that are still subject to a CDSC, the CDSC will carry over to
the shares you acquire by the exchange. Moreover, a Fund will compute any future
CDSC based upon the date you originally purchased the shares you tendered for
exchange.
Waiver of Sales Charges
Purchases of Class A shares made after January 1, 1997, (i) in the
amount of $1 million or more; (ii) by a corporate or certain other qualified
retirement plan or a non-qualified deferred compensation plan or a Title 1 tax
sheltered annuity or TSA plan sponsored by an organization having 100 or more
eligible employees (a "Qualifying Plan") or a TSA plan sponsored by a public
educational entity having 5,000 or more eligible employees (an "Educational TSA
Plan"); or (iii) by (a) institutional investors, which may include bank trust
departments and registered investment advisers; (b) investment advisers,
consultants or financial planners who place trades for their own accounts or the
accounts of their clients and who charge such clients a management, consulting,
advisory or other fee; (c) clients of investment advisers or financial planners
who place trades for their own accounts if the accounts are linked to the master
account of such investment advisers or financial planners on the books of the
broker-dealer through whom shares are purchased; (d) institutional clients of
broker-dealers, including retirement and deferred compensation plans and the
trusts used to fund these plans, which place trades through an omnibus account
maintained with a Fund by the broker-dealer; and (e) employees of First Union
National Bank of North Carolina ("FUNB") and its affiliates, EKD and any
broker-dealer with whom EKD has entered into an agreement to sell shares of a
Fund, and members of the immediate families of such employees, will be at net
asset value without the imposition of a front-end sales charge. Certain
broker-dealers or other financial institutions may impose a fee on transactions
in shares of the Funds.
Shares of a Fund may also 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 Directors,
Trustees, officers, full-time employees or sales representatives of the Fund,
Keystone, the Principal Underwriter, and certain of their affiliates who have
been such for not less than ninety days, and to members of the immediate
families of such persons; (2) a pension and profit-sharing plan established by
such companies, their subsidiaries and affiliates, for the benefit of their
Directors, Trustees, officers, full-time employees, and sales representatives;
or (3) a registered representative of a firm with a dealer agreement with the
Principal Underwriter; provided, however, that 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 a Fund.
No initial sales charge or CDSC is imposed on purchases or redemptions
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
a Fund or any fund in the Keystone Investments Family of Funds, purchased
pursuant to this waiver is at least $500,000 and any commission paid at the time
of such purchase is not more than 1.00% of the amount invested.
With respect to Class C shares purchased by a Qualifying Plan, no CDSC
will be imposed on any redemptions made specifically by an individual
participant in the Qualifying Plan. This waiver is not available in the event a
Qualifying Plan, as a whole, redeems substantially all of its assets.
In addition, no CDSC 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; (5) automatic
withdrawals under a Systematic Income Plan of up to 1.0% per month of the
shareholder's initial account balance; (6) withdrawals consisting of loan
proceeds to a retirement plan participant; (7) financial hardship withdrawals
made by a retirement plan participant; or (8) withdrawals consisting of returns
of excess contributions or excess deferral amounts made to a retirement plan
participant.
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DISTRIBUTION PLANS
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Rule 12b-1 under the 1940 Act permits investment companies, such as the
Funds, 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 (a "Distribution Plan").
The Funds' Class A, B, and C Distribution Plans have been 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, and who have no
direct or indirect financial interest in the Distribution Plans or any agreement
related thereto (the "Independent Trustees").
The NASD 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 1.00% 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 the Distribution Plan, plus interest at the prime
rate plus 1% on such amounts (less any CDSCs paid by shareholders to the
Principal Underwriter) remaining unpaid from time to time.
CLASS A DISTRIBUTION PLAN
The Class A Distribution Plan provides that a Fund may expend daily
amounts at an annual rate, which is currently limited to 0.15% of such 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 the
Principal Underwriter to enable the Principal Underwriter to pay or to have paid
to others who sell Class A shares a service or other fee, at any such intervals
as the Principal Underwriter may determine, in respect of Class A shares
maintained by any such recipient and outstanding on the books of such Fund for
specified periods.
Amounts paid by a Fund under the Class A Distribution Plan are
currently used to pay others, such as broker-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 others and outstanding on the books of such Fund for specified periods.
CLASS B DISTRIBUTION PLANS
The Class B Distribution Plans provide that a Fund may expend daily
amounts at an annual rate of up to 1.00% (currently limited to 0.90%) of such
Fund's average daily net asset value attributable to Class B shares to finance
any activity that is primarily intended to result in the sale of Class B shares,
including, without limitation, expenditures consisting of payments to the
Principal Underwriter and/or its predecessor. Payments are made to the Principal
Underwriter (1) to enable the Principal Underwriter to pay to others
(broker-dealers) commissions in respect of Class B shares sold since inception
of a Distribution Plan; (2) to enable the Principal Underwriter to pay or to
have paid to others a service fee, at such intervals as the Principal
Underwriter may determine, in respect of Class B shares maintained by any such
recipient and outstanding on the books of such Fund for specified periods; and
(3) as interest.
The Principal Underwriter generally reallows to broker-dealers or
others a commission equal to 4.00% of the price paid for each Class B share
sold. The broker-dealer or other party may also receive service fees at an
annual rate of 0.15% of the average daily net asset value of such Class B share
maintained by the recipient and outstanding on the books of a Fund for specified
periods.
The Principal Underwriter 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 the Principal Underwriter from a Fund ("Advances"). The Principal Underwriter
intends to seek full reimbursement of such Advances from such Fund (together
with annual interest thereon at the prime rate plus 1%) at such time in the
future as, and to the extent that, payment thereof by such Fund would be within
the permitted limits. If the FUND's Independent Trustees authorize such
reimbursements of Advances, the effect would be to extend the period of time
during which such Fund incurs the maximum amount of costs allowed by the Class B
Distribution Plans.
In connection with financing its distribution costs, including
commission advances to broker-dealers and others, EKIS, the predecessor to the
Principal Underwriter sold to a financial institution substantially all of its
12b-1 fee collection rights and CDSC collection rights in respect of Class B
shares sold during the period beginning approximately June 1, 1995 through
November 30, 1996. The FUND has agreed not to reduce the rate of payment of
12b-1 fees in respect of such Class B shares unless it terminates such shares'
Distribution Plan completely. If it terminates such Distribution Plans, the
Funds may be subject to adverse distribution consequences.
The financing of payments made by the Principal Underwriter to
compensate broker-dealers or other persons for distributing shares of the Funds
will be provided by FUNB or its affiliates.
CLASS C DISTRIBUTION PLAN
The Class C Distribution Plan provides that a Fund may expend daily
amounts at an annual rate of up to 1.00% (currently limited to 0.90%) of such
Fund's average daily net asset value attributable to Class C shares to finance
any activity that is primarily intended to result in the sale of Class C shares,
including, without limitation, expenditures consisting of payments to the
Principal Underwriter and/or its predecessor. Payments are made to the Principal
Underwriter (1) to enable the Principal Underwriter to pay to others
(broker-dealers) commissions in respect of Class C shares sold since inception
of the Distribution Plan; (2) to enable the Principal Underwriter to pay or to
have paid to others a service fee, at such intervals as the Principal
Underwriter may determine, in respect of Class C shares maintained by any such
recipient and outstanding on the books of such Fund for specified periods; and
(3) as interest.
The Principal Underwriter generally reallows to broker-dealers 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. Beginning approximately fifteen
months after purchase, broker-dealers or others receive a commission at an
annual rate of 0.75% (subject to NASD rules) plus service fees at the annual
rate of 0.25%, respectively, of the average daily net asset value of each Class
C share maintained by the recipient and outstanding on the books of a Fund for
specified periods.
DISTRIBUTION PLANS - GENERAL
The total amounts paid by a Fund under the foregoing arrangements may
not exceed the maximum Distribution Plan limits specified above. The amounts and
purposes of expenditures under a Distribution Plan must be reported to the
Independent Trustees quarterly. The Independent 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 such Distribution Plan
as stated above.
Each of the Distribution Plans may be terminated at any time by a vote
of the Independent Trustees, or by vote of a majority of the outstanding voting
shares of the respective class of Fund shares. If the Class B Distribution Plan
is terminated, the Principal Underwriter and EKIS will ask the Independent
Trustees to take whatever action they deem appropriate under the circumstances
with respect to payment of such Advances.
Any change in a Distribution Plan that would materially increase the
distribution expenses of a Fund provided for in a Distribution Plan requires
shareholder approval. Otherwise, a Distribution Plan may be amended by votes of
the majority of both (1) the FUND's Trustees and (2) the Independent Trustees
cast in person at a meeting called for the purpose of voting on each amendment.
While a Distribution Plan is 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 Independent Trustees of the FUND have determined that the sales of
the Funds' shares resulting from payments under the Distribution Plans have
benefited the respective Fund.
For the period February 1, 1994 (Commencement of Operations) to
November 30, 1994, the California Fund and the Missouri Tax Free Fund paid EKIS
(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.
For the fiscal year ended November 30, 1995, the California Fund paid
EKIS $5,342, $144,008 ($123,756 with respect to Class B shares sold prior to
June 1, 1995 and $20,252 with respect to Class B shares sold on or after June 1,
1995) and $9,218 pursuant to its Class A, Class B and Class C Distribution
Plans, respectively. These amounts were used to pay commissions and services.
For the fiscal year ended November 30, 1995, the Missouri Tax Free Fund
paid EKIS $4,684, $154,093 ($145,112 with respect to Class B shares sold prior
to June 1, 1995 and $8,981 with respect to Class B shares sold on or after June
1, 1995) and $14,349 pursuant to its Class A, Class B and Class C Distribution
Plans, respectively. These amounts were used to pay commissions and services.
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INVESTMENT ADVISER
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Subject to the general supervision of the FUND's Board of Trustees,
Keystone, located at 200 Berkeley Street, Boston, Massachusetts 02116-5034,
provides investment advice, management and administrative services to each Fund.
Keystone, organized in 1932, is a wholly-owned subsidiary of Keystone
Investments, 200 Berkeley Street, Boston, Massachusetts 02116-5034.
On December 11, 1996, the predecessor corporation to Keystone
Investments and indirectly each subsidiary of Keystone Investments, including
Keystone, were acquired (the "Acquisition") by FUNB, a wholly-owned subsidiary
of First Union Corporation ("First Union"). The predecessor corporation to
Keystone Investments was acquired by FUNB by merger into a wholly-owned
subsidiary of FUNB, which entity then succeeded to the business of the
predecessor corporation. Contemporaneously with the Acquisition, each Fund
entered into a new investment advisory agreement with Keystone and into a
principal underwriting agreement with EKD, a wholly-owned subsidiary of Furman
Selz LLC ("Furman Selz"). The new investment advisory agreement (the "Advisory
Agreement") was approved by the shareholders of each Fund on December 9, 1996,
and became effective on December 11, 1996.
Keystone Investments and each of its subsidiaries, including Keystone,
are now indirectly owned by First Union. First Union is headquartered in
Charlotte, North Carolina, and had $133.9 billion in consolidated assets as of
September 30, 1996. First Union and its subsidiaries provide a broad range of
financial services to individuals and businesses throughout the United States.
The Capital Management Group of FUNB, together with Lieber & Company and
Evergreen Asset Management Corp., wholly-owned subsidiaries of FUNB, manage or
otherwise oversee the investment of over $50 billion in assets belonging to a
wide range of clients, including the Evergreen Family of Funds.
Pursuant to the Advisory Agreement and subject to the supervision of
the FUND's Board of Trustees, Keystone furnishes to each Fund investment
advisory, management and administrative services, office facilities, and
equipment in connection with its services for managing the investment and
reinvestment of each Fund's assets. Keystone pays for all of the expenses
incurred in connection with the provision of its services.
Each Fund pays for all charges and expenses, other than those
specifically referred to as being borne by Keystone, including, but not limited
to, (1) custodian charges and expenses; (2) bookkeeping and auditors' charges
and expenses; (3) transfer agent charges and expenses; (4) fees of Independent
Trustees; (5) brokerage commissions, brokers' fees and expenses; (6) issue and
transfer taxes; (7) costs and expenses under the Distribution Plan; (8) taxes
and trust fees payable to governmental agencies; (9) the cost of share
certificates; (10) fees and expenses of the registration and qualification of
such Fund and its shares with the SEC or under state or other securities laws;
(11) expenses of preparing, printing and mailing prospectuses, statements of
additional information, notices, reports and proxy materials to shareholders of
such Fund; (12) expenses of shareholders' and Trustees' meetings; (13) charges
and expenses of legal counsel for such Fund and for the Independent Trustees of
the FUND on matters relating to such Fund; (14) charges and expenses of filing
annual and other reports with the SEC and other authorities; and all
extraordinary charges and expenses of such Fund.
Each Fund pays Keystone a fee for its services at the annual rate of:
Management Aggregate Net Asset Value
Fee of the shares of the Fund
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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.
Keystone's fee is computed as of the close of business each business day and
payable daily.
Under the Advisory Agreement, any liability of Keystone in connection
with rendering services thereunder is limited to situations involving its
willful misfeasance, bad faith, gross negligence or reckless disregard of its
duties.
The Advisory Agreement continues in effect for two years from its
effective date and, thereafter, from year to year only if approved at least
annually by the Board of Trustees of the FUND or by a vote of a majority of a
Fund's outstanding shares (as defined in the 1940 Act). In either case, the
terms of the Advisory Agreement and continuance thereof must be 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. The Advisory
Agreement will terminate automatically upon its "assignment" as that term is
defined in the 1940 Act.
For the period February 1, 1994 (commencement of operations) to
November 30, 1994, the California 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.
For the fiscal year ended November 30, 1995, the California Fund and
the Missouri Tax Free Fund paid or accrued to Keystone investment management and
administrative service fees of $113,353 and $120,166, respectively. These
amounts represented 0.55% and 0.55% of the respective Fund's average net assets.
Keystone has voluntarily limited the expenses of Class A shares of each
Fund to 0.75% of average daily net assets of such class and has voluntarily
limited the expenses of Class B and C shares of each Fund to 1.50% of average
daily net assets of such class. Keystone currently intends to continue the
foregoing expense limitations on a calendar month-by-month basis. Keystone will
periodically evaluate the expense limitations and may modify or terminate them
in the future. 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 certain
expense limitations, for the fiscal period ended November 30, 1995, Keystone
reimbursed the California Fund and the Missouri Tax Free Fund (i) $21,353 and
$18,923, respectively, with respect to each Fund's Class A shares; (ii) $94,978
and $104,097, respectively, with respect to each Fund's Class B shares; and
(iii) $5,946 and $9,601, respectively, with respect to each Fund's Class C
shares.
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TRUSTEES AND OFFICERS
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Trustees and officers of the FUND, their principal occupations and some
of their affiliations over the last five years are as follows:
FREDERICK AMLING: Trustee of the Fund; Trustee or Director of all other
funds in the Keystone Investments Families of Funds;
Professor, Finance Department, George Washington
University; President, Amling & Company (investment
advice); and former Member, Board of Advisers,
Credito Emilano (banking).
LAURENCE B. ASHKIN: Trustee of the Fund; Trustee or Director of all other
funds in the Keystone Investments Families of Funds;
Trustee of all the Evergreen funds other than
Evergreen Investment Trust; real estate developer and
construction consultant; and President of Centrum
Equities and Centrum Properties, Inc.
CHARLES A. AUSTIN III: Trustee of the Fund; Trustee or Director of all other
funds in the Keystone Investments Families of Funds;
Investment Counselor to Appleton Partners, Inc.; and
former Managing Director, Seaward Management
Corporation (investment advice).
FOSTER BAM: Trustee of the Fund; Trustee or Director of all other
funds in the Keystone Investments Families of Funds;
Trustee of all the Evergreen funds other than
Evergreen Investment Trust; Partner in the law firm
of Cummings & Lockwood; Director, Symmetrix, Inc.
(sulphur company) and Pet Practice, Inc. (veterinary
services); and former Director, Chartwell Group Ltd.
(Manufacturer of office furnishings and accessories),
Waste Disposal Equipment Acquisition Corporation and
Rehabilitation Corporation of America (rehabilitation
hospitals).
*GEORGE S. BISSELL: Chairman of the Board, Chief Executive Officer and
Trustee of the Fund; Chairman of the Board, Chief
Executive Officer and Trustee or Director of all
other funds in the Keystone Investments Families of
Funds; Chairman of the Board and Trustee of Anatolia
College; Trustee of University Hospital (and Chairman
of its Investment Committee); former Director and
Chairman of the Board of Hartwell Keystone; and
former Chairman of the Board, Director and Chief
Executive Officer of Keystone Investments.
EDWIN D. CAMPBELL: Trustee of the Fund; Trustee or Director of all other
funds in the Keystone Investments Families of Funds;
Principal, Padanaram Associates, Inc.; and former
Executive Director, Coalition of Essential Schools,
Brown University.
CHARLES F. CHAPIN: Trustee of the Fund; Trustee or Director of all other
funds in the Keystone Investments Families of Funds;
and former Director, Peoples Bank (Charlotte, NC).
K. DUN GIFFORD: Trustee of the Fund; Trustee or Director of all other
funds in the Keystone Investments Families of Funds;
Trustee, Treasurer and Chairman of the Finance
Committee, Cambridge College; Chairman Emeritus and
Director, American Institute of Food and Wine;
Chairman and President, Oldways Preservation and
Exchange Trust (education); former Chairman of the
Board, Director, and Executive Vice President, The
London Harness Company; former Managing Partner,
Roscommon Capital Corp.; former Chief Executive
Officer, Gifford Gifts of Fine Foods; former
Chairman, Gifford, Drescher & Associates
(environmental consulting); and former Director,
Keystone Investments and Keystone.
JAMES S. HOWELL: Trustee of the Fund; Trustee or Director of all other
funds in the Keystone Investments Families of Funds;
Chairman and Trustee of the Evergreen funds; former
Chairman of the Distribution Foundation for the
Carolinas; and former Vice President of Lance Inc.
(food manufacturing).
LEROY KEITH, JR.: Trustee of the Fund; Trustee or Director of all other
funds in the Keystone Investments Families of Funds;
Chairman of the Board and Chief Executive Officer,
Carson Products Company; 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.
F. RAY KEYSER, JR.: Trustee of the Fund; Trustee or Director of all other
funds in the Keystone Investments Families of Funds;
Chairman and 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 Lahey
Hitchcock Clinic; Director, Vermont Yankee Nuclear
Power Corporation, Grand Trunk Corporation, Grand
Trunk Western Railroad, Union Mutual Fire Insurance
Company, New England Guaranty Insurance Company,
Inc., and the Investment Company Institute; former
Director and President, Associated Industries of
Vermont; former Director of Keystone, Central Vermont
Railway, Inc., S.K.I. Ltd., and Arrow Financial
Corp.; and former Director and Chairman of the Board,
Proctor Bank and Green Mountain Bank.
GERALD M. MCDONELL: Trustee of the Fund; Trustee or Director of all other
funds in the Keystone Investments Families of Funds;
Trustee of the Evergreen funds; and Sales
Representative with Nucor-Yamoto, Inc. (Steel
producer).
THOMAS L. MCVERRY: Trustee of the Fund; Trustee or Director of all other
funds in the Keystone Investments Families of Funds;
Trustee of the Evergreen funds; former Vice President
and Director of Rexham Corporation; and former
Director of Carolina Cooperative Federal Credit
Union.
*WILLIAM WALT PETTIT: Trustee of the Fund; Trustee or Director of all other
funds in the Keystone Investments Families of Funds;
Trustee of the Evergreen funds; and Partner in the
law firm of Holcomb and Pettit, P.A.
DAVID M. RICHARDSON: Trustee of the Fund; Trustee or Director of all other
funds in the Keystone Investments Families of Funds;
Vice Chair and former Executive Vice President, DHR
International, Inc. (executive recruitment); former
Senior Vice President, Boyden International Inc.
(executive recruitment); and Director, Commerce and
Industry Association of New Jersey, 411
International, Inc., and J& M Cumming Paper Co.
RUSSELL A. SALTON, III MD: Trustee of the Fund; Trustee or Director of all other
funds in the Keystone Investments Families of Funds;
Trustee of the Evergreen funds; Medical Director,
U.S. Health Care/Aetna Health Services; and former
Managed Health Care Consultant; former President,
Primary Physician Care.
MICHAEL S. SCOFIELD: Trustee of the Fund; Trustee or Director of all other
funds in the Keystone Investments Families of Funds;
Trustee of the Evergreen funds; and Attorney, Law
Offices of Michael S. Scofield.
RICHARD J. SHIMA: Trustee of the Fund; Trustee or Director of all other
funds in the Keystone Investments Families of Funds;
Chairman, Environmental Warranty, Inc. (Insurance
agency); Executive Consultant, Drake Beam Morin, Inc.
(executive outplacement); Director of Connecticut
Natural Gas Corporation, Hartford Hospital, Old State
House Association, Middlesex Mutual Assurance
Company, and Enhance Financial Services, Inc.;
Chairman, Board of Trustees, Hartford Graduate
Center; Trustee, Greater Hartford YMCA; former
Director, Vice Chairman and Chief Investment Officer,
The Travelers Corporation; former Trustee,
Kingswood-Oxford School; and former Managing Director
and Consultant, Russell Miller, Inc.
*ANDREW J. SIMONS: Trustee of the Fund; Trustee or Director of all other
funds in the Keystone Investments Families of Funds;
Partner, Farrell, Fritz, Caemmerer, Cleary, Barnosky
& Armentano, P.C.; Adjunct Professor of Law and
former Associate Dean, St. John's University School
of Law; Adjunct Professor of Law, Touro College
School of Law; and former President, Nassau County
Bar Association.
JOHN J. PILEGGI: President and Treasurer of the Fund; President and
Treasurer of all other funds in the Keystone
Investments Families of Funds; President and
Treasurer of the Evergreen funds; Senior Managing
Director, Furman Selz LLC since 1992; Managing
Director from 1984 to 1992; 230 Park Avenue, Suite
910, New York, NY.
GEORGE O. MARTINEZ: Secretary of the Fund; Secretary of all other funds
in the Keystone Investments Families of Funds; Senior
Vice President and Director of Administration and
Regulatory Services, BISYS Fund Services; 3435
Stelzer Road, Columbus, Ohio.
* This Trustee may be considered an "interested person" of the FUND within the
meaning of the 1940 Act.
Mr. Bissell is deemed an "interested person" of the FUND by virtue of
his ownership of stock of First Union Corporation ("First Union"), of which
Keystone is an indirect wholly-owned subsidiary. See "Investment Adviser." Mr.
Pettit and Mr. Simons may each be deemed an "interested person" as a result of
certain legal services rendered to a subsidiary of First Union by their
respective law firms, Holcomb and Pettit, P.A. and Farrell, Fritz, Caemmerer,
Cleary, Barnosky & Armentano, P.C. As of the date hereof, Mr. Pettit and Mr.
Simons are each applying for an exemption from the SEC which would allow them to
retain their status as an Independent Trustee.
After the transfer of EKD and its related mutual fund distribution and
administration business to BISYS, it is expected that all of the officers of the
FUND will be officers and/or employees of BISYS. See "Sub-administrator."
During the fiscal year ended November 30, 1995, no Trustee or officer
received any direct remuneration from the FUND. Annual retainers and meeting
fees paid by all funds in the Keystone Investments Families of Funds (which
includes more than thirty mutual funds) for the calendar year ended December 31,
1995 totaled approximately $450,716. As of December 31, 1995, none of the
Trustees or officers beneficially owned any of the FUND's then outstanding Class
A, Class B and Class C shares, respectively.
Except as set forth above, the address of all of the FUND's Trustees
and officers and the address of the FUND is 200 Berkeley Street, Boston,
Massachusetts 02116-5034.
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PRINCIPAL UNDERWRITER
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The FUND has entered into Principal Underwriting Agreements (each an
"Underwriting Agreement") with EKD with respect to each class. EKD, which is not
affiliated with First Union, replaces EKIS as the FUND's principal underwriter.
EKIS may no longer act as principal underwriter of the FUND due to regulatory
restrictions imposed by the Glass-Steagall Act upon national banks such as FUNB
and their affiliates, that prohibit such entities from acting as the
underwriters of mutual fund shares. While EKIS may no longer act as principal
underwriter of the FUND as discussed above, EKIS may continue to receive
compensation from the FUND or the Principal Underwriter in respect of
underwriting and distribution services performed prior to the termination of
EKIS as principal underwriter. In addition, EKIS may also be compensated by the
Principal Underwriter for the provision of certain marketing support services to
the Principal Underwriter at an annual rate of up to .75% of the average daily
net assets of a Fund, subject to certain restrictions.
The Principal Underwriter, as agent, has agreed to use its best efforts
to find purchasers for the shares. The Principal Underwriter may retain and
employ representatives to promote distribution of the shares and may obtain
orders from broker-dealers, and others, acting as principals, for sales of
shares to them. The Underwriting Agreements provide that the Principal
Underwriter will bear the expense of preparing, printing, and distributing
advertising and sales literature and prospectuses used by it. The Principal
Underwriter or EKIS, its predecessor, may receive payments from the FUND
pursuant to the Distribution Plans.
All subscriptions and sales of shares by the Principal Underwriter are
at the public offering price of the shares, which is determined in accordance
with the provisions of the FUND's Declaration of FUND, By-Laws, current
prospectuses 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 Agreements, the FUND is not
liable to anyone for failure to accept any order.
Each Fund has agreed under the Underwriting Agreements to pay all
expenses in connection with the registration of its shares with the SEC and
auditing and filing fees in connection with the registration of its shares under
the various state "blue-sky" laws.
The Principal Underwriter has agreed that it will, in all respects,
duly conform with all state and federal laws applicable to the sale of the
shares. The Principal Underwriter has also agreed that it 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, 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 the
Principal Underwriter or any other person for whose acts the Principal
Underwriter is responsible or is alleged to be responsible, unless such
misrepresentation or omission was made in reliance upon written information
furnished by the FUND.
Each Underwriting Agreement provides that it will remain in effect as
long as its terms and continuance are approved annually (i) by a vote of a
majority of the FUND's Independent Trustees, and (ii) by vote of a majority of
the FUND's Trustees, in each case, cast in person at a meeting called for that
purpose.
Each Underwriting Agreement may be terminated, without penalty, on 60
days' written notice by the Board of Trustees or by a vote of a majority of
outstanding shares subject to such agreement. Each Underwriting Agreement will
terminate automatically upon its "assignment," as that term is defined in the
1940 Act.
From time to time, if, in the Principal Underwriter's judgment, it
could benefit the sales of shares, the Principal Underwriter may provide to
selected broker-dealers promotional materials and selling aids, including, but
not limited to, personal computers, related software, and data files.
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SUB-ADMINISTRATOR
- --------------------------------------------------------------------------------
Furman Selz provides officers and certain administrative services to
each Fund pursuant to a sub-administration agreement. For its services under
that agreement Furman Selz will receive from Keystone an annual fee at the
maximum annual rate of .01% of the average daily net assets of each Fund. Furman
Selz is located at 230 Park Avenue, New York, New York 10169.
It is expected that on or about January 2, 1997, Furman Selz will
transfer EKD, and its related mutual fund distribution and administration
business, to BISYS Group, Inc. ("BISYS"). At that time, BISYS will succeed as
sub-administrator for each Fund. It is not expected that the acquisition of the
mutual fund distribution and administration business by BISYS will affect the
services currently provided by EKD or Furman Selz.
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BROKERAGE
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SELECTION OF BROKERS
In effecting transactions in portfolio securities for a Fund, Keystone
seeks the best execution of orders at the most favorable prices. Keystone
determines whether a broker has provided a Fund with best execution and price in
the execution of a securities transaction by evaluating, among other things:
1. overall direct net economic result to such Fund;
2. the efficiency with which the transaction is effected;
3. the broker's ability to effect the transaction where a large
block is involved;
4. the broker's readiness to execute potentially difficult
transactions in the future;
5. the financial strength and stability of the broker; and
6. the receipt of research services, such as analyses and reports
concerning issuers, industries, securities, economic factors and
trends and other statistical and factual information.
The Funds' management weighs these considerations in determining the
overall reasonableness of the brokerage commissions paid.
Should a Fund or Keystone receive research and other statistical and
factual information from a broker, such Fund would consider such services to be
in addition to, and not in lieu of, the services Keystone is required to perform
under the Advisory Agreement (as defined below). Keystone believes that the
cost, value and specific application of such information are indeterminable and
cannot be practically allocated between a Fund and its other clients 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 Keystone's 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 follows such a practice,
it will do so on a basis that is fair and equitable to the Funds.
Neither any Fund nor Keystone intends on placing securities
transactions with any particular broker. The FUND's Board of Trustees has
determined, however, that a Fund may consider sales of such Fund's shares as a
factor in the selection of brokers to execute portfolio transactions, subject to
the requirements of best execution described above.
BROKERAGE COMMISSIONS
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.
GENERAL BROKERAGE POLICIES
In order to take advantage of the availability of lower purchase
prices, a Fund may participate, if and when practicable, in group bidding for
the direct purchase from an issuer of certain securities.
Keystone makes investment decisions for each Fund independently from
those of its other clients. It may frequently develop, however, that Keystone
will make the same investment decision for more than one client. Simultaneous
transactions are inevitable when the same security is suitable for the
investment objective of more than one account. When two or more of its clients
are engaged in the purchase or sale of the same security, Keystone will allocate
the transactions according to a formula that is equitable to each of its
clients. Although, in some cases, this system could have a detrimental effect on
the price or volume of a Fund's securities, the FUND believes that in other
cases its ability to participate in volume transactions will produce better
executions.
A Fund does not purchase portfolio securities from or sell portfolio
securities to Keystone, the Principal Underwriter, or any of their affiliated
persons, as defined in the 1940 Act.
The Board of Trustees will, from time to time, review the FUND's
brokerage policy. Because of the possibility of further regulatory developments
affecting the securities exchanges and brokerage practices generally, the Board
of Trustees may change, modify or eliminate any of the foregoing practices.
During the fiscal period ended November 30, 1994 and the fiscal year
ended November 30, 1995, the FUND did not pay any brokerage commissions.
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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. Upon liquidation, Fund shares are entitled to a pro rata share of the
Fund based on the relative net assets of each class.
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; (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
No amendment may be made to the Declaration of Trust that adversely
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.
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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 Fund and the
Missouri Tax Free Fund for the fiscal year ended November 30, 1995 were 13.95%
and 14.16%, respectively, including applicable sales charges. The total returns
for the Class B shares of the California Fund and the Missouri Tax Free Fund for
the fiscal year ended November 30, 1995 were 14.95% and 14.79%, respectively,
including applicable sales charges. The total returns for the Class C shares of
the California Fund and the Missouri Tax Free Fund for the fiscal year ended
November 30, 1995 were 18.69% and 18.78%, 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 Fund and
the Missouri Tax Free Fund for the 30-day period ended November 30, 1995 were
4.70% and 4.77%, respectively. The current yields for the Class B shares of the
California Fund and the Missouri Tax Free Fund for the 30-day period ended
November 30, 1995 were 4.28% and 4.26%, respectively. The current yields for the
Class C shares of the California Fund and the Missouri Tax Free Fund for the
30-day period ended November 30, 1995 were 4.28% and 4.25%, 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 Fund
and the Missouri Tax Free Fund for an investor in the 31% federal tax bracket
for the 30-day period ended November 30, 1995 were 6.81% and 6.91%,
respectively. The tax equivalent yields for the Class B shares of the California
Fund and the Missouri Tax Free Fund for an investor in the 31% federal tax
bracket for the 30-day period ended November 30, 1995 were 6.20% and 6.17%,
respectively. The tax equivalent yields for the Class C shares of the California
Fund and the Missouri Tax Free Fund for an investor in the 31% federal tax
bracket for the 30-day period ended November 30, 1995 were 6.20% and 6.16%,
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.
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ADDITIONAL INFORMATION
- --------------------------------------------------------------------------------
REDEMPTIONS IN KIND
If conditions arise that would make it undesirable for the Fund to pay
for all redemptions in cash, the Fund may authorized 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 presented for redemption by
any one shareholder up to the lesser of $250,000 or 1% of the Fund's net assets
in any 90-day period. 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 would, to the extent permitted by law, be readily marketable.
Shareholders receiving such securities would incur brokerage costs upon the
securities' sale.
GENERAL
As of January 1, 1996, the following shareholders of record owned 5% or
more of the California Fund's outstanding Class A shares:
SHAREHOLDER OF RECORD % OF CLASS
Merrill Lynch Pierce Fenner & Pierce 13.404%
Attn: Book Entry
4800 Deer Lake Drive East, 3rd Floor
Jacksonville, FL 32246-6484
As of January 1, 1996, the following shareholders of record owned 5% or
more of the California Fund's outstanding Class B shares:
SHAREHOLDER OF RECORD % OF CLASS
Merrill Lynch Pierce Fenner & Pierce 19.033%
Attn: Book Entry
4800 Deer Lake Drive East, 3rd Floor
Jacksonville, FL 32246-6484
As of January 1, 1996, the following shareholders of record owned 5% or
more of the California Fund's outstanding Class C shares:
SHAREHOLDER OF RECORD % OF CLASS
Victor E. Rylander 12.811%
Lucille Rylander JT WROS
4102 Caflur Avenue
San Diego, CA 92117-4436
Alex Brown & Sons Inc. 6.994%
FBO 489-31533-14
PO Box 1346
Baltimore, MD 21203-1346
Prudential Securities FBO 6.862%
Rakesh C. Gupta
Neelam Gupta CO-TTEES
FBO Gupta Family Living Trust 12/22/94
Hemet, CA 92544
Prudential Securities FBO 6.622%
Betty Riback
13 Dartmouth Dr
Rancho Mirage, CA 92270-3151
Merrill Lynch Pierce Fenner & Smith 6.584%
ATTN: Book Entry
4800 Deer Lake Dr E 3rd Fl
Jacksonville, FL 32246-6484
Richard B Smith 6.153%
Doris M. Smith TTEE
U/A DTD 04-08-93
Smith Trust
4853 Mt. Royal Court
San Diego, CA 92117-2917
Kenneth E Everett 5.583%
FBO The Everett Family Trust
U/A DTD 05-18-77
3548 Herman Dr
Lafayette, CA 94549-4931
Prudential Securities FBO 5.269%
Ferne Rinnig TTEE
Ferne Rinnig
Intervivos Trust U/A DTD
12955 Riverside Dr Apt 203
Sherman Oaks, CA 91423-2201
As of January 1, 1996, 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. 60.522%
2709 State Highway 248
Branson, MO 65616-9226
Merrill Lynch Pierce Fenner & Pierce 5.292%
Attn: Book Entry
4800 Deer Lake Drive East, 3rd Floor
Jacksonville, FL 32246-6484
As of January 1, 1996, 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 24.325%
Attn: Book Entry
4800 Deer Lake Drive East, 3rd Floor
Jacksonville, FL 32246-6484
As of January 1, 1996, 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 12.034%
Dorothy K. Pruett Trustee
Dorothy K. Pruett Revocable
Trust UAD 7-10-92
516 West 119th Terrace
Kansas City, MO 64145-1043
Painewebber FBO 10.369%
Lorraine Wilder TTEE
Lorraine Wilder Rev Tr
U/A DTD 7-26-88
444 1/2 Jackson
Chillicothe, MO 64601
Painewebber FBO 8.389%
Jeannette M. Holz Trust
Jeannette M. Holz TTEE
U/A DTD 10/15/83
Box 698
Lake Ozark, MO 65049-0698
Merrill Lynch Pierce Fenner & Pierce 7.728%
Attn: Book Entry
4800 Deer Lake Drive East, 3rd Floor
Jacksonville, FL 32246-6484
Kathy D. Reise 6.202%
6926 Broken Oak Drive
Saint Louis, MO 63129
Dorothy D. Atkins 5.849%
4 Palmetto Dunes Court
Ormond Beach, FL 32174
State Street Bank and Trust Company, 225 Franklin Street, Boston,
Massachusetts 02110, is the custodian of all securities and cash of the FUND
(the "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, 99 High Street, Boston, Massachusetts 02110,
Certified Public Accountants, are the independent auditors for the FUND.
EKSC, located at 200 Berkeley Street, Boston, Massachusetts 02116-5034,
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 the Principal Underwriter, 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 16 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 BALANCED FUND II - Seeks current income and capital appreciation
consistent with the preservation of capital.
KEYSTONE CAPITAL PRESERVATION AND INCOME FUND - Seeks high level of current
income, consistent with low volatility of principal, by investing in adjustable
rate securities issued by the U.S. government, its agencies or
instrumentalities.
KEYSTONE FUND OF THE AMERICAS - Seeks long term growth of capital through
investments in equity and debt securities in North America (the United States
and Canada) and Latin America (Mexico and South and central America.
KEYSTONE 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 GLOBAL OPPORTUNITIES FUND - Seeks long-term capital growth from foreign
and domestic securities.
KEYSTONE GLOBAL RESOURCES AND DEVELOPMENT FUND - Seeks long term capital growth
by investing primarily in equity securities.
KEYSTONE 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 INTERMEDIATE TERM BOND FUND - Seeks income, capital preservation and
price appreciation potential from investment grade corporate bonds.
KEYSTONE OMEGA FUND - Seeks maximum capital growth from common stocks and
securities convertible into common stocks.
KEYSTONE SMALL COMPANY GROWTH FUND II - Seeks long term capital growth through
investments primarily in equity securities of companies with small market
capitalizations.
KEYSTONE 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 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 TAX FREE INCOME FUND - Seeks income exempt from federal income taxes
and capital preservation from the four highest grades of municipal bonds.
KEYSTONE 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.
<PAGE>
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APPENDIX A
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KEYSTONE CALIFORNIA 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 over 32 million represents over
12% of the total U.S. population and grew by 27% in the 1980's. Total personal
income in the State, at an estimated $703 billion in 1994, accounts for more
than 12% of all personal income in the nation. Total employment is over 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 has occurred since the start of 1994; pre-recession job levels are
expected to be reached in 1996. Unemployment, while higher than the national
average, has come down significantly from the January, 1994 peak of 10%.
Economic indicators show a steady recovery underway in California since the
start of 1994, although the residential housing sector has been weaker than in
previous recoveries. Any delay or reversal of the economic recovery may cause a
recurrence of revenue shortfalls for the State.
CONSTITUTIONAL AND STATUTORY 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 called "Proposition 62" that
imposed significant new limits on the ability of local entities to raise or levy
general taxes, except by receiving majority local voter approval. Court
decisions had struck down most of Proposition 62 and many local governments,
especially cities, had enacted or raised local "general taxes" without voter
approval. In September, 1995, the California Supreme Court overruled the prior
cases, and upheld the constitutionality of Proposition 62. Many aspects of this
decision remain unclear (such as its impact on charter (home rule) cities, and
whether it will have retroactive effect), but its future effect will be to
further limit the fiscal flexibility of many local governments.
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 December 31, 1995, the State had approximately $18.3 billion of
general obligation bonds outstanding, and $2.9 billion remained authorized but
unissued. In addition, at June 30, 1995, the State had lease-purchase
obligations, payable from the State's General Fund, of approximately $5.6
billion. State voters will have $5.0 billion of new bond authorizations on the
March 26 1996 ballot, and additional bonds may be placed on the November 5, 1996
ballot. In fiscal year 1994-1995, debt service on general obligation bonds and
lease-purchase debt was approximately 5.3% 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 1994-1995 were the
California personal income tax (43% of total revenues), the sales tax (34%),
bank and corporation taxes (13%), 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. These structural concerns
will continue in future years with the expected need to increase capital and
operating costs of the correctional system in response to a "Three Strikes" law
enacted in 1994 which mandates life imprisonment for certain felony offenders.
RECENT BUDGETS. As a result of these factors, among others, from the
late 1980's until 1992-93, the State had a period of nearly chronic budget
imbalance, with expenditures exceeding revenues in four out of six years, and
the State accumulated and sustained a budget deficit in the budget reserve, the
SFEU approaching $2.8 billion at its peak at June 30, 1993. Starting in the
1990-91 Fiscal Year and for each year thereafter, each budget required
multi-billion dollar actions to bring projected revenues and expenditures into
balance and to close large "budget gaps" which were identified. The Legislature
and Governor eventually agreed on a number of different steps to produce Budget
Acts in the Years 1991-92 to 1994-95, including:
* significant cuts in health and welfare program expenditures;
* transfers of program responsibilities and some funding sources from
the state to local governments, coupled with some reduction in mandates on local
government;
* transfer of about $3.6 billion in annual local property tax revenues
from cities, counties, redevelopment agencies and some other districts to local
school districts, thereby reducing state funding for schools;
* reduction in growth of support for higher education programs, coupled
with increases in student fees;
* revenue increases (particularly in the 1991-92 Fiscal Year budget),
most of which were for a short duration;
* increased reliance on aid from the federal government to offset the
costs of incarcerating, educating and providing health and welfare services to
undocumented aliens (although these efforts have produced much less federal aid
than the State Administration had requested); and
* various one-time adjustment and accounting changes.
Despite these budget actions, the effects of the recession led to large
unanticipated deficits in the SFEU, as compared to projected positive balances.
By the start of the 1993-94 Fiscal Year, the accumulated deficit was so large
(almost $2.8 billion) that it was impractical to budget to retire it in one
year, so a two-year program was implemented, using the issuance of revenue
anticipation warrants to carry a portion of the deficit over the end of the
fiscal year. When the economy failed to recover sufficiently in 1993-94, a
second two-year plan was implemented in 1994-95, to carry the final retirement
of the deficit into 1995-96.
The combination of stringent budget actions cutting State expenditures,
and the turnaround of the economy by late 1993, finally led to the restoration
of positive financial results. While General Fund revenues and expenditures were
essentially equal in FY 1992-93 (following two years of excess expenditures over
revenues), the General Fund had positive operating results in FY 1993-94 and
1994-95, which have reduced the accumulated budget deficit to around $600
million as of June 30, 1995. The 1996-97 Governor's Budget projects complete
elimination of the deficit by June 30, 1996.
A consequence of the accumulated budget deficits in the early 1990's,
together with other factors such as disbursement of funds to local school
districts "borrowed" from future fiscal years and hence not shown in the annual
budget, was to significantly reduce the state's cash resources available to pay
its ongoing obligations. When the Legislature and the Governor failed to adopt a
budget for the 1992-93 Fiscal Year by July 1, 1992, which would have allowed the
state to carry out its normal annual cash flow borrowing to replenish its cash
reserves, the State Controller was forced to issue approximately $3.8 billion of
registered warrants ("IOUs") over a 2-month period to pay a variety of
obligations representing prior years' or continuing appropriations, and mandates
from court orders. Available funds were used to make constitutionally-mandated
payments such as debt service on bonds and warrants.
The state's cash condition became so serious in late spring of 1992
that the State Controller was required to issue revenue anticipation warrants
maturing in the following fiscal year in order to pay the State's continuing
obligations. The State was forced to rely increasingly on external debt markets
to meet its cash needs, as a succession of notes and warrants (both forms of
short-term cash flow financing) were issued in the period from June 1992 to July
1994, often needed to pay previously-maturing notes or warrants. These
borrowings were used also in part to spread out the repayment of the accumulated
budget deficit over the accumulated budget over the end of the fiscal year.
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 its accumulated
deficit to the 1995-96 fiscal year. In order to assure repayment of $4.0 billion
of this borrowing which matures on April 25, 1996, the State enacted legislation
(the "Trigger Law") which would lead to automatic, across-the-board budget cuts
in General Fund expenditures if cash flow projections made at certain times
deteriorated from estimates made in July 1994 when the borrowings were made. The
State's cash position remained favorable enough during the 1994-95 fiscal year
that the State Controller determined that no automatic budget cuts were needed
in that year.
CURRENT BUDGET. For the first time in four years, the State entered the
1995-96 fiscal year with strengthening revenues based on an improving economy.
The major feature of the Governor's proposed budget, a 15% phased cut in
personal income and business taxes, was rejected by the Legislature.
The 1995-96 Budget Act was signed by the Governor on August 3, 1995, 34
days after the start of the fiscal year. The Budget Act projected General Fund
revenues and transfers of $44.1 billion, a 3.5 percent increase from the prior
years. Expenditures were budgeted at $43.4 billion, a 4 percent increase. The
Department of Finance projected that, after repaying the last of the carryover
budget deficit, there would be a positive balance of less than $30 million in
the budget reserve, the Special Fund for Economic Uncertainties, at June 30,
1996.
The Department of Finance projected cash flow borrowings in the 1995-96
Fiscal Year would be the smallest in many years, comprising about $2 billion of
notes to be issued in April, 1996, and maturing by June 30, 1996. With full
payment of $4 billion of revenue anticipation warrants on April 25, 1996, the
Department saw no further need for borrowing over the end of the fiscal year.
The Department projected that available internal cash resources to pay State
obligations would be about $1.9 billion at June 30, 1996. On October 15, the
State Controller, in the last step in the trigger Law process, reported that
projected cash resources in the General Fund during fiscal year 1995-96 would be
large enough to again avoid the need for any automatic budget cuts. However, the
Controller estimated that the State's cash position on June 30, 1996 would be
about $500 million less than estimated by the Department of Finance.
The principal features of the 1995-96 Budget Act, in addition to those
noted above, were additional cuts in health and welfare expenditures (some of
which are subject to approvals or waivers by the federal government); assumed
further federal aid for illegal immigrant costs; and an increase in per-pupil
funding for public schools and community colleges, the first such significant
increase in four years.
The Governor's Proposed Budget for the 1996-97 Fiscal Year (the
Governor's Budget), released on January 10, 1996, updated financial projections
for the current year. With the improved economic conditions, the Department of
Finance projects $45.0 billion of General Fund revenues, and expenditures are
projected to increase to $44.2 billion for FY 1995-96. The net results are
projected to leave a budget reserve in the SFEU of about $40 million at June 30,
1996, thus finally repaying the accumulated deficits of the recession years.
The Governor's Budget proposed General Fund spending in 1996-97 of
$45.2 billion, with revenues of $45.6 billion, leaving a budget reserve in the
SFEU of about $400 billion. The Governor has again proposed a three-year phased
15% reduction of personal income and corporate tax rates. The Governor's Budget
also assumes implementation of certain previously-approved cuts in health and
welfare costs, adoption of further cuts in welfare payments, and receipt of new
federal aid for illegal immigrant costs. The Governor's Budget proposed
increased expenditures for K-12 school aid, higher education, and corrections.
The Governor's budget projects annual cash flow borrowing of about $3.2 billion.
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.
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 PROCEEDINGS
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. At the start of the 1995-96
fiscal year, Los Angeles County, the largest in the State, faced a nominal $1.2
billion gap in its $12 billion budget, half of which was in the County health
care system. The gaps were closed only with significant cuts in services and
personnel, particularly in the health care system, federal aid, and transfer of
some funds from other local governments to the County pursuant to special
legislation. The County's debt was downgraded by Moody's and S&P in the summer
of 1995. The Richmond Unified School District (Contra Cost County) entered
bankruptcy proceedings in May 1991, but the proceedings have been dismissed.
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 200 other public
entities, most but not all located in the County, were also depositors in the
Pools. 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 which kept money
in the Pools (Pool participants), including the County, faced cash flow
difficulties, suffered ratings adjustments, and implemented cuts in personnel
and programs. Some obligations of the County and certain other Pool participants
had technical defaults, or were rescheduled. The bankruptcy court has approved a
settlement agreement between the county and most of the other Pool participants
which provided about 80% (90% in the case of school districts) return of cash
invested, with the balance to be repaid over time, including from potential
recoveries in lawsuits. The County has implemented a financial recovery plan
which includes significant personnel cuts, and refinancing of current debts
using new funds transferred to the County from certain other local governments
pursuant to special legislation adopted in late 1995.
The State of California has no existing obligation with respect to any
obligations or securities of the County or any of the other Pool participants.
However, the State may be obligated to intervene to ensure that school districts
have sufficient funds to operate, or to maintain certain county-administered
state programs. As of January 1, 1996, no school districts which were Pool
participants had become insolvent.
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
is unavailable for beneficial 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 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 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 August 1995, the State's unemployment rate was
estimated to be 5.0% as against the national rate of 5.6%. In recent years,
Missouri's wealth indicators have grown at a slower rate than national levels
and in 1994 the State's per capita personal income was approximately 96.5% 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.
REVENUE AND LIMITATIONS THEREON
Article X, Section 16-24 of the Constitution of Missouri (the "Hancock
Amendment"), imposes limitations on the amount of State taxes which may be
imposed by the General Assembly of Missouri (the "General Assembly") 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) which 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 State limit on taxes is tied to total State revenues for fiscal
year 1980-81, 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 certain
designated periods. The details of the Amendment are complex and clarification
from subsequent legislation and further judicial decisions may be necessary.
Generally, if the total State revenues exceed the State revenue limit imposed by
Section 18 of Article X by more than one percent, the State is required to
refund the excess. The State revenue limitation imposed by the Hancock Amendment
does not apply to taxes imposed for the payment of principal and interest on
bonds, approved by the voters and authorized by the Missouri constitution. The
revenue limit also can be exceeded by a constitutional amendment authorizing new
or increased taxes or revenue adopted by the voters of the State of Missouri.
The Hancock Amendment 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.
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 fees 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.
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 1,938,400 and 1,007,000 residents, respectively,
constituting over fifty percent of Missouri's 1995 population census of
approximately 5,237,820. 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.
There are a large number of civilians employed at the various military
installations and training bases in the state and recent action of the Defense
Base Closure and Realignment Commission will result in the loss of a substantial
number of civilian jobs in the St. Louis Metropolitan area. Further, aircraft
and related businesses in Missouri are the recipients of substantial annual
dollar volumes of defense contract awards. The contractor receiving the largest
dollar volume of defense contracts in the United States in 1994 was McDonnell
Douglas Corporation. McDonnell Douglas Corporation is the State's largest
employer, currently employing approximately 24,000 employees in Missouri. 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 four 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 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. A recent Supreme Court
decision favorable to the State may decrease the level of State funding required
in the future, but the impact of this decision is uncertain. The State paid $282
million for desegregation costs in fiscal 1994 and for fiscal 1995 provided $315
million. This expense accounts for close to 7% of total state General Revenue
Fund spending.
<PAGE>
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APPENDIX B
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This Appendix is solely intended to provide additional investment
information and is qualified in its entirety by the information and language
contained in the Fund's prospectus.
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.
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.
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 CONTRACTS 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.
<PAGE>
Keystone California Insured Tax Free Fund
SCHEDULE OF INVESTMENTS--November 30, 1995
Coupon Maturity Principal Market
Rate Date Amount Value
----------------------------------------------------------------------------
MUNICIPAL BONDS (100.6%)
Alameda County,
California,
Certificates of
Participation, Santa
Rita Jail Project
(MBIA) 5.700% 12/01/2014 $1,000,000 $1,011,650
Beverly Hills,
California, School
District (MBIA) 5.750 05/01/2020 500,000 508,135
California Housing
Finance Agency, Home
Mortgage, Series B 8.600 08/01/2019 250,000 263,727
California State Public
Works Board (AMBAC) 5.250 12/01/2013 40,000 39,582
California State
Universities and
Colleges, San Diego
State University
(AMBAC) 6.125 11/01/2024 1,000,000 1,051,110
California Statewide
Communities
Certificates (AMBAC) 5.500 10/01/2014 400,000 400,064
Corona, California,
Redevelopment Agency,
Tax Allocation,
Refunding
Redevelopment Project,
Area A, Series A
(FGIC) 6.250 09/01/2016 500,000 528,180
East Bay, California,
Municipal Utilities,
Water System (MBIA) 5.000 06/01/2021 300,000 279,969
La Canada, California,
Unified School
District (FGIC)
(effective yield
6.35%)(b) 0.000 08/01/2011 500,000 210,290
Los Angeles, California,
Community
Redevelopment Agency
Refunding, Tax
Allocation (FSA) 6.500 12/01/2016 750,000 807,300
Los Angeles, California,
Convention and
Exhibition Center
Authority, Lease
Refunding, Series A
(MBIA) 5.375 08/15/2018 240,000 236,429
Los Angeles, California,
Convention and
Exhibition Center
Authority, Lease
Refunding, Series A
(MBIA) 5.125 08/15/2013 400,000 385,704
Los Angeles, California,
Convention and
Exhibition Center
Authority, Lease
Refunding, Series A
(MBIA) 6.000 08/15/2010 1,000,000 1,052,740
Los Angeles, California,
Department of
Airports, Series A
(FGIC) 5.500 05/15/2010 120,000 121,064
Los Angeles, California,
Wastewater Systems
Revenue, Series B
(MBIA) 5.875 06/01/2024 680,000 694,906
Los Angeles County,
California,
Metropolitan
Transportation
Authority, Sales Tax
Revenue (AMBAC) 5.000 07/01/2025 350,000 327,512
Los Angeles County,
California,
Metropolitan
Transportation
Authority, Sales Tax
Revenue (AMBAC) 5.500 07/01/2017 1,000,000 1,000,400
MSR Public Power Agency,
California, San Juan
Project, Series B
(MBIA) 6.750 07/01/2011 400,000 434,540
Madera County,
California,
Certificates of
Participation, Valley
Children's Hospital
(MBIA) 6.250 03/15/2007 250,000 274,540
Oakland, California,
Redevelopment Agency,
Tax Allocation,
Central District
Redevelopment (MBIA) 5.000 09/01/2021 1,000,000 939,410
Oakland, California,
Pensions, Series A
(FGIC) 7.600 08/01/2021 3,750,000 4,116,112
Petaluma, California,
City Joint High School
District (MBIA)
(effective yield
5.70%)(b) 0.000 08/01/2011 1,375,000 587,208
Petaluma, California,
City Joint High School
District (MBIA)
(effective yield
5.75%)(b) 0.000 08/01/2012 1,555,000 623,866
Petaluma, California,
City Joint High School
District (MBIA)
(effective yield
5.80%)(b) 0.000 08/01/2013 1,755,000 660,828
Pleasant Hill,
California, Joint
Powers Financing,
Capital Improvement
Project, Series A
(MBIA) 5.250 12/01/2016 400,000 388,104
Rancho, California,
Water District
Financing Authority,
Series 1994 (MBIA) 5.000 08/15/2014 300,000 284,568
Rio Linda, California,
Unified School
District, Series A
(AMBAC) 7.400 08/01/2010 725,000 852,745
Sacramento, California,
Municipal Utility
District, Series D
(FGIC) 5.250 11/15/2012 650,000 636,305
See Notes to Schedule of Investments. (continued on next page)
<PAGE>
MUNICIPAL BONDS
(continued)
San Diego County,
California, Water
Authority, Water
Revenue Certificates
of Participation
(FGIC) 5.681% 04/23/2008 $1,100,000 $ 1,158,762
San Joaquin Hills,
California,
Transportation
Corridor Agency, Toll
Road Revenue 7.000 01/01/2030 400,000 422,344
San Jose, California,
Redevelopment Tax
Allocation (MBIA) 6.000 08/01/2015 980,000 1,058,067
San Jose-Santa Clara,
California, Water
Financing Authority,
Sewer Revenue, Series
A (FGIC) 5.375 11/15/2015 1,000,000 992,060
San Mateo, Foster City,
California, School
District Capital
Appreciation, Series C
(FGIC) (effective
yield 5.60%)(b) 0.000 09/01/2003 100,000 69,202
Santa Ana, California,
Financing Authority
(MBIA) 6.250 07/01/2015 300,000 332,895
Santa Ana, California,
Financing Authority
(MBIA) 6.250 07/01/2024 2,000,000 2,249,860
Southern California
Public Power
Authority,
Transmission Project
Revenue (FSA)
(effective yield
7.30%)(b) 0.000 07/01/2014 2,500,000 901,325
Vista, California,
Community Development
Commision, Tax
Allocation Revenue
(MBIA) 5.250 09/01/2015 2,000,000 1,942,240
Walnut Creek,
California,
Certificates of
Participation, John
Muir Medical Center
(MBIA) 5.000 02/15/2016 700,000 654,269
Walnut Valley,
California, Unified
School District,
Series A (MBIA) 6.000 08/01/2014 190,000 203,275
Yorba Linda, California,
Redevelopment Agency
Capital Appreciation
(MBIA) (effective
yield 5.80%)(b) 0.000 09/01/2016 1,000,000 305,500
---------------------------------------------------------------------------
TOTAL MUNICIPAL BONDS (Cost--$27,470,228) 29,006,787
---------------------------------------------------------------------------
TEMPORARY TAX-EXEMPT INVESTMENTS (1.5%)
Anaheim, California,
Certificates of
Participation (Cost
$430,000)(a) 3.800 08/01/2019 430,000 430,000
---------------------------------------------------------------------------
TOTAL INVESTMENTS (Cost $27,900,228)(c) 29,436,787
OTHER ASSETS AND LIABILITIES--NET (-2.1%) (604,208)
---------------------------------------------------------------------------
NET ASSETS (100.0%) $28,832,579
---------------------------------------------------------------------------
NOTE TO SCHEDULE OF INVESTMENTS:
(a) Variable or floating rate instruments 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) Effective yield (calculated at the date of purchase) is the annual yield
at which the bond accretes until its maturity date.
(c) The cost of investments for federal income tax purposes amounted to
$27,913,350. Gross unrealized appreciation and depreciation of
investments, based on identified tax cost, at November 30, 1995 are as
follows:
Gross unrealized
appreciation $1,525,781
Gross unrealized
depreciation (2,344)
---------
Net unrealized appreciation $1,523,437
=========
LEGEND OF PORTFOLIO ABBREVIATIONS:
AMBAC--American Municipal Bond Assurance Corp.
FGIC--Financial Guaranty Insurance Corp.
FSA--Financial Security Assurance
MBIA--Municipal Bond Insurance Association
See Notes to Financial Statements.
<PAGE>
FINANCIAL HIGHLIGHTS--CLASS A SHARES
(For a share outstanding throughout the period)
February 1, 1994
Year (Commencement of
Ended Operations) to
November 30, November 30,
1995 1994
---------------------------------------------------------------
Net asset value, beginning
of period $ 8.70 $10.00
---------------------------------------------------------------
Income from investment
operations:
Net investment income 0.49 0.44
Net realized and
unrealized gain (loss)
on investments and
closed futures contracts 1.17 (1.30)
---------------------------------------------------------------
Total from investment
operations 1.66 (0.86)
---------------------------------------------------------------
Less distributions from:
Net investment income (0.47) (0.44)
In excess of net
investment income (0.03) 0.00
---------------------------------------------------------------
Total distributions (0.50) (0.44)
---------------------------------------------------------------
Net asset value, end of
period $ 9.86 $ 8.70
---------------------------------------------------------------
Total return (a) 19.63% (8.78%)(c)
Ratios/supplemental data
Ratios to average net
assets:
Total expenses (b) 0.72%(e) 0.41%(d)
Net investment income 5.37% 5.53%(d)
Portfolio turnover rate 119% 104%
---------------------------------------------------------------
Net assets, end of period
(thousands) $4,555 $3,006
---------------------------------------------------------------
(a) Excluding applicable sales charges.
(b) Figures are net of the expense reimbursement by Keystone in connection
with the voluntary expense limitation. Before the expense reimbursement,
the "Ratio of total expenses to average net assets" would have been 1.31%
and 1.66% (annualized) for the fiscal year ended November 30, 1995 and
the period February 1, 1994 (Commencement of Operations) to November 30,
1994, respectively.
(c) Total return is calculated from February 1, 1994 (Commencement of
Operations) to November 30, 1994.
(d) Annualized.
(e) "Ratio of total expenses to average net assets" for the year ended
November 30, 1995 includes indirectly paid expenses. Excluding indirectly
paid expenses, the expense ratio would have been 0.69%.
See Notes to Financial Statements.
<PAGE>
FINANCIAL HIGHLIGHTS--CLASS B SHARES
(For a share outstanding throughout the period)
February 1, 1994
Year (Commencement of
Ended Operations) to
November 30, November 30,
1995 1994
--------------------------------------------------------------------------
Net asset value, beginning of period $ 8.68 $10.00
--------------------------------------------------------------------------
Income from investment operations:
Net investment income 0.44 0.40
Net realized and unrealized
gain (loss) on investments and
closed futures contracts 1.17 (1.28)
--------------------------------------------------------------------------
Total from investment operations 1.61 (0.88)
--------------------------------------------------------------------------
Less distributions from:
Net investment income (0.44) (0.40)
In excess of net investment income (0.03) (0.04)
--------------------------------------------------------------------------
Total distributions (0.47) (0.44)
--------------------------------------------------------------------------
Net asset value, end of period $ 9.82 $ 8.68
--------------------------------------------------------------------------
Total return (a) 18.95% (9.00%)(c)
Ratios/supplemental data
Ratios to average net assets:
Total expenses (b) 1.48%(e) 1.16%(d)
Net investment income 4.57% 4.83%(d)
Portfolio turnover rate 119% 104%
--------------------------------------------------------------------------
Net assets, end of period (thousands) $22,743 $11,415
--------------------------------------------------------------------------
(a) Excluding applicable sales charges.
(b) Figures are net of the expense reimbursement by Keystone in connection
with the voluntary expense limitation. Before the expense reimbursement,
the "Ratio of total expenses to average net assets" would have been 2.07%
and 2.36% (annualized) for the fiscal year ended November 30, 1995 and
for the period February 1, 1994 (Commencement of Operations) to November
30, 1994, respectively.
(c) Total return is calculated from February 1, 1994 (Commencement of
Operations) to November 30, 1994.
(d) Annualized.
(e) "Ratio of total expenses to average net assets" for the year ended
November 30, 1995 includes indirectly paid expenses. Excluding indirectly
paid expenses, the expense ratio would have been 1.45%.
See Notes to Financial Statements.
<PAGE>
FINANCIAL HIGHLIGHTS--CLASS C SHARES
(For a share outstanding throughout the period)
February 1, 1994
Year (Commencement of
Ended Operations) to
November 30, November 30,
1995 1994
- ---------------------------------------------------------------------
Net asset value, beginning of
period $ 8.68 $10.00
- ---------------------------------------------------------------------
Income from investment
operations:
Net investment income 0.43 0.39
Net realized and unrealized
gain (loss) on investments
and closed futures contracts 1.15 (1.29)
- ---------------------------------------------------------------------
Total from investment
operations 1.58 (0.90)
- ---------------------------------------------------------------------
Less distributions from:
Net investment income (0.43) (0.39)
In excess of net investment
income (0.03) (0.03)
- ---------------------------------------------------------------------
Total distributions (0.46) (0.42)
- ---------------------------------------------------------------------
Net asset value, end of period $ 9.80 $ 8.68
- ---------------------------------------------------------------------
Total return (a) 18.69% (9.08%)(c)
Ratios/supplemental data
Ratios to average net assets:
Total expenses (b) 1.49%(e) 1.16%(d)
Net investment income 4.51% 4.96%(d)
Portfolio turnover rate 119% 104%
- ---------------------------------------------------------------------
Net assets, end of period
(thousands) $1,535 $624
- ---------------------------------------------------------------------
(a) Excluding applicable sales charges.
(b) Figures are net of the expense reimbursement by Keystone in connection
with the voluntary expense limitation. Before the expense reimbursement,
the "Ratio of total expenses to average net assets" would have been 2.07%
and 2.38% annualized for the fiscal year ended November 30, 1995 and for
the period February 1, 1994 (Commencement of Operations) to November 30,
1994, respectively.
(c) Total return is calculated from February 1, 1994 (Commencement of
Operations) to November 30, 1994.
(d) Annualized.
(e) "Ratio of total expenses to average net assets" for the year ended
November 30, 1995 includes indirectly paid expenses. Excluding indirectly
paid expenses, the expense ratio would have been 1.46%.
See Notes to Financial Statements.
<PAGE>
Keystone California Insured Tax Free Fund
STATEMENT OF ASSETS AND LIABILITIES
November 30, 1995
Assets (Notes 1 and 4):
Investments at market value (identified
cost--$27,900,228) $29,436,787
Cash 1,122
Receivable for:
Fund shares sold 30,261
Interest 471,665
Due from Investment Adviser 32,086
Unamortized organization expenses 4,291
Prepaid expenses 42
------------------------------------------------------------------
Total assets 29,976,254
------------------------------------------------------------------
Liabilities (Notes 1, 2 and 4):
Payable for:
Investments purchased 977,460
Fund shares redeemed 38,377
Distribution to shareholders 103,065
Commissions payable to Principal Underwriter 2,244
Accrued reimbursable expenses 3,200
Other accrued expenses 19,329
------------------------------------------------------------------
Total liabilities 1,143,675
------------------------------------------------------------------
Net assets $28,832,579
------------------------------------------------------------------
Net assets represented by (Note 1):
Paid-in capital $27,723,538
Accumulated distributions in excess of net
investment income (27,037)
Accumulated net realized gain (loss) on
investments and closed futures contract (400,481)
Net unrealized appreciation (depreciation)
on investments 1,536,559
------------------------------------------------------------------
Total net assets $28,832,579
------------------------------------------------------------------
Net asset value per share (Note 2):
Class A Shares
Net asset value of $4,554,679 / 462,058 shares
outstanding $9.86
Offering price per share ($9.86 / 0.9525)
(based on a sales charge of 4.75% of the
offering price on November 30, 1995) $10.35
Class B Shares
Net asset value of $22,743,281 / 2,317,182
shares outstanding $9.82
Class C Shares
Net asset value of $1,534,619 / 156,535 shares
outstanding $9.80
------------------------------------------------------------------
See Notes to Financial Statements.
STATEMENT OF OPERATIONS
Year Ended November 30, 1995
Investment Income (Note 1):
Interest $1,241,768
-------------------------------------------------------------------
Expenses (Notes 1, 2 and 4):
Management fee $ 113,353
Transfer agent fees 24,058
Custodian fees 34,925
Accounting 19,921
Auditing 5,342
Legal 14,222
Printing 19,075
Registration fees 5,582
Organization expenses 1,169
Distribution Plan expenses 158,568
Miscellaneous expenses 3,147
Reimbursement from Investment Adviser (122,277)
-------------------------------------------------------------------
Total expenses 277,085
Less: Expenses paid indirectly
(Note 4) (5,486)
-------------------------------------------------------------------
Net expenses 271,599
-------------------------------------------------------------------
Net investment income 970,169
-------------------------------------------------------------------
Net realized and unrealized gain (loss)
on investments and futures contracts
(Notes 1 and 3):
Realized gain (loss) on:
Investments sold 1,017,407
Closed futures contracts (346,168)
-------------------------------------------------------------------
Net realized gain (loss) on
investments and closed futures
contracts 671,239
-------------------------------------------------------------------
Net change in unrealized appreciation
(depreciation) on:
Investments 1,970,314
Futures contracts (87,875)
-------------------------------------------------------------------
Net change in unrealized appreciation
(depreciation) on investments 1,882,439
-------------------------------------------------------------------
Net realized and unrealized gain
(loss) on investments and futures
contracts 2,553,678
-------------------------------------------------------------------
Net increase (decrease) in net assets
resulting from operations $3,523,847
-------------------------------------------------------------------
<PAGE>
Keystone California Insured Tax Free Fund
STATEMENTS OF CHANGES IN NET ASSETS
February 1, 1994
(Commencement of
Year Ended Operations) to
November 30, November 30,
1995 1994
=========================================================================
Operations (Notes 1 and 3):
Net investment income $ 970,169 $ 449,809
Net realized gain (loss) on
investments and closed futures
contracts 671,239 (1,047,295)
Net change in unrealized
appreciation (depreciation) on
investments 1,882,439 (345,880)
- -------------------------------------------------------------------------
Net increase (decrease) in net
assets resulting from operations 3,523,847 (943,366)
- -------------------------------------------------------------------------
Distributions to shareholders from
(Note 1):
Net investment income
Class A Shares (180,675) (103,422)
Class B Shares (746,674) (327,857)
Class C Shares (47,288) (17,973)
In excess of net investment
income
Class A Shares (12,433) 0
Class B Shares (51,381) (47,642)
Class C Shares (3,254) (2,036)
- -------------------------------------------------------------------------
Total distributions to
shareholders (1,041,705) (498,930)
- -------------------------------------------------------------------------
Capital share transactions
(Note 2):
Proceeds from shares sold:
Class A Shares 1,987,577 3,653,153
Class B Shares 11,405,882 13,549,247
Class C Shares 1,005,793 942,116
Payment for shares redeemed:
Class A Shares (918,227) (364,506)
Class B Shares (2,323,287) (1,189,908)
Class C Shares (229,742) (265,039)
Net asset value of shares issued
in reinvestment of dividends and
distributions:
Class A Shares 45,806 19,906
Class B Shares 307,457 132,637
Class C Shares 24,916 8,952
- -------------------------------------------------------------------------
Net increase (decrease) in net
assets resulting from capital share
transactions 11,306,175 16,486,558
- -------------------------------------------------------------------------
Total increase (decrease) in
net assets 13,788,317 15,044,262
Net assets:
Beginning of period 15,044,262 0
- -------------------------------------------------------------------------
End of period [Including
undistributed net investment
income (accumulated
distributions in excess of net
investment income) as follows:
November 1995--($27,037) and
November 1994--$4,468] (Note 1) $28,832,579 $15,044,262
- -------------------------------------------------------------------------
See Notes to Financial Statements.
<PAGE>
Keystone Missouri Tax Free Fund
SCHEDULE OF INVESTMENTS--November 30, 1995
Coupon Maturity Principal Market
Rate Date Amount Value
-----------------------------------------------------------------------------
MUNICIPAL BONDS (96.4%)
Butler County, Missouri,
Public Facilities
Authority 6.500% 12/01/2014 $1,105,000 $1,191,720
Cape Girardeau County,
Missouri, Industrial
Development Authority,
Southeast Missouri
Hospital Association 5.250 06/01/2016 1,750,000 1,667,540
Chesterfield, Missouri,
General Obligation 6.300 02/15/2013 830,000 889,511
Clay County, Missouri,
Public Building
Authority 7.000 05/15/2014 1,000,000 1,132,160
Greene County, Missouri,
Single Family Mortgage
(effective yield
6.53%)(b) 0.000 03/01/2016 1,000,000 305,240
Jackson County,
Missouri, Single
Family Mortgage
Revenue (effective
yield 11.25%)(b) 0.000 03/01/2015 3,750,000 1,243,575
Missouri Higher
Education, Loan
Authority, Student
Loan, Series D 6.750 02/15/2009 500,000 525,810
Missouri Higher
Education, Student
Loan, Series A 5.450 02/15/2009 600,000 567,078
Missouri State
Environmental
Improvement and Energy
Resource Authority,
Union Electric Co.
Project 5.450 10/01/2028 700,000 678,405
Missouri State Fourth
Building, Series A 5.500 04/01/2020 4,000,000 4,057,120
Missouri State Health
and Educational
Facilities Authority,
Barnes-Jewish Inc. 5.250 05/15/2012 500,000 485,845
Missouri State Health
and Educational
Facilities Authority,
BJC Health Systems,
Series A 6.500 05/15/2020 500,000 542,010
Missouri State Health
and Educational
Facilities Authority,
Bethesda Health Group,
Project A 7.500 08/15/2012 1,000,000 1,042,970
Missouri State Health
and Educational
Facilities Authority,
National Benevolent
Association 6.000 02/01/2024 750,000 717,608
Missouri State Health
and Educational
Facilities Authority,
Series AA 6.250 06/01/2016 1,500,000 1,584,015
Missouri State Housing
Development
Commission, Single
Family, GNMA, Series A 7.125 12/01/2014 500,000 543,265
Missouri State Regional
Convention and Sports
Project 5.500 08/15/2013 950,000 942,229
Missouri State
Environmental
Improvement and Energy
Resource Authority, Water
Pollution Control,
Capital Appreciation
Revolving Program, Series
D effective yield
6.25%)(b) 0.000 01/01/2017 975,000 294,041
Missouri State
Environmental
Improvement and Energy
Resource Authority, Water
Pollution Control,
Capital Appreciation
Revolving Program, Series
D (effective yield
6.25%)(b) 0.000 01/01/2016 985,000 314,451
Missouri State
Environmental
Improvement and Energy
Resource Authority, Water
Pollution Control,
State Revolving
Program, Series A 6.050 07/01/2015 250,000 261,910
Missouri State
Environmental
Improvement and Energy
Resource Authority, Water
Pollution Control,
State Revolving
Program, Series B 5.800 01/01/2015 500,000 518,610
Missouri State
Environmental
Improvement and Energy
Resource Authority, Water
Pollution Control,
State Revolving
Program, Series B 7.200 07/01/2016 600,000 696,984
Missouri State
Environmental
Improvement and Energy
Resource Authority, Water
Pollution Control,
State Revolving
Program, Series E 5.625 07/01/2016 500,000 504,345
Puerto Rico
Commonwealth,
Refunding (Capital
Guaranty) 6.450 07/01/2017 500,000 533,345
Puerto Rico
Commonwealth,
Telephone Authority 5.400 01/01/2008 600,000 611,292
See Notes to Schedule of Investments. (continued on next page)
<PAGE>
MUNICIPAL BONDS (continued)
Puerto Rico Electric
Power Authority,
Series Z 5.250% 07/01/2021 $1,000,000 $ 950,120
Puerto Rico Electric
Power Authority,
Series T 6.000 07/01/2016 300,000 307,641
Puerto Rico Electric
Power Authority,
Series U 6.000 07/01/2014 320,000 328,150
Puerto Rico Electric
Power Authority,
Series Y 6.500 07/01/2006 1,000,000 1,131,790
St. Louis County,
Missouri, Industrial
Development Authority,
Health Facilities
Revenue, GNMA, Mother
of Perpetual Help 6.400 08/01/2035 500,000 530,135
St. Louis County,
Missouri, Regional
Convention and Sports
Facility, Convention
and Sports Project 5.750 08/15/2021 500,000 495,380
St. Louis County,
Missouri, Series D 5.650 02/01/2015 250,000 249,665
St, Louis, Missouri,
Industrial Development
Authority, Sewer and
Solid Waste Disposal
Facilities 5.875 11/01/2026 1,000,000 1,009,820
-----------------------------------------------------------------------------
TOTAL MUNICIPAL BONDS (Cost--$25,009,224) 26,853,780
-----------------------------------------------------------------------------
TEMPORARY TAX-EXEMPT INVESTMENTS (2.4%)
Missouri State Health
and Educational
Facilities Authority
(a) 3.650 12/01/2019 595,000 595,000
Missouri Higher
Education, Student
Loan, Series A (a) 3.850 06/01/2017 75,000 75,000
-----------------------------------------------------------------------------
TOTAL TEMPORARY TAX-EXEMPT INVESTMENTS (COST $670,000) 670,000
-----------------------------------------------------------------------------
TOTAL INVESTMENTS (COST--$25,679,224)(c) 27,523,780
OTHER ASSETS AND LIABILITIES--NET (1.2%) 343,940
-----------------------------------------------------------------------------
NET ASSETS (100.0%) $27,867,720
-----------------------------------------------------------------------------
NOTE TO SCHEDULE OF INVESTMENTS:
(a) Variable or floating rate instruments 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) Effective yield (calculated at the date of purchase) is the yield at
which the bond accretes on an annual basis until maturity date.
(c) The cost of investments for federal income tax purposes amounted to
$25,692,265. Gross unrealized appreciation and depreciation of investments,
based on identified tax cost, at November 30, 1995 are as follows:
Gross unrealized
appreciation $1,831,515
Gross unrealized
depreciation 0
---------
Net unrealized appreciation $1,831,515
=========
LEGEND OF PORTFOLIO ABBREVIATIONS
GNMA--Government National Mortgage Association
See Notes to Financial Statements.
<PAGE>
FINANCIAL HIGHLIGHTS--CLASS A SHARES
(For a share outstanding throughout the period)
February 1, 1994
(Commencement of
Year Ended Operations) to
November 30, November 30,
1995 1994
- -------------------------------------------------------------------------
Net asset value, beginning of
period $8.72 $10.00
- -------------------------------------------------------------------------
Income from investment operations:
Net investment income 0.50 0.44
Net realized and unrealized gain
(loss) on investments and closed
futures contracts 1.19 (1.28)
- -------------------------------------------------------------------------
Total from investment operations 1.69 (0.84)
- -------------------------------------------------------------------------
Less distributions from:
Net investment income (0.47) (0.44)
In excess of net investment income (0.03) 0.00(e)
- -------------------------------------------------------------------------
Total distributions (0.50) (0.44)
- -------------------------------------------------------------------------
Net asset value, end of period $9.91 $ 8.72
- -------------------------------------------------------------------------
Total return (a) 19.86% (8.55%)(c)
Ratios/supplemental data
Ratios to average net assets:
Total expenses (b) 0.72%(f) 0.43%(d)
Net investment income 5.26% 5.38%(d)
Portfolio turnover rate 74% 25%
- -------------------------------------------------------------------------
Net assets, end of period
(thousands) $4,848 $3,581
- -------------------------------------------------------------------------
(a) Excluding applicable sales charges.
(b) Figures are net of the expense reimbursement by Keystone in connection
with the voluntary expense limitation. Before expense reimbursement, the
"Ratio of total expenses to average net assets" would have been 1.32% and
1.54% (annualized) for the fiscal year ended November 30, 1995 and for
the period February 1, 1994 (Commencement of Operations) to November 30,
1994, respectively.
(c) Total return indicated is calculated from February 1, 1994 (Commencement
of Operations) to November 30, 1994.
(d) Annualized.
(e) Amount represents less than $0.01 per share.
(f) "Ratio of total expenses to average net assets" for the year ended
November 30, 1995 includes indirectly paid expenses. Excluding indirectly
paid expenses, the expense ratio would have been 0.69%.
See Notes to Financial Statements.
<PAGE>
FINANCIAL HIGHLIGHTS--CLASS B SHARES
(For a share outstanding throughout the period)
February 1, 1994
(Commencement of
Year Ended Operations) to
November 30, November 30,
1995 1994
- -------------------------------------------------------------------------
Net asset value, beginning of
period $8.67 $10.00
- -------------------------------------------------------------------------
Income from investment operations:
Net investment income 0.44 0.40
Net realized and unrealized gain
(loss) on investments and closed
futures contracts 1.15 (1.29)
- -------------------------------------------------------------------------
Total from investment operations 1.59 (0.89)
- -------------------------------------------------------------------------
Less distributions from:
Net investment income (0.43) (0.40)
In excess of net investment income (0.03) (0.04)
- -------------------------------------------------------------------------
Total distributions (0.46) (0.44)
- -------------------------------------------------------------------------
Net asset value, end of period $9.80 $ 8.67
- -------------------------------------------------------------------------
Total return (a) 18.79% (9.06)(c)
Ratios/supplemental data
Ratios to average net assets:
Total expenses (b) 1.47%(e) 1.16%(d)
Net investment income 4.56% 4.70%(d)
Portfolio turnover rate 74% 25%
- -------------------------------------------------------------------------
Net assets, end of period
(thousands) $21,231 $12,906
- -------------------------------------------------------------------------
(a) Excluding applicable sales charges.
(b) Figures are net of the expense reimbursement by Keystone in connection
with the voluntary expense limitation. Before expense reimbursement, the
"Ratio of total expenses to average net assets" would have been 2.08% and
2.49% (annualized) for year ended November 30, 1995 and for the period
February 1, 1994 (Commencement of Operations) to November 30, 1994,
respectively.
(c) Total return is calculated from February 1, 1994 (Commencement of
Operations) to November 30, 1994.
(d) Annualized.
(e) "Ratio of total expenses to average net assets" for the year ended
November 30, 1995 includes indirectly paid expenses. Excluding indirectly
paid expenses, the expense ratio would have been 1.44%.
See Notes to Financial Statements.
<PAGE>
FINANCIAL HIGHLIGHTS--CLASS C SHARES
(For a share outstanding throughout the period)
February 1, 1994
(Commencement of
Year Ended Operations) to
November 30, November 30,
1995 1994
- -------------------------------------------------------------------------
Net asset value, beginning of
period $ 8.66 $10.00
- -------------------------------------------------------------------------
Income from investment operations
Net investment income 0.43 0.39
Net realized and unrealized gain
(loss) on investments and closed
futures contracts 1.16 (1.29)
- -------------------------------------------------------------------------
Total from investment operations 1.59 (0.90)
- -------------------------------------------------------------------------
Less distributions from:
Net investment income (0.43) (0.39)
In excess of net investment income (0.03) (0.05)
- -------------------------------------------------------------------------
Total distributions (0.46) (0.44)
- -------------------------------------------------------------------------
Net asset value, end of period $9.79 $ 8.66
- -------------------------------------------------------------------------
Total return (a) 18.78% (9.25%)(c)
Ratios/supplemental data
Ratios to average net assets:
Total expenses (b) 1.46%(e) 1.15%(d)
Net investment income 4.56% 4.72%(d)
Portfolio turnover rate 74% 25%
- -------------------------------------------------------------------------
Net assets, end of period
(thousands) $1,788 $1,045
- -------------------------------------------------------------------------
(a) Excluding applicable sales charges.
(b) Figures are net of the expense reimbursement by Keystone in connection
with the voluntary expense limitation. Before expense reimbursement, the
"Ratio of total expenses to average net assets" would have been 2.07% and
2.60% (annualized) for the year ended November 30, 1995 and the period
February 1, 1994 (Commencement of Operations) to November 30, 1994,
respectively.
(c) Total return is calculated from February 1, 1994 (Commencement of
Operations) to November 30, 1994.
(d) Annualized.
(e) "Ratio of total expenses to average net assets" for the year ended
November 30, 1995 includes indirectly paid expenses. Excluding indirectly
paid expenses, the expense ratio would have been 1.44%.
See Notes to Financial Statements.
<PAGE>
Keystone Missouri Tax Free Fund
STATEMENT OF ASSETS AND LIABILITIES
November 30, 1995
Assets (Notes 1 and 4):
Investments at market value (identified
cost--$25,679,224) $27,523,780
Cash 128
Interest receivable 435,462
Due from Investment Adviser 34,400
Unamortized organization expenses 2,360
Prepaid expenses 44
------------------------------------------------------------------
Total assets 27,996,174
------------------------------------------------------------------
Liabilities (Notes 1, 2 and 4):
Income distribution payable 101,846
Commissions payable to Principal Underwriter 2,474
Accrued reimbursable expenses 3,200
Other accrued expenses 20,934
------------------------------------------------------------------
Total liabilities 128,454
------------------------------------------------------------------
Net assets $27,867,720
------------------------------------------------------------------
Net assets represented by (Note 1):
Paid-in capital $26,732,969
Accumulated distributions in excess of net
investment income (39,999)
Accumulated net realized gain (loss) on
investments and closed futures contracts (669,806)
Net unrealized appreciation on investments 1,844,556
------------------------------------------------------------------
Total net assets $27,867,720
------------------------------------------------------------------
Net asset value per share (Note 2)
Class A Shares
Net asset value of $4,848,325 / 489,023 shares
outstanding $ 9.91
Offering price per share ($9.91 / 0.9525)
(based on a sales charge of 4.75% of the
offering price November 30, 1995 $10.40
Class B Shares
Net asset value of $21,230,965 / 2,166,339
shares outstanding $ 9.80
Class C Shares
Net asset value of $1,788,430 / 182,615 shares
outstanding $ 9.79
------------------------------------------------------------------
See Notes to Financial Statements.
STATEMENT OF OPERATIONS
Year Ended November 30, 1995
-----------------------------------------------------------------
Investment Income (Note 1):
Interest $1,310,031
Expenses (Notes 1, 2 and 4):
Management fee $ 120,166
Transfer agent fees 33,338
Custodian fees 29,698
Accounting 20,721
Auditing 5,342
Legal 9,825
Printing 19,239
Registration fees 13,937
Organization expenses 592
Distribution Plan expenses 173,126
Miscellaneous expenses 3,782
Reimbursement from Investment Adviser (132,621)
-----------------------------------------------------------------
Total expenses 297,145
Less: Expenses paid indirectly
(Note 4) (5,258)
-----------------------------------------------------------------
Net expenses 291,887
-----------------------------------------------------------------
Net investment income 1,018,144
-----------------------------------------------------------------
Net realized and unrealized gain (loss)
on investments and futures contracts
(Notes 1 and 3)
Realized gain (loss) on:
Investments (50,881)
Closed futures contracts (354,300)
-----------------------------------------------------------------
Net realized gain (loss) on
investments and closed futures
contracts (405,181)
-----------------------------------------------------------------
Net change in unrealized appreciation
(depreciation) on:
Investments 3,182,450
Futures contracts (94,156)
-----------------------------------------------------------------
Net change in unrealized appreciation
(depreciation) on investments 3,088,294
-----------------------------------------------------------------
Net realized and unrealized gain
(loss) on investments and closed
futures contracts 2,683,113
-----------------------------------------------------------------
Net increase (decrease) in net assets
resulting from operations $3,701,257
-----------------------------------------------------------------
<PAGE>
Keystone Missouri Tax Free Fund
STATEMENTS OF CHANGES IN NET ASSETS
February 1, 1994
(Commencement of
Year Ended Operations) to
November 30, November 30,
1995 1994
=========================================================================
Operations (Notes 1 and 3):
Net investment income $ 1,018,144 $ 416,949
Net realized gain (loss) on
investments and closed futures
contracts (405,181) (253,329)
Net change in unrealized
appreciation (depreciation) on
investments 3,088,294 (1,243,738)
- -------------------------------------------------------------------------
Net increase (decrease) in net
assets resulting from operations 3,701,257 (1,080,118)
- -------------------------------------------------------------------------
Distributions to shareholders from
(Note 1):
Net investment income
Class A Shares (153,289) (58,702)
Class B Shares (791,351) (324,108)
Class C Shares (73,504) (34,139)
In excess of net investment
income
Class A Shares (11,167) (466)
Class B Shares (57,652) (58,892)
Class C Shares (5,355) (5,609)
- -------------------------------------------------------------------------
Total distributions to
shareholders (1,092,318) (481,916)
- -------------------------------------------------------------------------
Capital share transactions
(Note 2):
Proceeds from shares sold:
Class A Shares 4,076,405 4,347,894
Class B Shares 7,170,581 14,457,771
Class C Shares 931,369 1,600,310
Payment for shares redeemed-Class
A Shares
Class A Shares (3,330,599) (570,413)
Class B Shares (1,245,399) (479,634)
Class C Shares (414,529) (448,097)
Net asset value of shares issued
in reinvestment of dividends and
distributions:
Class A Shares 103,984 29,808
Class B Shares 392,566 144,139
Class C Shares 42,017 12,642
- -------------------------------------------------------------------------
Net increase (decrease) in net
assets resulting from capital
share transactions 7,726,395 19,094,420
- -------------------------------------------------------------------------
Total increase (decrease) in net
assets 10,335,334 17,532,386
Net assets:
Beginning of period 17,532,386 0
- -------------------------------------------------------------------------
End of period [Including
accumulated distributions in
excess of net investment income
as follows:
November 1995--($39,999) and
November 1994--($7,792)]
(Note 1) $27,867,720 $17,532,386
- -------------------------------------------------------------------------
See Notes to Financial Statements.
<PAGE>
FEDERAL TAX STATUS-FISCAL 1995 DISTRIBUTIONS
(Unaudited)
The per share distributions paid to you for fiscal 1995, whether taken in
shares or cash, are as follows:
Tax-Exempt Income
Dividends
------------------------
Class A $0.50
------------------------
Class B $0.46
------------------------
Class C $0.46
------------------------
In January 1996, we will send you complete information on distributions paid
during the calendar year 1995 to assist you in completing your federal tax
return.
<PAGE>
Keystone State Tax Free Fund-Series II
NOTES TO FINANCIAL STATEMENTS
(1.) Significant Accounting Policies
Keystone State Tax Free Fund-Series II ("FUND") (formerly Keystone America
State Tax Free Fund-Series II) was formed as a Massachusetts business trust
on December 15, 1993 and is registered under the Investment Company Act of
1940 (the "1940 Act") as an open-end management investment company. Keystone
Investment Management Company (formerly Keystone Custodian Funds, Inc.)
("Keystone") is the Investment Adviser. The FUND currently offers shares of
two separate non-diversified series evidencing interests in different
portfolios of securities (individually the "Fund", collectively the "FUNDS"):
Keystone California Insured Tax Free Fund ("California Fund") (formerly
Keystone America California Insured Tax Free Fund) and Keystone Missouri Tax
Free Fund ("Missouri Fund") (formerly Keystone America Missouri Tax Free
Fund). The Funds had no operations prior to February 1, 1994.
Each Fund currently issues three classes of shares. Class A shares are sold
subject to a maximum sales charge of 4.75% payable at the time of purchase.
Class B shares are sold subject to a contingent deferred sales charge which
varies depending on when shares were purchased and how long they are held.
Class C shares are sold subject to a contingent deferred sales charge payable
upon redemption within one year of purchase, and are available only through
dealers who have entered into special distribution agreements with Keystone
Investment Distributors Company (formerly Keystone Distributors, Inc.)
("KIDC"), the FUND's principal underwriter.
Keystone is a wholly-owned subsidiary of Keystone Investments, Inc. (formerly
Keystone Group, Inc.) ("KII"), a Delaware corporation. KII is privately owned
by an investor group consisting of members of current and former members of
management of Keystone and its affilates.
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.
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
<PAGE>
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 delivery
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. Each Fund may enter into currency and other financial futures contracts as
a hedge against changes in interest or currency exchange rates. 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 the 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 a Fund's federal taxable income. In
addition to market risk, the Funds are subject to the credit risk that the
other party will not complete the obligations of the contract.
D. Securities transactions are accounted for no later than one business day
after the trade date. Realized gains and losses are recorded on the
identified cost basis. 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.
E. 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 (the "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.
Each Fund intends to avoid excise tax liability by making the required
distributions under the Internal Revenue Code.
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.
G. 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. Distributions are determined in accordance with income tax
regulations. The significant differences between financial statement amounts
available for distribution and distributions made in accordance with income
tax regulations are primarily due to differences in the treatment of 12b-1
Distribution Plan charges and market discount of investment securities.
(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:
<PAGE>
February 1,
1994
(Commencement
Year Ended of
November Operations) to
30, November 30,
1995 1994
--------------------------------------------------------------
California Fund
Class A Shares
Shares sold 210,863 382,583
Shares redeemed (99,402) (39,080)
Shares issued in reinvestment
of dividends and
distributions 4,943 2,151
--------------------------------------------------------------
Net increase (decrease) 116,404 345,654
--------------------------------------------------------------
Class B Shares
Shares sold 1,223,780 1,429,334
Shares redeemed (254,280) (129,251)
Shares issued in reinvestment
of dividends and
distributions 33,291 14,308
--------------------------------------------------------------
Net increase (decrease) 1,002,791 1,314,391
--------------------------------------------------------------
Class C Shares
Shares sold 107,136 99,167
Shares redeemed (25,172) (28,249)
Shares issued in reinvestment
of dividends and
distributions 2,687 966
--------------------------------------------------------------
Net increase (decrease) 84,651 71,884
--------------------------------------------------------------
Missouri Fund
Class A Shares
Shares sold 429,776 467,351
Shares redeemed (362,420) (60,027)
Shares issued in reinvestment
of dividends and
distributions 11,139 3,204
--------------------------------------------------------------
Net increase (decrease) 78,495 410,528
--------------------------------------------------------------
Class B Shares
Shares sold 769,123 1,523,789
Shares redeemed (134,192) (50,032)
Shares issued in reinvestment
of dividends and
distributions 42,162 15,489
--------------------------------------------------------------
Net increase (decrease) 677,093 1,489,246
--------------------------------------------------------------
Missouri Fund
Class C Shares
Shares sold 101,419 167,136
Shares redeemed (44,088) (47,712)
Shares issued in reinvestment
of dividends and
distributions 4,503 1,357
--------------------------------------------------------------
Net increase (decrease) 61,834 120,781
--------------------------------------------------------------
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 pursuant
to Rule 12b-1 under the 1940 Act.
Each Class A Distribution Plan provides for payments at an annual rate of up
to 0.15% annually of the average daily net asset value of Class A shares to
pay expenses for the distribution of Class A shares. Amounts paid by each
Fund to KIDC 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 and
remaining outstanding on the books of the Fund for specified periods.
Each Class B Distribution Plan provides for payments at an annual rate of
0.90% of the average daily net asset value of Class B shares to pay expenses
for the distribution of Class B shares. Amounts paid by each Fund under the
Class B Distribution Plan are currently used to pay others (such as dealers)
a commission at the time of purchase normally equal to 4.00% of the price
paid for each Class B share sold plus the first year's service fee in advance
in the amount of 0.15% of the price paid for each Class B
<PAGE>
Keystone State Tax Free Fund-Series II
share sold. Beginning approximately 12 months after the purchase of a Class B
share, the dealer or other party will receive service fees at an annual rate
of 0.15% of the average daily net asset value of the Class B shares
maintained by such others and remaining outstanding on the Fund's books for
specified periods. A contingent deferred sales charge will be imposed, if
applicable, on Class B shares purchased on or after June 1, 1995 at rates
ranging from a maximum of 5.00% of amounts redeemed during the first twelve
months following the date of purchase to 1.00% of amounts redeemed during the
sixth twelve month period following the date of purchase. Class B shares
purchased on or after June 1, 1995 that have been outstanding for eight years
from the month of purchase will automatically convert to Class A shares
without a front end sales charge or exchange fee. Class B shares purchased
prior to June 1, 1995 will retain their existing conversion rights.
Each Class C Distribution Plan provides for payments at an annual rate of up to
0.90% of the average daily net asset value of Class C shares to pay expenses for
the distribution of Class C shares. Amounts paid by each Fund under the Class C
Distribution Plan are currently used to pay others (such as dealers) a
commission at the time of purchase normally equal to 0.75% of the price paid for
each share sold plus the first year's service fee in advance in the amount of
0.15% of the price paid for each Class C share. Beginning approximately 15
months after purchase, the dealer or other party will receive a commission at an
annual rate of 0.75% (subject to applicable limitations imposed by a rule of the
National Association of Security Dealers, Inc. ("NASD Rule")) plus service fees
at the annual rate of 0.15%, respectively, of the average net asset value of
each Class C share sold by such others and remaining outstanding on the Fund's
books for specified periods.
Each of the Distribution Plans may be terminated at any time by vote of the
Independent Trustees or by a majority of the outstanding voting shares of the
respective class. However, after the termination of any Distribution Plan, at
the discretion of the Board of Trustees, payments to KIDC may continue as
compensation for its services which had been earned while the Distribution
Plan was in effect.
For the year ended November 30, 1995 the California Fund paid KIDC $5,342,
$144,008 and $9,218 and the Missouri Fund paid $4,684, $154,093 and $14,349,
pursuant to each Fund's respective Class A, Class B and C Class Distribution
Plans.
Under the NASD Rule, the maximum uncollected amounts for which KIDC may seek
payment from the FUND under its Class B Distribution Plans are $881,590 and
$1,004,012 for shares purchased prior to June 1, 1995 and $503,630 and
$226,290 for shares purchased on or after June 1, 1995, for the California
Fund and the Missouri Fund, respectively, as of November 30, 1995. The
maximum uncollected amounts for which KIDC may seek payment from the FUND
under its Class C Distribution Plans are $94,402 and $123,873, respectively,
for the California Fund and the Missouri Fund as of November 30, 1995.
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, 1995, the capital loss carryover for federal income
purposes for the California Fund was $387,000 which expires in 2002; and the
capital
<PAGE>
loss carryover for the Missouri Fund was $657,000 which expires as follows:
2002--$152,000 and 2003--$505,000.
Purchases and sales of investment securities, excluding short-term
securities, for the year ended November 30, 1995 were as follows:
Cost of Proceeds
Purchases From Sales
- ----------------------------------------------------
California Fund $35,705,748 $24,090,235
Missouri Fund $21,413,118 $15,927,734
(4.) Investment Management Agreement and Other Transactions
Under the terms of the Investment Advisory and Management Agreement between
Keystone and the FUND, dated December 15, 1993, Keystone provides investment
management and administative services to each Fund. In return, Keystone is
paid a management fee computed and paid daily. The management fee is
calculated by applying percentage rates, which start at 0.55% and declining
as net assets increase to 0.25% per annum, to the average daily net asset
value of each Fund.
During the year ended November 30, 1995, the California Fund and the Missouri
Fund paid or accrued to Keystone $113,353 and $120,166, respectively, for
investment management and administrative service fees.
Keystone Investor Resource Center, Inc. ("KIRC"), a wholly-owned subsidiary
of Keystone, is the FUND's transfer agent. During the year ended November 30,
1995, the California Fund and the Missouri Fund paid or accrued to KIRC
$24,058, and $33,338, respectively, for transfer agent fees.
During the year ended November 30, 1995, the California Fund and the Missouri
Fund paid or accrued to KII $19,921, and $20,721, respectively, for certain
accounting services.
Keystone had voluntarily limited the expenses of Class A Shares of each Fund
to 0.35% for the Fund's first six months, after which the expense limitation
was increased by 0.10% per quarter until May 15, 1995 when expenses were
limited to 0.75%; expenses for Class B and C shares were limited to 1.10% for
each Fund's first six months, after which the expense limitations were
similarly increased until May 15, 1995 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 the 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
$122,277 and $132,621, respectively, for the year ended November 30, 1995.
Keystone does not intend to seek repayment for these amounts.
The FUND has entered into an expense offset arrangement with its custodian.
For the year ended November 30, 1995, the California Fund and the Missouri
Fund paid custody fees in the amount of $29,439 and $24,440, respectively,
and received a credit of $5,486 and $5,258, respectively, pursuant to the
expense offset arrangement, resulting in a total expense of $34,925 and
$29,698, respectively. The assets deposited with the custodian under this
expense offset arrangement could have been invested in an income-producing
asset.
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.
<PAGE>
Keystone State Tax Free Fund-Series II
INDEPENDENT AUDITORS' REPORT
The Trustees and Shareholders
Keystone State Tax Free Fund--Series II
We have audited the financial statements of Keystone California Insured Tax
Free Fund and Keystone Missouri Tax Free Fund, portfolios of Keystone State
Tax Free Fund -- Series II (formerly Keystone America State Tax Free Fund --
Series II) ("FUND"), including the schedules of investments as of November
30, 1995 and the related statement of operations for the year then ended and
the statements of changes in net assets and financial highlights for the year
then ended and 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 audits.
We conducted our audits 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, 1995 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 audits provide
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 California Insured Tax Free Fund and Keystone Missouri Tax Free
Fund, as of November 30, 1995, the results of their operations for the year
then ended and the changes in their net assets and financial highlights for
the year then ended and 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 5, 1996
